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Chapter 6

Cost of Sales and


Inventories

McGraw-Hill/Irwin Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.


What is Inventory?

 Asset items held for sale in the ordinary


course of business, or
 Goods that will be used or consumed in
the production of goods or services to be
sold.

6-2
3

Clickof to
Objectives editover
Control Master title
Inventory style
Two primary objectives of control over inventory are:

• Safeguarding the inventory


Controls over inventory include developing and using security
measures to prevent inventory damage or customer or
employee theft.

• Properly reporting it in the financial statements.


To ensure the accuracy of the amount of inventory reported
in the financial statements, a merchandising business should
take a physical inventory.
3
Supplies

 Tangible items that will be consumed in


the course of normal operations.
 E.g., office and janitorial supplies,
lubricants, repair parts.
 Will be consumed, not sold as
merchandise.
 Therefore, not accounted for as part of
inventory or cost of goods sold.
6-4
Types of Companies
• Merchandising company.
– Sells goods in same form as acquired.
– Merchandising inventory.
• Manufacturing company.
– Converts raw material into finished goods.
– Materials inventory, work in process inventory,
finished goods inventory.
• Service company.
– Provides intangible services.
– Parts inventory, jobs in progress.
6-5
Cost of Merchandise Purchased
 Cost of merchandise, and
 Expenditures necessary to make goods
ready to be received:
 Freight (i.e., freight-in).
 Handling, processing , assembling, etc.
 Adjust for returns and allowances.
 Adjust for cash (purchase) discounts from
supplier.
 NOTE: Record purchases when received
(i.e., title transfers) not when ordered.
6-6
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Cost of Merchandise purchased 6-2

As we discussed before, sellers may offer customers


sales discounts for early payment of their bills. From
the buyer’s perspective, such discounts are referred to
as purchase discounts. Remember term of payment
2/10, n 30.
The buyer may return merchandise to the seller (a
purchase return), or the buyer may receive a reduction
in the initial price at which the merchandise was
purchased (a purchase allowance).
7
How about Trade Discount?
8

Cost of purchased
Cost of Merchandise Merchandise 6-2
Sold

Merchandise Inventory, January 1,2009............ Rp 59,700


Purchases Rp521,980
Less: Purchases returns and allowances ......... Rp9,100
Purchase discounts ................................ 2,525 11,625
Net purchases.................................................... Rp510,355
Add transportation in.......................................... 17,400
Cost of merchandise purchased .................. 527,755
Merchandise available for sale .......................... Rp587,455
Less merchandise inventory, December 31, 2009 62,150
Cost of merchandise sold .................................. Rp525,305

8
Inventory Cost Flow
Inventory
Beginning (+) Cost of goods
Cost of GP (+) sold (-)
(=) Ending

 Cost of Goods Purchased.


 Gross purchases - purchase returns & allowances + freight-in.
 Goods available for sale.
 Beginning inventory + net purchases.
 Cost of goods sold.
 Goods available for sale – ending inventory.
 Beginning inventory + net purchases – ending inventory.
6-9
Measurement Issue

• Goods available for sale (i.e., beginning


inventory plus purchases).
– How much becomes cost of goods sold?
– How much becomes ending inventory?
• Two approaches:
1. Periodic inventory method.
2. Perpetual inventory method.
6-10
Periodic Inventory Method
 Goods available for sale.
 Beginning inventory + Purchases.
 NOTE: Beginning inventory is the ending
inventory from the previous period.
 Determine ending inventory.
 Physical inventory (count) is taken.
 Deduce cost of goods sold.
 Good available for sale – Ending inventory.

6-11
Perpetual Inventory Method
 Perpetual (continuous) record is kept for
each item in inventory.
 When sale is made, cost of goods sold is
immediately updated.
 Merchandise inventory account is reduced,
cost of goods sold account is increased.
 Balance in Merchandise Inventory:
 Is goods available for sale at all times.
 Is also ending inventory at all times.
6-12
Inventory Systems
Two accounting systems are used to record
transactions involving inventory:

Perpetual Periodic Inventory


Inventory System System
The inventory
account is The inventory
continuously account is
updated as adjusted at the end
purchases and of a reporting
sales are made. cycle.
Perpetual Inventory System
Lothridge Wholesale Beverage Company (LWBC)
purchases on account $600,000 of merchandise
for resale to customers.
GENERAL JOURNAL
Date Description Debit Credit
2009 Inventory 600,000
Accounts Payable 600,000

Returns of inventory are credited to the inventory account.


Discounts on inventory purchases can be recorded using
the gross or net method.
Perpetual Inventory System
LWBC sold, on account, inventory with a
retail price of $820,000 and a cost basis
of $540,000, to a customer.

GENERAL JOURNAL
Date Description Debit Credit
2009 Accounts Receivable 820,000
Sales 820,000

Cost of Goods Sold 540,000


Inventory 540,000
Periodic Inventory System

Beginning Inventory
+ Cost of Goods Purchased
Cost of Goods Available for Sale
- Ending Inventory
= Cost of Goods Sold
Periodic Inventory System
LWBC purchases on account $600,000
of merchandise for resale to customers.

GENERAL JOURNAL
Date Description Debit Credit
2009 Purchases 600,000
Accounts Payable 600,000

Returns of inventory are credited to the Purchase


Returns and Allowances account.
Discounts on inventory purchases can be recorded
using the gross or net method.
Periodic Inventory System
LWBC sold on account, inventory with a
retail price of $820,000 and a cost basis
of $540,000, to a customer.
GENERAL JOURNAL
Date Description Debit Credit
2009 Accounts Receivable 820,000
Sales 820,000

No entry is made to record Cost of Goods Sold. Assuming Beginning


Inventory of $120,000, a physical count of Ending Inventory shows
a balance of $180,000. Let’s calculate Cost of Goods Sold at
the end of the accounting period.
Periodic Inventory System
Calculation of Cost of Goods Sold
Beginning inventory $ 120,000
Plus: Purchases 600,000
Cost of goods available for sale 720,000
Less: Ending inventory (180,000)
Cost of goods sold $ 540,000

Adjusting entry to determine Cost of Goods Sold


Date Description Debit Credit
12/31/09 Cost of Goods Sold 540,000
Inventory (ending) 180,000
Inventory (beginning) 120,000
Purchases 600,000
Comparison of Inventory Systems
Periodic vs. Perpetual

 Periodic method.
 Less recordkeeping.
 Perpetual method.
 Detailed record is useful for reordering.
 Built in check (i.e., identifies shrinkage by
inventory item during physical inventory).
 Income statement can be prepared
without taking a physical inventory.

6-21
22

Retail Inventory Method 7-7


Click to edit Master
Retail Method title style
The retail inventory method of
estimating inventory cost is based on the
relationship of the cost of merchandise
available for sale to the retail price of the
same merchandise.

22
Retail Method

• Approximates use of perpetual method.


 Steps:
1. Record purchases at both cost and retail.
2. Calculate gross margin (mark-up) percent.
3. 100% - Gross margin % = Cost %.
4. Cost of goods sold = Cost % x Retail sales.
 Variation is gross profit method.
 Difference is use of an average or normal
gross margin percentage in calculation.

6-23
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RetailClick Determining Inventory by


Methodto 7-7
editMethod
the Retail Master title style
A B C
Cost Retail
1 Merchandise inventory, January 1 Rp19,400,000 Rp36,000,000 1
2 Purchases in January (net) 42,600,000 64,000,000 2
3 Merchandise available for sale Rp62,000,000 Rp100,000,000 3
Ratio of cost to retail price: (Rp 62,000,000:Rp
4 4
100,000,000) = 62%
5 Sales for January (net) 70,000,000 5
6 Merchandise inventory, January 31, at retail Rp30,000,000 6
7 Merchandise inventory, January 31, at estimated cost 7
8 (Rp30,000,000 x 62%) Rp18,600,000 8

24
Manufacturing Inventory
Accounts
 Materials inventory.
 Not yet used in production.
 Adjusted for returns and freight-in.
 Work-in-process inventory.
 Goods started, but not yet finished.
 Materials + conversion costs.
 Finished goods inventory.
 Manufactured, but not yet shipped.
6-25
Manufacturing Companies

Materials
Inventory
Work in Finished Cost of
Direct
Process Goods Goods
Labor
Inventory Inventory Sold

Overhead
Cost of Goods
Manufactured

6-26
Flow Through Accounts
Materials Inventory
Beginning (+) Materials Work in Process
Net purchases (+) Used (-) Inventory
(=) Ending Beginning (+)
Materials
Used (+) Cost of Goods
Manufactured
Conversion (-)
Costs (+)
(=) Ending

6-27
Flow Through Accounts

Work in Process Finished Goods


Inventory Inventory
Beginning (+) Beginning (+)
Materials Cost of
Cost of Goods Cost of Goods
Used (+) Goods
Manufactured Manufactured
Conversion (-) (+) Sold (-)
Costs (+)
(=) Ending (=) Ending

6-28
Manufacturing Companies:
Additional Items
• Product costing systems.
– Perpetual inventory system for
manufacturing companies (covered in
Chapters 17-19).
• Product (inventoriable) costs.
– Items of cost used to produce goods (i.e.,
materials, labor, overhead).
– Do not impact income until product is
sold.
6-29
Service Companies
 Personal services organizations.
 E.g., hotels, beauty salons, dentists.
 No inventories, just supplies.
 Building trade and repair businesses.
 May have parts inventory.
 Professional service firms.
 E.g., law and accounting firms.
 Jobs in progress account (similar to work in
process inventory).
6-30
Inventory Costing Methods
(Cost Flow Assumptions)
 What if inventory prices fluctuate?
• Goods available for sale:
• How much becomes cost of goods sold?
• How much becomes ending inventory?
 Will need to choose a cost flow assumption:
• Specific identification.
• Average cost.
• First-in, first-out (FIFO).
• Last-in, last-out (LIFO).
6-31
Inventory Costing
Inventory CostingMethods
Method 7-2

10
Inventory Costing Method 7-2

(Continued)
11
Inventory Costing Method 7-2

(Continued)
12
Inventory Costing Method 7-2

(Concluded) 13
Perpetual Average Cost
The following schedule shows the Frame
inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30
shows 600 frames in ending inventory.
Use the perpetual average cost method to
determine:
(1) Ending inventory cost
(2) Cost of goods sold
Perpetual Average Cost

Date Sales Units


9/1 600
9/10 300
9/30 450
Perpetual Average Cost
Date Purchased Sold Balance
Beg. Inv. 800 x 22.00 = 17,600 $ 17,600.00
1-Sep 600 x 22.000 = 13,200.00 4,400.00
Perpetual Average Cost
Date Purchased Sold Balance
Beg. Inv. 800 x 22.00 = 17,600 $ 17,600.00
1-Sep 600 x 22.000 = 13,200.00 4,400.00
3-Sep 300 x 24.00 = 7,200 11,600.00
10-Sep 300 x 23.200 = 6,960.00 4,640.00

$11,600.00 ÷ (800-600+300) = $23.200


Perpetual Average Cost
Date Purchased Sold Balance
Beg. Inv. 800 x 22.00 = 17,600 $ 17,600.00
1-Sep 600 x 22.000 = 13,200.00 4,400.00
3-Sep 300 x 24.00 = 7,200 11,600.00
10-Sep 300 x 23.200 = 6,960.00 4,640.00
15-Sep 250 x 25.00 = 6,250 10,890.00
21-Sep 200 x 27.00 = 5,400 16,290.00
29-Sep 400 x 28.00 = 11,200 27,490.00
30-Sep 450 x 26.181 = 11,781.45 15,708.55

$27,490.00 ÷ (800-600+300-300+250+200+400) = $26.181


Perpetual Average Cost
Date Purchased Sold Balance
Beg. Inv. 800 x 22.00 = 17,600 $ 17,600.00
1-Sep 600 x 22.000 = 13,200.00 4,400.00
3-Sep 300 x 24.00 = 7,200 11,600.00
10-Sep 300 x 23.200 = 6,960.00 4,640.00
15-Sep 250 x 25.00 = 6,250 10,890.00
21-Sep 200 x 27.00 = 5,400 16,290.00
29-Sep 400 x 28.00 = 11,200 27,490.00
30-Sep 450 x 26.181 = 11,781.45 15,708.55
Cost of Goods Sold in September
Sale Date Units Cost/Unit Total

Sum
9/1 600 22.000 $ 13,200.00
9/10 300 23.200 6,960.00
9/30 450 26.181 11,781.45
Total 1,350 31,941.45
Weighted-Average Periodic
System
Let’s use the same information to assign costs to
ending inventory and cost of goods sold using the
periodic system.
Ending Inventory
(600 units)
Beginning Inventory
Available
(800 units)
for Sale
(1,950 units)
Goods Sold
(1,350)

$47,650 ÷ 1,950 = $24.4359 weighted-


average per unit cost
Weighted-Average Periodic
System
Yore Frame, Inc.
Frame Inventory
Date Units $/Unit Total
Beg. Inventory 800 $ 22.00 $ 17,600.00
9/3 300 24.00 7,200.00
9/15 250 25.00 6,250.00
9/21 200 27.00 5,400.00
9/29 400 28.00 11,200.00
Goods Available for
Sale 1,950 $ 47,650.00
Ending Inventory 600 24.4359 14,661.54
Cost of Goods Sold 1,350 24.4359 $ 32,988.46
First-In, First-Out (FIFO)

The FIFO • The cost of the oldest


method inventory items are
assumes that charged to COGS when
items are sold goods are sold.
in the • The cost of the newest
chronological inventory items remain
order of their in ending inventory.
acquisition.
First-In, First-Out (FIFO)
Even though the periodic
and the perpetual
approaches differ in the
timing of adjustments to
inventory . . .
. . . COGS and Ending
Inventory Cost are the
same under both
approaches.
46

7-3
Click to edit Master title style
Objective 3
Determine the cost of
inventory under the perpetual
inventory system, using
FIFO, LIFO, and average
cost methods.
46
47

FIFO Perpetual 7-3


Click to edit Master title style
On January 1, the firm had 100 units of
Item 127B that cost Rp20,000 per unit.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000

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18
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FIFO Perpetual 7-3


Click to edit Master title style
On January 4, the firm sold 70 units
of 127B at Rp30,000 each.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000
4 Sale 70

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FIFO Perpetual 7-3


Click to edit Master title style
On January 4, the firm sold 70 units
of 127B at Rp30,000 each.

4 Accounts Receivable 2 100 000


Sales 2 100 000

On4 January 22, the


Cost of Merchandise firm sold1 twenty
Sold 400 000
units atMerchandise
$30. Inventory 1 400 000

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20
50

FIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600

50
21
The cost was in Rp000
51

FIFO Perpetual 7-3


Click to edit Master title style
On January 10, the firm purchased
80 units at Rp21,000 each.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000
4 Sale 70
10 Purchase 80 21,000

51
22
52

FIFO Perpetual 7-3


Click to edit Master title style
On January 10, the firm purchased
80 units at Rp21,000 each.

10 Merchandise Inventory 1 680 000


Accounts Payable 1 680 000

52
23
53

FIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680

53
24
The cost was in Rp000
54

FIFO Perpetual 7-3


Click to edit Master title style
On January 22, the firm sold 40 units
for Rp30,000 each.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000
4 Sale 70
10 Purchase 80 21,000
22 Sale 40

54
25
55

FIFO Perpetual 7-3


Click to edit Master title style
On January 22, the firm sold 40 units
for Rp30,000 each.

22 Accounts Receivable 1 200 000


Sales 1 200 000

On
22 January 22, theSoldfirm sold twenty
Cost of Merchandise 810 000
units atMerchandise
$30. Inventory 810 000

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56

FIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 30 20 600
10 21 210 70 21 1,470

Of the forty sold, thirty are considered to be from


those acquired at Rp20,000 each. The other ten are
considered to be from the January 10 purchase. 56
27
The cost was in Rp000
57

FIFO Perpetual 7-3


Click to edit Master title style
On January 28, the firm sold 20
units at Rp30,000 each.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000
4 Sale 70
10 Purchase 80 21,000
22 Sale 40
28 Sale 20
57
28
58

FIFO Perpetual 7-3


Click to edit Master title style
On January 28, the firm sold 20
units at Rp30,000 each.

28 Accounts Receivable 600 000


Sales 600 000

28 Cost of Merchandise Sold 420 000


Merchandise Inventory 420 000

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59

FIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 30 20 600
10 21 210 70 21 1,470
28 20 21 420 50 21 1,050

59
30
Unit Cost and Total Cost is in Rp000
60

FIFO Perpetual 7-3


Click to edit Master title style
On January 30, purchased ten additional
units of Item 127B at Rp22,000 each.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000
4 Sale 70
10 Purchase 80 21,000
22 Sale 40
28 Sale 20
30 Purchase 100 22,000 60
31
61

FIFO Perpetual 7-3


Click to edit Master title style
On January 30, purchased ten additional
units of Item 127B at Rp22,000 each.

30 Merchandise Inventory 2 200 000


Accounts Payable 2 200 000

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62

FIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 30 20 600
10 21 210 70 21 1,470
28 20 21 420 50 21 1,050
30 100 22 2,200 50 21 1,050
100 22
2,200

62
33
Unit Cost and Total Cost is in Rp000
63

FIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 30 20 600
10 21 210 70 21 1,470
28 20 21 420 50 21 1,050
30 100 22 2,200 50 21 1,050
100 22
2,200

Cost of merchandise sold for 63


34
Unit Cost and Total
January is Rp2,630,000.
Cost is in Rp000
64

FIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 30 20 600
10 21 210 70 21 1,470
28 20 21 420 50 21 1,050
30 100 22 2,200 50 21 1,050
100 22
2,200

January 31, inventory is Rp3,250,000 64


35
The cost was in Rp000 (Rp1,050,000 + Rp2,200,000)
65

7-3
-

Click to edit Master title style


Example Exercise 7-2
Beginning inventory, purchases, and sales for Item ER27
are as follows:
Nov. 1 Inventory 40 units at Rp5,000
5 Sale 32 units
11 Purchase 60 units at Rp7,000
21 Sale 45 units
Assuming a perpetual inventory system and the first-in,
first-out (FIFO) method, determine (a) the cost of the
merchandise sold for the November 21 sale and (b) the
inventory on November 30.
65
36
66

7-3

Click to edit
Follow My Example 7-2
Master title style

a) Cost of merchandise sold:


8 units @ Rp5,000 Rp40,000
37 units @ Rp7,000 259,000
45 units Rp299,000
b) Inventory, November 30:
Rp161,000 = (23 units x Rp7,000)

37
66
For Practice: PE 7-2A, PE 7-2B
67

LIFO Perpetual 7-3


Click to edit Master title style
On January 1, the firm had 100 units of
Item 127B that cost Rp20,000 per unit.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000

67
38
68

LIFO Perpetual 7-3


Click to edit Master title style
On January 4, the firm sold 70 units
of 127B at Rp30,000 each.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000
4 Sale 70

68
39
69

LIFO Perpetual 7-3


Click to edit Master title style
On January 4, the firm sold 70 units
of 127B at Rp30,000 each.

4 Accounts Receivable 2 100 000


Sales 2 100 000

On4 January 22, theSoldfirm sold1 400


Cost of Merchandise twenty
000
units atMerchandise
$30. Inventory 1 400 000

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40
70

LIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600

70
41
The unit cost and total cost is in Rp000
71

LIFO Perpetual 7-3


Click to edit Master title style
On January 10, the firm purchased
80 units at Rp21,000 each.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000
4 Sale 70
10 Purchase 80 21,000

71
42
72

LIFO Perpetual 7-3


Click to edit Master title style
On January 10, the firm purchased
80 units at Rp21,000 each.

10 Merchandise Inventory 1 680 000


Accounts Payable 1 680 000

72
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73

LIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680

73
44
The unit cost and total cost is in Rp000
74

LIFO Perpetual 7-3


Click to edit Master title style
On January 22, the firm sold 40 units
for Rp30,000 each.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000
4 Sale 70
10 Purchase 80 21,000
22 Sale 40

74
45
75

LIFO Perpetual 7-3


Click to edit Master title style
On January 22, the firm sold 40 units
for Rp30,000 each.

22 Accounts Receivable 1 200 000


Sales 1 200 000

On
22 January 22, theSoldfirm sold twenty
Cost of Merchandise 840 000
units atMerchandise
$30. Inventory 840 000

75
46
76

LIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 40 21 840 30 20 600
40 21 840

All of the 40 sold are considered to be from


the January 10 purchase.

76
47
The unit cost and total cost is in Rp000
77

LIFO Perpetual 7-3


Click to edit Master title style
On January 28, the firm sold 20
units at Rp30,000 each.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000
4 Sale 70
10 Purchase 80 21,000
22 Sale 40
28 Sale 20
77
48
78

LIFO Perpetual 7-3


Click to edit Master title style
On January 28, the firm sold 20
units at Rp30,000 each.

28 Accounts Receivable 600 000


Sales 600 000

28 Cost of Merchandise Sold 420 000


Merchandise Inventory 420 000

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79

LIFO Perpetual 7-3


Click to edit Master title style
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 40 21 840 30 20 600
40 21 840
28 20 21 420 30 20 600
20 21 420

All of the 20 sold are considered to be from


the January 22 purchase. 79
50
The unit cost and total cost is in Rp000
80

LIFO Perpetual 7-3


Click to edit Master title style
On January 30, the firm purchased one hundred
additional units of Item 127B at Rp22,000 each.
Item 127B
Units Cost
Jan. 1 Inventory 100 Rp20,000
4 Sale 70
10 Purchase 80 21,000
22 Sale 40
28 Sale 20
30 Purchase 100 22,000 80
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LIFO Perpetual 7-3


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On January 30, the firm purchased one hundred
additional units of Item 127B at Rp22,000 each.

30 Merchandise Inventory 2 200 000


Accounts Payable 2 200 000

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LIFO Perpetual 7-3


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Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 40 21 840 30 20 600
40 21 840
28 20 21 420 30 20 600
20 21 420
30 100 22 2,200 30 20 600
20 21 420
100 22 2,200
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53
The unit cost and total cost is in Rp000
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LIFO Perpetual 7-3


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Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 40 21 840 30 20 600
40 21 840
28 20 21 420 30 20 600
20 21 420
30 100 22 2,200 30 20 600
20 21 420
Cost of merchandise sold Rp2,660,000 100 22 2,200
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The unit cost and total cost is in Rp000
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LIFO Perpetual 7-3


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Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total


Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 40 21 840 30 20 600
40 21 840
28 20 21 420 30 20 600
20 21 420
30 100 22 2,200 30 20 600
20 21 420
100 22 2,200
January 31, inventory…..Rp3,220,000 84
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The unit cost and total cost is in Rp000
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7-3
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Example Exercise 7-3
Beginning inventory, purchases, and sales for Item ER27
are as follows:
Nov. 1 Inventory 40 units at Rp5,000
5 Sale 32 units
11 Purchase 60 units at Rp7,000
21 Sale 45 units
Assuming a perpetual inventory system and the last-in,
first-out (LIFO) method, determine (a) the cost of the
merchandise sold for the November 21 sale and (b) the
inventory on November 30.
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86

7-3

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Follow My Example 7-3
Master title style

a) Cost of merchandise sold:


Rp315,000 = (45 units x Rp7,000)

b) Inventory, November 30:


8 units @ Rp5,000 Rp 40,000
15 units @ Rp7,000 105,000
23 Rp145,000

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For Practice: PE 7-3A, PE 7-3B
87

7-4
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Objective 4
Determine the cost of inventory
under the periodic inventory
system, using FIFO, LIFO, and
average cost methods.

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88

FIFO Periodic 7-4


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Using FIFO, the earliest
batch purchased is
considered the first batch
of merchandise sold. The
physical flow does not
have to match the
accounting method chosen.
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89

FIFO Periodic 7-4


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Jan. 1 100 units @ Rp20,000 =Rp2,000,000

Jan. 10 80 units @ Rp21,000 = 1,680,000

Jan. 30 100 units @ Rp22,000 = 2,200,000

280 units available Rp5,880,000


for sale during
year Cost of merchandise
available for sale 89
60
90

FIFO Periodic 7-4


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The physical count on January 31 shows that 150
units are on hand (conclusion: 130 units were
sold). What is the cost of the ending inventory?

Jan. 1 100 Sold


unitsthese
@ $20 = Rp 0

Sold 30 of these
Jan. 10 80 units @ $21 = 1,050,000
50 units @ Rp21,000

Jan. 30 100
100 units
units @ $22
@ Rp22,000 = 2,200,000

Ending inventory Rp3,250,000 90


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FIFO Periodic 7-4


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Now we can calculate the cost of goods
sold as follows:
Beginning inventory, January 1 (Slide 60) Rp2,000,000
Purchases (Rp1,680,000 + Rp2,200,000) 3,880,000
Cost of merchandise available for sale Rp5,880,000
Ending inventory, January 31(Slide 61) 3,250,000
Cost of merchandise sold Rp2,630,000

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92

LIFO Periodic 7-4


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Using LIFO, the most recent batch
purchased is considered the first batch of
merchandise sold. The actual flow of goods
does not have to be LIFO. For example, a
store selling fresh fish would want to sell the
oldest fish first (which is FIFO) even though
LIFO is used for accounting purposes.
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93

LIFO Periodic 7-4


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Jan. 1 100 units @ Rp20,000 =Rp2,000,000

Jan. 10 80 units @ Rp21,000 = 1,680,000

Jan. 30 100 units @ Rp22,000 = 2,200,000

280 units available Rp5,880,000


for sale during
year Cost of merchandise
available for sale 93
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94

LIFO Periodic 7-4


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Assume again that the physical count on January
31 is 150 units (and that 130 units were sold).
What is the cost of the ending inventory?

Jan. 1 100 units @ Rp20,000 =Rp2,000,000


50 units @ Rp21,000 = 1,050,000
1, 680
Jan. 10 80 units @ $21
Sold 30 of these
Jan. 30 100 Sold
unitsthese
@ $22 = 2,2000
Ending inventory Rp3,050,000 94
65
95

LIFO Periodic 7-4


Click to edit Master title style
Now we can calculate the cost of goods
sold as follows:
Beginning inventory, January 1 (Slide 64) Rp2,000,000
Purchases (Rp1,680,000 + Rp2,200,000) 3,880,000
Cost of merchandise available for sale Rp5,880,000
Ending inventory, January 31(Slide 65) 3,050,000
Cost of merchandise sold Rp2,830,000

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Average Cost 7-4


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The weighted average unit cost
method is based on the average
cost of identical units. The total
cost of merchandise available
for sale is divided by the related
number of units of that item.

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97

Average Cost 7-4


Click to edit Master title style
Jan. 1 100 units @ Rp20,000 =Rp2,000,000

Jan. 10 80 units @ Rp21,000 = 1,680,000

Jan. 30 100units
100 units @ $22
@ Rp22,000 = 2,200,000

280 Rp5,880,000
Average unit cost: Rp5,880,000 ÷ 280 = Rp21,000
Cost of merchandise sold: 130 units at Rp21,000 = Rp2,730,000
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68
Ending merchandise inventory: 150 units at Rp21,000=
Rp3,150,000
98

Average Cost 7-4


Click to edit Master title style
Now we can calculate the cost of goods
sold as follows:
Beginning inventory, January 1 (Slide 68) Rp2,000,000
Purchases (Rp1,680,000 + Rp2,200,000) 3,880,000
Cost of merchandise available for sale Rp5,880,000
Ending inventory, January 31(Slide 68) 3,150,000
Cost of merchandise sold Rp2,730,000

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7-4
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Example Exercise 7-4
The units of an item available for sale during the year were as
follows:
Jan. 1 Inventory 6 units @ Rp50,000 Rp 300,000
Mar. 20 Purchase 14 units @ Rp55,000 770,000
Oct. 30 Purchase 20 units @ Rp62,000 1,240,000
Available for sale 40 units Rp 2,310,000
There are 16 units of the item in the physical inventory at
December 31. The periodic inventory system is used.
Determine the inventory cost by (a) the first-in, first-out
(FIFO) method, (b) the last-in, first-out (LIFO) method, and
(c) the average cost method. 99
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100

7-4

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Follow My Example 7-4
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a) First-in, first-out (FIFO) method: Rp992,000 (16 units


x Rp62,000)
b) Last-in, first-out (LIFO) method: Rp850,000 (6 units
x Rp50,000) + (10 units x Rp55,000)
c) Average method: Rp924,000 (16 units x
Rp57,750) where average cost = Rp57,750
(Rp2,310,000 ÷ 40 units)

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100
For Practice: PE 7-4A, PE 7-4B
101

7-5
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Objective 5
Compare and contrast the
use of the three inventory
costing methods.

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Partial Income Statements 7-5


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First-In, First-Out
Net sales Rp3,900,000
Cost of merchandise sold:
Beginning inventory Rp2,000,000
Purchases 3,880,000
Merchandise available for sale Rp5,880,000
Less ending inventory 3,250,000
Cost of merchandise sold 2,630,000
Gross profit Rp1,270,000

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Partial Income Statements 7-5


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Average Cost
Net sales Rp3,900,000
Cost of merchandise sold:
Beginning inventory Rp2,000,000
Purchases 3,880,000
Merchandise available for sale Rp5,880,000
Less ending inventory 3,150,000
Cost of merchandise sold 2,730,000
Gross profit Rp1,170,000

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Partial Income Statements 7-5


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Last-In, First-Out
Net sales Rp3,900,000
Cost of merchandise sold:
Beginning inventory Rp2,000,000
Purchases 3,880,000
Merchandise available for sale Rp5,880,000
Less ending inventory 3,050,000
Cost of merchandise sold 2,830,000
Gross profit Rp1,070,000

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105

Recap 7-5
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Weighted
FIFO Average LIFO
Ending inventory Rp3,250,000 Rp3,150,000 Rp3,050,000
Cost of merchandise sold Rp2,630,000 Rp2,730,000 Rp2,830,000
Gross profit Rp1,270,000 Rp1,170,000 Rp1,070,000

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Last-In, First-Out

The LIFO • The cost of the newest


method inventory items are
assumes that charged to COGS when
the newest goods are sold.
items are sold • The cost of the oldest
first, leaving the inventory items remain
older units in in inventory.
inventory.
Last-In, First-Out
Unlike FIFO, using the
LIFO method may
result in COGS and
Ending Inventory Cost
that differ under the
periodic and perpetual
approaches.
Supplemental LIFO Disclosures
Many companies use LIFO for external reporting and
income tax purposes but maintain internal records using
FIFO or average cost.

The conversion from FIFO or average cost


to LIFO takes place at the end of the
period. The conversion may look like this:

2009 2008
Total inventories at FIFO $ 15,429 $ 15,387
Less: LIFO allowance (1,508) (1,525)
Inventories, at LIFO cost $ 13,921 $ 13,862
Specific Identification

 Track purchase cost of each item.


 Used for:
 Big ticket items (e.g., automobile).
 Uniquely identified items (e.g., jewelry).

6-109
Other LIFO Features
 LIFO layers.
 Can distort income if company reduces level of
inventory (i.e., old costs being expensed).
 LIFO Reserve.
 Difference between LIFO valuation and FIFO (or
average cost) valuation.
 Disclosed in financial statements.

6-110
Arguments for FIFO

 Usually follows physical flow of goods.


 More accurate balance sheet valuation.

6-111
Arguments for LIFO
• Conceptually better for pricing products.
 When using cost-plus pricing, prices will be based
on current costs.
 Therefore, better matching and a more useful
income statement (i.e., closest to reflecting
current or replacement cost of goods sold).
 NOTE: LIFO amounts are still historical costs
and could differ from current costs.

6-112
Arguments for LIFO

 During periods of price increases:


 Higher costs of goods sold.
 Lower taxable income.
 Lower income taxes.
 Higher cash flows.

6-113
Why Not More LIFO?

 Most countries use IFRS (therefore, do


not permit use of LIFO).
 Only beneficial in periods of rising prices.
 Because of LIFO conformity rule, lower
earnings will also be reported to
shareholders.

6-114
Lower of Cost or Market (LCM)

 Market price may be below cost due to:


 Physical deterioration.
 Change in consumer tastes.
 Technological obsolescence.
 LCM is a reflection of the conservatism
concept.
 Market is defined as replacement cost.
6-115
LCM: Upper and Lower Bounds
 Ceiling or upper bound:
 Net realizable value (i.e., Estimated selling
price – Estimated costs of selling).
 Reasoning: Inventory not above cash that will
be received.
 Floor or lower bound:
 Net realizable value - normal profit margin.
 Reasoning: Inventory not written down
artificially low (which could overstate income).
6-116
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7-6
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Example Exercise 7-5
On the basis of the following data, determine the value
of the inventory at the lower of cost or market. Apply
lower of cost or market to each inventory item as shown
in Exhibit 7.
Inventory Unit Unit
Commodity Quantity Cost Price Market Price
C17Y 10 Rp 39,000 Rp 40,000
B563 7 Rp 110,000 98,000

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7-6
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Follow My Example 7-5
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Unit Unit Lower of


Commodity Qty Cost Price Market Price Cost Market C or M

C17Y 10 Rp 39,000 Rp 40,000 Rp 390,000 Rp 400,000 Rp 390,000


B563 7 110,000 98,000 770,000 686,000 686,000
Total Rp1,160,000 Rp1,086,000 Rp1,076,000

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For Practice: PE 7-5A, PE 7-5B
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7-6
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Example Exercise 7-6

Agung Jaya Motor Shop incorrectly counted its


December 31, 2008 inventory as Rp250,000,000
instead of the correct amount of Rp220,000,000.
Indicate the effect of the misstatement on Agung
Jaya Motor Shop December 31, 2008 balance sheet
and income statement for the year ended December
31, 2008.

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7-6
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Amount of Misstatement
Overstatement (Understatement)
Balance Sheet:
Merchandise inventory overstated Rp 30,000,000
Current assets overstated 30,000,000
Total assets overstated 30,000,000
Owner’s equity overstated 30,000,000
Income Statement:
Cost of merchandise sold understated Rp(30,000,000)
Gross profit overstated 30,000,000
Net income overstated 30,000,000

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For Practice: PE 7-6A, PE 7-6B
Analysis of Inventory
 Inventory turnover.
 Cost of goods sold ÷ Inventory.
 For inventory, can use period average or ending.
 Measures velocity with which merchandise
moves through business.
 Days’ inventory.
 Inventory turnover expressed in number of days.
 Inventory ÷ (Cost of goods sold  365).
 Gross margin percentage.
 Gross margin as % of net sales.
 Profitability measure, earnings before period 6-121

costs.
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7-7
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Inventory turnover measures the
relationship between the volume of goods
(merchandise) sold and the amount of
inventory carried during the period.
Cost of merchandise sold
Inventory turnover =
Average inventory

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7-7
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HERO RIMO
Cost Of Merchandise Sold Rp4,035,116,000,000 Rp87,696,796,439
Inventories
Beginning Of Year Rp427,941,000,000 Rp24,907,993,901
End Of Year Rp494,919,000,000 Rp28,537,693,305
Average Rp461,430,000,000 Rp26,722,843,603

Inventory Turnover 8.74 times 3.28 times

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7-7
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Generally, the larger the


inventory turnover, the more
efficient and effective the
management of inventory.

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7-7
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The number of days’ sales in
inventory is a rough measure of the
length of time it takes to acquire,
sell, and replace the inventory.
Number of days’ Average inventory
sales in inventory = Average daily cost of
merchandise sold

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7-7
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HERO RIMO
Average Daily Cost Of Merchandise Sold
Rp16,681,472,000/365 Rp11.055.112.328,77
Rp1,157,226,000/365 Rp240.265.196
Average Inventory Rp461.430.000.000 Rp26.722.843.603

Number Of Days' Sales in Inventory 41.74 days 111.22 days

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