Inventories
CHAPTER 6
TEACHER VERSION
LO 1
Describe the
importance of
control over
inventory.

Control of Inventory
Two primary objectives of control over inventory
are:
1. Safeguarding the inventory from damage or
theft.
2. Reporting inventory in the financial
statements.
Safeguarding Inventory

LO 1
The Purchase Order authorizes the purchase of the
inventory from an approved vendor.
 The Receiving Report establishes an initial record of
the receipt of the inventory.
 Recording inventory using a perpetual inventory system
is also an effective means of control. The amount of
inventory is always available in the Subsidiary
Inventory Ledger.
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LO 1
Safeguarding Inventory
Controls for safeguarding inventory should include
security measures to prevent damage and customer or
employee theft. Some examples of security measures
include:
Storing inventory in areas that are restricted
to only authorized employees.
2. Locking high-priced inventory in cabinets.
3. Using two-way mirrors, cameras, security tags,
and guards.
1.
LO 1
Reporting Inventory

A Physical Inventory or count of inventory
should be taken near year-end to make sure that
the quantity of inventory reported in the financial
statements is accurate.
Describe three inventory cost flow assumptions
and how they impact the income statement and
balance sheet.
• Under the Specific Identification Inventory Cost Flow Method,
the unit sold is identified with a specific purchase.
This method is used by automobile dealerships, jewelry stores and art galleries.
 Under the First-in, First-out (FIFO) Inventory Cost Flow
Method, the first units purchased are assumed to be sold first and the
ending inventory is made up of the most recent purchases.
This method is used for Perishable items.
 Under Last-in, First-out (LIFO) Inventory Cost Flow Method,
the last units purchased are assumed to be sold first and the ending
inventory is made up of the first units purchased.
This method is used for hardware stores. Customers buy newest first.
 Under the Average Inventory Cost Flow Method, the cost of the
units sold and in ending inventory is an average of the purchase costs.
This method is used for mines, gas, stone, dirt.
Determine the cost of inventory under the perpetual
inventory system, using the FIFO, LIFO, and
average cost methods.
LO 3
Inventory Costing Methods
For purposes of illustration, the data for Item 127B
are used, as shown below. We will examine the
__________________________________ first.
LO 3
First-In, First-Out Method
LO 3
Last-In, First-Out Method
LO 3
Average Cost Method

When the average cost method is used in a
perpetual system, an average unit cost for each
item is computed each time a purchase is made.

This unit cost is then used to determine the cost
of each sale until another purchase is made and a
new average is computed. This averaging
technique is called a moving average.
First-In, First-Out Method
Determine the cost of inventory under the periodic
inventory system, using the FIFO, LIFO, and average
cost methods.
Beginning inventory and purchases of Item 127B in January are as follows:
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?
Last-In, First-Out Method
LO 4
Beginning inventory and purchases of Item 127B in January are as follows:
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?
Using the last-in, first-out method, the cost of the ending inventory on
January 31 is determined as follows:
LO 4
Average Cost Method
Beginning inventory and purchases of Item 127B in January are as follows:
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?
The weighted average unit cost is determined as follows:
Average Unit Cost =
Total cost of Units Available for Sale
Units Available for Sale
Average Unit Cost =
5880
280 units
Average Unit Cost = $21 per unit
Compare and contrast the use of the three
inventory costing methods.
LO 5
Comparing Inventory Cost Methods
Using the Periodic inventory system illustration with
sales of $3,900 (130 units x $30), the differences in
ending inventory, cost of merchandise sold, and
gross profit illustrated below.
LO 6
Reporting Merchandise Inventory

Cost is the primary basis for valuing and reporting
inventories in the Financial Statements. However,
inventory may be valued at other than cost in the
following cases:


The cost of replacing items in inventory is Below
the recorded cost.
The inventory cannot be sold at normal prices due to
imperfections, style changes, or other causes.
Describe and illustrate the reporting of merchandise
inventory in the financial statements.
Valuation at Lower of Cost or Market
LO 6
 Market, as used in Lower-of-cost-or-market
metnod, is the cost to replace the merchandise on
the inventory date.

Cost and replacement cost can be determined for:

Each item in the inventory.

Each major class or category of inventory.

Total inventory as a whole.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Valuation at Net Realizable Value

Merchandise that is out of date, spoiled, or damaged
should be written down to its Net Realizable Value.
This is the estimated selling price less any direct costs of
disposal, such as sales commissions or special
advertising.
Assume the following data about an item of damaged
merchandise:
Original cost
Estimated selling price
Selling expenses
$1,000
800
150
The merchandise should be valued at its net realizable value of
$650($800– $150).
Merchandise Inventory on the Balance Sheet

Merchandise inventory is usually presented in the
Current Assets section of the balance sheet, following
Receivables.
 The method of determining the Cost of the inventory
(FIFO, LIFO, or weighted average) and the method of
valuing the inventory (cost or the lower of cost or
market) should be shown.
Inventory Errors

Some reasons that inventory errors may occur
include:
 Physical inventory on hand was miscounted.
 Costs were incorrectly assigned to inventory.
 Inventory in transit was incorrectly included or
excluded from inventory.
 Consigned inventory was incorrectly included or
excluded from inventory.
Inventory Errors

LO 6
Inventory errors often arise from Consigned Inventory.
Manufacturers sometimes ship merchandise to retailers
who act as the manufacturer’s agent.
 The manufacturer, called the Consignor retains title
until the goods are sold. Such merchandise is said to be
shipped on consignment to the retailer, called the
Consignee.
Describe and illustrate the inventory turnover and the number of days’
sales in inventory in analyzing the efficiency and effectiveness of inventory
management.
Inventory Turnover

Inventory Turnover measures the relationship
between cost of merchandise sold and the amount
of inventory carried during the period. It is
calculated as follows:
Inventory Turnover =
Cost of Merchandise Sold
Average Inventory
LO 7
Inventory Turnover
 Inventory turnover for Best Buy is shown
below (in millions).
LO 7
Inventory Turnover
 The Number of days’ sales in inventory measures
the length of time it takes to acquire, sell, and
replace the inventory. It is computed as follows:
Number of Days’ =
Sales in Inventory
Average Inventory
Average Daily Cost of
Merchandise Sold
LO 7
Inventory Turnover
 The number of days’ sales in inventory for
Best Buy is computed below (in millions).