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Average Inventory
Number of Days’ Sales in Inventory Average Daily Cost of Merchandise Sold
The average daily cost of merchandise sold is determined by dividing the cost of merchandise
sold by 365. The number of days’ sales in inventory for SUPERVALU and Zale is computed as shown
below.
SUPERVALU
Average daily cost of merchandise sold:
$16,681,472,000/365 . . . . . . . . . . . . . . . . . . . . . . .
$1,157,226,000/365 . . . . . . . . . . . . . . . . . . . . . . . .
Average inventory . . . . . . . . . . . . . . . . . . . . . . . . . .
Number of days’ sales in inventory . . . . . . . . . . . .
Zale
$45,702,663
$1,055,188,500
23.1 days
$3,170,482
$840,202,000
265.0 days
Generally, the lower the number of days’ sales in inventory, the better. As with inventory turnover,
we should expect differences among industries, such as those for SUPERVALU and Zale.
Business Connections
RAPID INVENTORY AT COSTCO
counts. As sales in a given warehouse increase and inventory turnover becomes more rapid, a greater percentage
of the inventory is financed through payment terms provided by vendors rather than by working capital (cash).
© DON RYAN/ASSOCIATED PRESS
Costco Wholesale Corporation operates over 300 membership warehouses that offer members low prices on a limited selection of nationally branded and selected private
label products. Costco emphasizes generating high sales
volumes and rapid inventory turnover. This enables Costco
to operate profitably at significantly lower gross margins
than traditional wholesalers, discount retailers, and supermarkets. In addition, Costco’s rapid turnover provides it the
opportunity to conserve on its cash, as described below.
Because of its high sales volume and rapid inventory
turnover, Costco generally has the opportunity to receive
cash from the sale of a substantial portion of its inventory
at mature warehouse operations before it is required to
pay all its merchandise vendors, even though Costco takes
advantage of early payment terms to obtain payment dis-
At a Glance
1. Describe the importance of control over inventory.
Key Points
Key Learning Outcomes
Two primary objectives of control over inventory are safeguarding the inventory and
properly reporting it in the financial statements. The perpetual inventory system enhances control over inventory. In addition, a
physical inventory count should be taken
periodically to detect shortages as well as to
deter employee thefts.
• Describe controls for safeguarding inventory.
• Describe how a perpetual
inventory system enhances
control over inventory.
• Describe why taking a physical
inventory enhances control
over inventory.
Example
Exercises
Practice
Exercises
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2. Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet.
Key Points
Key Learning Outcomes
The three common cost flow assumptions used
in business are the (1) first-in, first-out method
(FIFO); (2) last-in, first-out method (LIFO); and
(3) average cost method. The choice of a cost
flow assumption directly affects the income
statement and balance sheet.
• Describe the FIFO, LIFO, and
average cost flow methods.
• Describe how choice of a cost
flow method affects the income statement and balance
sheet.
Example
Exercises
Practice
Exercises
7-1
7-1A, 7-1B
3. Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and average
cost methods.
Key Points
Key Learning Outcomes
In a perpetual inventory system, the number
of units and the cost of each type of merchandise are recorded in a subsidiary inventory
ledger, with a separate account for each type
of merchandise.
• Determine the cost of inventory and cost of merchandise
sold using a perpetual inventory system under the FIFO
method.
• Determine the cost of inventory and cost of merchandise
sold using a perpetual inventory system under the LIFO
method.
Example
Exercises
Practice
Exercises
7-2
7-2A, 7-2B
7-3
7-3A, 7-3B
4. Determine the cost of inventory under the periodic inventory system, using the FIFO, LIFO, and average
cost methods.
Key Points
Key Learning Outcomes
In a periodic inventory system, a physical inventory is taken to determine the cost of the
inventory and the cost of merchandise sold.
• Determine the cost of inventory and cost of merchandise
sold using a periodic inventory system under the FIFO
method.
• Determine the cost of inventory and cost of merchandise
sold using a periodic inventory system under the LIFO
method.
• Determine the cost of inventory and cost of merchandise
sold using a periodic inventory system under the average cost method.
Example
Exercises
Practice
Exercises
7-4
7-4A, 7-4B
7-4
7-4A, 7-4B
7-4
7-4A, 7-4B
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5. Compare and contrast the use of the three inventory costing methods.
Key Points
Key Learning Outcomes
The three inventory costing methods will normally yield different amounts for (1) the ending inventory, (2) the cost of merchandise
sold for the period, and (3) the gross profit
(and net income) for the period.
• Indicate which inventory cost
flow method will yield the
highest and lowest ending inventory and net income under
periods of increasing prices.
• Indicate which inventory cost
flow method will yield the
highest and lowest ending inventory and net income under
periods of decreasing prices.
Example
Exercises
Practice
Exercises
6. Describe and illustrate the reporting of merchandise inventory in the financial statements.
Example
Exercises
Practice
Exercises
• Determine inventory using
lower of cost or market.
• Illustrate the use of net realizable value for spoiled or
damaged inventory.
• Prepare the Current Assets
section of the balance sheet
that includes inventory.
7-5
7-5A, 7-5B
• Determine the effect of inventory errors on the balance
sheet and income statement.
7-6
7-6A, 7-6B
Example
Exercises
Practice
Exercises
Key Points
Key Learning Outcomes
The lower of cost or market is used to value
inventory. Inventory that is out of date,
spoiled, or damaged is valued at its net realizable value.
Merchandise inventory is usually presented
in the Current Assets section of the balance
sheet, following receivables. The method of
determining the cost and valuing the inventory is reported.
Errors in reporting inventory based upon
the physical inventory will affect the balance
sheet and income statement.
7. Estimate the cost of inventory, using the retail method and the gross profit method.
Key Points
Key Learning Outcomes
The retail method of estimating inventory determines inventory at retail prices and then
converts it to cost using the ratio of cost to
selling (retail) price.
The gross profit method of estimating inventory deducts gross profit from the sales to
determine the cost of merchandise sold. This
amount is then deducted from the cost of
merchandise available for sale to determine
the ending inventory.
• Estimate ending inventory
using the retail method.
7-7
7-7A, 7-7B
• Estimate ending inventory
using the gross profit
method.
7-8
7-8A, 7-8B