Accounting for Merchandise Inventory pdf

Compute and record journal entries for perpetual inventory amounts under FIFO, LIFO, and average cost... Cost of inventory on hand = Quantity × unit cost Computing the Cost of Inventory

Accounting for Merchandise Inventory

Chapter 6

Perpetual systems maintain a running record

to show the inventory on hand at all times

Periodic systems do not keep acontinuous record of inventory on hand

Inventory Accounting Systems

Compute and record journal

entries for perpetual inventory amounts under FIFO, LIFO, and average

cost.

Objectives 1 and 2

Debit Cash or Accounts Receivable

Credit Sales Revenue

Debit Cost of Goods Sold

Cost of inventory on hand = Quantity × unit cost

Computing the Cost of Inventory

• Physical count is made at least once a year,

even with a perpetual system

• Consigned goods are excluded

Perpetual System Examples

• Assume the following:

Perpetual System FIFO Example

• Many companies keep their perpetual

inventory records in quantities only

• Other companies keep perpetual records in both quantities and dollar cost

Perpetual FIFO

• Consistent with the physical flow of

inventory

• Oldest inventory sold first

• Most recent purchases make-up ending inventory

Perpetual System FIFO Example

Item: Ski Parka

Received Sold Balance on Hand

Date Qty Cost Total Qty Cost Total Qty Cost Total

Perpetual System FIFO Example

Item: Ski Parka

Received Sold Balance on Hand Unit Unit Unit Date Qty Cost Total Qty Cost Total Qty Cost Total

Nov 26 7 $50 $ 350 3 $45 $135

7 50 350

30 3 $45 135

5 50 250 2 50 100 Totals 13 $ 620 12 $560 2 $100

Columbia Sportswear

Perpetual System FIFO Example

Perpetual System FIFO Example

Perpetual System LIFO Example

Item: Ski Parka

Received Sold Balance on Hand

Date Qty Cost Total Qty Cost Total Qty Cost Total

5 6 $45 $270 1 40 40

6 45 270

Columbia Sportswear

Perpetual System LIFO Example

Item: Ski Parka

Received Sold Balance on Hand Unit Unit Unit Date Qty Cost Total Qty Cost Total Qty Cost Total

Perpetual System LIFO Example

Perpetual System LIFO Example

Perpetual System Average Cost

• Ending inventory and cost of goods sold are based on the average cost per unit

• A new average cost per unit is computed after each purchase

Perpetual System Average Cost

Example

Item: Ski Parka

Received Sold Balance on Hand

Date Qty Cost Total Qty Cost Total Qty Cost Total

Perpetual System Average Cost

Example

Item: Ski Parka

Received Sold Balance on Hand Unit Unit Unit Date Qty Cost Total Qty Cost Total Qty Cost Total

Nov 26 7 $50 $ 350 10 48.30 483

30 8 48.30 386 2 48.30 97

Totals 13 $ 620 12 $563 2 $ 97

Columbia Sportswear

Perpetual System Average Cost

Perpetual System Average Cost

Objective 3

Compare the effects of FIFO, LIFO,

and average cost

Cost of Goods Sold

Comparison of Methods

When prices are rising LIFO produces

Compute periodic inventory

amounts under weighted-average cost,

FIFO, and LIFO.

Objective 4

Cost-of-Goods-Sold Model

Budgeted Cost of Goods Sold Budgeted Ending Inventory+

Cost of Goods Sold under a

periodic

BeginningInventory

$100,000

NetPurchases

100,000 Beginning Balance

Cost of Goods Sold

100,000

560,000 540,000

120,000 Ending Balance

560,000 Purchases

560,000 Purchases

100,000

Beginning

Balance

Periodic System

• The inventory account carries the

beginning inventory balance until adjusted

at period end

Units sold by date:

30 units left in inventory

Units Sold and in

Ending Inventory

Cost of Goods Sold

Weighted Average

$2,825 total cost/100 units = $28.25/unit

Cost of goods sold = 70 × $28.25 = $1977.50 Ending inventory = 30 × $28.25 = $847.50

Cost of Goods Sold

Cost of Goods Sold

Cost of Goods Sold

When prices are rising LIFO produces

The Income Tax Advantage of LIFO

• During periods of inflation, LIFO’s income

is the lowest

• The most attractive feature of LIFO is

reduced income tax payments

Use of the Various Inventory

Costing Methods

LIFO 32%

FIFO

Average

20%

Other 4%

LIFO Liquidation

• When prices are rising

• the company draws down inventory

quantities below the level of the previous period which releases older costs to the income statement

The business should use the same accounting

methods and procedures from one period to the next

A company may change inventory methods, but itmust disclose the effects of the change on net income

Accounting Principles:

Consistency

The financial statementsshould report enoughinformation to enable

an outsider to makeknowledgeable decisions

about the company

Accounting Principles:

Disclosure

Accounting Principles:

Materiality

An item is material if it has the potential

to alter a statement user’s decision

Materiality is specific tothe entity being evaluated

Err on the side

of caution whenreporting any item inthe financial statements

Accounting Principles:

Conservatism

Apply the

lower-of-cost-or-market rule to

inventory.

Objective 5

• An asset is reported at the lower of its historical cost or market (replacement) value

• If the replacement cost falls below its historical cost, the business must write down the value of its inventory

December 31Cost of Goods Sold 800

Inventory 800Write down inventory to LCM

Lower-of-Cost-or-Market

Example

• Cost of inventory: $3,000

• Market value at balance sheet date: $2,200

• What is the journal entry?

Determine the effects

of inventory errors.

Objective 6

Inventory Errors

• If inventory is computed incorrectly, how many years of financial statements will it affect?

• Two years

• The current year’s ending inventory is next year’s beginning inventory

Estimate ending inventory

by the gross profit

method.

Objective 7

Sales revenues – Cost of goods sold =Gross margin (before operating expenses)

Gross margin – Operating expenses =

Net income

Gross Profit

Gross Profit Method Example

BeginningInventory

$18,500

NetPurchases

End of Chapter 6