copyright © 2007 prentice-hall. all rights reserved 1 inventoryinventory chapter 8

Copyright © 2007 Prentice-Hall. All rights reserved 1

InventoryInventoryInventoryInventory

Chapter 8


Objective 1Objective 1Objective 1Objective 1

Describe inventory and discuss the related internal

controls


InventoryInventoryInventoryInventory

• Goods that a business owns and has available to sell to customers as part of normal operations

• Current asset – usually listed after accounts receivable


Internal ControlsInternal ControlsInternal ControlsInternal Controls

• Separation of access to assets from access to record

• Secure inventory items• Physical count at least once a year• Maintain perpetual records of

inventory transactions• Document purchases and sales



Compute inventory costs using first-in, first-out (FIFO), last-in, first-out (LIFO),

and average cost methods and journalize inventory transactions


Inventory Costing Inventory Costing MethodsMethods

Inventory Costing Inventory Costing MethodsMethods

• Specific Unit Cost• FIFO• LIFO• Average Cost

Copyright © 2007 Prentice-Hall. All rights reserved

Perpetual Inventory CostsPerpetual Inventory Costs

Inventory cost data to demonstrate Inventory cost data to demonstrate FIFO and LIFO Perpetual SystemsFIFO and LIFO Perpetual Systems


Cost ofCost ofMdse. SoldMdse. Sold

Smart Touch Learning Units Cost Price

July 1 Inventory 1 $405 Purchase 6 $45

15 Sale 4 $80 26 Purchase7 $50 31 Sale 8 $80

31 Purchase 5 $55




31 Purchase 5 $55

Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.


July 1 1 40 $40

Item DVD’s

FIFO Perpetual Inventory AccountFIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost









31 Purchase 5 $55




31 Purchase 5 $55



DateDate DescriptionDescription DebitDebit CreditCredit

FIFO Perpetual Inventory AccountingFIFO Perpetual Inventory Accounting

Inventory. 270Accounts Payable 270

July 5


July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270

Item DVD’s




Because the purchase price of $45 is different than the cost of the previous unit on hand, the inventory balance of 7 units is accounted for separately.


First-In, First-Out (FIFO)First-In, First-Out (FIFO)First-In, First-Out (FIFO)First-In, First-Out (FIFO)

Cost of Goods Sold

Ending Inventory

Valued based on the earlier

cost of purchases.

Valued based on the most recent costs of purchases









31 Purchase 5 $55




31 Purchase 5 $55



July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $470

Item DVD’s






July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $470 15 1 $40 $40

3 $45 $135 3$45 $135

Item DVD’s


Purchases Cost of Goods Sold Inventory Balance





Accounts Receivable 320Sales 320

Cost of Goods Sold 175 Inventory 175

July 15









31 Purchase 5 $55




31 Purchase 5 $55






July 26


July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270 15 1 $40 $40

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

7 $50 $350

Item DVD’s











15 Sale 4 $80 26 Purchase7 $50 31 Sale 8 $8031 Purchase 5 $55







Cost of Goods Sold

Ending Inventory


cost of purchases.



July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $470 15 1 $40 $40

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

7 $50 $350

Item DVD’s





July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $470 15 1 $40 $40

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

7 $50 $350 31 3 $45 $135

5 $50 $250 2 $50 $100

Item DVD’s









July 31


July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $470 15 1 $40 $40

3 $45 $135 3$45 $135 267 $50 $350 3 $45 $135

7 $50 $350 31 3 $45 $135

31 5 $50 $250 2 $50 $100 315 $55 $275 2$50 $100

5 $55 $275

Item DVD’s


Purchases Cost Goods Sold Inventory Balance



Inventory ShrinkageInventory ShrinkageInventory ShrinkageInventory Shrinkage

• Loss of inventory• Compare physical count with balance

in books• Sources

– Breakage– Theft– Obsolescence



• Took a physical count of DVD’s and determined that two were damaged during shipment.

• Record the adjusting entry for inventory shrinkage.


July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $470 15 1 $40 $40

3 $45 $135 3$45 $135 267 $50 $350 3 $45 $135

7 $50 $350 31 3 $45 $135

31 5 $50 $250 2 $50 $100 315 $55 $275 2$50 $100

5 $55 $275

Item Suede Jacket


Purchases Cost Goods Sold Inventory Balance




Cost of Goods Sold

and shrinkage

Ending Inventory


cost of purchases.



Inventory ShrinkageInventory Shrinkage

5 at $55 = $275 ($375-$275 = $100)

Inventory value of 5 units Remaining



FIFO Inventory ShrinkageFIFO Inventory Shrinkage


July 31


July 1 1 40 $40

Item DVD’s

LIFO Perpetual Inventory AccountLIFO Perpetual Inventory Account





LIFO Perpetual Inventory AccountingLIFO Perpetual Inventory Accounting

Inventory 270Accounts Payable 270

July 5


Nov. 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270

Item DVD’s






Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)

Valued based on the most recent costs

of purchases

Cost of Goods Sold


costs of purchases

Ending Inventory


July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270

Item DVD’s








of purchases

Cost of Goods Sold


costs of purchases

Ending Inventory


July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270

Item DVD’s






July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270 15 1 $40 $40

4 $45 $180 2 $45 $90

Item DVD’s









July 15





July 26


July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270 15 1 $40 $40

4 $45 $180 2 $45 $90 267 $50 $350 1$40 $50

2 $45 $90

7 $50 $350

Item DVD’s







of purchases

Cost of Goods Sold


costs of purchases

Ending Inventory


July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270 15 1 $40 $40

4 $45 $180 2 $45 $90 267 $50 $350 1$40 $50

2 $45 $90

7 $50 $350

Item DVD’s





July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270 15 1 $40 $40

4 $45 $180 2 $45 $90 267 $50 $350 1$40 $50

2$45 $90

7 $50 $350

31 7 $50 $350 1$40 $40 1 $45 $45 1$45 $45









July 31


July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270 15 1 $40 $40

4 $45 $180 2 $45 $9026 7 $50 $350 1$40 $50

2$45 $90

7 $50 $350

31 7 $50 $350 1$40 $40 1 $45 $45 1$45 $45

31 5 $55 $275 1$40 $40 1 $45 $45

5 $55 $275






• Loss of inventory• Compare physical count with balance

in books• Sources

– Breakage– Theft– Obsolescence



• Took a physical count of DVD’s and determined that two were damaged during shipment.

• Record the adjusting entry for inventory shrinkage.


July 1 1 $40 $40 5 6 $45 $270 1 $40 $40

6 $45 $270 15 1 $40 $40

4 $45 $180 2 $45 $9026 7 $50 $350 1$40 $50

2$45 $90

7 $50 $350

31 7 $50 $350 1$40 $40 1 $45 $45 1$45 $45

31 5 $55 $275 1$40 $40 1 $45 $45

5 $55 $275







of purchases

Cost of Goods Sold

and shrinkage


costs of purchases

Ending Inventory


Inventory ShrinkageInventory Shrinkage

1 at $40 = $401 at $45 = $453 at $55= $165 $250 ($360-$250 = $110)

Inventory value of 5 units Remaining



LIFO Inventory ShrinkageLIFO Inventory Shrinkage


July 31



Compare the effects of the different costing methods on the

financial statements


ComparisonComparisonComparisonComparison

FIFO LIFO

Sales $960 $960

COGSGross Profit

$660$300

$685$275


ComparisonComparisonComparisonComparison

FIFO LIFO

Inventory $275 $250


Advantage of Each Advantage of Each MethodMethod

Advantage of Each Advantage of Each MethodMethod

Smoothes out price changesSmoothes out price changes

During inflation minimizes net income and

income taxes. Better matching of

current costs in cost of goods sold

with revenues

During inflation minimizes net income and

income taxes. Better matching of

current costs in cost of goods sold

with revenues

Matches actual flow of goods.

Inventory valued closest to

replacement value

Matches actual flow of goods.

Inventory valued closest to

replacement value

First-In, First-Out

Weighted Average

Last-In, First-Out


Use of Inventory Methods Use of Inventory Methods in Practicein Practice

Use of Inventory Methods Use of Inventory Methods in Practicein Practice



Apply the lower-of-cost-or-market (LCM) rule to value

inventory


Conservatism PrincipleConservatism PrincipleConservatism PrincipleConservatism Principle

• Exercise caution in reporting items in the financial statements

• Report realistic figures


Lower-of-Cost-or-MarketLower-of-Cost-or-MarketLower-of-Cost-or-MarketLower-of-Cost-or-Market

• Inventory is reported at whichever is lower – historical cost or market value (current replacement cost)

• If market is lower than cost – write inventory down– Debit Cost of Goods Sold– Credit Inventory


Lower-of-Cost-or-MarketLower-of-Cost-or-MarketLower-of-Cost-or-MarketLower-of-Cost-or-Market

• Must disclose method of valuation in financial statements– As parenthetical in statements or– In notes to financial statements



Report inventory on the balance sheet and measure the effect of

inventory errors


Materiality ConceptMateriality ConceptMateriality ConceptMateriality Concept

• A company must perform strictly proper accounting only for significant items


Full Disclosure PrincipleFull Disclosure PrincipleFull Disclosure PrincipleFull Disclosure Principle

• Report enough information for outsiders to make wise decisions about the company


Consistency in ReportingConsistency in ReportingConsistency in ReportingConsistency in Reporting

• A company should use the same accounting methods from period to period so that financial statements are comparable across periods


Effects of Inventory Effects of Inventory ErrorsErrors


• Ending inventory becomes next year’s beginning inventory

• Results in misstatement of income statement over two years

• Misstatement of balance sheet in first year and then error counterbalances itself




If ending inventory is overstated, so is net income and gross profit. Cost of Goods sold is understated.If ending inventory is understated, so is net income and gross profit. Cost of Goods sold is overstated.In year two, the effects of year one are reversed.


End of Chapter 6End of Chapter 6End of Chapter 6End of Chapter 6

copyright © 2007 prentice-hall. all rights reserved 1 inventoryinventory chapter 8

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