Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
6-1
Chapter 6
Inventories and Cost of Sales
Student Learning Objectives and Related Assignment Materials*
Student Learning Objectives
Discussion
Questions
Quick
Studies
Exercises
Problems
(A &B set)**
Beyond the
Numbers
Conceptual objectives:
C2. Identify the costs of
merchandise inventory.
1, 2, 3
6-2, 6-23
6-2
6-1, 6-8
Analytical objectives:
A1. Analyze the effects of
4, 5, 6, 7, 14,
6-18
6-4, 6-6,
6-8
6-3, 6-4, 6-6
A2. Analyze the effects of
inventory errors on current and
future financial statements.
8, 9
6-20
6-12
6-6
A3. Assess inventory management
using both inventory turnover
and days' sales in inventory.
6-21
6-11, 6-13
SP
6-1, 6-2, 6-5,
6-7, 6-9
Procedural objectives:
P1. Compute inventory in a
perpetual system using the
1
6-3, 6-4, 6-5,
6-6, 6-10,
6-3, 6-7, 6-8
6-1, 6-3
6-6
P2. Compute the lower of cost or
market amount of inventory.
10, 11
6-19, 6-23
6-10, 6-18
6-5, SP
P3. Compute inventory in a periodic
system using the methods of
1, 13
6-7, 6-8,
6-9, 6-14,
6-5, 6-9,
6-14, 6-15
6-2, 6-4,
6-7, 6-8, ES
P4. Apply both the retail inventory
and gross profit methods to
estimate inventory.
(Appendix 6B)
13
6-22
6-16, 6-17
6-9, 6-10
Notes appear on next page.
*See additional information on next page that pertains to these quick studies, exercises and problems.
SP refers to the Serial Problem
GL refers to the General Ledger problems
ES refers to Excel Simulations
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
6-2
Additional Information on Related Assignment Material
Connect
Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all Exercises
and Problems Set A. Connect also provides algorithmic versions for Quick Study, Exercises and
Problems. It allows instructors to monitor, promote, and assess student learning. It can be used in
practice, homework, or exam mode.
Connect Insight
The first and only analytics tool of its kind, Connect Insight is a series of visual data displays that are each framed
The Serial Problem (SP) for Success Systems continues in this chapter.
General Ledger
Assignable within Connect, General Ledger (GL) problems offer students the ability to see how transactions post
Excel Simulations
Assignable within Connect, Excel Simulations allow students to practice their Excel skills—such as basic formulas
Synopsis of Chapter Revisions
NEW opener—Homegrown Sustainable Sandwich and entrepreneurial assignment.
Simplified “specific identification” calculations in Exhibit 6.4.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
6-3
Chapter Outline
Notes
I. Inventory Basics
A. Determining Inventory Items
Merchandise inventory includes all goods that a company owns and
holds for sale. The following inventory items require special
attention:
1. Goods in Transit - if ownership has passed to the purchaser, the
goods are included in the purchaser’s inventory. Ownership is
2. Goods on Consignment—goods shipped by the owner, called the
consignor, to another party, the consignee.
3. Goods Damaged or Obsolete
a. Damaged and obsolete (and deteriorated) goods are not
reported in inventory if they cannot be sold.
B. Determining Inventory Costs
1. The cost of an inventory item includes its invoice cost minus any
2. The expense recognition or matching principle states that
C. Internal Controls and Taking a Physical Count
2. Nearly all companies take a physical count of inventory at least
3. Internal controls when taking a physical count of inventory:
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
accounted for.
b. Those responsible for the inventory do not count the
inventory.
II. Inventory Costing under a Perpetual System
The major goal is to properly assign costs with sales. The expense
recognition (or matching principle) is used to compute how much of
the cost of goods available for sale is expensed (on the income
statement) and how much is carried forward as inventory (on the
balance sheet). One of the most important issues in accounting for
inventory is determining the per unit cost assigned to inventory items.
A. Inventory Cost Flow Assumptions
Four methods are used to assign costs to inventory and cost of
goods sold. Each method assumes a particular pattern for how
costs flow through inventory. Physical flow and cost flow need
not be the same.
1. First-in, first-out (FIFO)—assumes costs flow in the order
2. Last-in, first-out (LIFO)—assumes costs flow in the reverse
order incurred. (Results differ from perpetual in the appendix
3. Weighted average—assumes costs flow in an average of the
costs available. (Results differ from perpetual in the appendix
4. Specific identification—each item can be identified with a
specific purchase and invoice. Specific identification is
usually only practical for companies with expensive, custom-
Chapter Outline
Notes
B. Inventory Costing Illustration
1. First-in, first-out (FIFO)—assumes costs flow in the order
incurred.
6-5
2. Last-in, first-out (LIFO)—assumes costs flow in the reverse
order incurred.
3. Weighted average—assumes costs flow using an average of
4. Specific identification—each item can be identified with a
5. The units of inventory are identical under all methods.
C. Financial Statement Effects of Costing Methods
1. When purchase prices do not change, each inventory costing
method assigns the same amounts to inventory and to cost of
goods sold. When purchase prices are different, the methods
assign different cost amounts. When purchase costs regularly
rise:
a. FIFO assigns the lowest amount to cost of goods sold
resulting in the highest gross profit and the highest net
D. Tax Effects of Costing Methods
Since inventory costs affect net income, they have potential tax
effects.
1. Financial reporting often differs from the method used for tax
reporting.
Chapter Outline
Notes
E. Consistency in Using Costing Methods
6-6
2. Method change is acceptable if it will improve financial
3. Different methods may be consistently applied to different
categories of inventory.
III. Valuating Inventory at LCM and the Effects of Inventory Errors
A. Lower of Cost or Market
Accounting principles require that inventory be reported on the
balance sheet at the lower of cost or market (LCM).
1. Computing the Lower of Cost or Market:
2. When the recorded cost of inventory is higher than the
3. Lower of cost or market pricing is applied in one of three
ways to:
4. Recording the Lower of Cost or Market: accounting rules
require that inventory be adjusted to market when market is
less than cost, but inventory normally cannot be written up to
B. Financial Statement Effects of Inventory Errors.
An inventory error causes misstatements in cost of goods sold,
Chapter Outline
Notes
1. Income Statement Effects:
a. If ending inventory is understated, cost of goods sold is
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
6-7
2. Balance Sheet Effects:
a. If ending inventory is understated, assets and equity are
understated.
IV. Decision Analysis—Inventory Turnover and Days’ Sales in
Inventory
A. Inventory Turnover
1. Inventory turnover, also called simply turns, is used to
2. It is calculated by dividing cost of goods sold by average
inventory.
3. It measures the number of times a company's average
inventory was sold during an accounting period.
B. Days' Sales in Inventory
2. It is calculated by dividing ending inventory by cost of goods
sold, and then multiplying the result by 365.
3. It estimates how many days it will take to convert inventory at
the end of a period into accounts receivable or cash.
C. Analysis of Inventory Management
V. Inventory Costing under a Periodic System (Appendix 6A)
The major goal is to properly assign costs with sales. The expense
statement) and how much is carried forward as inventory (on the
Chapter Outline
balance sheet). One of the most important issues in accounting for
inventory is determining the per unit cost assigned to inventory items.
Notes
A. Inventory Cost Flow Assumptions
Four methods are commonly used to assign costs to inventory and
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
6-8
1. Specific identification—At period-end, cost of goods sold is
2. First-in, first-out (FIFO)— At period-end, FIFO charges costs
3. Last-in, first-out (LIFO)— At period-end, LIFO charges costs
4. Weighted average—At period-end, weighted average
computes the average cost per unit of inventory available for
5. The units of inventory are identical under all methods.
VI. Inventory Estimation Methods (Appendix 6B)
Inventory sometimes requires estimation for two reasons. First,
companies often require interim financial statements, but only take an
annual physical count of inventory. Second, companies may require an
inventory estimate if some casualty makes taking a physical count
impossible. Estimates are usually only required for companies that use
the periodic system.
A. Retail Inventory Method
The retail inventory method estimates the cost of ending
inventory for interim statements in a periodic inventory when a
physical count is taken only annually. Steps include:
1. Subtract sales (general ledger amount) from goods available
3. Apply cost ratio to ending inventory at retail to convert to
ending inventory at cost.
Chapter Outline
B. Gross Profit Method
The gross profit method estimates the cost of ending inventory
by applying the gross profit ratio to net sales (at retail). This type
of estimate is often used for insurance claims when inventory is
Notes
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
6-9
destroyed, lost or stolen. Steps include:
1. Determine the normal gross profit percentage from recent
years.
3. Multiply actual sales by the cost of goods sold percentage to
get estimated cost of goods sold.
4. Subtract estimated cost of goods sold from the actual amount
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
6-10
VISUAL #6-1
Computation of Cost of Goods Available
Units Cost Total
Jan. 1 Beginning Inventory 60 @ $10 = $ 600
Mar. 27 Purchase 90 @ 11 = 990
Methods of Assigning Cost to Units in Ending Inventory
(2) Weighted Average - a weighted average cost per unit is determined
(3) First-in, First-out (FIFO) - assumes the first units acquired (beginning
(4) Last-in, First-out (LIFO) - assumes the last units acquired (most recent
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
6-11
VISUAL #6-2
O
OBSERVATIONS
COGA Net Sales
Goods
Available
(COGA)
has 2 parts
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
Chapter 6 Alternate Demonstration Problem #1 (Periodic)
The ABC Company had the following inventory record for the month of
January:
# of
Unit
Date
Description
Items
Price
Item
1/1
Beginning
inventory
5
$20
Z1, Z2, Z3, Z4, Z5
1/5
Sale
2
Z2, Z5
1/11
Purchase
9
12
Z6, Z7, Z8, Z9, Z10, Z11,
Z12, Z13, Z14
1/28
Sale
7
Z1, Z3, Z6, Z7, Z8, Z9, Z14
Required:
Assuming a periodic system is in use, determine the following:
1. Cost of goods available for sale.
2. Cost of goods sold and the ending inventory using each of the
following methods:
a. FIFO
b. LIFO
c. Weighted Average
d. Specific Identification
6-13
Solution: Chapter 6 Alternate Demonstration Problem #1
1. Cost of goods available for sale:
Date
Units
Unit Cost
Cost
2. a. FIFO Periodic (FIFO under periodic and perpetual yields identical results).
Total goods available for sale
$208
Ending inventory
b. LIFO Periodic:
Total goods available for sale
$208
Ending inventory
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
6-14
Specific Identification Periodic
Date
Purchases
Sales at Cost
Inventory
Balance
1/1
Beginning
Inventory
5 @ $ 20 = $100
Z1-Z5
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
Chapter 6 Alternate Demonstration Problem #2 (Perpetual)
The ABC Company had the following inventory record for the month of
January:
# of
Unit
Date
Description
Items
Price
Item
1/1
Beginning
inventory
5
$20
Z1, Z2, Z3, Z4, Z5
1/5
Sale
2
Z2, Z5
1/11
Purchase
9
12
Z6, Z7, Z8, Z9, Z10, Z11,
Z12, Z13, Z14
1/28
Sale
7
Z1, Z3, Z6, Z7, Z8, Z9, Z14
Required:
Assuming a perpetual system is in use, determine the cost of goods sold
and the ending inventory using each of the following methods:
1. FIFO
2. LIFO
3. Weighted average
4. Specific identification
6-16
Solution: Chapter 6 Alternate Demonstration Problem #2
1.
FIFO Perpetual
Date
Purchases
Sales at Cost
Inventory
Balance
2.
LIFO Perpetual
Date
Purchases
Sales at Cost
Inventory
Balance
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
Solution: Chapter 6 Alternate Demonstration Problem #2, continued
3.
Weighted Average Perpetual
Date
Purchases
Sales at Cost
Inventory
Balance
4.
Specific Identification Perpetual
Date
Purchases
Sales at Cost
Inventory
Balance
1/1
5 @ $ 20 = $100
