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6-12
1.
Cost of goods available for sale
=
Cost of
goods sold
+
Ending
inventory
Beginning
inventory
and
purchases
Number
of units
x
Unit
cost
=
Total
Cost
2.
Cost of goods available for sale
=
Cost of
goods sold
+
Ending
inventory
Beginning
inventory
and
purchases
Number
of units
x
Unit
cost
=
Total
Cost
50
$20
$1,000
Not Sold
$1,000
3.
Weighted-average unit cost
=
$11,500
=
$23
500
Chapter 06 - Inventory and Cost of Goods Sold
6-13
Problem #2
A company accounts for its inventory using FIFO with a perpetual system. At the beginning of
March, the company has inventory of $40,000.
Required:
Record the following transactions for the company for the month of March:
1. On March 7, the company purchases additional inventory for $65,000 on account, terms 3/10,
n/30.
2. On March 7, the company purchases additional inventory for $65,000 on account, terms 3/10,
n/30.
3. On March 10, inventory that cost $5,000 arrived damaged and was returned for a full refund.
4. On March 16, the company makes full payment for inventory purchased on March 7,
excluding inventory returned and the discount received.
5. During the month of March, revenue from inventory sales totals $85,000. All sales are for
cash. The cost of inventory sold is $35,000.
Solution:
1.
Inventory 65,000
6-14
Problem #3
J-Lo Fashions provides year-round specialty jeans. At December 31, the company’s records
show the following amounts in ending inventory for each item.
Inventory items
Quantity
Cost
Per unit
Market
per unit
Fall jeans
50
$100
$ 70
Winter jeans
200
120
140
Spring jeans
300
150
180
Required:
1. Determine ending inventory using the lower of cost and net realizable value.
2. Record any necessary year-end adjustment associated with the lower of cost and net realizable
value.
Solution:
1.
Inventory items
Quantity
Cost
per unit
NRV
per unit
Per unit lower
of cost or NRV
Total lower
of cost or
NRV
Fall jeans
50
$100
$ 70
➔
$ 70
$ 3,500
2.
December 31
Debit
Credit
Chapter 06 - Inventory and Cost of Goods Sold
6-15
Key Points by Learning Objective
LO6-1 Trace the flow of inventory costs from manufacturing companies to merchandising
companies.
LO6-2 Understand how cost of goods sold is reported in a multiple-step income statement.
Inventory is a current asset reported in the balance sheet and represents the cost of inventory not
yet sold at the end of the period. Cost of goods sold is an expense reported in the income
statement and represents the cost of inventory sold.
LO6-3 Determine the cost of goods sold and ending inventory using different inventory cost
methods.
LO6-4 Explain the financial statement effects and tax effects of inventory cost methods.
Generally, FIFO more closely resembles the actual physical flow of inventory. When inventory
LO6-5 Record inventory transactions using a perpetual inventory system.
The perpetual inventory system maintains a continual—or perpetual—record of inventory
purchased and sold. When companies purchase inventory using a perpetual inventory system,
Chapter 06 - Inventory and Cost of Goods Sold
6-16
LO6-6 Apply the lower of cost and net realizable value rule for inventories.
We report inventory at the lower of cost and net realizable value; that is, at cost (specific
Analysis
LO6-7 Analyze management of inventory using the inventory turnover ratio and gross
profit ratio.
The inventory turnover ratio indicates the number of times the firm sells, or turns over, its
Appendixes
LO6-8 Record inventory transactions using a periodic inventory system.
Using the periodic inventory system, we record purchases of inventory, freight-in, purchase
LO6-9 Determine the financial statement effects of inventory errors.
In the current year, inventory errors affect the amounts reported for inventory and retained
Chapter 06 - Inventory and Cost of Goods Sold
6-17
Common Mistakes
Common Mistake
Many students find it surprising that companies are allowed to report inventory costs using
assumed amounts rather than actual amounts. Nearly all companies sell their actual inventory in
a FIFO manner, but they are allowed to report it as if they sold it in a LIFO manner. Later, we’ll
see why that’s advantageous.
Common Mistake
In calculating the weighted-average unit cost, be sure to use a weighted average of the unit cost
instead of the simple average. In the example above, there are three unit costs: $7, $9, and $11. A
simple average of these amounts is $9 [= (7 + 9 + 11) ÷ 3]. The simple average, though, fails to
Common Mistake
FIFO and LIFO describe more directly the calculation of cost of goods sold, rather than ending
inventory. For example, FIFO (first-in, first-out) directly suggests which inventory units are
assumed sold (the first ones in) and therefore used to calculate cost of goods sold. It is implicit
under FIFO that the inventory units not sold are the last ones in and are used to calculate ending
inventory.
Common Mistake
Many students use ending inventory rather than average inventory in calculating the inventory
turnover ratio. Generally, when you calculate a ratio that includes an income statement item (an
Chapter 06 - Inventory and Cost of Goods Sold
6-18
Decision Points
Question
Accounting Information
Analysis
When comparing
inventory amounts
between two
companies, does the
choice of inventory
method matter?
The LIFO difference
reported in the notes to the
financial statements
When inventory costs are rising, FIFO
results in a higher reported inventory.
The LIFO difference can be used to
compare inventory of two companies
if one uses FIFO and the other uses
LIFO.
Question
Accounting Information
Analysis
Is the company
effectively managing
its inventory?
Inventory turnover ratio
and average days in inventory
A high inventory turnover ratio (or
low average days in inventory)
generally indicates that the company’s
Chapter 06 - Inventory and Cost of Goods Sold
6-19
Career Corner
Career Corner
Many career opportunities are available in tax accounting. Because tax laws constantly change
and are complex, tax accountants provide services to their clients not only through income tax
statement preparation but also by formulating tax strategies to minimize tax payments. The
choice of LIFO versus FIFO is one such example.
Chapter 06 - Inventory and Cost of Goods Sold
6-20
Ethical Dilemma
Ethical Dilemma
Diamond Computers, which is owned and operated by Dale Diamond, manufactures and sells
different types of computers. The company has reported profits every year since its inception in
2002 and has applied for a bank loan near the end of 2018 to upgrade manufacturing facilities.
These upgrades should significantly boost future productivity and profitability.
In preparing the financial statements for the year, the chief accountant, Sandy Walters,
mentions to Dale that approximately $80,000 of computer inventory has become obsolete and a
write-down of inventory should be recorded in 2018.
Dale understands that the write-down would result in a net loss being reported for company
operations in 2018. This could jeopardize the company’s application for the bank loan, which
would lead to employee layoffs. Dale is a very kind, older gentleman who cares little for his
personal wealth but who is deeply devoted to his employees’ well-being. He truly believes the
loan is necessary for the company’s sustained viability. Dale suggests Sandy wait until 2019 to
write down the inventory so that profitable financial statements can be presented to the bank this
year.
Explain how failing to record the write-down in 2018 inflates profit in that year. How would
this type of financial accounting manipulation potentially harm the bank? Can Sandy justify the
manipulation based on Dale's kind heart for his employees?
Key Issues
• Writing off inventory reduces net income and total assets in the year of the write-off. By
delaying the write-off, the company shifts profits from the following year to the current
year, overstating current performance.
• Proper reporting vs. the long-term care of the company and its employees
Option 1: Wait to book the write-off
• Booking the write-off could be very damaging to the long-term health of the company
and its employees. Missing out on the loan could damage the profitability of future years,
leading to layoffs.
• Dale should be commended for his attentiveness to his employees’ careers.
• Accounting rules can be bent a little to help the company and employees, and five years
from now, it will not matter whether the write-off was booked in 2018 or 2019.
• As an employee, Sandy should do whatever her boss asks her to do. Any responsibility
for wrongdoing would fall on Dale.
Chapter 06 - Inventory and Cost of Goods Sold
6-21
Option 2: Book the write-off now
• The company is in the situation they are in concerning the obsolete inventory because of
business decisions and circumstances over the past few years. Bad decision making
should not be corrected via creative accounting.
• Despite the possible increased productivity that would be generated from the loan that
will fund upgrades, there is no guarantee that these increases will lead to enough profits
to offset the write-off if postponed to 2019. Then the company will be in a similar
situation a year later.
• Sandy should realize that her responsibility is to present accurate financial statements, not
please Dale’s good intentions. If this write-off is postponed and then later discovered by
auditors, then she has lost her credibility and may personally lose her own job despite
saving the job of many others.
