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Chapter 06 - Inventory and Cost of Goods Sold
6-1
Chapter 6
Inventory and Cost of Goods Sold
INSTRUCTOR’S MANUAL
Authors’ Perspectives
Before covering this chapter, if you asked introductory students to guess how companies account
for inventory, their answer would probably resemble something close to perpetual specific
identification. Students would be surprised to learn that inventory transactions can be recorded
using two inventory systems (periodic and perpetual) and three inventory assumptions (FIFO,
PART A: Understand Inventory and Cost of Goods Sold
LO6-1 Understand that inventory flows from manufacturing companies to merchandising
companies and is reported as an asset in the balance sheet.
LO6-2 Understand how cost of goods sold is reported in a multiple-step income statement.
Merchandising and Manufacturing – Part A begins with a discussion of service companies
Chapter 06 - Inventory and Cost of Goods Sold
6-2
the first five chapters) to companies that sell products (this chapter).
• Illustration 6-2 provides an easy-to-understand diagram of the flow of inventory from
manufacturing companies to merchandising companies to the end user.
Multiple-Step Income Statement – We introduce the multiple-step income statement before
covering the various methods used to calculate cost of goods sold. The idea is to first give
Inventory Cost Methods – Once students are familiar with the concepts of ending inventory and
cost of goods sold and where in the financial statements these items are reported, they are ready
to see how they are calculated. Students initially think that all companies use specific
identification. However, inventory cost flow methods provide a good example of the application
Effects of Inventory Cost Methods – Once the inventory cost flow methods have been
reinforced, students are guided through the different financial statement effects that arise from
these inventory accounting choices. They can now more easily understand why companies would
use LIFO to save on taxes.
Chapter 06 - Inventory and Cost of Goods Sold
6-3
PART B: Recording Inventory Transactions
LO6-5 Record inventory transactions using a perpetual inventory system.
Perpetual Inventory System – After students become familiar with the concepts of calculating
the cost of ending inventory and cost of goods sold, Part B shows students how to record
inventory transactions using the perpetual inventory system. The perpetual inventory systems is
PART C: Lower of Cost and Net Realizable Value
LO6-6 Apply the lower of cost and net realizable value rule for inventories.
Conservatism – The lower of cost and net realizable value (LCNRV) rule for inventories
provides a clear example of conservatism in accounting. Most students easily understand that
when NRV falls below cost, we record the bad news. However, when NRV is above cost, we
don’t record that good news. Many students will find this curious, and they can read more about
ANALYSIS
LO6-7 Analyze management of inventory using the inventory turnover ratio and gross
profit ratio.
Chapter 06 - Inventory and Cost of Goods Sold
6-4
APPENDIX A
LO6-8 Record inventory transactions using a periodic inventory system.
Periodic inventory system – Appendix A provides a side-by-side comparison of the periodic
APPENDIX B
LO6-9 Determine the financial statement effects of inventory errors.
Inventory error – Appendix B details the balance sheet and income statement effects that result
from an inventory error. One advantage of studying inventory errors is that they reinforce the
Self-Study Materials
■ Let’s Review—Inventory cost methods (p. 292).
■ Let’s Review—Recording transactions using a perpetual inventory system (p. 303).
Chapter 06 - Inventory and Cost of Goods Sold
6-5
Chapter 06 - Inventory and Cost of Goods Sold
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Key Points by Learning Objective
Throughout the chapter, Key Points provide quick synopses of the critical pieces of information
students should be understanding. These Key Points are summarized by Learning Objective at
the end of the chapter, providing students with a convenient study guide.
LO6-1 Trace the flow of inventory costs from manufacturing companies to merchandising
companies.
A multiple-step income statement reports multiple levels of profitability. Gross profit equals net
revenues (or net sales) minus cost of goods sold. Operating income equals gross profit minus
operating expenses. Income before income taxes equals operating income plus nonoperating
revenues and minus nonoperating expenses. Net income equals all revenues minus all expenses.
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
Chapter 06 - Inventory and Cost of Goods Sold
6-7
or Accounts Receivable) and increase Sales Revenue, and (2) they increase Cost of Goods Sold
and decrease Inventory.
Most companies maintain their own inventory records on a FIFO basis, and then some prepare
LO6-6 Apply the lower of cost and net realizable value rule for inventories.
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
6-8
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Questions
Learning
Objective(s)
Topic
Time
(Min.)
1
LO6-1
Discuss the nature of inventory
5
2
LO6-1
Distinguish between a service company and a
5
statement
7
LO6-3
Explain recording inventory using assumed units
sold
5
8
LO6-3
List the three primary inventory cost flow
assumptions
5
9
LO6-4
Explain financial statement effects of inventory cost
flow assumptions
5
10
LO6-4
Explain financial statement effects of inventory cost
flow assumptions
5
17
LO6-6
Describe the adjustment to write down inventory to
market value
5
18
LO6-6
Explain the relationship between conservatism and
the lower of cost and net realizable value for
inventory
5
19
LO6-7
Describe the inventory turnover ratio
5
20
LO6-7
Discuss the gross profit ratio
5
Chapter 06 - Inventory and Cost of Goods Sold
6-9
Brief
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
BE6-1
LO6-1
Understand terms related to types of companies
5
BE6-2
LO6-1
Understand terms related to inventory
5
BE6-3
LO6-2
Calculate cost of goods sold
5
BE6-4
LO6-2
Calculate amounts related to the multiple-step
10
using specific identification
BE6-9
LO6-4
Identify financial statement effects of FIFO and
LIFO
5
BE6-10
LO6-5
Record inventory purchases and sales using a
perpetual system
5
BE6-11
LO6-5
Record freight charges for inventory using a
perpetual system
5
BE6-12
LO6-5
Record purchase returns of inventory using a
perpetual system
5
BE6-13
LO6-5
Record purchase discounts of inventory using a
5
BE6-17
LO6-8
Record inventory purchases and sales using a
periodic system
5
BE6-18
LO6-8
Record freight charges for inventory using a
periodic system
5
Chapter 06 - Inventory and Cost of Goods Sold
6-10
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
E6-1
LO6-2
Calculate cost of goods sold
10
E6-2
LO6-2
Prepare a multiple-step income statement
15
E6-3
LO6-2
Prepare a multiple-step income statement and
analyze profitability
15
E6-7
LO6-5
Record inventory purchase and purchase return
using a perpetual system
10
E6-8
LO6-5
Record inventory purchase and purchase discount
using a perpetual system
10
E6-9
LO6-5
Record transactions using a perpetual system
10
E6-10
LO6-5
Record transactions using a perpetual system
10
E6-11
LO6-5
Record transactions using a perpetual system
10
ratio, and average days in inventory
E6-16
LO6-2, 6-7
Calculate levels of profitability for a multiple-step
income statement and the gross profit ratio
15
E6-17
LO6-8
Record transactions using a periodic system
20
E6-18
LO6-8
Record transactions using a periodic system
20
Chapter 06 - Inventory and Cost of Goods Sold
Problems
Learning
Objective(s)
Topic
Time
(Min.)
P6-1A
LO6-3
Calculate ending inventory and cost of goods sold
for four inventory methods
30
P6-2A
LO6-3, 6-4, 6-5
Calculate ending inventory, cost of goods sold, sales
revenue, and gross profit for four inventory methods
40
P6-3A
LO6-2, 6-5
Record transactions and prepare a partial income
25
P6-6A
LO6-2, 6-3,
6-4, 6-5, 6-6
Record transactions using a perpetual system,
prepare a partial income statement, and adjust for
the lower of cost and net realizable value
25
P6-7A
LO6-2, 6-7
Prepare a multiple-step income statement and
calculate the inventory turnover ratio and gross
profit ratio
20
revenue, and gross profit for four inventory methods
P6-3B
LO6-2, 6-5
Record transactions and prepare a partial income
statement using a perpetual inventory system
25
P6-4B
LO6-6
Report inventory using lower of cost and net
realizable value
25
P6-5B
LO6-3, 6-6
Calculate ending inventory and cost of goods sold
using FIFO and LIFO and adjust inventory using the
20
