Chapter 06 – Inventory and Cost of Goods Sold
6-12
P6-9B
LO6-8
FIFO
Record transactions and prepare a partial income
20
Additional
Perspectives
Topic
Time
(Min.)
AP6-1
Continuing Problem: Great Adventures
40
AP6-2
Financial Analysis: American Eagle Outfitters, Inc.
25
AP6-3
Financial Analysis: The Buckle, Inc.
25
Buckle, Inc.
AP6-5
Ethics
20
AP6-6
Internet Research
30
AP6-7
Written Communication
25
AP6-8
Earnings Management
30
Chapter 06 – Inventory and Cost of Goods Sold
6-13
Alternate Let’s Review
Problem #1
For the current year, a company has the following beginning inventory and purchase.
Date
Transaction
Number
of units
Unit
cost
Total
cost
Jan. 1
Beginning inventory
200
$20
$ 4,000
Jun. 15
Purchase
300
500
$11,500
Required:
1. Calculate cost of goods sold and ending inventory using the FIFO method.
Chapter 06 – Inventory and Cost of Goods Sold
6-14
Solution:
1.
Cost of goods available for sale
=
Cost of
goods sold
+
Ending
inventory
Beginning
inventory
and
purchases
Number
of units
×
Unit
cost
=
Total
Cost
2.
Cost of goods available for sale
=
Cost of
goods sold
+
Ending
inventory
Beginning
inventory
and
purchases
Number
of units
×
Unit
cost
=
Total
Cost
3.
Weighted-average unit cost
=
$11,500
=
$23
500
Cost of goods sold
=
×
=
Ending inventory
=
×
=
500
Chapter 06 – Inventory and Cost of Goods Sold
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 10, inventory that cost $5,000 arrived damaged and was returned for a full refund.
3. On March 16, the company makes full payment for inventory purchased on March 7,
excluding inventory returned and the discount received.
4. 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
Accounts Payable 65,000
Chapter 06 – Inventory and Cost of Goods Sold
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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.
Cost
NRV
Inventory items
Quantity
Per
unit
Total
Per
unit
Total
Lower
of cost
and NRV
Year-end
adjustment
needed
Fall jeans
Winter jeans
28,000
24,000
Spring jeans
54,000
45,000
$74,000
inventory
2.
December 31
Debit
Credit
Cost of Goods Sold
Chapter 06 – Inventory and Cost of Goods Sold
6-17
Common Mistakes
Common Mistakes made by students are highlighted in each of the chapters. With greater
awareness of the potential pitfalls, student can avoid making the same mistakes and gain a deeper
understanding of the chapter material.
Common Mistake
When calculating cost of goods sold using FIFO, students sometimes forget to count beginning
inventory as the first purchase. These units were purchased last period, which was before any
purchases this period, so they are assumed to be the first units sold.
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
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
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
Chapter 06 – Inventory and Cost of Goods Sold
6-18
Decision Points and Decision Maker’s Perspective
Decision Points and Decision Maker’s Perspectives are provided throughout each chapter to give
insight into how measurement and communication of financial accounting information help
decision makers.
Decision Points
Question
Accounting Information
Analysis
When comparing
The LIFO difference
When inventory costs are rising, FIFO
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
inventory policies are effective.
Question
Accounting Information
Analysis
For how much is a
Gross profit and net sales
The ratio of gross profit to net sales
Decision Maker’s Perspective
Investors Understand One-Time Gains
Investors typically take a close look at the components of a company’s profits. For example,
Ford Motor Company announced that it had earned a net income for the fourth quarter (the
Chapter 06 – Inventory and Cost of Goods Sold
6-19
FIFO or LIFO?
Management must weigh the benefits of FIFO and LIFO when deciding which inventory cost
flow assumption will produce a better outcome for the company. Here we review the logic
behind that decision.
Why Choose FIFO?
Most companies’ actual physical flow follows FIFO. Think about a supermarket, sporting
goods store, clothing shop, electronics store, or just about any company you’re familiar with.
Why Choose LIFO?
If FIFO results in higher total assets and higher net income and produces amounts that most
closely follow the actual flow of inventory, why would any company choose LIFO? The
Conservatism and the Lower of Cost and Net Realizable Value Method
Firms are required to report the falling value of inventory, but they are not allowed to report any
increasing value of inventory. Why is this? The answer lies in the conservative nature of some
Chapter 06 – Inventory and Cost of Goods Sold
6-20
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 2021 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 2021.
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
Chapter 06 – Inventory and Cost of Goods Sold
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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
saving the job of many others.