3

Chapter 5

Wild & Shaw

Financial and Managerial Accounting
9th Edition

Copyright ©2022 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 Chapter 5 Learning
Objectives
CONCEPTUAL
C1 Identify the items and costs of merchandise inventory.
ANALYTICAL
A1 Analyze the effects of inventory methods for both financial and tax reporting.
A2 Analyze the effects of inventory errors on current and future financial statements.
A3 Assess inventory management using both inventory turnover and days’ sales in inventory.
PROCEDURAL
P1 Compute inventory in a perpetual system using the methods of specific identification, FIFO, LIFO,
and weighted average.
P2 Compute the lower of cost or market amount of inventory.P3 Appendix 5A—Compute inventory
in a periodic system using the methods of specific identification, FIFO, LIFO, and weighted average.
P4 Appendix 5B—Apply both the retail inventory and gross profit methods to estimate inventory.

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 Learning Objective
C1
Identify the items and costs of
merchandise inventory.

© McGraw-Hill Education
 Determining Inventory Items
Merchandise inventory includes all goods that a
company owns and holds for sale, regardless of where
the goods are located when inventory is counted.

Items requiring special attention

include:
Goods in Goods
Transit Damaged or
Goods on Obsolete
Consignment

© McGraw-Hill Education
Learning Objective C1: Identify the items and costs of merchandise
inventory.
 Goods in Transit
FOB shipping point – goods included in buyer’s
inventory when shipped.
FOB destination – goods included in buyer’s
inventory after arrival at destination.

Exhibit
5.1

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Learning Objective C1: Identify the items and costs of merchandise
inventory.
 Goods on Consignment
Consignor: owner of goods.
Consignee: sells goods for the owner.
Merchandise is included in the inventory of the
consignor.
Consignee never reports consigned goods in
inventory.

© McGraw-Hill Education
Learning Objective C1: Identify the items and costs of merchandise
inventory.
 Goods Damaged or Obsolete
Damaged or obsolete goods are not reported in
inventory if they cannot be sold.
Damaged or obsolete goods which can be sold are
included in inventory at net realizable value.
Net realizable value = sales price minus selling
costs.
Loss is recorded when damage or obsolescence
occurs.

© McGraw-Hill Education
Learning Objective C1: Identify the items and costs of merchandise
inventory.
 Determining Inventory Costs
Include all expenditures necessary to bring
an item to a salable condition and location.
Inventory cost = Invoice cost - discounts +
other costs
Other costs include:
Shipping
Storage
Insurance
Import duties

© McGraw-Hill Education
Learning Objective C1: Identify the items and costs of merchandise
inventory.
 Internal Controls and Taking a Physical
Count
Most companies take a Physical count is used to adjust
physical count of the inventory account balance
inventory at least once to the actual inventory
each year. available.

Good internal controls over the inventory count include:

1. Prenumbered inventory tickets.
1.

2. Counters have no inventory responsibility.

2.

3. Counters confirm existence, amount, andcondition of

3.

inventory.
4. Second count is taken by a different counter.
4.

5. Manager confirms all items counted only once.

5.

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Learning Objective C1: Identify the items and costs of merchandise
inventory.
 Inventory Costing Methods
Four methods are used to assign costs to inventory
and to cost of goods sold:
1. Specific identification
2. First-in, First-out (FIFO)
3. Last-in, First-out (LIFO)
4. Weighted average

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Learning Objective C1: Identify the items and costs of merchandise
inventory.
 Inventory Cost Flow Methods
Exhibit
5.2

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Learning Objective C1: Identify the items and costs of merchandise
inventory.
 Cost Flow of Inventory

© McGraw-Hill Education
Learning Objective C1: Identify the items and costs of merchandise
inventory.
 Learning Objective
P1
Compute inventory in a
perpetual system using the
methods of specific
identification, FIFO, LIFO, and
weighted average.

© McGraw-Hill Education
 Inventory Costing under a Perpetual System

Balance Income
Inventory Statement:
Sheet:Ending
Inventory affects Cost of Goods
Sold

Physical flow does not

need to follow cost
flow.

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Inventory Costing Illustration:Perpetual
System Exhibit
5.3
Here is information about the mountain bike inventory of
Trekking for the month of August.

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Specific Identification:Perpetual
Exhibit
5.4

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 First-In, First-Out (FIFO):Definition
Perpetual

Oldest Cost of Goods

Costs Sold

Recent Ending
Costs Inventory

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 First-In, First-Out (FIFO):Perpetual
Exhibit
5.5

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Last-In, First-Out (LIFO): Definition
Perpetual

Recent Cost of Goods

Costs Sold

Oldest Ending
Costs Inventory

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Last-In, First-Out (LIFO):Perpetual
Exhibit
5.6

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Weighted Average:Perpetual
When a unit is sold, the average cost of each
unit in inventory is assigned to cost of goods sold.

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Weighted Average: Perpetual Part 1

On August 14, 20 bikes are sold. To determine the cost of the units
sold, we first need to compute the weighted average cost per unit of
items in inventory.

The cost of goods sold for the August 14 sale is $2,000. After this
sale, there are five $100 units in inventory totaling $500.

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Weighted Average: Perpetual Part 2

After the August 14 sale, there are 5 units in inventory totaling $500.
On August 17, 20 units are purchased for $2,300.
($2,300 + 500) / 25 = $2,800 / 25 = $112 per unit.
Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Weighted Average: Perpetual Part 3

After
Afterthe
theAugust
August2828purchase,
purchase,there
thereare
are(5
(5++20
20++10)
10)==35
35units
unitsin
ininventory
inventory
totaling
totaling($2,800
($2,800++1,190)
1,190)==$3,990.
$3,990.
$3,900
$3,900//3535==$114
$114per
perunit.
unit.
Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
Weighted Average: Perpetual Part
4 Exhi
bit
5.7

Cost of goods sold for August Ending inventory is

composed of 12 units @ an
30 sale is = $2,622 average cost of $114 each
or $1,368.

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Weighted Average: Perpetual Part 5
Exhibit
5.7

Learning Objective P1: Compute inventory in a perpetual system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Learning Objective
A1
Analyze the effects of
inventory methods for both
financial and tax reporting.

© McGraw-Hill Education
 Financial Statement Effectsof Costing Methods

First-In, Last-In, Weighted

First-Out First-Out Average

Ending inventory Cost of goods sold on Smooths out

approximates income statement price changes.
current cost. approximates its
current costs.

© McGraw-Hill Education
Learning Objective A1: Analyze the effects of inventory methods for both financial and tax
reporting.
 Financial Statement Effects of
Inventory Costing Methods Exhibit
5.8

Because prices change, inventory methods nearly always

assign different cost amounts.

© McGraw-Hill Education
Learning Objective A1: Analyze the effects of inventory methods for both financial and tax
reporting.
 Tax Effects of Costing Methods
The Internal Revenue Service (IRS) requires
that when LIFO is used for tax reporting, it
must also be used for financial reporting. This
is called the LIFO conformity rule.

© McGraw-Hill Education
Learning Objective A1: Analyze the effects of inventory methods for both financial and tax
reporting.
 Learning Objective P2

Compute the lower of cost or

market amount of inventory.

© McGraw-Hill Education
 Lower of Cost or Market (1 of 2)
Inventory must be reported at market
value when market is lower than cost.

Defined as current Can be applied three ways:

replacement cost (not (1) separately to each
sales price).
individual item.
(2) to major categories of
assets.
(3) to the whole inventory.

© McGraw-Hill Education
Learning Objective P2: Compute the lower of cost or market amount of
inventory.
 Lower of Cost or Market (2 of 2)
A motor sports retailer has the following Exhibit
items in inventory: 5.9

Journal entry to write down inventory follows:

© McGraw-Hill Education
Learning Objective P2: Compute the lower of cost or market amount of
inventory
 Learning Objective
A2
Analyze the effects of
inventory errors on current and
future financial statements.

© McGraw-Hill Education
 Income Statement Effects of
Inventory Errors

Exhibit
s 5.10
and
5.11

© McGraw-Hill Education
Learning Objective A2: Analyze the effects of inventory errors on current and future financial
statements.
 Financial Statement Effects of Inventory
ErrorsBalance Sheet Effects
Exhibit
5.12

© McGraw-Hill Education
Learning Objective A2: Analyze the effects of inventory errors on current and future financial
statements.
 Learning Objective
A3
Assess inventory management
using both inventory turnover
and days’ sales in inventory.

© McGraw-Hill Education
 Inventory Turnover
Shows how many times a company turns over its inventory
during a period. Indicator of how well management is
controlling the amount of inventory available.

Exhi
Inventory Cost of goods sold bit

turnove = Average inventory

5.13

© McGraw-Hill Education
Learning Objective A3: Assess inventory management using both inventory turnover and days’ sales in
inventory.
 Days’ Sales in Inventory
Reveals how much inventory is available in
terms of the number of days’ sales.
Exhi
bit
5.14

Days‘ sales in Ending inventory

inventor = × 36
Cost of goods sold 5
y

© McGraw-Hill Education
Learning Objective A3: Assess inventory management using both inventory turnover and days’ sales in
inventory.
 Analysis of Inventory Management
Merchandisers plan and control inventory
purchases and sales.
Costco and Walmart’s inventory turnover
and days’ sales in inventory are shown
below:
Exhibit
5.15

© McGraw-Hill Education
Learning Objective A3: Assess inventory management using both inventory turnover and days’ sales in
inventory.
 Learning Objective
P3
Appendix 5A:Compute
inventory in a periodic system
using the methods of specific
identification, FIFO, LIFO, and
weighted average.

© McGraw-Hill Education
 Inventory Costing under a Periodic System

Balance Income
Inventory Statement:
Sheet:
affects Cost of Goods
Ending Sold
Inventory
Physical flow does
not need to follow
cost flow.

Learning Objective P3: Compute inventory in a periodic system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Inventory Costing IllustrationPeriodic
System Exhibit
5A.1

Learning Objective P3: Compute inventory in a periodic system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Inventory Costing Illustration Periodic
SystemSpecification Identification
Exhibit
5A.2

Learning Objective P3: Compute inventory in a periodic system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Inventory Costing IllustrationPeriodic
System - FIFO
Exhibit
5A.3

Learning Objective P3: Compute inventory in a periodic system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Inventory Costing IllustrationPeriodic
System - LIFO
Exhibit
5A.4

Learning Objective P3: Compute inventory in a periodic system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Inventory Costing Illustration
Periodic System – Weighted
Average
When a unit is sold, the average cost of
each unit in inventory is assigned to cost of
goods sold.

Learning Objective P3: Compute inventory in a periodic system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Inventory Costing Illustration
Periodic System – Weighted Exhibit
5A.5
Average: Cost per Unit

Learning Objective P3: Compute inventory in a periodic system using the methods of specific © McGraw-Hill Education
identification, FIFO, LIFO, and weighted average.
 Learning Objective
P4
Appendix 5B: Apply both the
retail inventory and gross profit
methods to estimate inventory.

© McGraw-Hill Education
 Exhibits
Inventory Estimation Methods 5B.1 &
5B3
Inventory sometimes requires estimation for interim statements or if
some casualty such as fire or flood makes taking a physical count
impossible.

Retail Inventory Method Gross Profit Method

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Learning Objective P4: Apply both the retail inventory and gross profit methods to estimate inventory.
End of Chapter 5

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