Lesson

7Merchandise

Inventories

and

Costof

SalesTask

Team

ofFUNDAMENTAL

ACCOUNTINGSchool

of

Business,

Sun

Yat-senUniversity1OutlineFlow

of

inventory

costItems

and

costs

of

merchandising

inventoryAssigning

costs

to

inventoryLower

of

cost

or

marketErrors

inmeasuringinventoryInventory

estimating

method2Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Introduction3Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,While

sales

and

purchases

are

the

focus

ofoperations,

inventory

is

no

less

important.Inventory

costing

and

evaluation

methods

cansubstantially

influence

the

bottom

line.

SinceChina’s

listed

companies

were

permitted

towrite

down

inventories

in

1998,

inventory

has

longbeen

criticized

as

the

“income

adjustor”.Besides,

inventory

costing

policies

and

the

scopeinventory

can

also

significant

change

the

currentand

future

years

income

numbers.Nature

of

Inventory

and

Cost

of

Goods

SoldBeginningInventoryPurchasesfor

the

PeriodEnding

Inventory(Balance

Sheet)Cost

of

Goods

Sold(Income

Statement)Beginning

inventory

+

Purchases

–

Ending

inventory

=

Cost

of

goods

sold+Goods

Availablefor

Sale+4Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Flow

of

Inventory

CostsCost

ofGoods

SoldMerchandiseInventoryDirectLabourFactoryOverheadRaw

MaterialsInventoryWork

in

ProcessInventoryFinished

GoodsInventoryCost

ofGoods

SoldMerchandiserMerchandisePurchasesManufacturerRawMaterials5Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Accounting

for

Inventory6Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Accounting

for

inventory

requiresseveral

decisions

which

include:Items

to

include

in

cost.Inventory

System.→

Perpetual

or

PeriodicCosting

Method.→

FIFO,

LIFO,WeightedAverage,Specific

IDUse

of

estimates.→

Gross

profit

method,

Retailinventory

methodItems

in

Merchandise

Inventory7Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Inventory

includes

all

goods

owned

bya

company

and

held

for

sale.Items

requiring

special

attention:→→→Goods

in

TransitGoods

on

consignmentObsolete

or

damaged

goodsCosts

of

Merchandise

Inventory8Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,All

expenditures

necessary

to

bring

anitem

to

a

saleable

condition

andlocation.This

includes:→→→→→Invoice

price

less

discountsImport

dutiesTransportation-inStorageInsuranceManagement

must

decide

on

method

ofdetermining

unit

cost.This

will

affect

both

the

income

statement

and

the

balance

sheet.Methods:9Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,→→→→Specific

IdentificationFIFOLIFOAverage

CostAssigning

Costs

to

InventorySpecific

IdentificationThis

method

is

used

when

items:Are

unique.Can

be

directly

identified

with

aspecific

purchaseand

its

invoice.Examples:

Automobiles,custom

furniture,

art.10Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Specific

Identification-ExampleThe

opening

inventory

consists

of

10

units

@

$90/unit.11Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Specific

Identification-ExampleThis

results

in

two

layers

ofinventory.Additional

units

repurchased

@

$100/unit.12Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Specific

Identification-ExampleOn

August

14,

20

units

are

sold.

Eight

of

these

units

came

fromthe

opening

inventory

and

the

remaining

12

units

came

from

the

August

3

purchase.13Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Specific

Identification-ExampleThis

leaves

2

units

remaining

from

theoriginal

inventory

and

3

units

remainingfrom

the

August

3

purchase.14Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Basedonthe

assumption

that

the

items

aresold

in

the

order

acquired.When

a

sale

occurs:The

earliest

units

purchased

are

chargedto

Cost

of

Goods

Sold.The

cost

of

the

most

recent

purchasesremain

in

inventory15Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,First-In,

First-Out

(FIFO)FIFO-ExampleUnder

FIFO,

units

are

assumed

to

be

sold

in

the

order

acquired.

Therefore,of

the

20

units

sold

on

August

14,

the

first

10

units

come

from

beginninginventory.

Therefore,

those

10

units

are

removed

from

the

inventory

recorbased

on

the

cost

of

those

units

of

$90.16Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,FIFO-ExampleThe

remaining

10

units

sold

on

August

14th

come

from

the

nextpurchase,

made

on

August

3rd.

Therefore,

these

units

areremoved

from

the

inventory

record

based

on

their

cost

of

$1017Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,FIFO-ExampleThe

ending

inventory

consists

ofthe

5

remaining

units

from

theAugust

3

purchase.Ending

inventoryapproximates

currentreplacement

cost.18Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Last-In,

First-Out

(LIFO)19Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Based

onthe

assumption

that

the

mostrecently

purchased

items

are

sold

first.When

a

sale

occurs:The

latest

units

purchased

are

charged

to

Cost

ofGoods

Sold.The

cost

of

the

earliest

purchases

remain

ininventory.LIFO-ExampleOf

the

20

units

sold,

theseunits

are

assumed

to

be

soldfirst.20Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,LIFO-ExampleOnce

the

latest

units

purchased

aresold,

units

are

sold

from

theprevious

purchase.21Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,LIFO-ExampleThis

leaves

5

units

remainingfrom

the

first

purchase.Better

matchescurrent

costs

in

costof

goods

sold

withrevenues.22Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Under

this

method,

the

cost

of

all

units

areaveraged

together.Average

cost

per

unitCost

of

goods

available

for

saleNumber

of

units

available

for

sale=23Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Moving

Weighted

Average

MethodMoving

Weighted

Average-ExampleAdditional

units

arepurchased

@

$100/unit.This

results

in

an

average

costof

$100/unit.(10

x

$90)

+

(15

x

$100)25

units24Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Moving

Weighted

Average-ExampleThese

20

units

are

sold

at

theaverage

cost

of

$96/unit.25Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Moving

Weighted

Average-ExampleThis

leaves

5

units

remainingat

an

average

cost

of

$96/unit.Smoothes

outpurchase

pricechanges.26Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Because

prices

change,

the

choice

of

an

inventorymethod

influences

both

income

statement

and

thebalance

sheet.Financial

Reporting27Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Inventory

must

be

reported

at

market

value

whenmarket

is

lower

than

cost

(conservatism

principleMarket

may

be

defined

as:Net

realizable

valueCurrent

replacement

costMay

be

applied

in

one

of

three

ways:Separately

to

each

item.To

major

categories

of

items.To

the

inventory

as

a

whole.28Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Lower

of

Cost

or

MarketA

motor

retailer

has

the

following

items

in

inventoryLower

of

Cost

or

Market29Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Compute

lower

of

cost

or

market

for

individual

inventory

ite30Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Lower

of

Cost

or

MarketLower

of

Cost

or

MarketCompute

lower

of

cost

or

market

for

the

two

groups

of

inventory

items.31Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Lower

of

Cost

or

MarketCompute

lower

of

cost

or

market

for

the

entire

inventory.32Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Errors

in

Measuring

Inventory33Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Occasionally

used

for

interim

periodreporting.Needed

information

includes:Beginning

inventory

at

cost

and

retail.Net

purchases

at

cost

and

retail.Net

sales.34Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Retail

Inventory

MethodRetail

Inventory

MethodStep

3Cost

toretail

ratioEndinginventory

atretailEstimatedendinginventory

atcost=×Step

2Goodsavailable

forsale

at

retailGoodsavailable

forsale

at

cost=÷Cost

toretail

ratioStep

1Net

sales

atretailGoodsavailable

forsale

at

retail–=Endinginventory

atretail35Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Retail

Inventory

Method36Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Retail

Inventory

Method37Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Retail

Inventory

Method38Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Gross

Profit

Method39Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Estimate

ending

inventory

by

applying

thegross

profit

ratio

to

net

sales

at

retail.Useful

when

inventories

have

beendestroyed,

lost

or

stolen.Gross

Profit

MethodStep

11.0

minusthe

grossprofit

ratioNet

sales

atretail×=Estimatedcost

ofgoods

soldStep

2Estimatedcost

ofgoods

soldGoodsavailable

forsale

at

cost–=Estimatedendinginventory

atcost40Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Gross

Profit

MethodIn

March

of

2002,

CheTec

Company’s

inventory

wasdestroyed

by

fire.

CheTec’s

normal

gross

profit

ratio40%

of

net

sales. At

the

time

of

the

fire,

CheTec

showedthe

following

balances:41Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Gross

Profit

MethodStep

142Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Gross

Profit

MethodStep

243Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Discussion

Case44Task

Team

of

FUNDAMENTAL

ACCOUNTING,BusinessSchool,Northeast

PharmaceuticalWhen

preparing

financial

statement

of

199Northeast

Pharmaceutical

recorded

RMB21,280,000

expenses

as

inventory

cost,which

carries

to

next

year’s

beginninginventory.

As

aresult,

the

bottom

line

isRMB

19,950,000

profits,

instead

of

a

bigloss.

This

was

discovered

and

was

fined

byCSRC

as

securities

fr