Slide 1

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 2

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 3

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 4

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 5

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 6

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 7

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 8

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 9

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 10

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 11

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 12

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 13

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 14

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 15

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 16

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 17

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 18

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 19

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 20

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 21

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 22

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 23

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 24

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 25

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 26

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 27

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 28

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 29

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 30

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 31

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 32

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 33

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 34

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 35

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 36

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 37

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 38

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 39

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40


Slide 40

Valuation of Inventories:
A Cost-Basis Approach

1

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

2

Learning Objectives
1.
2.
3.
4.

Physical Goods included in Inventory
Costs Included in Inventory
Inventory: Periodic vs. Perpetual
Purchase Discounts
•

Gross versus Net

5. Cost Flow Assumptions
1. Specific Identification, Average Cost, FIFO, LIFO

6. Specific Issues Related to LIFO
1.
2.
3.
4.

LIFO Reserve
LIFO Liquidation
Dollar-Value LIFO
Major advantages/disadvantages

3

Inventory
Careful attention is given to the inventory
account by many business organizations
because it represents one of the most
significant assets held by the enterprise.
Inventories are of particular importance to
merchandising and manufacturing companies
because they represent the primary source of
revenue for the organization.
Inventories are also significant because of their
impact on both the balance sheet and the

Inventory Classification and
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

or

Manufacturer

LO 1 Identify major classifications of inventory. 5

Inventory Classification and
Systems
Flow of Costs

Illustration 8-2

LO 1 Identify major classifications of inventory. 6

Inventory Classification and
Systems
Control
Two systems for maintaining inventory records:

Perpetual system
Periodic system

7

Inventory Systems
Perpetual Method
•
• Purchases are debited
to Inventory account •
• Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in
Inventory account.
•
• Debit COGS and credit
Inventory account for
each sale.

Periodic Method
Purchases are debited
to Purchases account.
Freight-in, Purchase
Returns and
Allowances and
Purchase Discounts
are recorded in their
respective accounts.
COGS is computed only
periodically :
COGAS – Ending
Inventory = COGS

Inventory Classification and
Systems
Perpetual System

vs.

Periodic System

|

1. Beginning inventory (100 units at $7 = 700)
|

2. Purchase 900 units at $7:

|
|

Inventory
Accounts payable

6,300

|

6,300

|

Purchases
Accounts payable

6,300

Accounts receivable
Sales

8,400

6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200

|
|

4. Adjusting entries (ending inventory = 400 units @ $7 = $2,800)
|

No Entry Necessary

|
|
|

Inventory
Cost of goods sold
Purchases

2,100
4,200
6,300

9

Basic Issues in Inventory
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

10

Physical Goods Included in
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.

The following goods are included in “seller’s” inventory:
• Goods in transit (FOB Destination)
• Goods on consignment with consignee
• Goods, sold under buy back agreements
• Goods, sold with high rates of return
• Installment sales (if bad debts can not be estimated)
11

Guidelines for Determining
Ownership

Costs Included in Inventory
Product Costs
Period Costs
Purchase Discounts – Gross vs. Net Method

13

Costs Included in Inventory
•

Product costs are those costs that "attach" to the
inventory and are recorded in the inventory
account. These costs include freight charges on
goods purchased, other direct costs of acquisition,
and labor and other production costs incurred in
processing the goods up to the time of sale.

•

Period costs, such as selling expenses and general
and administrative expenses, are not considered
inventoriable costs. The reason these costs are
not included as a part of the inventory valuation
concerns the fact that, in most instances, these
costs are unrelated to the immediate production
process.

Purchase Discounts: Two methods

If the gross method is used, purchase
discounts should be reported as a
deduction from purchases (purchase
discounts) on the income statement.
If the net method is used, purchase
discounts lost should be considered a
financial expense and reported in the
"other expense and loss" section of the
income statement.

Example: Treatment of Purchase
Discounts
Gross Method

Net Method

vs.
|

Purchase cost $20,000, terms 2/10, net 30:
|

Purchases
Accounts payable

20,000

|

20,000

|

Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700

|
|

Invoices of $5,000 are paid after discount period:
|

Accounts payable
Cash

5,000

|

5,000

|
|

Accounts payable
Purchase discount lost
Cash

4,900
100
5,000

16

Example: E8-3
Assuming each of the amounts is material, state whether the
merchandise should be included in the client’s inventory at
12/31/2007.
(1) A special machine, fabricated to order for a customer, was
finished and specifically segregated in the back part of the
shipping room on 12/31/07. The customer was billed on that
date and the machine excluded from inventory although it was
shipped on 1/4/2008.

17

Example: E8-3
(2) Merchandise costing 2,800 was received on 1/3/2008, and
the related purchase invoice recorded 1.5.08. The invoice
showed the shipment was made on 12/29/2007 f.o.b.
destination.

18

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

19

Example: E8-3
(3) A packing case containing a product costing 3,400 was
standing in the shipping room when the physical inventory was
taken. It was not included in the inventory because it was
marked “Hold for shipping instructions.” Your investigation
revealed that the customer's order was dated 12/18/2007, but
that the case was shipped and customer billed on 1/10/2008.
The product was a stock item of your client.

20

Example: E8-3
(4) Merchandise received on 1/6/2008, costing Rs680 was
entered in the purchase journal on 1/7/2008. The invoice
showed shipment was made f.o.b. supplier’s warehouse on
12/31/2007. Because it was not on hand at 12/31, it was not
included in inventory.

21

Example: E8-3
(5) Merchandise costing Rs720 was received on 12/28/2007,
and the invoice was not recorded. You located it in the hands of
the purchasing agent; it was market “on consignment.”

22

What Cost Flow Assumption to
Adopt?
FIFO
LIFO
Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification –
High-ticket items:
Automobiles, Jewelry,
Real estate
23

Cost Flow Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/07 for Rs10

2.

One item on 2/15/07 for Rs15

3.

One item on 2/25/07 for Rs20

Young & Crazy Company sells one item on 2/28/07 for
Rs90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2007,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
24

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
25

Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = Rs 35
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
10
80
14
12
7
33
47
14
Rs 33
26

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
27

Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = Rs 25
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
20
70
14
12
7
33
37
11
Rs 26
28

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
29

Cost Flow Assumptions
“Average Cost”
Inventory
Balance = Rs 30
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
15
75
14
12
7
33
42
12
Rs 30
30

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
31

Cost Flow Assumptions
“Specific Identification”
Inventory
Balance = Rs 45
Purchase on
2/25/07 for Rs20
Purchase on
2/15/07 for Rs15
Purchase on
2/2/07 for Rs10

Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

Rs 90
0
90
14
12
7
33
57
17
Rs 40
32

Special Issues Related to LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.

33

Special Issues Related to LIFO
LIFO Reserve is the difference between the

inventory method used for internal reporting purposes
and LIFO.
FIFO value per books Rs160,000
Example:
LIFO value
145,000
LIFO Reserve
Rs 15,000
Journal entry to reduce inventory to LIFO:
Cost of goods sold
LIFO reserve

15,000
15,000

Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
34

Special Issues Related to LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20

35

Special Issues Related to LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.

36

Special Issues Related to LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.

Use the dollar-value LIFO method to compute the ending
inventory for 2003 through 2005.

37

Special Issues Related to LIFO
Exercise 8-26 Solution
Inventory at

Inventory at

End-of-Year

Base-Year

Base

Prices

Layers

Year
2003
2004

2005

Prices
$

Index

$ Value
Index

$ Value

LIFO

LIFO

LIFO

TOTAL

Reserve

70,000

1.00

$ 70,000

$ 70,000

1.00

90,300

1.05

86,000

70,000

1.00

70,000

16,000

1.05

16,800

70,000

1.00

70,000

12,000

1.05

12,600

95,120

1.16

Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve

82,000

Dec. 31
2003
$
70,000
$
70,000

$

70,000

Dec. 31
2004
$
90,300
(3,500)
$
86,800

Dec. 31
2005
$
95,120
(12,520)
$
82,600

3,500
(3,500)

9,020
(9,020)

$

70,000

$

-

86,800

3,500

82,600

12,520

LO 8 Explain the dollar-value LIFO method.38

Special Issues Related to LIFO
Advantages

Disadvantages

Matching

Reduced earnings

Tax Benefits/Improved
Cash Flow

Inventory understated

Future Earnings Hedge

Physical flow
Involuntary Liquidation /
Poor Buying Habits

39

JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

•
•
•
•

CONTACT:
0322-3385752
0312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI,
PAKISTAN.

40