Fifo,lifo, average

1. Accounting

2. Dual Nature of Merchandise Transactions
Each merchandising transaction affects a buyer and a seller.
A selling transaction for a seller is purchase transaction for buyer.
Accounts payable for buyer is accounts receivable for seller.

3. Inventories
Control of Inventory
Two primary objectives of control over inventory:
◦ Safeguarding inventory from damage or theft.
◦ Reporting inventory in the financial statements.
Safeguarding inventory
◦ Purchase Order
◦ Receiving Report
◦ Vendor Invoice
Reporting Inventory
◦ Physical Inventory or Count of Inventory should be taken near year-end to make sure that the
quantity of inventory reported in the financial statements is accurate.

4. Periodic vs Perpetual Inventory System
The periodic system relies upon an occasional physical count of the inventory to determine the
ending inventory balance and the cost of goods sold, while the perpetual system keeps continual
track of inventory balances.
The more sophisticated of the two is the perpetual system, but it requires much more record
keeping to maintain.

5. Adjusting Inventory Shrinkage
There are some inventory losses due to shoplifting, employee theft or errors. This is called
Inventory Shrinkage or Inventory Shortage.
Account Balance of Merchandise Inventory $63,950
Physical Merchandise Inventory on hand 62,150
Inventory Shrinkage $ 1,800
Adjusting Entry
Dec 31 Cost of Merchandise Sold 1,800
Merchandise Inventory 1,800
Inventory Shrinkage ($63,950 - $61,150)

6. Cost Flow Assumption
Cost flow is in the order in which the costs were incurred.
First In, First Out (FIFO)
Cost flow is in the reverse order in which the costs were incurred.
Last In, First Out (LIFO)
Cost flow is an average of the costs.
AVERAGE COST

7. Illustration
May 10 Purchased 01 Unit for $9.00
May 18 Purchased 01 Unit for $13.00
May 24 Purchased 01 Unit for $14.00 Average Cost = (9+13+14)/3=36/3=$12.00
May 31 Sold 01 Unit for $20.00
Income statements using different cost methods
FIFO LIFO Average Cost
Sales $20 $20 $20
Cost of Merchandise Sold 9 14 12
Gross Profit $11 $6 $8

8. Inventory Costing Under Periodic
Inventory
Net Sales 3,900
$ 3,900
$ 3,900
$
Cost of Merchandise Sold
Beginning Inventory 2,000
$ 2,000
$ 2,000
Purchases 3,880 3,880 3,880
Merchandise Available for Sale 5,880
$ 5,880
$ 5,880
Less: Ending Inventory 3,250 3,150 3,050
Cost of Merchandise Sold 2,630 2,730 2,830
Gross Profit 1,270
$ 1,170
$ 1,070
$
PARTIAL INCOME STATEMENTS
FIFO Average Cost LIFO

9. Effects of Changing Costs : FIFO, LIFO
Increasing Costs
(Prices)
Decreasing Costs
(Prices)
Highest
Amount
Lowest
Amount
Highest
Amount
Lowest
Amount
Cost of merchandise sold LIFO FIFO FIFO LIFO
Gross profit FIFO LIFO LIFO FIFO
Net income FIFO LIFO LIFO FIFO
Ending merchandise
inventory
FIFO LIFO LIFO FIFO

10. Reporting Merchandise Inventory in the
Financial Statements
Cost is the primary basis for valuing and reporting inventories in the financial
statements. But, inventory may be valued other than cost in the following cases:
The cost of replacing items in inventory is below the recorded cost.
The inventory may not be sold at normal prices due to imperfections, style change, or other
causes.

11. Reporting Merchandise Inventory in the
Financial Statements
◦ If the cost of replacing inventory is lower than its purchase cost, the lower-of-cost-or-market
(LCM) method is used to value the inventory.
◦ Merchandise that is out of date, spoiled, or damaged can often be sold only at a price below its
original cost. Such merchandise should be valued at its net realizable value.
Net Realizable Value = Estimated Selling Price – Direct Costs of Disposal
Net Realizable Value = $800 – $150 = $650
Original cost $1,000
Estimated selling price 800
Selling expenses (special ads, additional commission 150

12. Effects of Inventory Errors on Income
Statement
Income Statement Effects
Inventory Error Cost of Merchandise Sold Gross Profit Net Income
Beginning Inventory is:
Understated Understated Overstated Overstated
Overstated Overstated Understated Understated
Ending Inventory is:
Understated Overstated Understated Understated
Overstated Understated Overstated Overstated

13. Effects of Inventory Errors on Balance
Sheet
Balance Sheet Effects
Ending Inventory Error Merchandise Inventory Current Assets Owner’s Equity
Understated Understated Understated Understated
Overstated Overstated Overstated Overstated