1) Using FIFO, COGS is $45,000 with ending inventory of $33,000. 2) Using LIFO, COGS is $48,000 with ending inventory of $30,000. 3) Using weighted average, COGS is $46,500 with ending inventory of $31,500.

1. Chapter 7
Reporting and Interpreting
Inventories and
Cost of Goods Sold

2. Learning Objectives
1. Describe the issues in managing different types
of inventory.
2. Explain how to report inventory and cost of
goods sold.
3. Compute costs using four inventory costing
methods.
4. Report inventory at the lower of cost or market.
5. Analyze and record inventory
purchases, transportation, returns and
allowances, and discounts.
6. Evaluate inventory management by computing
and interpreting the inventory turnover ratio.

3. Goals of Inventory Management
The primary goals of inventory managers
are to:
 Maintain a sufficient quantity to meet
customers’ needs
 Ensure quality meets customers’
expectations and company standards
 Minimize the costs of acquiring and
carrying the inventory

4. Types of Inventory
Inventory includes:
1. Merchandise inventory: Goods that are held for
sale in the normal course of business.
2. Manufacture inventory: Goods that are used to
produce goods for sale.

5. Types of Inventory
Inventory is acquired in a finished
Merchandiser condition and is ready for sale
without further processing.
Raw materials inventory includes
materials that are processed further
into finished goods.
Work in process inventory includes
Manufacturer goods that are in the process of
being manufactured.
Finished goods inventory includes
goods that are complete and ready to
sell.

6. Balance Sheet Reporting
Matrix, Inc.
Partial Balance Sheet
At December 31, 2008
Assets
Current Assets
Cash and Cash Equivalents $ 47,500
Accounts Receivable, net 94,800
Inventories 75,800
Prepaid Expenses 16,800
Total Current Assets $ 234,900
Inventory is reported on the balance sheet as
a current asset because it normally is used
or converted into cash within one year.

7. Income Statement Reporting
Matrix, Inc.
Income Statement
For the Year Ended December 31, 2008
Sales, net $ 592,800
Cost of Goods Sold 377,500
Gross Profit 215,300
Operating Expenses:
Selling Expenses $ 64,500
General and Administrative Expenses 119,400 183,900
Income Before Taxes 31,400
Income Tax Expense 9,420
Net Income $ 21,980
Multiple-step income statement:
1. Net sales – COGS = Gross Profit.
2. Gross Profit – Operating expenses = Income before Taxes
3. Income before Taxes – Tax expense = Net income

8. Cost of Goods Sold Equation
Beginning Net cost of
inventory
+ purchases
= Merchandise
Still here
Sold
available for sale
Cost of goods
Ending inventory
+ sold

9. Question
Retail Company has the following amounts on
its 2008 inventory operations:
Purchases, $45,000; Beginning 2008
inventory, $15,000; and Cost of goods
sold, $50,000. Therefore, the 2008 ending
inventory was:
a.$10,000.
b.$25,000.
c.$26,000.
d.$27,000.

10. Question
Richmond Company had the following information
taken from its 2008 inventory operations:
Sales, $200; Sales Return and Allowance, $4;
Beginning Inventory, $10; and Purchases, $140.
A physical count of the merchandise on hand at
the end of the year showed $20. Compute the
gross profit that would appear in the income
statement.
a.$70.
b.$74.
c.$66.
d.$62.

11. Cost of Goods Sold Equation
Schedule of Cost of Goods Sold
Beginning inventory
+ Purchases of merchandise
= Cost of goods available for sale
– Ending inventory
= Cost of goods sold
COGS = BI + P – EI
EI = BI + P - COGS

12. Inventory Cost Flow Methods
Example
In Feb 07, Young & Crazy Company starts from zero
inventory balance and makes the following
purchases:
1. One item on 2/2/07 for $10
2. One item on 2/15/07 for $15
3. One item on 2/25/07 for $20
Young & Crazy Company sells one item on 2/28/07
for $90. 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 methods? Assume a tax rate of 30%.

13. Inventory Cost Flow Methods
 May not match physical movement of
goods
 Allocates cost of goods available for sale
between
 Cost of sales $10+15+20=45
 Ending inventory
Merchandise
available for sale
Cost of goods
?
Ending inventory
+ sold ?

14. Inventory Cost Flow Methods
Specific When units are sold, the specific
cost of the unit sold is added to
Identification cost of goods sold.
First-In, First-Out Assumes costs flow in the order
(FIFO) incurred.
Last-In, First-Out Assumes costs flow in the
(LIFO) reverse order incurred.
Weighted Assumes costs flow at an
Average average of the costs available.

15. Specific Identification
When this method
is used, the cost
of each item sold
is individually
identified and
recorded as cost
of goods sold.

16. Specific Identification
Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Depends on which one is sold
Sales $ 90
Cost of goods sold 0
Purchase on Gross profit 90
2/25/07 for $20 Expenses:
Administrative 14
Selling 12
Purchase on Interest 7
Total expenses 33
2/15/07 for $15 Income before tax
Taxes
Net Income
Purchase on
2/2/07 for $10

17. First-In, First-Out (FIFO)
Oldest Cost of
Costs Goods Sold
Recent Ending
Costs Inventory

18. First In First Out (FIFO)
Inventory Balance Young & Crazy Company
= $ 35 Income Statement
For the Month of Feb. 2007
Sales $ 90
Purchase on Cost of goods sold 10
2/25/07 for $20 Gross profit 80
Expenses:
Administrative 14
Purchase on Selling 12
2/15/07 for $15 Interest 7
Total expenses 33
Income before tax 47
Purchase on Taxes 14
2/2/07 for $10 Net Income $ 33

19. Last-In, First-Out (LIFO)
Recent Cost of
Costs Goods Sold
Oldest Ending
Costs Inventory

20. Last In First Out (LIFO)
Inventory Balance Young & Crazy Company
= $ 25 Income Statement
For the Month of Feb. 2007
Sales $ 90
Purchase on Cost of goods sold 20
2/25/07 for $20 Gross profit 70
Expenses:
Administrative 14
Purchase on Selling 12
2/15/07 for $15 Interest 7
Total expenses 33
Income before tax 37
Purchase on Taxes 11
2/2/07 for $10 Net Income $ 26

21. Weighted Average
When a unit is sold, the
average cost of each unit
in inventory is assigned
to cost of goods sold.
Cost of Goods Units on hand
Available for ÷ on the date of
Sale sale
$ 45 / 3 = $15

22. Weighted Average
Inventory Balance Young & Crazy Company
= $ 30 Income Statement
For the Month of Feb. 2007
Sales $ 90
Purchase on Cost of goods sold 15
2/25/07 for $20 Gross profit 75
Expenses:
Administrative 14
Purchase on Selling 12
2/15/07 for $15 Interest 7
Total expenses 33
Income before tax 42
Purchase on Taxes 12
2/2/07 for $10 Net Income $ 30

23. Comparison
Financial Statement Summary
FIFO LIFO Wtd. Avg
Sales $ 90 $ 90 $ 90
Cost of goods sold 10 20 15
Gross profit 80 70 75
Net income 33 26 30
Ending Inventory 35 25 30
Balance
In periods of rising prices, FIFO results in
the highest ending inventory, gross profit,
and net income, and the lowest cost of
goods sold.

24. Comparison
Financial Statement Summary
FIFO LIFO Wtd. Avg
Sales $ 90 $ 90 $ 90
Cost of goods sold 10 20 15
Gross profit 80 70 75
Net income 33 26 30
Ending Inventory 35 25 30
Balance
In periods of rising prices, LIFO results
in the lowest ending inventory, gross
profit, and net income, and the highest
cost of goods sold.

25. Financial Statement Effects of Costing
Methods
Increasing Price Decreasing Price
FIFO LIFO FIFO LIFO
Income
Statement
COGS lower higher higher lower
GROSS PROFIT higher lower lower higher
Net income higher lower lower higher
Balance Sheet
Ending Inventory higher lower lower higher

26. Financial Statement Effects of Costing
Methods
Advantages of Methods
Weighted First-In, Last-In,
Average First-Out First-Out
Ending inventory Better matches
Smoothes out approximates current costs in cost
price changes. current of goods sold with
replacement cost. revenues.

27. Question
When the prices are rising:
a. LIFO will result in lower net income and a
higher inventory valuation than will FIFO.
b. LIFO will result in higher net income and
lower inventory valuation than will FIFO.
c. FIFO will result in lower net income and a
lower inventory valuation than will LIFO.
d. FIFO will result in higher net income and a
higher inventory valuation than will LIFO.

28. Reporting Inventory at the Lower of
Cost or Market
The value of inventory can fall below its
recorded cost for two reasons:
1. It’s easily replaced by identical goods at
a lower cost, or
2. It’s become outdated or damaged.

29. Reporting Inventory at the Lower of
Cost or Market
When the value of inventory falls below
its recorded cost, the amount recorded
for inventory is written down to its lower
market value. This is known as the
lower of cost or market (LCM) rule.
This method is an application of
Accounting Conservatism.

30. Reporting Inventory at the Lower of
Cost or Market
Replacement
Cost (Market
Item Quantity Cost Value) LCM Total LCM
Pentium chips 1,000 $ 250 $ 200 $ 200 $ 200,000
Disk drives 400 100 110 100 40,000
Pentium chips: total cost 1,000 $250 = $250,000
total replacement cost 1,000 × $200 = $200,000
write-down $250,000 - $200,000 = $50,000
Disk drives: No write-downs.

31. Reporting Inventory at the Lower of
Cost or Market
Accounts Debit Credit
Inventory Write-down (+E, -SE) 50,000
Inventory (-A) 50,000
Expense account, listed in
the income statement as
part of operating expenses.

32. Recording Inventory Transactions
We will now look at the accounting
for purchases, transportation costs,
purchase returns and allowances,
and purchase discounts. We will
record all inventory-related
transactions in the Inventory
account.

33. Inventory Purchases
American Eagle Outfitters purchases
$10,500 of vintage jeans on credit.
1 Analyze
Assets = Liabilities + Stockholders' Equity
Inventory –10,500 Accounts Payable +10,500
2 Record

34. Transportation Cost
American Eagle pays $400 cash to a trucker who
delivers the $10,500 of vintage jeans to one of its stores.
1 Analyze
Assets = Liabilities + Stockholders' Equity
Cash - 400
Inventory + 400
2 Record

35. Purchase Returns and Allowances
American Eagle returned some of the vintage jeans to the
supplier and received a $500 reduction in the balance owed.
1 Analyze
Assets = Liabilities + Stockholders' Equity
Inventory - 500 Accounts Payable - 500
2 Record

36. Purchase Discounts
American Eagle’s vintage jeans purchase for $10,500 had
terms of 2/10, n/30. Recall that American Eagle returned
inventory costing $500 and received a $500 reduction in its
Accounts Payable. American Eagle paid within
the discount period.
1 Analyze
Assets = Liabilities + Stockholders' Equity
Cash - 9,800 Accounts Payable -10,000
Inventory -200
2 Record

37. Summary of Inventory Transactions

38. Inventory Turnover Analysis

39. Comparison to Benchmarks

40. In class problem #1: rising price
The following information is available from the firm 's inventory
record.
Units Unit Cost
January 1, 2007 (beginning inventory) 1,500 @ $18.00
Purchases:
January 5, 2007 2,500 @$18.00
February 16, 2007 1,000 @$22.00
March 15, 2007 1,000 @$23.00
A physical inventory count on March 31, 2007 shows 2,500 units
on hand. Compute the COGS for the first three months, and the
ending inventory at March 31, 2007, under each of the following
inventory methods:
(a) FIFO.
(b) LIFO.
(c) Weighted-average.

41. In class problem #2: decreasing price
CGL’s sales revenue is $6,000 and operating expense is
$1,000. CGL’s income tax rate is 35%. Prepare income
statements using following inventory cost flow method:
1. FIFO
2. LIFO
3. Weighted-Average method.
Purchase Sale
# of units price/unit price/unit
Beginning balance 100 $15
1st Purchase 500 $13
2nd Purchase 200 $10
Sale (300) $20
Ending balance 500

42. In class problem #3
Calculate COGS and inventory balance at the end of the year
using FIFO, LIFO and weighted average costing methods:
Beginning inventory of the year 1,000 units @ $15 each
 Mar: Purchase inventory on account 3,000 units@ $18
each.
 Jun: Sold 2,000 units @ $30 each on account.
 Oct: Purchase inventory on account 2,000 units@ $21 each.
 Nov: Sold 1,000 units @ $32 each on account
The company uses a periodic inventory system.