Management countries developed underground

Course

1. chapter 2: Acct for inventories
•Defn. inventory is an item held by a business
enterprise for resale purpose or for
manufacturing purpose.
Two major classes of inventories are:
1)Inventories of merchandise business
Merchandise inventory
2)Inventories of manufacturing business
Direct material inventory
WIP
FGS

2. . There are many controlling mechanisms of
inventories
Safeguarding the inventory from damage or
theft
Using stock card
Recording
Counting
Segregation of duties b/n the store keeper and
the accountant
Using computerized system

3. .
The effect of inventory errors on the F/s
Inventory affects both the balance sheet
and income statement
Statement of CGS
BI……………………………...xx
Add: Net purchase…………. xx
CGSAFS………………………xx
Less: EI……………………… .xx
CGS…………………………… xx

4. . Or CGS= BI + Net purchase-EI
CGS=CGSAFS-EI
CGSAFS=CGS+EI
GP= Sales-CGS
NI=GP-OE
Therefore, when we made an error on EI,
will cause error on CGS, this in turn will
affect GP & NI.
4

5. .
EX: X co. reported cost of goods sold as follows:
2007 2008
BI……………………..$10,000………$20,000
Add: net purchase…130,000………150,000
CGSAFS…………….140,000……….170,000
Less: EI……………… 20,000…………30,000
CGS…………………$120,000……….$140,000

6. .
Additional information;
X co. made an error in computing EI for
2000.
Case 1: In 2007 EI is $ 20,000(correctly stated)
Case 2: In 2007 EI is $ 12,000
Case 3: In 2007 EI is $ 27,000
Required:
A)compute the incorrect CGS for 2007 & 2008.
B)Prepare I/s of the Co. assuming sales of $250,000
& $300,000 and operating expense of $30,000 &
$20,000 for the two years respectively.

7. .
Case 2:
a)Error adjustment
2007 year EI was under stated by $8,000,
Therefore, 20,000-8,000=$12,000
2007 2008
BI……………………..$10,000………$ 12,000
Add: net purchase…130,000………150,000
CGSAFS…………….140,000……….162,000
Less: EI……………… 12,000…………30,000
CGS…………………$128,000……..$132,000

8. XYZ
I/S
For the month ended

.
2007 2008
correct incorrect correct incorrect
Sales 250,000 250,000 300,000 300,000
BI 10,000 10,000 20,000 12,000
ADD: net purchase 130,000 130,000 150,000 150,000
CGSAFS 140,000 140,000 170,000 162,000
Less: EI 20,000 12,000 30,000 30,000
CGS 120,000 128,000 140,000 132,000
GP 130,000 122,000 160,000 168,000
Less: OE 30,000 30,000 20,000 20,000
NI 100,000 92,000 140,000 148,000
8

9. .
Case 3:
a)Error adjustment
2007 year EI was over stated by $7,000,
Therefore, 20,000+7,000=$27,000
2007 2008
BI……………………..$10,000………$ 27,000
Add: net purchase…130,000………150,000
CGSAFS…………….140,000……….177,000
Less: EI……………… 27,000…………30,000
CGS…………………$113,000……..$147,000

10. XYZ
I/S
For the month ended

.
2007 2008
correct incorrect correct incorrect
Sales 250,000 250,000 300,000 300,000
BI 10,000 10,000 20,000 27,000
ADD: net purchase 130,000 130,000 150,000 150,000
CGSAFS 140,000 140,000 170,000 177,000
Less: EI 20,000 27,000 30,000 30,000
CGS 120,000 113,000 140,000 147,000
GP 130,000 137,000 160,000 153,000
Less: OE 30,000 30,000 20,000 20,000
NI 100,000 107,000 140,000 133,000
10

11. Relationship
Current period R/s Next period R/s
BI & CGS Direct No R/s
BI & GP, NI Indirect No R/s
EI & CGS Indirect Direct
EI & GP, NI Direct Indirect
EI & Asset , Capital Direct No R/s
Note: all are current
period data
Note: BI is current
period data and the rest
are next period data
11

12. Inventory systems
There are two principal inventory systems;
Periodic
Perpetual
1) periodic: under this system, there is no
continuous records of merchandise inventory
account. The inventory balance remains the
same throughout the accounting period i.e.
the BI balance. This is b/c when goods are
purchased, they are debited to the purchase
account.
12

13. The revenue from sales is recorded at the
time of sale. No entry is made to record for
the CGS. So, physical inventory must be
taken periodically to determine the cost of
inventory on hand & CGS.
2) perpetual: under this system, there is
continuous records of merchandise
inventory account. The inventory balance
will not remain the same in the accounting
period. when goods are purchased, they
are debited to the merchandise account.
No need of physical counting to determine
their costs.

13

14. .
Periodic Perpetual
Purchase …………………xx
A/P/cash…………………………xx
Inventory …………………xx
A/P/cash…………………………xx
A/R/ cash…………………xx
sales ……………………………..xx
A/R/ cash…………………xx
sales ……………………………..xx
No entry CGS………………………..xx
Inventory …………………………xx
A/P/ cash………………….xx
Purchase R/A………………………..xx
A/P/ cash………………….xx
Inventory……..…………………..xx
IS………………………….xx
BI…………………………………….xx
No entry
EI…………………………..xx
IS…………………………………….xx
No entry
14

15. Inventory costing methods
A) using periodic inventory systems
It determines CGS and inventory on hand at
the end of the period.
There are four methods commonly used in
assigning costs to inventory & CGS
These are:
1)First in First out
2)Last in First out
3)Weighted average

15

16. 1) first in first out
The earliest items are sold first.
CGS is calculated from the earliest purchased items
EI cost is calculated from the recent purchased items
EX: assume the ff inventory data for XXYZ co.
Jan 1 BI………………..80 units @ $60..$4,800
February 16 purchase…400 units @ $56..22,400
September 2 purchase…160 units @ $50..8,000
November 26 purchase …320 units @ $46..14,720
December 4 purchase .240units @ $40..9,600
Total …………………1200……………$59,520
16

17. .
Note: there are 400 units of commodity at the end
of the period.
Required: determine the CGS & the cost of EI
(periodic inventory used)
Solns: 400 units in the EI, 800 units were
sold.

17
EI CGS
Dec 4 240 $40 $9,600 Jun1 80 $60 $4,800
Nov 26 160 46 7,360 Feb 16 400 56 22,400
Total $16,960 Sep 2 160 50 8,000
Nov 26 160 46 7,360
Total $42,560

18. 2) Last in first out
The last items are sold first.
CGS is calculated from the last purchased items
EI cost is calculated from the earliest purchased
items
EX: consider the above example
Solns: 400 units in the EI, 800 units were sold.

18
EI CGS
Jan 1 80 $60 $4,800 Dec 4 240 $40 $9,600
Feb 16 320 56 17,920 Nov 26 320 46 14,720
Total $22,720 Sep 2 160 50 8,000
Feb 16 80 56 4,480
Total $36,800

19. 3) Weighted average
CGS and EI calculated by using the average
unit cost
Average unit cost = CGSAFS/ total units available for sale
Solns: AUC= 59,520/1200= $49.60
Cost of EI= units in the EI X AUC
= 400 X 49.60=$19,840
CGS= units in the CGS X AUC
= 800 X 49.60 = $39,680
19

20. Comparisons of inventory costing methods
•If prices change, the three costing methods
provides different amounts for
EI
CGS
GP & NI

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Case=01, if
price
increase
FIFI Average LIFO
Higher EI B/n the two Lower EI
Lower CGS Higher CGS
Higher GP/NI Lower GP/NI

21. .
.
21
Case=02, if
price
decrease
FIFI Average LIFO
Lower EI B/n the two Higher EI
Higher CGS Lower CGS
Lower GP/NI Higher GP/NI

22. B) Using perpetual inventory system
•It determines CGS & cost of EI at the time of
each sale.
EX: the ff data related to merchandise of B
company.
Unit Cost
April 3 purchase……4,000 ………$8
April 10 purchase…..12,000….…..8.8
April 26 sales …..….8,000
April 29 purchase …4,000………..8.3
Required: compute the CEI & the CGS (using
perpetual inventory system) 22

23. Solns: a) FIFO method
Date Purchase CGS EI
Q UC TC Q UC TC Q UC TC
April 3 4,000 8 32,000 4,000 8 32,000
April 10 12,000 8.8 105,600 4,000
12,000
8
8.8
32,000
105,600
April 26 4,000
4,000
8
8.8
32,000
35,200
8,000 8.8 70,400
April 29 4,000 8.3 33,200 8,000
4,000
8.8
8.3
70,400
33,200
Total 67,200 103,600
23

24. b) LIFO method
Date Purchase CGS EI
Q UC TC Q UC TC Q UC TC
April 3 4,000 8 32,000 4,000 8 32,000
April 10 12,000 8.8 105,600 4,000
12,000
8
8.8
32,000
105,600
April 26 8,000 8.8 70,400 4,000
4,000
8
8.8
32,000
35,200
April 29 4,000 8.3 33,200 4,000
4,000
4,000
8
8.8
8.3
32,000
35,200
33,200
Total 67,200 100,400
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25. c) Weighted average method
Date Purchase CGS EI
Q UC TC Q UC TC Q UC TC
April 3 4,000 8 32,000 4,000 8 32,000
April 10 12,000 8.8 105,600 16,000 8.6 137,600
April 26 8,000 8.6 68,800 8,000 8.6 68,800
April 29 4,000 8.3 32,200 12,000 8.5 102,000
Total 68,800 102,000
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26. Valuation on inventory other than cost
Accounting principles require that
inventory be reported at cost. However,
sometimes it might be reported at other
than cost. This is happen when
Market value of inventory is less than the
recorded cost
Due to different reasons, the inventory
may not be salable at normal selling price.

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27. In the above case, inventory can be valued using:

1)the lower of cost or market(LCM) method
2)The net realizable value(NRV) method
1) LCM
LCM can be used if the market value of
inventory is lower than the recorded cost
Cost is the acquisition price of an
inventory computed using one of the
historical cost methods. Where as,
market is defined as the current market
value(cost of replacing inventories)
27

28. Steps in applying the LCM method
1) compute the cost of inventory
2) checking the current market value of inventory from
the suppliers
3) if market > cost; report inventory at cost, ignore the
unrealized gain
if market< cost, report inventory at market, record
the loss
28

29. LCM is applied in one of the three ways
•A) separately to individual items
•B) to major categories of items
•C) to the whole of inventory
29

30. EX: assume the ff inventory data for ABC co.

LCM Application
Inventory
category
Cost Market To
individual
item
To major
item
Total
inventory
Category 1
Item A 6,000 5,000 5,000
Item B 4,000 6,000 4,000
Sub total 10,000 11,000 10,000
Category 2
Item C 5,500 4,500 4,500
Item D 2,500 2,000 2,000
Sub total 8,000 6,500 6,500
Total 18,000 17,500 17,500
Valuation of inventory 15,500 16,500 17,500
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31. 2) NRV
NRV can be used if the inventory facing different
problems.
NRV=estimated selling price-direct selling expense
EX: assume that a damaged merchandise that had a
cost of $1,000 can be sold only $800 & direct
selling expenses are estimated to be $150.
Required : compute the NRV
NRV=800-150= $650
It is reported at $ 650 & loss of $350(1,000-650)
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32. Estimating cost of inventory
In practice, an inventory amount is estimated for
different reasons
It can be impossible to maintain perpetual inventory
records
It may be too costly to take physical inventory
Natural disaster may be happened .
To estimate the cost of inventory, two methods are
used
1)The retail method
2)The gross profit method
32

33. 1) Retail method of inventory costing
As the name implies that this method is mostly
used by retail business. The estimate is made
based on the r/s b/n the cost and the retail price
of merchandise available for sale.
33

34. The steps to be followed are:

Step 1: determine the total cost of goods
available for sale at cost and at retail
Step 2: calculate the cost to retail ratio
cost to retail ratio = CGSAFS at cost/ CGSAFS at retail
Step 3: calculate the EI at retail
EI at retail = CGSAFS at retail-net sales
Step 4: calculate the estimated cost of EI
Estimated cost of EI = cost to retail ratio X EI at retail
34

35. 2) Gross profit method of inventory costing
•This method uses estimated gross profit
rate during the period to estimate the cost
of inventory.
35

36. The steps to be followed are:

Step 1: determine the total cost of goods
available for sale at cost
Step 2: calculate the estimated gross profit
Estimated GP = GP rate X Net sales
Step 3: calculate the estimated CGS
Estimated CGS = Net sales - Estimated GP
Step 4: calculate the estimated cost of EI
Estimated cost of EI = CGSAFS - Estimated CGS

36

37. . EX: the ff data relates to merchandise
inventory of XYZ co.
cost retail
BI……………………..$14,000………$21,500
Add: Net purchase…..61,000………78,500
CGSAFS……………..75,000……….100,000
Net sales……………………………$70,000
Estimated GP rate…………………30%
Required: estimate the cost of EI using
retail method and gross profit method
37

38. a) Retail method
CGSAFS at cost= 75,000, CGSAFS at retail=100,000
cost to retail ratio=CGSAFS at cost/ CGSAFS at retail
= 75,000/100,000= 75%
EI at retail= CGSAFS at retail - net sales
= 100,000 - 70,000 = 30,000
Estimated cost of EI = cost to retail ratio X EI at retail
75% X 30,000 = 22,500
38

39. b) Gross profit method
CGSAFS at cost= 75,000
Estimated GP rate X net sales
= 30% X 70,000= 21,000
Estimated CGS= net sales – Estimated GP
= 70,000-21,000 = 49,000
Estimated cost of EI = CGSAFS at cost - Estimated
CGS
= 75,000 - 49,000= 26,000

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