Chapter 6

Inventory
Costing

Prepared by:
Debbie Musil
Kwantlen University College
Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Determining Inventory Quantities
• All companies must count their inventory at
least once a year
• The determination of inventory quantities
involves
• Taking a physical inventory of goods on hand
• Determining the ownership of the goods
• On board a public carrier as at the count date
• Look at FOB point to determine if they should be
included

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Inventory Costing
• Specific Identification
• Tracks the actual physical flow of goods
• Each inventory item is marked with its cost
• Cost Flow Assumptions
• Specific identification not always practical
• A cost flow assumption is used instead:
• First-in, first-out (FIFO)
• Average cost
• Last-in, first-out (LIFO)
• Flow of costs may not match physical flow
Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 First-in, First-out (FIFO)
• Earliest goods purchased are assumed
the first sold
• Often reflects the actual physical flow of
merchandise
• Costing:
• Costs of earliest goods purchased are first to
be recognized as Cost of Goods Sold
• Costs of most recent goods purchased are
recognized as ending inventory
Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Using FIFO
COST
COSTOF
OFGOODS
GOODSAVAILABLE
AVAILABLEFOR
FORSALE
SALE
Date
Date Explanation
Explanation Units
Units Unit
UnitCost
Cost Total
TotalCost
Cost
J Jan-01
an-01 Beginning
Beginninginventory
inventory 100
100 10
10 $$ 1,000
1,000
Apr-15
Apr-15 Purchase
Purchase 200
200 11
11 2,200
2,200
Aug-24
Aug-24 Purchase
Purchase 300
300 12
12 3,600
3,600
Nov-27
Nov-27 Purchase
Purchase 400
400 13
13 5,200
5,200
Total
Total 1,000
1,000 $$12,000
12,000
Step 1: Ending Inventory Step 2: Cost of Goods Sold
Step 1: Ending Inventory Step 2: Cost of Goods Sold
Date Units Unit Cost Total Cost
Date Units Unit Cost Total Cost
Nov-27 400 $ 13 $5,200 Cost of goods available for sale $ 12,000
Nov-27 400 $ 13 $5,200 Cost of goods available for sale $ 12,000
Aug-24 50 12 600 Less: Ending inventory 5,800
Aug-24 50 12 600 Less: Ending inventory 5,800
Total 450 $5,800 Cost of goods sold $ 6,200
Total 450 $5,800 Cost of goods sold $ 6,200

Alternate Calculation of Cost of Goods Sold

Alternate Calculation of Cost of Goods Sold
Date Units Unit Cost Cost of Goods Sold
Date Units Unit Cost Cost of Goods Sold
J an. 1 100 $10 $1,000
J an. 1 100 $10 $1,000
Apr. 15 200 11 2,200
Apr. 15 200 11 2,200
Aug. 24 250 12 3,000
Aug. 24 250 12 3,000
Total 550 $6,200
Total 550 $6,200

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Average Cost
• Assumes that it is not possible to measure
specific physical flow of inventory
• Therefore better to use an average price
• Allocation of cost of goods available for sale
is based on weighted average unit cost
• This is then applied:
• to units sold to determine cost of goods sold
• to units on hand to determine ending inventory
Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Using Average Cost
COST
COSTOF
OFGOODS
GOODSAVAILABLE
AVAILABLEFOR
FORSALE
SALE
Date
Date Explanation
Explanation Units
Units Unit
UnitCost
Cost Total
TotalCost
Cost
J Jan-01
an-01 Beginning
Beginninginventory
inventory 100
100 10
10 $$ 1,000
1,000
Apr-15
Apr-15 Purchase
Purchase 200
200 11
11 2,200
2,200
Aug-24
Aug-24 Purchase
Purchase 300
300 12
12 3,600
3,600
Nov-27
Nov-27 Purchase
Purchase 400
400 13
13 5,200
5,200
Total
Total 1,000
1,000 $$12,000
12,000
Step 1: Ending Inventory Step 2: Cost of Goods Sold
Step 1: Ending Inventory Step 2: Cost of Goods Sold

Calculate unit cost: $12,000 ÷ 1,000 = $12 Cost of goods available for sale $ 12,000
Calculate unit cost: $12,000 ÷ 1,000 = $12 Cost of goods available for sale $ 12,000
Units Unit Cost Total Cost Less: Ending inventory 5,400
Units + Unit Cost = Total Cost Less: Ending inventory 5,400
450 $12 $5,400 Cost of goods sold $ 6,600
450 $12 $5,400 Cost of goods sold $ 6,600

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Last-in, First-out (LIFO)
• Latest goods purchased assumed to be first sold
• Seldom coincides with actual physical flow of
inventory
• Costing:
• Costs of earliest goods purchased remain in ending
inventory
• Costs of most recent goods purchased are first to be
recognized as Cost of Goods Sold
• Recent changes prohibit its use in Canada

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Using LIFO
COST
COSTOF
OFGOODS
GOODSAVAILABLE
AVAILABLEFOR
FORSALE
SALE
Date
Date Explanation
Explanation Units
Units Unit
UnitCost
Cost Total
TotalCost
Cost
J Jan-01
an-01 Beginning
Beginninginventory
inventory 100
100 10
10 $$ 1,000
1,000
Apr-15
Apr-15 Purchase
Purchase 200
200 11
11 2,200
2,200
Aug-24
Aug-24 Purchase
Purchase 300
300 12
12 3,600
3,600
Nov-27
Nov-27 Purchase
Purchase 400
400 13
13 5,200
5,200
Total
Total 1,000
1,000 $$12,000
12,000

Step 1: Ending Inventory Step 2: Cost of Goods Sold

Step 1: Ending Inventory Step 2: Cost of Goods Sold
Date Units Unit Cost Total Cost
Date Units Unit Cost Total Cost
J an-01 100 $ 10 $1,000 Cost of goods available for sale $ 12,000
J an-01 100 $ 10 $1,000 Cost of goods available for sale $ 12,000
Apr-15 200 11 2,200 Less: Ending inventory 5,000
Apr-15 200 11 2,200 Less: Ending inventory 5,000
Aug-24 150 12 1,800 Cost of goods sold $ 7,000
Aug-24 150 12 1,800 Cost of goods sold $ 7,000
Total 450 $5,000
Total 450 $5,000

Alternate Calculation of Cost of Goods Sold

Alternate Calculation of Cost of Goods Sold
Date Units Unit Cost Cost of Goods Sold
Date Units Unit Cost Cost of Goods Sold
Nov. 27 400 $13 $5,200
Nov. 27 400 $13 $5,200
Aug. 24 150 12 1,800
Aug. 24 150 12 1,800
Total 550 $7,000
Total 550 $7,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Inventory Errors
• Effect of inventory errors on the current
year’s income statement:
Inventory
InventoryError
Error Cost
Costof
ofGoods
GoodsSold
Sold Net
NetIncome
Income
Beginning
BeginningInventory
Inventory
Understate
Understate Understate
Understate Overstate
Overstate
Overstate
Overstate Overstate
Overstate Understate
Understate
Ending Inventory
Ending Inventory
Understate
Understate Overstate
Overstate Understate
Understate
Overstate
Overstate Understate
Understate Overstate
Overstate

• An error in ending inventory of one period

will have the reverse effect on net income
of the next period
Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Balance Sheet Errors
• Effect can be determined by using the
basic accounting equation:
assets = liabilities + owner’s equity
Ending
EndingInventory
Inventory Assets
Assets -- Liabilities
Liabilities == Owner's
Owner'sEquity
Equity
Error
Error

Understate
Understate Understate
Understate -- No
NoEffect
Effect == Understate
Understate
Overstate
Overstate Overstate
Overstate -- No Effect
No Effect == Overstate
Overstate

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Inventory Valuation
• Lower of cost or market – when the value
of inventory is lower than cost, it is written
down to that lower value
• Market is defined as net realizable value
• Selling price less any costs to make the
goods ready for sale
• Assessed on an item-by-item basis

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Inventory Ratios:
Inventory Turnover Ratio
= Cost of goods sold ÷ average inventory
• The number of times inventory “turns over” during a
given period
• Average inventory is usually average of beginning and
ending inventories

Days Sales in Inventory

= Days in year ÷ inventory turnover ratio
• The number of days on average that the inventory is on
hand before being sold
Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Inventory Costing in a Perpetual
Inventory System
• FIFO:
• FIFO rule is applied at the time of each sale*
• Uses the oldest goods on hand before each sale in the
FIFO calculation
• Weighted average:
• New average is calculated after each purchase*
• Usually referred to as moving weighted average
• LIFO:
• LIFO rule is applied at the time of each sale*
• Use the most recent purchases before each sale in the
LIFO calculation

*Instead of at the end of the accounting period

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Perpetual System Inventory
Costing: FIFO
• Ending inventory and cost of goods sold under FIFO is
the same for perpetual and periodic systems
PURCHASES COST OF GOODS SOLD BALANCE
PURCHASES COST OF GOODS SOLD BALANCE
Date Units Cost Total Units Cost Total Units Cost Total
Date Units Cost Total Units Cost Total Units Cost Total
J an. 1 100 $10 $1,000
J an. 1 100 $10 $1,000
Apr. 15 200 $11 $2,200 100 10
Apr. 15 200 $11 $2,200 100 10 3,200
200 11 3,200
200 11
May 1 150 $10
May 1 150 $10 $1,550 150 11 1,650
50 11 $1,550 150 11 1,650
50 11
Aug. 24 300 12 3,600 150 11
Aug. 24 300 12 3,600 150 11 5,250
300 12 5,250
300 12
Sept. 1 150 11
Sept. 1 150 11 4,650 50 12 600
250 12 4,650 50 12 600
250 12
Nov. 27 400 13 5,200 50 12
Nov. 27 400 13 5,200 50 12 5,800
400 13 5,800
400 13
900 $11,000 550 $6,200
900 $11,000 550 $6,200

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Perpetual System Inventory
Costing: Average Cost
• Under a perpetual inventory system, a new weighted
average is calculated after each purchase.
• This average is then applied to:
• Units sold, to determine cost of goods sold
• Remaining units on hand, to determine ending inventory

PURCHASES COST OF GOODS SOLD BALANCE

PURCHASES COST OF GOODS SOLD BALANCE
Date Units Cost Total Units Cost Total Units Cost Total
Date Units Cost Total Units Cost Total Units Cost Total
J an. 1 100 $10.00 $ 1,000.00
J an. 1 100 $10.00 $ 1,000.00
Apr. 15 200 $11.00 $ 2,200.00 300 $10.67 3,200.00
Apr. 15 200 $11.00 $ 2,200.00 300 $10.67 3,200.00
May 1 150 $10.67 $ 1,550.00 150 $10.67 1,600.00
May 1 150 $10.67 $ 1,550.00 150 $10.67 1,600.00
Aug. 24 300 12.00 3,600.00 450 $11.56 5,250.00
Aug. 24 300 12.00 3,600.00 450 $11.56 5,250.00
Sept. 1 400 11.56 4,622.22 50 $12.00 577.78
Sept. 1 400 11.56 4,622.22 50 $12.00 577.78
Nov. 27 400 13.00 5,200.00 450 $12.84 5,777.78
Nov. 27 400 13.00 5,200.00 450 $12.84 5,777.78
900 $11,000.00 550 $ 6,222.22
900 $11,000.00 550 $ 6,222.22

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Perpetual System Inventory
Costing: LIFO
• Latest units purchased before each sale are allocated to cost of
goods sold (versus periodic: latest units bought during the period)
PURCHASES COST OF GOODS SOLD BALANCE
PURCHASES COST OF GOODS SOLD BALANCE
Date Units Cost Total Units Cost Total Units Cost Total
Date Units Cost Total Units Cost Total Units Cost Total
J an. 1 100 $10 $1,000
J an. 1 100 $10 $1,000
Apr. 15 200 $11 $2,200 100 10
Apr. 15 200 $11 $2,200 100 10 3,200
200 11 3,200
200 11
May 1 150 $11 $1,650 100 10
May 1 150 $11 $1,650 100 10 1,550
50 11 1,550
50 11
Aug. 24 300 12 3,600 100 10
Aug. 24 300 12 3,600 100 10
50 11 5,150
50 11 5,150
300 12
300 12
Sept. 1 300 12
Sept. 1 300 12
50 11 4,650 50 10 500
50 11 4,650 50 10 500
50 10
50 10
Nov. 27 400 13 5,200 50 10
Nov. 27 400 13 5,200 50 10 5,700
400 13 5,700
400 13
900 $11,000 550 $6,300
900 $11,000 550 $6,300

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Estimating Inventories
• Not always possible or practical to count
inventory – must be estimated
• Two estimating methods are available
Gross profit method
• Gross profit = net sales x gross profit margin
• Cost of goods sold = net sales less estimated
gross profit
• Estimated ending inventory = goods available
for sale less cost estimated cost of goods sold
Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 Estimating Inventories 2
Retail inventory method
• Cost-to-retail ratio: goods available for sale at
cost / goods available for sale at retail
• Goods available for sale at retail less net
sales = ending inventory at retail
• Ending inventory at retail x cost-to-retail ratio
= estimated cost of ending inventory

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.
 COPYRIGHT

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
© 2009 John Wiley & Sons Canada, Ltd.