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Costing Merchandise Inventory
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Physical Count Determining Inventory: Estimation Summary Solved Problems Introduction
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In a merchandising business, inventory is merchan dise that is held for resale. As such, it will ordinar ily be converted into cash in less than a year and is thus a current asset. In a manufacturing business, there will usually be inventories of raw materials and goods in process in addition to an inventory of nished goods. Since we have discussed the Merchandise Inventory ac count as it relates to the worksheet, let us now examine how the mer chandise inventory amount is calculated.
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62 BOOKKEEPING AND ACCOUNTING
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Determining Inventory: Physical Count
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Under the periodic method, inventory is physically counted at regular in tervals (annually, quarterly, or monthly). When this system is used, cred its are made to the Inventory account or to Purchases, not as each sale is made, but rather in total at the end of the accounting period. To approach the problem of inventory measurement, in order to as sign the business cost to each item, three methods of valuation (FIFO, LIFO, and weighted average) have been developed and approved by GAAP (Generally Accepted Accounting Practices). To compare these three methods, the following data will be used in all of the following in ventory examples. Date Type 1/1 Inventory 3/10 Purchase 6/6 Purchase 10/4 Purchase Available for sale Units 100 150 200 250 700 Unit Cost $6 8 9 10 Totals $ 600 1,200 1,800 2,500 $6,100
It will be assumed that a physical count of inventory on the last day of the accounting period (December 31) showed 320 units on hand. There fore, 380 units (700 320) were sold during the year.
Remember
When using the periodic method of inventory counting, the physical in ventory is taken at regular intervals. The credits reducing the Inventory account are made at the end of ac counting period, rather than as each sale is made.
Costing Inventory: First-In, First-Out (FIFO)
The rst-in, rst-out (FIFO) method of costing inventory assumes that
goods are sold in the order in which they were purchased. Therefore, the
CHAPTER 10: Costing Merchandise Inventory
goods that were bought rst ( rst-in) are the rst goods to be sold ( rst out), and the goods that remain on hand (ending inventory) are assumed to be made up of the latest costs. Therefore, for income determination, earlier costs are matched with revenue and the most recent costs are used for balance sheet valuation. This method is consistent with the actual ow of costs, since mer chandisers attempt to sell their old stock rst. (Perishable items and highfashion items are examples.) FIFO is the most widely used inventory method of those that will be discussed. Under FIFO, those goods left at the end of the period are considered to be those received last. Therefore, the 320 units on hand on December 31 would be costed as follows: Most recent purchase (10/4) Next most recent purchase (6/6) Ending inventory 250 units @ $10 = $2,500 70 units @ $ 9 = 630 320 units $3,130
The latest cost of the inventory consists of 250 units at $10. Howev er, since the ending inventory consists of 320 units, we must refer to the next most recent purchase of 70 units at $9. Therefore, you could say that the process for determining the cost of the units on hand involves work ing backward through the purchases until there is a suf cient quantity to cover the ending inventory count. Thus the ending inventory under the FIFO method would be valued and recorded at $3,130. The costs of goods sold can be determined by subtracting the value of the ending inventory from the total value of the inventory available for sale ($6,100 $3,130 = $2,970). Since 320 units remain as ending in ventory, the number of units sold is 380. It should be noted that as a method of assigning costs, FIFO may be used regardless of the actual physical ow of merchandise. Indeed, we might say that FIFO really stands for rst-price in, rst-price out. In a pe riod of rising prices, in ation, the FIFO method will yield the largest in ventory value, thus resulting in a larger net income. This situation occurs because this method assigns an inventory cost based on the most recent, higher costs. Conversely, the FIFO method would produce a smaller cost of goods sold, because the earlier, lower costs are assigned to the cost of goods sold.
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