CHAPTER 16 Ending Merchandise Inventory
I. Effect of changes in the dollar amount of the ending inventory and beginning inventory on net income.
A. Understatement and overstatement of ending inventory.
1. If the ending inventory is understated, net income will be understated.
2. If the ending inventory is overstated, net income will be overstated. B. Understatement and overstatement of beginning inventory.
1. If the beginning inventory is understated, net income will be overstated.
2. If the beginning inventory is overstated, net income will be understated. C. Over a two-year period: Since the ending inventory of one year becomes the beginning inventory of the next year, the effect of understating or overstating an ending inventory over a two-year period is equalized. At the end of the two- year period, both ending inventory and ending capital are correct.
II. Methods of assigning costs to the ending inventory—periodic inventory system.
A. Specific identification: Useful for higher-priced durable items that can be specifically identified, such as refrigerators, cars, and televisions.
B. Weighted-average-cost: Determine the total cost of all the units. Divide the total cost by the total number of units available to get the average cost per unit. Multiply the number of units in the ending inventory by the average cost per unit to get the dollar amount of the ending inventory. The “weighted” element refers to the fact that one large purchase at a given price will make up the largest portion of the total cost. Consequently, it will also have a greater effect on the average cost and the dollar amount of the ending inventory.
C. First-in, first-out: Assumes that the oldest stock is sold first. D. Last-in, first-out: Assumes that the newest stock is sold first.
E. Effect of inventory method on net income: In a period of rising prices, LIFO yields the smallest net income. With LIFO, the cost of goods sold is expressed at the most realistic amount. With FIFO, the dollar amount of the ending inventory on the balance sheet is expressed at the most realistic amount.
III. Lower-of-cost-or-market rule. Under certain conditions, when the replacement or market cost is lower than the original cost, the inventory should be valued at the lower amount.
IV. Methods of assigning costs to the ending inventory—perpetual inventory system.
A. When a company uses the perpetual inventory system, the value of the ending inventory and cost of goods sold will be the same under the specific identification method and the first-in, first-out method.
B. When using the moving-average-cost or LIFO method, a running total of the ending inventory must be kept.
V. Perpetual inventory record: Having an inventory record card for each inventory item makes it possible to determine the amount of inventory on hand at any given time.
Idle Company’s beginning inventory of item 273A and dates of purchases and sales for a three-month period are as follows:
NUMBER OF UNITS
PURCHASE PRICE PER UNIT
SELLING PRICE PER UNIT
Idle Company maintains a perpetual inventory using the first-in, first-out method.
1. Record the data for purchases of item 273A and the cost of goods sold for the months of June, July, and August on a perpetual inventory record, using the first-in, first-out method.
2. Determine the total cost of goods sold for item 273A during the three-month period.
3. Determine the total sales of item 273A during the three-month period.
4. Determine the gross profit from