Deitz J.E., Southam J.L. Contemporary Business Mathematics for Colleges
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INVENTORY SHEETS
At least once each year, businesses undertake a physical inventory—an actual counting
of the merchandise on hand. Some stores that require close control take a physical inven-
tory every six months, quarterly, or even monthly. Sometimes retail stores use outside
firms that specialize in taking inventory.
When inventory is counted, a description of each item, the quantity, the unit cost or
retail price, and the extension (quantity 3 price) are recorded on an inventory sheet, as
shown in Figure 17-1. The inventory value is then compared with accounting records,
and any needed adjustments are made.
A company’s inventory is the amount of goods it has on hand at any particular time.
Retailers and wholesalers have only one kind of inventory—merchandise, which are the
goods they sell.
344 Part 5 Business Applications
Accounting for Inventory
1
Learning Objective
Account for inventory by inventory
sheets and reports from a perpetual
inventory system.
17.1 A restaurant must keep
supplies of meat,potatoes,and
other foodstuffs to prepare its
menu items.These are counted and
constitute the physical inventory
for such establishments.
WARREN’S AUTO PARTS
Inventory Sheet
April 30, 20—
Unit Price
Description Quantity (Average Cost) Extension
Ignition terminals—#746083 318 $36.14 $11,492.52
Odometer cables—#007614 73 9.97 727.81
Wiper blades, compact—#417654 38 4.71 178.98
Spark plugs, 0.14—#772034 354 2.34 828.36
Hood/truck latches—#476508 58 13.42 778.36
Total $14,006.03
Figure 17-1 Inventory Sheet
PERPETUAL INVENTORY SYSTEMS
Some firms keep a perpetual inventory—a running count of all inventory items, based
on tracking each item as it comes into and goes out of inventory. In businesses that
handle high-cost items, such as cars or large appliances, the perpetual system keeps track
of each item by serial number and price.
Businesses that handle small items, such as candy bars or shoes, have difficulty
identifying each specific item. Their perpetual inventory systems keep a count of the
number of units on hand, not individual prices and serial numbers.
Data for a perpetual inventory system are usually kept on a computer. Figure 17-2
illustrates a computer printout of an inventory record sheet. The last item in the Balance
on Hand column shows how many units are on hand on the 4/30 recording date—354
Quickstart spark plugs: 0.14, part number 772034.
Chapter 17 Inventory and Turnover 345
WARREN’S AUTO PARTS
Inventory Record Sheet
ITEM: QUICKSTART SPARK PLUG: 0.14 ORDER FROM:
Northwest Distributors
PA RT NUMBER: #772034 2337 Colfax Avenue
Milbrae, CA 93233
LOCATION: Aisle 72, Bin 4, Box C Phone—(415) 345-7654
MINIMUM STOCK: 200 MAXIMUM STOCK: 800 ORDER: 100–800
Purchase Orders (PO) Inventory Control
Source Units UnitUnits Balance
Date PO No. Quantity Date Code In Cost Out on Hand
2/03 F0129 400 1/01 — $2.10 350
3/15 M1678 300 1/31 SJ01 120 230
3/22 M2076 200 2/28 SJ02 58 172
4/26 A3210 400 3/02 F0129 400 2.36 572
3/31 SJ03 315 257
4/03 M1678 300 2.40 557
4/20 M2076 200 2.64 757
4/30 SJ04 403 354
Note: The 400 units ordered 4/26 have not yet been received.
Figure 17-2 Inventory Sheet
The CompuParts wholesale computer store maintains a perpetual inventory of computer
parts received, removed, or shipped out.The following inventory record sheet shows the
data for May. Compute the balance on hand after each transaction.
COMPUPARTS WHOLESALE
Inventory Record Sheet
ITEM: MONITOR CORD #A718
Location: BIN #C7
Minimum Stock: 250 Maximum Stock: 1,000
Units UnitUnits Balance
In Cost Out on Hand
5/01 $15.40 390
5/11 470 $15.80 860
5/15 260 600
5/28 320 $15.90 920
5/31 410 510
✔
CONCEPT CHECK 17.1
Order From:
Myers Distributors
1422 Oak Drive
Stockton, CA 97777
Fax: 209-775-7823
In all inventory systems, the cost of the inventory on hand at the end of the period is
called ending inventory (EI). The ending inventory must be computed before financial
statements can be prepared.
To compute ending inventory, a business usually adopts one of three cost methods:
average cost; first-in, first-out (FIFO); or last-in, first-out (LIFO). Once selected, the
method must be followed consistently. We use the cost data from Figure 17-2 to illustrate
computations for the three cost methods.
346 Part 5 Business Applications
Computing Inventory, Using the Average Cost,
FIFO, and LIFO Methods
2
Learning Objective
Compute inventory value by the
average cost, LIFO, and FIFO
methods.
THE AVERAGE COST METHOD
The average cost method is based on the assumption that the cost for each item on hand
is the average cost for items from the opening inventory and items purchased during the
period.
EXAMPLE A
The average cost of the units on the inventory record sheet for stock part #772034
(Quickstart spark plugs: 0.14) is computed as follows:
Units
Date Purchased Cost Extension
1/01 350 $2.10 $ 735.00
3/02 400 2.36 944.00
4/03 300 2.40 720.00
4/20 200 2.64 0528.00
1,250 $2,927.00
Average cost per unit: $2,927 4 1,250 5 $2.34
Ending inventory (EI) at average cost: 354 units 3 $2.34 5 $828.36
THE FIFO METHOD
The first-in, first-out (FIFO) costing method is based on the assumption that the cost
for units sold is determined in the order in which the units were purchased. Thus, the
cost of the inventory remaining is assumed to be based on the price of the units received
most recently.
17.2 In periods of rising costs,the FIFO
method will result in higher gross
profit;in periods of decreasing costs,
the FIFO method will result in lower
gross profit.Just the opposite is true for
the LIFO method.In periods of rising
costs,the LIFO method will result in
lower gross profit; in periods of
decreasing costs, the LIFO method will
result in higher gross profit.
EXAMPLE B
Under the FIFO method, the inventory of 354 units would consist of the 200 units last
purchased plus 154 units from the preceding purchase.
Date
4/20 200 units 3 $2.64 5 $528.00
4/03
154 units 3 $2.40 5 369.60
354 $897.60 Ending inventory at FIFO cost
THE LIFO METHOD
The last-in, first-out (LIFO) costing method is based on the assumption that the cost of
the inventory remaining is determined by the cost of the units purchased the earliest.
Chapter 17 Inventory and Turnover 347
EXAMPLE C
Under the LIFO method, the 354 units would consist of the 350 units on hand on 1/01
plus 4 units from the first purchase on 3/02.
Date
1/01 350 units 3 $2.10 5 $735.00
3/02 4 units 3 $2.36 5 9.44
354 $744.44 Ending inventory at LIFO cost
Units
Date Purchased Cost Extension
1/01 2,000 $2.00 $ 4,000
1/30 200 2.10 420
2/20 700 2.10 1,470
3/17 1,100 2.00 2,200
10/30 500 2.20 1,100
11/17 500 2.10 1,050
5,000 $10,240
✔
Average Cost: $10,240 4 5,000 5 $2.048
1,500 3 $2.05 (rounded) 5 $3,075
FIFO: (500 3 $2.10) 1 (500 3 $2.20) 1
(500 3 $2.00) 5 $3,150
LIFO: (1,500 3 $2.00) 5 $3,000
The inventory record sheets for hairbrushes at Debbie’s Beauty Supply show 5,000 units purchased (or on hand) at
a total cost of $10,240.The inventory at year’s end was 1,500 units. Compute the value of the ending inventory by
each of the three methods: average cost, FIFO, and LIFO.
CONCEPT CHECK 17.2
Computing Inventory at the
Lower of Cost or Market Value
Financial statements usually present the ending inventory at its cost value, computed by
using the average, FIFO, or LIFO costing method. However, in some cases the market
value (current replacement cost) of goods is lower than the original or average cost of
those goods. Most companies prefer to show the lower of cost or market value in their
inventories. When market value exceeds the cost, the cost is used; when the cost exceeds
market value, market value is used.
Compute inventory by using the
lower of cost or market value.
3
Learning Objective
348 Part 5 Business Applications
17.3 Examples of inventory with a
current market value lower than cost
include fashion merchandise carried
in inventory so long that its value has
fallen below what the merchant
originally paid,and electronic
equipment that was state-of-the-art
when originally purchased but was
soon superseded by more advanced
and cheaper equipment.
to Determine the Lower of Cost or Market (LCM) Inventory Value
1. Compute the unit or total cost for each type of inventory item using the
average, FIFO, or LIFO costing method.
2. Determine the market value for each inventory item.
3. Compare the cost value from Step 1 with the market value from Step 2
and choose the lower of the two.
4. Compute the extension amount for each item based on the lower
amount.
5. Sum the amounts in Step 4 to determine the total inventory value under
LCM.
STEPS
EXAMPLE D
Under LCM, using the average cost method illustrated in example A, the total inventory shown in Figure 17-1 would be
valued at $13,802.13.
(B) (C) (D)
(A) Unit Price Unit Price Lower of
Description Quantity (Average Cost) at Market (B) or (C) Extension (A 3 D)
Ignition terminals—#746083 318 $36.14 $35.50 $35.50 $11,289.00 Market
Odometer cables—#007614 73 9.97 11.00 9.97 727.81 Cost
Wiper blades, compact—#417654 38 4.71 4.70 4.70 178.60 Market
Spark plugs, 0.14—#772034 354 2.34 2.64 2.34 828.36 Cost
Hood/trunk latches—#476508 58 13.42 14.10 13.42 778.36 Cost
Total $13,802.13
STEP 5
STEP 4STEP 3STEP 2STEP 1
EXAMPLE E
Under LCM, using the FIFO cost method illustrated in example B, the FIFO cost for the
inventory for Quickstart spark plugs would be $897.60. Combining LCM with FIFO for
the Quickstart spark plugs illustrated in example B, the ending inventory for this one
item would be valued at $897.60 because the market value ($934.56) is higher than the
FIFO cost.
Market Value
(C) (D)
(A) (B) Unit Price Total Lower of
Description Quantity FIFO Cost at Market (A 3 C) (B) or (D)
Spark plugs 354 $897.60 $2.64 $934.56 $897.60 Cost
For monthly financial statements, inventory frequently is estimated without a physical
count or a perpetual inventory system. The method usually used to estimate month-end
inventory is called the gross profit method. This method involves estimating the cost of
goods sold and subtracting this amount from the sum of the opening inventory and pur-
chases made during the month. Note that beginning inventory (BI) is the ending inven-
tory from the month before and purchases (P) are those goods for sale that have been
purchased during the current month. The gross profit method is based on the formula
Beginning inventory (BI)
1 Purchases (P)
Cost of goods available for sale
2 Cost of goods sold (CGS) (estimated)
Ending inventory (EI) (estimate)
Without a physical inventory, a precise cost of goods sold can’t be determined. In this
case, it is estimated by applying a markup percentage rate to net sales (total sales less
sales returned and adjustments for the period). The net sales (100%) less this markup
rate (percent) equals the cost of goods sold (percent). For instance, if the markup rate
were 30%, the cost of goods sold would be 100% 2 30% 5 70%. If the rate of markup
were 40%, the cost of goods sold would be 100% 2 40% 5 60%.
Chapter 17 Inventory and Turnover 349
L & L Records’inventory shows the following. Compute the inventory value at the lower of cost or market value.
Description Quantity Cost Market Extension
Classical #3 300 $ 7.07 $10.10 $2,121.00 Cost
Western #8 180 9.10 8.07 1,452.60 Market
Modern—light #11 410 11.17 12.08 4,579.70 Cost
Rock—new #4 89 12.10 12.10 1,076.90 Cost/market
Total $9,230.20
✔
CONCEPT CHECK 17.3
Estimating Inventory Value
Estimate inventory by using cost of
goods sold.
4
Learning Objective
17.4 Usually,the percent of markup
used to estimate cost of goods sold will
be slightly lower than the standard or
average percent of markup used by the
retailer.A lower rate is used to account
for special discounts,theft,loss through
breakage,and the like.
EXAMPLE F
Assume that Warren’s Auto Parts had a beginning inventory of $80,000. During the
month, the company purchased and received $50,000 in goods and had net sales of
$90,000. Throughout the month, Warren’s maintained a 40% markup on all sales. Its
cost of goods sold would be computed as follows:
Net sales for the month $90,000
Cost of goods sold (estimated) $54,000 [$90,000 3 (100% 2 40%) 5 $90,000 3 0.60]
Warren’s Auto Parts would then determine its ending inventory (estimated) as follows:
Inventory, beginning of month $ 80,000
Purchases for month 1 50,000
Goods available for sale $130,000
Cost of goods sold (estimated) 2 54,000
Ending inventory (estimated) $ 76,000
© JEREMY WEE/ISTOCKPHOTO
INTERNATIONAL
Inventory turnover is the number of times the average inventory is converted into sales
during the year. Inventory turnover is very high for a grocery store or ice cream parlor; it
is very low for a specialty jewelry store or an antique shop. Standard turnover rates for
corporate businesses are published. Some standard rates are 3.5 for hardware stores, 12.7
for grocery stores, 3.3 for nurseries, and 39.3 for stations and mini-marts.
Before turnover can be determined, average inventory must be calculated. Average
inventory is the average of the inventories taken over a specific period of time—
annually, semiannually, quarterly, or monthly.
Inventory is taken Average inventory (at retail or cost)
Annually (once a year) (BI 1 EI) 4 2
Semiannually (every six months) (BI 1 end of 6 months 1 EI) 4 3
Quarterly (every three months) (BI 1 3 quarterly 1 EI) 4 5
Monthly (every month) (BI 1 11 monthly 1 EI) 4 13
Sometimes a company’s markup rate is based on cost rather than selling price. In this
case, if the markup on cost were 30%, the cost of goods sold would be net sales divided
by 130%. If the markup on cost were 40%, the cost of goods sold would be net sales
divided by 140%.
350 Part 5 Business Applications
EXAMPLE G
Assume that Warren’s Auto Parts had a beginning inventory of $80,000. During the
month, it had purchases of $50,000 and net sales of $90,000. Throughout the month,
Warren’s maintained a markup of 50% based on cost. What were Warren’s cost of goods
sold and ending inventory?
Beginning inventory $80,000
Purchases 1 50,000
Cost of goods available for sale $130,000
Cost of goods sold (estimated) 2
60,000 ($90,000 4 150%)
Ending inventory (estimated) $70,000
C & S Electronics’ records show the following.Compute the estimated ending inventory
at cost.
Beginning inventory $24,000 Net sales for period $60,000
Purchases for period $33,000 Markup based on retail 40%
$24,000 1 $33,000 5 $57,000 cost of goods available
$60,000 3 60% 5 $36,000 cost of goods sold
$57,000 2 $36,000 5 $21,000 ending inventory
✔
CONCEPT CHECK 17.4
Computing Inventory Turnover
5
Learning Objective
Compute inventory turnover.
17.5 Inventory turnover is becoming
extremely important to large retail
outlets such as Target,Kmart,Office
Depot,and Sears.Many stock market
analysts use inventory turnover in
evaluating retail stores’relative
strength.
Computation of inventory turnover can be based on either retail (selling) price or
cost. Inventory turnover at retail is net sales divided by average inventory.
Chapter 17 Inventory and Turnover 351
to Compute Inventory Turnover at Retail
1. Determine net sales.
2. Compute average inventory using retail price.
3. Compute inventory turnover at retail: Net sales 4 Average inventory at
retail.
STEPS
EXAMPLE H
Assume that inventories for the year, based on selling price, are as follows: beginning,
$90,000; end of month 3, $80,000; end of month 6, $100,000; end of month 9, $70,000;
and end of month 12 (ending), $60,000. Net sales for the year are $520,000. Compute the
inventory turnover at retail.
Average inventory 5 ($90,000 1 $80,000 1 $100,000 1 $70,000
1 $60,000) 4 5
5 $400,000 4 5 5$80,000
Inventory turnover at retail 5 $520,000 net sales
4 $80,000 average inventory 5 6.5 times
Note: The value of net sales and average inventory must both be figured at retail.
STEP 3
STEP 2
Some retailers prefer to express their rate of inventory turnover in terms of cost.
Inventory turnover at cost is obtained by dividing the cost of goods sold (CGS) during
a period by the average inventory for the same period computed at cost prices. (CGS is
simply net sales at cost.)
to Compute Inventory Turnover at Cost
1. Compute the cost of goods sold using the formula BI 1 P 2 EI 5 CGS.
2. Compute the average inventory at cost.
3. Compute inventory turnover at cost: Cost of goods sold 4 Average
inventory at cost.
STEPS
© COMSTOCK IMAGES/JUPITERIMAGES
352 Part 5 Business Applications
EXAMPLE I
Assume that beginning inventory cost $60,000, purchases cost $300,000, and ending
inventory cost $80,000. Compute the inventory turnover at cost.
Cost of goods sold: Inventory at beginning of year $ 60,000
Purchases during year 1
300,000
Goods available for sale $ 360,000
Inventory at end of year 2 80,000
Cost of goods sold $ 280,000
Average inventory 5 ($60,000 BI 1 $80,000 EI) 4 2
5 $140,000 4 2 5 $70,000
Inventory turnover at cost 5 $280,000 cost of goods sold
4 $70,000 average inventory 5 4.0 times
Note: The value of goods sold and average inventory must both be figured at cost.
STEP 3
STEP 2
STEP 1
Brinkman Scooter Shop has two branches (A and B), each using a markup of 50% of retail. Compute ending inven-
tory, average inventory, and inventory turnover based on retail for each branch from the following data.Round
answers to the nearest hundreth.
Branch
A Branch B
Net sales $1,400,000 $1,200,000
Beginning inventory 220,000 300,000
Inventory (March 31) 190,000 400,000
Inventory (June 30) 280,000 350,000
Inventory (September 30) 280,000 360,000
Inventory (December 31) 200,000 300,000
Average inventory: A—($220,000 1 190,000 1 280,000 1 280,000 1 200,000) 4 5 5 $234,000
B—($300,000 1 400,000 1 350,000 1 360,000 1 300,000) 4 5 5 $342,000
Retail turnover: A—$1,400,000 4 $234,000 5 5.98
B—$1,200,000 4 $342,000 5 3.51
COMPLETE ASSIGNMENTS 17.1 and 17.2.
✔
CONCEPT CHECK 17.5
Chapter 17 Inventory and Turnover 353
average cost method
average inventory
beginning inventory (BI)
cost of goods sold (CGS)
ending inventory (EI)
extension
first-in, first-out (FIFO) costing
method
gross profit method
inventory sheet
inventory turnover
inventory turnover at cost
inventory turnover at retail
last-in, first-out (LIFO) costing
method
lower of cost or market value
(LCM)
market value
net sales
perpetual inventory
physical inventory
purchases (P)
Chapter Terms for Review