Chapter 6 - Retail inventory
In Chapter 5 you learned about retailing operations – the purchase and resale of goods. When
acquired, inventory (the goods) is a current asset that becomes an expense once the goods are sold. In
this chapter the principles of internal control are applied to this very important asset. Specifically you
will learn the techniques businesses use to determine the cost (i.e., value) of their ending inventory
and the corresponding cost of goods sold. The learning objectives for this chapter are to:
Calculate perpetual inventory amounts under FIFO, LIFO and average cost.
Record perpetual inventory transactions.
Compare the effects of FIFO, LIFO and average cost.
Calculate periodic inventory amounts under FIFO, LIFO and average cost.
Apply the lower-of-cost-and-net-realisable-value rule to inventory.
Measure the effects of inventory errors.
Estimate ending inventory by the gross profit and retail inventory methods.
system is used to keep a continuous record of each inventory item. With
the perpetual system, the inventory item record shows quantities received, quantities sold, and the
balance remaining on hand. With the
periodic inventory system
, inventory purchases are debited to
the Purchases account, the quantity of ending inventory is counted and valued, and the cost of goods
sold equation is used on the income statement.
Objective 1 – Calculate perpetual inventory amounts under FIFO, LIFO and
Inventories are initially recorded at historical cost. Inventory cost is what the business pays to acquire
the inventory. Inventory cost includes the invoice cost of the goods, plus taxes, tariffs, freight in, and
insurance while in transit, less purchase discounts.
Determining unit costs is easy when costs remain constant. But prices frequently change. GAAP
allows four different methods of assigning costs to each inventory item that is sold: 1)
, and 3)
(not allowed by Australian
Accounting Standard AASB 102).
Specific unit costing
(also called the
specific identification method
) is used by businesses whose
inventory items are expensive or have ‘one-of-a-kind’ characteristics - such as cars, high priced
jewellery, and works of art. Using specific unit cost to determine ending inventory is not practical for
many businesses. When this is the case, the accountant has to make an
flow of costs through the inventory. Why is an assumption necessary? Because the actual (i.e.,
specific) unit cost of each item cannot be determined.
The three cost flow assumptions are
average cost, FIFO, and LIFO