and (3) the gross profit (and net income) for the period.
During periods of inflation, the fifo method yields the low-
est amount for the cost of merchandise sold, the highest
amount for gross profit (and net income), and the highest
amount for the ending inventory. The lifo method yields the
opposite results. During periods of deflation, the preceding
effects are reversed. The average cost method yields results
that are between those of fifo and lifo.Determine the proper valuation of inventory
at other than cost, using the lower-of-cost-or-
market and net realizable value concepts. If the mar-
ket price of an item of inventory is lower than its cost, the
lower market price is used to compute the value of the item.
Market price is the cost to replace the merchandise on the
inventory date. It is possible to apply the lower of cost or
market to each item in the inventory, to major classes or
categories, or to the inventory as a whole.
Merchandise that can be sold only at prices below cost
should be valued at net realizable value, which is the esti-
mated selling price less any direct costs of disposal.Describe how inventories are being reduced through
quick response. Quick response is used to optimize
inventory levels by electronically sharing common forecast,
inventory, sales, and payment information between manu-
facturers and merchandisers, using the Internet or other
electronic means. Using shared information in this way
allows manufacturers to more quickly ship goods to replace
sold items on the retailer’s shelves.Determine and interpret the inventory turnover
ratio and the number of days’ sales in inventory. The
inventory turnover ratio, computed as the cost of merchan-
dise sold divided by the average inventory, measures the
relationship between the volume of goods (merchandise)
sold and the amount of inventory carried during the period.
The number of days’ sales in inventory, computed as the
average inventory divided by the average daily cost of
merchandise sold, measures the length of time it takes to
acquire, sell, and replace the inventory.Average cost methodThe method of inventory costing
that is based upon the assumption that costs should be
charged against revenue by using the weighted average unit
cost of the items sold.Cost of goods soldThe cost of product sold.
Finished goods inventoryThe cost of finished products
on hand that have not been sold.First-in, first-out (fifo) methodA method of inventory
costing based on the assumption that the costs of merchan-dise sold should be charged against revenue in the order in
which the costs were incurred.
Inventory ledgerThe subsidiary ledger that shows the
amount of each type of inventory.
Inventory turnoverA ratio that measures the relationship
between the volume of goods (merchandise) sold and the
amount of inventory carried during the period.
Last-in, first-out (lifo) methodA method of inventory
costing based on the assumption that the most recent mer-
chandise inventory costs should be charged against revenue.284 Chapter 6 Inventories
GLOSSARY
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Summarize and provide examples of control proce-
dures that apply to inventories. Control procedures
for inventories include those developed to protect the inven-
tories from damage, employee theft, and customer theft.
In addition, a physical inventory count should be taken
periodically to detect shortages as well as to deter employee
thefts.Describe three inventory cost flow assumptions and
how they impact the income statement and balance
sheet.The three common cost flow assumptions used in
business are the (1) first-in, first-out method, (2) last-in, first-
out method, and (3) average cost method. Each method nor-
mally yields different amounts for the cost of merchandise
sold and the ending merchandise inventory. Thus, the
choice of a cost flow assumption directly affects the income
statement and balance sheet.Determine the cost of inventory under the perpetual
inventory system, using the first-in, first-out; last-in,
first-out; and average cost methods. In a perpetual
inventory system, the number of units and the cost of
each type of merchandise are recorded in a subsidiary in-
ventory ledger, with a separate account for each type of
merchandise. Inventory costs and the amounts charged
against revenue are illustrated using the fifo and lifo
methods.Determine the cost of inventory under the periodic
inventory system, using the first-in, first-out; last-in,
first-out; and average cost methods. In a periodic
inventory system, a physical inventory is taken to deter-
mine the cost of the inventory and the cost of merchandise
sold. Inventory costs and the amounts charged against rev-
enue are illustrated using fifo, lifo, and average cost
methods.Compare and contrast the use of the three inventory
costing methods. The three inventory costing methods
will normally yield different amounts for (1) the ending in-
ventory, (2) the cost of the merchandise sold for the period,