A
VI
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ST
, AccountingCoach.com
Inventory and Cost of Goods Sold
All underlined words are defined in the attached Glossary (Pages 18 – 19).
Introduction to Inventory and Cost of Goods Sold
Inventory is merchandise purchased by merchandisers (retailers, wholesalers,
distributors) for the purpose of being sold to customers. The cost of the merchandise
purchased but not yet sold is reported in the account Inventory or Merchandise
Inventory.
ST
Inventory is reported as a current asset on the company's balance sheet. Inventory is a
significant asset that needs to be monitored closely. Too much inventory can result in
cash flow problems, additional expenses (e.g., storage, insurance), and losses if the
items become obsolete. Too little inventory can result in lost sales and lost customers.
U
Because of the cost principle, inventory is reported on the balance sheet at the amount
paid to obtain (purchase) the merchandise, not at its selling price.
VI
Inventory is also a significant asset of manufacturers. However, in order to simplify our
explanation, we will focus on a retailer.
A
Cost of Goods Sold
Cost of goods sold is the cost of the merchandise that was sold to customers. The cost
of goods sold is reported on the income statement when the sales revenues of the
goods sold are reported.
A retailer's cost of goods sold includes the cost from its supplier plus any additional
costs necessary to get the merchandise into inventory and ready for sale. For example,
let's assume that Corner Shelf Bookstore purchases a college textbook from a publisher.
If Corner Shelf's cost from the publisher is $80 for the textbook plus $5 in shipping costs,
Corner Shelf reports $85 in its Inventory account until the book is sold. When the book
is sold, the $85 is removed from inventory and is reported as cost of goods sold on the
income statement.
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 1
, When Costs Change
If the publisher increases the selling prices of its books, the bookstore will have a higher
cost for the next book it purchases from the publisher. Any books in the bookstore's
inventory will continue to be reported at their cost when purchased. For example, if the
Corner Shelf Bookstore has on its shelf a book that had a cost of $85, Corner Shelf will
continue to report the cost of that one book at its actual cost of $85 even if the same
book now has a cost of $90. The cost principle will not allow an amount higher than cost
to be included in inventory.
Let's assume the Corner Shelf Bookstore had one book in inventory at the start of the
year 2007 and at different times during 2007 purchased four identical books. During the
year 2007 the cost of these books increased due to a paper shortage. The following
chart shows the costs of the five books that have to be accounted for. It also assumes
that none of the books has been sold as of December 31, 2007.
Number Cost
Total
ST
of per
Cost
Books Book
Inventory at Dec. 31, 2006 1 @ $85 = $ 85
First purchase (January 2007) 1 @ 87 = 87
U
Second purchase (June 2007) 2 @ 89 = 178
Third purchase (December 2007) 1 @ 90 = 90
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Total goods available for sale 5 $440
Less: Inventory at Dec. 31, 2007 5 440
Cost of goods sold 0 $ 0
A
Cost Flow Assumptions
If the Corner Shelf Bookstore sells only one of the five books, which cost should Corner
Shelf report as the cost of goods sold? Should it select $85, $87, $89, $89, $90, or an
average of the five amounts? A related question is which cost should Corner Shelf
report as inventory on its balance sheet for the four books that have not been sold?
Accounting rules allow the bookstore to move the cost from inventory to the cost of
goods sold by using one of three cost flows:
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 2
VI
U
ST
, AccountingCoach.com
Inventory and Cost of Goods Sold
All underlined words are defined in the attached Glossary (Pages 18 – 19).
Introduction to Inventory and Cost of Goods Sold
Inventory is merchandise purchased by merchandisers (retailers, wholesalers,
distributors) for the purpose of being sold to customers. The cost of the merchandise
purchased but not yet sold is reported in the account Inventory or Merchandise
Inventory.
ST
Inventory is reported as a current asset on the company's balance sheet. Inventory is a
significant asset that needs to be monitored closely. Too much inventory can result in
cash flow problems, additional expenses (e.g., storage, insurance), and losses if the
items become obsolete. Too little inventory can result in lost sales and lost customers.
U
Because of the cost principle, inventory is reported on the balance sheet at the amount
paid to obtain (purchase) the merchandise, not at its selling price.
VI
Inventory is also a significant asset of manufacturers. However, in order to simplify our
explanation, we will focus on a retailer.
A
Cost of Goods Sold
Cost of goods sold is the cost of the merchandise that was sold to customers. The cost
of goods sold is reported on the income statement when the sales revenues of the
goods sold are reported.
A retailer's cost of goods sold includes the cost from its supplier plus any additional
costs necessary to get the merchandise into inventory and ready for sale. For example,
let's assume that Corner Shelf Bookstore purchases a college textbook from a publisher.
If Corner Shelf's cost from the publisher is $80 for the textbook plus $5 in shipping costs,
Corner Shelf reports $85 in its Inventory account until the book is sold. When the book
is sold, the $85 is removed from inventory and is reported as cost of goods sold on the
income statement.
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 1
, When Costs Change
If the publisher increases the selling prices of its books, the bookstore will have a higher
cost for the next book it purchases from the publisher. Any books in the bookstore's
inventory will continue to be reported at their cost when purchased. For example, if the
Corner Shelf Bookstore has on its shelf a book that had a cost of $85, Corner Shelf will
continue to report the cost of that one book at its actual cost of $85 even if the same
book now has a cost of $90. The cost principle will not allow an amount higher than cost
to be included in inventory.
Let's assume the Corner Shelf Bookstore had one book in inventory at the start of the
year 2007 and at different times during 2007 purchased four identical books. During the
year 2007 the cost of these books increased due to a paper shortage. The following
chart shows the costs of the five books that have to be accounted for. It also assumes
that none of the books has been sold as of December 31, 2007.
Number Cost
Total
ST
of per
Cost
Books Book
Inventory at Dec. 31, 2006 1 @ $85 = $ 85
First purchase (January 2007) 1 @ 87 = 87
U
Second purchase (June 2007) 2 @ 89 = 178
Third purchase (December 2007) 1 @ 90 = 90
VI
Total goods available for sale 5 $440
Less: Inventory at Dec. 31, 2007 5 440
Cost of goods sold 0 $ 0
A
Cost Flow Assumptions
If the Corner Shelf Bookstore sells only one of the five books, which cost should Corner
Shelf report as the cost of goods sold? Should it select $85, $87, $89, $89, $90, or an
average of the five amounts? A related question is which cost should Corner Shelf
report as inventory on its balance sheet for the four books that have not been sold?
Accounting rules allow the bookstore to move the cost from inventory to the cost of
goods sold by using one of three cost flows:
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 2
