Intermediate Accounting Rockhurst Chapter 8

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Inventory

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refers to the assets a company 1. intends to sell in the normal course of business, 2. has in production for future sale (work in progress), 3. uses currently in the production of goods to be sold (raw materials).

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The cost of merchandise inventory includes:

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the purchase price plus any ther costs necessary to get the goods in condition and location for sale.

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Raw materials

Back 3

cost of components purchased from other manufacturers that will become part of the finished product.

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Work in progress

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Products that are not yet complete. Includes cost of raw materials used in production, cost of labor that can be directly traced to the goods in process, and an allocated amount of other manufacturing costs called manufacturing overhead.

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Finished goods

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once the manufacturing process is completed, these costs that have accumulated in WIP are transferred to finished goods.

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Perpetual system

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designed to track inventory quantities from acquisition to their sale. Tracks both quantities and costs of inventory

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periodic inventory system

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not designed to track either quantity or costof merchandise. The merchandise inventory account balance is not adjusted as purchases and sales are made but only periodically at the end of a reporting period. Merchanidise purchases, purchase returns, purchase discounts, and freight in (purchases plus freight in less returns and discounts equals ent purchases) are recorded in temporary accounts and the period's cost of goods sold is determined at the end of the period by combining the temp accounts with the inventory account.

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Cost of goods sold equation for periodic system

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Beginning inventory + net purchases - ending inventory = COGS

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Net purchases

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purchases plus freight in less returns and discounts equals net purchases.

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Main difference between a perpetual and periodic system

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periodic system allocates cost of goods availbale for sale between ending inventory and cost of goods sold periodically at the end of the period. In contrast, the perpetual system performs this allocation by decreasing inventory and increasing cost of goods sold perpetually each time goods are sold.

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FOB Shipping point

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inventory shipped fob shipping point is included in the purchaser's inventory as soon as it is shipped.

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FOB destination

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Inventory shipped FOB destination is included in the purchasers inventory only after it reaches the purchaser's destination.

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Consignment

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Goods held on consignment are included in the inventory of the cosignor until sold by cosingee.

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Sales returns

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these are included in inventory

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Shipping charges on outgoing goods are reported either as:

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part of COGS or as an operating expense, usually among selling expenses.

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Freight in on purchases is commonlyu included in inventory value.

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These costs are necessary to get the inventory in location for sale or use and can generally be associated with particular goods. Freight in is added to net purchases. The account is closed to COGS along with purchases and other parts of COGS at the end of the period.

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purchase return

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purchase returns are subtracted from purchases when determining net purchases. The account is closed to COGS at the end of the reporting period.

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Purchase discounts

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recorded under gross method are subtracted from purchases when determining net purchases.

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Purchase return

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represents a reduction of net purchases.

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purchase discount

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represent reductions in the amount ot be paid if remittance is made within a designated period of time.

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discounts not taken

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included as purchases using the gross method and as interest expense using the net method

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gross method views discounts not taken as

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part of inventory cost

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net method considers discounts not taken as

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interest expense.

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specific identification method

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not feasible for many types of products either because items aren't uniquely identifiable or because it is too costly to match a specific purchase price with each item sold or each item remaining in ending inventory.

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average cost

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Average cost method assumes that items sold and items in ending inventory come from a mixture of all the goods available for sale.

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periodic average cost

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COGA / quantity available

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perpetiual average cost

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a moving average unit cost. A new weighted average unit cost is calculated each time additional units are purchased. Te new average is determined after each purchase by 1. summing the cost of the pervious inventory balance and the cost of the new purchase, and 2. dividing this new total cost (coga) by the numberof units on hand. This average is then used to cost any units sold before the next purchase is made.

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first in first out method

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Assumes that the items sold are those that were acquired first.

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LIFO

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assumes that items sold are those that were most recently acquired.

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Comparison of cost flow methods

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average cost falls between FIFO and LIFO for EI and COGS. During periods of rising costs FIFO results in lower COGS because lower costs of earliest purchases are assumed sold.

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Physical flow and costing methods

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A company is not required to choose an inventory method that approximates actual physical flow.

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Inventory method and income taxes

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When prices and inventory qauntities are not decreasing, LIFO has a higher COGS and lower net income than nother methods. Therefore, the company will have lower taxable income and lower taxes will be paid currently. The taxes are only deferred not reduced permanately.

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LIFO conformity rule

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IRS regulation requires that if the co uses LIFO to measure taxable income they must also use it in external reporting. Because of this to obtain tax advantages of using LIFO lower net income is reported to shareholders and creditors. The tax motivation for using LIFO may be offset by a desire to report higher net income. Now revised to permit LIFO users to report no LIFO inventory valuations in a supplemental disclosure note but not on the face of the income statement.

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LIFO reserve

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difference between internal method and LIFO --directly records into a contra account.
Entry looks like
COGS
LIFO reserve

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LIFO liquidations

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it is not uncommon for a company's LIFO balance to be based on unit costs incurred several years earlier. This distortion sometimes carries over to the income statement as well. When inventory quantities decline during a period, then these out of date inventory layers are liquidated and cost of goods sold will partially match noncurrent costs with current selling prices. The lower the costs of uits liquidated the more severe the impact on income

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Just in time system

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A system used by a manufacturer to coordinate production with suppliers so that raw materials or components arrive just as they are needed in the production process.

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Gross profit ratio

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Gross profit / net sales
The higher the ratio the higher is the markup a company is able to achieve on its product. A declining ratio may indicate that the company is unable to offset rising costs with corresponding increases in selling price, or perhaps that sales prices are declining without a commensurate reduction in costs.

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Inventory turnover ratio

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COGS / Average inventory

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Problems with LIFO

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1. can be very costly to implement. Requires record of each units in inventory. Costs of maintaining hese records can be significant.
2. Possibility that LIFO layers will be liquidated if the quantity of a particular inventory declines below its beginning balance.

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LIFO inventory pool

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Simplify recordkeeping by grouping inventory units into pools based on physical similarities of the individual units and reduce the risk of LIFO layer liquidation. Individual costs are converted into an average cost for the pool.

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Dollar value LIFO

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a dollar value lifo pool is made up of items that are likely to face the same cost change pressures.

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Advantages of Dollar Value LIFO

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simplifies recordkeeping process compared to unit LIFO because no info is needed about unit flows. SEcond minimizes probability of liquidation of LIFO inventory label even more so than use of pools alone, through the aggregation of many types of inventory into larger pools. In addition can be used by firms that do not replace units sold with new uniots of the same kind.

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Cost index in layer year equation

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cost in layer year / cost in base year