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38 Cards in this Set

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Types of Inventory
Inventories of goods must be periodically counted, valued, and recorded in the books of account of a business. 4 Types:
1. Retail (finished goods only)
2. Raw Materials
3. Work in Process
4. Finished Goods
Included in Inventory
General Rule: any goods and materials in which the company has legal title should be included in inventory.
Legal title typically follows possession of the goods. (There are many exceptions to the general rule)
Goods in Transit
-If no conditions are explicitly agreed upon, title passes from the seller to the buyer at the time and place where the seller's performance regarding delivery of goods is complete.
-F.O.B. means "free on board" and requires the seller to deliver the goods to the location indicated as F.O.B.
F.O.B. Shipping Point
-Buyer pays, title passes to the buyer when the seller delivers the goods to a common carrier.
-Should be included in buyer's inventory upon shipment.
-"Freight in" added to the cost of inventory.
F.O.B. Destination
-Seller pays, title passes to the buyer when the buyer receives the goods from the common carrier.
-Still in seller's inventory during shipment.
-"Freight out" is a selling expense for the seller.
Non-Conforming Goods
-If the seller ships the wrong goods, the title reverts to the seller upon rejection by the buyer.
-The goods should not be included in the buyer's inventory even though the buyer possesses them.
Sales With a Right to Return
General Rule: if the buyer has the right to return the goods, the goods should be included in the seller's inventory if the amount of goods likely to be returned cannot be estimated (no sale yet).
-If the amount of goods likely to be returned can be estimated, the transaction will be recorded as a sale with an allowance for estimated returns recorded.
-Revenue will be recognized only if all the following conditions are met:
1. The sales price is substantially fixed at the date of sale
2. The buyer assumes all risks of loss b/c the goods are in the buyer's possession
3. The buyer has paid some form of consideration
4. The product sold is substantially complete
5. The amount of future returns can be reasonably estimated
Consigned Goods
-The seller (the "consignor") delivers goods to a sales agent (the "consignee") to hold and sell on the consignor's behalf. The consignor should include the consigned goods in its inventory b/c the title and risk of loss is retained by the consignor.
If all the conditions (above) are not met, there is no revenue recognition from a sale. Revenue will be recognized when the goods are sold to a third party. Title passes directly to the third-party at the point of sale.
Public Warehouses
-Goods stored in a public warehouse and evidenced by a warehouse receipt should be included in the inventory of a company holding the warehouse receipt.
-The reason is that the warehouse receipt evidences title even thought the owner does not have possession.
Sales with a Mandatory Buyback
-Occasionally, as part of a financing arrangement, a seller has a requirement to repurchase goods from a buyer.
-If so, the seller should include the goods in inventory even though title has passed to the buyer.
Installment Sales
-If the seller sells good on an installment basis but retains title as security for the loan, the goods should be included in the seller's inventory if the percentage of uncollectible debts cannot be estimated.
-However, is the percentage of uncollectible debts can be estimated, the transaction would be accounted for as a sale, and an allowance for uncollectible debts would be recorded.
Valuation of Inventory
GAAP requires that inventory be stated at its cost. Where evidence indicates that cost will be recovered with an approximately normal profit in the ordinary course of business, no loss should be recognized even though replacement or reproduction costs are lower.
Cost: defined as the price paid or consideration given to acquire an asset. In inventory accounting, cost is the sum of the expenditures and charges, direct and indirect, in bringing goods to their required condition or location. (selling expenses, freight out, and abnormal spoilage not considered inventory costs.)
Lower of Cost or Market (GAAP)
-When the utility of goods is no longer as great as their cost, a departure from the cost basis principle of measuring inventory is required.
-This is usually accomplished by stating such goods at a lower level designated as market value, or the lower-of-cost-or-market principle.
Precious Metals and Farm Products
-Gold, silver, and other precious metals, and meat and some agricultural products are valued at NRV (net selling price less costs of disposal). Inventories reported at NRV include:
1. Inventories or gold and silver when there is effective government-controlled market at a fixed monetary value.
2. Inventories of agriculture or other products meeting all the following criteria: (1) Immediate marketability at quoted prices, (2) Unit interchangeability, (3) Inability to determine appropriate costs.
Lower of Cost or Market
-Purpose is to show the probable loss sustained (conservatism) in the period in which the loss occurred (matching).
-May be applied to a single item (results in most conservative ending inventory), a category, or total inventory, provided that the method most clearly reflects periodic income.
LCM- Recognize Loss in Current Period
-The difference in inventory should be recognized as a loss for the current period no matter the cause.
-The write-down of inventory to market is usually reflected in COGS, unless the amount is material, in which case the loss should be identified separately in the I/S.
-Under GAAP, "market" generally means current replacement cost (whether by purchase or reproduction), provided the current replacement cost does not exceed NRV (the "market ceiling") or fall below NRV reduced by normal profit margin (the "market floor")
Reversal of Inventory Write-Downs
-Under U.S. GAAP, reversals of inventory write-downs are prohibited.
-IFRS allow the reversal of inventory write-downs for subsequent recoveries in inventory value.*
*Reversal is limited to the amount of the original write-down and is recorded as a reduction of total inventory on the I/S (COGS) in the period of reversal.
Market Value
-Is the median (middle value) of an inventory item's replacement cost, its market ceiling, and its market floor (under GAAP).
-Replacement Cost: the cost to purchase the item of inventory as of the valuation date.
Market Ceiling & Floor
-Market ceiling is an item's net selling price (net of discounts) less the costs to complete and dispose (called the NRV)
-Market floor (NRV) is the market ceiling less a normal profit margin (based on selling price only)
Exceptions to LCM
-The lower of cost or market rule will not apply if:
1. The company has a firm sales price contract.
2. The subsequent sales price of an end product is not affected by its market value.
-When losses are both substantial and unusual from the application of the LCM principle, the amount of the loss is disclosed in income from continuing operations in the I/S and identified separately from the consumed inventory costs (COGS). Small losses from decline in value are included in COGS.
-Basic principle of consistency must be applied in the valuation of inventory and the method should be disclosed in the F/S's. In the event that a significant change takes place, adequate disclosure of the nature of the change and, if material (materiality), the effect on income should also be disclosed.
Lower of Cost or NRV (IFRS)
-IFRS requires inventory to be reported at the lower of cost or NRV.
-Like GAAP, cost is the sum of expenditures and charges (direct and indirect) in bringing goods to their required conniption or location.
-Selling expenses, including marketing costs and freight out, as well as abnormal spoilage and idle plant capacity costs should not be considered a part of inventory costs.
-Recognize loss in the current period but IFRS doesn't specify where an inventory write-down should be reported on the I/S.
-An item's net selling price less the costs to complete and dispose of the inventory.
-NRV under IFRS is the same as the "market ceiling" under GAAP.
Periodic Inventory System
-Quantity of inventory is determined only be physical count, usually at least annually. Therefore, units of inventory and their associated costs are counted and valued at the end of the accounting period.
-COGS for the period is determined after each count by "squeezing" (COGS "plug") the difference between beginning inventory plus purchases less ending inventory.
-Does not keep a running total of the inventory balances.
-Disadvantage: shortages "lumped in" with COGS

-Beginning Inventory + Purchases = Cost of Goods Available for Sale - (Ending Inventory) = COGS
-If E.I. is overstated, COGS is understated, Gross Profit is overstated.
Perpetual Inventory System
-The inventory record for each item of inventory is updated for each purchase and each sale as they occur.
-The actual COGS is determined and recorded with each sale. Therefore, the perpetual system keeps a running total of inventory balances.
Hybrid Inventory Systems
1. Units of Inventory on Hand (Quantities Only): some companies maintain a perpetual record of quantities only (for units on hand). This is often referred to as the "modified perpetual system" and changes in quantities are recorded after each sale and purchase.
2. Perpetual with Periodic at Year-End: most companies that maintain a perpetual inventory system still perform either complete periodic physical inventories or test count inventories on a random (cyclical) basis.
Inventory Cost Flow Assumptions
-Inventory valuation is dependent upon the cost flow assumption underlying the computation. Under GAAP, the cost flow assumption used by a company is not required to have a rational relationship with the physical inventory flows; however, the primary objective is the selection of the method that will most clearly reflect periodic income.
-Frequently, the identity of goods and their specific related costs are lost between the time of acquisition and the time of sale. This has resulted in the general acceptance of several cost flow assumptions (FIFO, LIFO, & Average Cost) to provide practical bases for the measurement of periodic income.
IFRS vs. GAAP- Inventory Cost Flow
-Under IFRS, the accounting method used to account for inventory should be based on the order in which the products are sold relative to when they were put in inventory.
-Specific identification should be used whenever possible.
-The LIFO method is prohibited under IFRS b/c it rarely reflects actual physical inventory flows.
Specific Identification Method
-The cost of each item in inventory is uniquely identified to that item. The cost follows the physical slow of the item in and out of inventory to COGS.
-Usually used for physically large or high value items and allows for greater opportunity for manipulation of income.
First In, First Out (FIFO) Method
-The first costs inventoried are the first costs transferred to COGS. Ending inventory includes the most recently incurred costs; thus, the ending balance approximates replacement cost.
-Ending inventory and COGS are the same whether a periodic or perpetual inventory system is used.
-In periods of inflation, the FIFO method results in highest ending inventory, lowest COGS, and the highest net income (current costs are not matched w/ current revenues).
Weighted Average Method
-At the end of the period, the average cost of each item in inventory would be the weighted average of the costs of all items in inventory. Particularly suitable for homogenous products and a periodic inventory system.
-Determined by dividing the total costs of inventory available by the total number of units of inventory available, remembering that beginning inventory is included in both totals.
Moving Average Method
-Computes the weighted average cost after each purchase by dividing the total cost of inventory available after each purchase (inventory + current purchases) by the total units available after each purchase.
-More current than the weighted average method. A perpetual inventory system is necessary to use this method.
Last In, First Out (LIFO) Method
-Prohibited under IFRS
-Last costs inventoried are the first costs transferred to COGS. Ending inventory includes the oldest costs and ending balance typically won't approximate replacement cost.
-Doesn't generally relate to actual flow of goods in a company b/c most companies sell or use their oldest goods first to prevent holding old or obsolete items.
-If LIFO is used for tax purposes, it must also be used in the GAAP F/S's.
LIFO F/S Effect
-Generally better matches expenses against revenues b/c it matches current costs with current revenues; thus, LIFO eliminates holding gains and reduces net income during times of inflation.
--If sales exceed production (or purchases) for a given period, LIFO will result in a distortion of net income b/c old inventory costs (called "LIFO layers") will be matched with current revenue.
-LIFO is also susceptible to income manipulation by intentionally reducing purchases in order to use old layers at lower costs.
-In periods of rising inflation, the LIFO method generally results in the lowest ending inventory, the highest COGS, and the lowest income (& thus the lowest taxes).
LIFO Layers
-Requires that records be maintained as to the base year inventory amount and additional layers that may be added yearly. After an original LIFO amount is created (base year), it may decrease, or additional layers may be created in each year according to the amount of ending inventory.
-An additional LIFO layer is created in any year where the ending inventory is created than the beginning inventory. An additional LIFO layer is priced at the earliest costs of the year in which it was created.
-Unlike FIFO, LIFO periodic doesn't = LIFO perpetual.
Comparison of Inventory Methods
-In a period of rising prices, FIFO results in the highest ending inventory and the lowest COGS.
-LIFO results in the lowest ending inventory and the highest COGS.
-The average method falls between the LIFO and FIFO balances.
-The moving average method results in higher ending inventory and lower COGS than the weighted average method.
Dollar-Value LIFO
-Under the regular LIFO method inventory is measured in units and is priced at unit prices.
-Under the dollar-value LIFO method inventory is measured in dollars and is adjusted for changing price levels. When converting to dollar-value LIFO (from regular), a price index will be used to adjust the inventory value.
Price Index = Ending Inventory at current year cost ÷ Ending Inventory at base year cost

-To compute the LIFO layer added in the current year at dollar-value LIFO, the LIFO layer at base year cost is multiplied by the internally generated price index.
Firm Purchase Commitments
-Legally enforceable agreement to purchase a specified amount of goods at some time in the future. All material firm purchase commitments must be disclosed in either the F/S's or notes thereto.
-If the contracted price exceeds the market price and if it is expected that losses will occur when the purchase is actually made, the loss should be recognized at the time of the decline in price.