Accounting Ch. 7

Financial Statement Effects

-The method that assigns the highest cost to ending inventory will assign the lowest cost to cost of goods sold (and vice versa). -When costs are rising, FIFO produces a higher inventory value (making the balance sheet appear to be stronger) and a lower cost of goods sold (resulting in a higher gross profit, which makes the company look more profitable). -When costs are falling, these effects are reversed; FIFO produces a lower ending inventory value and a higher cost of goods sold--a double whammy. -When faced with increasing costs per unit of inventory bought, a company that uses FIFO will have a higher income tax expense.

The Cost of Goods Sold Equation

Expresses the relationship between inventory on hand, purchased, and sold. BI + P - CGS = EI

Consignment Inventory

Refers to goods a company is holding on behalf of the goods' owner. Typically, this arises when a company is willing to sell the goods for the owner (for a fee) but does not want to take ownership of the goods in the event the goods are difficult to sell.

LIFO Conformity Rule

Requires that if LIFO is used on the income tax return, it also must be used in financial statement reporting. IFRS does not allow LIFO.

The Primary Goals of Inventory Managers

1) maintain a sufficient quantity of inventory to meet customers' needs 2) ensure inventory quality meets customers' expectations and company standards 3) minimize the cost of acquiring and carrying inventory (including costs related to purchasing, production, storage, spoilage, theft, obsolescence, and financing)

Days to Sell Ratio

A measure of the average number of days from the time inventory is bought to the time it is sold. Formula: 365/Inventory Turnover Ratio What it tells you: -Average number of days from purchase to sale -A higher number means a longer time to sell

Weighted Average Cost

An inventory costing assumption that uses the weighted average unit cost of the goods available for sale for both cost of goods sold and ending inventory. Weighted Avg.=Cost of goods available for sale/number of units available for sale

First-In, First-Out (FIFO)

Assumes that the cost of the first goods purchased (first in) are the costs of the first goods sold (first out).

Last-In, First-Out (LIFO)

Assumes that the costs of the last goods purchased (last in) are the costs of the first goods sold (first out).

Merchandise Inventory

Consists of products acquired in a finished condition, ready for sale without further processing.

Inventory Turnover Ratio

Formula: Cost of Goods Sold/Average Inventory What it tells you: -The number of times inventory turns over during the period -A higher ratio means faster turnover

Purchase Discounts

From the purchaser's perspective, these terms mean that the purchaser is allowed to deduct a 2 percent discount if payment is made within 10 days of the date of purchase, otherwise the purchase cost (net of any returns and allowances) is due within 30 days of the purchase date. Later, if payment is made within the discount period, the purchaser reduces the Inventory account by the amount of the discount because it effectively reduces the cost of the inventory.

Goods in Transit

Inventory items that are being transported. This type of inventory is reported on the balance sheet of the owner, not the company transporting it.

Manufacturers Inventory

Manufacturers often hold three types of inventory, with each representing a different stage in the manufacturing process. They start with "raw materials" inventory such as plastic, steel, or fabrics. When these raw materials enter the production process, they become part of "work in progress" inventory, which includes goods that are in the process of being manufactured. When completed, work in process inventory becomes "finished goods" inventory, which is ready for sale just like merchandise inventory.

Specific Identification

The inventory costing method that identifies the cost of the specific item that was sold.

Inventory Turnover Analysis

The process of buying and selling inventory, which is repeated over and over during each accounting period for each line of products.

Goods Available for Sale

The sum of beginning inventory and purchases for the period.

Lower of Cost or Market (LCM)

The value of inventory can fall below its recorded cost for two reasons: (1) its easily replaced by identical goods at a lower cost, or (2) it's become outdated or damaged. In either instance, when the value of inventory falls below its recorded cost, GAAP require that the inventory be written down to its lower market value. This rule is known as reporting inventories at the lower of cost or market (LCM).

Purchase Returns and Allowances

When goods purchased from a supplier arrive in damaged condition or fail to meet specifications, the buyer can (1) return them for a full refund or (2) keep them and ask for a cost reduction, called an allowance. Either way, these are accounted for by reducing the cost of the inventory and either recording a cash refund or by reducing the liability owed to the supplier.

Transportation Cost

When the purchaser pays for the shipping, the additional cost of transporting the goods (called freight-in) is added to the Inventory account. In general, a purchaser should include in the Inventory account any costs needed to get the inventory into a condition and location ready for sale.