Financial Accounting Vocabulary: Chapter 6 - Inventory and Cost of Goods Sold

Overhead Costs

Include costs to operate the manufacturing facility, depreciation of manufacturing equipment, and other costs.

Average Inventory

Is equal to the Beginning Inventory plus (+) the Ending Inventory, and divided by 2.

Cost of Inventory (cost of goods) Available for Sale

Is equal to the cost of beginning inventory plus (+) the additional purchases during the year.

Manufacturing Companies

Manufacture the inventories of which they sell, rather than purchasing them in finished form. Three types of inventory for manufacturers; 1) Raw Materials, 2) Work-in-Progress, & 3) Finished goods. EACH OF THESE INVENTORY ACCOUNTS INCLUDES ITS OWN COST.

First in, First out (FIFO)

The inventory costing method that assumes the first units purchased (first in) are the first units sold (first out). The only method which approximates a company's actual physical flow of inventory, and most companies actual physical flow follows FIFO.

Last in, First out (LIFO)

The inventory costing methods that assumes the last units purchased (the last in) are the first to be sold (first out). The primary benefit is tax savings

Work-in-Progress

The products that have started the production process but are not yet complete at the end of the period.

FOB Shipping Point

"Free On Board" - The title of ownership is passed when the seller ships the inventory, regardless of whether or not the buyer has actual physical possession.

Lower-of-Cost-or-Market (LCM) Method

A method where companies report inventory in the balance sheet at the lower of cost or market value, where market value is equal to the replacement cost.

LIFO Conformity Rule

An IRS rule requiring a company hat uses LIFO for tax reporting to also use LIFO for financial reporting.

LIFO Adjustment

An adjustment used to convert a company's own inventory records maintained on a FIFO basis to a LIFO basis for preparing financial statements.

Multiple-Step Income Statement

An income statement that reports multiple levels of income (or profitability). These levels include 1. Gross Profit, 2.Operating Income 3.Income before Income Taxes, and 4.Net Income

Perpetual Inventory System

An inventory system that maintains a continual record of inventory purchased and sold.

Periodic Inventory System

An inventory system that periodically adjusts for purchases and sales of inventory at the end of the reporting period based on a physical count of inventory on hand. Not commonly used due to the lack of a continuing record of inventory.

Freight-in vs. Freight-out

Freight-IN is the cost to transport inventory to the company, which is INCLUDED as part of the inventory cost. Freight-OUT is the cost of freight on shipments to customers, which is INCLUDED in the income statement either as part of cost of goods sold or as a selling expense.

Raw Materials

The components that will become part of the finished product, but have not yet been used in production.

Net Income

Equal to the difference (-) between all revenues and all expenses for the period.

Gross Profit

Equal to the difference (-) between sales revenue and cost of goods sold.

Income before Income Taxes

Equal to the operating income plus (+) non-operating revenue and reduced (-) by non-operating expenses

Merchandising Companies

Purchase inventory in primarily finished form for resale to customers. Wholesalers resell inventory to retail companies or to professional users, while Retailers purchase goods from either manufacturers or wholesalers and then resell the inventory to end users.

Average Days in Inventory

The approximate number of days the average inventory is held. It is equal to 365/Inventory Turnover Ratio

Costs of Goods Sold

The cost of the inventory that was sold during the period.

Replacement Cost

The cost to replace an inventory item in its identical form.

Operating Income

The income from normal operations is equal to gross profit less (-) operating expenses.

Weight Average Cost

The inventory costing method that assumes both cost of goods sold and ending inventory consist of a random mixture of all the goods available for sale. It is equal to the Costs of Goods available for sale/Number of Units available for sale

Specific Identification Method

The inventory costing method that matches or identifies each unit of inventory with its actual cost; practical for only companies with unique, expensive products with low sales volume.

Finished Goods

The inventory items for which the manufacturing process is complete.

Inventory

The items that a company intends for sale to customers.

Gross Profit Ratio

The measure of the amount by which the sale price of inventory exceeds its cost per dollar of sales. It is equal to Gross Profit/Net Sales

Inventory Turnover Ratio

The number of times a firm sells its average inventory balance during a reporting period. It is equal to the Cost of Goods Sold/Average Inventory

FOB Destination

"Free on Board" - Ownership is not exchanged between buyer and seller, and the inventory is not recorded until the shipment arrives.