ACC 211 Chapter 7

Inventory Costing Methods:

1) Specific identification 2) First-in, first-out (FIFO) 3) Last-in, first-out (LIFO) 4) Average cost

The primary goals of Inventory Management

1) To provide sufficient quantities of high-quality inventory 2) To minimize the costs of carrying inventory

Perpetual Inventory System

Purchase transactions are recorded directly in an inventory account. When each sale is recorded, a companion cost of goods sold entry is made, decreasing inventory and recording cost of goods sold. In a perpetual inventory system, a detailed record is maintained for each type of merchandise stocked, showing (1) units and cost of the beginning inventory, (2) units and cost of each purchase, (3) units and cost of the goods for each sale, and (4) units and cost of the goods on hand at any point in time. This up-to-date record is maintained on a transaction-by-transaction basis

When a net DECREASE in inventory for the period occurs

Sales are greater than purchases, and thus, the decrease must be added in computing cash flows from operations

When a net INCREASE in inventory for the period occurs

Sales are less than purchases, and thus, the increase must be subtracted in computing cash flows from operations

Net Realizable Value

Sales price less costs to sell

Inventory

Tangible property that is either held for sale in the normal course of business or used in producing goods or services for sale

What does the cost principle require?

That inventory be recorded at the price paid or the consideration given

Ending inventory is reported at what?

The Lower of Cost or Market (LCM)

LCM is important for two types of companies:

1) High-technology companies 2) Companies that sell seasonal goods

FIFO

"First in First Out". The costs of the most recently purchases are in the ending inventory

LIFO

"Last in First Out". The last goods purchased (the last in) are the first goods sold

Average Cost

1) Find weighted average cost of all the inventory items 2) Multiply units purchased by average 3) Total-Purchased=Ending Inventory

Average Inventory Formula

(Beginning Inventory+Ending Inventory)/2

Manufacturers hold three types of inventory:

1)Raw materials inventory: Items acquired for processing into finished goods. These items are included in raw materials inventory until they are used, at which point they become part of work in process inventory. 2) Work in process inventory: Goods in the process of being manufactured but not yet complete. When completed, work in process inventory becomes finished goods inventory. 3) Finished goods inventory: Manufactured goods that are complete and ready for sale.

Average Days to Sell Inventory Formula

365/Inventory Turnover This ratio reflects the average time in days it takes a company to produce and deliver inventory to its customers. A lower ratio is better as it reflects a quicker delivery

Goods Available for Sale Formula

Beginning inventory + purchases

Inventory Turnover Formula

Cost of Goods Sold/Average Inventory A higher ratio indicated that the inventory is moving more quickly, thus less need for storage

GAAP and IFRS rules on Inventory Costing Methods

GAAP allows companies to pick which one they want to use while IFRS prohibits LIFO. GAAP allows companies to change method from item to item, IFRS makes companies stick with one

Merchandise Inventory

Goods (or merchandise) held for resale in the normal course of business. The goods usually are acquired in a finished condition and are ready for sale without further processing.

Cost of Goods Sold Formula

Goods available for sale - ending inventory

Which process should we use?

In periods of rising prices, FIFO provides lowest cost of goods sold amount, but highest net income LIFO provides highest cost of goods sold, but lowest net income Average Cost falls in middle

Why do many companies record inspection and preparation costs as an expense?

Incidental costs, such as inspection and preparation costs, do not have to be assigned to the inventory cost if they are not material

What motivates companies to choose different inventory costing methods?

Net income effects (managers prefer to report higher earnings for their companies). Income tax effects (managers prefer to pay the least amount of taxes allowed by law as late as possible.)

Periodic Inventory System

No up-to-date record of inventory is maintained. An actual physical count of the goods remaining on hand is required at the end of each period. The number of units of each type of merchandise on hand is multiplied by unit cost to compute the dollar amount of the ending inventory. Cost of goods sold is calculated at the end of the accounting period using the cost of goods sold equation. Because the amount of inventory is not known until the end of the period, the amount of cost of goods sold cannot be reliably determined until the inventory count is complete. The primary disadvantage of a periodic inventory system is that managers are not informed about low or excess stock situations.

The amount of cost of goods sold and ending inventory can be determined by using one of two different inventory systems:

Perpetual or Periodic.

LIFO liquidation

When a company using LIFO sells more inventory than it purchases or manufactures, items from beginning inventory become part of cost of goods sold