Accounting Chapter 6

inventory cost

merchandise inventory includes costs of expenditures necessary, directly or indirectly, to bring an item to a salable condition and location - cost of an inventory item includes its invoice cost minus any discount, plus any incidental costs necessary (shipping, storage and insurance)

FOB destination point

not included in the buyer's inventory until they arrive at their destination

physical count of inventory

occurs at the end of a fiscal year or when inventory amounts are low - physical count used to adjust the Inventory account balance to the actual inventory available

consignor

owner of goods held by another party who will sell them for the owner - owns the goods and reports them in its inventory

consignee

receiver of goods owned by another who holds them for purposes of selling them for the owner

market in the term LCM

replacement cost

lower of cost or market (LCM)

require that inventory be reported on the balance sheet at market value when market is lower than

full-disclosure principle

requires any change, its justification and effect of net income be reported

consistency principle

requires that a company use the same accounting methods period after period (for comparability) unless a change will improve financial reporting

weighted average (average cost)

requires we compute the weighted average cost per unit of inventory at the time of each sale (cost of goods available divided by units available) - charge this weighted average cost per unit times units sold to cost of goods sold

inventory turnover

reveals how many times a company turns over (sells) its inventory during a period - a low ratio suggests inefficient use of assets and a high ratio suggests inventory may be too low COGS/avg merchandise inventory = inventory turnover

days' sales in inventory

reveals how much inventory is available in terms of the number of days' sales (how many days one can sell from inventory if no new items are purchased) (Ending inventory/COGS) x 365 = days' sales in inventory

LCM is applied

to each individual item separately, to major categories of products, to the entire inventory

specific identification

when each item in inventory can be identified with a specific purchase and invoice, we can use this method to assign actual cost of units sold to cost of goods sold and leave actual cost of units on hand in the inventory account

last-in, first-out (LIFO)

when sales occur, costs of the most recent purchases are charged to cost of goods sold, leaving costs of earliest purchases in inventory - comes closest to matching current costs against revenues

first-in, first-out (FIFO)

when sales occur, the costs of the earliest units acquired are charged to cost of goods sold, leaving costs of most recent purchases in inventory

Method Advantages:

FIFO assigns an amount to inventory on the balance sheet that approximates current replacement costs LIFO better matches current costs with revenues on the income statement Weighted average tends to smooth out erratic changes in costs Specific identification exactly matches costs with revenues they generate

When costs regularly rise

FIFO assigns the lowest amount to cost of goods solid yielding the highest gross profit and the highest net income LIFO assigns the highest amount to COGS yielding the lowest gross profit and the lowest net income Weighted average method yields results between FIFO and LIFO Specific identification always yields results that depend on which units are sold

Exception of different costing methods

When LIFO is used for tax purposes, IRS requires it also be used for financial statements

net realizable value

expected selling price (value) of an item minus the cost of making the sale

FOB shipping point

goods included in the buyer's inventory until they arrive at their destination

inventory items

includes all goods that a company owns and holds for sale - goods in transit included if ownership has passed, owned by consignor

entry when replacement cost (market) drops below cost

inventory is adjusted downward to market value Debit to cost of goods sold Credit Inventory - amount of the decrease