Accounting: Chapter 8

Double-extension method

A method for computing a specific internal price index, when a relevant external price index is not readily available, by determining current costs with reference to the actual cost of the goods most recently purchased. The price measure provides a measure of the change in the price or cost levels between the base year and the current year. The company then computes the index for each year after the base year.

Net method

A method in which a company considers purchase discounts lost as a financial expense and reports it in the "Other expenses and losses section" of the income statement.

Net of the cash discounts

A method in which a company records the failure to take a purchase discount within the discount period in a Purchase Discounts Lost account.

Gross method

A method in which a company reports purchase discounts as a deduction from purchases on the income statement.

Specific-goods pooled LIFO approach

A method used to alleviate LIFO liquidation Problems and to simplify LIFO accounting, by grouping goods into pools of similar items. Thus, instead of tracking specific inventory units, a company combines, and accounts for together, a number of similar units or products, which usually results in fewer LIFO liquidations.

Modified perpetual inventory system

A system that provides detailed inventory records of increases and decreases in quantities only, not dollar amounts.

Dollar-value LIFO

A variation of the LIFO inventory-costing method; it determines and measures any increases and decreases in a pool in terms of total dollar value, not the physical quantity of the goods in the inventory pool. The dollar-value LIFO method overcomes the Problems of redefining pools and eroding layers that occur with the regular LIFO method.

Purchase Discounts

An account in a periodic inventory system that indicates the company is recording its purchases and accounts payable at the gross amount.

Perpetual inventory system

An inventory system in which a company continuously tracks changes in the Inventory account. The company records all purchases and sales (issues) of goods directly in the Inventory account as they occur. The accounting records continuously show the balances in both the Inventory account and the Cost of Goods Sold account. A computerized recordkeeping system records nearly instantaneously any additions to and issuances from inventory.

Inventories

Asset items that a company holds for sale in the ordinary course of business, or goods that it will use or consume in the production of goods to be sold. The investment in inventories is frequently the largest current asset of merchandising (retail) and manufacturing businesses.

Product costs

Costs that "attach" to the inventory and are directly connected with bringing the goods to the buyer's place of business and converting such goods to a salable condition. Such costs include direct materials, direct labor, and manufacturing overhead costs (indirect materials, indirect labor, and various costs incurred in the manufacturing process such as depreciation, taxes, insurance, and heat and electricity). Companies record product costs as part of the inventory cost.

Period costs

Costs that attach to a specific accounting period. Examples are officers' salaries and other administrative expenses. Companies charge off such period costs in the immediate period even though benefits associated with these costs may occur in the future. Period costs are not included as part of inventory cost; instead, they are recorded in same period as the related revenue of a specific time period and expensed as incurred.

LIFO liquidation

Erosion of the LIFO inventory under a specific-goods (unit LIFO) approach. Such erosion matches costs from preceding periods against sales revenues reported in current dollars, which often distorts net income and leads to substantial tax payments.

Merchandise inventory

For a merchandising business, the cost assigned to unsold units left on hand, but ready for sale. Only one inventory account, Inventory, appears in a merchandiser's financial statements.

F.o.b. destination

Freight term indicating that shipped goods are placed free on board (“f.o.b.â€) to the buyer's place of business and the seller pays the freight costs; the goods belong to the seller while in transit and title passes to the buyer when the buyer receives the goods from the shipping carrier.

F.o.b. shipping point

Freight term indicating that shipped goods are placed free on board to the shipping carrier by the seller and the buyer pays the freight costs; the goods belong to the buyer while in transit.

Consigned goods

Inventory held by one party (the consignee) who acts as the agent for the owner of the goods (the consignor) in selling the goods. The consignee accepts and holds the consigned goods without any liability, except to exercise due care and reasonable protection from loss or damage until it sells the goods to a third party. When the consignee sells the goods, it remits the revenue to the consignor, less a selling commission and expenses incurred in accomplishing the sale.

Periodic inventory system

Inventory system in which a company uses a Purchases account to record purchases of inventory during the period. The Inventory account represents the beginning inventory amount throughout the period; at the end of the accounting period, the company adjusts the Inventory account by closing out the beginning inventory amount and recording the ending inventory amount, which is determined by a physical count of the items on hand, valued at cost or at the lower-of-cost-or-market.

First-in, first-out (FIFO) method

Inventory-costing method that assumes that a company uses goods in the order in which it purchases them. Thus, the costs of the earliest goods purchased are the first to be allocated to cost of goods sold. FIFO often approximates the physical flow of goods, prevents manipulation of income, and prices ending inventory close to current cost, but it fails to match current costs against current revenues on the income statement, possibly distorting gross profit and net income.

Last-in, first-out (LIFO) method

Inventory-costing method that assumes that a company uses the latest goods purchased before it uses the earlier goods purchased. Thus, the costs of the latest goods purchased are the first to be allocated to cost of goods sold. LIFO provides a good matching of recent costs against current revenues and tax benefits, but generally reports lower earnings, which some managers see as a disadvantage.

Average-cost method

Inventory-costing method that prices items in the inventory on the basis of the average cost of all similar goods available during the period. Companies that use the periodic inventory method use weighted averages and those that use the perpetual method use moving averages.

Moving-average method

Inventory-costing method, used by companies that use the perpetual inventory method. In this method, a company computes a new average unit cost (a "moving average") each time it makes a purchase

Weighted-average method

Inventory-costing method, used in the periodic inventory method, that prices items in the inventory on the basis of the average cost of all similar goods available during the period. The method calculates the total cost of inventories of similar goods, divides the total cost by the number of inventory units, and applies the weighted-average cost per unit to the items in ending inventory.

Specific identification

Inventory-costing methods in which companies identify and cost each item sold and each item in inventory. Retailers use this method only when handling a relatively small number of costly, easily distinguishable items, such as fur coats, automobiles, some furniture; manufacturers use it for special orders and many products manufactured under a job cost system.

Cost flow assumptions

Several systematic assumptions about the flow of inventory, used by companies to value their inventory. The main cost flow assumptions are specific identification, average-cost, FIFO, and LIFO. The actual physical movement of goods need not match the cost flow assumption a company adopts, but the company must use its selected cost flow assumption consistently from one period to the next. The objective should be to choose a cost flow assumption that most clearly reflects periodic income.

LIFO effect

The change from one period to the next in the balance of the account (Allowance to Reduce Inventory to LIFO, also called the LIFO reserve) that companies use to record the difference between the non-LIFO inventory method used for internal-reporting purposes and LIFO used for tax or external-reporting purposes.

Raw materials inventory

The cost assigned to goods and materials on hand but not yet placed into production. Raw materials can be traced directly to the end product. This category of inventory appears on the balance sheets of manufacturing companies.

Work in process inventory

The cost of partially processed units in a continuous production process, consisting of the raw material for these unfinished units, plus the direct labor cost applied specifically to this material and a ratable share of manufacturing overhead costs. This category of inventory appears on the balance sheets of manufacturing companies.

Finished goods inventory

The costs identified with the completed but unsold units on hand at the end of the fiscal period. This category of inventory appears on the balance sheets of manufacturing companies.

LIFO reserve

The difference between the inventory amount reported using LIFO for tax- or external-reporting purposes and the inventory amount using FIFO or some other method for internal-reporting purposes.