Accounting Chapter 8

In addition to the invoice cost, other common costs included in inventory are

freight costs, inspection costs, and preparation costs

Most managers choose accounting methods based on two factors:

Profit 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.)

The following are the most important control features:

1. Separation of responsibilities for inventory accounting and physical handling of inventory. 2. Storage of inventory in a manner that protects it from theft and damage. 3. Limiting access to inventory to authorized employees. 4. Maintaining perpetual inventory records (described below). 5. Comparing perpetual records to periodic physical counts of inventory.

perpetual inventory system

A detailed inventory system in which a company maintains the cost of each inventory item and the records continuously show the inventory that should be on hand.

periodic inventory system

An inventory system in which a company does not maintain detailed records of goods on hand and determines the cost of goods sold only at the end of an accounting period.

Errors in Measuring Inventory

Chapter 8_LO2 slides 13-14 and examples last 4 slides

First in First out method

When using first-in, first-out, we assign the older costs to the units sold. That leaves the more recent costs to be used to value ending inventory. In other words, the first-in, first-out method assumes that the first goods purchased (the first in) are the first goods sold.

The cost principle

requires that inventory be recorded at the price paid or the consideration given

The primary goals of inventory management

to have sufficient quantities of high-quality inventory available to serve customers' needs while minimizing the costs of carrying inventory such as production, storage, obsolescence, and financing.

Advantages

An advantage of weighted-average is that it smoothes out peaks and valleys in price changes that may occur during the period. First-in, first-out does a great job of valuing Ending Inventory at an approximate replacement cost. This is because first-in, first-out uses the most recent costs to value Ending Inventory.

the comparison of a periodic inventory system and a perpetual inventory system

Beginning inventory is carried over from the prior period in both inventory systems. In a periodic system, purchases of inventory are accumulated in the purchases account while in a perpetual system purchases are accumulated in the inventory account. In a periodic system, ending inventory is measured by a physical count of the inventory on hand at the end of the period. In a perpetual system, the inventory record is continuously updated so the information in the inventory account is always available. In a periodic system, cost of sales is computed as a residual amount at the end of the period. In a perpetual system, cost of sales is measured and recorded for every sale.

Comparison of journal entries

Chapter 8_LO2 slides 5-8

Valuation at Lower Cost or Net Realizable Value

Chapter 8_LO5

Inventory Turnover

Cost of Sales/Average Inventory

The flow of inventory for a manufacturer

First, a manufacturer purchases raw materials for use in making inventory. The items (and their costs) are included in raw materials inventory until they are used, at which point they become part of work in process inventory. As goods are manufactured, two other costs of manufacturing, direct labour and factory overhead, are also added. Direct labour refers to earnings of employees who work directly on the products being manufactured. Factory overhead includes manufacturing costs such as the costs of heat, light, and power to operate the factory. When the inventory is complete and ready for sale, the related amounts of work in process inventory are transferred to finished goods inventory. When the finished goods are sold, cost of sales is increased and finished goods inventory decreases.

The accounting system plays three roles in the inventory management process

First, the system must provide accurate information necessary for preparation of periodic financial statements and reports to tax authorities. Second, it must provide up-to-date information on inventory quantities and costs to facilitate ordering and manufacturing decisions. Third, because inventories are subject to theft and other forms of misuse, the system also must provide the information necessary to help protect and control these important assets.

Specific Identification

Using the specific identification method, we know the specific cost of each unit that is sold. It is most commonly used in businesses that have low sales volume of high dollar items, like car dealerships, exclusive jewelry stores, and custom builders. The specific identification method is impractical when large quantities of similar items are stocked.

Weighted average method

When using weighted average (also known as the average cost method), we assign the average cost of the goods available for sale to cost of sales. The average cost is determined by dividing the cost of goods available for sale by the number of units available for sale. The average cost method uses the weighted-average unit cost of the goods available for sale for both cost of sales and ending inventory.

The following are types of inventory.

• Merchandise inventory includes goods 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. • Raw materials inventory includes items acquired for processing into finished goods. • Work in process inventory includes goods in the process of being manufactured but not yet complete. • Finished goods inventory includes manufactured goods that are complete and ready for sale.