Chapter 5

2

# of years inventory errors take to correct

Average Inventory

(beginning inventory+ending inventory)/2

Perpetual Method

- keeps a running total of the inventory on hand - recognizes a loss - used with low- volume sales, high-priced goods

Periodic Method

- update at the end of the period - all items purchased for resale are debited to a "purchases" account [temporary account- not an asset; works like an expense] - uses the cogs formula - used in companies with 1. high volume of sales 2. wide variety of goods

Average Cost Method

- uses weighted average of all costs for goods available for sale - assigns average cost to both ending inventory and cost of goods sold - advantage: assigns cost on an equal unit basis to both ending inventory and cost of goods sold

Inventory Cost Flow Methods

1. specific identification 2. average cost method 3. first in, first out (fifo) 4. last in, first out (lifo)

Inventory Costing Methods with a Periodic System

1. uses cogs formula 2. physical count of # of units on hand at year end

2/10, Net 30

2% discount if they pay in 10 days; full amount due in 30 days

Inventory Turnover Ratio

a measure of the number of times inventory is sold during the period. the cost of storage and the lost income from the money tied up in inventory make it very expensive to keep on hand. thus, the more quickly a company can sell (turnover) its inventory the better

Gross Profit Method

an estimating method primary uses: 1. estimate inventory for interim financial statements: quarterly, monthly 2. estimate value of inventory destroyed/lost by casualty/theft to calculate: 1. determine gross profit % 2. sales x (1-gross profit %) 3. gas-cogs=ending inventory estimate

Inventory Costing

assigning value to goods in inventory

Inventory Turnover

cogs/ average inventory

First In, First Out (FIFO)

cost of first item purchased=cost of first item sold (cogs) advantages: - assigns current cost to inventory (ending inventory= most recent purchases) - good method when inventory turnover is rapid (bakery) disadvantages: - fails to match most recent costs with revenues (old costs on i/s) - if prices are rising, matches oldest unit costs with current revenues= overstatement of net income

Last In, First Out (LIFO)

cost of last item purchased= cost of first item sold advantages: - matches current costs with current revenues - in periods of rising prices, net income is always less (reduces income taxes) disadvantages: - gives non=current value to inventory on balance sheet

Working Capital

current assets-current liabilities

Current Ratio

current assets/current liabilities

COGS

formula: beginning inventory + net purchases -------------------- goods available for sale <ending inventory> ----------------------------

Net Purchases

formula: purchases <purchase returns and allowances> <purchase discounts> + freight in --------------------------

Ending Inventory Estimate

goods available for sale- cost of goods sold

Inventory

goods held for resale. reported as current assets on the balance sheet

Goods in Transit

goods ordered but not yet received; not in your or the other's warehouse; inventory goes to the person with legal title

Gross Profit Ratio

gross profit/net sales

True

in periods of declining prices, periodic fifo will have a lower net income than periodic lifo

LIFO Conformity Rule

its rule requires that if you use lifo on tax return, must also use lifo on your financial statements

Loss on Shrinkage

losses due to theft, breakage or spoilage are more easily detected

Net

means another calculation occurred

Inventory Profits

portion of gross profit that results from holding inventory in period of rising prices

PY Gross Profit

py net sales <py cogs> ----------------

Net Sales

sales revenue <sales returns and allowances> <sales discounts> -----------------------------

COGS Estimate

salesx (1-gross profit %)

Freight In

shipping cost paid by the buyer

Specific Identification

small quantity of inventory, high-priced items; this method tracks the *actual physical flow* of the goods. each item of inventory is marked, tagged, or coded with a specific unit cost

COGS

the amount we paid for goods we have sold. reported as an expense on the income statement

False

the gross profit method of estimating inventory can be used as a substitute for a physical inventory count under the periodic inventory method

Consigned Goods

the owner (consignor) transfers *physical* goods to agent (consignee) for purposes of selling *without* giving up legal title

False

the periodic inventory method requires an adjusting entry for a loss at the end of the period

FOB Shipping Point

title transfers to buyer when goods are accepted by *carrier*. buyer pays for shipping. freight in to buyer- include with net purchases

FOB Destination

title transfers when goods are *delivered to destination* of buyer; seller pays for shipping; freight out to the seller- include as selling expense

Average Cost Method

total cost of goods available for sale/total # units goods available for sale

COGS Formula

used with the periodic method