Chapter 6 - Inventories and Cost of Sales

LIFO = Last in, first out

method for assigning cost to inventory that assumes cost for the most recent items purchased are sold first and charged to "cost of goods sold."

Specific identification

method for assigning cost to inventory when the purchase cost of each item in inventory is identified and used to compute cost of good sold and/or cost of inventory.

Weighted average (aka average cost)

method for assigning inventory cost to sales; ** (cost of available-for-sale units) is divided by (number of units available) to determine per-unit cost prior to each sale that is then multiplied by the units sold to yield the cost of that sale.

Retail inventory method

method for estimating ending Inventory based on the ratio of the amount of goods for sale at cost to the amount of goods for sale at retail. goods (company cost) : goods (retail costs)

invoice cost

price a company pays to its wholesale dealer to purchase the item for resale (usually less than retail cost)

Consistency concept = be consistent with your accounting methods

principle that prescribes use of the SAME accounting method(s) overtime so that financial statements are comparable across periods.

Gross profit method

procedure to estimate inventory by using the past "gross profit rate" to estimate cost of good sold, which is then subtracted from the cost of goods available for sale.

Analyze the effects of inventory airs on current and future financial statements

An error in the amount of ending inventory affects assets (inventory), net income (cost of good sold), and equity for that period. *Since ending inventory is next period's. beginning inventory, an error in ending inventory affects next period's cost of goods sold and net income. *Inventory errors in one period are offset in the next period.

Interim statements (aka Interim financial statements)

Financial statements covering period of less than one year; usually based on one-, three- , or six-month periods

Cost of merchandise inventory

Includes expenditures necessary to bring an item to a salable condition and location. *Includes it's invoice cost minus any discount plus any added or incidental costs necessary to put it in a place and condition for sale

Compute the: "lower of cost or market" (LCM) amount of inventory

Inventory is reported at market cost when market cost is "lower" than recorded cost, called the "lower of cost or market (LCM) inventory". Market is typically measured as replacement cost. Lower of cost or market = can be applied separately to each item, to major categories of items, or to the entire inventory

Days sales' In inventory

an estimate of number of days needed to convert inventory into receivables or cash; equals ending inventory divided by cost of good sold and then multiply by 365. *also called "days stock on hand"

Inventory in a perpetual system using methods of: Special identification. FIFO. LIFO. Weighted average.

Costs are assigned to the "cost of good sold" account each time a sale occurs in a perpetual system. Specific identification = assigns a cost to each item sold by referring to its actual cost (for example, it's net invoice cost). Weighted average =Assigns a cost to item sold by dividing the current balance in the "inventory account" by the total items available for sale to determine cost per unit. *we then multiply the number of units sold by this cost per unit to get the cost of each sale. FIFO = assigns cost to items sold assuming that the earliest units purchased first are the first units sold. LIFO = assigns cost to items sold assuming that the most recent units purchased are the first units sold

Net realizable value

Expected selling price (value) of an item minus the cost of making the sale. Net realizable value = sell value - cost.

Items making up "merchandise inventory"

Merchandise inventory = refers to goods owned by a company and held for resale. Three special cases need addressed: Goods in transit = reported in inventory of the company that holds ownership rights. Goods on consignment = reported in the consignors inventory. Goods damaged = reported in inventory at their net realizable value

FIFO

Method to assign cost to inventory that assumes items are sold in the order acquired; earliest items purchased are the first sold.

Inventory turnover (aka merchandise turnover)

Or of times a companies average inventory is sold during a period; computed by: (cost of goods sold) / (average inventory). ... Inventory turnover = (cost of goods sold) / (average inventory).

consignor

Owner of goods held by another party who will sell them for the owner (Consignee = the receiver of goods who sells for owner. Consignor = the owner of goods ) **consigned goods are included in the consignor (owner's) inventory, not the consignee.

Inventory in a periodic system using the methods of: Special identification. FIFO. LIFO. Weighted average.

Periodic inventory systems allocate the cost of goods available for sale between cost of goods sold and ending inventory quote at the end of a period." Specific identification and FIFO = give identical results whether the periodic or perpetual system used. LIFO = assigns cost to Cost of good sold assuming the last units purchased for the period are the first unit sold. Weighted average = cost per unit is computed by dividing the "total cost of beginning inventory and net purchases for the period" by the "total number of units available." **then, it multiplies cost per unit by the number of units sold to give cost of goods sold

consignee

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

Lower of cost or market (LCM)

Required method to report inventory at market replacement cost when the market cost is lower than recorded cost.

Conservatism constraint

Simple that prescribes the less optimistic estimate went to estimates are about equally likely

Apply both the "retail inventory" and "gross profit" methods to: Estimate inventory

The retail inventory method involves three steps: 1. (Goods available at retail) - (net sales at retail) = (ending inventory at retail). 2. (Goods available at cost) / (goods available at retail) = (cost-to-retail ratio). 3. (Ending inventory at retail) x (cost-to-retail Ratio) = (est. ending inventory at cost)

Assess inventory management using both: "inventory turnover" and "days' sales and inventory"

We prefer a high inventory turnover, provided the goods are not out of stock and customers are not turned away. We use "days' sales and inventory" to assess the likelihood of goods being out of stock. *we prefer a small number of "days sales and inventory" if we can serve customer needs and provide a buffer for uncertainties.

Analyze the effects of inventory methods for both financial and tax reporting

When purchased costs are rising or falling, the inventory costing methods are likely to assign different cost to inventory. *Special identification exactly matches costs and revenues. Weighted average smooths out calls changes. *FIFO assigns an amount to inventory closely approximating current replacement cost. *LIFO assigns the most recent costs incurred to cost of goods sold and likely better matches current costs with revenues