Chapter 7: Inventory and Cost of Goods Sold

inventory costing methods effects on financial statements when costs are rising

FIFO produces a larger inventory value (making the balance sheet appear to be stronger) and a smaller cost of goods sold (resulting in a larger gross profit, which makes the company look more profitable)

how is inventory recorded on a balance sheet

-because it will be used within one year, it is reported as a current asset -initially recorded at cost: the amount paid to acquire the asset and prepare it for sale -when company sells goods, it removes their cost from the Inventory account and reports the cost on the income statement as the expense Cost of Goods Sold -Cost of Goods Sold (CGS) is subtracted from Net Sales to yield the income statement subtotal called Gross Profit

inventory costing method effects on financial statements when costs are falling

-effects are reversed; FIFO produces a smaller ending inventory value and larger cost of goods sold.

specific identification method

-individually identifies and records the cost of each item as Cost of Goods Sold -requires accountants keep track of the purchase cost of each item -tend to use specific identification method when accounting for individually expensive and unique items

Are companies allowed to go back and forth between costing methods depending on whether the companies costs are declining or rising during a period?

-not really, it makes it difficult to compare financial results across periods -a change in methods is only allowed if it improves the accuracy of the company's financial results

work in process inventory

-what raw materials become when they enter the production process -includes goods that are in the process of being manufactured

finished goods inventory

-what work in process inventory becomes when completed -ready for sale just like merchandise inventory

lower of cost or market/net realizable value (LCM/NRV)

-when inventory falls below its cost, GAAP requires the inventory to be written down to its lower value -"market value" focyses on how much the inventory would cost to replace in current market conditions (replacement cost) -"net realizeable value" focuses on inventory value likely to be realized when sold (selling price minus selling costs such as delivery)

the three other inventory costing methods that are not based on the physical flow of goods on and off shelves but are instead based on assumptions accountants make about the flow of inventory costs

1. First in, First out 2. Last in, First out 3. Weighted average cost

what are the two reasons that the value of inventory can fall below its recorded cost for:

1. easily replaced by identical goods at a lower cost or 2. its become outdated or damaged

What is the primary goal of inventory managers

1. maintain a sufficient quantity of inventory to meet customers' needs 2. ensure inventory quality meets customers' expectations and standards 3. Minimize the cost of acquiring and carrying inventory (including costs related to purchasing, production, storage, spoilage, theft, obsolescence, and financing

days to sell formula

365/inventory turnover

LIFO

assumes the inventory costs flow out in the opposite of the order the goods are received -assumes the newest goods (last in inventory) are the first ones sold (first out of inventory) -the costs of older goods, including those in beginning inventory, are included in the cost of the ending inventory

FIFO

assumes the inventory costs flow out in the order the goods are received -assumes the oldest goods (first in inventory) are the first ones sold -costs of newer goods are included in the cost of the ending inventory

average inventory is calculated...

by taking (BI+EI)/2

merchandise inventory

consists of products acquired in a finished condition, ready for sale without further processing

How do the costing methods affect the financial statements?

cost of goods sold, gross profit, income from operations, income before income tax expense, income tax expense, net income

inventory turnover ratio

cost of goods sold/average inventory

what are inventory costing methods used to calculate

how to calculate the cost of goods sold

goods in transit

inventory items being transported -reported on the balance sheet of the owner, not the company transporting it -if sale is FOB destination, goods in transit belong to the seller until they reach their destination (customer) -if sale is made FOB shipping point, goods in transit belong to the customer at the point of shipping (from the seller's premises)

raw materials inventory

plastic, steel, or fabrics

consignment inventory

refers to goods a company is holding on behalf of the goods' owner -typically arises when a company is willing to sell the goods for the owner (for a fee) but does not want to take ownership of the goods in the event that they are difficult to sell. -reported on the balance sheet of the owner, not the company holding the inventory

LIFO Conformity rule

requires that if LIFO is used on the income tax return, it also must be used in financial statement reporting

Weighted average cost

uses the weighted average of the costs of goods available for sale both the cost of each item sold and those remaining in inventory to calculate: -calculate the total cost of goods available for sale -multiply the number of units at each cost by the cost per unit and then sum these amounts to get the total cost, then use formula

weighted average cost formula

weighted average cost= cost of goods available for sale/number of units available for sale

why would a company use a costing method that produces a smaller inventory amount and a larger cost of goods sold?

when faced with increasing costs per unit, a company that uses FIFO will have a larger income tax expense