Chapter 8: Inventories

f.o.b. destination

seller pays for freight costs, goods belong to seller until receipt.

to value inventory

1) determine the physical goods to include in inventory. 2) costs to include whether period or product. 3) cost flow assumptions made.

LIFO reserve: when used

1) external pricing not based on LIFO. 2) record keeping easier with other methods. 3) profit-sharing and bonus based on non-LIFO. 4) LIFO hard for interim periods

purchase discounts: benefits of net method

1) it provides a correct reporting of the cost of the asset and related liability. 2) it can measure management inefficiency by holding them responsible for discounts not taken.

perpetual system

1) purchases of merchandise and raw materials are debits to inventory not purchases. 2) freight-in debited to inventory not purchases. purchase returns, allowances, discounts credit inventory. 3) record COGS at sale by debit cogs and credit inventory. 4) subsidiary ledger kept as a control. shows quantity and cost of each inventory type.

when LIFO is a bad idea

1) when prices are lagging behind costs. 2) when specific identification is used. 3) economies of scale killing the tax benefit.

when LIFO is preferred

1) when the increase in prices and revenue is faster then the increase in costs. 2) tradition.

goods in transit

F.O.B. destination versus shipping. based on title shift. not recording shipment understates alot. for FOB ship the buyer has title at point of delivery not receipt.

payments in purchases discount period

Gross: debit AP for payment. credit purchases discounts for discount. credit cash less discount. Net: debit accounts payable and credit cash less discount.

purchases inventory: comparing methods

Gross: debit purchases and credit A/P at gross. Net: debit purchases and credit AP less discount

LIFO liquidation

LIFO inventory becomes eroded via a the specific goods LIFO method. erosion matches costs from preceding periods to current revenues distorting net income and huge taxes.

dollar-value LIFO

LIFO variant. identifies and measures changes in a pool by dollar value not by physical count of goods in the inventory pool. gets rid of the problem of redefining pools and eroding layers that happen in regular LIFO

flow of inventory costs: merchandising

Merchandise inventory: debit cost of purchases credit cost of goods sold

flow of inventory costs: manufacturing

RM/Labor/OH: debit actual credit used and supplied. Work in process: credit cost of goods manufactured. finished goods: credit cogs. ends by cogs going to IS.

future earnings hedge

a benefit of LIFO. future price declines will not have as big of an impact on future earnings so less write-downs

interest expense

a cost associated with getting inventory ready for sale and are period costs. argument is that interest is really a financing cost.

reduced earnings in general

a disadvantage of LIFO. inflationary times means reduced profits

net method

a method where the company considers discounts lost as a financial expense and reports it in the other expenses and losses section of the IS.

net of the cash discounts

a method where the failure to exploit a purchase discount is recorded in the purchase discounts lost account.

modified perceptual inventory system

a system that provides detailed inventory records of changes in only quantities not dollar figures.

specific-goods pooled LIFO approach

alleviate LIFO liquidation problems and to simplify the process in general. groups goods to pools of common stuff. specific units not tracked but similars are accounted for. fewer LIFO liquidations

purchase discounts

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

ending inventory misstated

an inventory error. if ending inventory is misstated then inventory, retained earnings, current ratio and working capital are misstated. on the income statement COGS is overstated while net income is understated.

sales with buyback

an inventory issue where title and risk don't match. product financing arrangement where you don't report liability or inventory on balance sheet. collateral. retain risk while giving up title.

sales with high rates of return

an inventory issues where title and risk don't match. can record using the gross method or not record anything until the return period has ended. inventory considered sold when you can reasonably estimate the amount of returns and establish a return liability

inventories

asset items held for sale in operating cycle or goods that will be used in the manufacturing of to sale goods. usually the largest current asset.

purchases and inventory misstatements

assume we understated purchases. Balance sheet: understated inventory, no retained earnings effects, understated accounts payable, no working capital effect, overstated current ratio. Income Statement: purchases under, COGS not effected, net income not effected,

product costs

attached to inventory are directly connect to bringing goods to buyer's business and converting said goods to a form they can be sold. direct materials, labor overhead. product costs are part of inventory costs.

tax benefits and improved cash flow

benefit of LIFO. when prices increase without inflation we get to defer taxes somewhat. if you use LIFO for taxes you must use it for all external reporting

f.o.b. shipping point

buyer pays freight. goods belong to seller upon dispatch.

LIFO effect

change in one period to the next of whatever account is used to record the difference between non-LIFO inventory used for internal reports and the LIFO used for tax or external reports.

accounting for inventory acquisition

companies generally account for the acquisition of inventory like other assets on a cash basis.

perpetual inventory system

company non-stop tracks changes in the inventory account. record all purchases and sale of goods directly to the inventory account as incurred. will always jointly show balances in inventory and cost of goods sold. computerized.

gross method

company states purchase discounts as a deduction from purchases on the income statement.

raw materials inventory

cost assigned to goods and materials on hand but not yet in production. raw materials are traced directly to end good. only on balance sheet of manufacturing companies

work in process inventory

cost of partial units in a continuous production process. raw material and direct labor applied to a materials and a share of overhead. only for manufacturing companies.

finished goods inventory

costs associated with completed by not sold on hand units at the end of the period. part of manufacturing companies.

period costs

costs stuck to a unique accounting period. officer's salaries. they are charged in the immediate period even if benefits associated with costs are to be incurred. not part of inventory cost but are recorded in the same period as the related revenue of a specific period and expensed as incurred.

LIFO reserve

difference between the inventory reported using LIFO for tax or external means and the inventory using FIFO or something else internally.

cost of goods sold

difference of costs of goods for sale and on hand ending inventory

double extension method

ending inventory for period at current cost divided by ending inventory for period at the base year cost equals the price index for the current year.

periodic costs available for sale

ending purchases plus beginning on hand inventory

FIFO

first-in first-out. use of goods in order they are purchased. costs of earlier goods allocated earlier to COGS. physical flow of goods, prevents income alterations, prices of ending inventory closer to new cost. does not match costs to revenues.

cost flow assumptions

flow of inventories. made to value said account. most common are specific identification, average-cost, FIFO/LIFO. physical transfer of goods doesn't need to match the assumption but method need remain consistent. the assumption should be the one that most clearly shows period income.

payments post purchases discount

gross: debit accounts payable raw and credit cash. net: debit accounts payable raw less discount.s debit purchases discounts lost by raw times percentage. credit cash raw.

general rule of inventory title

inventory is buyers when received

consigned goods

inventory is held by a party as an agent for the true owner selling the good. cosigness holds goods without liability other then to make sure they are taken care of until sale. revenues are remitted to the consignor less any commissions and expenses to make the sale happen. cosignee never records inventory

average-cost method

inventory-costing method that prices inventory based on the average cost of all comparable goods in the period. uses weighted averages while users of perpetual use moving averages.

moving-average method

inventory-costing method. used by the perpetual inventory. computes a new average unit cost or average each time we make someone bought something.

specific identification

inventory-costing. identify and cost each item sold and each item in inventory. retailers only when handling a relatively small number of costly unique goods. manufacturers may use when special orders

weighted-average method

inventory-costing. periodic inventory method. prices items on average costs of all period similar goods. find total cost of similars divide by total cost of number of units inventory and applies this average per unit to the items in ending.

traits of FIFO

it tries to approximate the flow of goods. prevents income manipulation. ending inventory close to current cost. bad matching principal so profits may become distorted.

physical count

keep in mind that no matter the inventory system that you use it is important to do this once in awhile

LIFO

last-in first out. the latest goods are used to fit orders before older goods. costs of the latest goods go to COGS first. better matching of costs to revenues and tax benefits but reports lower earnings.

Merchandise inventory

merchandising business. cost given to the unsold units on hand but ready to ship. only one inventory account appears in the merchandiser's financial statements.

selecting a price index

must be done for using dollar value LIFO. if you can't find a market rate use the double extension method

traits of weighted average unit cost

new average unit cost found post purchase or sale for perpetual systems using moving average. simple and objective and free of income manipulation and good when it is hard to approximate the physical flow of goods.

inventory control

not having a grasp of inventory could mean lost sales or waste. to big means undue financing.

matching: LIFO

one of the advantages of LIFo. matches recent costs and revenues to better show earnings. during inflation non-lifo creates paper profits where inventory costs matched to sales are less than inventory replacement costs

inventory understated

outdated valuation. bad appearance of working capital

parking transaction

park the inventory in the other balance sheet

LIFO and timing

periodic system matches total month withdrawals for month with total purchases for month. perpetual matches withdrawals with preceding months purchases.

sales of inventory: comparing journal entries

perpetual: debit A/R and credit revenue. debit Cogs and credit inventory periodic: debit A/R and credit sales. no COGS.

purchases: comparing journal entries

perpetual: debit inventory credit accounts payable. periodic: debit purchases credit accounts payable.

end of period inventory: comparing journal entries

perpetual: no entry. periodic: debit inventory and cogs. credit purchases and beginning invetory

window dressing

poor inventory records makes the current ratio look falsely good.

periodic system

quantity of inventory on hand found periodically. acquisitions go to purchases account.

FASB and interest capitalization

the accounting standards board states a company should capitalize interest costs related to assets constructed for internal use or assets produced as discrete projects for sale or lease. not routine production

cost of goods available for sale

the beginning inventory plus the cost purchased.

issues of inventory valuation

the big problem is that cost of goods sold usually doesn't equal the cost produced.

periodic inventory system

the company uses a purchases account to record purchases inventory in period. inventory account shows the beginning inventory of period at the end of said period the company adjusts it by closing out the beginning inventory and recording the ending amount determined by a physical count of the items valued at cost or at lower-of-cost-or-market

note on fifo

the first goods purchases are the first used or the first sold for merchandising.

general rule of cost flow assumptions

there is not need for cash flow assumptions to actually match the physical movement of goods.

manufacturers inventories

they keep separate accounts for raw materials, finished goods and work in process

supplies inventory

this is an inventory sometimes used by manufacturers components that are secondary in nature and importance

LIFO: specific goods

this is an unrealistic way to value LIFO because: 1) when multi-product the tracking inventory is really expensive. 2) erosion of inventory can occur.

merchandisers inventories

this is just one account. inventory. (unless they have purchases)

traits of specific identification

this method matches physical flow of goods but allows income manipulation and costs are often assigned arbitrarily.

note on LIFo

under a periodic system it assumes the cost of the total quantity sold or issued during the month comes from the most recent purchases. using perpetual will result in a different ending inventory and cost of goods sold.

physical flow of LIFo

usually doesn't match the physical flow of goods.

classification of inventory

usually the largest current asset investment. merchandising concern is when goods bought will be for sale. manufacturing concern is how much do we need to produce to sell to merchandisers.

double-extension method

way to calculate a specific internal price index when you can't get an external one. done by finding current costs with reference to the actual cost of the goods just bought. price measures the change in the price or cost levels between base year and year now. then compute index per year post-base

LIFO cash and other method

when prices rise then LIFO will show a higher cash balance at the end of the year compared to other methods. when prices are falling LIFO will show a lower cash balance at the end of the year compared to ther methods.

inventory write down

when using perpetual and balance does not equal the ending physical count. debit inventory short and over and credit inventory. represents the incorrect cogs.

ending inventory and fifo

whenever FIFO is used the ending inventory and cost of goods sold will match whether using periodic or perpetual