Intermediate Accounting: Chapter 8

Average cost method

Average cost method Inventory-costing method that prices items in the inventory on the basis of the average cost of all similar goods available during the period. Companies that use the periodic inventory method use weighted averages and those that use the perpetual method use moving averages.

Interest Costs

FASB ASC 835-20-05. [Predecessor literature: "Capitalization of Interest Cost," Statement of Financial Accounting Standards No. 34 (Stamford, Conn.: FASB, 1979).]

Finished goods inventory

Finished goods inventory The costs identified with the completed but unsold units on hand at the end of the fiscal period. This category of inventory appears on the balance sheets of manufacturing companies.

Inventories

Inventories Asset items that a company holds for sale in the ordinary course of business, or goods that it will use or consume in the production of goods to be sold. The investment in inventories is frequently the largest current asset of merchandising (retail) and manufacturing businesses.

Inventory Control

Inventory Control For various reasons, management is vitally interested in inventory planning and control. Whether a company manufactures or merchandises goods, it needs an accurate accounting system with up-to-date records. It may lose sales and customers if it does not stock products in the desired style, quality, and quantity. Further, companies must monitor inventory levels carefully to limit the financing costs of carrying large amounts of inventory.

LIFO effect

LIFO effect The change from one period to the next in the balance of the account (Allowance to Reduce Inventory to LIFO, also called the LIFO reserve) that companies use to record the difference between the non-LIFO inventory method used for internal-reporting purposes and LIFO used for tax or external-reporting purposes.

LIFO liquidation

LIFO liquidation Erosion of the LIFO inventory under a specific-goods (unit LIFO) approach. Such erosion matches costs from preceding periods against sales revenues reported in current dollars, which often distorts net income and leads to substantial tax payments.

LIFO reserve

LIFO reserve The difference between the inventory amount reported using LIFO for tax or external-reporting purposes and the inventory amount using FIFO or some other method for internal-reporting purposes.

Major Advantages of Lifo (Physical Flow)

Physical Flow LIFO does not approximate the physical flow of the items except in specific situations (such as the coal pile discussed earlier). Originally companies could use LIFO only in certain circumstances. This situation has changed over the years. Now, physical flow characteristics no longer determine whether a company may employ LIFO.

Purchase Discounts

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

Raw materials inventory

Raw materials inventory The cost assigned to goods and materials on hand but not yet placed into production. Raw materials can be traced directly to the end product. This category of inventory appears on the balance sheets of manufacturing companies.

Specific identification

Specific identification Inventory-costing methods in which companies identify and cost each item sold and each item in inventory. Retailers use this method only when handling a relatively small number of costly, easily distinguishable items, such as fur coats, automobiles, some furniture; manufacturers use it for special orders and many products manufactured under a job cost system.

Perpetual System (accounting features)

The accounting features of a perpetual inventory system are as follows. 1. Purchases of merchandise for resale or raw materials for production are debited to Inventory rather than to Purchases. 2. Freight-in is debited to Inventory, not Purchases. Purchase returns and allowances and purchase discounts are credited to Inventory rather than to separate accounts. 3. Cost of goods sold is recorded at the time of each sale by debiting Cost of Goods Sold and crediting Inventory. 4. A subsidiary ledger of individual inventory records is maintained as a control measure. The subsidiary records show the quantity and cost of each type of inventory on hand. The perpetual inventory system provides a continuous record of the balances in both the Inventory account and the Cost of Goods Sold account.

Special Sales Agreements

Three special sales situations are illustrated here to indicate the types of problems companies encounter in practice. These are: 1. Sales with buyback agreement. 2. Sales with high rates of return. 3. Sales on installment.

f.o.b. destination

f.o.b. destination Freight term indicating that shipped goods are placed free on board ("f.o.b.") to the buyer's place of business and the seller pays the freight costs; the goods belong to the seller while in transit and title passes to the buyer when the buyer receives the goods from the shipping carrier.

f.o.b. shipping point

f.o.b. shipping point Freight term indicating that shipped goods are placed free on board ("f.o.b.") to the shipping carrier by the seller and the buyer pays the freight costs; the goods belong to the buyer while in transit.

Understand Why Companies Select Given Inventory Methods

Companies ordinarily prefer LIFO in the following circumstances: (1) if selling prices and revenues have been increasing faster than costs and (2) if a company has a fairly constant "base stock." Conversely, LIFO would probably not be appropriate in the following circumstances: (1) if sale prices tend to lag behind costs, (2) if specific identification is traditional, and (3) when unit costs tend to decrease as production increases, thereby nullifying the tax benefit that LIFO might provide.

Inventory Cost Flow

Companies that sell or produce goods report inventory and cost of goods sold at the end of each accounting period. The flow of costs for a company is as follows: Beginning inventory plus the cost of goods purchased is the cost of goods available for sale. As goods are sold, they are assigned to cost of goods sold. Those goods that are not sold by the end of the accounting period represent ending inventory.

Inventory Cost Flow Record Systems

Companies use one of two types of systems for maintaining accurate inventory records for these costs—the perpetual system or the periodic system.

Consigned goods

Consigned goods Inventory held by one party (the consignee) who acts as the agent for the owner of the goods (the consignor) in selling the goods. The consignee accepts and holds the consigned goods without any liability, except to exercise due care and reasonable protection from loss or damage until it sells the goods to a third party. When the consignee sells the goods, it remits the revenue to the consignor, less a selling commission and expenses incurred in accomplishing the sale. - The consignee makes no entry to the inventory account for goods received. Remember, these goods remain the property of the consignor until sold. In fact, the consignee should be extremely careful not to include any of the goods consigned as a part of inventory.

Cost flow assumptions

Cost flow assumptions Several systematic assumptions about the flow of inventory, used by companies to value their inventory. The main cost flow assumptions are specific identification, average cost, FIFO, and LIFO. The actual physical movement of goods need not match the cost flow assumption a company adopts, but the company must use its selected cost flow assumption consistently from one period to the next. The objective should be to choose a cost flow assumption that most clearly reflects periodic income.

Describe and Compare the Cost Flow Assumptions Used to Account for Inventories.

Describe and Compare the Cost Flow Assumptions Used to Account for Inventories. (1) Average cost prices items in the inventory on the basis of the average cost of all similar goods available during the period. (2) First-in, first-out (FIFO) assumes that a company uses goods in the order in which it purchases them. The inventory remaining must therefore represent the most recent purchases. (3) Last-in, first-out (LIFO) matches the cost of the last goods purchased against revenue.

Distinguish Between Perpetual and Periodic Inventory Systems

Distinguish Between Perpetual and Periodic Inventory Systems. A perpetual inventory system maintains a continuous record of inventory changes in the Inventory account. That is, a company records all purchases and sales (issues) of goods directly in the Inventory account as they occur. Under a periodic inventory system, companies determine the quantity of inventory on hand only periodically. A company debits a Purchases account, but the Inventory account remains the same. It determines cost of goods sold at the end of the period by subtracting ending inventory from cost of goods available for sale. A company ascertains ending inventory by physical count.

Dollar-value LIFO

Dollar-value LIFO A variation of the LIFO inventory-costing method; it determines and measures any increases and decreases in a pool in terms of total dollar value, not the physical quantity of the goods in the inventory pool. The dollar-value LIFO method overcomes the problems of redefining pools and eroding layers that occur with the regular LIFO method. - Note that a layer forms only when the ending inventory at base-year prices exceeds the beginning inventory at base-year prices. (P. 456)

Double-extension method

Double-extension method A method for computing a specific internal price index, when a relevant external price index is not readily available, by determining current costs with reference to the actual cost of the goods most recently purchased. The price measure provides a measure of the change in the price or cost levels between the base year and the current year. The company then computes the index for each year after the base year. - Use of the double-extension method is time consuming and difficult where substantial technological change has occurred or where many items are involved. That is, as time passes, the company must determine a new base-year cost for new products, and must keep a base-year cost for each inventory item.

Explain the Dollar-value Lifo Method.

Explain the Dollar-value Lifo Method. For the dollar-value LIFO method, companies determine and measure increases and decreases in a pool in terms of total dollar value, not the physical quantity of the goods in the inventory pool.

Explain the Significance and Use of a Lifo Reserve.

Explain the Significance and Use of a Lifo Reserve. The difference between the inventory method used for internal reporting purposes and LIFO is referred to as the Allowance to Reduce Inventory to LIFO, or the LIFO reserve. The change in LIFO reserve is referred to as the LIFO effect. Companies should disclose either the LIFO reserve or the replacement cost of the inventory in the financial statements.

Sales With Buyback Agreement

FASB ASC 470-40-05. [Predecessor literature: "Accounting for Product Financing Arrangements," Statement of Financial Accounting Standards No. 49 ( Stamford, Conn.: FASB, 1981).]

Sales With High Rates of Return

FASB ASC 605-15-15. [Predecessor literature: "Revenue Recognition When Right of Return Exists," Statement of Financial Accounting Standards No. 48 (Stamford, Conn.: FASB, 1981).]

First-in, first-out (FIFO) method

First-in, first-out (FIFO) method Inventory-costing method that assumes that a company uses goods in the order in which it purchases them. Thus, the costs of the earliest goods purchased are the first to be allocated to cost of goods sold. FIFO often approximates the physical flow of goods, prevents manipulation of income, and prices ending inventory close to current cost, but it fails to match current costs against current revenues on the income statement, possibly distorting gross profit and net income.

Major Advantages of Lifo (Future Earnings Hedge)

Future Earnings Hedge With LIFO, future price declines will not substantially affect a company's future reported earnings. The reason: Since the company records the most recent inventory as sold first, there is not much ending inventory at high prices vulnerable to a price decline. Thus LIFO eliminates or substantially minimizes write-downs to market as a result of price decreases. In contrast, inventory costed under FIFO is more vulnerable to price declines, which can reduce net income substantially.

Gross method

Gross method A method in which a company reports purchase discounts as a deduction from purchases on the income statement.

Basis for Selection of Inventory Method

How does a company choose among the various inventory methods? Although no absolute rules can be stated, preferability for LIFO usually occurs in either of the following circumstances: (1) if selling prices and revenues have been increasing faster than costs, thereby distorting income, and (2) in situations where LIFO has been traditional, such as department stores and industries where a fairly constant "base stock" is present (such as refining, chemicals, and glass). Conversely, LIFO is probably inappropriate in the following circumstances: (1) where prices tend to lag behind costs; (2) in situations where specific identification is traditional, such as in the sale of automobiles, farm equipment, art, and antique jewelry; or (3) where unit costs tend to decrease as production increases, thereby nullifying the tax benefit that LIFO might provide. Tax consequences are another consideration. Switching from FIFO to LIFO usually results in an immediate tax benefit. However, switching from LIFO to FIFO can result in a substantial tax burden. It is questionable whether companies should switch from LIFO to FIFO for the sole purpose of increasing reported earnings. Intuitively, one would assume that companies with higher reported earnings would have a higher share valuation (common stock price). However, some studies have indicated that the users of financial data exhibit a much higher sophistication than might be expected. Share prices are the same and, in some cases, even higher under LIFO in spite of lower reported earnings.

Identify Major Classifications of Inventory.

Identify Major Classifications of Inventory. Only one inventory account, Inventory, appears in the financial statements of a merchandising concern. A manufacturer normally has three inventory accounts: Raw Materials, Work in Process, and Finished Goods. Companies report the cost assigned to goods and materials on hand but not yet placed into production as raw materials inventory. They report the cost of the raw materials on which production has been started but not completed, plus the direct labor cost applied specifically to this material and a ratable share of manufacturing overhead costs, as work in process inventory. Finally, they report the costs identified with the completed but unsold units on hand at the end of the fiscal period as finished goods inventory.

Identify the Effects of Inventory Errors On the Financial Statements.

Identify the Effects of Inventory Errors On the Financial Statements. If the company misstates ending inventory: (1) In the balance sheet, the inventory and retained earnings will be misstated, which will lead to miscalculation of the working capital and current ratio, and (2) in the income statement the cost of goods sold and net income will be misstated. If the company misstates purchases (and related accounts payable) and inventory: (1) In the balance sheet, the inventory and accounts payable will be misstated, which will lead to miscalculation of the current ratio, and (2) in the income statement, purchases and ending inventory will be misstated.

Ending Inventory Misstated

If ending inventory is understated, working capital (current assets less current liabilities) and the current ratio (current assets divided by current liabilities) are understated. If cost of goods sold is overstated, then net income is understated.

Dollar-value Lifo (Decrease in quantity of goods)

If the ending inventory at base-year prices is less than the beginning inventory at base-year prices, a company must subtract the decrease from the most recently added layer. When a decrease occurs, the company "peels off" previous layers at the prices in existence when it added the layers. - EX: At December 31, 2011, a comparison of the ending inventory at base-year prices ($250,000) with the beginning inventory at base-year prices ($260,000) indicates a decrease in the quantity of goods of 10,000(250,000 - 260,000). this means that it removes $10,000 in base-year prices from the 2010 layer of $60,000 at base-year prices. It values the balance of 50,000 (60,000 - 10,000) at base-year prices at the 2010 price index of 115 percent. (p. 457) Note that if Bismark eliminates a layer or base (or portion thereof), it cannot rebuild it in future periods. That is, the layer is gone forever.

Inventory Over and Short

Inventory Over and Short -this account adjusts Cost of Goods Sold. In practice, companies sometimes report Inventory Over and Short in the "Other revenues and gains" or "Other expenses and losses" section of the income statement. - Only needed for a perpetual inventory system.

Major Advantages of Lifo (Inventory Understated)

Inventory Understated LIFO may have a distorting effect on a company's balance sheet. The inventory valuation is normally outdated because the oldest costs remain in inventory. This understatement makes the working capital position of the company appear worse than it really is. - The magnitude and direction of this variation between the carrying amount of inventory and its current price depend on the degree and direction of the price changes and the amount of inventory turnover. The combined effect of rising product prices and avoidance of inventory liquidations increases the difference between the inventory carrying value at LIFO and current prices of that inventory. This magnifies the balance sheet distortion attributed to the use of LIFO.

Major Advantages of Lifo (Involuntary Liquidation/poor Buying Habits)

Involuntary Liquidation/poor Buying Habits If a company eliminates the base or layers of old costs, it may match old, irrelevant costs against current revenues. A distortion in reported income for a given period may result, as well as detrimental income tax consequences. - Because of the liquidation problem, LIFO may cause poor buying habits. A company may simply purchase more goods and match these goods against revenue to avoid charging the old costs to expense. Furthermore, recall that with LIFO, a company may attempt to manipulate its net income at the end of the year simply by altering its pattern of purchases.14

Last-in, first-out (LIFO) method

Last-in, first-out (LIFO) method Inventory-costing method that assumes that a company uses the latest goods purchased before it uses the earlier goods purchased. Thus, the costs of the latest goods purchased are the first to be allocated to cost of goods sold. LIFO provides a good matching of recent costs against current revenues and tax benefits, but generally reports lower earnings, which some managers see as a disadvantage.

Special Issues Related to Lifo

Many companies use LIFO for tax and external reporting purposes. However, they maintain a FIFO, average cost, or standard cost system for internal reporting purposes. There are several reasons to do so: (1) Companies often base their pricing decisions on a FIFO, average, or standard cost assumption, rather than on a LIFO basis. (2) Recordkeeping on some other basis is easier because the LIFO assumption usually does not approximate the physical flow of the product. (3) Profit-sharing and other bonus arrangements often depend on a non-LIFO inventory assumption. Finally, (4) the use of a pure LIFO system is troublesome for interim periods, which require estimates of year-end quantities and prices.

Major Advantages of Lifo (Matching)

Matching LIFO matches the more recent costs against current revenues to provide a better measure of current earnings. During periods of inflation, many challenge the quality of non-LIFO earnings, noting that failing to match current costs against current revenues creates transitory or "paper" profits ("inventory profits"). Inventory profits occur when the inventory costs matched against sales are less than the inventory replacement cost. This results in understating the cost of goods sold and overstating profit. Using LIFO (rather than a method such as FIFO) matches current costs against revenues, thereby reducing inventory profits.

Merchandise inventory

Merchandise inventory For a merchandising business, the cost assigned to unsold units left on hand, but ready for sale. Only one inventory account, Inventory, appears in a merchandiser's financial statements.

Modified perpetual inventory system

Modified perpetual inventory system A system that provides detailed inventory records of increases and decreases in quantities only, not dollar amounts.

Moving-average method

Moving-average method Inventory-costing method, used by companies that use the perpetual inventory method. In this method, a company computes a new average unit cost (a "moving average") each time it makes a purchase.

Net method

Net method A method in which a company considers purchase discounts lost as a financial expense and reports it in the "Other expenses and losses" section of the income statement.

Net of the cash discounts

Net of the cash discounts A method in which a company records the failure to take a purchase discount within the discount period in a Purchase Discounts Lost account.

Selecting a Price Index

Obviously, price changes are critical in dollar-value LIFO. How do companies determine the price indexes? Many companies use the general price-level index that the federal government prepares and publishes each month. The most popular general external price-level index is the Consumer Price Index for Urban Consumers (CPI-U).

Purchases and Inventory Misstated

Omission of goods from purchases and inventory results in an understatement of inventory and accounts payable in the balance sheet; it also results in an understatement of purchases and ending inventory in the income statement. However, the omission of such goods does not affect net income for the period. - Total working capital is unchanged, but the current ratio is overstated because of the omission of equal amounts from inventory and accounts payable. (p.445)

FIFO

One objective of FIFO is to approximate the physical flow of goods. When the physical flow of goods is actually first-in, first-out, the FIFO method closely approximates specific identification. At the same time, it prevents manipulation of income. With FIFO, a company cannot pick a certain cost item to charge to expense. Another advantage of the FIFO method is that the ending inventory is close to current cost. Because the first goods in are the first goods out, the ending inventory amount consists of the most recent purchases. This is particularly true with rapid inventory turnover. This approach generally approximates replacement cost on the balance sheet when price changes have not occurred since the most recent purchases. However, the FIFO method fails to match current costs against current revenues on the income statement. A company charges the oldest costs against the more current revenue, possibly distorting gross profit and net income.

Period costs

Period costs Costs that attach to a specific accounting period. Examples are officers' salaries and other administrative expenses. Companies charge off such period costs in the immediate period even though benefits associated with these costs may occur in the future. Period costs are not included as part of inventory cost; instead, they are recorded in same period as the related revenue of a specific time period and expensed as incurred.

Periodic inventory system

Periodic inventory system Inventory system in which a company uses a Purchases account to record purchases of inventory during the period. The Inventory account represents the beginning inventory amount throughout the period; at the end of the accounting period, the company adjusts the inventory account by closing out the beginning inventory amount and recording the ending inventory amount, which is determined by a physical count of the items on hand, valued at cost or at the lower-of-cost-or-market. - To compute the cost of goods sold, the company then subtracts the ending inventory from the cost of goods available for sale. Note that under a periodic inventory system, the cost of goods sold is a residual amount that depends on a physical count of ending inventory. This process is referred to as "taking a physical inventory." Companies that use the periodic system take a physical inventory at least once a

Perpetual System

Perpetual inventory system An inventory system in which a company continuously tracks changes in the Inventory account. The company records all purchases and sales (issues) of goods directly in the Inventory account as they occur. The accounting records continuously show the balances in both the inventory account and the cost of goods sold account. A computerized recordkeeping system records nearly instantaneously any additions to and issuances from inventory.

Formula for Computing a Price Index (Double-extension method)

Price Index for Current Year = Ending Inventory for the period at Current Costs / ending Inventory for the Period at Base-year Cost

Product costs (inventory)

Product costs (inventory) Costs that "attach" to the inventory and are directly connected with bringing the goods to the buyer's place of business and converting such goods to a salable condition. Such costs include direct materials, direct labor, and manufacturing overhead costs (indirect materials, indirect labor, and various costs incurred in the manufacturing process such as depreciation, taxes, insurance, and heat and electricity). Companies record product costs as part of the inventory cost.

Major Disadvantages of Lifo (Reduced Earnings)

Reduced Earnings Many corporate managers view the lower profits reported under the LIFO method in inflationary times as a distinct disadvantage. They would rather have higher reported profits than lower taxes. Some fear that investors may misunderstand an accounting change to LIFO, and that the lower profits may cause the price of the company's stock to fall.

Sales On Installment

Sales On Installment "Goods sold on installment" describes any type of sale in which the sale agreement requires payment in periodic installments over an extended period of time. Because the risk of loss from uncollectibles is higher in installment-sale situations than in other sales transactions, the seller sometimes withholds legal title to the merchandise until the buyer has made all the payments. Underlying Concepts For goods sold on installment, companies should recognize revenues because they have been substantially earned and are reasonably estimable. Collection is not the most critical event if bad debts can be reasonably estimated. The question is whether the seller should consider the inventory sold, even though legal title has not passed. The answer is that the seller should exclude the goods from its inventory if it can reasonably estimate the percentage of bad debts.

Sales With High Rates of Return

Sales With High Rates of Return - In industries such as publishing, music, toys, and sporting goods, formal or informal agreements often exist that permit purchasers to return inventory for a full or partial refund. - When a company can reasonably estimate the amount of returns, it should consider the goods sold.

Specific-goods pooled LIFO approach

Specific-goods pooled LIFO approach A method used to alleviate LIFO liquidation problems and to simplify LIFO accounting, by grouping goods into pools of similar items. Thus, instead of tracking specific inventory units, a company combines, and accounts for together, a number of similar units or products, which usually results in fewer LIFO liquidations.

Dollar-value Lifo (equation)

Steps to calculating Dollar-value lifo: 1) End-of-Year Inventory at Base-Year Price = Inventory at end of year prices / Price Index Percentage 2) Increase in quantity of goods (in base-year prices) = ending inventory at base-year prices - beginning inventory at base-year prices - Note equation above is considered an increment layer and equation below shows how to make it a new layer. 3)New layer = increase in quantity of goods (in base-year prices) * Price Index Percentage 4) Ending inventory = beginning inventory + new layer

Major Advantages of Lifo (Tax Benefits/improved Cash Flow)

Tax Benefits/improved Cash Flow LIFO's popularity mainly stems from its tax benefits. As long as the price level increases and inventory quantities do not decrease, a deferral of income tax occurs. Why? Because a company matches the items it most recently purchased (at the higher price level) against revenues.

Interest Costs

The FASB ruled that companies should capitalize interest costs related to assets constructed for internal use or assets produced as discrete projects (such as ships or real estate projects) for sale or lease [4].3 The FASB emphasized that these discrete projects should take considerable time, entail substantial expenditures, and be likely to involve significant amounts of interest cost. A company should not capitalize interest costs for inventories that it routinely manufactures or otherwise produces in large quantities on a repetitive basis. In this case, the informational benefit does not justify the cost.

Identify the Major Advantages and Disadvantages of Lifo.

The major advantages of LIFO are the following: (1) It matches recent costs against current revenues to provide a better measure of current earnings. (2) As long as the price level increases and inventory quantities do not decrease, a deferral of income tax occurs in LIFO. (3) Because of the deferral of income tax, cash flow improves. Major disadvantages are: (1) reduced earnings, (2) understated inventory, (3) does not approximate physical flow of the items except in peculiar situations, and (4) involuntary liquidation issues.

Understand the Effect of Lifo Liquidations.

Understand the Effect of Lifo Liquidations. LIFO liquidations match costs from preceding periods against sales revenues reported in current dollars. This distorts net income and results in increased taxable income in the current period. LIFO liquidations can occur frequently when using a specific-goods LIFO approach.

Understand the Items to Include As Inventory Cost.

Understand the Items to Include As Inventory Cost. Product costs are those costs that attach to the inventory and are recorded in the inventory account. Such charges include freight charges on goods purchased, other direct costs of acquisition, and labor and other production costs incurred in processing the goods up to the time of sale. Period costs are those costs that are indirectly related the acquisition or production of the goods. These changes, such as selling expense and general and administrative expenses, are therefore not included as part of inventory cost.

Lifo Liquidation

Up to this point, we have emphasized a specific-goods approach to costing LIFO inventories (also called traditional LIFO or unit LIFO). This approach is often unrealistic for two reasons: 1. When a company has many different inventory items, the accounting cost of tracking each inventory item is expensive. 2. Erosion of the LIFO inventory can easily occur. Referred to as LIFO liquidation, this often distorts net income and leads to substantial tax payments.

Basic Issues in Inventory Valuation

Valuing inventories can be complex. It requires determining the following. 1. The physical goods to include in inventory (who owns the goods?—goods in transit, consigned goods, special sales agreements). 2. The costs to include in inventory (product vs. period costs). 3. The cost flow assumption to adopt (specific identification, average cost, FIFO, LIFO, retail, etc.).

Comparison of Lifo Approaches

We present three different approaches to computing LIFO inventories in this chapter—specific-goods LIFO, specific-goods pooled LIFO, and dollar-value LIFO. As we indicated earlier, the use of the specific-goods LIFO is unrealistic. Most companies have numerous goods in inventory at the end of a period. Costing (pricing) them on a unit basis is extremely expensive and time consuming. The specific-goods pooled LIFO approach reduces recordkeeping and clerical costs. In addition, it is more difficult to erode the layers because the reduction of one quantity in the pool may be offset by an increase in another. Nonetheless, the pooled approach using quantities as its measurement basis can lead to untimely LIFO liquidations. As a result, most companies using a LIFO system employ dollar-value LIFO. Although the approach appears complex, the logic and the computations are actually quite simple, after determining an appropriate index. However, problems do exist with the dollar-value LIFO method. The selection of the items to be put in a pool can be subjective.10 Such a determination, however, is extremely important because manipulation of the items in a pool without conceptual justification can affect reported net income. For example, the SEC noted that some companies have set up pools that are easy to liquidate. As a result, to increase income, a company simply decreases inventory, thereby matching low-cost inventory items to current revenues.

Weighted-average method

Weighted-average method Inventory-costing method, used in the periodic inventory method, that prices items in the inventory on the basis of the average cost of all similar goods available during the period. The method calculates the total cost of inventories of similar goods, divides the total cost by the number of inventory units, and applies the weighted-average cost per unit to the items in ending inventory.

Sales With Buyback Agreement

When an enterprise finances its inventory without reporting either the liability or the inventory on its BS. This approach usually involves a "sale" with either an implicit or explicit "buyback" agreement. AKA Product Financing Arrangement