Chapter 7

Consistency in Reporting

A change in method is allowed only if it improves the accuracy of the company's financial results. In the US, the 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 for both the cost of each item sold and those remaining in inventory.

Consignment Inventory

Refers to goods a company is holding on behalf of the good's owner. Typically, this is 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 the goods are difficult to dell. This is reported on the balance sheet of the owner, not the company holding the inventory.

Merchandise Inventory

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

Days to Sell

Converting the inventory turnover ratio to the number of days needed to sell the inventory. This is done by dividing 365 days by the year's inventory turnover ratio.

Specific Identification Method

Individually identifies and records the cost of each item sold as CGS. This method requires accountants to keep track of the purchase cost of each item.

Finished Goods Inventory

Inventory ready for sale just like merchandise inventory.

IFRS

LIFO is not allowed under International Financial Reporting Standards (IFRS)

Financial Statement Effects

Summarizes the financial statement effects of the FIFO, LIFO, and weighted average cost methods. These methods only differ in the way they split the cost of goods available for sale between ending inventory and cost of goods sold.

Inventory Turnover

The process of buying and selling

Cost Flow Assumptions

The three other inventory costing methods are not based on the physical flow of goods on and off the shelves. Instead, these methods are based on the assumptions that accountants make about the flow of inventory costs.

Goods in Transit

These are inventory items being transported. This is reported on the balance sheet of the owner, not the company transporting it.

FIFO (First- In, First Out)

This assumes that the inventory cost flows out in the order the goods are received.

LIFO (Last-In, First-Out)

This assumes that the inventory costs flow out int he opposite of the order the goods are received.

Raw Materials Inventory

This includes plastic, steel, or fabrics.

Costs are Falling

When costs are falling, these effects are reversed. FIFO produces a lower ending inventory value and a higher cost of goods sold.

Costs are Rising

When costs are rising, FIFO produces a higher inventory value (making the balance sheet appear to be stronger) and a lower cost of goods sold (resulting in a higher gross profit, which makes the company look more profitable)

Tax Implications and Cash Flow Effects

When faces with increasing costs per unit, a company that uses FIFO will have a higher income tax expense. This income tax effect is a real cost that will reduce the company's cash.

Lower of Cost or Market (LCM)

When the value of inventory falls below its recorded cost, GAAP requires the inventory be written down to its lower market value.

Work in Process Inventory

When these raw materials enter the production process which includes goods that are in the process of being manufactured.