ACCT Ch 8.txt

Inventory refers to the assets a company (1) intends to sell in the normal course of business, and (2) has in production for future sale (work in process), or (3) uses currently in the production of goods to be sold (raw materials).

The perpetual inventory system continuously tracks and records both changes in inventory quantity and inventory cost. the periodic inventory system adjusts inventory and records cost of goods sold only at the end of each period

Merchandise shipped f.o.b destination (seller is responsible for the shipping costs) is included in the purchaser's inventory only after it reaches the purchaser's location

in a periodic system, the weighted-average unit cost is determined by dividing the cost of goods available for sale by the quantity available for sale.

The first-in, first-out (FIFO) method assumes that items sold are those that were acquired first. Therefore, ending inventory applying FIFO consists of the most recently acquired items.

The last-in, first-out (LIFO) method assumes that items sold are those that were most recently acquired. Therefore, ending inventory applying LIFO consists of the items acquired first.

LIFO

The gross profit ratio is computed by dividing gross profit (sales - cost of goods sold) by net sales.

The inventory turnover ratio is computed by dividing costs of goods sold by average inventory

• The three step process used to determine ending inventory and costs of goods sold using the dollar-value approach are:
• Step 1. Convert ending inventory valued at year-end cost to base year cost. this is accomplished by dividing the ending inventory at year-end cost by the current year's cost index.
• Step 2. Identify the layers of ending inventory and the years they were created.
• Step 3. Convert each layer's base year cost to layer year cost using the cost index for the year it was acquired

inventory represents the quantities of goods acquired, manufactured, or in the process of being manufactured

freight charges on incoming goods borne by the buyer

insurance costs incurred by the buyer while goods are in transit (if f.o.b shipping point)

costs of unloading, unpacking and preparing merchandise inventory for sale or raw materials for used

• Called Product Costs
• - expensed as costs of goods sold only when the related products are sold.

The cost of merchandise inventory includes the purchase price plus any other costs necessary to get the goods in condition and location for sale.

• debit raw materials purchases, credit raw materials used
• debit direct labor incurred, credit direct labor applied
• debit manufacturing overhead incurred, credit manufacturing overhead applied

• Work in process:
• Debit work in process(raw mats, direct labor, overhead), credit work in process transferred to finished goods

• Finished goods:
• debit work in process, credit finished goods sold

• Cost of goods sold:
• debit finished goods sold

cost of goods sole account, along with the inventory account, is adjusted each time goods are sold or are returned by a customer

Purchase return - for buyer

sales return - for the seller

track inventory quantity from acquisition to sale

merchandise purchases, purchase returns, purchase discounts, and freight-in (purchase plus freight-in less returns and discounts equals net purchases) are recorded in temporary accounts and the period's cost of goods sold is determined at the end of the period by combining the temporary accounts with the inventory account

Beginning inventory + net purchases - ending inventory = cost of goods sold

• Beginning inventory
• add: Purchases
• =
• Cost of goods available for sale
• less: ending inventory (per physical count)
• =Cost of goods sold

• Debit cost of goods sold
• debt inventory (ending)

• Credit Inventory (beginning)
• Credit purchases

to adjust inventory, close the purchases acount, and record cost of goods sold.

• more accurate during the year.
• facilitate accurate information without the necessity of a physical count of inventory

more expensive

better with high cost items

makes preparation of interim financial statements more costly unless an inventory estimation technique is used.

because risk is retained by the consignor, the sale is not complete (revenue is not recognized) until an eventual sale to a third party occurs

An adjusting entry for estimated sales returns reduces sales revenue and accounts receivable.

cost of goods sold is reduced and inventory is increased.

Perpetual - costs are added to the inventory account

periodic - generally added to temporary account - Freight in or transportation in (added to purchases in determining net purchases

account is closed to cost of goods sold along with purchases and other components of cost of goods sold at the end of the reporting period

buyer views return as reduction to net purchases

Perpetual - reduction in both inventory and accounts payable

Periodic - account called purchase returns temporarily accumulates these amounts. Purchase returns are subtracted from purchases when determining net purchases. account is closed to cost of goods sold at end of period

represent reductions in amount to be paid by the buyer in the event payment is made within a specified period of time.

Gross method: views discount not taken as part of the cost of inventory. subtracted from purchases when determining net purchases. it is a temporary account that is closed to cost of goods sold at end of period


Net method - considers cost of inventory to include the net, after-discount amount, and any discounts not taken as reported as interest expense

under perpetual inventory system - purchase discounts are treated as a reduction in the inventory account

• Debit Inventory (purchases x (100%-discount %))
• Credit accounts payable

• debit inventory (freight charges)
• credit cash

• debit accounts payable (merch. returned net of discount)
• credit inventory

• debit accounts receivable
• credit sales revenue
• debit cost of goods sold
• credit inventory

• Purchases:
• debit purchases (merch. cost x (100%-discount%))
• credit accounts payable

• Freight:
• Debit freight in
• credit cash

• Returns:
• Debit accounts payable
• credit purchase returns

• Sales:
• Debit account receivable
• credit sales revenue

• Cost of Goods Sold:
• Beginning Inventory
• add Purchases
• less returns
• add freight in
• =net purchases (add to beginning inventory)
• = cost of good available for sale
• less ending inventory
• = cost of goods sold

• debit costs of goods sold
• debit inventory (ending)
• debit purchase returns

• credit inventory (beginning)
• credit purchases
• credit freight-in

matching each unit sold during period or each unit on hand at the end of the period to be matched with its actual cost.

usually for unique, expensive products with low sales volume

not feasible for many types of productes because items are not uniquely identifiable or because it is too costly to match a specific purchase price with each item sold or each item remaining in ending inventory

weighted average unit cost = cost of goods available for sale / quantity available for sale

a new weighted average unit cost is calculated each time additional units are purchased

new average determined by 1) summing the cost of the period inventory balance and the cost of the new purchase 2) dividing this new total cost (cost of goods available for sale) by the number of units on hand (the inventory units that are available for sale.

this average is then used to cost any units sold before the next purchase is made

the paper profit (losses) caused by including out of date, low (high) costs in cost of goods sold is referred to as the effect on income of liquidations of LIFO inventory

must disclose any material effect of LIFO liquidation on net income

• 1)actual physical flow of inventory
• 2) effect of inventory method on reported net income and the amount of income taxes payable currently
• 3) desire to provide a better match of expenses with revenues

Companies use LIFO for external reporting and income tax purposes, but maintain internal records using FIFO or average cost

• 1) bc high recordkeeping costs of the LIFO method
• 2) the existence of contractual agreements such as bonus or profit sharing plans that prohibit use of LIFO in the calculation of net income
• 3) the need for FIFO or average cost information for pricing decisions

management may closely monitor inventory levels to

• 1) ensure that the inventories needed to sustain operations are available
• 2) hold the cost of ordering and carrying inventories to the lowest possible layer

JIT is a system used by a manufacturer to coordinate production with suppliers so that raw materials or components arrive just as they are needed in the production process

allows company to maintain relatively low inventory balances

with efficient production techniques, excellent relationship with suppliers - can meet customer demands

Gross profit ration = gross profit (cost - sales price) / net sales

the higher the ration, the higher is the markup a company is able to achieve on its products- then more dollars are available to cover expenses other than cost of goods sold

declining ratio can indicate 1) company is unable to offset rising costs with corresponding increases in sale price 2) sales prices are declining without a commensurate reduction in costs

de

Inventory turnover ratio = cost of good sold / average inventory

usually, highter the ratio the more profitable a company will be

declining ratio is generally unfavorable and could be caused by the presence of obsolete or slow-moving products, or poor marketing and sales efforts.

inventory increases that outrun increases in cost of goods sold might indicate difficulties in generating sales.

may indicate that a company has obsolete or slow moving inventory

slowing turnover ratio combined with higher than normal inventory levels may indicate the potential for decreased production, obsolete inventory, or need to decrease prices to sell inventory (which will then decrease gross profit ratios and net income

Ford uses the LIFO inventory method to value about one-fourth of its inventories. the cost of the remaining inventories is determined primarily by the FIFO method. Yes, both of these methods are permissible according to GAAP

The LIFO conformity rule requires that if a company uses LIFO to measure taxable income, it also must use LIFO for external reporting. Ford does this. However, in 1981, the LIFO conformity rule was liberalized to allow LIFO users to provide supplement disclosure of the effect on inventories of using another method on inventory valuation rather than LIFO. Fords disclosure note offers this additional information.

Inventory costs in the balance sheet using LIFO generally are out of date because they reflect old purchase transactions. When inventory quantities decline during a period, these out of date inventory layers are then liquidated, and cost of goods sold will partially match noncurrent costs with current selling prices. IF costs have been rising, LIFO liquidations produce lower cost of goods sold and higher net income than would have resulted if the liquidated inventory were included in cost of goods sold at current costs.

Yes. If ford had used FIFO instead of LIFO for its LIFO inventories, income before taxes in all prior years, including 2006, would have been higher by $1,015 million (the increase in 2006 ending inventory). In 2006, alone, income before taxes would have been higher by $6 million. Here's why. The increase in ending inventory of $1,015 million decreases cost of goods sold, but the increase in beginning inventory of $1,009 million increases cost of goods sold, resulting in a net decrease in cost of goods sold of $6 million