Absorption (FULL) Costing
The method of including product costs (DM; DL; MOH) as the cost of inventory is called absorption costing or full costing, and is required by GAAP
- Period Cost include non-production costs.
- Ex: Marketing costs; Freight out; re-handling costs; abnormal spoilage; Idle plant capacity costs
- These costs are going to be expensed when they are incurred.
Under GAAP, market value is the middle value of an inventory item's replacement costs, its market ceiling, and its market floor.
Market Ceiling (NRV)
Market ceiling is item's net selling price less the costs to complete and dispose (called the NRV)
NRV - Profit Margin
Market floor is the market ceiling less a normal profit margin.
Periodic Inventory System Method (uses purchases)
Units of inventory and the associated costs are counted and valued at the end of the accounting period. The actual cost of goods sold for the period is determined after each physical inventory by squeezing the difference between the beginning inventory plus purchases less ending inventory, based on the physical count.
Perpectual Inventory Method (actual)
records of purchases and sales are recorded as they occur. The actual cost of goods sold is determined and recorded with each sale.
Periodic VS. Perpectual
- To Record Sale
- JE: To record sale (periodic method)
- JE: To record sale (perpetual method) Dr. Cash (A+) xx
- Cr. Sales (+) xx
- Dr. COGS (+) xx
- Cr. Inventory (A-) xx
- To Record Purchases
- To record purchases (periodic method)
- Dr. Purchases xx
- Cr. Cash xx
- To record purchases (perpectual method)
- Dr. Inventory
- Cr. Cash
Specific identification method
is a method of finding out the ending inventory cost. The cost of each item in inventory is uniquely identified to that item. This method is usually used for large items or high value items because it provides a greater opportunity for manipulation of income.
- Used when prices are going up: First ones in are first ones out. That means we are selling the old cheap ones. This will make the company have a lower COGS, lower expense, thus higher profit.
- *Tax impact: If you use FIFO on your books, you will be using FIFO on your tax return. By using FIFO, the company is showing a higher profit, thus a higher tax liability.
- *Whether you use a Perpectual or periodic method, the COGS and ending inventory are the same.
Weighted Average (is a periodic method)
Weighted average is determined by diving the total costs of inventory available by the total number of units in inventory available.
Moving average method (perpectual method only)
Moving average method can only be used if the inventory method is perpetual. it computes the weigthed average cost after each purchase. Divided total cost and units available each transaction
LIFO (Perpetual #'s does not equal periodic #'s as it did in the FIFI method (no short cut)
- Ending inventory is the old stuff not the new stuff as it is in the FIFO method.
- When prices are increasing: Expenses are higher, the new ones are sold first. Bad news is that lower profit, but you will show the government lower profit which means lower taxes. Ending Inventory will be understated (lower)
LIFO Financial Statements Effect
If sale exceeds production (or purchases) for a given period, LIFO will result in a distortion of net income because old inventory costs (called LIFO layers) will be matched with current revenue.
Gross Profit Method (Have to use the periodic method (squeeze)
Inventory is valued at at retail, and the average gross profit percentage is used to determine the inventory cost for the interim financial statements
cost of transportation to consignee are
included when calculating COGS