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accounting chap 5

accounting for inventories

QuestionAnswer
Merchandise inventory inclues all goods that a company owns and holds for sale
Does a purchaser's inventory include goods in transit from a supplier? Only if ownership has passed to the purchaser
FOB shipping point purchaser is responsible for paying freight, ownership passes when goods are loaded on transport vehicle
FOB destination ownership passes when goods arrive at their destination
Goods on consignment goods shipped by the owner (consignor) to another party (consignee)
What does a consignee do? Sell goods for the owner
How does a consignor report inventory? they continue to own the consigned goods until they are sold so they must continue to report these items in inventory until they are sold
Goods damaged or obsolete not counted in inventory if they cannot be sold. If they can be sold at reduced price, they are included in inventory at their net realizable value
Net realizable value sales price minus the cost of making the sale
When are damaged or obsolete goods reported? The period when damage or obsolescence occurs is the period when the loss in value is reported
merchandise inventory includes invoice cost minus any discount, plus any incidental cost necessary to put it in a place and condition for sale
What are incidental costs? Freight, import duties, storage, insurance and costs incurred in aging process
Accounting principles prescribe that incidental costs be added to inventory
Matching (expense recognition) principle states that inventory costs should be recorded against revenue in the period when inventory is sold
major goal in accounting for inventory to properly match costs with sales
Management decisions in accounting for inventory involve... a. items included in inventory and their costs b. costing method(specific identification, FIFO, LIFO, weighted average c. inventory system (perpetual or periodic) d. use of market values or other estimates
One of the most important issues in accounting for inventory is determining the per unit cost assigned to inventory items
First in, first out assumes cost flow in the order incurred
last in, first out assumes costs flow in the reverse order incurred
Weighted average assumes costs flow at an average of the costs available
specific identification each item in inventory can be identified with a specific purchase and invoice
Merchandise available for sale beginning inventory + net purchases = merchandise available for sale ending inventory + cost of goods sold = merchandise available for sale
FIFO assigns lowest amount to cost of goods sold-yielding highest gross profit and net income when purchase costs regularly rise
LIFO assigns highest amount to cost of goods sold-yielding lowest gross profit and net income, which also yields a temp tax advantage by postponing payments of some income tax when purchase costs regularly rise
weighted average yields results between FIFO and LIFO when purchase costs regularly rise
Specific identification always yields results that depend on which units are sold when purchase costs regularly rise
FIFO gives the highest cost of goods sold-yielding lowest gross profit and net income when costs regularly decline
LIFO gives lowest cost of goods sold-yielding the highest gross profit and income when costs regularly decline
Advantages of FIFO assigns an amount to inventory on the balance sheet that approximates its current cost; also mimics the actual flow of goods for most businesses
Advantages of LIFO assigns an amount to cost of goods sold on the income statement that approximates its current cost; it also better matches current costs with revenues in computing gross profit
Advantages of weighted average tends to smooth out erratic changes in costs
specific identification exactly matches the costs of items with the revenues they generate
Companies can and often do use... different costing methods for financial reporting and tax reporting.
Only exception for using different costing methods for financial reporting and tax reporting When LIFO is used for tax reporting; in this case, the IRS requires that is also be used in financial statements called LIFO conformity rule
Consistency concept prescribes a company use the same accounting methods period after period so that financial statements are comparable across periods-only exception is when a change from one method to another will improve financial reporting
consistency concept does not require a company to use one method exclusively
Lower of cost or market (LCM) accounting principles require that inventory be reported at the market value (cost) of replacing inventory when market value is lower than cost
Market of LCM defined as current replacement cost of purchasing the same inventory items in the usual manner
How is LCM applied? To each individual item separately, to major categories of items or to the whole of inventory
accounting rules require that inventory be adjusted to market when market is less than cost, but inventory normally cannot be written up to market when market exceeds cost
Conservatism constraint prescribes the use of less optimistic amounts when more than one estimate of the amount to be received or paid exists and these estimates are equally likely
Beginning inventory + net purchases - ending inventory = cost of goods sold
A lower cost of goods sold yields a higher income
A higher cost of goods sold yields a lower income
understating equity inventory understates both current and total assets
understating ending inventory understates equity because of the understatement in net income
errors in beginning inventory do not yield misstatements in the end of period balance sheet, but they do affect the current period's income statement
inventory turnover = cost of goods sold/average inventory
days' sales in inventory = ending inventory/cost of goods sold * 365
Steps of retail inventory method 1.goods avail for sale at retail-net sales at retail=ending inventory at retail 2.goods avail for sale at cost/goods avail for sale at retail=cost to retail ratio 3.ending inventory at retail*cost to retail ratio=estimated ending inventory at cost
steps of gross profit method 1.net sales at retail*1.0-gross profit ratio = estimated cost of goods sold 2. goods available for sale at cost- estimated cost of goods sold = estimated ending inventory at cost
Created by: sjnelson86