Accounting: Chapter 6

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Determine Inventory Quantities

1) take a physical inventory count
2) determine ownership of goods

Goods in Transit

when a company takes a physical inventory, it determines the total cost of goods on hand at the end of the accounting period...goods may be in transit at this time

Goods in Transit: FOB Shipping Point

-the title to the goods transfers when the inventory is delivered to the shipping agent
-the title transfers when shipped (from seller to customer)

Goods in Transit: FOB Destination

-the title to the goods transfers when the inventory arrives at the place of delivery
-title transfers when arrived (from seller to customer)

Determine Ownership for Consigned Goods

-a consignment agreement transfers goods from a consignor to a consignee, who agrees to sell the goods
-consignee remits proceeds to the consignor when inventory is sold
-inventory on consignment is included in the consignor's inventory until sold

Inventory Costing Methods with a Periodic System

-physical flow basis
-costs flow basis

Physical Flow Basis

-find out exactly which items were sold
-specific identification

Costs Flow Basis

-assume the costs of the units that were sold and that are on hand
-weighted average: FIFO, LIFO

Inventory Costing: Periodic System

-pool of costs-cost of goods available for sale
-step 1: ending inventory
-step 2: COGS

Specific Identification

-tracks the actual flow of goods
-each item marked with its unit cost

Assumed Cost Flow Methods

-these methods assume cost flows that may be unrelated to the actual physical flow of goods
-these cost flow assumptions do not have to be consistent with the actual flow of goods
-FIFO, LIFO, average cost

FIFO

-first-in, first-out
1) earliest goods purchased are the first to be sold
2) oldest costs->COGS
3) recent costs->ending inventory

In a period of rising prices, will FIFO produce a higher or lower net income than LIFO? Why?

FIFO will produce a higher net income because COGS is made up of items purchased early in the year at lower prices

LIFO

-last-in, first-out
1) latest goods purchased are the first to be sold
2) recent costs->COGS
3) oldest costs->ending inventory

In a period of rising prices, will LIFO produce a higher or lower ending inventory than FIFO? Why?

LIFO will produce a lower ending inventory because ending inventory is made up of items purchased early in the year at lower prices

Average Cost

1) goods available for sale are homogeneous
2) cost of goods available fore sale is allocated on the basis of the weighted average unit cost incurred
3) the weighted average unit cost is applied to the units on hand to determine the cost of ending inventory
-when a unit is sold, the average cost of each unit in inventory is assigned to COGS
-(cost of goods available for sale)/(units on hand on the date of sale)

Financial Reporting-Advantages of Each Method

-weighted average = smooths out price changes
-FIFO = ending inventory approximates current replacement cost
-LIFO = better matches current costs in COGS with revenues

Tax Reporting

if LIFO is used for tax purposes, the IRS requires it be used in financial statements

Use Cost Flow Methods Consistently

-a company needs to use its chosen cost flow method consistently from one period to another
-consistent application makes more comparable financial statements
-changes in cost flow method should be disclosed in the financial statements

Lower of Cost or Market

-inventory must be reported at market value when market is lower than cost
-defined as current replacement cost

Lower of Cost or Market: Applications

1) separately to each individual item
2) to major categories of assets
3) to the whole inventory

Inventory Disclosure

-inventory is classified as a current asset in the balance sheet
-COGS is subtracted from sales in the income statement

Inventory Disclosure: Notes to Financial Statements Should Include:

-major inventory classes (if not on balance sheet)
-basis of accounting (cost or LCM)
-costing method (FIFO, LIFO, average cost)

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