Intermediate Accounting II Chapter 8

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Inventories

Asset items that a company holds for sale in the ordinary course of business, or goods that it will use or consume in the production of goods to be sold.

Merchandise Inventory

The cost assigned to unsold units left on hand.

Raw Materials Inventory

The cost assigned to goods and materials on hand but not yet placed into production

Work in Process Inventory

The cost of raw material for unfinished units, plus the direct labor cost applied specifically to this material and a ratable share of manufacturing overhead costs.

Finished Goods Inventory

The costs identified with the completed but unsold units on hand at the end of the fiscal period

Perpetual Inventory System

Continuously tracks changes in the Inventory account. That is, a company records all purchases and sales (issues) of goods directly in the Inventory account as they occur. It provides a continuous record of the balances in both the Inventory account and the Cost of Goods Sold account.

Periodic Inventory System

An inventory system under which a company determines the quantity of inventory on hand only periodically.

A company records all acquisitions of inventory during the accounting period by debiting the Purchases account.

A company then adds the total in the Purchases account at the end of the accounting period to the cost of the inventory on hand at the beginning of the period.

This sum determines the total cost of the goods available for sale during the period.

Periodic Inventory System (COGS)

To compute the cost of goods sold, the company then subtracts the ending inventory from the cost of goods available for sale. Not that under a periodic inventory system, the cost of goods sold is a residual amount that depends on a physical count of ending inventory.

Modified Perpetual Inventory System

This system provides detailed inventory records of increases and decreases in quantities only -- not dollar amounts. It is merely a memorandum device outside the double-entry system, which helps in determining level of inventory at any point in time.

The Cost of Goods Available for Sale or Use

The sum of:
(1) the cost of the goods on hand at the beginning of the period, and
(2) the cost of the goods acquired or produced during the period.

The Cost of Goods Sold

The difference between:
(1) the cost of goods available for sale during the period, and
(2) the cost of goods on hand at the end of the period.

FOB Shipping Point

Title passes to the recipient once the goods are transferred to the common carrier.

FOB Destination

Title passes to the recipient only after the goods are delivered to the recipient by the common carrier.

Consignment

Under this arrangement, a company ships goods to a second company which acts as an agent of the first company. Once the goods have sold, the second company remits the revenue, less a selling commission and expenses incurred in accomplishing the sale, to the first company.

Special Sales Agreements

1. Sales with buyback agreement
2. Sales with high rates of return
3. Sales on installment

Ending Inventory Understated

Retained earnings understated
Working capital understated
Current ratio understated
Cost of goods sold overstated
Net income understated

Ending Inventory Overstated

Retained earnings overstated
Working capital overstated
Current ratio overstated
Cost of goods sold understated
Net income overstated

Purchases and Inventory Understated

Retained earnings -- no effect
Accounts payable -- understated
Working capital -- no effect
Current ratio -- overstated
Cost of goods sold -- no effect
Net income -- no effect
Ending inventory -- understated

Purchase and Inventory Overstated

Retained earnings -- no effect
Accounts payable -- overstated
Working capital -- no effect
Current ratio -- understated
Cost of goods sold -- no effect
Net income -- no effect
Ending inventory -- overstated

Product Costs

Those costs that "attach" to the inventory.

Recorded in the inventory account

Such charges include freight charges on goods purchased, other direct costs of acquisition, and labor and other production costs incurred in processing the goods up to the time of sale.

Period costs

Those costs that are indirectly related to the acquisition or production of goods.
Selling expenses
General and administrative expenses

Specific Identification (cost flow assumption)

Calls for identifying each item sold and each item in inventory.
The cost flow matches the physical flow of the goods.

Average cost (cost flow assumption)

Prices items in the inventory on the basis of the average cost of all similar goods available during the period.

First-in, First-out (FIFO) (cost flow assumption)

assumes that a company uses goods in the order in which it purchases them.

Assumes that the first goods purchased are the first used (in a manufacturing concern) or the first sold (in a merchandising concern).

Last-in, First-out (LIFO) (cost flow assumption)

Matches the cost of the last goods purchased against revenue.

Assumes that the cost of the total quantity sold or issued during the month comes from the most recent purchases.

LIFO Reserve

The difference between the inventory method used for internal reporting purposes.

LIFO Effect

The change in the Allowance to Reduce Inventory to LIFO balance from one period to the next.

The adjustment that companies must make to the accounting records in a given year.

LIFO Liquidation

Erosion of the LIFO inventory.

Distorts net income and leads to substantial tax
payments.

Specific-goods pooled LIFO approach

A company combines, and counts as a group, a number of similar units or products.

Results in fewer LIFO liquidations because the reduction of one quantity in the pool may be offset by an increase in another.

Dollar-value LIFO

Overcomes the problems of redefining pools and eroding layers.

Determines and measures any increases and decreases in a pool in terms of total dollar value, not the physical quantity of the goods in the inventory pool.

Price Index for Current Year

Ending Inventory for the Period at Current Cost
DIVIDED BY
Ending Inventory for the Period at Base-Year Cost

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