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Accounting Ch. 6
Terms in this set (39)
an inventory costing method that uses the weighted-average unit cost to allocate the cost of goods available for sale to ending inventory and cost of goods sold
goods held for sale by one party although ownership of the goods is retained by another party
Current replacement cost
the cost of purchasing the same goods at the present time from the usual suppliers in the usual quantities
Days in inventory
measure of the average number of days inventory is held; calculated as 365 divided by inventory turnover
Finished goods inventory
manufactured items that are completed and ready for sale
First-in, First-out (FIFO) method
an inventory costing method that assumes that the earliest goods purchased are the first to be sold
freight terms indicating that ownership of goods remains with the seller until the goods reach the buyer
FOB shipping point
freight terms indicating that ownership of goods passes to the buyer when the public carrier accepts the goods from the seller
a ratio that indicates the liquidity of inventory by measuring the number of times average inventory sold during the period; computed by dividing cost of goods sold by the average inventory during the period
Just-in-time (JIT) inventory
inventory system in which companies manufacture or purchase goods just in time for use
Last-in, First-out (LIFO) method
an inventory costing method that assumes that the latest units purchased are the first to be sold
for a company using LIFO, the difference between inventory reported using LIFO and inventory using FIFO
a basis whereby inventory is stated at the lower of either its cost or its market value as determined by current replacement cost
basic goods that will be used in production but have not yet been placed in production
Specific identification method
an actual physical-flow costing method in which particular items sold and items still in inventory are specifically costed to arrive at cost of goods sold and ending inventory
Weighted-average unit cost
average cost that is weighed by the number of units purchased at each unit cost
Work in process
that portion of manufactured inventory that has begun the production process but is not yet complete
The classification of a merchandising company
3 classifications of a manufacturing company
1. Raw materials
2. Work in process
3. Finished goods
Physical inventory taken for 2 reasons according to the Perpetual system
1. Check accuracy of inventory records
2. Determine amount of inventory lost due to wasted raw materials, shoplifting, or employee theft
Physical inventory taken for 2 reasons according to the Periodic system
1. Determine the inventory on hand
2. Determine the cost of goods sold for the period
Taking a Physical Inventory
- Involves counting, weighing, or measuring each kind of inventory on hand
*when the business is closed or business is slow
*at the end of the accounting period
Determining Ownership of Goods
- Goods in transit
- Goods in transit should be included in the inventory of the company that has legal title to the goods. Legal title is determined by the terms of sale
- FOB shipping point-> Buyer pays freight costs
- FOB destination-> Seller pays freight costs
- Consigned goods
Goods in Transit
- Purchased goods not yet received
- Sold goods not yet delivered
FOB shipping point->Buyer pays freight costs
- Ownership of the goods remains with the buyer when the public carrier accepts the goods from the seller
FOB destination-> Seller pays freight costs
- Ownership of the goods remains with the seller until the goods reach the buyer
To hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of the goods
How is inventory accounted for a cost?
- Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale.
- Unit costs are applied to quantities to determine the total cost of the inventory and the cost of goods sold using cash flow assumptions
Cash flow assumptions
- Specific identification
- First-in, First-out (FIFO)
- Last-in, First-out (LIFO)
* Actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of the ending inventory
- Practice is relatively rare
- Most companies make assumptions (cost flow assumptions) about which units were sold.
Cash Flow Assumption
- does not need to be consistent with the physical movement of goods
- 45% FIFO
(Beginning Inventory+Purchases)-Ending Inventory=Cost of Goods Sold
First-in, First out (FIFO)
- Costs of the earliest goods purchased are the first to be recognized in determining cost of goods sold
- Often parallels actual physical flow of merchandise
- Companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed.
Last-in, First-out (LIFO)
- Costs of the latest goods purchased are the first to be recognized in determining cost of goods sold
- Seldom coincides with actual physical flow of merchandise
- Exceptions include goods stored in piles, such as coal or hay
- Allocates cost of goods available for sale on the basis of weight-average until cost incurred
- Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory
Using the Cost Flow Methods Consistently
- Method should be used consistently in order to enhance comparability.
- Although consistency is preferred, a company may change its inventory costing method.
Lower-of-Cost-or Market (LCM)
- When the value of inventory is lower than its costs
* Companies can "write down" the inventory to its market value in the period in which the price decline occurs
* Market value=Replacement cost
* Example of conservatism
Why is inventory management a critical task?
1. High inventory levels- storage costs, interest cost (on funds tied up in inventory), and costs associated with the obsolescence of technical goods of shifts in fashion
2. Low inventory- may lead to lost sales
Analyst's Adjustments for LIFO Reserve
- Companies using LIFO are required to report the difference between inventory reported using LIFO and Inventory using FIFO. This amount is referred to as the LIFO reserve.
- The LIFO reserve can have a significant effect on ratios analyst's commonly use.
What are the common causes of inventory errors?
- Failure to count or price inventory correctly.
- Not properly recognizing the transfer of legal title to goods in transit.
- Errors affect both the income statement and balance sheet.
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