Chapter 17 Merchandise Inventory Flashcards
Merchandise Inventory account:
Merchandise Inventory account appears on both the balance sheet and the income statement. Often inventory represents the largest current asset on the balance sheet. Inventory valuation also affects the net income or net loss reported on the income statement.
A higher ending inventory value results in a lower cost of goods sold, which results in higher income from operations. On the other hand, a lower ending inventory value results in a higher cost of goods sold, which results in a lower income from operations.
Merchandise inventory is counted at the end of the accounting period. The inventory value is calculated by multiplying the number of units on hand by the cost per item.
Merchandise inventory is counted at the end of the accounting period. The inventory value is calculated by multiplying the number of units on hand by the cost per item.
Taking an actual count of the number of units of each type of good on hand is known as taking a physical inventory. An inventory system in which the amount of goods on hand is determined by periodic counts is called a periodic inventory. It is the method that we use in this chapter.
Taking an actual count of the number of units of each type of good on hand is known as taking a physical inventory. An inventory system in which the amount of goods on hand is determined by periodic counts is called a periodic inventory. It is the method that we use in this chapter.
specific identification method:
The specific identification method of inventory valuation is based on the actual cost of each item of merchandise. Cost of goods sold is the exact cost of the specific merchandise sold, and the ending inventory balance is the exact cost of the specific inventory items on hand. Businesses that sell high-priced or one-of-a-kind items, such as art and automobile dealers, use the specific identification method. However, this method is not practical for a business where hundreds of similar items of relatively small unit value are carried in inventory.
important: Physical Inventory
important!
Physical Inventory
Whether a perpetual or periodic inventory system is used, a physical inventory should be taken at least once a year.
The formula for Cost of Goods Sold is:
Beginning inventory
+ Purchases
− Ending inventory
= Cost of goods sold
The method of inventory valuation must be disclosed in the financial reports.
The method of inventory valuation must be disclosed in the financial reports.
inventory valuation FIFO:
The first in, first out method A method of inventory costing that assumes the oldest merchandise is sold first of inventory valuation, usually referred to as FIFO. A method of inventory costing that assumes the oldest merchandise is sold first, assumes that the oldest merchandise is sold first.
SPECIFIC IDENTIFICATION METHOD:
The specific Identification method of inventory valuation is based on the actual cost of each item of merchandise. Cost of goods sold is the exact cost of the specific merchandise sold, and the ending inventory balance is the exact cost of the specific inventory items on hand. Businesses that sell high-priced or one-of-a-kind items, such as art and automobile dealers, use the specific identification method. However, this method is not practical for a business where hundreds of similar items of relatively small unit value are carried in inventory.
Inventory Valuation LIFO:
The last in, first out (LIFO) method assumes that the most recently purchased merchandise is sold first, and thus assigns the most recent costs to cost of goods sold. The “last cost in is the first cost transferred out” to cost of goods sold. Thus, the cost of ending inventory is computed using the cost of the oldest merchandise on hand during the period.
Under the LIFO method, the balance sheet reflects the earliest costs. The cost of goods sold reflects the costs applicable to the most recent purchases.
Under the LIFO method, the balance sheet reflects the earliest costs. The cost of goods sold reflects the costs applicable to the most recent purchases.
Table 17.4 shows the results obtained for the average cost, FIFO, and LIFO inventory methods. The ending inventory is highest under FIFO and lowest under LIFO. The cost of goods sold is highest under LIFO and lowest under FIFO. This is true because costs have risen during the year.
Table 17.4 shows the results obtained for the average cost, FIFO, and LIFO inventory methods. The ending inventory is highest under FIFO and lowest under LIFO. The cost of goods sold is highest under LIFO and lowest under FIFO. This is true because costs have risen during the year.
Remember the following important points about inventory valuation methods:
Except for specific identification, the physical flow of inventory and the costs assigned to inventory are not specifically matched. Average, FIFO, and LIFO cost methods assign costs to inventory but do not track the cost to the specific inventory item.
Businesses can use separate inventory valuation methods for different classes of inventory.
Remember the following important points about inventory valuation methods:
Except for specific identification, the physical flow of inventory and the costs assigned to inventory are not specifically matched. Average, FIFO, and LIFO cost methods assign costs to inventory but do not track the cost to the specific inventory item.
Businesses can use separate inventory valuation methods for different classes of inventory.
Following the consistency principle, once a business adopts an inventory valuation method, it uses that method consistently from one period to the next. A business cannot change its inventory valuation method at will, although a one-time change is acceptable.
A business can use one inventory costing method for financial accounting purposes and another for federal income tax, with the exception of LIFO costing. A taxpayer who adopts LIFO for federal tax purposes must also adopt it for financial accounting purposes.
FIFO focuses on the balance sheet. The most current costs are in ending inventory.
LIFO focuses on the income statement and the matching principle. The most recent costs are matched with revenue. LIFO is considered the most conservative costing method in a period of rising prices.
Following the consistency principle, once a business adopts an inventory valuation method, it uses that method consistently from one period to the next. A business cannot change its inventory valuation method at will, although a one-time change is acceptable.
A business can use one inventory costing method for financial accounting purposes and another for federal income tax, with the exception of LIFO costing. A taxpayer who adopts LIFO for federal tax purposes must also adopt it for financial accounting purposes.
FIFO focuses on the balance sheet. The most current costs are in ending inventory.
LIFO focuses on the income statement and the matching principle. The most recent costs are matched with revenue. LIFO is considered the most conservative costing method in a period of rising prices.
Since price trends represent a vital element in any inventory valuation, remember these basic rules:
When prices are rising, cost of goods sold is highest and net income is lowest under LIFO. Therefore, in periods of inflation, LIFO results in the lowest income tax expense.
When prices are falling, cost of goods sold is lower and net income is higher under LIFO.
Whatever direction prices take, the average cost method almost always results in net income between the amounts obtained with FIFO and LIFO.
Since price trends represent a vital element in any inventory valuation, remember these basic rules:
When prices are rising, cost of goods sold is highest and net income is lowest under LIFO. Therefore, in periods of inflation, LIFO results in the lowest income tax expense.
When prices are falling, cost of goods sold is lower and net income is higher under LIFO.
Whatever direction prices take, the average cost method almost always results in net income between the amounts obtained with FIFO and LIFO.
