Chapter 6: Inventories Flashcards
Lower-of-Cost-or-Market Rule
If value of ending inventory is lower than the cost the inventory must be valued at cost OR at market value (whichever is lower)
- companies must “write down” (recognize a loss on the income statement) the inventory to its market value (replacement cost, not selling price) in the period where a decline below cost occurs
(principle of conservatism)
LIFO Conformity Rule
A tax rule
If LIFO is used for tax purposes it must also be used for financial reportin
Inventory costing methods
methods for finding unit cost.
- Specific Identification
- First-in, First-out (FIFO) *most used
- Last-in, First-out (LIFO) *2nd most used
- Average Cost
All cost flow assumptions
should be used consistently, but it is possible to change between them.
Cost Flow Assumptions
Assumptions made by company about which units of inventory were sold
various methods approximate flow of inventory costs to determine cost of goods sold
Specific Identification Costing Method
Rarely used
Items must be individually tagged to track cost so generally used for large, high-value items
- can be manipulated to boost income by selling low-cost units and vv
First-In, First-Out Costing Method
FIFO
Ending inventory valued by taking the unit cost at the most recent purchase and working backwards until all current inventory is accounted for.
In a period of rising prices this results in the highest net income - is appealing to investors but results in higher taxes
Average Cost Costing Method
All units valued by weighted average unit cost - new weighted average calculated after each purchase?
Assumes the similarity of all goods
Total cost of goods available for sale/ total units available for sale
In period of rising prices usually results in a net income between FIFO (higher) and LIFO (lower)
Last-In, First-Out costing method
COGS valued at most recent purchase price
Ending inventory valued by taking the unit cost of the oldest purchase and working down until all units are accounted for
Not actually reflective of movement of goods (except for piled items like hay and coal?)
In periods of rising prices results in lower net income than FIFO - tends to defer income tax liability
Cost of Goods Available For Sale
Total cost spent on inventory that was AVAILABLE to be sold during a period
Conservatism
A business should report the least favorable figures in the financial statements when two or more possible options are presented
“Anticipate no gains but provide for all probable losses”
Materiality Concept
A company must perform strictly proper accounting only for items that are significant to that businesses financial situation (relative to company size)
Ownership of Goods in Transit
- Purchased goods not yet received/ Sold goods not yet delivered.
- Depends on who holds the legal title
FOB Shipping Point: Ownership passes to buyer when freight carrier accepts the goods
FOB Destination- Ownership passes to buyer when the goods are delivered to buyer
Consigned goods- ownership remains with originator
Reason for Physical Inventory
Perpetual System:
- Check accuracy of records
- Determine amount of loss
Periodic System:
- Determine inventory on hand
- Determine costs of good sold
Inventory Classifications
Merchandising: Merchandise Inventory
Manufacturing: Raw Materials, Work in Process, and Finished Goods
All considered current Assets
Disclosure Principle
A businesses financial statements must report enough information for outsiders to make knowledgeable decisions about the company
- relevant
- faithful representation
-methods and procedures should be included in the foot notes
Consistency Principle
Business should use the same accounting methods and procedures from period to period
Journaling Lower-of-Cost-or-Market inventory write-down adjustment
Debit (increase) COGS
Credit (decrease) Merchandise inventory
both for the amount of difference in the merchandise value
have to disclose write-down in footnotes
Effects of inventory errors on financial statements
Effects two periods
Error in period one will cause the reverse error in the next period
Total income corrected over two periods (assuming error is caught in the next period)
Effects of overstating or understating inventory
Beginning Inventory:
- Overstated: COGS overstated, Net Income understated
- Understated: COGS understated, Net Income overstated
Ending Inventory:
- Overstated: COGS understated, Net Income overstated, Assets and Equity Overstated
- Understated: COGS overstated, Net Income understated, Assets and Equity Understated
Financial statement effects of FIFO and LIFO
- In periods of inflation FIFO best approximates ending inventory costs
- In periods of inflation LIFO may significantly understate ending inventory costs
Tax effects during inflation:
- FIFO - highest inventory cost/ income/ taxes (CHECK THIS)
- LIFO - Lower net income / taxes
Effects of costing methods on financial statements
In a period of rising inventory costs:
COGS: FIFO=lowest, LIFO= highest
Net Income: FIFO=highest, LIFO=lowest
End Merchandise Inventory: FIFO= highest, LIFO=lowest
In a period of declining inventory costs:
COGS: FIFO=highest, LIFO=lowest
Net Income: FIFO=lowest, LIFO=highest
End Merchandise Inventory: FIFO= lowest, LIFO=highest
Average weighted is always in the middle
Specific ID costing always varies
Inventory Cost (COGS)
Includes all expenditures necessary to acquire goods and place them in a condition for sale.
Beginning inventory \+ Net purchases (purchases- returns and allowances- discounts) = Goods available for sale (AFS) - Ending inventory = Cost of goods sold (COGS)
Weighted average unit cost
Cost of goods available for sale (total)/ total units available for sale
Days in Inventory
An inventory analysis ratio
= days in year/ inventory turnover ratio
Average number of days inventory is held
Inventory Turnover Ratio
An Inventory Analysis ratio
= Cost of Goods Sold/ Average inventory
Average inventory = (beginning inventory + ending inventory)/ 2
Measures the number of times inventory is sold in a period
IFRS vs GAAP years of reporting required
IFRS requires 2 years of income statement information
GAAP requires 3 years
Inventory under IFRS
IFRS prohibits LIFO, only allows FIFO and Average cost
- any goods held in consignment are not included in inventory
- Market value = “net realizable sales price” rather than replacement price (as it does in GAAP)
Inventory Write-UPS GAAP vs IFRS
IFRS- inventory value can be written-up, but entire class must be re-valued
GAAP- Inventory can only be written DOWN, not up.
