Chapter Eight: Valuation of Inventories: A Cost-Basis Approach Flashcards
Inventory
assets we hold that are intended for sale in ordinary course of business
Describe a wholesaler and retailers inventory.
Merchandise inventory, buy inventory and sell at a higher price
Describe a manufacturer’s inventory.
raw materials, work-in-process, and finished goods, buys materials and makes something to sell
Two inventory systems
Perpetual and periodic
Perpetual Inventory
running record of amount of inventory (both dollars and units)
Periodic Inventory
Keeps dollars only record of amount of inventory purchases
Cost of Goods Sold Calculation
Beginning Inventory + Net Purchases = Goods Available for Sale - Ending Inventory (physical count) = Cost of Goods Sold
What are the three issues with inventory?
1) What are physical goods included in inventory?
2) What costs are included in inventory?
3) What cost flow assumption is used?
Physical goods included in inventory
Goods in transit, consignments, special sales arrangements
Two types of goods in transit
F.O.B. shipping point and F.O.B. destination
F.O.B. shipping point
title of inventory passes when put on truck
F.O.B. destination
title transferred when taken off truck at final destination
Consignments
company gives items to 3rd party with commission, return inventory if not sold but inventory still belongs to original inventory
Special Sales Arrangements
financing arrangements (ex. if not sold, send back (buy-back arrangement))
Costs included in inventory
Product Costs, Period Costs, and Purchase Discounts
Product Costs
associated with inventory, not expense until sold
Period Costs
belongs to time-frame, not normal and necessary to get asset ready for use
Purchase discounts
vendors offer discounts for timely payment
Gross Method of purchase discounts
easier and less costly, record purchase at full amount and if take discount credit Purchases Department
Net Method of purchase discounts
Record purchase as if had taken purchase discount, if don’t take discount debit Purchase Discounts Lost
Cost Flow Assumptions for Inventory
specific identification, average cost, LIFO, FIFO
How are Goods Available for sale allocated?
allocated between ending inventory and cost of goods sold and the choice of how to allocate is determined by cost flow assumption
Specific Identification
Keep track of each inventory item sold at quantity and price
When do you use specific identification?
High dollar value, easily differentiated
Average cost
Average money in system and comes out as one unit cost
FIFO
first in, first out
LIFO
last in, first out
Steps to solve inventory problems
1) Calculate goods available for sale (same for every cost flow assumption)
2) Calculate ending inventory
3) Calculates COGS = goods available for sale - ending inventory
LIFO layer liquidation
when firm dips into LIFO layers, profit distortion occurs as inventory holding gains ignored in previous years are shifted to income statements
LIFO Conformity Rule
U.S. tax laws specify if company uses LIFO for tax purposes, must also use LIFO for financial reporting
What problem do the short-term cash flow tax benefits from LIFO cause?
managers may be motivated to make undesirable purchasing decisions to avoid LIFO layer liquidation and lower taxes
Steps for Dollar-Value LIFO
1) Determine inventory value at year end prices
2) Determine price index: published indexes or ending inventory at current cost/ending inventory at base year cost
3) Determine inventory at base year price: inventory at year end price/price index
4) Determine layers
5) Multiply each layer by respective index to find year end dollar-value ending inventory
