F3 - M3 - Inventory Flashcards
List types of inventory
- Retail
- Manufacturing
- Raw Materials
- Work in Process
- Finished Goods
When does title of goods pass from the buyer to the seller?
At the time that was noted in the agreement
If non-existing, title passes once goods have been physically delivered to the buyer
What does FOB mean?
Free On Board
Requires seller to deliver the goods to the location indicated as FOB at seller’s expense
FOB Shipping Point
Title passes to buyer when seller delivers the goods to a common carrier. (i.e., when the goods get in the truck for delivery)
FOB Destination
Title passes to buyer when the goods are delivered to the buyer
What happens if the seller ships the wrong goods (nonconforming)?
Title reverts to the seller upon rejection by the buyer
Revenue Recognition Rule
1 - Price is substantially fixed at date of sale
2 - Buyer assumes all risk of loss and are in possession
3 - Buyer has paid some form of consideration
4 - Product sold is substantially complete
5 - Amount of future returns can be reasonably estimated
Sales with a Right to Return
Can you reasonably estimate returns?
If NO - goods should be included in sellers inventory
If YES - record as a sale with an allowance for returns
Consigned Goods
Consignor = True Owner
Consignee = Sales Agent ("Commissions")
Consignor includes goods in inventory because title and risk of loss remain with them until the goods are sold to a third party
Public Warehouses
Goods stored in a public warehouse and evidenced with a receipt should be included in the inventory of the company who holds the receipt.
Warehouse receipt acts as a title.
Sales with Mandatory Buyback
Occasionally, as part of a financing agreement
Seller includes goods in inventory even though title has passed to the buyer because they may be obligated to repurchase
Installment Sales
Seller retains legal title as security for the loan.
Can percentage of uncollectible debts be estimated?
If NO - sellers inventory
If YES - buyers inventory. Record as sale and set up an allowance
Valuation of Inventory
Inventory must be stated at COST.
No loss should be recognized even if replacement or reproduction costs are lower
Cost includes freight in - cost to ship to buyer.
Methods to determine cost of inventory
- First In, First Out (FIFO)
- Last In, First Out (LIFO) —> Not IFRS approved
- Average cost
- Retail Inventory
When is inventory NOT recorded at cost?
- Precious Metals and Farm Products = NRV
- If selling price is not as great as the cost (loss)
How to write down inventory
Immaterial - Increase COGS, Decreases Net Income
Material - List separately on the Income Statement and Disclose
Lower of Cost and Net Realizable Value
IFRS - Allows with use of all methods
GAAP - Can only use with FIFO and Weighted Average
What is Net Realizable Value?
Net Selling Price less costs to complete/dispose
Same as “Market Ceiling” in lower of cost or market method
Lower of Cost or Market
IFRS - Does NOT allow
GAAP - LIFO and Retail only
Market = Current Replacement Cost
Define Market Value
The middle value of an inventory item’s replacement cost, market ceiling, and market floor
Define Replacement Cost
Cost to purchase the item of inventory as of the valuation date
Define Market Ceiling
Net Realizable Value
Define Market Floor
Net Realizable Value less profit
What are the two types of inventory systems?
- Periodic
- Perpetual
What is the Periodic Inventory System?
Only uses physical count to determine amount of inventory and is usually done annually
COGS is calculated by backing into the number from beginning and ending inventory balance, as well as purchases
How to calculate COGS
Beginning Inventory
+ Purchases
- Ending Inventory
= COGS
Journal Entry to record sale of Inventory under the Periodic Inventory System
DR Cash
CR Sales
*There is NO Inventory or COGS entry
What is the downside to the Periodic Inventory System?
It assumes:
- Inventory is sold –> Could be stolen
- Inventory count is correct
*If inventory count is overstated, then COGS is understated, and gross profit is overstated
What is the Perpetual Inventory System?
Inventory is updated for each purchase and sale as they occur. Keeps a running total of inventory balances
Journal Entry to record sale of Inventory under the Perpetual Inventory System
Purchase:
DR Inventory
CR Cash
Sale:
DR COGS
CR Inventory
Cost Flow Assumption
Methods available for moving costs from inventory to COGS
GAAP does not require a rational relationship with the physical inventory flows as long as the method most clearly reflects periodic income
What is the Specific Identification Method?
The cost of an item in inventory is uniquely identified to that item. Typical for physically large or high value items.
Examples: Vin# for cars, boats, diamonds, etc.
First In, First Out (FIFO)
- Sell old first
- Ending Inventory = Replacement Cost
- Ending Inventory and COGS are the SAME whether a periodic or perpetual inventory system is used
- Better ratios –> Appears more profitable
- Lower of Cost or NRV
Effect of FIFO and rising prices
FIFO - Selling the oldest (cheapest)
Decreases Expense –> Increases Gross Profit –> Increases Retained Earnings –> Increases Equity –> Increases Asset = Unsold New (Expensive)
What is the Weighted Average Method?
Total Cost of Goods Available for Sale ($) / Total Units of Goods Available for Sale
Periodic Inventory System ONLY
What is the Moving Average Method?
Computes the Weighted Average cost after EACH purchase
Perpetual Inventory System ONLY
Last In, First Out (LIFO)
- US GAAP ONLY
- Sells last first
- Ending inventory is the oldest cost
- Tax Benefit - Minimizes Taxable Income
- Lower of Cost or Market (Middle)
What is the LIFO Conformity Rule?
If LIFO is used to compile taxable income, it must also be used in the financial statements.
Prevents companies from reducing their taxable income while using a different method to derive a higher income figure in their financial statements
Effect of LIFO and rising prices
LIFO - Selling the newest (expensive)
Increases Expense –> Decreases Gross Profit –> Decreases Retained Earnings –> Decreases Equity –> Decreases Asset = Ending Inventory is cheaper price
Lower Gross Profit is good for taxable income, but not for financial statements
Dollar Value LIFO
Inventory is measured in dollars and is adjusted for changing price levels. An estimate of change in price levels is required by use of a price index.
LIFO layer at base year x price index
= Dollar Value LIFO
How to calculate the price index?
Ending Inventory at Current Year Cost /
Ending Inventory at Base Year Cost
Gross Profit Method
Used for Interim Financials - Quarterly and Periodic
Inventory is valued at retail and the average gross profit percentage is used to determine the inventory cost - have to back into COGS (plug)
What are Firm Purchase Commitments?
A legally enforceable agreement to purchase a specified amount of goods at some time in the future
Benefit - Locking into a set price if prices increase
Disadvantage - If prices go down, you are at a loss
Requires disclosure
