Inventory Flashcards
Facts on goods and materials to be included in inventory
title passes from the seller to the buyer in the manner and under the conditions explicitly agreed on by the parties; if no conditions are explicitly agreed on ahead of time, title passes from the seller to the buyer at the time and place where the seller’s performance regarding delivery of goods is complete
FOB = free on board
FOB shipping point = title passes to the buyer when the seller delivers the goods to a common carrier; goods shipped in this manner should be included in the buyer’s inventory upon shipment
FOB destination = title passes to the buyer when the buyer receives the goods from the common carrier
if the seller ships the wrong goods, the title reverts to the seller upon rejection by the buyer; thus, the goods should not be included in the buyer’s inventory, even if the buyer possesses the goods prior to their return to the seller
in a consignment arrangement, the seller (consignor) delivers goods to an agent (consignee) to hold and sell on the consignor’s behalf; the consignor should include the consigned goods in its inventory because title and risk of loss is retained by the consignor even though the consignee possesses the goods
goods stored in public warehouse and evidenced by a warehouse receipt should be included in the inventory of the company holding the warehouse receipt; the reason is that the warehouse receipt evidences title even though the owner does not have possession
occasionally, as part of a financing arrangement, a seller has a requirement to a repurchase goods from the buyer; if so, the seller should include the goods in inventory even though title has passed to the buyer
if the seller sells goods on an installment basis but retains legal title as security for the loan, the goods should be included in the seller’s inventory if the percentage of uncollectible debts cannot be estimated; however, if the percentage of uncollectible debts can be estimated, the transaction would be accounted for as a sale, and an allowance for uncollectible debts would be recorded
Facts on valuation of inventory
U.S. GAAP requires that inventory be stated at its cost (price paid or consideration given to acquire an asset); methods used to determine the cost of inventory include FIFO, LIFO, average cost, and the retail inventory method
departures from the cost basis includes precious metals and farm products as they are valued at net realizable value (net selling price less costs of disposal)
the purpose of reducing inventory to an amount below cost is to show the probably loss sustained (conservatism) in the period in which the loss occurred (matching principle)
under U.S. GAAP, the write-down of inventory is usually reflected in COGS, unless the amount is material, in which case the loss should be identified separately in the income statement
under U.S. GAAP, reversals of inventory write-downs are prohibited
under U.S. GAAP, the lower of cost and net realizable value method is used for all inventory that is NOT costed using LIFO or the retail inventory method
under U.S. GAAP, the lower of cost or market method is used when inventory is costed using LIFO or the retail inventory method
market value = the median (middle value) of an inventory item’s replacement cost, its market ceiling, and its market floor
replacement cost = the cost to purchase the item of inventory as of the valuation date
market ceiling = an item’s net selling price less the costs to complete and dispose (called the net realizable value)
market floor = the market ceiling less a normal profit margin
substantial and unusual losses from the subsequent measurement of inventory should be disclosed in the financial statements; small losses from a decline in value are included in the COGS
the basic principle of consistency must be applied in the valuation of inventory and the method should be disclosed in the financial statements; in the event that a significant change takes place in the measurement of inventory, adequate disclosure of the nature of the change and, if material (materiality principle), the effect on income should be disclosed in the financial statements
What are the 2 types of inventory systems used to count inventory?
periodic = the quantity of inventory is determined only by physical count, usually at least annually; therefore, units of inventory and the associated costs are counted and valued at the end of the accounting period; the actual COGS for the period is determined after each physical inventory, cased on the physical count; this method does not keep a running total of the inventory balances; ending inventory is physically counted and priced
perpetual = the inventory record for each item of inventory is updated for each purchase and each sale as they occur; the actual COGS is determined and recorded with each sale; therefore, this system keeps a running total of inventory balances
What are some primary inventory cost flow assumptions?
inventory valuation is dependent on the cost flow assumption underlying the computation; as the identity of goods and their related costs are lost between the time of acquisition and the time of sale, it has resulted in the development and general acceptance of several assumptions with respect to the flow of cost factors to provide practical bases for the measurement of periodic income
specific identification method = the cost of each item in inventory is uniquely identified to that item; the cost follows the physical flow of the item in and out of inventory to COGS; this is usually for physically large or high-value items and allows for greater opportunity for manipulation of income
FIFO method = the first costs inventoried are the first costs transferred to COGS; ending inventory includes the most recently incurred costs; thus, the ending balance approximates replacement cost; ending inventory and COGS are the same whether a periodic or perpetual inventory system is used; in periods with rising prices, the FIFO method results in the highest ending inventory, the lowest COGS, and the highest net income (current costs are not matched with current revenues)
weighted average method = at the end of the period, the average cost of each item in inventory would be the weighted average of the cots of all items in inventory; the weighted average is determined by dividing the total costs of inventory available by the total number of units of inventory available, remembering that the beginning inventory is included in both totals; this method is suitable for homogeneous products and a periodic inventory system
moving average method = this computes the weighted average cost after each purchase by dividing the total cost of inventory available after each purchase (inventory plus current purchase) by the total units available after each purchase; the moving average is more current than the weighted average; a perpetual inventory system is necessary to use this method
LIFO method = the last costs inventoried are the first costs transferred to COGS; ending inventory, therefore, includes the oldest costs; the ending balance of inventory will typically not approximate replacement cost; it does not generally relate to actual flow of goods in a company because most companies sell or use their oldest goods first to prevent holding old or obsolete items; if LIFO is used for tax purposes, it must be used in the GAAP financial statements as well; this method generally better matches expense against revenues because it matches current costs with current revenues; thus, LIFO eliminates holding gains and reduces net income during times of inflation; in periods with rising prices, LIFO generally results in the lowest ending inventory, the highest COGS, and the lowest net income
dollar-value LIFO = when converting from LIFO inventory to dollar-value LIFO, a price index will be used to adjust the inventory value; to compute the LIFO layer added in the current year at dollar-value LIFO, the LIFO layer at base year cost is multiplied by the internally generated price index (same process if the price index is supplied)
price index = ending inventory at current year cost / ending inventory at base year cost
What is the gross profit method?
it is used for interim financial statement as part of a period inventory system; inventory is valued at retail, and the average gross profit percentage is used to determine the inventory cost for the interim financial statements; this method is known and is used to calculate the cost of sales
What are firm purchase commitments?
a legally enforceable agreement to purchase a specified amount of goods at some time in the future; all material firm purchase commitments must be disclosed in either the financial statements or the notes thereto
if the contracted price exceeds the market price and if it is expected that losses will occur when the purchase is actually made, the loss should be recognized at the time of the decline in price; a description of losses recognized on these commitments must be disclosed in the current period’s income statement
