Inventory Flashcards
Inventory Definition
- Inventory is defined as items of tangible property that are held for sale in the ordinary course of business (finished Goods Inventory), in the process of production for such sale (work-in-process inventory), or which are to be currently consumed in the production of goods and services to be available for sale (raw materials inventory)
Inventory for trading and manufacturing organizations
Trading Organization
- Finished Goods inventory
Manufacturing Organizations
- Raw Material Organizations
- Work-in-process inventory
- Finished goods inventory
Inventory Capitalization Rules
Capitalized
- Direct Materials
- Direct Labor
- Overheads- Fixed & Variable
- Freight-in
- Inventory Handling costs
Non Capitalized
- Freight out
- Interest on loan to manufacture or purchase
- Discount lost when using net method
Inventory System
- Inventory System refer to the methods and processes that businesses use to manage and track their inventory of goods, raw materials, and finished goods
- Perpetual Inventory System
- Periodic Inventory System
Period Inventory system
- In the periodic inventory system, inventory and the cost of good sold are not continuously updated. Instead, they are determined at specific intervals, usually at the end of an accounting period (annually).
Periodic Inventory Systems: How it works
Purchases
Purchases Debit
Accounts payable Credit
Sales
Accounts Receivable Debit
Sales Credit
Year-end
(Determine COFGS)
Opening Inventory
Add: Purchases
less: Ending inventory
= COFGS
Record COFGS and Ending inventory
Record COFGS
CofGS Debit
Purchases Credit
Record Ending Inventory
Inventory (ending) Debit
COFGS Credit
Perpetual Inventory System
- The perpetual inventory system is a method of managing inventory that keeps continuous, real-time records of the quantities and costs of items in inventory. Inventory levels are the COFGS are updated continuous as transactions occur.
Perpetual Inventory System: How it works
Purchases
Inventory Debit
Accounts Payable Credit
Sales
Accounts Receivable Debit
Sales Credit
Cost of Good Sold
COFGS Debit
Inventory Credit
- Year end: Unlike the periodic inventory system, no adjusting journal entry is required at year-end, as inventory balances are always up to date.
Specific Identification Method
- Specific identification method assigns the actual cost of each item to that item, tracking its costs from purchase through the sale.
How does it work?
- Recording purchases: When items are purchased, the exact cost of each item is recorded and tracked often using serial numbers, barcodes, or other identifying features.
- Recording Sales: When an item is sold, the specific cost of that particular item is recognized as the COFGS.
- Cost of ending inventory: The cost of ending inventory is the specific cost of the remaining individual items.
First-in, first out (FIFO Methd)
Under FIFO method, units purchased first are treated as sold first, regardless of the actual flow of goods. Therefore, the cost of goods sold consists of the earliest purchases, whereas the ending inventory consists of the latest purchases.
How it works
- Recording purchases: Inventory purchases are recorded at the cost paid for each batch.
- Recording sales: When items are sold, the cost of the oldest items in inventory (those first purchased or produced) is recognized at the Cost of Good Sold.
- Cost of ending inventory: The cost of ending Inventory is the cost of the most recent purchased or produced items.
Weighted Average Method
- Weighted Avg. method assume that the cost of goods sold and ending inventory should be based on the average cost of the inventories available for sale during the period.
How it works:
- Recording purchases: inventory purchases are recorded at the cost paid for each batch.
- Calculate Average cost per unit: Average cost per unit is calculated by dividing the total cost of good available for sale by the total number of units available. This includes both beginning inventory and purchases during the period.
- Recording sales: When items are sold, COFGS is recognized based on the Weighted Avg. cost per unit.
- Cost of ending inventory: The cost of ending inventory is calculated by multiplying the remaining units by the weighted avg. cost per unit.
Moving Average Method
- moving average method calculates the average cost per unit of inventory after each purchase by considering the total cost of goods available and the total number of units available at that specific time providing a continuously updated average cost.
How it works
- Recording purchases: Inventory purchases are recorded at the cost paid for each batch.
- Calculating moving avg. cost: After each purchase, the avg. cost per unit is recalculated by dividing the total cost of goods available (including the new purchase) by the total number of units available.
- Recording sales: When items are sold, the COFGS is recorded based on the latest calculated moving average cost per unit.
- Cost of ending inventory: the cost of ending inventory is calculated by multiplying the remaining units by the latest moving average cost per unit.
Comparison FIFO to LIFO
Period of Rising Prices
FIFO
- COFGS less
- Net Income More
Taxes More
Inventory More
LIFO
COFGS More
Net Income Less
Taxes Less
Inventory Less
Period of falling prices
FIFO
COFGS More
Net Income Less
Taxes Less
Inventory Less
LIFO
COFGS Less
Net Income More
Taxes More
Inventory More
Inventory Valuation
Inventory Costing Technique
-FIFO
-Specific Identification
- Average Method
The above will use the Inventory Valuation Techniques
- Lower of:
* Cost
* Net Realizable Value, NRV (Selling price- Disposal Cost)
Inventory Costing Techniques
- LIFO
-Dollar Value LIFO
- Retail Inventory Method
The above use these inventory Valuation Techniques
- Lower of:
* Cost
* Market Value, I.E.- Median of:
- Ceiling, NRV
- Replacement Cost
- Floor: NRV- Normal profit margin
LIFO Method (last in-first out)
- Units purchased last are treated as sold first, regardless of the actual flow goods. Therefore, the cost of Goods Sold consists of the latest purchases, whereas the ending inventory consists of the earliest purchases.
How it Works
- Recording purchases: Inventory purchases are recorded at the cost paid for each batch.
- Recording sales: When items are sold, the cost of the newest items in inventory (Those purchased or produced last) is recognized as the Cost of Good Sold (COFGS).
- Cost of ending inventory: The cost of ending inventory is the cost of the oldest items in the inventory.
