Inventory Flashcards
Trading organization - flow of inventory
buys and sells goods. does not produce goods.
opening finished goods
+ purchases
- units sold
= closing finished goods
Manufacturing organization - flow of inventory
produces goods from raw materials
opening raw materials
+ purchases
- UNITS TRANSFERRED TO PRODUCTION
= ending raw materials units
opening WIP \+ UNITS TRANSFERRED FROM PRODUCTION \+ freight-in \+ insurance \+ warehouse \+ labor \+ overheads - UNITS PRODUCED = ending WIP
opening finished goods
+ UNITS PRODUCED
- units sold
= closing finished goods
What is capitalized in inventory?
Capitalized:
direct material
direct labor
overheads (fixed & variable; aka indirect costs)
freight-in
inventory handling costs (insurance, warehouse cost)
Not capitalized:
freight-out
interest paid on loans to finance inventory
discount lost when using net method on purchases with credit discounts.
Inventory purchased on credit terms
If inventory is purchased and there are credit terms (e.g. 2/10 net 30), the expense needs to be recorded gross or net.
Gross - you do not expect to utilize the discount.
Net - you do expect to utilize the discount. If you record at net, but do not end up taking the discount the additional expense is treated as a financing expense. It is NOT added to inventory costs (capitalized)
When is revenue recognized and inventory derecognized?
When risks and rewards of ownership is transferred, revenue is recognized and inventory is derecognized.
FOB Destination
inventory policies
“freight-on-board” destination
risk transferred to buyer when the inventory REACHES the buyer’s destination
FOB Shipping Point
inventory policies
risk transferred to buyer when the inventory is handed over to the common carrier
Sales with right to return
inventory policies
Sale where the buyer has the right to return the goods.
If the amount of returns can be reasonably estimated, then sales s/b recorded with an allowance for expected returns.
Consignment sales
inventory policies
Goods are shipped from the consignor to a 3rd party (consignee) who holds and sells the inventory on the consignor’s behalf.
Unsold inventory held by the consignee is included in the consignor’s inventory.
Freight costs for shipping to consignee, in-transit insurance, and warehousing costs by consignee are all included in inventory costs (capitalized).
Specific identification method
inventory costing methods
Used for unique (not homogenous) goods. Cost and selling price of the individual goods varies. E.g. airplane
Specific identification method
inventory costing methods
Used for unique (heterogeneous) goods. Cost and selling price of the individual goods varies. E.g. airplane
Cost for the specific item sold is identified and booked to the IS.
First in first out
inventory costing methods
used for homogeneous units; selling price for each unit is the same. the oldest cost is booked to the IS first.
Last in first out
inventory costing methods
used for homogeneous units; selling price for each unit is the same. the newest cost is booked to the IS first.
Weighted average cost method
inventory costing methods
used for homogeneous units; selling price for each unit is the same. the average of price of all the inventory is booked to the IS.
Periodic system - weighted average cost
inventory costing methods
At the end of the period, the weighted average price is calculated and assigned to the inventory sold.
aka…average inventory method
Perpetual system - weighted average cost
inventory costing methods
At every point of sale, the average of all previous inventory purchases is calculated. This cost amount is assigned to the inventory sold.
aka…moving average inventory method
Periodic system
inventory systems
Inventory and cost of goods sold balance is known only at the year end.
During the year, all inventory purchases are accumulated into purchase account(s).
At the year end, all units sold are removed from purchases and transferred to cost of goods sold.
Remaining purchases are transferred to the inventory.
Difference between COGS valued using FIFO perpetual and periodic?
inventory systems
FIFO perpetual = FIFO periodic
none; cogs calculated under both systems will be the same. they are both pulling from the oldest purchases first.
Difference between COGS valued using LIFO perpetual and periodic?
inventory systems
LIFO perpetual != LIFO periodic
under perpetual system, the cogs will be valued using the most recent purchase.
under periodic, cogs will be valued using the last purchase of the year.
FIFO objective
to match the accounting with the actual flow of inventory
LIFO objective
to make sure the COGS is at current prices
IFRS v. LIFO
IFRS wants COGS to match the flow of inventory, so FIFO is allowed.
Because LIFO does not necessarily match the flow of inventory, it is not allowed in IFRS.
Period of rising prices - FIFO & LIFO effects
FIFO: cogs lower, net income higher, taxes higher
LIFO: cogs higher, net income lower, taxes lower
Period of falling prices - FIFO & LIFO effects
FIFO: cogs higher, net income lower, taxes lower
LIFO: cogs lower, net income higher, taxes higher
LIFO conformity rule
If LIFO is used for taxes, then it must be used for accounting as well.
LIFO generally produces a lower tax burden, which mgmt wants. However, it also results in lower value of inventory on the balance sheet, which mgmt does not want. Can’t have cake and eat it too.
HOWEVER - you can use LIFO for accounting and FIFO for taxes.
LIFO reserve
Using LIFO method for accounting, but other method for taxes (FIFO, weighted average, specific identification)
LIFO reserve is the difference between COGS per the accounting financials (higher) and the tax financials (lower).
Tax COGS + LIFO reserve = LIFO cogs
Tax inventory - LIFO reserve = LIFO inventory
Dollar Value LIFO v. LIFO (standard)
Normally under LIFO, inventory is valued in units, then converted to dollars.
In dollar value LIFO, inventory is immediately valued in dollars.
Dollar Value LIFO - calculation method
Count only the layers of inventory added in the current year. Measure at CPI (current price index).
The balance of inventory is measured at base yer prices.
Dollar Value LIFO - example
Year EB Inv(CY$) CPI EB Inv(Base$) Layer
2015 10,000 / 1.0 10,000 -0-
2016 12,100 / 1.1 11,000 1,000
2017 15,000 / 1.2 12,500 1,500
2018 13,500 / 1.25 10,800 (1,700)
Year Layer(B$) Used Bal(B$) Bal(CY$)
2015 -0- -0- -0- X1.0 -0-
2016 1,000 (200) 800 X1.1 880
2017 1,500 (1,500) -0- X1.2 -0-
2018 (1,700) 1,700 -0- X1.25 -0-
Year Layer Bal(CY$)
2015 -0-
2016 880
2017 -0-
2018 -0-
---------------------------
Net Layer 880
Base Layer + 10,000
= 10,880 2018 Inventory EB
Dollar Value LIFO - steps
1) convert inventory to standard unit (BY$ base yr)
2) calculate increase (decrease) in inv for each year
3) calculate what portion of each year’s inc(dec) was utilized (when there is a decrease, aka “LIFO liquidation”)
4) calculate the balance of each years inc(dec)
5) convert each year’s remaining amt back to CY$
6) sum the amounts in #5
7) add the base layer = EB inventory CY$
COLUMNS IN SPREADSHEET
A) EB inv CY$
B) CPI
C) EB inv BY$ (A / B)
D) Increase(Decrease) BY$
2020 EB - 2019 EB year over year
E) Utilized BY$
from newest to oldest, subtract the portion of the
layer utilized
F) Balance BY$
Net coulmn D and E
G) Convert back to CY$ (BY$ X CPI)
H) Sum amounts in column G
I) Add base year inventory
Inventory Valuation - US GAAP
Purpose: revalue the inventory every year to account for losses in inventory value. (Account for future losses now - matching)
LIFO methods or Retail Inventory Method –> must value using Lower of Cost or Market Value (LCM)
FIFO or Specific Identification Method –> must value using Lower of Cost or Net Realizable Value (LCNRV)
Net realizable value
Inventory Valuation - US GAAP
Selling price - selling cost
used in revaluing inventory at LCNRV for FIFO or specific identification methods
Market value
Inventory Valuation - US GAAP
Median value of…
ceiling NRV
floor NRV - normal profit margin
replacement cost cost to replace inv now
used in revaluing inventory at LCM for LIFO or Retail Inventory Method
Ceiling
Inventory Valuation - US GAAP
ceiling equals net realizable value
selling price - selling cost
Floor
Inventory Valuation - US GAAP
floor equals net realizable value less the normal profit margin
NRV - Normal Profit Margin
(selling price - selling floor) - normal profit margin
LIFO/Retail Identification Method
Inventory Valuation - US GAAP
1) Find median of
NRV
NRV - profit margin
Replacement cost
= MARKET
2) Find lower of
COST
MARKET
= inventory valuation amount
FIFO/Specific Identification
Inventory Valuation - US GAAP
1) Find NRV (selling price - selling cost)
2) Find lower of
NRV
COST
= inventory valuation amount
Inventory valuation adjustment - journal entries
Inventory Valuation - US GAAP
Loss on inventory write-down XXX
Inventory XXX
US GAAP does NOT allow a reversal of a loss
Inventory Valuation - IFRS
Regardless of inventory method, ALWAYS use LCRNV
Loss on inventory write-down XXX
Inventory XXX
Reversal of loss on inventory write-down is ALLOWED (only to the extent of the reversal though, not more)
Inventory Estimation - steps
Allowed only for interim financial statements
COGS + PROFIT = SALES
1) Estimate COGS: using profit mark-up or margin
mark-up (profit is % of cost)
margin (profit is % of sales)
2) Calculate Inventory:
BB inv
\+ purchases
- COGS (estimated above)
= EB inv
Mark-up
Inventory Estimation
Profit, expressed as a percentage of cost
E.g. Sales = Y
Cost = X
Profit = 0.25X
COGS + 0.25COGS = SALES
1.25 COGS = SALES
COGS = SALES / 1.25
Margin
Inventory Estimation
Profit, expressed as a percentage of sales
E.g. Sales = Y
Cost = X
Profit = 0.25Y
SALES - 0.25 SALES = COST
COST = 0.75 SALES
Retail inventory method
Businesses in the retail industry might have to keep inventory at two prices, cost and sales. Prior to computers, this would have been cumbersome and costly.
Instead of maintaining two sets of inventory prices, businesses keep inventory at retail price and calculate a cost-to-retail ratio to estimate the cost of inventory.
Conventional method
retail inventory method
To calculate the cost-to-retail ratio calculate the total inventory available for sale at both cost and retail prices. Divide cost price by retail price.
COST RETAIL BB inv xxx yyy \+ purchases xxx yyy \+ freight-in xxx ---- \+ net-markups ---- yyy = Inv available for sale XXX / YYY (XXX / YYY) cost-to-retail ratio
= inv available for sale XXX YYY
- net markdowns —– (yyy)
= total inv AFS @ retail —– YYY
- sales —– (yyy)
= EB inv @ retail ZZZ
ZZZ * cost-to-retail ratio = EB inv @ cost
LIFO retail method
retail inventory method
COST RETAIL
purchases xxx yyy
+ freight-in xxx —-
+ net markups —- yyy
- net markdowns —- (yyy)
= inventory XXX / YYY
(XXX / YYY) cost-to-retail ratio
= inventory XXX YYY
+ beginning inv @ retail —- yyy
= total inv AFS @ retail —– YYY
- sales —– (yyy)
= EB inv @ retail ZZZ
Differences b/w conventional and LIFO retail methods
1) LIFO does not start with BB inv (PY EB). Conventional does start w/ PY EB, which is based on the PY cost-to-retail ratio
2) LIFO includes markups and markdowns in the cost-to-retail ratio
Total list of inventory calculation methods
total of eleven methods
a)
perpetual periodic
specific identification x x
FIFO x x
LIFO x x
weighted average x x
b) dollar value LIFO method
c) retail method: conventional LIFO
Purchase commitment
Forward contract to set price for purchase in the future
contracted price > market price = probable loss in future, so have to recognize estimated loss
(contract price - market price)
estimated loss on purchase commitment XXX
accrued loss on purchases commitment XXX
at time of actual purchase, accrued loss is reversed
purchases XXX
accrued loss on purchase commitment XXX
accounts payable or cash XXX
