Week 2 - Inventory and Merchandising Operations Flashcards
inventries are valued at
lower of cost and net realizable value (NRV)
lower-of-cost-or market rule
business must record the cost of inventory at whichever cost is lower - the original purchase cost or its current market value
Why are inventories recorded at the lower of cost or NRV?
because of the reliability qualitative characteristic. Not revaluing the inventory to the lower NRV lends bias to the ending inventory, which violates the reliability requirements.
The entity may not be able to recover the cost of inventory if the goods are damaged or obsolete, or if their selling price has declined below cost.
net realizable value
estimated selling price - estimated cost to be incurred to sell the goods
The estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale
What is inventory referred to once it is sold?
Once inventory is sold, it gets shifted to the expense account, called COGS
Selling goods on consignment
Consignor: The consignor may also be referred to as the shipper
Consignee: is the entity who is financially responsible (the buyer) for the receipt of a shipment
Consignment is when goods are shipped to a dealer. The dealer, who is the consignee, has the right to return the goods to you when they don’t sell.
FOB
Freight on board; shipping terms that determine who owns the goods at a particular time
FOB Shipping Point
Ownership of goods changes hands at the shipping point.
- buyer pays for shipping
- buyer includes the goods in its inventory while the goods are in transit
FOB Destination
Ownership of goods changes hands at the destination
- the seller pays for shipping
- the seller includes the goods in its inventory while the goods are in transit
Perpetual Inventory System
- used for all types of goods
- keeps a running record of all goods bought, sold, and on hand
- inventory counted at least once a year to determine any discrepancies between accounting records and inventory on hand
Periodic Inventory System
- used for inexpensive goods
- does not keep a running record of all goods
- inventory counted at least once a year to determine ending inventory with any difference assumed to be used or sold
purchase return
decrease in the cost of inventory because the buyer return the goods to the vendor
purchase allowance
decreases the cost of inventory because the buyer got an allowance from the amount owed; A purchase allowance is a reduction in the buyer’s cost of merchandise that it had purchased. The purchase allowance is granted by the supplier because of a problem such as shipping the wrong items, the incorrect quantity, flaws in the goods, etc.
Where are shipping costs recorded
as an expense, not COGS
inventory costing methods
first-out (FIFO); last-in, first-out (LIFO); and weighted average cost method
Specific identification/specific-unit-cost method
cost of inventory items that are not ordinarily interchangeable shall be assigned by using specific identification of the individual costs (e.g. cars, real estate)
Inflation/when inventory costs increase:
Under which costing method are COGS highest?
LIFO
Inflation/when inventory costs increase:
Under which costing method is ending inventory highest?
FIFO
Deflation/when inventory costs are decreasing:
Under which costing method is ending inventory highest?
LIFO
Which costing method is not allowed under IFRS
LIFO
Inventory Error:
Period 1: Ending inv. overstated.
–> What happens to COGS and profit in period 1 and 2
Period 1:
- COGS understated
- Profit overstated
Period:
- COGS: overstated
- Profit: understated
gross profit percentage
gross profit/ sales
inventory turnover
COGS/ average inventory
average inventory
(beginning balance + ending balance)/2
What does inventory turnover tell us?
shows us how many times the company sold its average level of inventory during the year
inventory resident period
365/ inventory turnover
- expressing the turnover in days
inventory resident period: should it be high or low?
Less days are better
Estimating ending inventory by the gross profit method/gross margin method
Beginning inv. \+ purchases = COG available - COGS = Ending inv.
Types of inventory in retail companies
merchandise (finished goods)
Types of inventory in manufacturing companies
Raw materials
Work in progress
Finished goods
Situations in which NRV might be lower than cost of inventory
- when there is an increase in costs to complete or selling costs
- a fall in selling price
- Obsolescence of products
- A decision to manufacture and sell products at a loss, this can happen when management decide to gain market share
- Errors in production or purchasing
What is obsolescence?
Recognition that a product is no longer fit for purpose
Types of obsolescence?
- Functional obsolescence
- Economic obsolescence
- Physical deterioration
Functional obsolescence
there is nothing wrong with the product, but due to new technologies a better product is available today
Economic obsolescence
there is nothing wrong with the product, however there is no market demand anymore
Fashion
Physical deterioration
the product is damaged
For what is LIFO used
Under certain circumstances, it is allowed under the US GAAP
Often allowed for tax purposes
Average cost of inventory
average purchase price over a certain period
–> often in between LIFO and FIFO in estimating COGS or ending inventory prices for
costs of inventory should include all:
- Costs of purchase (including taxes, transport, and handling) net of trade discounts received
- Costs of conversion (including fixed and variable manufacturing overheads)
- Other costs incurred in bringing the inventories to their present location and condition
Gross profit margin
Gross profit / sales
