week 5 | inventory Flashcards
Flow of Costs
When inventory is purchased or produced, it is capitalized on the BS
When inventory is sold, its cost is transferred from BS → IS as COGS
Cost of Goods Sold: Beginning inventory
carryover from the ending inventory balance of the prior period
Cost of Goods Sold: Current period inventory purchases (manufacturing costs)
added to beg. invt, yielding the cost of goods (inventory) available for sale
Cost of Goods Sold: Goods available
sold & flow to COGS or goods remain unsold & still in inventory at end of period
Gross Profit & Managerial Choice
COGS is deducted from sales to yield gross profit:
Gross Profit = Sales - COGS
Companies have a choice → determining the COGS & cost of inventory remaining on BS
Higher cost units transferred from BS
COGS is higher & GP is lower
Lower cost units transferred from BS
COGS is lower & GP is higher
3 inventory costing methods:
FIFO, LIFO, & average cost
First-In, First-Out (FIFO)
Transfer costs from inventory in the order initially recorded
Last-In, First-Out (LIFO)
Transfers the most recent inventory costs from BS to COGS
Average Cost
Computes the average cost to purchase or manufacture inventory available for sale during the period & applies the average to determine COGS & ending inv’t
FS effects of FIFO
Lowest COGS & higher GP (less taxes paid)
Matches older, lower-cost inv’t against current selling prices
Recent years: GP impact from using FIFO has been minimal for companies due to…
Lower rates of inflation ???
Increased management focus on reducing inv’t quantities through improved manufacturing processes & better inventory control
during periods of rising costs…
LIFO inventories can be markedly lower than under FIFO
LIFO effects on BS
LIFO BS do not accurately represent the cost that a company would incur to replace its current inv’t
LIFO & FIFO BS are not comparable
- GAAP requires firms that choose LIFO to also report (in footnotes) the equivalent FIFO inv’t amount (LIFO Reserve)
