Merchandise Inventory

Consistency Principle

States that businesses should use the same accounting methods and procedures from period to period.

Disclosure Principle

Requires businesses to release financial statements with enough information for outsiders to make informed decisions.

Materiality Concept

Indicates that a company must perform proper accounting only for items significant to its financial situation; material dollar amounts differ based on company size.

Goal of Conservatism

Encourages businesses to report modest figures in financial statements to avoid overstating assets or net income.

Control over Merchandise Inventory

Involves measures like authorized purchases, tracking inventory, recording damages, and conducting physical counts.

SPID Method

Specific identification method that totals the value of each individual inventory item.

FIFO Method

First in, first out; assumes the first items bought are the first sold, affecting ending inventory.

LIFO Method

Last in, first out; assumes the last items bought are the first sold, impacting ending inventory.

Weighted Average Method

Calculates the average cost of goods bought and applies it to the amount of inventory.

Weighted-Average Cost Calculation

A new weighted-average cost per unit is computed whenever new supplies are purchased.

FIFO and Gross Profit

During rising costs, the FIFO method produces the highest gross profit.

Lower-of-Cost-or-Market (LCM) Rule

Requires merchandise inventory to be reported at the lower of historical cost or market value.

Adjusting Entry for LCM

Cost of goods sold is debited, and merchandise inventory is credited when writing down inventory.

Effects of Understated Ending Inventory

Results in overstated COGS, understated gross profit, and understated net income.

Inventory Error Cancellation

An inventory error cancels out when ending inventory is moved to beginning inventory in the next period.

Inventory Turnover Calculation

Calculated by dividing average merchandise inventory by COGS; measures how quickly supplies are sold.

Days’ Sales in Inventory Calculation

Calculated by dividing inventory turnover rate by 365; measures average days inventory is held.

FIFO in Periodic System

FIFO always produces the same result in both periodic and perpetual inventory systems.

Weighted-Average Cost in Periodic System

The weighted-average cost per unit is computed at the end of the period in a periodic system.