Inventory Costing and Valuation

Comprehensive vocabulary flashcards covering inventory controls, costing methods (Specific Identification, FIFO, Average Cost), inventory schedule calculations, error handling, and the lower of cost and net realizable value rule.

Counting Inventory

A control activity within a company's internal control system, alongside review and reconciliation, used to verify inventory quantities.

Specific Identification

An inventory costing method used exclusively in perpetual systems where each unit of inventory is tagged with its specific cost, directly tracking the physical flow of goods.

Criteria for Using Specific Identification

Can only be used when the actual cost of each item can be determined and goods are easily distinguishable from one another rather than interchangeable.

Cost Formulas

Methods that assume a specific flow of costs that may not necessarily mirror the actual physical flow of goods.

FIFO (First-In, First-Out)

A cost formula where the oldest goods purchased are assumed to be sold first, assigning the cost of the earliest purchased items to cost of goods sold and leaving ending inventory composed of the newest goods.

FIFO Financial Statement Impact

Ending merchandise inventory is reported at recent (current) cost in the current assets section of the Statement of Financial Position, while cost of goods sold is recorded as an expense on the Statement of Income.

FIFO Invariance Under Periodic and Perpetual Systems

Ending inventory and cost of goods sold yields identical values under FIFO whether an entity uses a periodic or perpetual inventory system.

Average Cost Method

An inventory cost formula used when the physical flow of inventory cannot specifically be identified or measured.

Weighted Average Unit Cost

Calculated under a perpetual inventory system after each purchase as: $\text{Cost of Goods Available for Sale} \div \text{Units Available for Sale}$.

Selection of Inventory Cost Formulas

The requirement to choose a formula that best approximates the physical flow of goods, reports ending inventory at recent cost, and applies uniformly across inventories of similar nature and usage.

Advantages of Specific Identification

Exactly matches costs and revenues on the Statement of Income and mirrors the actual physical movement of goods.

Advantages of FIFO

Presents ending inventory on the Statement of Financial Position at values nearest to current replacement cost and approximates the normal physical flow for most retail businesses.

Advantages of Average Cost

Smooths out price fluctuations by dampening price peaks and troughs, yielding inventory and cost of goods sold values that fall between the extremes.

Inventory Errors

Accounting inaccuracies stemming from incorrect assigned costs, miscounted stock, or improper timing entries for goods in transit at the end of an accounting period.

Financial Statement Effects of Inventory Errors

Simultaneously distorts the Statement of Financial Position via merchandise inventory and the Statement of Income via cost of goods sold.

Settling of Inventory Errors

When an ending inventory count is accurately performed in the subsequent period, the prior ending inventory error reverses its effect on net income in that following period.

Lower of Cost and Net Realizable Value (LCNRV) Rule

The accounting rule requiring inventory to be written down when its net realizable value falls below its recorded historical cost.

Net Realizable Value (NRV)

The estimated selling price of inventory minus any costs required to prepare the goods for sale.

Counting Inventory

A control activity within an internal control system (which includes review and reconciliation) used by companies to ensure inventory is properly accounted for.

Cost Formulas

Formulas applied to inventory quantities to determine the total cost of inventory; they assume a flow of costs that may not be the same as the actual physical flow of goods.

Specific Identification

An inventory cost method used only in a perpetual system that tracks the physical flow of goods by tagging each unit of inventory with its specific cost.

Requirements for Specific Identification

Conditions under which specific identification can be used: the actual cost of each item can be determined, and goods are easily distinguishable rather than easily interchangeable.

First-In, First-Out (FIFO)

A cost formula assuming that the oldest goods are sold first (the cost of the first item purchased is the cost of the first item sold), leaving ending inventory made up of the newest goods.

Financial Statement Presentation under FIFO

Merchandise inventory is reported at the most recent (current) cost in the current assets section of the Statement of Financial Position, while Cost of Goods Sold is reported at the earliest inventory cost as an expense on the Statement of Income.

FIFO Periodic vs. Perpetual Equivalence

The accounting principle that ending inventory and cost of goods sold under the FIFO method yield the exact same dollar amounts in both periodic and perpetual inventory systems.

Average Cost Method

An inventory costing method used when the physical flow of goods cannot be specifically identified, where a new (moving) average unit cost is calculated after each purchase in a perpetual inventory system.

Weighted Average Unit Cost Formula

$$\text{Cost of Goods Available for Sale} \div \text{Units Available for Sale} = \text{Weighted Average Unit Cost}$$

Choice of Inventory Cost Formulas

Criteria dictating that a business should select the formula that best represents the physical flow of goods, reports ending inventory at recent cost, and uses the same formula for inventories of similar nature and usage.

Advantages of Specific Identification

Exactly matches costs and revenues on the Statement of Income and tracks the actual physical flow of inventory.

Advantages of FIFO

Reports ending inventory on the Statement of Financial Position at values closest to the most current cost (replacement cost) and closely approximates the physical flow of most retailers.

Advantages of Average Cost

Smoothes out the effects of cost price changes to determine a middle-of-the-road average cost, canceling extremes for both Cost of Goods Sold on the Statement of Income and ending inventory on the Statement of Financial Position.

Inventory Errors

Errors occurring from incorrect cost assignment or counting errors when measuring goods in transit at the end of an accounting period, which impact both merchandise inventory on the Statement of Financial Position and Cost of Goods Sold on the Statement of Income.

Counterbalancing of Inventory Errors

The effect where an uncorrected inventory error in one period has a reverse effect on net income in the next accounting period; once inventory is counted correctly in the next period, the ending inventory error no longer exists.

Lower of Cost and Net Realizable Value (LCNRV) Rule

A valuation requirement stating that when the net realizable (fair) value of inventory is less than its cost, the carrying inventory value must be written down.

Net Realizable Value (NRV)

The estimated selling price of inventory less any estimated costs necessary to make the goods ready for sale.