ACCT 2293 Chapter 6: Reporting and Analyzing Inventory

Vocabulary flashcards covering inventory valuation, ownership rules, cost formulas (FIFO, moving average, weighted average, specific identification), LCNRV, error analysis, and inventory ratios.

Shrinkage

The loss of inventory identified during a physical count (due to theft, damage, or spoilage), recorded with a debit to Cost of Goods Sold and a credit to Merchandise Inventory.

FOB shipping point

A shipping term indicating that ownership and title of goods in transit pass to the buyer the moment the merchandise leaves the seller's shipping dock.

FOB destination

A shipping term indicating that ownership and title of goods in transit remain with the seller until the merchandise arrives at the buyer's destination.

Consigned goods

Goods held physically by an agent, gallery, or store (consignee) that remain the legal property of the owner (consignor) and must be included in the consignor's inventory, not the consignee's.

Specific identification

An inventory cost formula required when goods are unique and not interchangeable (such as art, cars, jewellery, and pianos), which tracks and uses the actual cost of each individual item sold.

FIFO (first-in, first-out)

An inventory cost formula for interchangeable goods assuming the oldest purchase costs are transferred to cost of goods sold first, leaving the newest acquisition costs in ending inventory.

Moving average

A perpetual inventory cost formula that recalculates a new weighted average unit cost after every purchase, while sales are deducted at the prevailing average and do not alter it.

Weighted average (periodic)

A periodic inventory cost formula that computes a single average cost per unit for the entire period by dividing total cost of goods available for sale by total units available for sale.

Lower of cost and net realizable value (LCNRV)

A valuation rule requiring inventory to be written down to net realizable value (Dr Cost of Goods Sold / Cr Merchandise Inventory) whenever NRV falls below historical cost; inventory is never written above cost.

Net realizable value (NRV)

The estimated selling price of inventory in the ordinary course of business less estimated costs to sell: $\text{Net realizable value} = \text{expected selling price} - \text{costs to sell}$.

Inventory turnover

An activity ratio indicating how many times a company's average inventory balance is sold during an accounting period, computed as: $\text{Inventory turnover} = \frac{\text{Cost of goods sold}}{\text{Average inventory}}$.

Days in inventory

A liquidity metric that measures the average number of days inventory sits on hand before being sold, calculated as: $\text{Days in inventory} = \frac{365}{\text{Inventory turnover}}$.

Average inventory

The mean dollar value of inventory held over a financial period, calculated as: $\text{Average inventory} = \frac{\text{Beginning inventory} + \text{Ending inventory}}{2}$.

Two-year inventory error reversal

The accounting phenomenon where an error in ending inventory affects gross profit and net income in opposite directions across two consecutive periods, leaving retained earnings correctly stated by the end of the second year.

Purchase recorded in the wrong period

An inventory error occurring when goods in transit at year-end are improperly recorded, causing inventory and accounts payable to be misstated by equal amounts without affecting cost of goods sold, net income, or retained earnings.

Standard four-step sequence for inventory cost allocation

1. Calculate cost of goods available for sale ($\text{Beginning Inventory} + \text{Purchases}$ ).
   
   2. Determine ending inventory.
   
   3. Calculate cost of goods sold $\text{Cost of Goods Sold} = \text{Goods Available for Sale} - \text{Ending Inventory}$
   
   4. Verify that $\text{Cost of Goods Sold} + \text{Ending Inventory} = \text{Cost of Goods Available for Sale}$

Calculation of unit cost under the moving average method

Recalculate average unit cost after each purchase by dividing total remaining inventory cost by total units on hand: $\text{New Average Unit Cost} = \frac{\text{Total Remaining Cost}}{\text{Total Remaining Units}}$. Sales are deducted using the prevailing average without altering the unit cost.

Procedure for allocating costs under periodic FIFO

1. Determine cost of goods available for sale
   (Beginning inventory + purchases), ignoring sale dates.
   
   2. Price ending inventory units using the newest purchase unit costs.
   
   3. Deduct ending inventory from cost of goods available for sale to obtain cost of goods sold.

Calculation of periodic weighted average unit cost and inventory valuation

Calculate a single unit rate for the period: weighted average cost per sale = COGS / total units AFS

Value ending inventory as units on hand multiplied by this rate, and subtract ending inventory from cost of goods available for sale to find cost of goods sold.

Period-end adjusting journal entry in a periodic inventory system

Debit Merchandise Inventory for the ending count balance, debit Cost of Goods Sold for the calculated amount,

credit Purchases to close the account balance, and credit Merchandise Inventory to remove the beginning balance.

Step-by-step procedure for a lower of cost and net realizable value (LCNRV) write-d

1. Compute net realizable value for each item:

NRV = Expected selling price - costs to sell

2. Compare cost and NRV per item and select the lower amount.

Write-down = Total Cost - LCNRV

Adjusting journal entry to record an LCNRV inventory write-down

Debit Cost of Goods Sold and credit Merchandise Inventory for the excess of historical cost over net realizable value.

Condensed income statement calculation sequence for merchandising

1. Compute Gross Profit: Gross Profit = Sales Revenue - Cost of Goods Sold
   
   

2. Compute Income Before Income Tax: Gross Profit - Operating Expenses

   
   

3. Compute Income Tax: Income Tax / Income Tax Rate
   
   

4. Compute Net Income: Income Before Tax - Income Tax Rate

Formulas for inventory turnover and days in inventory

Calculate average inventory as $(\text{Beginning Inventory} + \text{Ending Inventory}) \div 2$, then calculate: $\text{Inventory Turnover} = \frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}$ and $\text{Days in Inventory} = \frac{365}{\text{Inventory Turnover}}$.

Mathematical effect of an understated ending inventory over two consecutive years

In Year 1, cost of goods sold is overstated and net income is understated by the error amount.

In Year 2, beginning inventory is understated, making cost of goods sold understated and net income overstated by that same amount, resulting in correctly stated retained earnings by the end of Year 2.