Chapter 5 – Accounting for Inventories

Vocabulary flashcards covering key terms, concepts, and principles from Chapter 5 – Accounting for Inventories.

Inventory

Goods a company owns and holds for sale at the balance-sheet date.

Ending Inventory

Merchandise still unsold at period end that appears as an asset on the balance sheet.

Cost of Goods Sold (COGS)

Expense representing the cost of inventory that has been sold during the period and reported on the income statement.

Merchandise Inventory

All goods owned and held for sale by a merchandising company, regardless of their physical location when counted.

Inventory in Transit

Goods being shipped that are included in the buyer’s or seller’s inventory depending on the shipping terms (FOB).

FOB Shipping Point

Ownership transfers to the buyer when goods leave the seller’s dock; buyer records inventory while in transit.

FOB Destination

Ownership transfers to the buyer upon delivery; seller owns the goods while in transit.

Inventory on Consignment

Inventory physically held and sold by a consignee but legally owned and reported by the consignor.

Consignor

The owner of goods placed with another party for sale on consignment; retains ownership until goods are sold.

Consignee

The party that receives goods on consignment and sells them on behalf of the owner.

Damaged or Obsolete Inventory

Items that cannot be sold at normal prices; if salable, their cost is reduced to net realizable value; if unsalable, they are excluded from inventory.

Net Realizable Value (NRV)

Estimated selling price of inventory minus any costs of completion, disposal, and transportation.

Cost of Inventory

All expenditures necessary to bring inventory to a salable condition and location, including invoice price minus discounts plus freight, storage, insurance, and import duties.

Perpetual Inventory System

System that continuously updates the inventory account and COGS each time a sale or purchase occurs.

Periodic Inventory System

System that records inventory and COGS at period end by physical count rather than after each transaction.

Specific Identification Method

Costing method that tracks the actual cost of each specific item sold and remaining.

First-In, First-Out (FIFO)

Cost flow assumption where the earliest acquired costs are assigned to COGS and the most recent costs to ending inventory.

Last-In, First-Out (LIFO)

Cost flow assumption where the most recent costs are assigned to COGS and the oldest costs to ending inventory.

Weighted Average Method

Costing method that assigns an average cost per unit, computed as total cost of goods available divided by units available.

Weighted-Average Cost per Unit

The average unit cost computed under the weighted average method and applied to COGS and ending inventory.

Inventory Cost Flow Assumptions

Approaches (Specific ID, FIFO, LIFO, Weighted Average) used to assign costs between COGS and ending inventory.

Financial Statement Effects of Costing Methods

Differences in reported COGS, gross profit, net income, and inventory values that arise from the chosen cost flow assumption.

Lower of Cost or Market (LCM)

Rule requiring inventory to be reported at the lower of its historical cost or current market (replacement) cost.

Market (Replacement Cost)

Current cost to replace an inventory item; used in the LCM comparison.

Conservatism Principle

Guideline to avoid overstating assets or income; underlies the LCM rule for inventory.

Inventory Write-Down

Adjustment recorded when market value of inventory falls below cost, reducing inventory and increasing COGS.

IRS LIFO Conformity Rule

Tax rule that requires companies using LIFO for tax reporting also to use LIFO in financial statements.

Consistency Principle

Principle that a company should use the same accounting methods from period to period so statements remain comparable.

Rising Prices: FIFO vs LIFO

During rising costs, FIFO yields lower COGS and higher net income and inventory than LIFO.

Falling Prices: FIFO vs LIFO

During falling costs, FIFO yields higher COGS and lower net income and inventory than LIFO.

Inventory Error – Understated Ending Inventory

Error that overstates COGS and understates net income, assets, and equity.

Inventory Error – Overstated Ending Inventory

Error that understates COGS and overstates net income, assets, and equity.

Inventory Error – Understated Beginning Inventory

Error that understates COGS and overstates net income for the period.

Inventory Error – Overstated Beginning Inventory

Error that overstates COGS and understates net income for the period.

Good Matching (LIFO)

Characteristic of LIFO in which current costs are matched with current revenues on the income statement.

Current Balance-Sheet (FIFO)

Advantage of FIFO that ending inventory reflects recent costs, providing a more current asset valuation.

Smoothing Effect (Weighted Average)

Weighted average cost moderates the impact of price fluctuations, producing results between FIFO and LIFO.

Inventory Categories for LCM

Three application levels of LCM: individual items, major categories, or the entire inventory.