Chapter 5 - Inventory and Cost of Sales

Merchandise Inventory

all goods that a company owns and hold for sale

The 3 Inventory Items that require special attention

• Goods In Transit

• Goods on Consignment

• Goods damaged or obsolete

Shipping Terms

who is responsible for paying any freight costs and who bears the risk of loss during transit

FOB Shipping Points

ownership transfers from seller to buyer when goods are shipped

FOB Destination

ownership transfers from seller to buyer when goods are arrive at the buyer’s place of business

Consignor

owner of goods in consignment

Consignee

seller of goods in consignment

Consignor

_______ retains title to the item AT ALL TIMES, and, as such, items on consignment are INCLUDED in the inventory of _______

Consignee

________ NEVER includes consigned goods in their inventory

Obsolete

out of date (no one wants to buy it anymore)

loss

Damages/Obsolete/Deteriorated Goods reported as a ______

Damages/Obsolete/Deteriorated Goods: (two types)

Cannot be sold - do not include

Can be sold - included as “NET RELIZABLE VALUE”

Net Realizable Value Formula

Sales Price - Cost of Making the Sale

Merchandise Inventory Includes Formula

invoice cost - any discount + any other cost to get the inventory to its saleable condition and location

2000-40+300+50+100=$2410

Suppose an item was shipped from a supplier under FOB Shipping Point. The invoice in the amount of 2000 included terms of 2/10,n30. When the invoice was paid, a purchase discount of 40 was taken. Other details relating to the purchase of this item included the following : shipping charges of 300, storage fees of 50 and insurance premium of 100. The cost of inventory is:

Theft, Loss, Damage, Error

What are the events that cause Inventory Account Balance to DIFFER from ACTUAL Inventory balance

lowest, highest

FIFO

• assigns _______ amount of cost of goods sold

• ________ gross profit and net income

• COST REGURARLY RISE

highest, lowest

LIFO

• assigns _______ amount of cost of goods sold

• ________ gross profit and net income

• COST REGURALY RISE

Weighted Average

between FIFO AND LIFO

Specific Identidication

results that depend on which units are sold

highest,lowest

FIFO

• assigns _______ amount of cost of goods sold

• ________ gross profit and net income

• COST REGURARLY DECLINE

lowest, highest

LIFO

• assigns _______ amount of cost of goods sold

• ________ gross profit and net income

• COST REGURALY DECLINE

FIFO

• Inventory on the balance sheet is assigned on amount that approximates current cost

• Follows the actual flow of goods for next business

LIFO

• Cost of Goods Sold on the income statement

• Better matched the current costs with revenues in computing gross profit

Weighted Average

Smoothes out erratic changes in costs

Specific Identification

Exactly matches the cots of items with the revenues they generate

LIFO

_____ has LESS Income to be taxed = why companies use it

LIFO Conformity Rule

IRS requires that when LIFO is used for tax reporting, it also MUST be used for financial reporting

Lower of Cost or Market (LCM), Lower of Cost or Net Realizable Value (LCNRV)

After companies apply one of four costing methods, inventory is reviewed to ensure it is reported at the _________ or the ________

Market Value

replacement cost of inventory

Cost of Goods Sold ….. 30000

…. Merchandise Inventory…… 3000

Inventory MUST be adjusted downward when MARKET is LESS than COST

Lower of Cost or Market. Record Journal Entry

Inventory Errors can occur in

• Physical count

• Inventory Count (ex. ownership of inventory in transit might be mistaken)

• In the assignment of costs to the inventory items (ex. a purchase might be overlooked)

Ending Inventory	Year 1		Year 2
	Cost of Goods Sold	Net Income	Cost of Goods Sold	Net Income
Understated	overstated	understated	understated	overstated
Overstated	understated	overstated	overstated	understated

Ending Inventory	Year 1		Year 2
	Cost of Goods Sold	Net Income	Cost of Goods Sold	Net Income
Understated
Overstated

BALANCE SHEET EFFECTS

Ending Inventory	Assets	Equity
Understated	understated	understated
Overstated	overstated	overstated

BALANCE SHEET EFFECTS

Ending Inventory	Assets	Equity
Understated
Overstated

Inventory Turnover Formula and Definition

one ratio used to assess the effectiveness of the management of the company’s inventory levels

Cost of Goods Sold/Average Inventory

(Beg. Inventory + End Inventory)/2

Inventory Formula Helps Analyze:

• Short Term Liquidity

• Assess whether management is doing a good job controlling the amount of inventory available

• A low ratio compared to that of competitors suggests inefficient use of assets

• A high ratio compared tot hat of competitions suggests inventory might be too low

Days’ Sales in Inventory Formula & Definition

a ratio that reveals how much inventory is available in terms of the number of days’ sales

—> # of days one can sell from inventory is now new items are purchased

(Ending inventory)/(Cost of Goods Sold) x 365

FIFO Method

• Cost Flow in the order incurred (order we purchased)

• FIRST IN, FIRST OUT

***** THE PHYSICAL FLOW AND COST FLOW DO NOT HAVE TO BE THE SAME *****

this goes for any of the four methods!!!!

LIFO Method

• Cost Flow in the reverse order incurred

• LAST IN, FIRST OUT

***** THE PHYSICAL FLOW AND COST FLOW DO NOT HAVE TO BE THE SAME *****

this goes for any of the four methods!!!!

Weighted Average

• Assumes costs flows at an average of the costs available

2 Majors Factors that cost will go UP overtime:

1. Scarcity

2. Labor Cost increases overtime

sell price

The Cost of the good will INCREASE, so the ___________ will increase as well

Right Down

can still be sold ( it lost value)

*permanent

GOGGLE : A partial reduction in an asset's recorded value because its fair market value has fallen below its current carrying (book) value due to damage, aging, obsolescence, or market shifts.

Right Off

inventory looses its complete value (whole amount)

*permanent

GOOGLE: A complete elimination of an asset's value down to $0 because it has become completely worthless, destroyed, stolen, or unrecoverable.

Book Value

what it took to make

GOOGLE: The net value of an asset or an entire company as recorded on the balance sheet

Consumer

_____ ultimately pays for the tariff