Ch+8-essential
Chapter 8: Inventories and the Cost of Goods Sold
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Title: Chapter 8 Inventories and the Cost of Goods Sold
Page 2: Defining Inventory
Inventory in Merchandising Companies:
Definition: All goods owned for sale to customers.
Expected to convert into cash within the operating cycle.
Balance Sheet Presentation: Inventory is listed after accounts receivable as it is a step closer to cash conversion.
Page 3: Flow of Costs through Financial Statements
The process of how costs associated with inventory are recorded and reported across financial statements.
Page 4: Identical Unit Costs
Cost Variability Factors:
Units acquired at different dates, from different suppliers, or in different quantities.
Key Point: When identical units have different costs, determining which cost to apply for cost of goods sold (COGS) becomes necessary.
Page 5: Inventory Subsidiary Ledger
A detailed ledger that tracks the individual components of inventory.
Page 6: Inventory Layers
Cost Layering:
The presence of different layers of costs for identical units purchased at various prices.
Whenever units are sold, their cost layer is eliminated.
Businesses typically maintain three or four cost layers at a time.
Page 7: Inventory Costing Options (U.S. GAAP)
Four methods of inventory costing:
Specific Identification: When actual costs of each item can be tracked.
Cost Flow Assumption: Assumes sequence in which units are withdrawn from inventory.
Page 8: Inventory Cost Flow Assumptions
Costing methods details:
Average Cost: All merchandise valued at average cost.
FIFO (First-In, First-Out): Assumes oldest inventory sold first.
LIFO (Last-In, First-Out): Assumes newest inventory sold first.
Page 9: Average-Cost Method Overview
The average cost is recalculated after each purchase by dividing total cost by the number of units in inventory.
Commonly referred to as moving average in perpetual systems.
Page 10: Average-Cost Method Example
Example Calculation:
Initial average cost for generators: $1,000.
Average cost after additional units: $1,120 (calculated from total cost of $5,600 for 5 units).
Page 11: Average-Cost Method Example (Continued)
Recording sales entries utilizes average-cost calculated, ensuring sales revenue recognition remains consistent across inventory methods.
Page 12: Average-Cost Method Example (Concluded)
Inventory ledger reflects actual purchase costs for purchases but average costs for sales and remaining inventory.
Page 13: FIFO Method Overview
FIFO care necessary for accurate COGS recording. First units bought are considered first sold, impacting profit reporting positively in inflation periods.
Page 14: Inventory Subsidiary Ledger: FIFO Basis
Reflects specific costs using FIFO for tracking inventory.
Page 15: FIFO Example 2
Under FIFO, Generate Sold Calculation: Total cost of goods sold for generators includes units of differing costs.
Page 16: LIFO Method Overview
LIFO assumes that the most recently obtained units (last in) are sold first. It can minimize reported income taxes by reducing taxable income during inflation.
Page 17: Inventory Subsidiary Ledger: LIFO Basis
Records transactions based on LIFO assumptions.
Page 18: LIFO Example 2
Illustrates the COGS calculation under LIFO for multiple sold units.
Page 19: Evaluation of the Methods
Acceptability of FIFO, LIFO, average cost for financial statements and tax returns.
Cost flow assumptions do not need to match physical movement.
Page 20: Specific Identification: Pros and Cons
Pros: Ideal for unique, high-value items, corresponds well to physical flow.
Cons: Not practical for homogenous items, risk of profit manipulation.
Page 21: Average Cost: Pros and Cons
Pros: Uniformity in item valuation, simplified tracking, reduced manipulation risk.
Cons: Inventory valuation may lag behind current replacement costs.
Page 22: FIFO: Pros and Cons
Pros: Higher profits reported in inflation, recent costs on balance sheets.
Cons: Higher taxes due to higher income, potential gross profit inflation.
Page 23: LIFO: Pros and Cons
Pros: Matches current costs with revenues, lower reported income means lesser taxes.
Cons: Does not reflect physical flow, antiquated inventory valuation.
Page 24: Summary of Valuation Methods
Wrap up of pros and cons of inventory valuation methods.
Page 25: Principle of Consistency
Companies must consistently apply adopted accounting methods, changes require justification and disclosure.
Page 26: Physical Inventory Counts
Conducted annually to adjust for unrecorded shrinkage losses, often timed at fiscal year's end.
Page 27: Recording Shrinkage Losses
Removal of costs for missing/damaged goods, consistency in accounting methods applies.
Page 28: Write-Downs of Inventory
When inventory value declines, costs must be adjusted to reflect the new values, impacting both inventory and net income.
Page 29: Write-Downs of Inventory (Concluded)
Write-down handling depends on severity: small losses to COGS or larger sums to a special loss account.
Page 30: Lower-of-Cost-or-Market (LCM)
Inventory is valued at the lower of historical cost or market value (current replacement cost).
Page 31: LCM Example
Specific example illustrating LCM application.
Page 32: Goods in Transit
Ownership during transit determined by shipment terms: F.O.B. shipping point (buyer owns) vs. F.O.B destination (seller owns).
Page 33: International Case in Point
International standards generally prohibit LIFO, raising comparability concerns for U.S. companies using it in financial reporting.
Page 34: Summary of Inventory Error Impact
Overview of implications arising from inventory valuation errors.
Page 35: Inventory Analysis Formula
Formula: (Beginning Inventory + Ending Inventory) / 2
Page 36: Inventory Analysis: Example
Example calculations to illustrate inventory analysis.
Page 37: Learning Objective Summary LO8-1
Key learning objectives on COGS determination using various methods and evaluation of their pros/cons.
Page 38: Learning Objective Summary LO8-1 (Concluded)
Further examination of FIFO, LIFO, and average cost methods regarding inventory COGS.
Page 39: Learning Objective Summary LO8-2
Explains the necessity of physical inventory counts.
Page 40: Learning Objective Summary LO8-3
Shrinkage losses and adjustments detailed in this section, addressing methodologies for recording such losses.
Page 41: Learning Objective Summary LO8-4
LO8-4 highlights how to determine ending inventory through specific identification, average cost, FIFO, and LIFO methods.
Page 42: Learning Objective Summary LO8-5
Errors in inventory valuation affect cost of goods sold, suggesting opposite effects on gross profit in successive accounting periods.
Page 43: Learning Objective Summary LO8-6
Illustrates estimation of COGS and ending inventory via gross profit and retail methods.
Page 44: Learning Objective Summary LO8-7
Inventory turnover equal to COGS/average inventory, crucial for assessing liquidity and inventory management.
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End of Chapter 8.