Lecture 9

Operating Activities: Review of Concepts

  • Purchasing Inventory:

    • Reviewing the inventory purchasing process and the implications of inventory acquisition from wholesalers.

  • Sales Transactions:

    • Explaining how inventory sales can occur using cash or credit.

  • Shipping Terms:

    • Important concepts include FOB Shipping Point and FOB Destination.

    • FOB Shipping Point:

      • Ownership transfers from seller to buyer as soon as shipping starts.

      • Buyer pays for shipping; they own goods en route.

    • FOB Destination:

      • Ownership transfer occurs only upon delivery of goods.

      • Seller pays shipping costs, retaining ownership en route.

    • Legal Implications:

    • Important for financial reporting and liability during transit.

Sales Terms and Discounts

  • Sales Terms:

    • Commonly expressed in a fraction format where:

    • The numerator indicates the discount percentage.

    • The denominator indicates the days allowed for discount eligibility.

    • Example: 2/10, n/30 means:

    • 2% discount if paid within 10 days.

    • Full payment due within 30 days without a discount.

  • Benefits to Buyer and Seller:

    • Encourages quicker cash flow for sellers and savings for buyers if payment terms are met.

Recording Discounts and Inventory Adjustments

  • Accounting Assumptions:

    • Always assume full price until discounts are confirmed thereafter.

    • Discounts must be recorded against inventory after payment to ensure accurate reporting.

  • Example Scenario:

    • Suppose a company purchases $2,000 worth of inventory on January 1 with terms 3/15, n/45.

    • If it pays on the 30th, it does not qualify for a discount; if it pays on the 10th, it does.

    • If a discount applies, the correct accounting for the payable is to write it off completely, reflecting true obligations.

Cost Flow Assumptions for Inventory

  • Specific Identification Method:

    • Useful for high-cost, low-volume goods (e.g., cars, fine jewelry).

    • Tracks individual item costs precisely.

Cost Flow Alternatives

  • FIFO (First In, First Out):

    • Assumes the oldest inventory is sold first.

    • Results in lower cost of goods sold in rising price environments, reflecting higher profits.

  • LIFO (Last In, First Out):

    • Assumes the newest inventory is sold first.

    • Often leads to lower profits for tax benefits as it recognizes higher costs of goods sold.

  • Average Cost Method:

    • Calculates cost of goods sold using the average cost of inventory available.

    • Provides a balanced approach, not skewing profits significantly.

  • GAAP Compliance:

    • All businesses must stick to the selected cost flow method consistently.

Global Standards and Inventory Accounting

  • IFRS Considerations:

    • Many global companies must adhere to different standards which disallow LIFO due to its manipulation potential.

    • Could significantly affect tax strategy for US-based companies transitioning to IFRS.

Concluding Thoughts

  • Future sessions will delve deeper into projects and further practice with the outlined concepts.

  • Ensures clarity on all aspects of inventory, accounting terms, and reporting functionalities as they pertain to operating activities and financial implications.