AC

Valuation of Inventories - Chapter 7

Inventory:

  • they are assets held for sale

  • goods used for production

Merchandising Companies:

  • One inventory account

  • Inventory is ready for sale

Inventory Account:

  • Raw materials

  • Work in process

  • Finished goods

Flow of costs - manufacturing/merchandising

Manufacturing:

  • Raw materials

    • Debit DM, Credit DM Used

  • Labor

    • Debit DL, Credit Applied amount

  • Overhead

    • Debit Actual, Credit Applied

  • WIP

    • Credit Cost of Good Manufactured

Merchandising:

  • Inventory

    • Dr Cost of good purchase, Cr Cost of good sold

  • Finished goods

    • Cr COGS

Beginning Inventory

Purchases

Goods available for sale

  • COGS

  • Ending Inventory

Calculation of COGS:

Beg Inv

Purchases

Available for ale

Less: Ending Inv

COGS

Inv Cost Flow:

Perpetual system

  1. Purchases are debited to inventory

  2. Freight in is debited to inventory- transportation cost

  3. Purchases, returns, and allowances are credited to inventory

  4. COGS is debited and inventory is credited

Periodic system

  • Inventory on hand is determined on a periodic basis

Control of Inventory:

  • Control of the inventory is established when a company recognizes inventory and accounts payable

Terms:

  • Free On Board shipping point - shipping cost

    • Buyer takes ownership and control of inventory

    • Buyer pay freight cost

  • FOB destination

    • Seller pay freight cost

    • Ownership passes to buyer

  • Goods out on consignment remain the property consigner

Product cost vs Period cost:

Product cost - cost directly connected to the product

Period cost - indirectly related to the acquisition of goods

  • difficult to assign to a specific inventory item

Product cost:

Freight charges (all included in inventory amount)

  • Insurance cost incurred while goos are in transit

  • Unpacking and unloading

Period cost: (expense incurred on income statement)

  • Selling expenses related to inventory

  • Interest cost related to financing inventory

  • General and Admin cost related to inventory

Purchase discount

  • Accounted for either using the gross method or the net method

  • Gross Method - purchases and payable are recorded at invoice price

  • Net method - purchases and accounts payable equals the invoice price less any purchase discounts that are expected to be taken

Inventory Methods

Periodic System: Inventory on hand is determined on periodic basis

Specific Identification

  • Includes in cost of sales of specific items sold

  • Is used for items that can easily be distinguishable

  • Cost flow matches the physical flow

  • Matches actual cost with actual revenue

Average cost

  • Inventory are calculated on average cost (used for value of inventory at hand or sold)

  • Measuring a specific flow of inventory is not feasible

FIFO (First-In, First-Out)

  • Assumed goods are sold in order in which they are purchased

  • Align with physical flow of goods

  • Ending inventory is close to current cost

  • Does not match current cost against current revenue (selling current revenue but cost is old)

LIFO (Last In, First Out)

  • Matches the cost of last goods purchased against revenue

LIFO Reserve

  • Difference between the inventory method used for internal reporting and LIFO