Inventory Costing & Controls Study Notes

Chapter 6 – Inventory Costing & Controls

BFTP6-1: Shipping Terms Preference

  • As a wholesaler purchasing from overseas suppliers in China and Taiwan, it is preferable to choose FOB Destination shipping terms because:
      - The seller (supplier) retains ownership and responsibility for the goods during transit.
      - Any damages or losses that occur during transit are the supplier's responsibility.
      - It reduces risk and potential additional costs for the buyer.

BFTP6-2: Transaction Recording

  • Assume you had the following transactions:
      - Transaction 1: April 18 - Purchase of 25 items @ $8 each; credit terms 1/15, n/35; shipping term FOB Destination.
        - Accounting Entries:
          - Assets: +200 (Inventory)
          - Liabilities: +200 (Accounts Payable)
      - Transaction 2: April 19 - Shipping costs paid @ $50.
        - Accounting Entries:
          - Assets: -50 (Cash)
          - Expenses: +50 (Freight Expense)
      - Transaction 3: April 30 - Payment to supplier.
        - Accounting Entries:
          - Assets: -200 (Cash)
          - Liabilities: -200 (Accounts Payable)
      - Transaction 4: May 15 - Sale of 12 items @ $15 each; credit terms 2/10, n/30; shipping term FOB Destination.
        - Accounting Entries:
          - Assets: +180 (Accounts Receivable)
          - Revenue: +180 (Sales Revenue)
      - Transaction 5: May 16 - Freight paid on incoming shipment @ $25.
        - Accounting Entries:
          - Assets: -25 (Cash)
          - Expenses: +25 (Freight Expense)
      - Transaction 6: May 18 - Return of 2 items; return freight cost paid by customer @ $10.
        - Accounting Entries:
          - Revenue: -30 (Sales Returns & Allowances)
          - Assets: +16 (Inventory)
          - Expenses: -10 (Freight Expense)
      - Transaction 7: May 24 - Customer pays outstanding invoice.
        - Accounting Entries:
          - Assets: +147 (Cash)
          - Assets: -147 (Accounts Receivable)

Expanded Accounting Equation Effect Summary

  • Assets
      - Cash +147 (Transaction 7)
      - Inventory +16 (Transaction 6)
      - Accounts Receivable +180 (Transaction 4)

  • Liabilities:
      - Accounts Payable +200 (Transaction 1)
      - Accounts Payable -200 (Transaction 3)

  • Equity:
      - Revenue +180 (Transaction 4)
      - Sales Returns & Allowances -30 (Transaction 6)

BFTP6-3: Inventory Costing and Strategies

  • As a wholesaler selling clothing for dogs, consider the following:
      - Inventory costs are intricately affected by:
        - Import duties and taxes (7% import duty and 13% HST).
        - Shipping costs from Taiwan, highly influenced by fuel prices.
        - Customs broker fees (1% on total cost).
        - Currency exchange rates: $0.78 (December start) and projected $0.70 (year-end).

Inventory Cost Calculation for Shipments

Date of Shipment

Number of Units

Total Cost

Per Unit Cost

February 15

750

$10,200

$13.60

May 28

500

$7,550

$15.10

August 18

350

$5,915

$16.90

October 12

1250

$29,100

$23.28

Analysis of Inventory Price Trends

  • Inventory prices are increasing due to:
      - Shipping cost increments.
      - Increasing prices from the supplier.
      - Fuel cost impacts on shipping.
      - Potential longer-term contracts for discounting may become voided leading to price raises.

Inventory Control System Recommendation

  • Recommend establishing a Perpetual Inventory System:
      - Allows real-time tracking of inventory levels and costs.
      - Optimizes decision-making regarding purchasing and pricing based on ongoing analysis.

Chapter 5 Knowledge Integration

  • Reflect on pricing as an essential function of costing inventory.

  • The cost structure of inventory must be consistently monitored to adapt pricing strategies in real-time based upon competitive analysis and market shifts.

Inventory Costing Methods Overview

1. Specific Identification Method

  • Each item is uniquely tracked for its cost; ideal for high-value low-volume items (e.g., art pieces, cars).

  • Drawbacks:
      - High administrative costs to maintain detailed records.

2. Average Cost Method

  • Assigns average cost to each unit of inventory, useful for homogeneous goods.

  • Provides cost smoothing, which can offset price fluctuations over time.

3. First-in, First-out (FIFO) Method

  • Assumes the oldest inventory items are sold first.

  • Aligns with the natural flow of goods but may not accurately depict current costs if prices are rising.

Decision for FIFO

  • FIFO is generally chosen by retailers to maintain freshness in inventory, like perishable goods, thus allowing for more accurate pricing strategies based on current market demands.

Importance of Accurate Inventory Values

  • Knowing the exact cost of inventory:
      - Influences pricing strategy decisions; higher inventory costs can lead to inflation in consumer prices.
      - Enables negotiation power with suppliers; good information aids in asking for better terms and decreasing operational risks.
      - Forms the basis of financial statements critical for evaluating shareholder equity and attracting investment.