Chapter 5: Inventories and Cost of Sales

Inventory Basics

• Determining Inventory Items

  • Merchandise inventory includes all goods that a company owns and holds for sale. This is true regardless of where the goods are located when inventory is counted. Special attention is directed at goods in transit, goods on consignment, and goods that are damaged or obsolete.

  • Goods in Transit

    • Does a buyer’s inventory include goods in transit from a supplier? If ownership has passed to the buyer, the goods are included in the buyer’s inventory. We determine this by reviewing shipping terms, which are illustrated in

    • 

      • FOB shipping point—goods are included in buyer’s inventory once they are shipped.

      • FOB destination—goods are included in buyer’s inventory after arrival at the destination.

  • Goods on Consignment

    • Goods on consignment are goods sent by the owner, called the consignor, to another party, the consignee. A consignee sells goods for the owner. The consignor owns the consigned goods and reports them in its inventory. For example, Upper Deck pays sports celebrities such as Russell Wilson of the Seattle Seahawks to sign memorabilia, which are ordered to card shops on consignment. Upper Deck, the consignor, reports these items in its inventory until sold. The consignee never reports consigned goods in inventory

  • Goods Damaged or Obsolete

    • Damaged, obsolete (out-of-date), and deteriorated goods are not reported in inventory if they cannot be sold. If

      these goods can be sold at a lower price, they are included in inventory at net realizable value. Net realizable value

      is sales price minus the cost of making the sale. A loss is recorded when the damage or obsolescence occurs.

• Determining Inventory Costs

  • Merchandise inventory includes costs to bring an item to a salable condition and location. Inventory costs include invoice cost minus any discount, plus any other costs. Other costs include shipping, storage, import duties, and insurance. The expense recognition principle says that inventory costs are expensed as cost of goods sold when

    inventory is sold.

• Internal Controls and Taking a Physical Count

  • Events can cause the Inventory account balance to be dierent than the actual inventory available. Such events include theft, loss, damage, and errors. Thus, nearly all companies take a physical count of inventory at least once each year. This physical count is used to adjust the Inventory account balance to the actual inventory available

Inventory Costing Under a Perpetual System