Term
| Determining Inventory Items |
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Definition
•Goods in transit: FOB Shipping and FOB destination
•Goods on consignment: are goods shipped by the owner, called the consignor, to another party, the consignee.
•Goods Damaged or Obsolete: damaged and obsolete (and deteriorated) goods are not counted in inventory if they cannot be sold. If these goods can be sold at a reduced price, they are included in inventory at a conservative estimate of their net realizable value. |
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| Determining Inventory cost: |
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Definition
Includes all expenditures necessary to bring an item to a salable condition and location.
• Invoice cost + insurance + freight-in + import duties –discounts and allowances |
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Term
| Internal Controls and Taking a Physical counting |
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Definition
Most companies take a physical count of inventory at least once each year.
When the physical count does not match the Merchandise Inventory account, an adjustment must be made (SHRINKAGE) |
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| Inventory effects Balance Sheet and Income Statement: |
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Definition
| The matching principle requires matching cost of sales with sales |
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Term
| First-In, First-Out (FIFO): |
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Definition
Assumes costs flow in the order incurred.
Oldest cost -> COGS, Recent Cost -> Ending Inventory.
Advantage: Ending inventory approximates current replacement cost; |
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| Last-In, First-Out (LIFO): |
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Definition
Assumes costs flow in the reverse order incurred.
Recent cost -> COGS, Oldest Cost -> Ending Inventory.
Advantage: Better matches’ current costs with cost of goods sold on Income Statement; also better matches current costs with revenues in computing gross profit |
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Definition
Assumes costs flow at an average of the costs available.
When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Available for Sale/ units on hand on the date of Sale.
Advantage: Smoothes out price changes. |
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| Financial Statement Effects of Costing Methods: |
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Definition
| Because prices change, inventory methods nearly always assign different cost amounts. |
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| Costing Methods: purchase costs regularly rise |
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Definition
•FIFO: assigns the lowest amount to COGS -> yields the highest gross profit and net income
•LIFO: assigns the highest amount to COGS -> yields the lowest gross profit and net income -> also yields a temporary tax advantage by postponing payment of some income tax
•Weighted average: yields results between FIFO and LIFO |
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| Costing Methods: purchase cost regularly decline |
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Definition
•FIFO: assigns the highest amount to COGS -> yields the lowest gross profit and net income -> also yields a temporary tax advantage by postponing payment of some income tax
•LIFO: assigns the lowest amount to COGS -> yields the highest gross profit and net income
•Weighted average: yields results between FIFO and LIFO |
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Term
| Tax Effects of Costing Methods |
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Definition
| The Internal Revenue Service (IRS) identifies several acceptable methods for inventory costing for reporting taxable income. If LIFO is used for tax purposes, the IRS requires it be used in financial statements. |
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Term
| The consistency principle: |
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Definition
| requires a company to use the same accounting methods period after period so that financial statements are comparable across periods. |
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| Lower of Cost or Market: Three ways |
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Definition
Defined as current replacement cost (not sales price). Consistent with the conservatism principle.
Can be applied three ways:
(1)separately to each individual item.
(2)to major categories of items.
(3)to the whole inventory. |
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•A decline in replacement cost reflects a loss of value in inventory
•When the recorded cost of inventory is higher than the replacement cost , a loss is recognized
•When the recorded cost is lower, no adjustment is made |
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| Financial Statement Effects of Inventory Errors: INCOME STATEMENT |
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Definition
*Error: understated ending inventory -> overstated COGS, understated net income
*Error: understated beginning inventory -> understated COGS, overstated net income
*Error: overstated ending inventory ->understated COGS, overstated net income
*Error: overstated beginning inventory -> overstated COGS, understated net income |
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| Financial Statement Effects of Inventory Errors: BALANCE SHEET |
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Definition
*Error: understated ending inventory -> understated Assets, understated Equity
*Error: overstated ending inventory -> overstated Assets, overstated Equity |
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