Classification of Inventories
Merchandise vs. Manufacturing Company
Merchandise Company:
- Inventory
–> Current Asset
Manufacturing Company
- Raw Materials
- Work in Process
- Finished Goods
–> Current Asset
Determine Ownership of Goods:
Goods in Transit
- Purchased Goods not yet received
- Sold goos not yet delivered
Goods in transit should be included in the inventory of the company that has a LEGAL TITLE to the goods.
Legal Title
Is Determined by the terms of sale
Determining Ownership of Goods:
Consigned Goods
- Goods held for sale by one party
- Ownership of the goods is retained by another party
Name Three Inventory Costing Methods
- Specific Identifciation
- FIFO
- Average-Cost
Inventory Method
Specific Identification
- Actual Physical Flow Costing method
- Each item is specifically costed
Question: Does COST FLOW need to be consistent with PHYSICAL MOVMENT of the goods
NO!!!
FIFO
- First In First Out
- Earliest goods purchased are first to be sold
- Parallels actual physcial flow of merchandies
Average Cost
+ Formel
- Allocates cost of goos avaiable for sale on the basis of weighted-average units cost incurred
- Assumes goods are similar in nature
- Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory
COGS Formular
Beginning Inventory
+ Cost of Goods Purchased
- Ending Inventory
= COGS
Inventory Turnover
= COGS / Average Inventory
- measures the number of times on average the inventory is sold during the period
- Purpose:
- to measrue the liquidity of the inventory
Days in Inventory
= Days in a YEAR (365) / Inventory Turnover
- measures the average number of days inventory is held (before it’s sold)
Cost Flow Assumption
- Assume flows of costs that may be unrelated to the physical flow of goods
- FIFO
- Average Cost
- There is NO accounting requirement that the cost flow assumption be consistent with the physical movement of the goods
Lower-of-Cost-or-Net Realizable Value
Niederstwertrpinzip
- When the value of Inventory is lower than its cost, companies must “write down” the inventory to its net realizable value
- This is done by valuing the inventory at the lower-of-cost-or-net realizable value in the period in which the price decline occurs
- At NET REALIZABLE VALUE
Net Realizable Value
- Amount that a company expects to realize/receive from the sale of inventory
Estimated Selling Price
- Estimated Cost to complete and sell
Income Statement Effect
Inventory Error
- Affect the computation of COGS and NET Income
- in TWO PERIODS
- An error in ending Inventory of the current period will have a reverse effect on net incoome of the next accounting period
- Over the two year, the total net income is corrected because the errors offset each other
