Bus. 312: Financial Accounting

Bus. 312: Financial Accounting

Dr. Ahiarah

CHAPTER 6:

WHAT IS INVENTORY: Merchandise Inventory consists of all goods owned and held for sale in the regular course of business by a merchandising concern. It includes incoming goods (in transit) if shipped FOB shipping point, and all outgoing goods if shipped FOB destination, as well as the concern’s goods on consignment. Because it would normally be converted into cash within a year’s time, it is usually classified as a current asset.

By contrast to a merchandising concern’s inventory, a manufacturer’s inventory consists of (1) raw materials, (2) work-in-process, and (3) finished goods. Of the three, finished goods inventory is the only one comparable to a merchandise inventory.

Inventory Cost Accounting: (A) When Purchased, (B) When Sold, and (C) How Reported in the F/Ss
(A) How inventory is costed and accounted for when it is purchased depends on:

1. The inventory Cost Accounting System in place. There are two that we will consider: Perpetual and Periodic. These determine the account titles, which are used to record, inventory purchase cost. AND
2. Whether Gross or Net method is used in the accounting entity. These determine the amount that is recorded for merchandise purchased on credit.
   

(B) How inventory is costed and accounted for when it is sold depends on #1 and #2 above, as well as (3) the cost flow assumption adopted. The Cost Flow Assumptions available for adoption by an accounting entity include:

a) First In, first out (FIFO)

b) Last In, First Out (LIFO)

c) Weighted Average (WAV)

d) Specific Identification (SPID)

You might question why any cost flow assumption other than SPID needs to be made, in the first place.

The response is that the purpose of inventory cost accounting is not necessarily to achieve a correspondence between the physical flow of inventory and associated cost. Rather, traditionally, the objective has been to:

• control the amount of income the entity reports for tax purposes. Depending on the economic condition, the different cost flow assumptions lead to different figures and tax advantages
• avoid (in combination with the periodic cost accounting system) unwieldy record keeping, if possible.

(C) Inventory reporting in the financial statements centers on Cost of Goods Sold (COGS) (which is reported in the Income Statement), and Ending Inventory (EI) (which is reported in the Balance Sheet). Determinants of how much inventory is reported as COGS or EI are:

• The Inventory Cost Accounting System in place.
• Whether the Gross or Net method is in use
• The inventory cost flow assumption in place.

We will now use P6-5B below to illustrate inventory cost computations for financial reporting P6-5B You have the following information for Venus Inc. for the month ended June 30, 2007. Venus uses the periodic method for inventory.

Date / Description / Quantity / Unit cost or Selling Price
June 1 / Beginning inventory / 25 / $60
June 4 / Purchase / 85 / 64
June 10 / Sale / 70 / 90
June 11 / Sale return / 5 / 90
June 18 / Purchase / 40 / 68
June 18 / Purchase return / 15 / 68
June 25 / Sale / 50 / 95
June 28 / Purchase / 20 / 75

Instructions:: (a) Calculate ending inventory, cost of goods sold, gross profit, and gross profit rate under periodic method, assuming Lifo, Fifo and Weighted Avg. cost flows; (b) compare results. (c) Repeat ‘a’ and ‘b’ above, under perpetual method, instead of the periodic method

Gross profit
LIFO / $2,920
FIFO / $3,320
Average / $3,077
TYPE OF INVENTORY COST REPORTED IN F/S / COST FLOW ASSUMPTION
First In, First Out (Fifo) / Last In, First Out (Lifo)
Goods Out—Sold to Customers
(COST OF GOODS SOLD—(C O G S)) /
First Costs in are assigned to goods out as COGS / Last Costs In are assigned to goods out—i.e. to COGS
Goods Still Here
(ENDING INVENTORY) / Last Costs In are still here, assigned or attached to Ending Inventory (LISH) / First Costs In are still here, attached or
assigned to Ending Inventory (FISH)

CHAPTER 6 SUMMARY REQUIREMENT:

Please, follow the examples on pages 3 to 5 here to do Problem 6-5B in the text. You may complete the Periodic Inventory part for P6-5A on WILEY-PLUS (P6-5b is not in Wiley-Plus!), but the Perpetual inventory part is not on Wiley-Plus either, and has to be completed by hand—typewritten, as in the examples.

LCM Application from Handout
Lower of Cost or Market
Item / Cost / Market / Individual / Maj.Categ / Ttl. Inv
Cameras
Minolta / 5X175 / 875 / 5X160 / 800 / 800
Canon / 7X150 / 1050 / 7X152 / 1064 / 1050
Total / 1925 / 1864 / 1864
Light Meters
Vivitar / 12X125 / 1500 / 12X110 / 1320 / 1320
Kodak / 10X115 / 1150 / 10X135 / 1350 / 1150
Total / 2650 / 2670 / 2650
Ttl. Inventory method / 4575 / 4534 / 4534
Total inventory valuation under the three alternative mthds / 4320 / 4514 / 4534
RELATIVE IMPLICATIONS OF LIFO VS FIFO INVENTORY POLICY DECISIONS
Period of
Rising Prices
ENDING / COST OF
INVENTORY / GOODS / INCOME
COST (EI) / SOLD
LIFO / Lower than / Higher than / Lower
Fifo / Fifo / relative to
(Lower older / (Higher latest / Fifo
costs are / costs are / (Latest higher
assigned to / assigned to / costs are matched
EI) / units sold) / against risen prices)
FIFO / Higher than / Lower than / Higher
Lifo / Lifo / relative to
(Higher latest / (Lower older / Lifo
costs are / costs are / (Lower older
assigned to / assigned to / costs are matched
EI) / units sold) / against risen prices)
Period of
Declining Prices
ENDING / COST OF
INVENTORY / GOODS / INCOME
COST (EI) / SOLD
LIFO / Higher than / Lower than / Higher
Fifo / Fifo / relative to
(Higher older / (Lower latest / Fifo
costs are / costs are / (Latest lower
assigned to / assigned to / costs are matched
EI) / units sold) / against fallen prices)
FIFO / Lower than / Higher than / Lower
Lifo / Lifo / relative to
(Lower latest / (Higher older / Lifo
costs are / costs are / (Higher older
assigned to / assigned to / costs are matched
EI) / units sold) / against fallen prices)