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Study Smarter.....Study The Answers!

Inventory

1) Key Things To Know 5) Medium Test
2) Self Test 6) Hard Test
3) Practice as You Learn 7) On Your Test
4) Easy Test 8) Quick Study Sheet

Key Things to Know

 Inventory:  Items that you buy or make only for the purpose of selling the items to
                      customers for a profit.
 
Terms related to purchasing inventory that determines who owns the inventory when
   it is in transit (in shipment between the seller and the buyer)
 
      F.O.B. Destination:        Buyer owns when they receive the goods
 
      F.O.B.  Shipping:           Buyer owns at the time it is shipped (owns in transit)
 
      Goods on Consignment:    A company holds inventory for someone else, and
                                                  does not take title.  The company that has title to the
                                                  inventory records the inventory.
 
 
Calculating Cost of Goods Sold:  The cost of the inventory sold to customers
                                                                 Reported on the income statement as an expense
               Beginning Inventory
            + Purchases
            = Available for sale
            -  Ending Inventory **
            = Cost of Goods Sold
 
            ** Ending inventory is valued at the quantity on hand x the cost for each one
                 The ending inventory is the amount reported on the balance sheet.
 
 
On the Balance Sheet - reported inventory as the total $ of all items = quantity x cost:
 

Quantity
x
Each Cost
=
Total Cost
Item A
100
25
2,500
Item B
50
10
500
Item C
200
15
3,000
Item D
500
5
2,500
Total
8,500

            Inventory will be reported at a cost of $8,500 on the balance sheet
 
 
Which cost do you use to value inventory when the same item is purchased at
  different unit costs and items are exactly the same?
 
 
  Example:   Purchased 150 units of Item A at $24 and 200 units of Item A at $27 and
                        300 units of Item A at $26.   You sold 550 to customers.   What cost
                        should you multiply by the total 100 quantity left to get the ending
                        inventory amount?   All items look the same and you can not tell what was
                        actually paid for the items that are left.
 
FASB gives you a choice of methods to use to value ending inventory when the same
    items are purchased at different costs:
 
 
FIFO (first in – first out):               
 
Units purchased first are sold first.  The last units purchased are the ones you have left
 
LIFO (last in – first out):
 
Units purchased last are sold first.  The first units purchased are the ones you have left
 
Weighted Average:
 
Inventory is valued at the average purchase cost.
   Total available cost divided by total available units = average cost per unit
 
Specific Identification:
 
Use when you are able to tell the specific cost of the item in inventory. 
 
 
Each method will give a different cost of goods sold expense and inventory cost.
 
  In times of inflation:
            FIFO gives a lower cost of goods sold and higher income than LIFO
 
  In times of deflation:
           FIFO gives a higher cost of goods sold and a lower income than LIFO
 
   Which method gives a higher income depends on inflation/deflation of the product.
 
 
 
Lower of Cost or Market (LCM)  
 
Inventory is initially valued at the purchase cost.
 
A company may not report inventory on their balance sheet at more than they expect
   to benefit from the sale of the inventory.
 
    You must determine if the inventory has lost value below cost:
 
           Compare cost to market value (also called replacement cost)
 
            If cost is more than market, the reported cost must be reduced to market.
           If cost is less than market, no adjustment is made, do not adjust up.
 
                        The journal entry to adjust for the difference down to LCM is:
 
                                    Cost of goods sold (or loss on inventory)
                                                Inventory (or inventory reserve)
 
 
                        Write-down of inventory is called “impairment”
                        Inventory is not increased above cost.
  
 
 
 
Two Methods for Recording Inventory transactions – Periodic or Perpetual:
 
 
Periodic –    Record inventory purchases initially as “purchases” - an expense   
                      Record sales without recording the change to the inventory
                      Adjust at the end of the period to record CGS and:
                           1) Get inventory to what you really have
                           2) Get purchases to equal 0 (the real expense is CGS)
                        ** Don’t use the inventory account until the final adjustment
 
 
Perpetual –   Record to the inventory account every time inventory moves
                        Record inventory purchases initially as an asset called inventory:   
                        Record sales at the sales price and the reduction of inventory at cost:
                        Final adjustment at the end of the period to get inventory to be
                          what you really have on hand.
 
    A reduction in inventory is due to employee theft, damage to inventory, or the
    wrong thing being put into the box and shipped to the customer.   This is often
    called “shrinkage”.  You can not determine shrinkage using the periodic method.
 
    It is possible that inventory must go up to get to what you really have if not enough
      was really shipped to the customer or inventory received was incorrectly recorded.
 
 
*** Notice that the balance in the inventory account and the cost of goods sold account
       is the same under both the periodic and perpetual methods at the end of the period.
 
 
 
Journal entries for recording inventory transactions:
 
            Periodic                                                                    Perpetual
 
 
Purchases                                 Purchase                          Inventory
      Cash or A/P                                                                                Cash or A/P
 
 
 
A/P                                              Return                               A/P
      Purchase Returns                                                                     Inventory
 
 
A/R                                             Sale                                    A/R                                price to
      Sales                                                                                            Sales                 customer
 
                                                                                                CGS                              original
                                                                                                            Inventory            cost
                                             Adjusting Entry
 
CGS                                                                                      CGS
Purchase Returns                                                               Inventory
Inventory(ending)                                                   
      Inventory (beginning)                                                either account can be                    
      Purchases                                                                 the debit or credit
    
 
 
Inventory Errors:
 
Inventory costs are reported as either inventory on the balance sheet or cost of
   goods sold on the income statement.
          Total cost = Inventory + Cost of Goods Sold
 
Typically, inventory is counted and valued to determine the inventory balance and
      cost of goods sold is the other part of the cost.
 
    When ending inventory is incorrect, cost of goods sold and income will be
      incorrect also
 
            Ending inventory too high, cost of goods sold too low, income too high
            Ending inventory too low, cost of goods sold too high, income too low
 
               **  Income has the same error as the ending inventory error.
 
                        When beginning inventory is incorrect, the opposite occurs.

 


 

 

 

 
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