CLASSIFYING AND DETERMINING INVENTORY-Two important steps in the reporting of inventory at the end of the accounting period are the classification of inventory based on its degree of completeness and the determination of inventory amounts. - Classifying Inventory-depends on whether the firm is a merchandiser or a o In a merchandising company, inventory consists of many different items. o These items have two common characteristics: (1) they are owned by the company and (2) they are in a form ready for sale to customers. o Only one inventory classification, is needed to describe the many different items that make up the total inventory In a company, inventory is usually classified into three categories: Finished goods, Work in process, and Raw materials. inventory-the basic goods that will be used in production but have not yet been placed into production. o Work in -that portion of manufactured inventory that has been placed into the production process but is not yet complete goods inventory-items that are completed and ready for sale. Raw o Determining Inventory Quantities---No matter whether they are using a periodic or perpetual inventory system all companies need to determine inventory quantities at the end of the accounting period. If using a system, companies take a physical inventory at year-end for two purposes (1) to check the of their perpetual inventory records and (2) to determine the amount of inventory due to wasted raw materials, shoplifting, or employee theft Companies using a inventory system must take a physical inventory for two different purposes (1) to determine the ininton at the balance chant data and in to . Companies using a inventory system must take a physical inventory for two different purposes. (1) to determine the inventory at the balance sheet date, and (2) to determine the cost of goods sold for the period. Determining inventory quantities involves two steps: (1) taking a physical inventory of goods on hand and (2) determining the of goods. Taking a Physical Inventory_taken at the of the accounting period. o Taking a physical inventory involves actually weighing, each kind of inventory on hand. Determining Ownership of Goods-two questions must be answered: 1. Do all of the goods included in the count belong to the company? 2. Does the company own any goods that were not included in the count? . O o To arrive at an accurate count, ownership of goods transit (on board a truck, train, ship, or plane) must be determined Goods in transit should be included in the inventory of the company that has legal to the goods. Legal title is determined by the When the terms are FOB (free on board) point, ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. When the terms are FOB ownership of the goods remains with the seller until the goods the buyer. In some lines of business it is customary to hold the goods of other . 1 2 3 5 6 @ In some lines of business, it is customary to hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of the goods. These are called goods. raming Objective 2 - Apply Inventory Cost Flow Methods and Discuss Their Financial Effects. INVENTORY COSTING--After a company has determined the quantity of units of ending inventory, it applies unit costs to the quantities to determine the total of the ending inventory and the cost of goods sold. There are different inventory costing methods available: Specific method requires that companies keep records of the original cost of each individual inventory item. . Cost Assumptions-other cost flow methods differ from the specific identification method in that they assume flows of costs may be unrelated to the physical flow of goods. There are three assumed cost flow methods. The cost of goods sold formula in a periodic system is (Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold. The value assigned to the ending inventory will depend on which cost method used. There is accounting requirement that the cost flow assumption be consistent with the movement of the goods. One of the three cost flow assumptions may be used: First-in, first out (FIFO) o Last-in, first out (LIFO) o Average-cost . First-in, First-out (FIFO) method assumes that the earliest goods purchased are the first to be Under FIFO, the cost of the ending inventory is obtained by taking the unit cost of the most recent First-in, First-out (FIFO) method assumes that the earliest goods purchased are the first to be Under FIFO, the cost of the ending inventory is obtained by taking the unit cost of the most recent purchase and working backward until all of the units of inventory have been assigned a cost. o FIFO often the actual physical flow of goods. . Last-in, First-out (LIFO) method assumes that the last goods purchased are the first to be LIFO seldom coincides with the actual physical flow of inventory. Under LIFO, the cost of the ending inventory is obtained by taking the unit cost of the earliest goods available for sale and working forward until all the units of inventory have been assigned a cost. o Beginning inventory is the earliest cost. Average- method assumes that the goods available for sale are similar in nature and allocates the cost of goods available for sale on the basis of the weighted-average unit cost incurred. The weighted- unit cost is then applied to the units on hand to determine the cost of the ending inventory. FINANCIAL STATEMENT AND TAX EFFECT OF COST FLOW METHODS ---Each of the three assumed cost flow methods is . FINANCIAL STATEMENT AND TAX EFFECT OF COST FLOW METHODS-Each of the three assumed cost flow methods is for use under GAAP. The reasons companies adopt different inventory cost flow methods are varied, but they usually involve one of the following three factors: o Income effects sheet effects effects Income Statement EffectsIn periods of increasing prices, FIFO reports the net income, LIFO the net income and average-cost falls in the middle. In periods of decreasing prices, the opposite is true. FIFO will report the net income, LIFO the highest, with average-cost in the middle. O o Sheet Effects-In a period of inflation, the costs allocated to ending inventory, using FIFO, will approximate current costs. Conversely, during a period of increasing prices, the costs allocated to ending inventory using LIFO will be significantly understated. Tax Effects-Both inventory on the balance sheet and net income on the income statement are higher when FIFO is used in a period of Using Inventory Cost Flow Methods Consistently-company should use the method chosen from one accounting period to another When a company adopts a different method, it should in the financial statements and its effects on net income aming Objective 3 - Explain the Statement Presentation and Analysis of Inventory. LOWER-OF-COST-OR-MARKET__When the value of inventory is than its cost, the inventory is down to its market value by valuing the inventory at the lower-of-cost-or-market (LCM) in the period in which the price decline occurs. LCM is an example of which means that the approach adopted among accounting alternatives is the method that least likely to overstate assets and net income. Under the LCM basis, market is defined as current cost, not the selling price. ANALYSIS of INVENTORY--For merchandising companies, managing inventory levels is critical. Too much inventory on hand money, and too little inventory results in lost - Inventory turnover ratio indicates how many times the inventory "turns over" (is _) during the year Days in inventory, indicates the average number of days inventory is held o High inventory turnover (low days in inventory) indicates the company is tying up little of its funds in inventory (has minimal inventory on hand at any one time). Although minimizing the funds tied up in inventory is efficient, it may lead to lost sales due to inventory o Management should closely monitor the inventory turnover ratio to achieve the best balance between too much and too little inventory