Chapter 6 Inventory I Classifying Inventory A Manufacturing Classifications 1 Finished goods is manufactured items that are completed and ready for sale completed and ready for sale have not yet been placed into production 2 Work in Process is that portion of manufactured raw materials that are 3 Raw Materials are the basic goods that will be used in production but companies manufacture and purchase goods just B Just In Time Inventory JIT in time to sell II Determining Inventory Quantities A Taking a physical Inventory count at the end of accounting period B Determining ownership of goods a Do all goods belong to the company b Does the company own any goods that were not included in the inventory count C Goods in Transit a FOB Shipping Point Ownership passes to the buyer after seller packs b FOB Destination Ownership passes to the buyer after trucks are truck BUYER PAYS unloaded SELLER PAYS D Consigned Goods fee without taking ownership of the goods hold goods for another party and try to sell the goods for a III Inventory Costing costs and cost of goods sold A Specific Identification Companies can accurately determine ending inventory a Only useful for companies that sell a limited number of goods b Generally impractical becaue of the volume of inventory turnover assumes that the earliest goods purchased are the B First in First Out FIFO first to be sold a Generally follows the flow of merchandise sold b Doesn t mean that necessarily the oldest goods are sold first but that they are recognized first C Last in First Out LIFO assumes latest goods purchased are the first ones sold a All goods purchased during the period are assumed to be available for the first sale regardless of the date purchase i Hay coal gravel in a pile D Average Cost weighted average unit cost incurred allocates the cost of goods available for sale on the basis of the a assumes that goods are similar in nature b Cost of goods available for sale Total units available for sale weighted average unit cost IV Financial Statemnents ant tax effects of cash flow methods A Companies adopt different inventory systems for Income Statement effects Balance sheet effects or tax effects B Income statement effects a Inflation Times i FIFO Higher Net income More Taxes ii LIFO Lower Net Income Less Taxes 1 allows company to avoid reporting phantom profit C Balance Sheet Effects a Inflation Times D Tax Effects a Inflation Times i FIFO More beneficial because cost of ending inventory will approximate their current costs ii LIFO costs allocated to inventory are significantly understated i LIFO results in the lowest taxes paid E Consistency Principal methods from year to year F Lower of Cost or Market LCM value in the period in which the price decline occurred a company uses the same accounting principles and write down assests that have gone down in a Value of inventory Cost b Applied after using either FIFO LIFO or Average Cost c Conservation that is least likely to overstate assets and net income Ignore cost principle d e Market price is defined as Current replacement cost NOT Selling price best choice among accounting alternatives is the method IV Inventory Errors A Income Statement Effects a Cost of goods sold Beginning inventory Cost of Goods Purchsed Ending Inventory When Inventory Error Understates Beginning Inventory Overstates Beginning Inventory Understates Ending inventory Oversates ending inventory Cost of Goods Sold Net Income Is Understated Overstated Overstated Overstated Underatated Understated Understated Overstated b an error in the ending inventory of the current period will have areverse effect on the net income of the next accounting period c After 2 years errors offset each other B Balance Sheet Effects Ending Inventory Error Overstated Understated Liabilities Assets No Effect Overstated Understated No Effect Stockholders Equity Overstated Understated V Presentation and Analysis A Presentation a b Cost of goods sold Sales c Disclosures listed as current asset below accounts receivable i Major inventory classifications ii Basis of accounting Cost or Lower of cost of Market iii Cost method FIFO LIFO Average B Analysis for Inventory Turnover a Inventory Turnover inventory is sold during the period measures the number of times on average the i Measures liquidity of the inventory ii Cost of goods sold Chapter 7 I Fraud Internal Control A Fraud employee at the cost to the employer 1 Reason fraud occurs is a dishonest act by employees that result in the personal benefit to the i Opportunity workplace envrironment provides opportunities for employees to take advantage ii Financial Pressure too much debt or trying to live too nice of a lifestyle iii Rationalization make their actions seem like they are ok and deserve the money consits of all the related methods and measures adopted B Internal Control within an organization to safeguard assets 1 A control Environment Determine where risk is created and determine how to management makes it clear that organization does not tolerate unethical activity 2 Risk Assesment manage this risk 3 Control Activities design policies and procedures to address the specific risk faced by company Information Communication Internal control system must capture and communicate all info both down and up organization as well as communicate to appropriate external parties To reduce the occurance of fraud management must 4 5 Monitoring internal control systems must be monitored periodically for their adequacy Deficiences need to be reported to top level management C Principles of Control Activities 1 Establishment of Responsibility control is most effective when only one person is responsible for a given task duplication of effort provide a reliable basis for evaluating the work of another employee the work of one employee should without a 2 Segregation of Duties i Different individuals should be responsible for related activities ii The responsibility of record keeping for an asset should be separate from the physical custody of that asset 3 Documentation Procedures all documents should be accounted for and promply forward documents for accounting entries to the accounting department realiability of the accounting records Independent Internal Verification data prepared by employees Safeguarding assets and enhance the accuracy and pronciple involves the review of the 4 Physical Controls 5 i Companies should verify records periodically or on a surprise basis ii An employee who is independent
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