Chapter 18: Reporting Inventory- Inventory describes assets that areo Ready for saleo Being produced for saleo Ready to use in the production process- Retail companies have merchandise inventorieso Purchase inventory for resale from wholesalers or manufacturers- Manufacturerso Raw materials inventoryo Goods in process inventoryo Finished goods inventory- Perpetual inventory systemo Keeps a continuous record of the cost of inventory on hand and the cost of inventory sold- Periodic inventory systemo When it does not need to keep a continuous record of the inventory on hand and soldo Determines inventory on hand by a physical count at the end of the accounting period- Specific identification methodo A company assigns a specific cost (what it paid for that specific unit) to each unit of inventory it sells and to each unit that it holds in its ending inventory- Reporting Inventory on the Balance Sheeto A company using GAAP is required to base its inventory reporting on two accounting concepts: Historical cost concept- A company records its transactions on the basis of dollars exchanged (aka the cost) in the transaction- Once the company records a transaction, it usually retains the cost involved in the transaction in its accounting records- Critics question the relevance of historical cost because manufacturing a product adds more value- Supporters o say that until the company has a transaction with a buyer at an agreed price, there is insufficient evidence to support any other value than the costo “companies earn a profit by selling, not by manufacturing items or putting them on the shelves.”o Reliability of historical costs and GAAP’s emphasis on conservatism outweigh any potential increase in relevance that would be gained from using any other measure of value, such as selling price Matching concept- To determine its net income for an accounting period, a company computes the total expenses involved in earning the revenues of the period and deducts them from the revenues earned in that period- Company reports the inventory expense, known as costs of goods sold or cost of sales, in the period in which it sells the item and reports the revenue from the saleo Historical cost and matching concepts provide the basis for how a company accounts for inventory and reports it in the company’s financial statements.o Five important issues in this chapter: Computing the historical cost and the amount of inventory Using alternative inventory cost flow assumptions Using a company’s inventory and cost of goods sold disclosures for evaluation Using the lower of cost or market rule Estimating the cost of inventory and the cost of goods sold- Computing the Historical Cost and the Amount of Inventoryo Cost of each inventory-all costs incurred to bring the item to its existing condition and location Purchase price less any discounts Sales tax Applicable transportation costs Insurance Customs duties Other similar costso When a company takes inventory, counts everything it physically haso A company could own inventory in transit In transit: that a freight company is in the process of delivery the inventory from the selling company to the buying company the company that has economic control over the items in transit includes them in its inventory economic control transfers the same time legal ownership transferso FOB (free on board) shipping point means that the selling company transfers ownership to the buyer at the place of sale; before the inventory is in transit Selling company excludes these items in transit from its inventory Buying company includes these items in transit in its inventory Buying company is responsible for any transportation costs incurred to deliver the items, and includes those costs as a cost of its inventoryo FOB (free on board) destination means that the selling company transfers ownership to the buyer at the place of delivery (after transit is completed) Selling company includes these items in transit in its inventory until delivery takes place Buyer excludes them from inventory Selling company is responsible for any transportation costs incurred to deliver the items and includes those costs in its selling expenses- Using Alternative Inventory Cost Flow Assumptionso After a company has determined the number of units in ending inventory, must allocate the total cost of these units (costs of goods available for sale) between the ending inventory (balance sheet) and the costs of goods sold (income statement)Costs ofBeginningInventory=Cost of GoodsAvailable for Sale=Cost of EndingInventoryBalance Sheet+ +Cots ofPurchasesCost of GoodsSoldIncomestatemento GAAP allows a company to choose one of four alternative cost flow assumptions to allocate its cost of goods available for sale between ending inventory and costs of goods sold: Specific identification First in, first out (FIFO) Average cost Last in, first out (LIFO)o Company must disclose which method it uses, and it must use that method consistently every yearo When the costs to acquire the inventory have changed during the period, each of the inventory cost flow assumptions produces different amounts for the costs of goods sold and the ending inventory balance.o These cost flow assumptions may not be related to the actual physical flow of the goods in inventoryo A company will typically use FIFO physical flow of inventory to reduce the risk of obsolescence,but may still use any of the cost flow assumptions to allocate its cost of goods available for sale between ending inventory and cost of goods soldo First In, First Out First in, first out (FIFO) cost flow assumption, it includes the earliest (first) costs it incurred in the costs of goods sold as it sells its products, leaving the latest costs in ending inventory- Company assumes that it sells the inventory in the same order that they purchasedito Average cost Must compute an average cost per unit after each purchase and then assign this new average cost to items sold until the next purchase (when it computers another new average cost) Moving average cost flow assumption because this method involves tedious calculations, no further discussiono Last in, First Out Last in, first out cost flow assumption, it includes the latest costs it incurred before a sale in its cost of goods sold and the earliest costs in ending inventory it assumes