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OU ACCT 2113 - Understanding Inventory and Cost of Goods Sold

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ACCT 2113 1st Edition Lecture 6 Outline of Last Lecture II. Recognition of Accounts ReceivableA. Credit salesB. ReceivablesC. Calculating Net revenues using discounts, returns, and allowancesD. ExamplesIII. Valuation of Accounts ReceivableA.Uncollectible accountsB.Allowance MethodC.Bad Debt ExpenseD.Accounts written ofE.Net Accounts ReceivableF.Aging MethodIV. Notes ReceivableA. Interest calculationB. Collection of notes receivableC. Uncollectible AccountsD. Accrued InterestE. Receivables Turnover RatioF. Percentage-of-credit sales methodOutline of Current Lecture II. Understanding Inventory and Cost of Goods SoldA. InventoryB. Merchandising companyC. Manufacturing companyD. Calculating Cost of goodsE. Inventory Cost MethodsF. ExampleIII. Recording Inventory TransactionsA.Perpetual vs. Periodic Inventory SystemsB.ExamplesC.Freight chargesD.Purchase discountsE.Purchase returnsThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.F.Multiple step income statementIV. Other Inventory Reporting IssuesA. Lower-of-cost-or-market Method (LCM)B. Calculating the lower of cost or marketC. Inventory turnover ratioD. Gross profit ratioE. ExamplesF. Period-end adjustmentG. Inventory errorsH. Inventory amountsCurrent Lecture Chapter 6: Inventory and Cost of Goods SoldInventory- Includes items a company intends for sale to customers. For example, clothes at The Limited, shoes at Payless ShoeSource, building supplies at Home Depot, and so on. Also includes items that are not yet finished products. For instance, lumber at a cabinet manufacturer, and rubber at a tire manufacturer is part of inventory because the firm will use them to make a finished product for sale to customers. We report inventory as a current asset in the balance sheet—an asset because it represents a valuable resource the company owns, and current because the company expects to convert it tocash in the near term. At the end of the period, the amount the company reports for inventory is the cost of inventory not yet sold. Part A Understanding Inventory and Cost of Goods SoldMany companies, though, earn revenues by selling inventory rather than a service. Cost of the inventory that was sold during the period is known as Cost of goods sold.Many companies earn revenues by selling inventory rather than a service. These companies are either manufacturing or merchandising companies. Inventory  merchandise company  Wholesaler AND RetailerInventory  Manufacturing company  Raw material AND Work in progress AND Finished goodsMerchandising Companies purchase inventories that are primarily in finished form for resale to customers. These companies may assemble, sort, repackage, redistribute, store, refrigerate, deliver, or install the inventory, but they don’t manufacture it. They simply serve as intermediaries in the process of moving inventory from the manufacturer, the company that actually makes the inventory, to the end user.Wholesalers resell inventory to retail companies or to professional users. Retailers purchase inventory from manufacturers or wholesalers and then sell this inventory to end users.Manufacturing Companies manufacture the inventories they sell, rather than buying them in finished form from suppliers.Manufacturers classify inventory into three categories:1. Raw materials inventory: Includes the cost of components that will become part of the finished product but have not yet been used in production. 2. Work-in-process inventory: Refers to the products that have started the production process but are not yet complete at the end of the period.3. Finished goods inventory: It includes the cost of the units that have been completed by the end of the period but not yet sold. Types of Companies and Flow of Inventory Costs-Inventory’s journey begins when manufacturing companies purchase raw materials, hire workers, and incur manufacturing overhead during production. Once the products are finished, manufacturers normally pass inventories to merchandising companies, whether wholesalers or retailers. Merchandising companies then sell inventories to you, the end user. In some cases, manufacturers may sell directly to end users. Some companies provide both services and inventories to customers. In this chapter, we focus on merchandising companies, both wholesalers and retailers. Still, most of the accounting principles and procedures discussed here also apply to manufacturing companies. We focus on the financial reporting implications of inventory cost flows.Calculating Cost of goods sold- Inventory represents the cost of inventory not sold, while cost of goods sold represents the cost of inventory sold. Also referred to as cost of sales, cost of merchandise sold, or cost of products sold. The costs of beginning inventory plus additional purchases make up the cost of goods (or inventory) available for sale.Relationship Between Inventory and Cost of Goods Sold-The costs of beginning inventory plus the additional purchases during the year make up the cost of inventory (cost of goods) available for sale. Remember that inventory represents the cost of inventory not sold, while cost of goods sold represents the cost of inventory sold. Thus, we can see that the amount reported for inventory turns into the amount reported for cost of goods sold once the inventory is sold.To this point, we’ve discussed the cost of inventory without considering how we determine that cost. We do that now by considering four methods for inventory costing:1. Specific Identification 2. First-In, first-Out (FIFO) 3. Last-In, first-Out (LIFO) 4. Weighted-average cost.The specific identification method is the method you might think of as the most logical. It matches or identifies each unit of inventory with its actual cost. As you might imagine, though, the specific identification method is practicable only for companies selling unique, expensiveproducts. For example, an automobile has a unique serial number that we can match to an invoice identifying the actual purchase price. Fine jewelry and pieces of art are other possibilities. Specific identification works well in such cases. However, the specific identification method is practicable only for companies selling unique, expensive products.Specific identification would be very difficult for such merchandisers. Although bar codes and RFID tags now make it possible to identify and


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