Classifying InventoryMerchandising Company: merchandising goods; 2 common characteristics:They are owned by the companyThey are in the form of ready to saleNeeds only one classification; merchandise inventoryManufacturing company: goods might not be ready for sale3 inventory classifications: (current assets)Finished goods inventory: ready for saleWork in process: not yet completeRaw material: not yet been placed into productionObserving the 3 levels financial statement users can gain insight into management production plansJust-in-time (JIT) inventory: manufacture or purchase goods just in time for useDetermining InventoryPerpetual:Physical Inventory CheckCheck accuracy of perpetual inventory recordsRecord inventory lostPeriodic:Physical Inventory CheckDetermine inventory on handDetermine COGS2 steps for determining inventorytaking physical countdetermining ownership of goodsDetermining OwnershipDo all goods included in the count belong to the companyDoes the company own any goods not included in the countComplications: goods that haven’t arrived or been deliveredGoods in transit: on board a truck, etc.FOB (Free On Board) shipping point:Ownership passes to buyer when public carrier accepts good from carrierBuyer pays freight costFOB destination:Buyer receives ownership when goods are receivedSeller pays freight-costConsigned goods: selling another parties goods for a feeSeller never takes ownership of goodsInventory CostingSpecific identification method: system to identify what inventory was soldHistorically, only possible when sold a limited variety of high-unit-cost itemsRare practiceCost flow assumption: alternate methodMake assumption of what units were soldCost Flow AssumptionsNo accounting requirement that cost flow assumption be consistent with physical movement of goodsAssume LIFO, FIFO and average cost uses periodic method; 2 reasons:Most small companies use periodic rather than perpetualFew companies use perpetual LIFO, FIFO, or avg-cost to cost their inventory and COGSPeople who use perpetual often use an assumed cost (standard cost) to record COGS at time of saleThen recalculate COGS using periodicCOGS = Beginning Inventory + Purchases – Ending InventoryFirst-In, First-Out (FIFO)Assumes earliest goods purchased are first to be soldOften parallels actual physical flow of merchandise b/c it generally is good business practice to sell the oldest units firstHelpful thinking: LISH assumption (last in still here)Last-In, First-Out (LIFO)Assumes latest goods purchased are the first to be sold.Seldom coincides with actual flow of inventoryHelpful thinking: FISH assumption (first in still here)Under periodic all goods purchased during the period are available for the first saleAverage-CostAverage-cost method allocates cost of goods available for sale on the basis of the weighted-average unit costWeighted-average unit cost = Cost of goods available for sale / Total units available for saleFinancial Statement and Tax Effects of Cost Flow MethodsAccepted under GAAP:FIFO (first-in, first-out) method: earliest goods purchased are first to be soldGood practice to sell oldest units firstLIFO (last-in, first-out) method: latest goods purchased are first to be soldSeldom coincides with actual physical flow of inventoryCost of latest goods are first to be recognizedAverage-Cost method: allocates COGS on a weighted-average unit costCost of goods available for sale / Total units available for sale3 reasons companies adopt different inventory cost flow methods:Income statement effectsBalance sheet effectsTax effectsIncome Statement EffectsDuring inflation FIFO produces a high net incomeb/c lower unit cost are matched against revenuesNet incomes:FIFO: highestAverage-cost: middleLIFO: lowestIf prices are falling roles are reversedHigher net income benefits:External users view the company more favorablyManagement bonuses based on net incomeBalance Sheet EffectsMajor advantage of FIFO during inflation, costs allocated to ending inventory will approximate their current costShortcoming of LIFO during inflation, cost allocated to ending inventory may be significantly understated in terms of current cost.Tax EffectsDuring inflation, FIFO methods show higher inventory on balance sheet and higher net income on balance sheetLIFO results in the lowest income taxesLower-of-Cost-or-MarketLower-of-Cost-or-Market: if market value falls below cost; mark down cost to market valueFollows the concept of conservatismCurrent replacement cost: cost of purchasing same goods at the present time from the usual suppliers in the usual quantities.Inventory Cost Flow Methods in Perpetual Inventory SystemsFIFO: calculations are the sameLIFO: latest units purchased prior to each sale are allocated to COGSAverage-cost: called moving-average method; computes a new average after each purchase Classifying Inventory Merchandising Company: merchandising goods; 2 common characteristics:- They are owned by the company- They are in the form of ready to sale Needs only one classification; merchandise inventory Manufacturing company: goods might not be ready for sale 3 inventory classifications: (current assets)- Finished goods inventory: ready for sale- Work in process: not yet complete- Raw material: not yet been placed into production Observing the 3 levels financial statement users can gain insight into management production plans Just-in-time (JIT) inventory: manufacture or purchase goods just in time for use Determining Inventory Perpetual: Physical Inventory Check- Check accuracy of perpetual inventory records- Record inventory lost Periodic: Physical Inventory Check- Determine inventory on hand- Determine COGS 2 steps for determining inventory- taking physical count- determining ownership of goods Determining Ownership- Do all goods included in the count belong to the company- Does the company own any goods not included in the count Complications: goods that haven’t arrived or been delivered- Goods in transit: on board a truck, etc. FOB (Free On Board) shipping point: - Ownership passes to buyer when public carrier accepts good from carrier- Buyer pays freight cost FOB destination:- Buyer receives ownership when goods are received- Seller pays freight-cost Consigned goods: selling another parties goods for a fee- Seller never takes ownership of goods Inventory Costing Specific identification