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ACIS2115 Chapter 6, 02/28

by: Shannon Cummins

ACIS2115 Chapter 6, 02/28 ACIS 2115

Shannon Cummins
Virginia Tech
GPA 3.34

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Covers different classifications of inventory, as well as the two steps of determining inventory quantities. Also covers the three cost flow assumptions (FIFO, LIFO, and average-cost) and their ef...
intro to accounting
Class Notes
ACIS2115, Accounting, Ch6, FIFO, LIFO, Inventory, cost flow assumptions, average-cost, turnover
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This 3 page Class Notes was uploaded by Shannon Cummins on Sunday February 28, 2016. The Class Notes belongs to ACIS 2115 at Virginia Polytechnic Institute and State University taught by in Spring 2015. Since its upload, it has received 33 views. For similar materials see intro to accounting in Accounting at Virginia Polytechnic Institute and State University.

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Date Created: 02/28/16
Chapter 6 Notes: Merchandisers need only one inventory classification, merchandise inventory. Manufacturing companies classify inventory into three categories: finished goods inventory, work in process, and raw materials.  Finished goods inventory – manufactured items that are completed and ready for sale.  Work in progress – the portion of manufactured inventory that has begun the production process but is not yet complete.  Raw materials – basic goods that will be used in production but have not yet been placed into production. Just-in-time (JIT) inventory – inventory system in which companies manufacture of purchase goods only when needed. Many have significantly lowered inventory levels and costs using this method. Determining inventory quantities involves two steps: (1) taking a physical inventory of goods on hand and (2) determining the ownership of goods. 1. Taking a physical inventory: At the end of an accounting period; involves actually counting, weighing, or measuring each kind of inventory on hand. 2. Determining the ownership of goods: Two questions must be answered. a. Do all of the goods included in the count belong to the company? b. Does the company own any goods that were not included in the count? A complication of determining ownership is goods in transit (on board a truck, train, ship, and plane). Goods in transit should be included in the inventory of the company that has legal title to the goods. a. When the terms are free on board shipping point, ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. b. When the terms are free on board destination, ownership of the goods remains with the seller until the goods reach the buyer. In some lines of business, it is common 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 (consigned goods). Specific identification method – an actual physical-flow costing method in which particular items sold and items still in inventory are specifically costed to arrive at cost of goods sold and ending inventory; a relatively rare practice. Cost flow assumptions: Because specific identification is often impractical, other cost flow methods are permitted. They assume flows of costs that may be unrelated to the actual physical flow of goods.  First-in, first-out (FIFO) These are OKAY! There is no accounting requirement  Last-in, first-out (LIFO) that the cost flow assumption be consistent with the physical movement of the goods.  Average-cost ***Reminder: Cost of goods sold = (beginning inventory + purchases) – ending inventory 1. FIFO method – an inventory costing method that assumes that the earliest goods purchased are the first to be sold; costs of the earliest goods purchased are the first to be recognized in determining cost of goods sold, regardless of which units were actually sold. Companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed. 2. LIFO method – an inventory costing method that assumes that the latest units purchased are the first to be sold; costs of the latest goods purchased are the first to be recognized in determining cost of goods sold, regardless of which units were actually sold. Companies obtain the cost of the ending inventory by taking the unit cost of the earliest goods available for sale and working forward until all units of inventory have been costed. to analyze a company’s financial statements over successive time period.ory costing method that uses the weighted-average unit cost to Consistent applallocate the cost of goods available for sale to ending inventory and cost of goods sold. Cost of goods available for sale / total units available for sale = weighted-average unit cost. The reasons companies adopt different inventory cost flow methods:  Income statement effects o In a period of inflation, FIFO produces a higher net income because lower unit costs of the first units purchased are matched against revenue. o In a period of inflation, LIFO produces a lower net income because lower unit costs of the last goods purchased are matched against revenue. o If prices are falling, the results from the use of FIFO and LIFO are reversed. FIFO will report the lowest net income and LIFO the highest. o Regardless of whether prices are rising or falling, average-cost produces net income between FIFO and LIFO.  Balance sheet effects o In a period of inflation, the costs allocated to ending inventory will approximate their current cost. o In a period of inflation, the costs allocated to ending inventory may be significantly understated in terms of current cost.  Tax effects o During a time of rising prices, LIFO results in the lowest income taxes (because of lower net income). Lower-of-cost-or-market (LCM) – a basis whereby inventory is stated at the lower of either its cost or its market value as determined by current replacement cost.  Current replacement cost – the cost of purchasing the same goods at the present time from the usual suppliers in the usual quantities. Inventory turnover – a ratio that indicates the liquidity of inventory by measuring the number of times average inventory is sold during the period. Inventory turnover = Cost of goods sold / Average inventory during the period Days in inventory – measure of the average number of days inventory is held. Days in inventory = 365 / inventory turnover Companies using LIFO are required to report the difference between inventories reported using LIFO and using FIFO. This amount is referred to as the LIFO reserve. This enables analysts to make adjustments to compare companies that use different cost flow methods.


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