Inventory
Key Things to Know
Inventory: Items that you buy or make only for the purpose of selling the items to
customers for a profit.
Terms related to purchasing inventory that determines who owns the inventory when
it is in transit (in shipment between the seller and the buyer)
F.O.B. Destination: Buyer owns when they receive the goods
F.O.B. Shipping: Buyer owns at the time it is shipped (owns in transit)
Goods on Consignment: A company holds inventory for someone else, and
does not take title. The company that has title to the
inventory records the inventory.
Calculating Cost of Goods Sold: The cost of the inventory sold to customers
Reported on the income statement as an expense
Beginning Inventory
+ Purchases
= Available for sale
- Ending Inventory **
= Cost of Goods Sold
** Ending inventory is valued at the quantity on hand x the cost for each one
The ending inventory is the amount reported on the balance sheet.
On the Balance Sheet - reported inventory as the total $ of all items = quantity x cost:
|
Quantity |
x |
Each Cost |
= |
Total Cost |
Item A |
100 |
|
25 |
|
2,500 |
Item B |
50 |
|
10 |
|
500 |
Item C |
200 |
|
15 |
|
3,000 |
Item D |
500 |
|
5 |
|
2,500 |
Total |
|
|
|
|
8,500 |
Inventory will be reported at a cost of $8,500 on the balance sheet
Which cost do you use to value inventory when the same item is purchased at
different unit costs and items are exactly the same?
Example: Purchased 150 units of Item A at $24 and 200 units of Item A at $27 and
300 units of Item A at $26. You sold 550 to customers. What cost
should you multiply by the total 100 quantity left to get the ending
inventory amount? All items look the same and you can not tell what was
actually paid for the items that are left.
FASB gives you a choice of methods to use to value ending inventory when the same
items are purchased at different costs:
FIFO (first in – first out):
Units purchased first are sold first. The last units purchased are the ones you have left
LIFO (last in – first out):
Units purchased last are sold first. The first units purchased are the ones you have left
Weighted Average:
Inventory is valued at the average purchase cost.
Total available cost divided by total available units = average cost per unit
Specific Identification:
Use when you are able to tell the specific cost of the item in inventory.
Each method will give a different cost of goods sold expense and inventory cost.
In times of inflation:
FIFO gives a lower cost of goods sold and higher income than LIFO
In times of deflation:
FIFO gives a higher cost of goods sold and a lower income than LIFO
Which method gives a higher income depends on inflation/deflation of the product.
Lower of Cost or Market (LCM)
Inventory is initially valued at the purchase cost.
A company may not report inventory on their balance sheet at more than they expect
to benefit from the sale of the inventory.
You must determine if the inventory has lost value below cost:
Compare cost to market value (also called replacement cost)
If cost is more than market, the reported cost must be reduced to market.
If cost is less than market, no adjustment is made, do not adjust up.
The journal entry to adjust for the difference down to LCM is:
Cost of goods sold (or loss on inventory)
Inventory (or inventory reserve)
Write-down of inventory is called “impairment”
Inventory is not increased above cost.
Two Methods for Recording Inventory transactions – Periodic or Perpetual:
Periodic – Record inventory purchases initially as “purchases” - an expense
Record sales without recording the change to the inventory
Adjust at the end of the period to record CGS and:
1) Get inventory to what you really have
2) Get purchases to equal 0 (the real expense is CGS)
** Don’t use the inventory account until the final adjustment
Perpetual – Record to the inventory account every time inventory moves
Record inventory purchases initially as an asset called inventory:
Record sales at the sales price and the reduction of inventory at cost:
Final adjustment at the end of the period to get inventory to be
what you really have on hand.
A reduction in inventory is due to employee theft, damage to inventory, or the
wrong thing being put into the box and shipped to the customer. This is often
called “shrinkage”. You can not determine shrinkage using the periodic method.
It is possible that inventory must go up to get to what you really have if not enough
was really shipped to the customer or inventory received was incorrectly recorded.
*** Notice that the balance in the inventory account and the cost of goods sold account
is the same under both the periodic and perpetual methods at the end of the period.
Journal entries for recording inventory transactions:
Periodic Perpetual
Purchases
Purchase Inventory
Cash or A/P Cash or A/P
A/P
Return A/P
Purchase Returns Inventory
A/R
Sale A/R price to
Sales Sales customer
CGS original
Inventory cost
Adjusting Entry
CGS CGS
Purchase Returns Inventory
Inventory(ending)
Inventory (beginning) either account can be
Purchases the debit or credit
Inventory Errors:
Inventory costs are reported as either inventory on the balance sheet or cost of
goods sold on the income statement.
Total cost = Inventory + Cost of Goods Sold
Typically, inventory is counted and valued to determine the inventory balance and
cost of goods sold is the other part of the cost.
When ending inventory is incorrect, cost of goods sold and income will be
incorrect also
Ending inventory too high, cost of goods sold too low, income too high
Ending inventory too low, cost of goods sold too high, income too low
** Income has the same error as the ending inventory error.
When beginning inventory is incorrect, the opposite occurs.
