Inventory Costing and Accounting: Methods, Errors, and Financial Statement Impact | Sintesi del corso di Ragioneria

CHAPTER 6. INVENTORIES

We explain the methods used to calculate the cost of inventory on hand at the statement of financial

position date and the cost of goods sold.

Inventories:

CLASSIFYING AND DETERMINING INVENTORY:

- Classifing inventory

- Determining inventory quantities

INVENTORY COSTING

- Specific identification

- Cost flow assumptions

- Financial statement and tax effects

- Consistent use

- Lower-of-cost-or-net realizable value

INVENTORY ERROS

- Income statement effects

- Statement of financial position effects

STATEMENT PRESENTATION AND ANALYSIS:

- Presentation

- Analysis

CLASSIFYING AND DETERMINING INVENTORY

Two important steps in the reporting of inventory at the end of the accounting period are the classification

of inventory based on its degree of completeness and the determination of inventory amounts.

Classifying inventory

Different for merchandiser or a manufacturer firm.

In a merchandising company, inventory consists of many different items(for exemple in a grocery store,

canned goods, daiary products, meats, and produce) These items have two common characteristics: they

are owned by the company and they are in a form ready for sale to custormes in the ordinary course of

business. Merchandiser need only one inventory classification “merchandise inventory”.

In a Manufacturing company, some inventory may not yet be ready for sale. And usually m company

classify inventory into 3 categories: 1) Finished goods inventory (manufactured items that are completed

and ready for sale); 2)Work in progress (portion of manufactured inventory that has been placed into the

production process but is not yet complete); 3) Raw materials are the basic goods that will be used in

production but have not yet been placed into production.

Ny observing the levels and changes in the levels of these 3 inventory types, financial statement users can

gain into management´s production plans.

Many company have significantly lowered inventory levels and cost using just in time JIT inventory

methods. Under a just in time method, companies manufacture or purchase goods only when needed for

use(advantage in an industry where products become obsolete nearly overnight)

Determining Inventory Quantities

No matter whether they are using a periodic or perpetual system, all companies need to determine

inventory quantities at the end of the accounting period. If using a perpetual system, companies take a

physical inventory for two reasons: 1. To check the accuracy of their perpetual inventory records

2. To determine the amount of inventory lost due to wasted raw materials, shoplifting, or employee theft.

6.1

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CHAPTER 6. INVENTORIES

We explain the methods used to calculate the cost of inventory on hand at the statement of financial position date and the cost of goods sold. Inventories: CLASSIFYING AND DETERMINING INVENTORY:

Classifing inventory
Determining inventory quantities INVENTORY COSTING
Specific identification
Cost flow assumptions
Financial statement and tax effects
Consistent use
Lower-of-cost-or-net realizable value INVENTORY ERROS
Income statement effects
Statement of financial position effects STATEMENT PRESENTATION AND ANALYSIS:
Presentation
Analysis CLASSIFYING AND DETERMINING INVENTORY Two important steps in the reporting of inventory at the end of the accounting period are the classification of inventory based on its degree of completeness and the determination of inventory amounts. Classifying inventory Different for merchandiser or a manufacturer firm. In a merchandising company, inventory consists of many different items(for exemple in a grocery store, canned goods, daiary products, meats, and produce) These items have two common characteristics: they are owned by the company and they are in a form ready for sale to custormes in the ordinary course of business. Merchandiser need only one inventory classification “merchandise inventory”. In a Manufacturing company, some inventory may not yet be ready for sale. And usually m company classify inventory into 3 categories: 1) Finished goods inventory (manufactured items that are completed and ready for sale); 2)Work in progress (portion of manufactured inventory that has been placed into the production process but is not yet complete); 3) Raw materials are the basic goods that will be used in production but have not yet been placed into production. Ny observing the levels and changes in the levels of these 3 inventory types, financial statement users can gain into management´s production plans. Many company have significantly lowered inventory levels and cost using just in time JIT inventory methods. Under a just in time method, companies manufacture or purchase goods only when needed for use(advantage in an industry where products become obsolete nearly overnight) Determining Inventory Quantities No matter whether they are using a periodic or perpetual system, all companies need to determine inventory quantities at the end of the accounting period. If using a perpetual system, companies take a physical inventory for two reasons: 1. To check the accuracy of their perpetual inventory records

To determine the amount of inventory lost due to wasted raw materials, shoplifting, or employee theft.

Companies using a periodic inventory system take a physical inventory for 2 different purposes: to determine the inventory on hand at the statement of financial position date, and to determine the cost of goods sold for the period. Determining inventory quantities involves two steps: 1)taking a physical inventory of goods on hand and 2)determining the ownership of goods. Taking a physical inventory Companie take a physical inventory at the end of the accounting period. Taking a physical inventory involves actually counting, weighing, or measuring each kind of inventory on hand. An inventory count is generally more accurate when goods are not being sold or received during the counting. Consequently, companies often “take inventory” when the business is closed or when business is slow. Determining ownership of Goods One challenge in computing inventory quantities is determining what inventory a company owns.

- Goods in transit : A complication in determining ownership is goods in transit at the end of the period. He company may have purchase goods that have not yet been received or it may have sold goods that have not yet been delivered. To arrive at an accurate count, the company must determine ownership of these goods. 1)When the terms are FOB (free on boaerd) shipping point, ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. 2) When the terms are FOB destination, ownership of the goods remains with the seller until the goods reach the buyer. If good in transit at the statement date are ignored, inventory quantities may be miscounted. - Consigned Goods: in some lined 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. INVENTORY COSTING Inventory is accounted for a cost. After a company has determined the quantity of units of inventory, it applies unit costs to the quantities to compute the total cost of the inventory and the cost of goods sold. This process can be complicated if a company has purchased inventory items at different times and at different prices. Specific Identification If a company can positively identify which particular units it sold and which are still in ending inventory, it can use the specific identification method of inventory costing. Specifi Identification requires that companies keep records of the original cost of each individual inventory item. Today bar coding make it theoretically possible to do specific identification with nearly any type of product. But the reality is that this practice is still relatively rare. Instead, most companies make assumptions, called “cost flow assumptions” about which units were sold. Cost Flow Assumptions There are two assumed cost flow methods: There is no accounting requirement that the cost flow assumption be consistent with the physical movement of goods. To demonstrate them, we´ll use a periodic inventory system: because many small companies use periodic rather than perpetual system, and because very few companies use perpetual FIFO or average-cost to cost their inventory and related cost of goods sold. (Beginning inventory+Purchase) – Ending Inventory = Cost of Goods sold.

INVENTORY ERRORS

Unfortunately, errors occasionally occur in accounting for inventory. In some cases, errors are caused by failure to count or price the inventory correctly. In other cases, errors occur because companies do not properly recognize the transfer of legal title to goods that are in transit. When errors occur; they affect both the income statement and the statement of financial position. Income Statement Effects The ending inventory of one period automatically becomes the beginning inventory of the next period. Thus, inventory errors affect the computation of cost of goods sold and net income in two periods. Beginning inventory + Cost of goods purchase – Ending Inventory = Cost of Goods sold If error understated beginning inventory, cost of goods sold will be understated. If the error understates ending inventory, cost of goods sold will be overstated. An error in the ending inventory of the current period will have a reverse effect on net income to the next accounting period. Statement of Financial Position Effects Companies can determine the effect of ending inventory errors on the statement of financial position by using the basic accounting equation. Recall that if the error is not corrected, the combined total net income for the 2 periods would be correct. Thus, total equity reported on the statement of financial position at the end will also be correct. Ending Inventory Error Assets Liabilities Equity Overstated Understated Overstated understated No effect No effect Overstated Understated STATEMENT PRESENTATION AND ANALYSIS Thera also should be disclosure of 1) the major inventory classifiactions, 2) the basis of accounting and 3)the cost method Analysis The amount of inventory carried by a company has significant economic consequences. And inventory management is a double-edged sword that requires constant attention. On the other hand, management wants to have a great variety and quality on hand so that customers have a wide selection and items are always in stock. But, such a policy may incur high carrying costs. On the other hand low inventory levels lead to stock-outs and lost sales. Common ratios used to manage and evaluate inventory levels are inventory turnover and a related measure, days in inventory. Inventory turnover measures the number of times on average the inventory is sold during the period. Its purpose is to measure the liquidity of the inventory. The inventory turnover is computed by dividing cost of goods sold by the average inventory during the period. Cost of Goods sold/Average Inventory = Inventory Turnover A variant of the inventory turnover is days in inventory. This measures the average number of days inventory is held. It is calculated as 365 divided by the inventory turnover.

Inventory Costing and Accounting: Methods, Errors, and Financial Statement Impact, Sintesi del corso di Ragioneria

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CHAPTER 6. INVENTORIES

INVENTORY ERRORS