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Accounting: The Language of Business - Vol. 2 (Intermediate: Part 161)
1 Corinthians 16:2
On the first day of every week, each of you is to put something aside and store it up, as he may prosper, so that there will be no collecting when I come.
Short-Term Operating Assets: Inventory (Part G)
by
Charles Lamson
Inventory Allocation Methods
There are four common methods to allocate the cost of goods available for sale between ending inventory (the value of a company's inventory that is still available for sale at the end of an accounting period) and cost of goods sold (the total cost a business incurs to produce and sell its goods):
Specific identification method: The company identifies each unit and tracks the cost associated with that specific unit.
Moving average method: The company determines an average cost for the units on hand and applies that average unit cost to the next sale to determine the cost of goods sold.
First-in, first-out (FIFO) method: The company assigns the most recent cost to ending inventory and the oldest cost to cost of goods sold.
Last-in, first out (LIFO) method: The company assigns the oldest costs to ending inventory and the most recent cost to cost of goods sold.
It is important to note that a company does not have to sell its inventory in a pattern that resembles its accounting assumptions. For example, a grocery store is likely to sell gallons of older milk first. Yet, it could choose to use a moving average cost to determine the cost of goods sold because it is easier to implement. We will examine the four methods in depth using a common example to compare and contrast the financial reporting effects.
Each of two other approaches to inventory allocation---the retail inventory method and gross profit method--approximate the ending inventory balance reported. We discuss the retail inventory method and the gross profit method in a later post.
Specific Identification Method
With the specific identification method, a company identifies each unit and tracks its actual cost, as illustrated in Example 10.6. This approach is suitable for companies that sell high-dollar products with low sales volume. For example, a truck dealer can identify a vehicle that was available for sale by referencing its vehicle identification number and determining whether it was sold or is still in ending inventory. The method is impractical, however, for most companies. Imagine a grocery wholesaler using specific identification on each of the products it sells.
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*GORDON, RAEDY, SANNELLA, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 518-519*
Thursday, August 29, 2024
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Accounting: The Language of Business - Vol. 2 (Intermediate: Part 160)
Moreover, it is required of stewards that they be found faithful.
Short-Term Operating Assets: Inventory (Part F)
by
Charles Lamson
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Inventory Cost-Flow Assumption A company usually does not track each individual item of inventory in its accounting system as the item is purchased and eventually sold. Rather, a company will choose a cost-flow assumption to move the cost of the item from inventory to cost of goods sold in the accounting system. Consider a store that buys sweaters in different sizes and colors during the year. The cost of each type of sweater varies slightly depending on when it was purchased. If the same store does not track each individual sweater, how does the store determine the cost of the sweaters sold and the cost of the sweaters remaining in the store? If the cost of each sweater were always the same, the store would simply multiply the number of sweaters sold and the number of sweaters remaining in ending inventory by the constant cost to determine the cost of goods sold in ending inventory, respectively. But a constant cost is unlikely to occur in practice. Thus, the store must determine which of the sweaters available for sale were sold and which remain in the store.  To make the allocation, the store first determines the cost of the goods that it has available for sale as illustrated in Example 10.5. %20(3)%20(1)%20(2)%20(1)%20(3).jpg)  Example 10.5 illustrates that allocation complexities result from varying inventory acquisition costs. Cowboy Accessories Enterprises has a total cost of $35,850. Allocating the $35,850 cost of goods available for sale between cost of goods sold and ending inventory depends on which hats were sold and which hats remain in inventory. Exhibit 10.4 depicts this allocation issue. Beginning inventory of $20,000 and purchases of $15,850 contribute to cost of goods available for $35,850. Cowboy Accessories must allocate the amount between cost of goods sold and ending inventory. That is, it needs to determine the portion of the $35,850 to include in ending inventory on the balance sheet and how much of the cost of goods available for sale to report as cost of goods sold on the income statement. %20(3)%20(1)%20(2)%20(2)%20(1)%20(1)%20(1).jpg) If the cost of hats is constant over time or if Cowboy Accessories can specifically identify the exact cost of the units sold, the allocation is straightforward. However, prices are seldom constant overtime, and it is not always practical to specifically identify each unit. It is the cost of changing prices, in the case of changing prices, firms usually make cost-flow assumptions. Specifically, rather than tracking the cost of each hat purchased and sold, Cowboy can use cost flow assumptions to allocate the $35,850 total cost of goods available for sale to the 400 hats in ending inventory and the 1,250 hats sold.  *GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 516-517* end |
Monday, August 26, 2024
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Accounting: The Language of Business - Vol. 2 (Intermediate: Part 159)
(Proverbs 30:25)
“Ants are creatures of little strength, yet they store up their food in the summer;”
Short-Term Operating Assets: Inventory (Part E)
by
Charles Lamson
Costs Included in Inventory
Inventory costs reflect the price paid for the goods to be held for resale or the manufacturing costs incurred in producing the units, including materials, labor, and allocated overhead. The costs initially also include expenditures such as freight-in costs, the transportation costs incurred to bring the inventory to the appropriate location. Other capitalized costs include packaging and handling costs. These reasonable and necessary expenditures are considered to have asset value because they are required to acquire the inventory. Freight-out costs, transportation costs incurred by the seller to move the inventory to the buyer, are expensed as a component of selling, general, and administrative expenses when incurred. Although the accounting standards specify general rules, there is a great deal of discretion regarding cost in inventory and to expense as incurred. For example, in its significant accounting policies footnote in the 2016 financial statements, Foot Locker explained that it capitalized transportation, distribution center, and sourcing costs in inventory and merchandise inventory (Gordon, Raedy, Sannella, 2019, Intermediate Accounting, 2nd ed. p. 514). The cost of inventory excludes expenditures related to abnormal costs. The treatment is based on the theory that abnormal costs are not reasonable and necessary and do not represent asset value. Abnormal costs include abnormal spoilage and access freight, which are costs that exceed the normal costs expected to be incurred. Purchase Discounts Finally, inventory costs are reduced by purchase discounts. Purchase discounts reduce the amount that is due to sellers if the buyer pays within a certain time period. Purchase discounts are related to sales discounts discussed in Part 138. The company selling the inventory offers a discount to the buyer. The selling company accounts for the sales discount. The company buying the inventory accounts for the purchase discount. A typical purchase discount is stated as 2/10, n/30, which means the buyer will receive a 2% discount by paying within 10 days; otherwise, the buyer must pay the balance within 30 days. There are two acceptable approaches to recording purchase discounts: the gross method and the net method.  Gross Method. Under the gross method, a company making a purchase initially records the inventory and accounts payable at the full (gross) purchase amounts on the invoice.
Net Method. Under the net method, the company making the purchase assumes that it will take the discount and initially records the accounts payable and inventory at the net amount.
Example 10.4 illustrates accounting for purchase discounts under both the growth and net methods. %20(1).jpg) %20(2).jpg) %20(1).jpg) In practice, the net method is more appropriate than the gross method, because buyers usually take the discount. thus, recording the payable as the net amount is likely an accurate portrayal of the amount that the buyer will ultimately pay and therefore minimizes the need for adjustments. *GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 513-515* end |
Tuesday, August 20, 2024
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Accounting: The Language of Business - Vol. 2 (Intermediate: Part 158)
Short-Term Operating Assets: Inventory (Part D)
by
Charles Lamson
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Inventory Costing: Units and Costs Included
So far, we have focused on the total dollar amount of inventory that the firm reports on its balance sheet. The total dollar amount of inventory is equal to the number of units on hand multiplied by the cost per unit. To illustrate, consider the inventory of sweaters at a clothing store. To assign a value, the firm multiplies the number of sweaters by the cost of each sweater. Although the total inventory value is a straightforward concept, there are four complexities in practice:
We begin by briefly covering the types of goods included in inventory and then each of the remaining three issues. Goods Included in Inventory Ending inventory typically consists of the goods that are in the company's physical possession as well as some goods in transit and some goods in consignment arrangements. Companies selling products often give the buyer the right to return the product. If the company estimates that returns will be a material amount, then it must record the estimated returns. We discuss sales returns in more depth in Part 130.  Goods in Transit. Goods in transit are items that have left the seller's place of business but have not yet been received by the buyer. If inventory is in transit at the end of the reporting period, does the buyer or the seller report these items in inventory? The answer depends on who has title to the goods:
Example 10.3 provide an example of determining the title of good and transit. %20(1).jpg)  Consigned Goods. A company enters into a consignment arrangement when one party (the consignee) agrees to sell a product to another party (the consignor) without taking ownership of the merchandise. In this case, although the consignee has physical possession of the inventory, the inventory is reported on the consignors balance sheet. For example, Electronics Emporium may ship 100 DVD players to Look Videos, Inc. on consignment. In this case, Electronics Emporium is the consignor and Look Videos is the consignee. Although Look Videos has physical possession of the DVD players, it does not report them as part of its inventory. Electronics Emporium will include the DVD players in its inventory because the company still has control of the inventory. *GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 512-513* end |
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Accounting: The Language of Business - Vol. 2 (Intermediate: Part 157)
- Jesus says, "I tell you that on the day of judgment people will have to account for every careless word they speak".
Short-Term Operating Assets: Inventory (Part C)
by
Charles Lamson
Personal Inventory System. In practice, technological advances have made the periodic system (covered in Part 156) obsolete and provided the computer software for firms to use a perpetual system. Under a perpetual system, Firms continually update inventory accounts for each purchase and each sale. A perpetual system is superior to a periodic system because it always provides current information about inventory levels, cost of goods sold, and gross profits.
The following t-account shows the activity in a perpetual system of inventory. Inventory increases with net purchases and is reduced when units are sold. The inventory balance is always current. %20(1).jpg) At the end of the period, a company performs a physical count of inventory. The company adjusts for the difference between the actual count and the perpetual records resulting from issues such as theft, breakage, and obsolescence. Example 10.2 illustrates accounting under a perpetual inventory system. %20(1).jpg) %20(1).jpg) %20(1).jpg) %20(1).jpg) %20(1).jpg)  *GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 510-512* end |
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Product Life Cycles by Charles Lamson Marketers theorize that just as humans pass through stages in life from infancy to death,...
