Accounting: The Language of Business - Vol. 2 (Intermediate: Part 158)

Maintaining honest weights and measures is an explicit precept of the Bible. The Bible states, in Leviticus: “Just scales, just weights, just dry measures, and just liquid measures you shall have” (19:35-36).

 Short-Term Operating Assets: Inventory (Part D)

by

Charles Lamson 

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: 

1. Determining what goods are included in inventory.

2. Measuring cost per unit.

3. Allocating the cost of the goods purchased or manufactured by the company between the units that remain in inventory at the end of the period and the units that are sold during the period.

4. Accounting for a decrease in the market value of inventory. 

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: 

1. If the goods are shipped f.o.b. (free on board) shipping point, then title passes from the seller to the buyer when the goods are shipped. Consequently, the buyer reports the goods in its inventory because the buyer obtains title to the goods as soon as they leave the seller's location. 

2. If goods are shipped f.o.b. destination, then title passes from the seller to the buyer when the goods are received by the buyer. Thus, it reports the goods in its inventory while in transit because the seller remains the owner until the goods arrived at the buyer's destination. 

Example 10.3 provide an example of determining the title of good and transit. 

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*

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