Inventory

Key Things To Know

 

Inventory:
Items a company buys or makes only for the purpose of selling to customers.

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:
One company holds inventory for another company and does not take title.
The company that has title to the inventory records the inventory.

Include in the cost of inventory:

Freight In:
Costs to get the inventory to the purchaser

Purchase Returns:
Return inventory to the supplier (seller)

Purchase Discounts:
A discount for early payment on the purchase
When payment is due is based on the “terms” agreed upon

Examples:

“2/10, n 30”
means – 2% discount / if pay in 10 days, or full payment is due in 30 days

“n 60”
means no discount offered, payment due in 60 days

Gross Method or Net Method

Gross method:
Record the purchase and accounts payable at full amount
Record a purchase discount (or reduce inventory) for the discount amount

Purchase discounts are reported on the income statement as part of net purchases:

    Purchases
+  Freight In
–   Purchase Returns
–   Purchase Discount
=  Net Purchases

Net Method:
Record the purchase and accounts payable at the net amount
Record interest expense when a discount is not taken

Interest expense is reported below operating income

Periodic or Perpetual: Two Methods for Recording Inventory transactions

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) Move purchases, purchase discounts, purchase returns, and freight to CGS

Record to the inventory account only in adjusting entry at end of month

Perpetual
Record inventory purchases, purchase discounts, purchase returns, and freight-in to inventory
Record sales and the reduction of inventory at cost:
Final adjustment at the end of the period is to get inventory to the actual on hand.

Adjust inventory for employee theft, damage to inventory, and human error (shrink)

Record to the inventory account every time inventory moves

Journal entries for recording inventory transactions:

Debits and credits in the above entries are for both the gross and the net method.
Add the accounts interest expense and purchase discounts when necessary

Net method:
Always record the inventory and accounts payable at the net amount.

Gross method:
Always record the inventory and accounts payable at the gross amount

Important:
Inventory and cost of goods sold is the same for both the periodic and perpetual method after all entries are made.

Compute Cost of Goods Sold:
Beginning Inventory
+ Freight In
+ Purchases
– Purchase Returns
– Purchase Discounts
= Available for sale
– Ending Inventory **
= Cost of Goods Sold

** The value of ending inventory is: quantity on hand x the cost for each one

Inventory Errors:

Inventory costs are reported as either inventory on the balance sheet or cost of
goods sold on the income statement.

Inventory + Cost of Goods Sold = Total Available Cost

Typically, inventory is counted and valued to determine the cost of inventory and
cost of goods sold is total available cost less inventory.

Incorrect ending inventory gives incorrect cost of goods sold and income

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

Important:
Income has the same error as the ending inventory error.
Income has the opposite error as the beginning inventory error (beginning inventory too high gives high cost of goods sold and low income)

Report on the Balance Sheet

Inventory is reported at a cost of $8,500 on the balance sheet

What is the cost of inventory items purchased more than one time at a different cost per unit when the 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. Sold 550 units of Item A to customers.

What is the cost of the 100 units that were not sold (ending inventory) when all items are the same and the company cannot determine which ones are sold?

FASB gives a choice of methods to use to value ending inventory when the same
items are purchased (or made) at different costs:

FIFO (first in – first out):
Units purchased first are sold first.
The last units purchased are the ones in inventory

LIFO (last in – first out):
Units purchased last are sold first.
The first units purchased are the ones in inventory

Weighted Average:
Inventory is valued at the average purchase cost per unit.
Average cost = total available cost divided by total available units
Available = beginning + all purchases

Specific Identification:
The company can determine the specific cost of the item in inventory.
High dollar unique items

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

Inflation or deflation determines which method gives a higher income.

FIFO, LIFO, Weighted Average: Periodic and Perpetual

Periodic:
The date the sale occurs does not matter.
Consider units sold in total at the end of each period.

1/1     Purchase               500
1/24   Purchase               100
1/28   Purchase               200
    Available                      800
     – Sold                        (450)
    Ending Inventory         350

Perpetual:
The date the sale occurs does matter.
Set up transactions in date order.
Only inventory held at the time the sale occurs can be sold.

1/1      Purchase               500
1/6      Sold                     (200)
1/24    Purchase              100
1/26    Sold                     (250)
1/28    Purchase              200
     Ending Inventory        350

FIFO: Periodic or Perpetual give the same value for inventory and cost of goods sold

LIFO & Weighted Average: Periodic and Perpetual give different values for inventory and cost of goods sold.

See Practice as You Learn for examples of Periodic and Perpetual