Key Things To Know

Financial Accounting

Key Things To Know


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 controls (has title) to the inventory records and reports the inventory.

Calculating Cost of Goods Sold:  

The cost of the inventory sold to customers is 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 

Inventory is 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

When the same item is purchased at different unit costs:

Purchased 150 units of Item A at $24 and 200 units of Item A at $27 and 300 units of Item A at $26.   550 units were sold 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 Method    

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 Method

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:

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.