| Inventory | | Important issues to be familiar with regard to inventory include |
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| | | 1) The valuation of inventory when it is purchased and recorded. |
| | | 2)The determination of which specific items of the inventory are inluded in the inventory at year end. |
| | | 3) The recognition of permanent declines in value of the inventory. |
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| Classification of Inventory | | Raw Materials |
| | | Work-in-Process |
| | | Finished Good |
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| | | If a company recieves any discounts related to the purchase of the inventory, the disounted price it pays is the amount that should be recorded as the value of the inventory |
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| In Transit Goods | | Goods Sent To FOB (Free on Board) Shipping Point - Title Transfer To Buyer at shipping point-Goods belongs to Buyer |
| | | Goods Sent To FOB Destination - Title Transfer when goods reched to buyer destingation-Goods belongs to Seller |
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| | | Note: The issue of the Owner of goods in Transit is also connected to accounts recievable. For the Seller, if any individual shipment made near the end of period should be reported on period end balance sheet as either inventory or as recievable or cash if the sale was a cash sale
For Example a shipment Shipped to FOB Destination on December 30 that arrives on January 3 will be inventory on the seller book until January 3. On January 3, the seller account receivable is debited for the full amount of the sale and revenue is credited for the same amount, cost is debited for for the cost of sale while inventory is credited for the same amount. The shipment should never be shown on seller book as both inventory and recievable.
For the Buyer the item will be either 1)Both inventory and accounts Payable or 2) neither invenotory nor payable. |
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| Goods out on Approval | | Goods with customer and he has some time to decide to purchase or not. |
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| Consignment | | |
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| Obsolete Inventory | | |
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| Obsolete Inventory | | |
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| Cost included in Inventory | | Product Cost are also called inventoriable cost |
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| | | Although Cost of purchasing and storing the inventory could be considered product cost, usually those are not included in product cost because of the difficulty of allocating them to speicific unit. Usually those costs are considered Period cost. Period cost, as opposed to product cost , are cost not directly related to acquiring or product goods . Period cost included general and administrative expnses and selling costs, including outgoing frieght on shipment to the customers |
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| Determiming which item is sold. Cost Flow Assumption | | FIFO |
| | | LIFO |
| | | Average Cost |
| | | Specific Identification |
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| | | IFRS Note: Under IFRS LIFO is prohibbited |
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| FIFO | | Under FIFO most recent item purchased inventory items are including in Ending Inventory - Fruit Seller |
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| | | In ther Period of rising costs, Using FIFO result in a higher Ending Invenoty balance and low COGS and therefore highter operating Income when compared to LIFO. |
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| | | Note. Under FIFO, ending inventory is essentially valued at current cost (or replacement cost), and cost of goods sold is reported an an older and historical cost. Therefore the balancesheet has current figures because the inventory is valued at more current cost. |
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| Benefits of FIFO | | NET Income will be highter which will be beneficial for some companies |
| | | Closing stock will be at current market prices |
| | | IN the US, FIFO is the only inventory cost flow assumption that is not restricted in its usage for income tax purposes by the IRS. |
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| Limitation of FIFO | | Decreased in NET Cash Flow due to more Income TAX. |
| | | Shot term operating income is not sustainable |
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| LIFO | | Under rising pricces LIFO will create lower ending Inventory and higher COGS and therfore lower operating INCOME |
| | | Elevator is the example |
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| | | Note: Under LIFO cost of goods sold is valued at the current cost or replacement cost of the invenotry. Inventory is recorded at histroical cost. Therefore the income statement has the current figures on it because cost of sold is valued at current cost |
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| Benefits of LIFO | | LIFO is sometimes the best match for the way goods physically flow into and out of the inventory. When new inventory is received and displayed for sale, Items may be placed in front of the exiting invenotry unless a concerted effort is made to posistion newer items on behind older ones. If newer item are consistently placed on front of older ones, the newest units units are always units sold. |
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| | | LIFO Better matches current cost against the current revenue and therefore provides a better measure of current earning when pricing are rising, Use of LIFO leads to the better quality earnings. |
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| | | The Primary advantag of LIFO is lower operating Income and lower income tax and higher cash flow. |
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| Limitations of LIFO | | IF a company uses LIFO for its Tax reporting to gain the advantage of lower taxes, TAX law in US requires that the company also use LIFO for its financcial reporting. As a result company's reported earnings will be lower then they would be under the other cost flow assumptions , assuming rising prices. Tax law doesnot a similar requirements for other inventory cost flow assumptions |
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| | | Since Items reported on invnentory will be valued too low on the balance sheet |
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| | | If Sales exceed purchased inventory , layers of old inventory will be liquidated. The old cost will be match against current revenue and will cause an increase in reported income for the period in which liquidation occurs. |
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| | | A Company using LIFO may manipulate its net income by altering its purchasing pattern at year end. |
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| | | Accounting under LIFO can be complex because of LIFO cost layers |
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| | | Using LIFO is not permitted under IFRS |
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| Average Cost | | IRS (Internal Revenue Service) does not permit the average cost method to be used on company's Tax Return |
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| | | IRO doesnot permit the average mehtod on company's Tax Retrun |
| | | If a company choses to use average method for financial reporting, it can use only FIFO for income Tax reporting. Using Average cost and LIFO for tax return is not an option because as noted above if LIFO is used on Income Tax return, Tax regulations in US state the LIFO must be used for financial reporting purposes. |
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| | | Rising Prices |
| | | Falling Prices |
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| The Frequency of Determining Inventory Balances | | 1) Periodic |
| | | 2) Prepatual |
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| | | Under FIFO, the periodic and the prepatual method result in the same numbers because according to FIFO the oldes unit is sold first |
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| The Pysical Inventory Count | | Note: A Physical count is required by US GAAP for annual reporting purposes. Under GAAP a physical count of invenotry must be done each year regardless of which invenotry cost flow method is being used. A Physical count is not reguired for interim financial statment however. |
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| Errors In Invenotry | | Note; When COGS (An expense) is overstaed, operating income is understated, Coversely when COGS is understated Operating income is under stated |
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| | | On the question cadidates are strongly encouraged to set up these two columns in order to answer a question about to effect of an inventory error or erros |
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| | | A Self correcting Error is one that corrects itself in time, even if it is not discovered. The miscounting of invntory is a self correcting error. While the error in ending invenotry will have an effect on two balance sheet and two income statement. If inventory is correctly counted at the end of the next year when there will be no further error as a result of miscounting. |
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| Recognizing Permanent Decline in Inventory Values | | Under US GAAP, the way inventories measured using any method other than LIFO or the retailed method, the inventory should be meausred at the lower of cost or net relizable Value. |
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| | | Measuremment for Invenotry measured using LIFO or the Retailed method is at lower of cost or market. |
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| | | The Value of Inventory reported on the balance sheet should be lower of cost or net reliziable Value or Lower of cost or its designated market Value.. |
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| Inventories measured using Any method other then LIFO or the retailed Method | | Inventories measured using any method other then LIFO or retailed method are meaused lower of cost or net relizable Value. Net relizable value is defined as the estimated selling price in ordinary course of business minus reasonabily predictable cost of selling including cost of completion, disposal and the transportation. |
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| | | Historical Cost |
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| | | Note: Lower of Cost or net relizable value can be applied to the entire inventoy as one group, to groups or pools of inventory items or each item individually. Applying to each item individually will provide the lower of the amount for ending Inventory. When each item is calculated seperately, any decrease in value will be recorded. However when groups or pools of inventory are used a decline in the value of one item may be offset by increase in the value of another item |
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| Inventorie measued using LIFO or Retailed Method | | For Inventories valued using LIFO or retailed method , the inventory should be measured at the lower of cost or market (LCM) using designated market value as the market valu. |
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| | | Note: For a retailer that buys merchandise and resell it, "market" reffers to market in which the retailer purchases the inventory, not the market in which it sells the inventory. For a manufacturer, the market refers to cost to reproduce the invenotry.
Thus for both retailers and manufactures, "market" means the cost to replace the inventory. Thus the invnetory should be valued at either the historical cost or the cost to replace it, whatever is lower. |
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| | | The cost of inventory is its hostorical cost, which is determined using either LIFO or retaield method. |
| | | The market value is used for designated market value and its middle value of the following three numbers, subject to ceiling as follows. |
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| Ceiling | | Ceiling is also called Net Relizable Value or NRV. The net relizable value is the item estimated normal selling Price minus reasonable cost to complete and dispose the item. |
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| | | Net Relizable Value is the maximum value for the designated market value of the invnentory. |
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| | | Net Relizable Value = Selling Price minus cost to complete and dispose. |
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| Current Replacement Cost | | Current replacement cost, or cost to purchase the invnetory. The current replacement cost will usually given in any LCM Problem |
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| Floor | | Floor or minimun value that will be used as the designated market value for the invnentory. |
| | | The Floor is Net Relizable Vlaue - Profit Margin |
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| | | If the replacement cost is higher than the Net relizable value, the net relizable value will still serve as the ceiling (the maximun value for the designated market value. |
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| | | Exam Tips: Compare the cost of inventory to the middle Value of the three values (not the average of three amounts) to determine the lower of cost or market |
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| LCM Table | | Next Tab |
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| LIFO and LCM | | U.S GAAP doesnot prescibe rules for applying LIFO cost flow assumption in valuing inventory. Instead IRS regulation provide the rules. LCM may not be used with LIFO cost flow assumption under IRS regulations. If a company uses LIFO for tax purposes , the IRS requires it to also use LIFO for its financial reporting. However, the company is not required to use same LIFO application for Tax reporting and its financial reporting. A company may use different LIFO application for its tax reporting. The use of LCM with LIFO costing is an example of this flexiblity. |
| | | Although IRS regulation do not permit the use of LCM with LIFO on the income tax return, LCM is applied with LIFO for financial reporting purposes. However when prices are rising, the instance in which inventory is written down will be fewer under LIFO then under the other cost flow assumption are being used and the lower of cost or net relizable value is being used. |
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| Innventory markedown on interim Financial Statement | | Note; Under U.S GAAP recording Inventory recoveries in the value to the extent of the previously recognized losses is limited to reporting within a single fiscal year. Inventory markdown reporting on an annual financial statement may not be restored at later annual period. |
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| | | IFRS Note: Under IFRS all inventory is valued at lower of cost or net relizable value. In U.S GAAP, the inventories measured under using any method othen then LIFO or the Retail Method should also be measued at lower of cost or net relizable Value . HOwever in U.S GAAP inventory valued using LIFO or the Retailed method is valued at lower of cost or market value instead of of lower of cost or net relizable value.
Under IFRS, Previsouly written down of invenotry may be recovered up to the original cost of the inventory. Gains can't be recoginzed on appreciated invnetory but previous losses can be reversed. Reversal of previous inventory write downs in interim in financial statemnt is not permitted in a later annual period under US GAAP (although invnentory write down in interim financial statement up to the original cost of the invnentory within the same fiscal year. |
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| Financial Statements | | |
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| User of Financial Statements | | Direct and Idirect |
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| | | Note: Users of Financial statement are assumed to have reasonable knowledg of business and economic activites and to willing to study the information with reasonable deligence (Careful, consiousness.). Those assumptions are imprtant because they mean that, in preparation of financial statement, a reasonable level of competence on the part of the users can be assumed. Someone who has "reasonable understanding" of business accounting, economic activities should be able to read the financial information and undertand it. |
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| The Financial Statement | | The Five statement used under U.S GAAP are |
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| | | 1. Balance Sheet also called "Statement of Financial Position" |
| | | 2. Income Statement |
| | | 3. Statement of Cash Flow |
| | | 4. Statement of Comprehensive Income |
| | | 5. Statement of changes in Stock holders Equity |
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| | | Notes: The Notes to the financial statements are also considered an integral part of financial statement but are not an actual financial statement. The Purpose of Notes is Provide information discolosure required by US GAAP |
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| | | Note: A Company can prepare prospective financial statements. Prospective financial statements are financial statements based on the set of assumption that present projected information about a future period. Whenever prospective finanncial is prepared, the significant policies and significant assumption used need to be disclose. |
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| The Difference Between U.S GAAP and IFRS | | Propriety theory, that net assets are viewed as belongings to the owner |