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Chapter 5

Controlling and Reporting of Inventories

Book Version 3
By Boundless
Boundless Accounting
Accounting
by Boundless
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Section 1
Understanding Inventory
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Nature of Inventory

Inventory represents finished and unfinished goods which have not yet been sold by a company.

Categories of Goods Included in Inventory

Most manufacturing organizations usually divide their "goods for sale" inventory into raw materials, work in process, and finished goods.

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Components of Inventory Cost

The cost of goods produced in the business should include all costs of production: parts, labor, and overhead.

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Flow of Inventory Costs

Accounting techniques are used to manage assumptions of cost flows related to inventory and stock repurchases.

Section 2
Controlling Inventory
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Internal Controls

Inventory internal controls ensure that a company has sufficient resources to meet its customers' needs without having too much goods.

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Perpetual vs. Periodic Counting

Perpetual inventory updates the quantities continuously and periodic inventory updates the amount only at specific times, such as year end.

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Conducting a Physical Inventory

There are three phases of a physical inventory: planning and preparation, execution, and analysis of results.

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Impact of Measurement Error

Measurement error leads to systematic errors in replenishment and inaccurate financial statements.

Section 3
Valuing Inventory
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Costing Methods Overview

There are four accepted methods of costing items: specific identification; first-in, first-out; last-in, first-out; and weighted-average.

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Specific Identification Method

Specific identification is a method of finding out ending inventory cost that requires a detailed physical count.

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Cost Flow Assumptions

Inventory cost flow assumptions (e.g., FIFO) are necessary to determine the cost of goods sold and ending inventory.

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Average Cost Method

Under the Average Cost Method, It is assumed that the cost of inventory is based on the average cost of the goods available for sale during the period.

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FIFO Method

FIFO stands for "first-in, first-out," and assumes that the costs of the first goods purchased are charged to cost of goods sold.

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LIFO Method

LIFO stands for last-in, first-out, meaning that the most recently produced items are recorded as sold first.

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Gross Profit Method

The gross profit method uses the previous year's average gross profit margin to calculate the value of the inventory.

Selecting an Inventory Method

When selecting an inventory method, managers should look at the advantages and disadvantages of each.

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Impacts of Costing Methods on Financial Statements

The method a company uses to determine it cost of inventory (inventory valuation) directly impacts the financial statements.

Section 4
Detail on Using LIFO
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The LIFO Reserve

The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the LIFO reserve.

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Comparability

If a company uses LIFO, the recorded amount of inventory is not an accurate reflection of cost, reducing comparability to companies using FIFO.

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Liquidation

In law, liquidation is the process by which a company is brought to an end, and the assets and property of the company redistributed.

Dollar-Value LIFO

Dollar value LIFO (last-in, first-out) is calculated with all figures in dollar amounts, rather than inventory units.

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Advantages of LIFO

Using LIFO accounting for inventory, a company generally pays lower taxes in periods of inflation.

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Disadvantages of LIFO

LIFO is facing pressures from international standards boards that may result in its possible complete elimination.

Section 5
Additional Topics in Inventory Valuation
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Lower of Cost or Market

In lower of cost or market (LCM), inventory items are written down to market value when the market value is less than the cost of the items.

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Methods in Retail Inventory

For some companies, taking a physical inventory is impossible or impractical so the Retail Inventory Method is used to estimate.

Section 6
Assessing Inventory Management
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Efficiency Metrics

Efficiency ratios for inventory measure how effectively a business uses its inventory resources.

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Impact of Inventory Method on Financial Statement Analysis

The inventory method chosen will affect the amount of current assets and gross profit income statement, especially when prices are changing.

Section 7
Reporting and Analyzing Inventories
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Reporting Inventories

Inventory is an asset and its ending balance should be reported as a current asset on the balance sheet.

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Inventory Turnover Ratio

Inventory turnover is the measure of the number of times inventory is sold or used in a time period such as a year.

Adjusting for LIFO Reserve

The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the LIFO reserve.

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Controlling and Reporting of Cash and Receivables
  • Overview of Cash
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Chapter 5
Controlling and Reporting of Inventories
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  • Valuing Inventory
  • Detail on Using LIFO
  • Additional Topics in Inventory Valuation
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Controlling and Reporting of Real Assets: Property, Plant, Equipment, and Natural Resources
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