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ACCT Chapter 7 Condensed (Day 3).docx

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Northeastern University
ACCT 1201
Ronen Gal-or

Chapter 7 Condensed (Day 3) I. Valuing Inventory and Cost of Goods Sold (COGS) II. Inventory Costing Methods: Specific Identification, FIFO, LIFO, and Average Cost III. When managers use FIFO, LIFO, and Average Cost IV. Lower-of-Cost-or-Market (LCM) V. Inventory Turnover Ratio VI. Perpetual and Periodic Inventory Systems VII. Errors in valuing inventory IV. Lower-of-Cost-or-Market (LCM) A. Historical Cost principle – inventories should be measured initially at their purchase cost B. Conservatism constraint – special care is required to avoid overstating assets and income and understating expenses and liabilities. C. Lower of cost or market (LCM) rule a. Serves to recognize a loss when replacement cost or net realizable value drops below cost. b. When the inventory can be replaced with identical goods at a lower cost the lower replacement cost should be used as the inventory valuation c. Replacement Cost - the current purchase price for identical goods Eg. Fred Corporation is preparing its financial statements for the year ending Dec 31, 2010. Ending inventory information about the three major items stocked for regular sale follows: Quantity Unit Cost When Replacement Cost Item on Hand Acquired (FIFO) (Market) at Year-End AA 100 $ 30 $ 26 BB 150 80 80 CC 200 100 104 Compute the valuation that should be used for the ending inventory using the LCM rule applied on an item-by-item basis. Total Total LCM Item Quantity Cost Market Valuation AA 100 $3,000 (100 * 26) 2,600 BB 150 12,000 (150 * 80) 12,000 CC 200 20,000 (200 * 104) 20,000 35,000 34,600 Book the Journal Entry to reduce the value of inventory. Current Ending Inventory = 35,000 LCM Ending Inventory = 34,600 35,000 – 34,600 = 400 Journal Entry to reduce the value of inventory Dr. COGS 400 Cr. Inventory 400 1 V. Inventory Turnover Ratio = Cost of Goods Sold ÷ Average Inventory The inventory turnover ratio reflects how many times average inventory was produced and sold during the period (year). The higher the ratio, the faster inventory moves through the production process to the ultimate customer. Lower inventory (J-I-T inventory) is better for ratio. Average Days to Sell Inventory = 365 ÷ Inventory Turnover Ratio Indicates the average time it takes the company to produce and deliver inventory to customers. Eg. UCC Company provides the following information for its three (3) most recent years: 2007 2006 2005 Inventory, 12/31 $ 90,000 $100,000 $ 60,000 Net A/R 120,000 80,000 100,000 Net credit sales 600,000 500,000 700,000 Cost of goods sales 400,000 350,000 600,000 REQUIRED: Determine the following: 2007 2006 a) Inventory turnover 400,000/(100,000+90,000/2) 350,000/(60,000+100,000/2) = 4.21 times = b) Avg. Days to Sell 365 /4.21 = 87 days 365/ Inventory c) Receivables turnover 600,000/(120,000+80,000/2) = 6 times d) Avg Collection Pd. 365/6 = 61 days Estimated operating cycle = 87 + 61 = 148 days VI. Perpetual and Periodic Inventory Systems A. Periodic inventory system – ending inventory and cost of goods sold are determined at the end of the accounting period based on a physical count. Lauren Corporation uses the periodic inventory system and the following information about their inventory is available: Date Transaction Number of Units Cost per Unit 1/1 Beginning Inventory 100 $ 70 5/5 Purchase 200 $ 80 8/10 Purchase 300 $ 95
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