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Chapter 7

BUSI 2150U Chapter Notes - Chapter 7: Perpetual Inventory, Balance Sheet, Financial Statement


School
UOIT
Department
Business
Course Code
BUSI 2150U
Professor
Michael Konopaski
Chapter
7

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Inventory
Chapter 7 – Inventory
Introduction
A challenge accountants face is how to determine the value of inventory on hand and the
cost of inventory sold when we don't know the cost of the specific inventory sold or used
What is Inventory?
Inventory are goods that are available for sale by an entity, or goods that will be used to
produce goods that will be sold when they are completed
Inventory can also include materials used in supplying a service to customers
We can learn a lot about the nature of a business from the composition of its balance
sheet
Many entities have different categories of inventory, and information about these is
disclosed on the balance sheet or in the notes
Companies that manufacture or process inputs into finished goods can break inventory
down into three subcategories
Raw materials is the inputs into the production process of a manufacturer or
processor
Work-in-progress (WIP) is inventory that is partially completed on the financial
statement date
Finished goods is inventory that has been completed and is ready for sale
What Do IFRS Say?
IFRS require inventory to be valued at cost on the balance sheet
When the net realizable value (NRV) of inventory is less than cost, inventory is written
down to its NRV
Known as the lower of cost and NRV rule
Cost of inventory usually includes more than the amount paid to the supplier
Cost includes all costs incurred to ready the inventory for sale or use: purchase price of
the inventory, import duties and other taxes, shipping and handling, etc.
IFRS require that the cost of inventory include the cost of materials used plus the cost of
labour directly used to produce the product, plus an allocation of overhead incurred in
the production process
Overhead is the cost costs in a manufacturing process other than direct labour and
direct materials
Overhead costs are more difficult or even impossible to associate directly with the
product being made
IFRS don't provide specific directions for determining which costs and how much of
them should be included
Different entities can determine the cost of inventory differently, which impairs
comparability

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Inventory
FOB destination is when the inventory remains on the books of the seller until they're
received by the buyer
FOB shipping point is when the buyer includes them in inventory when they're shipped
Perpetual and Periodic Inventory Control Systems
Perpetual inventory control system is a system of inventory control that keeps an
ongoing record of purchases and sales of inventory
When inventory is purchased or sold, the inventory account is immediately debited or
credited to record the change
When inventory is sold, cost of sales is immediately debited
Perpetual system can determine cost of sales at any time
With a perpetual system, the cost of the inventory sold is known when the sale occurs and
is recorded at that time
Periodic inventory system is an inventory control system where the inventory account is
not adjusted whenever a transaction affects inventory
The balance in the inventory account at the end of period and cost of goods sold for the
period are determined by counting the inventory on hand on the period ending date
The beginning and ending inventory balances are known from the inventory counts and
the amount of purchases is available from the purchases account
It isn't possible to determine cost of sales from the accounting system before the end of a
period
Purchases is an expense account

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Inventory
No entry records cost of sales until the end of the period after the inventory has been
counted
Internal Control
A perpetual inventory control system doesn't eliminate the need for counting the
inventory from time to time
Sales aren't the only way inventory is consumed; it can be stolen, lost, damaged, or
destroyed
A perpetual system only accounts for the cost of inventory actually sold and only a
physical count will determine inventory consumed in other ways
Differences between the accounting records and the count can also be due to errors in
recording transactions
Counting inventory is important for internal control
Differences between the count and the accounting records allow management to identify
inventory “shrinkage,” allowing it to investigate its cause and implement a plan for
reducing or eliminating the problem
With a periodic inventory control system, it isn't possible to determine whether any theft
has taken place because there are no records to compare with the physical count
It isn't possible to tell from the accounting records that there is a problem with stolen
inventory
A periodic system doesn't allow for as effective control over inventory as a perpetual
system
Managers choose between periodic and perpetual inventory control systems based on the
costs and benefits of the two systems
Inventory Valuation Methods
To determine cost of sales for a period and the amount of ending inventory, it's necessary
to assign a cost to the inventory used or sold
Accountants have developed methods called cost formulas that move costs through the
inventory account to cost of sales without regard for the actual physical movement of the
inventory
IFRS allow three cost formulas
First-in, first-out (FIFO)
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