Textbook Notes (368,434)
Canada (161,878)
MGAC01H3 (34)
Daga (20)
Chapter 8

Chapter 8 Notes

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Financial Accounting

Chapter 8 Inventory Notes Introduction Definition inventories are defined as assets: (a) held for sale in the ordinary course of business; (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services sometimes there is a fine line between what is inventory and what is better classified as property, plant, and equipment Inventory Categories the identification, measurement, and disclosure of inventories must be done carefully because the investment in inventories is often the largest current asset of many companies; and is usually referred to as merchandise inventory amounts for goods and materials that are on hand but have not yet gone into production are reported as raw materials inventory the cost of the raw material on which production has started but is not yet complete, plus the direct labour cost applied specifically to this material and its applicable share of manufactured overhead costs, constitutes the work-in-process inventory the costs associated with the completed but still unsold units on hand are reported as finished goods inventory the cost of goods manufactured represents the product costs of goods that are completed and transferred to Finished Goods Inventory the cost of goods manufactured during the year is similar to the cost of goods purchased in a merchandising company Inventory under the Lower of Cost and Net Realizable Value Model the cost of goods available for sale or use is the total of (1) the cost of the goods on hand at the beginning of the period and (2) the cost of the goods acquired or produced during the period the cost of goods sold is the difference between those available for sale during the period and those on hand at the end of the period Recognition and Measurement Physical Goods Included in Inventory Goods in Transit if the goods are shipped f.o.b. shipping point, the risks and rewards of ownership, which usually go with having legal title, pass to the buyer when the seller delivers the goods to the common carrier (transporter), who then acts as an agent for the buyer if goods are shipped f.o.b. destination, ownership and its associated risks and rewards do not pass until they reach the destination goods in transit at the end of a fiscal period that were sent f.o.b. shipping point are recorded by the buyer as purchases of the period and should be included in ending inventory, else the result is understated inventories and accounts payable in the balance sheet, and understated purchases and ending inventories when calculating cost of goods sold for the income statement the accountant normally prepares a purchase cut-off schedule for the end of a period to ensure that goods received from suppliers around the end of the year are recorded in the appropriate period because goods that are bought f.o.b. shipping point may still be in transit when a period ends, the cut-off schedule is not completed until a few days after the periods end since this gives time for goods in transit at year end to be received Consigned Goods in terms of accounting for inventory, it is important to recognize that goods out on consignment remain the consignors property and are included in their inventory at purchase price or production cost plus the cost of handling and shipping the goods to the consignee when consignee sells the goods, the revenue, less a selling commission and expenses incurred in accomplishing the sale, is remitted inventory out on consignment is shown as separate item or is reported in notes, but unless amount is large, there is little need for this the consignee should be extremely careful not to include any consigned goods in its inventory count Special Sales Agreements while the transfer of legal title is a general guideline for whether the risks and rewards of ownership have passed from a seller to a buyer, transfer of legal title and the transfer of the risks and rewards do not always go hand in hand sometimes enterprise finances its inventory without reporting either liability or the inventory on its balance sheet; this approach often referred to as a product financing arrangementusually involves a sale with either a real or implied buyback agreement if the risks and rewards of ownership have not been transferred, the inventory should remain on the sellers books Costs Included in Inventory Cost Purchase Discounts when suppliers offer cash discounts to purchasers, there are 2 methods to account for the purchases: gross method and net method under the gross method, both the purchases and payables are recorded at the gross amount of the invoice, and any purchase discounts that are later taken are credited to a Purchase Discount account, which is later reported as a contra account to Purchases under the net method, the purchases and accounts payable are recorded initially at an amount net of the cash discounts if the account payable is paid within the discount period, the cash payment is exactly equal to the amount originally set up if the account payable is paid after the discount period is over, the discount that is lost is recorded in Purchase Discounts Lost recording the loss allows the company to assign responsibility for the loss to a specific employee this treatment is considered more theoretically appropriate because it (1) provides a correct reporting of the asset cost and related liability, and (2) makes it possible to measure the inefficiency of financial management if the discount is not taken Vendor Rebates in general: o If it is discretionary by the supplier, no rebate is recognized until it is paid or supplier becomes obligated to make a payment.o If it is probable and the amount can be estimated, the asset recognition criteria are met and the receivable can be recorded. It is recognized as a reduction in the cost of purchases. The receivable is allocated between remaining inventory, and goods sold. o The receivable recognized is based on the proportion of the total rebate that is expected relative to the transactions to date. Product Costs product costs are costs that attach to inventory and are recorded in the inventory accountthat is, they are capitalized these costs are directly connected with bringing goods to the buyers place of business and converting them to a saleable condition conversion costs include direct labour and allocation of fixed and variable production overhead costs that are incurred in processing direct materials into finished goods; the allocation of fixed production costs is based on the companys normal production capacity Basket Purchases and Joint Product Costs a group of units with different characteristics is purchased at a single lump-sum price; i.e., in what is called a basket purchase when this situation occurs most reasonable practice is to allocate total cost among various units based on their relative sales value relative sales value method is rational, can be applied consistently, is used whenever there is a joint cost that needs to be allocated Inventory Accounting Systems Perpetual System a perpetual inventory system continuously tracks changes in the Inventory accountthis means that the cost of all purchases and the cost of the items sold (or issued out of inventory) are recorded directly in the Inventory account as the purchases and sales occur the accounting features of a perpetual inventory system are as follows: 1) Purchases of merchandise for resale or raw materials for production are debited to Inventory rather than to Purchases. 2) Freight-in is debited and purchase returns and allowances and purchase discounts are credited to Inventory instead of being accounted for in separate accounts. 3) The cost of the items sold is recognized at the time of each sale by debiting Cost of Goods Sold and crediting Inventory. 4) Inventory is a control account that is supported by a subsidiary ledger of individual inventory records. The subsidiary records show the quantity and cost of each type of inventory on hand. Periodic System in a periodic inventory system, the quantity of inventory on hand is determined, only periodically each acquisition of inventory during the accounting period is recorded by a debit to the Purchases account the total in the Purchases account at the end of the accounting period is added to the cost of the inventory on hand at the beginning of the period to determine the total cost of the goods available for sale during the period the cost of ending inventory is subtracted from the cost of goods available for sale to calculate the cost of goods sold under a periodic inventory system, the cost of goods sold is a residual am
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