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Chapter 7

COM 270 Chapter Notes - Chapter 7: Perpetual Inventory, Consignor, Consignee

Course Code
COM 270
Graham Chris

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inventory: any item purchased by a company for resale to customers or to
be used in the manufacture of items to be sold to customers
-the most significant current asset & the largest asset to be converted into
cash within the next year
merchandisers (retailers/resellers): companies that buy a finished
product & sell it to customers
-inventory is made of finished goods
manufacturers: make the product & then sell it to customers
-inventory is made up of components & materials
(a) raw material (RM): all the items required to make a product
(b) work in progress (WIP): products that have been started but
not yet completed at the end of the accounting period
includes costs of RM, labour costs, & overhead costs
(c) finished goods (FG): completed products ready for sale
-inventory flows through the 3 categories in 4 transactions
(1) RM are purchased
(2) RM are used in the manufacturing of products (WIP)
(3) manufacturing process ends & products move from WIP to FG
(4) goods are sold & moved from FG to costs of goods sold
inventory ownership — determining when it becomes an asset/expense
-key criterion: who has title to the goods
(a) FOB (free on board) shipping point:buyer owns the inventory
when it leaves the seller’s premises (seller loads in onto transport)
records as inventory even though it has not yet arrived
(b) FOB destination: buyer owns the inventory when it arrives at
the buyer’s promises (seller ships & off-loads)
records as inventory once arrived
(c) consignment: consignor keeps the title of the goods, while the
consignee is just selling it for a commission
remains the inventory of the consignor
inventory systems — depends on the nature & amount of inventory on hand
-beginning inventory: inventory remaining on hand from the last
accounting period
-costs of goods available for sale (COGAS): the cost of opening
inventory, plus the costs of purchases
the cost of all the goods that the company has available to sell to
customers during the period
Beginning Inventory + Net Purchases = COGAS
-ending inventory: goods that aren’t sold during the accounting period
-2 systems used to account for the cost of goods sold & inventory:
(1) periodic inventory system: update a company’s inventory
information periodically
purchases of inventory are recored in a Purchase account!
(inventory purchase - debit Purchases & credit Cash/Accounts
no entry to inventory/COGS is made at the time of sale !
(time of sale - debit Cash/Accounts payable & credit revenue)
at the end of the period, count inventory to determine
quantity on-hand & assign costs (missing inventory becomes
costs of goods sold)
easier to operate, but do not provide management with up-
to-date info about quantities & costs
unable to quantify the theft of inventory
require regular inventory counts/observation to prevent
usually cheaper, in terms of initial costs
beginning inventory (last period’s ending inventory)
+ purchases (based on invoices during the period)
- ending inventory (based on a physical count)
= costs of goods sold (goods not on hand & assumed to be sold)
(2) perpetual inventory system: continuously tracking inventory
& updating cost of goods sold after every transaction
any unit sold is immediately removed from inventory account!
(inventory purchase - debit Inventory & credit Cash/Accounts
(time of sale - debit Cash/Accounts payable & credit Revenue,
debit Cash/Accounts payable & credit Inventory)
inventory & COGS are up-to-date accounting records
still requires physical count to determine the correct COGS/
ending inventory, because theft, shrinkage, unreported
spoilage/damage, etc. are not explicitly accounted for
beginning inventory (last period’s ending inventory)
+ purchases (based on invoices during the period)
- cost of goods sold (updated after each sale)
= ending inventory (inventory that should be on hand)
- ending inventory per count (actual inventory on hand)
= shrinkage/theft
choosing an inventory system — management must consider:
-the importance of complete, timely inventory information
-cost of purchasing & maintaining the inventory system
-the importance & cost of inventory
inventory costs — all the costs incurred b the company to purchase the goods,
make them ready for sale, & getting them to where they will be sold
-for a retailer:
purchase price of time
non-refundable taxes
shipping or transporting in
import duties
-for a manufacturer:
purchase price of RM
non-refundable taxes
shipping or transporting in
import duties
labour costs
overhead costs
cost formulas: methods of allocating cost of goods available for sale to cost of
goods sold & ending inventory
(a) specific identification: costs of specific units are recored in the
COGS & the ending inventory
-required to track the purchase cost of each item
(b) weighted average (WA): the cost of items are determined by using a
weighted average of the cost of the items purchased
-recalculated every time additional goods are purchased
(c) first-in, first-out (FIFO): assume that the first item to be
purchased/already in the inventory is the first item to be sold
-when unit costs , FIFO ending inventory is than WA, &
FIFO COGS is than WA
selecting a cost formula — based on the nature of the inventory
-Q: are the goods interchangeable? (are they not unique, identifiable items?)
(a) No - must use specific identification
(b) Yes - cannot use specific identification
must choose between WA & FIFO
consider how goods physically flow through the inventory
consider the impact that the choice would have on the value
of inventory & cost of goods sold
inventory valuation — considering all of the different factors that may impact
that value of the inventory when preparing the financial statements
-when inventory is bought/obtain, it is recorded at its cost
-when inventor is carried on the statement of financial position, it must be
recorded at a lower cost, such that it doesn’t represent a greater vale that
is expected to flow in from it
-net realizable value (NRV): the normal selling price of the goods, less
the estimated costs to make the sale
NVR = selling price - estimated selling costs
-if NVR is lower than original cost, the inventory must be written down
-inventory write-down: the reduction of an inventory’s carrying
amount when its estimated NVR is less than its costs
treated as an expense
(debit COGS & credit Inventory)
COM 270 - Chapter 7: Inventory
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