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Chapter 8

Management and Organizational Studies 3360A/B Chapter Notes - Chapter 8: Consignor, Net Income, Consignee


Department
Management and Organizational Studies
Course Code
MOS 3360A/B
Professor
Christina Maco
Chapter
8

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Inventory- Chapter 8
Understanding Inventory
What types of companies have inventory?
o Manufacturing, retail, wholesale, merchandising
Inventory categories
o Retailers and wholesalers
Inventory ready for sale
Merchandise inventory- unsold units left on hand from merchandise in a form that is
ready for sale
o Manufacturing companies
Inventories in various stages of completion
Raw materials inventory- amounts for goods and materials that are on hand but have
not yet gone into production
Work-in-process inventory- cost of raw material + direct labour cost applied
specifically to this material and its applicable share of manufacturing overhead costs
Finished goods inventory- costs associated with the completed but unsold units on
hand
Inventory planning and control
o Higher levels of inventory results in higher costs of looking after them
o Companies must monitor inventory levels carefully to
Minimize carrying costs
Meet customer demands
Information for decision making
o The existence of inventory that the company owns must be clearly represented and
information as to how this inventory has been measured must also be disclosed
o COGAFU(S) = cost of goods on hand at beginning of period + cost of goods acquired or
produced during the period
o COGS = COGAFU(S) cost of goods on hand at end of period
Recognition
Valuation requires determining the physical goods (goods on hand, goods in transit, consigned
goods, special sales agreements)
Inventories are defined as assets
o Held for sale in the ordinary course of business
o Goods to be used in the production of goods to be sold, or
o Materials or supplies to be consumed in the production process
Inventories represent a future benefit, which the entity has control over or access to
Physical goods included in inventory
o When all risks and rewards of ownership and control have passed to the purchaser,
inventory is recognized
Legal title passes = purchased goods included in inventory
Acquisitions are often recorded when the inventory is received (possession)
Inventory is buyer's when received, except:
o Goods in transit
FOB shipping point
Buyer pays freight costs
Ownership passes buyer before transportation

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Ownership of the goods passes to the buyer when the public carrier
accepts the goods from the seller
FOB destination
Seller pays freight costs
Ownership passes to buyer after transportation
Ownership of the goods remains with the seller until the goods reach the
buyer
Cut-off schedule- prepared for the end of each period to ensure that goods
received from suppliers around the end of the year are recorded in the appropriate
period
Curtailing and controlling the receipt and shipment of goods around the
time of the count
Marking freight and shipping documents as before and after inventory
count
Ensuring that receiving reports on goods received before the count are
linked to invoices that are also recorded in the same period
o Consignment goods
Remain the consignor’s property
Included in consignor’s inventory at purchase price or production cost + shipping &
handling fee to consignee
When the consignee sells the consigned goods the revenue selling commission &
expenses incurred in sale is given to consignor
o Sales with high rates of return
If a reasonable prediction of the returns can be established, then the goods may be
considered sold by the vendor and the expected value of the sale is recorded as
revenues
If returns are unpredictable, the sale is not recognized, and the goods aren’t
removed from the inventory account
o Sales with buyback agreements
Product financing arrangement- involves a transfer of the inventory with either a
real or implied buyback agreement
Purchaser agrees to buy the inventory and then sell it back later to the same
supplier
If risks and rewards of ownership and control have not been transferred, the
inventory should remain on the seller’s books
o Sales with delayed payment terms
Seller retains legal title to the merchandise until all payments have been received
If all other revenue recognition criteria are met, then inventory can be considered
sold, even if legal title hasn’t passed
Sale recorded, and goods removed from seller’s inventory
o Purchase commitments
Agreements where a company agrees to buy inventory weeks, months or even years
in advance
Generally, title doesn’t pass to the buyer until delivery
Ordinary orders- prices determined at time of shipment and buyer/seller can still
cancel the order, don’t represent an asset or liability to the buyer, not recorded or
reported

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Non-cancellable purchase contracts- no asset or liability is recognized on the date
when the contract takes effect, because it is an executory contract
Neither party has performed or fulfilled its part of the contract
Onerous contract- where the unavoidable costs of completing the contract are
higher than the benefits expected from receiving the contracted goods or services
Loss provision recognized
Inventory Errors
Ending inventory misstated
Statement of Financial Position
Income Statement
Inventory
Understated
Cost of goods sold
Overstated
Retained earnings
Understated
Net income
Understated
Working capital
Understated
Current ratio
understated
Purchases and inventory misstated
Statement of Financial Position
Income Statement
Inventory
Understated
Purchases
understated
Retained earnings
No effect
Ending inventory
Understated
Accounts payable
understated
Cost of goods sold
No effect
Working capital
No effect
Net income
No effect
Current ratio
overstated
o Examples
Not recording a purchase but counting new inventory
Not recording a sale in the current period although the items have been delivered
Omitting the adjusting entry to update the account allowance for sales returns and
allowances in situations where the sales are known to have a high rate of return
Failing to adjust inventory to the lower of cost and net realizable value
Measurement
The costs to include (product vs. period costs)
o Inventory cost includes
All costs of purchase, costs of conversion, and other costs incurred in bringing the
inventories to their present location and condition
Includes
o Product costs- costs that attach to inventory and are recorded in the inventory account
(capitalized)
Freight charges, direct costs of acquisition, labour and other production costs
Taxes that can’t be recovered (provincial sales taxes paid on goods purchased for
resale/manufacturing)- cost of inventory
Taxes that can be recovered (federal goods and service tax, harmonized sales tax)-
not included
Allocation of production costs is based on the company’s normal production
capacity- the usual amount of goods a company can produce in a year
o Standard costs
A company that uses a standard cost system predetermines the unit costs for
material, labour and manufacturing overhead
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