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Chapter 8

BU127 Chapter 8 Notes

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James Moore

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BU127 Chapter 8 Notes Nature of Inventory and Cost of Sales Items Included in Inventory (Balance sheet under current assets) • Inventory is tangible property that is either o Held for sale in the normal course of business o Used to produce goods or services for sale • Merchandise Inventory o Includes goods held for resale in the ordinary course of business • Raw Materials Inventory o Includes items acquired for the purpose of processing into finished goods • Work­In­Process Inventory o Includes goods in the process of being manufactured • Finished Goods Inventory o Includes manufactured goods that are complete and available for sale Costs Included in Inventory Purchases • Goods in inventory are recorded in conformity with the cost principle • Inventory Costs includes in principle the sum of the applicable expenditures and  charges directly or indirectly incurred to be able to use or sell the item Flow of inventory Costs • When merchandise is purchased the merchandise inventory account is increased,  and when they are sold it decreases • For raw labour there are extra expenditure to prepare and are add to the work in  process • Manufacturing Costs o Direct Labour: refers to the earning of employees who work directly on  the products being manufactured o Factory Overhead: comprises manufacturing costs that are not raw  material or direct labour costs Nature of Cost of Sales • Cost of Sales: number of units X unit costs • Cost of Goods Available for Sale: refers to the sum of the cost of beginning  inventory and the cost of purchases (or additions to finished goods) for the period • Cost of Sales Equation:  o Beginning Inventory + Purchases – Ending Inventory = COS Control of Inventory Internal Control of Inventory 1. Separation of responsibilities for inventory accounting and physical handling of  inventory 2. Storage of inventory in a manner that protects it from theft and damage 3. Limiting access to inventory to authorized employees 4. Maintaining perpetual inventory records 5. Comparing perpetual records to periodic physical counts of inventory Perpetual and Periodic Inventory Systems • Perpetual Inventory System: a detailed inventory record is maintained recording  each purchase and sale during the accounting period • Periodic Inventory System: ending inventory and cost of sales are determined at  the end of the accounting period based on a physical count • Perpetual Inventory Systems in practice: the choice between the two is based on  management’s need for timely information for operating decisions Errors in Measuring Ending Inventory • Ending inventory and costs affects are in the balance sheet and income statement  (cost of sales) • If ending inventory is overstated in year one then in year two profits would be  overstated and taxes payable would be overstated. As well retained earnings  would be overstated Inventory Costing Methods 1. Specific Identification 2. First­in, first­out (FIFO) 3. Weighted Average 4. LIFO (prohibited in the international accounting standards) Specific Identification Method • Identifies the cost of the specific item that was sold • International Financial Reporting Standards prohibit the use of this method when  there is a large amount of inventory • This method requires keeping track of the purchase cost of each item through  coding the purchase cost on each unit or keeping a separate record through its  serial number Cost Flow Assumptions • The choice of an inventory costing method is NOT based on the physical flow of  goods on and off the shelves • Assume that the company is using the periodic method, the oldest cell phones are  placed at the top of the stack because they are typically sold first  First­In, First­Out
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