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Chapter 8

Chapter 8 BU227.docx

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Carolyn Mac Tavish

BU227 Chapter 8 – Reporting and Interpreting Cost of Sales and Inventory Week 7 Nature of Inventory and Cost of Sales Items Included in Inventory -Inventory – tangible property held for sale in the normal course of business or used in producing goods or services for sale -Current asset Merchandise Inventory -Merchandise inventory – includes goods held for resale in the ordinary course of business -The goods are usually acquired in a finished condition and are ready for sale without further processing -Raw materials inventory – items acquired for the purpose of processing into finished goods -Work in process inventory – includes goods in the process of being manufactured -Finished goods inventory – 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 cost includes, the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to a usable or saleable condition and location -Ex. When Nokia purchases raw materials (processing chip) for use in the manufacturing of cell phones, the amount recorded should include the invoice price and indirect expenditures to the purchase, such as import duties; freight charges; inspection and preparation costs -Any additional costs related to selling the merchandise inventory to customers, such as salaries of marketing personnel should be included in selling and marketing expenses of the period of sale since they are incurred after the inventory is ready for sale Flow of Inventory Costs -When merchandise is purchased, the merchandise inventory account is increased Nature of Cost of Sales -Cost of sales is the number of units sold multiplied by their unit costs BU227 Chapter 8 – Reporting and Interpreting Cost of Sales and Inventory Week 7 -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 = Beginning inventory + Purchases – Ending Inventory Control of Inventory Internal Control of Inventory -The following are the most important control features: 1. Separation of responsibilities for inventor 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 -Perpetual Inventory System – a detailed inventory record is maintained, recording each purchase and sale during the accounting period -Shows: units and cost of the beginning inventory, units and cost of each purchase, units and cost of the goods for each sale, the units and cost of the goods on hand at any point in time -Purchase transactions are directly recorded in an inventory account Periodic Inventory System -Periodic Inventory System – ending inventory and cost of sales are determined at the end of the accounting period based on a physical count -The amount of inventory is not known until the end of the period when the physical inventory count is taken -Inventory purchases are debited to a temporary account called purchases -Provides more timely information about inventory quantities and costs Perpetual Inventory Records in Practice -The decision to use a perceptual versus a periodic inventory system is based primarily on management’s need for timely information for use in operating decisions and on the cost of the perpetual system Errors in Measuring Ending Inventory -The measurement of ending inventory affects both the balance sheet and income statement Inventory Costing Methods -When inventory costs change, the determination of the cost of sales and the cost of ending inventory can turn profits into losses and case companies to pay or save millions in taxes -Three generally accepted inventory costing methods are: 1. Specific identification, 2. First-in, first-out, 3. Weighted average -The selected inventory costing method should be the one that provides the best correspondence between expenses and revenues BU227 Chapter 8 – Reporting and Interpreting Cost of Sales and Inventory Week 7 Spe
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