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Chapter 5

MGT 11A Chapter Notes - Chapter 5: Financial Statement, Income Statement, European Cooperation In Science And Technology


Department
Management
Course Code
MGT 11A
Professor
John Hancock
Chapter
5

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CHAPTER 5: REPORTING AND ANALYZING INVENTORIES
Goods Damaged or Obsolete (out-of-date) or Deteriorated
If goods can be sold at a lower price, they are included in inventory at net realizable value
Net Realizable Value: Sales Price - Cost of Making the Sale
Loss is recorded when the damage or obsolescence (outdated) occurs
Expense Recognition Principle says that inventory costs are expensed as cost of goods sold in
the period when inventory is sold
Internal Controls and Taking a Physical Count
Companies take a physical count of inventory at least once each year
Due to events such as theft, loss, damage, and errors
Used to adjust the Inventory account balance to the actual inventory available
INVENTORY COSTING UNDER A PERIODIC SYSTEM
Inventory Cost Flow Assumptions
PHYSICAL FLOW OF GOODS AND COST FLOW DO NOT HAVE TO BE THE SAME
1) Specific Identifications: each item in inventory matched with a specific purchase and
invoice
2) First-in, First-out (FIFO)
3) Last-in, First-out (LIFO)
4) Weighted Average (WA or Average Cost): requires we use the average cost per unit of
inventory
Financial Statement Effects of Costing Methods
Rising Costs: when purchase costs regularly rise,
FIFO reports the lowest cost of goods sold, yielding the highest gross profit and
net income
LIFO reports the highest cost of goods sold, yielding the lowest gross profit and
net income
Weighted average yields between FIFO and LIFO
Falling Costs: when costs regularly decline,
FIFO gives the highest cost of goods sold, yielding the lowest gross profit and
income
LIFO gives the lowest cost of goods sold, yielding highest gross profit and
income
Method Advantages: a company must report the inventory method it uses
FIFO - inventory on the balance sheet approximates its current cost
Also follows actual flow of goods for most businesses
LIFO - cost of goods sold on the income statement approximates its current cost
Also better matches current costs with revenues
Weighted Average - smooths out erratic changes in costs
Specific Identification - matches costs of items with revenues they generate
Tax Effects of Costing Methods
Many companies use LIFO because there is a temporary tax advantage because
it has less income to be taxed when using LIFO
LIFO Conformity Rule: IRS requires that when LIFO is used for tax reporting, it
also must be used for financial reporting
VALUING INVENTORY AT LCM AND THE EFFECTS OF INVENTORY ERRORS
Lower of Cost or Market
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