Reporting and Interpreting Cost of Goods Sold and Inventory ANSWERS TO QUESTIONS 1. Inventory often is one of the largest amounts listed under assets on the balance sheet which means that it represents a significant amount of the resources available to the business. The inventory may be excessive in amount, which is a needless waste of resources; alternatively it may be too low, which may result in lost sales. Therefore, for internal users inventory control is very important. On the income statement, inventory exerts a direct impact on the amount of income.
Therefore, statement users are interested particularly in the amount of this effect and the way in which inventory is measured. Because of its impact on both the balance sheet and the income statement, it is of particular interest to all statement users. 2. Fundamentally, inventory should include those items, and only those items, legally owned by the business. That is, inventory should include all goods that the company owns, regardless of their particular location at the time. 3. The cost principle governs the measurement of the ending inventory amount.
The ending inventory is determined in units and the cost of each unit is applied to that number. Under the cost principle, the unit cost is the sum of all costs incurred in obtaining one unit of the inventory item in its present state. 4. Goods available for sale is the sum of the beginning inventory and the amount of goods purchased during the period. Cost of goods sold is the amount of goods available for sale less the ending inventory. 5. Beginning inventory is the stock of goods on hand (in inventory) at the start of the accounting period.
The Essay on Opportunity Cost Good Economic Resources
Utility: satisfaction derived from consuming a good. Profit: Profit = TR - TC = Q (AR-AC). Normal Profit: profit that the firm could make by using its resources in their next best use (opportunity cost) Supernormal profit: profit above normal profit. Welfare maximization: Adaptive Expectations: where decisions are based upon past information. Rational Expectations: where decisions are based on ...
Ending inventory is the stock of goods on hand (in inventory) at the end of the accounting period. The ending inventory of one period automatically becomes the beginning inventory of the next period. 6. (a)Average cost–This inventory costing method in a periodic inventory system is based on a weighted-average cost for the entire period. At the end of the accounting period the average cost is computed by dividing the goods available for sale in units into the cost of goods available for sale in dollars.
The computed unit cost then is used to determine the cost of goods sold for the period by multiplying the units sold by this average unit cost. Similarly, the ending inventory for the period is determined by multiplying this average unit cost by the number of units on hand. (b)FIFO–This inventory costing method views the first units purchased as the first units sold. Under this method cost of goods sold is costed at the oldest unit costs, and the ending inventory is costed at the newest unit costs. c)LIFO–This inventory costing method assumes that the last units purchased are the first units sold. Under this method cost of goods sold is costed at the latest unit costs and the ending inventory is costed at the oldest unit costs. (d)Specific identification–This inventory costing method requires that each item in the beginning inventory and each item purchased during the period be identified specifically so that its unit cost can be determined by identifying the specific item sold. This method usually requires that each item be marked, often with a code that indicates its cost.
When it is sold, that unit cost is the cost of goods sold amount. It often is characterized as a pick-and-choose method. When the ending inventory is taken, the specific items on hand, valued at the cost indicated on each of them, is the ending inventory amount. 7. The specific identification method of inventory costing is subject to manipulation. Manipulation is possible because one can, at the time of each sale, select (pick and choose) from the shelf the item that has the highest or the lowest (or some other) unit cost with no particular rationale for the choice.
The Essay on Inventory Management 2
The relationship between inventory management and transport is a complicated an interesting one. A lot of attention has been given to this relationship. Through logical thinking it can be deduced that there is a direct relationship between transport and inventory management. If inventory is managed better, transport performance can become better. This paper will discuss the inventory management- ...
The rationale may be that it is desired to influence, by arbitrary choice, both the amount of income and the amount of ending inventory to be reported on the financial statements. To illustrate, assume item A is stocked and three are on the shelf. One cost $100; the second one cost $115; and the third cost $125. Now assume that one unit is sold for $200. If it is assumed arbitrarily that the first unit is sold, the gross profit will be $100; if the second unit is selected, the gross profit will be $85; or alternatively, if the third unit is selected, the gross profit will be $75.
Thus, the amount of gross profit (and income) will vary significantly depending upon which one of the three is selected arbitrarily from the shelf for this particular sale. This assumes that all three items are identical in every respect except for their unit costs. Of course, the selection of a different unit cost, in this case, also will influence the ending inventory for the two remaining items. 8. LIFO and FIFO have opposite effects on the inventory amount reported under assets on the balance sheet.
The ending inventory is based upon either the oldest unit cost or the newest unit cost, depending upon which method is used. Under FIFO, the ending inventory is costed at the latest unit costs, and under LIFO, the ending inventory is costed at the oldest unit costs. Therefore, when prices are rising, the ending inventory reported on the balance sheet will be higher under FIFO than under LIFO. Conversely, when prices are falling the ending inventory on the balance sheet will be higher under LIFO than under FIFO. 9.
LIFO versus FIFO will affect the income statement in two ways: (1) the amount of cost of goods sold and (2) income. When the prices are rising, FIFO will give a lower cost of goods sold amount and hence a higher income amount than will LIFO. In contrast, when prices are falling, FIFO will give a higher cost of goods sold amount and, as a result, a lower income amount. 10. When prices are rising, LIFO causes a lower taxable income than does FIFO. Therefore, when prices are rising, income tax is less under LIFO than FIFO. A lower tax bill saves cash (reduces cash outflow for income tax).
The Essay on Auto Data System Cost Inventory
XYZ QUICK LUBE Co. The purpose of this exercise is to design a single user system, to solve the needs of a startup business. The business I chose is a service oriented, automotive oil change company. This system will need to satisfy the business needs of a small company, including database queries, inventory management, customer tracking, form generating, accounting, and many other functions. This ...
The total amount of cash saved is the difference between LIFO and FIFO inventory amounts multiplied by the income tax rate. 11. LCM is applied when market (defined as current replacement cost) is lower than the cost of units on hand. The ending inventory is valued at market (lower), which (a) reduces net income and (b) reduces the inventory amount reported on the balance sheet.
The effect of applying LCM is to include the holding loss on the income statement (as a part of CGS) in the period in which the replacement cost drops below cost rather than in the period of actual sale. 2. When a perpetual inventory system is used, the unit cost must be known for each item sold at the date of each sale because at that time two things happen: (a) the units sold and their costs are removed from the perpetual inventory record and the new inventory balance is determined; (b) the cost of goods sold is determined from the perpetual inventory record and an entry in the accounts is made as a debit to Cost of goods sold and a credit to Inventory.
In contrast, when a periodic inventory system is used the unit cost need not be known at the date of each sale. In fact, the periodic system is designed so that cost of goods sold for each sale is not known at the time of sale. At the end of the period, under the periodic inventory system, cost of goods sold is determined by adding the beginning inventory to the total goods purchased for the period and subtracting from that total the ending inventory amount.
