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tangible property that is held for sale in the normal course of business, or used to produce goods or services for sale.
Goods or merchandise held for resale in the normal course of business. usually are acquired in a finished condition and are ready for sale without further processing.
- Raw Materials: items acquired for processing into finished goods.
- Included in raw materials inventory until they are used, where they become work in progress.
Manufacturing Inventories (conti)
- Work in progress: goods in process of being manufactured but not yet complete.
- When completed work in process inventory becomes finished goods inventory.
Manufacturing Inventories (cont.)
Finished goods: Manufactured goods that are complete and ready for sale.
Cost of Goods Sold
- Directly related to sales revenue.
- Unites X unit costs
- Beginning Inventory (BI) + purchases (P) = Goods available for sale during the period.
- Ending Inventory (EI): What remains unsold at the end of the period. (balance sheet)
- Cost of goods sold: portion of goods available for sale that is sold (income statement)
- Equation: BI + P - EI= CGS
- Cost of each item sold is individually identified and recorded as cost of goods sold.
- Have to keep track of each purchases cost of each item.
- Earliest goods purchases (first ones in) are the first goods sold
- The last goods purchased are left in ending inventory.
- Allocates the oldest unit costs to cost of goods sold and newest unit costs to ending inventory.
- Assumes that the most recently purchased goods ( the last ones in) are sold first and the oldest units are left in ending inventory.
- Allocates the newest unit costs to cost of goods sold, and the oldest unit costs to ending inventory.
- Uses the weighted average unit cost of the goods available for sale for both cost of goods sold and ending inventory.
- Average cost = Cost of goods available for sale/ number of units available for sale
Financial Statement Effects
- In general: Method that gives highest ending inventory amount, also gives lowest cost of goods sold and highest gross profit, income tax expense and income amounts.
- When unit costs are rising, LIFO produces lower income and lower inventory valuation than FIFO
- When unit costs are falling, LIFO produces higher income and higher inventory valuation that FIFO.
- 1. Net income: prefer to report higher earnings for companies
- 2. Income tax: prefer to pay the least amount of taxes allowed by law as late as possible
Increasing Cost Inventories
- LIFO used on tax return because it normally results in lower income taxes.
- LIFO conformity rule: if used on the income tax return must also be used to calculate inventory and cost of goods sold for the financial statements.
Decreasing Cost Inventories
- FIFO used for both the tax return and the financial statements.
- Produces the lowest tax payments for companies with decreasing cost inventories.
- Produces the highest cost of goods sold, lowest pretax earnings, thus lowest income tax liability.
LCM- Lower of cost or market
method departing from the cost principle; it serves to recognize a loss when replacement cost or net realizable value drops below cost.
is the current purchase price for identical goods.
- Cost of goods sold; average inventory
- Measures the company's success in balancing these conflicting goals.
- Higher the better
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