Principles of Accounting: Chapter Eight

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Chapter Summary

Chapter 8 identifies the appropriate items to include inventory, including the treatment of goods in transit and consigned goods. Further, a company must allocate total cost of goods available for sale (beginning inventory plus purchases) between ending inventory and cost of goods sold. This requires the adoption of a costing technique. Methods include first-in, first-out (FIFO), last-in, first-out (LIFO), and weighted average. These techniques attribute cost to units based on the assumed cost flow pattern, and each is illustrated in the chapter. Inventory costing can be applied on either a periodic or perpetual basis.

In addition to assigning costs to units, it is also necessary to assess whether inventory value is impaired. This requires implementation of lower-of-cost-or-market testing, which is a two-step process to identify "market" and then compare that value to cost. The chapter continues with an examination of the gross profit technique for preparing inventory estimates, and the retail method that is quite useful if specific conditions are met. The chapter concludes by examining inventory management, the inventory turnover ratio, and the effects of errors.

To aid in your understanding of this chapter, exercises with solutions are available for free download at Bookboon.com. You will find these exercises very helpful in providing models and guidelines for solving all of the problems at principlesofaccounting.com.

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Objectives: Chapter Eight

The following learning objectives for this chapter map to the curriculum design for our online university-level courses. These courses are offered through Utah State University, and result in the awarding of up to 6 hours of highly transferrable college credit. To learn more, check out the classroom link.

The correct components to include in inventory.

Identify three basic categories of inventory, and know where inventory is reported on the balance sheet.

What is meant by the term "F.O.B."?

How are goods in transit classified on the financial statements?

How are goods on consignment classified on the financial statements?

Inventory costing methods.

Understand cost of goods available for sale, and how this cost must be allocated to inventory and cost of goods sold.

Be able to apply inventory costing methods such as FIFO, LIFO, weighted average, and specific identification.

Distinguish between the physical flow of goods and their cost flow for accounting purposes.

Know the general impacts of alternative cost flow assumptions, with special attention to the tax and financial statement results.

Must inventory methods be used consistently?

The perpetual system for valuing inventory.

Distinguish between a periodic and a perpetual inventory system.

Calculate ending inventory and cost of goods sold under a perpetual system, using FIFO, LIFO, or moving average methods.

Understand how the accounting records are updated with a perpetual system (versus a periodic system).

Lower-of-cost-or-market inventory valuation adjustments.

What is the purpose of the lower-of-cost-or-market rule?

How is "market" generally defined in the lower-of-cost-or-market method?

Be able to perform lower-of-cost-or-market method computations.

Two inventory estimation techniques: the gross profit and retail methods.

Understand the occasional need for inventory estimates.

Be able to apply the gross profit method.

Understand the benefits and application of the retail inventory method.

Inventory management and monitoring, and the impact of errors.

Be able to calculate the inventory turnover ratio.

Understand the importance of managing inventory investment and activity.

Consider the impact of inventory errors, and note the effect of these errors on subsequent accounting periods.

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