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.

Exercises

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Key Terms

Key Terms: Chapter Eight

conservatism

A general principle of accounting measurement; when in doubt understate assets and income and overstate liabilities

consignment

To place inventory in the custody of another party without requiring them to purchase it, as a sales agent

cost flow assumption

An assumption about how costs are assigned to inventory in the accounting records

first-in, first-out

FIFO; An inventory cost flow assumption based on the notion that the earliest costs are to be assigned to units sold

goods in transit

Goods in the process of being transported to the buyer; ownership is based on freight terms

gross profit method

An technique that purports to estimate inventory and cost of goods sold by applying historic percentage relationships to observable sales information

last-in, first-out method

LIFO; An inventory cost flow assumption based on the notion that the most recent costs are to be assigned to units sold

lower-of-cost-or-market

To report inventory at the lower of its cost or market value; market is generally defined as replacement cost

moving-average method

Under the perpetual inventory system; to recompute running average cost with each purchase transaction

physical inventory

The process of counting inventory actually on hand

retail inventory method

A inventory costing technique used by retailers that extrapolates inventory values by applying cost-to-retail percentages to known sales and purchase transactions

specific identification method

Inventory costing method where the actual cost of each unit of merchandise is tracked and used for accounting purposes

weighted-average inventory method

Under the periodic inventory system; inventory cost is based on the average cost of units purchased giving consideration to the quantities purchased at different prices