Inventory Issues (Links to all examples are below)

Authoritative Standards

Inventory System

periodic

Under the periodic system all purchases are recorded in a separate account (purchases).  At the end of the accounting period, the purchases and related accounts (freight-in; purchases returns/allowances; purchase discounts (lost)) are closed to (added to) the inventory account.  The ending inventory is determined through a physical count.  The difference between beginning inventory plus purchases minus the ending inventory is considered cost of goods sold.

Example:
Inventory (12/31/97) Purchases Freight-in Purchase discounts Purchase returns Inventory (12/31/1998) per count Cost of goods sold $2,400 38,000   1,000 (   700) (1,200) (4,500) $35,000
Perpetual

In the perpetual system, all purchases are recorded directly (added) to inventory.  Each time a sale occurs, the cost of goods sold is also recorded to (subtracted from) the inventory account.  At the end of the accounting period the cost of actual goods sold is readily available.  A physical count is taken to determine the actual inventory at hand.  The difference between the actual inventory at the end of the accounting period and the balance in the inventory account identifies the amount of goods that are (a) not at hand and (b) were not sold ---> This is referred to as shrinkage.  It arises from theft, spoilage, etc.

If the amount is reasonable (< than 5%), it is added to cost of goods sold.  Unusual amounts of shrinkage must be disclosed separately and are classified as losses.

Example:

Inventory (12/31/97)

Purchases

Freight-in

Purchase discounts

Purchase returns

Cost of goods sold (per records)

Inventory (12/31/98) per records

Inventory (12/31/98) per count

Shrinkage

Cost of goods sold reported

         $2,400

38,000

  1,000

(   700)

(1,200)

$34,000

$ 5,500

$ 4,500

$ 1,000

$35,000

Inventory Cost Determination

Merchandising Company

Manufacturing Company

Inventory Valuation Issues

historical cost

lower of cost or market net realizable value

Inventory Cost Flow Assumptions

specific identification

average cost FIFO (first-in, first-out) LIFO (lst-in, first-out)

Problem areas and solutions - "Involuntary LIFO liquidation"
Determination of Ending Inventory
Physical count
Problem areas:

Consignments "parking arrangements" "Right-of-return" sales

Estimation Methods

Gross Profit method and the Retail Inventory Method.

Retail Dollar Value LIFO

return to chapter 7 resource page