One of the largest current assets of all retail or wholesale business
Sales of merchandise is major source of revenue
consists of all goods owned and held for sale to customers
converted into cash within the operating cycle
listed immediately after A/R on Balance Sheet
In a merchandising company, all of the inventory is purchased in a ready-to-sell condition
Manufacturing company has 3 types: 1. finished goods - goods ready to sell 2. work in process - good in the process of being manufactured 3.materials - raw materials and component parts used in the manufacture of finished products. All three listed in current asset section of balance sheet
The Flow of Inventory Costs
As items are sold from inventory, their costs are removed from asset and transferred into cost of goods sold, which is offset against sales revenue
In perpetual inventory system, accounting entries parallel this flow of costs. - When merchandise in purchased, its cost (net of allowable cash discounts) is DR Inventory. - Merchandise sold : DR Cost of Goods Sold, CR Inventory
As merchandise is sold, its cost is removed from the Inventory account and debited to the Cost of Goods Sold account
The valuation of inventory and of the cost of goods sold are of critical importance to managers and to users of financial statements.
In most cases, Inventory is the largest current asset, and costs of goods sold is the largest expense
These two accounts have significant effect upon the financial statement subtotals and ratios used in evaluating the solvency and profitability of the business
can be used only when the actual costs of individual units of merchandise can be determined from the accounting records.
the actual cost of this particular unit then is used in recording cost of goods sold
Cost Flow Assumptions
If the items in inventory are similar in terms of cost, function, and sales value, it is not appropriate for the seller to use specific identification method in determining CGS. 1. Average Cost - This assumption values all merchandise (units sold and units remaining) at the average per-unit cost. 2. First in, First-out (FIFO) - goods first sold are the oldest goods on hand 3. Last-in, first out (LIFO) - lastest goods are first to be sold
Evaluation of the Methods
Specific Identification - best suited for high-priced inventories, low volume, unique, non-homogeneous items - when units are identical or nearly identical, result from this method maybe misleading
Average Cost - identical items will have the same accounting values only under this method - avoid short-comings of "specific" method
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