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CHAPTER 7 CLASS NOTES INVENTORIES AND COST OF GOODS SOLD Inventory is an asset that is held for resale in the normal course of business of a merchandiser, either a wholesaler or retailer. They buy the goods in a finished state and sell it in the same finished state. For a manufacturer, part of the inventory is held for sale as finished goods or product, while other parts of the inventory are held in a raw or semi- finished state to be used in the production of finished product. To date, all our examples of inventory have been those of a merchandiser. We will now look at the inventory in terms of a manufacturer. A manufacturer has three categories of inventory: raw materials, work in process, and finished goods. Raw Materials are the ingredients used in making products, i.e. steel for producing automobile frames. Work-in-Process are the costs associated with inventory that has been started in production, but not completed by the end of the accounting period. . Finished Goods represent product that has been completed and is ready for sale to the customer, either a wholesaler, retailer, another manufacturer, or the consumer. The valuation of inventory is an important process as it affects the assets on the balance sheet as well as the determination of cost of sales on the income statement, which in turn impacts a company’s net income. The typical determination of valuation of inventory is as follows: Beginning Inventory XXXX Add- Purchases XXXX Cost of goods available for sale XXXX Less- Cost of Sales XXXX Ending Inventory XXXX The key is to first determine the cost of each unit of inventory purchased and therefore, the cost elements to be included in inventory are very important. Secondly, to determine the number of units remaining in ending inventory and multiply this by the appropriate unit cost. There are two basic approaches to ascertain the Inventory and cost of sales balances--- Perpetual or Periodic Systems. The perpetual system allows a company to determine its inventory as each individual purchase and sale are recorded. Therefore, when a sale is recorded, the cost of the product sold can be recorded in cost of sales at the same time. The balances in the perpetual records at the end of the period are used to verify the ending inventory, which when subtracted from the cost of goods available for sale should equal the cost sales amount. The periodic system determines the inventory at a point in time, usually at the end of an accounting period, by counting the merchandise physically on hand and costing it accordingly through a review of prices paid as shown in the purchasing records. Once you determine this number and subtract it from goods available for sale, the result is the cost of sales.
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-2- Cost of Sales ( or cost of goods sold) is also made up of a number of individual account balances and an accountant or business person needs to understand how this amount that eventually appears on the income statement is determined. One of the most important
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This note was uploaded on 04/19/2008 for the course ACCT 151 taught by Professor Largay during the Spring '07 term at Lehigh University .

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