ch06 - CHAPTER 6 Reporting and Analyzing Inventory Study...

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CHAPTER 6 Reporting and Analyzing Inventory Study Objectives 1. Describe the steps in determining inventory quantities. 2. Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. 3. Explain the financial statement and tax effects of each of the inventory cost flow assumptions. 4. Explain the lower of cost or market basis of accounting for inventories. 5. Compute and interpret the inventory turnover ratio. 6. Describe the LIFO reserve and explain its importance for comparing results of different companies. Study Objective 1 - Describe the Steps in Determining Inventory Quantities In a merchandising company, inventory consists of many different items. These items have two common characteristics: (1) they are owned by the company and (2) they are in a form ready for sale to customers. Only one inventory classification, merchandise inventory , is needed to describe the many different items that make up the total inventory. In a manufacturing company , inventory is usually classified into three categories: Finished goods, Work in process, and Raw materials. Raw materials inventory the basic goods that will be used in production but have not yet been placed into production. Work in process —that portion of manufactured inventory that has been placed into the production process but is not yet complete. Finished goods inventory —items that are completed and ready for sale. By observing the levels and changes in the levels of these three inventory types, financial statement users can gain insight into management’s production plans. 6-1
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No matter whether they are using a periodic or perpetual inventory system, all companies need to determine inventory quantities at the end of the accounting period. If using a perpetual system, companies take a physical inventory at year-end for two purposes: (1) to check the accuracy of their perpetual inventory records and (2) to determine the amount of inventory lost due to wasted raw materials, shoplifting or employee theft.
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