Chapter 7 Inventories

Chapter 7 Inventories - Chapter 7 Inventories _ Chapter 7...

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Chapter 7 Inventories ______________________________________________ Chapter 7 comprehensively covers the topic of inventories, including the effects of inventory errors, internal controls, inventory costing methods, lower-of-cost-or-market adjustments, and estimating inventory. Internal control procedures that apply to inventories. Internal controls for inventory exist to (1) protect inventory from theft and damage and (2) ensure that inventory is reported accurately in the financial statements. Examples of how retail stores safeguard inventories might include cameras locked show cases, and inventory control tags. Effect of inventory errors on the financial statements It is crucially important to accurately count a business’ ending inventory by listing the financial statement items affected by physical inventory errors. The physical inventory count is the basis for recording the adjusting entry for inventory shrinkage. The adjusting entry to reduce merchandise inventory for shrinkage is: Cost of Merchandise Sold……… XXX Merchandise Inventory… XXX If the physical inventory count is understated, too much shrinkage will be recorded. This will understate Merchandise Inventory on the Balance Sheet and overstate Cost of Merchandise Sold on the Income Statement. If the physical inventory count is overstated, the accountant will not record enough shrinkage. This will overstate Merchandise Inventory on the Balance Sheet and understate Cost of Merchandise Sold. An incorrect value for Cost of Merchandise Sold effects a company’s reported net income. If net income is not computed accurately, this incorrect amount will be closed into the owner’s capital account, causing owner’s equity to be misstated. Three inventory cost flow assumptions and how they impact the income statement and balance sheet. Inventory Costing Methods First-in, First-out (FIFO) Method Last-in, First-out (LIFO) Method Average Cost Method Method ( out the door) Ending Inventory
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First-in, first- out First items Last Items Still Here (LISH) Last-in, first- out Last items First Items Still Here (FISH) To establish the need for inventory costing methods, let’s study the following. At the beginning of the current year, John Bach opened a music store that sells compact disks of classical music. The store is called Strictly Classical. During the year, Strictly Classical purchased 10,000 compact disks for $7 each. At the end of the year, a physical inventory count revealed that 1,000 of those disks were on hand. What value should be shown for ending inventory on the year-end balance sheet? (Answer: 1,000 x $7 = $7,000). How realistic is it that every item of merchandise that a business purchases during a year has the same cost? Answer: Not very realistic, except perhaps in electronic industry. Assume instead that Strictly Classical purchased 10,000 compact disks as follows:
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This note was uploaded on 04/03/2010 for the course ACTG 1A 1 taught by Professor E during the Spring '10 term at Foothill College.

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Chapter 7 Inventories - Chapter 7 Inventories _ Chapter 7...

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