Handout 08 - INTRODUCTION TO FINANCIAL ACCOUNTING 33:010:272 SECTIONS 08 09 |FALL 2011 PROFESSOR JULIAN YEO Class Notes 8 Assets Inventory In this

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Copyright © 2011 1 You may only share these materials with current term students. I NTRODUCTION TO F INANCIAL A CCOUNTING 33:010:272 S ECTIONS 08 09 |FALL 2011 P ROFESSOR J ULIAN Y EO Class Notes 8: Assets - Inventory In this document, we address the following issues related to inventories. 1. What are inventories? 2. How do we account for inventory using the inventory equation? 3. How does the choice of Inventory System affect the amount of inventory reported? 4. How does the assumption of cost flow affect the amount of inventory reported? 5. How do I compare firms that report their inventory under different cost flow assumptions (FIFO vs LIFO)? Learning Objectives Appreciate that inventories are all subject to Lower of Cost or Market (LCM) rule Appreciate the difference between inventories for a merchandizing firm and a manufacturing firm Understand how manufacturing costs (Direct Materials, Direct Labor, and Manufacturing Overhead) are capitalized in the following three accounts o Raw Materials Inventory o Work-in-Process Inventory o Finished Goods Inventory Able to account for inventories under both the Perpetual and the Periodic Inventory Systems Journal Entries under each system Understand Cost Flow Assumptions and report inventories under each of the following assumption: Specific identification Weighted average FIFO LIFO Able to compare inventories under LIFO and FIFO LIFO reserve LIFO Effect (∆LIFO reserve)
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Copyright © 2010 2 You may only share these materials with current term students. 1. What are inventories? Definition - Inventory consists of all goods owned by the company, which are held for sale in the ordinary course of business. For merchandising firms , inventories are physical goods that firms acquire for sale. For manufacturing firms , inventories consist of raw materials inventory (including both direct and indirect raw materials), work-in-process inventory and finished goods inventory. Inventories are classified as a current asset and appear on the balance sheet at the lower of cost or market value. Following the conservatism principle, losses due to a decrease below cost in the market value of inventory are recognized in the period of the market- value decline. In contrast, market value gains (and cost recoveries) are not recognized until realized, i.e., until the inventory is sold. This procedure is known as the Lower of Cost or Market (LCM) rule - i.e., the unit cost of an inventory is identified as the lower of the original (or already reduced) cost or the current market price (calculated either as net-realizable-value or replacement costs) at the end of the current period. The remainder of this handout discusses and compares the different methods used in
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Handout 08 - INTRODUCTION TO FINANCIAL ACCOUNTING 33:010:272 SECTIONS 08 09 |FALL 2011 PROFESSOR JULIAN YEO Class Notes 8 Assets Inventory In this

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