Chapter 8 Class Notes

Chapter 8 Class Notes - Chapter 8 VALUATION OF INVENTORIES...

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Chapter 8 VALUATION OF INVENTORIES: A COST-BASIS APPROACH Classification Issues Inventories are asset items that a company holds for sale in the ordinary course of business. The investment in inventory is often the largest current asset of merchandising (retail) and manufacturing businesses. Know the differences between a merchandiser’s inventory account (Merchandise Inventory or just Inventory) and a Manufacturer’s inventory accounts (Raw Materials, Work in Process, and Finished Goods). You will need to put in your notes the illustrations I put on the board for the cost flows of a merchandising company and the cost flows of a manufacturing company. Perpetual vs. Periodic Inventory Systems Companies typically use one of two types of systems for maintaining accurate inventory records for beginning inventory and purchases as well as Cost of Goods Sold and Ending Inventory: perpetual or periodic systems. Perpetual System A perpetual inventory system continuously tracks changes in the inventory account. That is, a company records all purchases and sales of goods directly in the inventory account as they occur. The accounting features of a perpetual inventory system are as follows: 1
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1. Purchases of merchandise for resale or raw materials for production are debited to Inventory rather than to Purchases. 2. Freight-In, purchase returns and allowances, and purchase discounts are debited or credited directly to Inventory rather than in separate stand alone accounts. 3. Cost of Goods Sold is recorded at the time of each sale by debiting Cost of Goods Sold and crediting Inventory. 4. A subsidiary ledger of individual inventory records is maintained as a control measure. The subsidiary records show the quantity and cost of each type of inventory on hand. 5. A physical count is done (normally annually) to verify the Ending Inventory balance. The perpetual system provides a continuous record of the balances in both the Inventory account and the Cost of Goods Sold account. Periodic System Under this system, the quantity of inventory on hand is determined only periodically. A company records all acquisitions of inventory during the accounting period by debiting the Purchases account. It then adds the total in the Purchases account (net) at the end of the accounting period to the cost of the inventory on hand at the beginning of the period. This sum determines the total Cost of Goods Available for Sale during the period. To compute the cost of goods sold the company then subtracts the ending inventory from the cost of goods available for sale. Under a period inventory system, the cost of goods sold is a residual amount that depends on a physically counted ending inventory. Once a year, companies take the physical inventory count required by a periodic system. During the year, companies estimate ending inventories, or use a modified inventory system so as to obtain earlier information. The accounting features of a periodic system are:
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Chapter 8 Class Notes - Chapter 8 VALUATION OF INVENTORIES...

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