Chapter 7 - Chapter 7 Reporting and Interpreting Cost of...

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Chapter 7 - Reporting and Interpreting Cost of Goods Sold and Inventory Overview Costs flow into inventory when goods are purchased or manufactured and flow out when the goods are sold. In conformity with the matching principle, the total cost of the goods sold during the period must be matched with the sales revenue earned during the period. Cost of Goods Sold measures the cost of inventory that was sold while Sales Revenue measures the selling price of the same inventory. When cost of goods sold is deducted from sales revenue for the period, the difference is called gross profit or gross margin on sales. From this amount, the remaining operating expenses must be deducted to derive net income. This chapter focuses on the problem of measuring cost of goods sold and ending inventory when unit costs change during the period. Inventory should include all the items held for resale that the entity owns. When there are different unit cost amounts, a rational and systematic method must be used to allocate costs to the units remaining in inventory and to the units sold. This chapter discusses four different inventory costing methods and their applications in different economic circumstances. The methods discussed are specific identification, FIFO, LIFO, and average cost. Each of these inventory costing methods is in conformity with GAAP. The selection of a method of inventory costing is important because it will affect reported income, income tax expense (and hence cash flow), and the inventory valuation reported on the balance sheet. In a period of rising prices, FIFO normally results in a higher net income than does LIFO; in a period of falling prices, the opposite result occurs. Public companies using LIFO provide footnote disclosures that allow conversion of inventory and cost of goods sold to FIFO amounts. Business Background Inventory is a major concern to all merchandisers and manufacturers. Beginning and ending inventories are used in the calculation of Cost of Goods Sold on the Income Statement. A good accounting system is an important factor to furnish information for proper inventory management. It should provide for accurate data, timely information, and the protection of the inventory assets. Chapter 7 Review Notes Acc 311 - Page 1
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Nature of Inventory Inventory is tangible property held for sale in the normal course of business or that will be used in producing goods or services for sale. There are various types of inventories depending on the industry of a company. Merchandise inventory includes goods (merchandise) held for resale in the ordinary course of business. These goods are usually in a finished condition when acquired.
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