252 chapter 6 inventories 1 to estimate the cost of

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252 Chapter 6 Inventories 1 To estimate the cost of inventory when a physical inventory cannot be taken (e.g., the inventory is destroyed) or when it is inconvenient (e.g., during interim periods), companies can use estima- tion methods. We discuss these methods—gross profit method and retail inventory method—in Appendix 6B. 1. When the terms are FOB (free on board) shipping point , ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. 2. When the terms are FOB destination , ownership of the goods remains with the seller until the goods reach the buyer. If goods in transit at the statement date are ignored, inventory quantities may be seriously miscounted. Assume, for example, that Hargrove Company E T H I C S N O T E In a famous fraud, a salad oil company filled its storage tanks mostly with water. The oil rose to the top, so auditors thought the tanks were full of oil. The company also said it had more tanks than it really did: It repainted numbers on the tanks to confuse auditors. FOB Shipping Point FOB Destination Public Carrier Co. Seller Buyer Ownership passes to buyer here Public Carrier Co. Seller Buyer Ownership passes to buyer here Illustration 6-1 Terms of sale PDF Watermark Remover DEMO : Purchase from to remove the watermark
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has 20,000 units of inventory on hand on December 31. It also has the following goods in transit: (1) sales of 1,500 units shipped December 31 FOB destination, and (2) purchases of 2,500 units shipped FOB ship- ping point by the seller on December 31. Hargrove has legal title to both the 1,500 units sold and the 2,500 units purchased. If the company ignores the units in transit, it would understate inventory quantities by 4,000 units (1,500 H11001 2,500). As we will see later in the chapter, inaccurate inventory counts affect not only the inventory amount shown on the balance sheet but also the cost of goods sold calculation on the income statement. CONSIGNED GOODS In some lines of business, it is common to hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of the goods.These are called consigned goods . For example, you might have a used car that you would like to sell. If you take the item to a dealer, the dealer might be willing to put the car on its lot and charge you a commission if it is sold. Under this agreement the dealer would not take ownership of the car, which would still belong to you. Therefore, if an inventory count were taken, the car would not be included in the dealer’s inventory. Many car, boat, and antique dealers sell goods on consignment to keep their in- ventory costs down and to avoid the risk of purchasing an item that they won’t be able to sell. Today even some manufacturers are making consignment agreements with their suppliers in order to keep their inventory levels low.
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