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    This document provides an overview of key concepts relating to inventory accounting, including how to determine inventory ownership, acceptable cost flow methods like FIFO and LIFO, calculating average cost, factors for choosing a cost flow method, valuing inventory at the lower of cost or net realizable value, and liquidity ratios involving inventory turnover and days in inventory. Acceptable cost flow methods include specific identification, FIFO, LIFO, and average cost. Inventory is valued at the lower of original cost or net realizable value, with write-downs impacting cost of goods sold. Liquidity ratios like inventory turnover and days in inventory measure how quickly inventory is sold.

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    This document provides an overview of key concepts relating to inventory accounting, including how to determine inventory ownership, acceptable cost flow methods like FIFO and LIFO, calculating average cost, factors for choosing a cost flow method, valuing inventory at the lower of cost or net realizable value, and liquidity ratios involving inventory turnover and days in inventory. Acceptable cost flow methods include specific identification, FIFO, LIFO, and average cost. Inventory is valued at the lower of original cost or net realizable value, with write-downs impacting cost of goods sold. Liquidity ratios like inventory turnover and days in inventory measure how quickly inventory is sold.

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    12 views2 pages

    Tutoring Session 3

    Uploaded by

    Murtaza Hussain
    This document provides an overview of key concepts relating to inventory accounting, including how to determine inventory ownership, acceptable cost flow methods like FIFO and LIFO, calculating average cost, factors for choosing a cost flow method, valuing inventory at the lower of cost or net realizable value, and liquidity ratios involving inventory turnover and days in inventory. Acceptable cost flow methods include specific identification, FIFO, LIFO, and average cost. Inventory is valued at the lower of original cost or net realizable value, with write-downs impacting cost of goods sold. Liquidity ratios like inventory turnover and days in inventory measure how quickly inventory is sold.

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    of 2

    Financial Accounting – Study Guide

    Chapter 6: Reporting and Analyzing Inventory

    Determining Ownership of Inventory

     Goods in transit are owned by the company that has a legal title to them.
     Use FOB destination and FOB shipping point to determine the terms of sale.
     Consigned goods are owned by the owner (consignor), not the holder of the goods (consignee).

    Specific Identification Cost Formula

     Tracks the physical flow of inventory and allocates the exact cost to merchandise.
     Can only be used under 2 conditions:
    1. When the exact costs of each good can be determined.
    2. When the goods are not easily interchangeable.

    First In, First Out (FIFO) Cost Formula

     Assumes that the cost of the first item purchased is the cost of first item sold.

    Last In, First Out (LIFO) Cost Formula

     Assumes that the cost of the last item purchased is the cost of first item sold.
     Has been deemed inappropriate for Canadian GAAP/IFRS.
     If prices are rising, LIFO undervalues Inventory on statement of financial position, increases Cost of
    Goods Sold, and lowers net income.

    Average Cost Formula

     Used when physical flow of inventory cannot specifically be measured.


     New weighted average is calculated after each purchase.
     Weighted Average Unit = Cost of Goods Available for Sale / Units Available for Sale.

    Choice of Cost Formula

     Choose a formula that best represents the physical flow of inventory.


     Choose a formula that reports ending inventory at recent cost.
     Use the same formula for inventories of similar nature and usage.

    Valuing Inventory

     Net realizable value: selling price of an inventory item, less any costs required to make it sellable.
     Lower of cost and net realizable value: basis for stating inventory at the lower of its original cost and
    its net realizable value at the end of the accounting period.
     When the net realizable value is less than cost, the value is written down.
     Credit Inventory by the amount of write-down and debit the Cost of Goods Sold.
    Liquidity Ratios: Inventory Turnover and Days in Inventory

    Ratio Description
    Inventory Turnover  Measures number of times inventory is sold.
     Inventory Turnover = Cost of Goods Sold / Average Inventory.
    Days in Inventory  Measures number of days inventory is on hand.
     Days in Inventory = 365 Days / Inventory Turnover.

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