Chapter 4. PREPARING FOR SALES Building Up Inventory; Establishing Credit Policies. IDIS 364 Spring 2007. PREPARING FOR SALES Acquiring Inventory and Establishing Credit Policies. Purchasing inventory (merchandising firms) Manufacturing inventory (manufacturing firms)
PREPARING FOR SALES
Building Up Inventory;
Establishing Credit Policies
IDIS 364 Spring 2007
Firms buy/manufacture inventory as the critical part of strategic plans to obtain revenues,but ...
In theory, all costs of acquiring inventory should be reflected in the inventory asset.
Theoretically, all costs of acquiring inventory should be capitalized as inventory cost
Purchase discounts ...
The exact location of subtotals in the format is a matter of preference.
What happens if a firm presumes that the purchase discounts will be taken, but misses the deadline?
The check will be for the gross amount billed and a Purchases Discounts Lost account develops, which is an excellent managerial aid since any balance this account indicates problems.
*The text examples use the periodic system to simplify the computations.
Two companies are contrasted in the following display of the Cost of Goods Sold section of an Income Statement.
Which company is in manufacturing (and what do the abbreviations mean)?
Costs to be consistently assigned to ending inventory is a function of the cost flow assumptions used for homogeneous items:
What about non-homogeneous items?
The presumption is that uniqueitems would be such that the specific identification method would apply (e.g., artworks, cars, antiques, race horses). Individual tagging of items, if practical!
[Opposite results are reported during deflationary times.]
Is LIFO common in international business? Is LIFO, which is acceptable per GAAP, also OK for income tax purposes?
No. The U.S. is the only major country to allow LIFO. As to taxes, if LIFO is used for financial reporting purposes, the IRS requires that it be used for tax purposes!
Annual inventory activity follows:
The cost of the first 9,000 units purchased: 9,000 beginning inventory × $6
Details: (8,000 × $8.50) + ($15,000 × $8) + (10,000 × $7) + (5,000 × $6)
The cost of the last 9,000 units purchased: (8,000 × $8.50) + (1,000 × $8)
Details: (14,000 × $6) + (10,000 × $7) + (14,000 × $8)
$342,000 cost of goods available for sale 47,000 units available for sale
9,000 units × $7.2766
38,000 units × $7.2766
An excellent alternative provides a perpetual reading of the cost of inventory on hand. After every purchase, a new average is calculated (based on the prior balance plus the purchased items). Any items sold are issued at the then-current average cost.
(1) In a period of rising prices, LIFO has the smallest ending inventory and FIFO the largest.
(2) In a period of rising prices, LIFO has the largest cost of goods sold and FIFO the smallest.
(3) In a period of rising prices, FIFO has the largest gross profit and LIFO has the smallest.
2004: 300,000 × 1.00 = 300,000
2005: 300,000 + (110,000 × 1.10) = 421,000
2006: 300,000 + (100,000 × 1.10) = 410,000
NRV: Sales price minus cost to complete and dispose of the item.
Using NPM, a normal profit margin, is theoretically sound; it means that no profit is recognized until a sale is made!
Determine market value to be used in lower of cost or market computation based on the following assumed data.
(1) Ceiling = NRV
(2) R.C. = Current replacement cost
(3) Floor = NRV – NPM
(4) Designated market used for computing LCM by comparing market to cost.
The “direct write-off” method: No bad debt is recognized until a specific customer’s account is identified for a write-off.
Unacceptable under GAAP!
Borrowing using accounts receivable as collateral
If accepted in return for sale of inventory, the notes receivable are designated as Notes Receivable - Trade in the Balance Sheet.
The indirect approach to the SCF is thought by many to be somewhat difficult to interpret.
(1) Non-cash expenses and revenues affect net income, but not cash.
(2) Gains and losses are non-operational in nature for most companies.
(3) Reconciling items adjust from the accrual basis effects, reflected in net income, to the cash basis effects. (Deferred income tax assets and liabilities are discussed in Chapter 11.)