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Class 6 Inventory + Class 7

Accounting

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20 views

Class 6 Inventory + Class 7

Accounting

Uploaded by

polinapechenenko
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Inventory Overview

Inventory Definition

 Assets awaiting sale as part of the firm's principal activity.


 Types of Firms:
o Merchandising Firms: Sell purchased goods.
o Manufacturing Firms: Produce and sell goods created within
the firm.

Inventory Equations

 Purchase Equation: Gross Purchases + Transportation In - Purchase


Returns and Allowances - Purchase Discounts = Net Purchases.
 Inventory Equation: (Opening Inventory + Net Purchases) - Cost of
Goods Sold (COGS) = Ending Inventory.
 Cost of Goods Sold Equation: (Opening Inventory + Net Purchases)
- Ending Inventory = COGS.

Inventory Methods

 Periodic Inventory System:


o Calculates COGS and Ending Inventory at the end of the period.
o Advantage: Requires less frequent bookkeeping.
o Disadvantage: Does not provide up-to-date inventory
information.
 Perpetual Inventory System:
o Updates COGS and inventory balances continuously after each
transaction.
o More accurate and useful for real-time tracking of inventory
levels.

Cost Flow Assumptions

 Specific Identification:
o Tracks individual items, often used for high-value or unique
products (e.g., luxury cars, airplanes).
o Provides the most accurate matching of cost and revenue but
requires detailed record-keeping.
 FIFO (First-In, First-Out):
o Assumes the oldest inventory is sold first. Commonly used in
Canada and is effective in rising price environments to reflect
higher net income.
 LIFO (Last-In, First-Out):
o Assumes the newest inventory is sold first. Discontinued in
Canada but used by non-Canadian firms. Tends to minimize
taxes in inflationary periods by showing lower net income.
 Weighted Average Cost:
o Calculates an average cost per unit by dividing the total cost by
the total number of units available. It considers larger purchases'
impact on the average.
o Used under both periodic and perpetual systems.

Inventory Valuation

 Lower of Cost and Market (LCM):


o Valuation method that ensures inventory is reported at the lower
of its historical cost or market value.
o Market value varies:
 Canada: Net Realizable Value (NRV).
 U.S.: Replacement Cost.
o This conservative approach recognizes losses but not unrealized
gains.
 Gross Profit Method:
o Estimates inventory value when exact counts are unavailable,
useful in cases like fire or disaster.
 Retail Inventory Method:
o A variation of the gross profit method, used primarily by retailers
for convenience.

Inventory Errors

 Can impact financial statements for two periods:


o An understatement in one year results in an overstatement the
next year, balancing retained earnings over the two years.
o Effects are measured using the COGS and net income equations.
Additional Concepts

 Physical vs. Cost Flow:


o The physical movement of inventory may not align with the cost
flow method chosen for accounting.
 Impact of Price Levels:
o Rising Prices: FIFO shows the highest net income, while LIFO
shows the lowest.
o Falling Prices: FIFO shows the lowest net income, while LIFO
shows the highest.

Capital Assets

1. Definition:
a. Assets used in production or service provision, with the intention
of long-term use (not for resale).
b. Examples include property, plant, equipment (PPE), and natural
resource properties.
c. Three balance sheet classifications: property, plant and
equipment, intangible assets.
2. Accounting for Capital Assets:
a. At Acquisition: Includes purchase price, commissions, taxes,
obligations to dismantle, and other necessary costs to get the
asset ready for use. Historical cost
b. During Use: Distinguishes between maintenance expenses and
improvements that extend asset life or enhance capacity.
c. Depreciation Methods: (accumulated depreciation is a contra-
asset)
i. Straight-Line: Even distribution of cost over useful life.
Book value (BV) = Cost – Acc. Dep
ii. Units of Production/Activity methods: Based on asset
usage.
Example: Example: ◼ A truck is $11,000 at cost, residual
$2,000. What is the depreciation expense in year 3 if the
truck is expected to be driven 90,000 Km in total? (Do not
look at the year, but the km. Driven)
Step1: ✓ Per Km depreciation= (11,000 -2000)/90,000 =
$.10
Step2:
✓ 30,000Km Yr 1: (11000-2000)*(30000/90000)=3000
✓ 15,000 Km Yr 2: (11000-2000)*(15000/90000)=1500
✓ 45,000 Km Yr 3 (11000-2000)*(45000/90000)=4500

iii. Declining Balance: Higher depreciation expense early in


the asset's life. (do not consider residual)

d. Disposal: Recognizing gains or losses when an asset is sold or


scrapped.
3. Depreciation Examples:
a. Straight-line, units of activity, and declining balance methods are
illustrated with examples of trucks.
4. Intangible Assets:
a. Assets without physical substance, like patents, copyrights, and
goodwill.
b. Amortized over their useful lives, with some exceptions (e.g.,
goodwill is not amortized but tested for impairment).
5. Impairment of Assets:
a. Testing occurs when the carrying value exceeds fair value.
Losses are recorded, and the asset’s value is adjusted
accordingly.

Time Value of Money (TVM)

1. Concept:
a. Money today is worth more than the same amount in the future

b. Simple Interest: I=P×r×tI = P \times r \times tI=P×r×t


due to earning potential (interest).
c. Compound Interest: Interest calculated on the initial principal,
which grows over time.
2. Present Value and Future Value:
a. Calculation methods for determining the present and future
values of single amounts and annuities.
b. Annuities: Stream of equal payments over time, calculated as
ordinary (end of period) or due (start of period).
3. Valuation of Assets and Liabilities:
a. Longer time periods require using present value for accurate
valuation.
b. Examples are provided for calculating present value of future
sums.

These points cover the essentials of Chapter 9. Let me know if you need
further details on any specific section!

Property, plant and equipment:

• Land (PROPERTY) cost includes: Purchase price, Commissions, Survey and


legal fees, Back property taxes paid, Grading and removing unwanted
buildings

Less: Any proceeds from salvage.

Doesn't depreciate

• Land improvements: Parking lots, Driveways, Signs, Fences, Sprinkler


systems

Depreciates

Leasehold Improvements – depreciates over lease term

• Buildings

Office equipment • Machinery • Motor vehicles • Furniture and fixtures • Etc.

Basket Purchases: 2 or more assets acquired with a single cheque,


separate G/L, use relative sales value method (appraisal)

EXAMPLE Compute the land, building and equipment cost:

• Pay $595,000 plus $5,000 legal fees for land, building and equipment
(600,000 total of what we payed)
• Land is appraised for $375,000, the building for $300,000, and the
equipment for $75,000 (750 total worth)

Initial Allocation

• Land = 375/750 x 600 = 300

• Building = 300/750 x 600 = 240

• Equipment = 75/750 x 600 = 60

• cost $3,000 to demolish an unneeded shed on the property (land)

• architectural fees of $50,000 and additional construction costs of $100,000


were incurred to adapt the building for its intended use (building)

• An additional $20,000 was incurred for relocating and testing the


equipment (equipment)

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