Measuring and Reporting Inventories

Summary :

This chapter explains how inventory errors affect financial statement items, which costs belong in inventory, and how to calculate the cost of ending inventory and cost of goods sold under the four major inventory costing methods, using both periodic and perpetual procedures, along with net realizable value and the lower-of-cost-or-market rule.

Inventory errors and inventoriable costs

An error in counting or valuing ending inventory flows directly into cost of goods sold and net income, and because ending inventory of one period becomes beginning inventory of the next, the error affects two periods' statements before it finally corrects itself. The chapter also identifies which costs, beyond the purchase price alone, properly belong in the inventory figure reported on the balance sheet.

The four costing methods for measuring and reporting inventories

Specific identification, first-in first-out, last-in first-out, and weighted average each assign cost to units sold and units remaining in inventory differently, and can produce materially different reported income and inventory values from the exact same underlying purchases. The chapter works through calculating cost of ending inventory and cost of goods sold under each of these four methods in turn.

Net realizable value and lower-of-cost-or-market

Inventory is not always carried at its originally recorded cost. When net realizable value falls below cost, the lower-of-cost-or-market rule requires writing the inventory down, so the balance sheet does not overstate an asset whose value has genuinely declined since purchase. The chapter shows how this adjustment is calculated, applied, and recorded in the accounts.