Page 308 - Accounting Principles (A Business Perspective)

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turnover could be the result of a company carrying too much inventory or stocking inventory that is obsolete, slow-
moving, or inferior.
In assessing inventory turnover, analysts also consider the type of industry. When making comparisons among

firms, they check the cost-flow assumption used to value inventory and cost of products sold.
Abercrombie & Fitch reported the following financial data for 2000 (in thousands):
Cost of goods sold....... $728,229
Beginning inventory...... 75,262
Ending inventory........ 120,997
Their inventory turnover is:
USD 728,229/[(USD 75,262 + USD 120,997)/2] = 7.4 times

You should now understand the importance of taking an accurate physical inventory and knowing how to value
this inventory. In the next chapter, you will learn the general principles of internal control and how to control cash.
Cash is one of a company's most important and mobile assets.
Understanding the learning objectives

• Net income for an accounting period depends directly on the valuation of ending inventory.
• If ending inventory is overstated, cost of goods sold is understated, resulting in an overstatement of gross
margin, net income, and retained earnings.
• When ending inventory is misstated in the current year, companies carry that misstatement forward into
the next year.
• An error in the net income of one year caused by misstated ending inventory automatically causes an error
in net income in the opposite direction in the next period because of the misstated beginning inventory.
• Inventory cost includes all necessary outlays to obtain the goods, get the goods ready to sell, and have the
goods in the desired location for sale to customers.

• Inventory cost includes:
a. Seller's gross selling price less purchase discount.
b. Cost of insurance on the goods while in transit.
c. Transportation charges when borne by the buyer.
d. Handling costs, such as the cost of pressing clothes wrinkled during shipment.
• Specific identification: Attaches actual cost of each unit of product to units in ending inventory and cost
of goods sold. Specific identification creates precise matching in determining net income.

• FIFO (first-in, first-out): Ending inventory consists of the most recent purchases. FIFO assumes that
the costs of the first goods purchased are those charged to cost of goods sold when goods are sold. During
periods of rising prices, FIFO creates higher net income since the costs charged to cost of goods sold are lower.
• LIFO (last-in, first-out): Ending inventory consists of the oldest costs. LIFO assumes that the costs of
the most recent purchases are the first costs charged to cost of goods sold. Net income is usually lower under
LIFO since the costs charged to cost of goods sold are higher due to inflation. The ending inventory may differ
between perpetual and periodic inventory procedures.
• Weighted-average: Ending inventory is priced using a weighted-average unit cost. Under perpetual
inventory procedure, a new weighted-average is determined after each purchase. Under periodic procedure,

the average is determined at the end of the accounting period by dividing the total number of units purchased
plus those in beginning inventory into total cost of goods available for sale. In determining cost of goods sold,

Accounting Principles: A Business Perspective 309 A Global Text