Physical Inventory & Goods in Transit

• Physical inventory involves counting, weighing, or measuring each inventory item on hand, usually when the store is closed.
• Typically, items are counted, and their quantity, description, location, and inventory number are marked on pre-numbered tags.
• Retailers often have thousands of items to count.
• Unit costs are applied to inventory quantities using specific identification or a cost formula.
• Electronic devices like hand-held scanners can automate the inventory process by uploading data to the perpetual inventory system.

Goods in Transit

• Goods in transit at year-end are included in the inventory of the company that has ownership.
• Ownership is determined by the terms of sale, indicated by FOB (free on board) terms.
• FOB shipping point: ownership transfers to the buyer when the carrier receives the goods from the seller.
• FOB destination: ownership remains with the seller until the goods reach the buyer.
• Sales revenue is recorded when ownership transfers.

Consigned Goods

• Consigned goods are held on a company’s premises (consignee) but belong to another party (consignor).
• The consignee sells the goods for a fee but never takes ownership.
• The consignor owns the goods and includes them in their inventory.

Inventory Inclusion Examples

• Include goods in transit for which the company has ownership based on FOB terms.
• Do not include goods held on consignment from another company.
• Include goods held on a layaway plan, assuming legal ownership remains with the store.

Physical Flow

• Actual physical flow may be impractical due to the indistinguishability of items.
• Even if identifiable, tracking each item's physical flow can be costly and complex.
• Management may manipulate profit through specific identification of items sold.

Specific Identification

• Specific identification is appropriate for uniquely identifiable goods or those produced for a specific purpose, like automobiles.
• GAAP does not allow specific identification for interchangeable goods.

Specific Identification vs. FIFO/Average Cost

• Specific identification tracks the actual physical flow and matches the cost of a specific item against its sale price.
• This method can produce more accurate financial results.
• Specific identification may be more expensive due to individual item tracking.
• FIFO assumes the first goods purchased are the first goods sold.
• The average cost formula uses a weighted average of purchase costs.
• FIFO and average cost may not match the actual physical flow of goods.
• FIFO and average cost can be used in periodic and perpetual inventory systems, while specific identification is used only in a perpetual system.
• FIFO and average cost make bookkeeping simpler and less expensive.
• Electronic products may be valued using FIFO, while clothing might be valued using the average cost method.

Average Cost Method

• The average cost per unit is calculated by dividing the cost of goods available for sale by the units available for sale at each purchase date.
• Each purchase changes the average cost per unit
• Sales remove items from inventory at the average cost without changing the average cost.

Inventory Cost Formula Impact

• Cash: No effect. The cash impact of the purchase and sale is the same regardless of the chosen inventory cost formula.
• Ending Inventory: In rising prices, FIFO results in a higher ending inventory because it uses the most recent (higher) prices.
• Average cost results in a lower ending inventory because it's calculated at an average of all inventory available for sale during the period.
• Cost of Goods Sold: Cost of goods sold will be lower under FIFO and higher under average cost.
• Profit: Profit will be higher under FIFO and lower under average cost due to the effect on cost of goods sold.

FIFO vs. Average Cost Valuation

• The average cost formula reflects more recent costs in cost of goods sold, better matching current costs with current revenues for income statement valuation.
• The FIFO formula provides a better balance sheet valuation, leaving the more recently purchased items in ending inventory, which better reflects replacement cost.

Inventory Method Selection

• Choose a method that corresponds as closely as possible to the physical flow of goods.
• Report an inventory cost on the balance sheet that is close to the inventory’s recent costs.
• Use the same method for all inventories having a similar nature and use in the company.

Inventory Error Impact

• An understatement of ending inventory overstates profit in the next year because the ending inventory of one year becomes the beginning inventory of the next year.
• The combined profit for the two years will be correct because the errors offset each other.
• It is necessary to correct the error because users of the financial statements look at the results for individual years and also look at any trends.

Inventory Write-Down

• A departure from the cost basis is justified when the utility of the goods is no longer as great as its cost.
• The write-down to net realizable value should be recognized in the period when the decline in utility occurs.
• It is not appropriate to use the cost basis when the current value of the inventory is less than the cost price.
• Net realizable value is the estimated selling price less any estimated costs required to complete the sale.

Net Realizable Value

• Net realizable value is the selling price of an inventory item, less any estimated costs required to make the item saleable.
• Net realizable value is usually higher than cost because this is the nature of selling merchandise inventory for a profit.
• The recognition of the gain occurs when the inventory is sold, in accordance with revenue recognition criteria.

Inventory Turnover Ratio

• An inventory turnover ratio that is too high may be caused by sales opportunities being lost because of inventory shortages, which can also lead to customer ill will and result in lost future sales.
• An inventory turnover ratio that is too low may be caused by excess inventory which is not being sold and which may be obsolete, resulting in the company spending too much to carry its inventory.

Days Sales in Inventory Ratio

• A decrease in the days sales in inventory ratio from one year to the next would usually be seen as an improvement in the company’s efficiency in managing inventory.
• It means that less inventory is being held relative to sales.

IFRS vs. ASPE

• There are no significant differences in the valuation and reporting of inventory between IFRS and ASPE.

Physical inventory involves counting and measuring items. Unit costs are applied to inventory quantities. Goods in transit at year-end are included in the inventory of the company that has ownership. Ownership is determined by FOB terms.