USCPA (FAR) – (14) Inventory

I would like to record about the key points of the US CPA exam content.

<Create and note the points based on mainly Becker’s workbook>

FOB Shipping Point (Freight Prepaid)

• Definition: Under FOB shipping point terms, ownership of the goods transfers to the buyer as soon as the goods leave the shipping point.
• With FOB shipping point, title passes to the buyer when the seller delivers the goods to a common carrier.
• Accounting Treatment for the Seller: When the goods leave the shipping point, the seller records the sales revenue. This is because the ownership of the goods has transferred to the buyer, fulfilling the revenue recognition criteria. The inventory is removed from the books and recognized as sales revenue.
• Accounting Treatment for the Buyer: As soon as the goods leave the shipping point, the buyer records the inventory as an asset. Transportation costs are borne by the buyer and these expenses are capitalized as part of the inventory acquisition cost.

FOB Destination (Freight Collect)

• Definition: Under FOB destination terms, ownership of the goods transfers to the buyer only when the goods arrive at the buyer’s specified location.
• Accounting Treatment for the Seller: The seller records the sales only when the goods arrive at the buyer’s specified location. Until arrival, the goods are included in the seller’s inventory and revenue is not recognized. Transportation costs are also borne by the seller and treated as an operating expense.
• Accounting Treatment for the Buyer: When the goods arrive and ownership has transferred, the buyer records them as inventory. Since the transportation costs are borne by the seller, the buyer does not include these in the inventory acquisition costs.

Example of FOB teams etc.

• Vendors drop shipment: Title and transfer of risk takes place at the point of shipping, according to the vendor terms, net 30, FOB shipping point. The goods were shipped directly to the customer by the vendor, have not been invoiced or billed, were never recorded in our Co.’s books, nor were they present during the company’s physical inventory count. No adjustments are needed to either balance.
• Goods in-transit from vendor: According to the vendor terms, net 30, FOB shipping point, the goods in-transit should be reflected in our Co.’s inventory at year-end as title transfers at the point of shipping. The goods must be added to the physical count and also to the book count as there is no evidence or mention that an invoice for these shipped goods has been received.
• Goods in-transit from vendors (FOB destination): As these goods were shipped FOB destination, and had not arrived at year-end, they are not reflected in the physical count. No adjustment is necessary because the goods are not Our Co.’s inventory until arrival at the warehouse.
• Goods in-transit from vendors (FOB shipping point): The shipment made on 1/1/Year2 would not be included in inventory in transit, even though it was made with FOB shipping point terms, as it was shipped after the year end.
• Goods held on consignment: This is the inventory of the consignor, not the consignee. Our Co. is the consignee in this scenario. The goods were counted and included in the year-end physical count, but must be excluded.

Consignor’s Accounting Treatment

• Inventory Recording: The consignor continues to record the goods as inventory in their books even after sending them to the consignee. There is no reduction in inventory for goods moved for consignment sales.
• Revenue Recognition: The consignor recognizes revenue only when the goods are actually sold. Revenue should not be recorded until a sale occurs.
• Receipt of Payment and Expense Recording: After receiving sales reports and payments from the consignee, the consignor records sales revenue and books any fees paid to the consignee and other related expenses as costs.

Consignee’s Accounting Treatment

• Non-recording of Inventory: The consignee does not record the consigned goods as their own inventory. This is because the ownership of the goods does not belong to the consignee.
• Sales Recording and Fee Receipt: The consignee records sales only when the goods are actually sold, and these sales are attributed to the consignor. The consignee pays the consignor the amount of the sales minus any fees retained and records the retained fees as revenue.
• Expense Recording: The consignee may record direct costs associated with the sale of consigned goods (for example, advertising and shipping costs) as expenses.
• Freight cost for merchandise shipped that is a cost of inventory and expensed when inventory is sold.

Inventoriable costs

“Inventoriable costs” include all costs necessary to bring an inventory item to a state where it is ready to be sold. For manufactured inventory, this includes the cost of raw materials, direct labor (wages for workers directly involved in production), and factory overhead (indirect costs incurred during the manufacturing process, such as maintenance expenses for equipment).

Lower of Cost or Market (LCM)” method

<Market Value>

• Replacement Cost: The cost needed to replace inventory under current market conditions.
• Market Ceiling (NRV): The amount derived from the estimated selling price minus the costs associated with the sale such as the estimated cost of disposal.
• Market Floor: The amount after subtracting the usual profit margin from the NRV, representing the potential minimum revenue from the inventory.

<Market Floor Calculation>

• Purpose: Indicates the minimum revenue expected when inventory is sold.
• Importance of Calculation: Crucial in industries or markets where the value of inventory can rapidly decrease, including industries with fast technological advancements or products sensitive to trends.
• Calculation Conditions: The market floor is calculated as the Net Realizable Value (market ceiling) minus the expected profit margin. This calculation is necessary in unstable markets with significant price fluctuations or where there has been a history of substantial price drops.

<Intermediate Value Calculation>

• Purpose: To select the most realistic market value among replacement cost, market ceiling, and market floor.
• Importance of Calculation: Used in inventory valuation to avoid overly optimistic or pessimistic valuations.
• Calculation Conditions: Performed when it is necessary to choose an intermediate value that best reflects market reality among these three values, especially when market information varies widely, and reliance on a single value may not be appropriate.

<Conditions Where Market Floor and Intermediate Value Calculations are Not Necessary>

• When Market Floor Is Unnecessary: In stable markets with little price fluctuation. When the Net Realizable Value is close to or lower than the cost, calculating the market floor does not impact inventory valuation and is therefore unnecessary.
• When Intermediate Value Is Unnecessary: When one of the values among replacement cost, market ceiling, or market floor is significantly lower than the others, this lowest value is directly adopted as the inventory market value based on the principle of Conservatism in Accounting, making the calculation of an intermediate value unnecessary. In situations where market information is consistent, and the three values are very close to each other. In such cases, choosing any of the values would not significantly impact the inventory valuation, thus negating the need to identify an intermediate value.

Lower of Cost or Net Realizable value method

• The “lower of cost or net realizable value (LCNRV)” rule is an accounting principle that, in valuing inventory, mandates recording the inventory at the lower of its cost or its net realizable value (NRV). This rule is used to ensure that the value of the inventory is realistically reflected, thereby making financial reporting more reliable.
• It is also adopted by the International Financial Reporting Standards (IFRS) and the recent updates to the United States Generally Accepted Accounting Principles (GAAP).

The “Dollar-Value LIFO method

The “Dollar-Value LIFO (Last In, First Out)” method is an inventory valuation technique used particularly in market environments where there are price fluctuations. This method tracks inventory costs chronologically, taking into account the effects of inflation and other price changes. A key feature of the dollar-value LIFO method is that each addition to inventory forms a new layer (layer), each valued at the prices of different periods. This allows businesses to more accurately reflect the cost of inventory and optimize revenue management.

• Valuation of Inventory at Base-Year Prices: Calculation Formula: Base-Year Inventory Value=Initial Year Total Inventory Amount For example, the base-year inventory value is $100,000.
• Calculation of Current Year Inventory Value: Calculation Formula: Current Year Inventory Value=Current Year Inventory Cost For example, the current year inventory value is $132,000.
• Conversion to Base-Year Prices: Calculation Formula: Conversion to Base-Year Prices=Current Year Inventory Value /(Price Increase Rate+1). Here, the price increase rate is 20%, so divide by 1.2. Conversion to Base-Year Prices=$132,000/1.2=$110,000.
• Recognition and Price Adjustment of Inventory Increase: Calculation of Inventory Increase: Current Year Base-Year Price−Previous Year Base-Year Price Inventory Increase=$110,000−$100,000=$10,000. Calculation of Price-Adjusted Inventory Increase: Inventory Increase X(1+ Price Increase Rate) = $10,000×1.2=$12,000.
• Update of Total Inventory Value: Calculation of Total Inventory Value: Previous Year Inventory Value +Price-Adjusted Inventory Increase =$100,000+$12,000=$112,000.
• Dollar-value LIFO is a method of inventory valuation that adjusts for inflation, providing an effective means of more accurately reflecting the real value of inventory.
• If the relevant price index is 1.00, 1.05 and 1.12 and each year’s inventory current year cost is 250,000, 278,250, and 364,000, the third’s years dollar-value LIFO inventory amount is as followed.
• 250,000 / 1.00 = 250,000, 278,250 / 1.05 = 265,000 which is 250,000 X 1.00 + 15,000 X 1.05 = 265,750. 364,000 / 1.12 = 325,000 which is 250,000 X 1.00 + 15,000 X 1.05 + 60,000 X 1.12 = 332,950.

Loss on Purchase Commitment

• When the current market value of the inventory is less than the fixed purchase price in a purchase commitment, the loss must be recognized at the time of the decline in price, a liability must be recognized on the balance sheet and a description of the losses must be described in the footnotes.
• (DR) Loss on Purchase Commitment / (CR) Accrued Liability

COGS and Ending Inventory: FIFO method (Perpetual) vs FIFO(Periodic)

The result of them is the same.

Discount terms

• 2/10, Net 30: Under these terms, a 2% discount is applied to the invoice amount, but only if the full payment is made within 10 days from the date of the invoice. “Net 30” means that if the payment is made without a discount, the payment deadline is 30 days from the date of the invoice.