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6.01 Inventory Control Methods

6.01 Inventory Control Methods. Understand Inventory Control Methods. PowerPoint #3. Inventory Control Methods. Help businesses account for Ending Inventory and help determine Cost of Goods Sold If Inventory consists of large, identifiable items , it is easy to compute the above.

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6.01 Inventory Control Methods

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  1. 6.01 Inventory Control Methods Understand Inventory Control Methods PowerPoint #3

  2. Inventory Control Methods • Help businesses account for Ending Inventory and help determine Cost of Goods Sold • If Inventory consists of large, identifiable items, it is easy to compute the above. • If Inventory consists of lots of items that are not specifically identifiable, such as in a hardware store, it is not very easy to compute the above. • Businesses use Inventory Control Methods to help with these computations.

  3. Assumptions • Because of fluctuations in purchase price of the inventory, businesses must make assumptions about which items have sold and which remain. • These Methods are: • Specific Identification • First In First Out • Last In Last Out • Weighted Average

  4. Specific Identification • The actual cost of each item is assigned to the item. • Firms that sell big ticket items such as cars, appliances, or furniture may use specific identification. • This method is rarely used in practice today.

  5. First In First Out • Based on the assumption that the first items purchased are the first items sold • Assumes the newest acquired items remain in inventory • During periods of inflation, FIFO will result in the lowest Cost of Goods Sold and the highest income.

  6. Last In First Out • Based on the assumption that the last items purchased are the first items sold • Assumes the oldest acquired items remain in inventory. • During periods of inflation, the use of LIFO results in the highest Cost of Goods Sold and the lowest income.

  7. Weighted Average • Assigns an average cost to each unit in inventory • This average unit price is calculated prior to each sale. • This method results in a Cost of Goods Sold amount that is between the FIFO and LIFO amounts.

  8. Lower of Cost or Market • Lower of Cost or Market is not an inventory method, it is an application of the GAAP principle of Conservatism. • Per GAAP, inventory is valued at historical cost. • Sometimes, the original cost of the ending inventory is more than its replacement cost. • If inventory has decreased significantly below historical cost, the Lower of Cost or Market is used.

  9. Lower of Cost or Market (cont’d) • First, inventory is calculated by one of the inventory control methods. • Next, inventory value is compared to market value to determine if an adjustment should be made. • The difference is charged to the Cost of Goods Sold account or to a special Loss Account if material.

  10. Questions for Understanding/Discussion • Why would a hardware store opt to account for inventory using an inventory control method rather than count each individual bin of nails, screws, and bolts? • Explain the differences between the four inventory control methods? • Summarize each of the four methods in your own words. • Explain why the lower of cost or market method is used by companies.

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