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• The disclosure principle states that financial statements should report enough information for outsiders to make knowledgeable decisions about the company.
• Information should be relevant and have faithful representation.
• The materiality concept states that a company must perform strictly proper accounting only for items that are significant to the business’s financial situation.
• Information is significant when it would cause someone to change a decision.
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For example, $10,000 is material to a small business
• Conservatism means a business should report the least favorable figures in the financial statements when two or more possible options are presented.– Anticipate no gains, but provide for all probable
losses.– Record an asset at the lowest reasonable amount
and a liability at the highest reasonable amount. – When there’s a question, record an expense rather
than an asset. – Choose the option that undervalues, rather than
• Good inventory controls ensure that inventory purchases and sales are properly authorized and accounted for by the accounting system by: – Ensuring inventory is purchased with proper
authorization.– Tracking and documenting receipt of inventory.– Recording damaged inventory properly. – Performing physical counts of inventory annually. – Recording and removing inventory from
• An inventory costing method approximates the flow of inventory costs in a business that is used to determine the amount of cost of goods sold and ending merchandise inventory.
• Four basic inventory costing methods are allowable by GAAP:1. Specific identification2. First-in, first-out (FIFO)3. Last-in, first-out (LIFO)4. Weighted-average
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HOW ARE MERCHANDISE INVENTORY COSTS DETERMINED UNDER A
• Last-in, first-out (LIFO) method is the opposite of FIFO.
• As inventory is sold, the cost of the newest item in inventory is assigned to each unit as Cost of Goods Sold.• Cost of Goods Sold closely reflects current
replacement cost.• Ending Inventory contains the oldest costing
The goods sold on August 15 are then costed out at $356.67 per unit. On August 26 when the next purchase is made, the new weighted-average unit cost is as follows:
The weighted-average cost summary at August 31 is as follows:• Cost of goods sold: 14 units that cost a total of $5,193.• Ending inventory: 4 units that cost a total of $1,507.
HOW IS MERCHANDISE INVENTORY VALUED WHEN USING THE LOWER-OF-
COST-OR-MARKET RULE?
• The lower-of-cost-or-market (LCM) rule requires that inventory be reported in the financial statements at the lower of the inventory’s historical cost or its market value.
• Market value generally means the current replacement cost.
Recording the Adjusting Journal Entry to Adjust Merchandise Inventory
Smart Touch Learning paid $3,000 for its TAB0503 inventory. By December 31, it can be replaced for only $2,200, and the decline in value appears permanent.
WHAT ARE THE EFFECTS OF MERCHANDISE INVENTORY ERRORS ON
THE FINANCIAL STATEMENTS?
• An error in inventory can lead to errors in other related accounts.
• Because the ending inventory number is used in other computations, when ending inventory is incorrect, other numbers will also be incorrect, such as:• Cost of goods sold• Gross profit• Net income
• The inventory turnover ratio measures how rapidly inventory is sold.
• The ratio should be evaluated against industry averages.– A high turnover rate indicates ease of selling.– A low turnover rate indicates difficulty of