Accounting for merchandise inventory requires several decisions which include:
a. Items included and their costs.
b. Costing Method. (specific identification, moving weighted average or FIFO)
c. Merchandise Inventory System. (perpetual or periodic)
d. Use of net realizable value or other estimates.
e. All of the above
The correct answer and explanation is:
The correct answer is e. All of the above.
Accounting for merchandise inventory involves several key decisions that affect both the balance sheet and the income statement. The following aspects are critical in determining how merchandise inventory is reported:
- Items Included and Their Costs: The first decision in accounting for inventory is determining which items will be included in the inventory. This decision is based on what constitutes inventory for the business, such as raw materials, goods for resale, and finished goods. Additionally, the cost of these items must be determined, which could include the purchase price, shipping costs, handling fees, and any other expenses directly related to bringing the inventory to its current condition and location.
- Costing Method: There are several methods for calculating the cost of goods sold (COGS) and ending inventory. The three primary methods are:
- Specific Identification: Used for expensive, unique items where each piece can be tracked individually.
- Moving Weighted Average: This method averages the cost of goods available for sale and applies it to each unit sold during the period.
- FIFO (First-In, First-Out): Assumes that the first units purchased are the first units sold, which may be more reflective of actual inventory flow in certain industries, especially when prices are rising.
- Merchandise Inventory System: The two types of systems are:
- Perpetual: Continuously updates inventory records in real-time as transactions occur. This system provides immediate feedback on inventory levels and is commonly used in large businesses.
- Periodic: Updates inventory records at the end of the accounting period, which is less accurate during the period but simpler to implement for smaller businesses.
- Net Realizable Value (NRV) or Other Estimates: When the market value of inventory falls below its cost, businesses may need to adjust the value of their inventory to the lower NRV. This estimate reflects the potential selling price of the inventory less any costs to complete the sale. This can impact the reported value of the inventory and the corresponding profit or loss.
Each of these decisions plays a significant role in ensuring accurate and consistent reporting of inventory and its associated costs.