A warehouse count establishes physical quantities, but the inventory balance also depends on ownership, eligible costs, cost allocation and subsequent measurement. The preparer resolves those questions in sequence to calculate the carrying amount of inventory.
Cutoff assigns inventory movements to the proper reporting period using the applicable transfer conditions, rather than invoice dates alone.
The following terms assume no conflicting contractual transfer conditions:
A consignment places goods with another entity for sale while the consignor retains ownership until the specified transfer occurs. A consignee's receipt report establishes custody, and a consignment agreement supplies the information needed to determine whose inventory includes the goods.
Product costs are acquisition and conversion costs that qualify for inclusion in inventory under United States generally accepted accounting principles (U.S. GAAP). Period costs enter expense when incurred; an expectation of future benefit alone does not establish eligibility for capitalization.
Exclusion from the carrying amount of inventory does not require immediate expensing. Recoverable incremental contract-acquisition costs require separate capitalization.
Common mistakes
- Capitalizing idle capacity. Using $20 instead of $12 overhead per unit in the plant illustration overstates assigned production cost by $48,000.
- Using later perpetual purchases. Vellan's January perpetual LIFO sale costs $1,400; February's $14 units were unavailable at that sale date.
- Repricing surviving layers. Norlen's Year 3 inventory is $116,500; applying 1.25 to the entire base-year pool incorrectly produces $143,750.
Bottom line
- Ownership and cutoff determine which goods enter inventory before costs or measurement rules are applied.
- Eligible acquisition and conversion costs enter inventory; ordinary administration, abnormal waste and abnormal idle capacity enter current expense. Selling costs are excluded from inventory, but qualifying contract-acquisition costs require separate capitalization unless the applicable practical expedient is elected.
- FIFO, LIFO, weighted average and specific identification allocate available cost between ending inventory and COGS; transaction timing can distinguish periodic from perpetual LIFO and average cost.
- LIFO liquidation consumes old layers within COGS, the reserve bridges FIFO and LIFO, and dollar-value LIFO retains each surviving layer's original index.
Exam shortcut
A dated transaction grid establishes owned units and costs available at each sale; the stated system determines whether costs are assigned periodically or perpetually. Ending inventory plus COGS provides an independent available-cost control; a failed reconciliation requires investigation before measurement. Separate ceiling, floor and replacement-cost columns establish designated market before its comparison with cost. Quantity, ownership, posting and valuation findings identify the affected record; a write-down uses corrected owned quantities.
The full lesson (about 9,112 words, 61 min read) adds 6 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.C1
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