Chapter 7 Inventories: Cost Measurement and Flow Assumptions

Classifications of Inventory

Raw Materials Inventory – includes the tangible goods acquired for direct use in the productions process.

Goods in Process Inventory – includes the products that have been started in the manufacturing process but have not yet been completed.

The partially completed inventory includes three cost components:

1) raw materials
2) direct labor, which is the cost of the labor used directly in the manufacture of the product, and
3) manufacturing (or factory) overhead, which includes the costs other than raw materials and direct labor that are associated with the manufacturing process. It includes:
a. variable manufacturing overhead (ex. Supplies and indirect labor)
b. fixed manufacturing overhead (ex. Insurance, utilities, and depreciation)

Finished Goods Inventory – includes the completed manufactured products awaiting sale.

Alternative Inventory Systems

Perpetual System – maintains a continuous record of the physical quantities in its inventory. It records the purchase, or production, and use of each item of inventory in detailed subsidiary records, although often only in units without including costs.

Periodic Inventory System – a company using a periodic system does not maintain a continuous record of physical quantities (or costs) of inventory on hand. It takes physical counts periodically, which should be at least once a year and generally at the end of the year.

In a periodic system the company usually records (debits) costs of acquisitions of inventory in a temporary account, Purchases, while the beginning inventory cost remains in the Inventory account.

Amounts are calculated in the following computation:

Net Purchases = Purchases + Freight-In - Purchase Returns - Purchase Discounts And Allowances Taken