Chapter 6: How Do The Shipping Terms FOB Shipping Point And

Chapter 6how Do The Shipping Terms Fob Shipping Point And Fob Destina

How do the shipping terms (FOB shipping point and FOB destination) affect ownership of goods? What are terms and give an example of terms on an account. Explain the basis of accounting for inventories and apply the inventory cost flow methods— FIFO, LIFO, and average–cost—under a periodic inventory system. Discuss the differences between the physical movement of goods and cost flow assumptions. Discuss the effects on the income statement and balance sheet and tax effects of each of the inventory cost flow assumptions—FIFO, LIFO, and average-cost.

What is the lower-of-cost-or-market (LCM) basis of accounting for inventories? Describe the application of LCM. What is the inventory turnover ratio? How is it computed? How is it used by external users and management?

What is the LIFO reserve? Explain its importance for comparing results of different companies. Please rephrase 2 versions.

Paper For Above instruction

The understanding of shipping terms such as FOB (Free on Board) shipping point and FOB destination is essential in determining the transfer of ownership and responsibility for goods during transit. FOB shipping point indicates that ownership transfers to the buyer once the goods leave the seller’s shipping dock, implying that the buyer bears the risk and costs thereafter. Conversely, FOB destination means ownership transfers when the goods reach the buyer’s location, with the seller assuming risks and costs until delivery. These terms influence when and how companies recognize revenue and inventory assets in their accounting records.

Terms are contractual stipulations that specify rights, responsibilities, and transfer points related to goods or services. For example, an account may be described with terms like “2/10, net 30,” indicating a 2% discount if paid within 10 days, otherwise the full amount is due in 30 days. Such terms influence cash flows and credit decisions, affecting the company’s financial management.

The basis of accounting for inventories generally follows the historical cost principle, which emphasizes recording inventories at acquisition cost. Companies apply various inventory cost flow methods— FIFO (First-In, First-Out), LIFO (Last-In, First-Out), and the weighted-average cost—under a periodic inventory system to determine the cost of goods sold (COGS) and ending inventory. These methods differ in how they assign costs to inventory and COGS, affecting reported income and financial position.

The FIFO method assumes that the oldest inventory costs are recognized first, often resulting in higher net income during periods of rising prices and a balance sheet reflecting recent inventory costs. LIFO assumes the newest inventory costs are recognized first, which can lead to lower taxable income and lower ending inventory values, especially in inflationary environments. The average-cost approach smooths out price fluctuations by allocating an average cost to all units available for sale.

There are significant differences between the physical movement of goods and the application of cost flow assumptions. While physical flow is determined by actual movement — such as goods moving from warehouse to sales — cost flow assumptions are accounting conventions that allocate costs to inventory and COGS regardless of physical movement. This discrepancy can cause differences between reported inventory and actual units available.

The selection of inventory methods impacts the income statement and balance sheet. FIFO tends to report higher net income and higher ending inventory, while LIFO often results in lower net income but tax savings in inflationary periods. The average-cost method provides a middle-ground effect. These choices also influence tax liabilities, as different methods affect taxable income.

The lower-of-cost-or-market (LCM) rule requires companies to report inventory at the lower of its historical cost or current market value. This conservative approach ensures that inventories are not overstated on financial statements, with the application involving comparing the cost of inventory to its market value and recording inventory at the lower amount when necessary. This protects creditors and investors by reducing overstated assets.

The inventory turnover ratio is a measure of how many times a company sells and replaces its inventory during a period. It’s calculated by dividing the cost of goods sold by average inventory. Higher ratios indicate efficient inventory management, while lower ratios suggest overstocking or slow sales. External users such as investors and creditors analyze this ratio to assess liquidity and operational efficiency. Managers utilize it for decision-making, like optimizing inventory levels and reducing holding costs.

The LIFO reserve represents the difference between inventory reported using LIFO and what it would have been under FIFO or other methods. It is important for comparing financial results across companies that use different inventory methods, as it adjusts for the effects of LIFO’s lower ending inventory value. The reserve provides transparency to stakeholders by indicating the impact of inventory accounting choices on reported income and assets. It is particularly relevant in inflationary environments, where LIFO results in lower taxable income and deferred tax liabilities.

References

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