 Hello and welcome to this session. This is Professor Farhad and this session we're going to determine the inventory item and inventory cost. This topic is covered in a financial accounting introductory course obviously covered on the CPA exam, the FAR section. As always I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1600 plus accounting, auditing, tax and finance lectures. This is a list of all the courses that I have on my YouTube so please subscribe. If you like my lectures, please like them. Click on the like button. It doesn't cost you anything. Share them. Put them in playlists especially in today's world where the coronavirus is spreading. Online education is extremely important. Please share the wealth. Also connect with me on Instagram. If you are looking for additional resources or to supplement your CPA studies, please check out farhadlectures.com. So now we need to determine inventory items. Simply put, what we need to know is how many items do we have and what dollar amount do we assign to those items. So you might be saying it's easy. Let's just count all the inventory and that's it. Well it is. It will start by counting the inventory but we have to pay attention to other things other than just counting. So merchandise inventory include all goods that a company owns and holds for sale regardless of where the location of the goods are located when the inventory is counted. In other words, counting the physical goods at your warehouse may not be enough or at your store. Why? Because sometimes you might have to include goods that you don't physically have at this moment although you own those goods. So what are those items that we're talking about here? Well, goods in transit, goods on consignment and goods damage or absolute. So we have to pay attention to those three particular items. Now when you are working in the real world, you have to pay attention especially when you are an auditor. When you are an auditor, sometimes you might be assigned to count inventory. So it's easy to count in, not easy but it's straightforward to count the inventory but you still have to ask the owner of the business, do you have any goods in transit? Now what's goods in transit? We're going to talk about each one of this, each one of them. Do you have any goods on consignment? If the answer is no, I don't have any goods on consignment then it's easy. Then I don't have to worry about this but if there's any goods on consignment I have to worry about this. I have to look at their purchasing record and see if they purchase anything toward the end of the year and if they did so, what is the shipping term? Is this their inventory or not? And I have to inspect the goods. It's not only I count them, if the goods are no good, if the inventory is broken, if the inventory is damaged then I cannot account for it as if it was in a full saleable position. So let's start with to talk about goods in transit. So simply put, you have those goods someplace in the ocean. Whose goods is it? Is it the buyer or is it the seller? Okay, so these goods are like in between, it's being shipped. A buyer, we have a buyer and a seller. Well it all depends on the shipping terms. We have FOB shipping point, FOB shipping point and FOB destination. If it's FOB shipping, if this goods, the buyer says I'm gonna buy those goods and I'm gonna ship them FOB shipping. It means the buyer is paying for them, therefore the goods are included in the buyer's inventory. Okay, so let's assume we have Company A and Company B. Company A is the buyer, Company B is the seller. If the goods are FOB shipping, although they're in the Atlantic Ocean somewhere or in the Pacific Ocean, they're the buyer's good. Why? Because it's FOB shipping. Now if the terms of the shipment is FOB destination, if it's FOB destination, goods included in the buyer's inventory after arrival of destination. What does that mean? It means during destination in transit, they are the sellers, they are still the sellers. Let's assume this is a U.S. company buying stuff from China. Well, that's a bad example of China these days, but yes, well, yes, buying from China. So the goods are Chinese goods if they're FOB destination. Okay, if it's FOB shipping point and the U.S. is the buyer, then they are the U.S. inventory. That's one item we have to be aware of. What's the shipping terms? Another item we said it's goods on consignment and when you think of goods on consignment, think about Walmart and Coca-Cola. Why? Because here's what Walmart has. Walmart and Coca-Cola has an arrangement where Coca-Cola simply placed their merchandise on Walmart's shelves and Walmart don't own the merchandise until the moment that they sell them. They own them for a moment, then they sell them, then they no longer own them. So we have two parties here. We have the consignor, the owner of the goods, and here think of Coca-Cola and the consignee sells goods for the owner. Think of Walmart. Think of Walmart. Okay. Think of Walmart. Walmart. Now, the merchandise is included in the inventory of the consignor. Although the goods are sitting on Walmart shelves, they are Coke's inventory. So when Coca-Cola counter-inventory, think it's based in Atlanta, right? I believe Coca-Cola is based in Atlanta. I could be wrong. Then they count this inventory that's sitting on the shelves in Missouri and in Walmart and Missouri. It doesn't matter. Okay. So you have to be aware of this. Consignee never report the consigns goods in inventory. So Walmart cannot count that inventory. It's inventory. Although it's sitting in their physical location, but it's not their inventory. So that's another thing we have to be aware of. So when you're counting inventory as an auditor, one of the questions that you ask is, do you have any goods on consignment? Okay. Or consign goods. You have to know this. And if the answer is no, then it's easy. Let's move on with our life. Okay. Another thing that we have to be aware of is goods damage or obsolete that we have to pay attention to. And what's goods damage? Basically, goods damage. The goods are damaged. It's no longer in good condition. On what's goods obsolete? Think of Windows 95. If you still have CDs, they used to sell them on CDs, brand new CDs of Windows 95. They are considered obsolete. They're still in good physical condition, but they're obsolete. Or if you have, you know, flip phones, some people still buy flip phones. That's not a good example. But yeah, Windows 95. I don't think anyone is still using Windows 95. And if you are, good luck. Okay. So goods damage or obsolete are not reported in the inventory if they cannot be sold. So simply put, if you still have $3,000 worth of Windows 95 CDs, guess what? They're worth zero. You cannot count them in inventory. You have to take a loss. Damage goods or obsolete can be sold are included in inventory at the net realizable value. So think of this package. This package included, I don't know, a clock. Okay. The clock is damaged. The clock, you paid for the clock $100. Now, because it's damaged, you can sell it for 60. Well, guess what? 60 is what you call the net realizable value. How much you can get for it? Okay. So you have to compute it at the net realizable value, which is the selling price minus any sales price, minus any selling cost. So we'd assume it's 60. Okay. So that's the sales price. There's no selling cost minus zero. So net realizable value is 60. We assume the selling cost is zero. Okay. So you need to do, you need to record a loss when the damage, when the goods are damaged or obsolete. So if they are, if they are damaged or obsolete, you just have to say, I have to take a loss for it. Think about it. If you own a computer and it broke and now it's not worth as much, then you have to take the loss. Basically, you have a loss and inventory is subject to losses. That's why companies try to minimize inventory because if you have inventory and it became obsolete or damaged, you have to absorb the loss. That's why you want to maintain minimum inventory and sell it as soon as possible. Okay. Sell it as soon as possible. Determining inventory costs. Now we determine which items are counted. So how do we determine the cost, the dollar amount? Okay. So we have to include all expenditure necessary to bring an item to a saleable condition and location. So what costs are included is any cost that we incur to make sure our product is available for sale, available for sale. So what would it include? Well, it will include obviously the invoice cost, how much you paid for it. If you received any discount, as we learned in the prior lecture, you deduct the discount. If you have any other cost, you'll include any other cost. What could be considered any other cost? Well, think of shipping. You remember transportation in, you add it to your inventory. Storage, if you're incurring storage cost, if you are incurring insurance to protect the inventory, that's part of the inventory cost. If you had to pay taxes, if those items are coming from another country and you have from Europe and you have to pay taxes, import duties, that's also included in the inventory cost. So this is how to determine the inventory cost. So let's assume you paid for something, $200, you get a discount of 10, shipping was 10, storage was 20, insurance was 30, pretty expensive insurance and you pay $10 in import duties, then you have to add everything up. So 10 cancel each other to 20 to 50. So this item costs you $260. So you have to include all the items. Now, last but not least, we need to talk about internal control and taking physical count, because when you have inventory, the most important thing is to make sure your inventory is there. In other words, if it's not there, if it's not, if it's not there, then it's an issue, it's not there. So it's not inventory. In other words, if it's tolling absolute damage or anything like this, then it's not inventory. So most companies, what they do is they take a physical count at least once a year. But in the real world, some companies take account on a monthly basis. Some companies take count on a weekly basis. Some companies take count on a daily basis. Like if you're a work in a jewelry store, they take counts every day to make sure they're accounting for the inventory because their inventory is very expensive and it's susceptible to theft. So if they lose it, the company is in trouble if they lose one or two items. So companies will take a physical count. Okay, when the physical count does not match merchandise inventory, an adjustment must be made. So when those two don't match, you have to make an adjustment. So if you counted the inventory and it says you should have inventory of 100,000, but you only have 95, that means you have 5,000 missing, then you have to make an adjustment and take a loss. And we'll look at this entry later on. Now, when you count the inventory, there are proper ways on counting inventory. So how do we count inventory? Well, one thing is we have to use pre-numbered inventory ticket items. So basically put once we count an item, we have to tag it. And that tag is pre-numbered. It's unique. So this way we don't double count something twice. The other control is inventory counters. The people that are counting the inventory, they should have no inventory responsibility. What does that mean? It means they cannot be the person that are in charge of the inventory. They cannot be the person that are buying the inventory. They cannot be the person that are selling the inventory. Why? Because they miscount it. They may tell you the items are there, but they're not there. Why? Because if they steal it, they have interest to cover it. So therefore, the counters should bring them from some companies, they bring outsiders like an outside company to count their inventory. Some companies, they assign to different individuals. The counters should confirm existence, that the item is there, the amount, the dollar amount, and the condition. Is it good or not good? So you don't only count, you count, you open the box sometime, you inspect the inventory, and you check it to compare it to what we paid for it and make sure it's still in saleable condition. A second count is taken by a different counter. Obviously, you want to do two counts to make sure that the count is correct, especially when the inventory is expensive. That's extremely important. And a manager confirms all items counted only once. So the manager will confirm if needed, it could be more than once. If there's any conflict between the two counters, you may have to take a third count, and the manager will have to confirm that. So depending on the situation, but those are good internal controls. Now what are internal controls? We'll talk about a little bit more about internal controls in the coming chapter. In the next four to five lessons, we'll start with internal control. But those internal control are policies and procedures specifically for inventory to make sure our inventory is in good saleable condition. Now in the next session, what we'll look at is a very important topic and accounting. And that means the cost flow of inventory. This is what we talk about FIFO, LIFO, weighted average specific identification. As always, I would like to remind you to visit my website for additional resources. And if you're studying for your exam CPA exam, make sure to study hard, invest in your career. The CPA exam is a 20 to 30 year investment. Make it wisely, study hard.