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What do these accounting terms mean? Any calculations involved?
Physical flow of merchandise inventory vs. cost flow of merchandise inventory
Goods in transit
- JaredLv 68 years agoFavorite Answer
I will comment on the first. Accounting 101 will talk about First-In-First-Out (FIFO) accounting methods and Last-In-First-Out (LIFO) accounting methods.
In most markets costs of goods sold fluctuate over time. Some manufacturers and resellers (a good example, here, would be Wal-Mart) can keep up with ACTUAL costs of goods sold. Smaller organizations must estimate these costs of goods sold. Two of the methods for estimation of COGS are FIFO and LIFO.
Let me give you a real-world example from a business I oversee.
I run a concrete plant. For simplicity purposes, I will say it takes cement, rock, and water to make concrete. The fluctuations in cost of water are minimal, so it is safe to say the cost of water is constant.
The cost of rock and cement fluctuates.
Furthermore, I am never completely out of rock or cement before I place an order for more. So, Rock(Price #1) and newly purchased Rock(Price #2) are mixed together. Cement (Price - $X) and newly purchased Cement (Price - $Y) are mixed together.
Once they are mixed together, it is either
1) no longer able to tell how much of #1/#2 or $X/$Y go into the product; and/or
2) it is prohibitively expensive to do so, so I choose to use an estimation method.
Now, you can explain the difference between physical flow and cost flow of inventory.
The physical flow of inventory will, from a cost standpoint, be
?% Rock @ Price #1 + ?% Rock @ Price #2 + ?% Cement at $X + ?% Cement at $Y + Water
In an ideal world, that formula can be solved to yield a per-unit cost of your merchandise (one unit of concrete). But, we are feel unable or unwilling to be so diligent as to be able to calculate it.
So, we choose FIFO or LIFO methods for rock and cement. If you choose FIFO for one component, you need to choose FIFO for estimating usage of all components. Or, LIFO for one, LIFO for all. This is the conservative accounting approach. Either estimation will lead to a "MISMATCH" -- an accounting term you should acquaint yourself with -- between the actual costs of merchandise sold (physical cash flows) and estimated costs of merchandise sold (accounting cash flows).
Let me give you an example of the difference between FIFO and LIFO methods.
Rock on the ground now cost me $50 per unit of concrete.
I just had a shipment of rock that cost me $55 per unit of concrete.
Cement in the silo now cost me $110 per unit of concrete.
I just added a shipment of cement to the silo at a cost of $102 per unit concrete.
The physical flow of merchandise inventory shows 500 units of concrete sold.
Under FIFO method my cost is 500($50 + $110) + water.
Under LIFO method my cost is 500($55 + $102) + water.
We have set market fluctuations in cost of water as negligible, so we are left with
Cost of 500 units of concrete under
Both of these are estimates. The are accounting artifacts, but nonetheless accepted cash flow values. We hope they are related to the physical (actual) cash flows.
So, yes, calculations are needed for this.
Goods in transit are goods sold but for which the company has not yet received all (or any) reimbursement. These refer to receivables.
I sell 10 units of concrete blocks to XYZ, Corp, cash-on-delivery. The goods are currently in transit.
Under accrual accounting I have recorded the sale, reducing inventory and increasing sales (income).
Under cash accounting I will record an increase to accounts receivable and a decrease in inventory.
When delivery is made and payment accepted, I will increase sales (income) and decrease accounts receivable.
- eagleboyLv 58 years ago
for inventory some people worry about the actual flow of goods, which items get sold first. these are the same goods but we may have 100 of them so you want to make sure which items are physically sold. the accountants look at the flow of the costs -they need to make decisions as to which costs were sold first - they use fifo or lifo to determine the costs.
goods in transit refers to inventory that is in transit at the end of the year. we need to decide who owns those goods. the typical shipping terms are fob shipping point (buyer owns goods) or fob destination (seller owns goods)
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