FAR coverage for inventory systems, cost-flow assumptions, estimation methods, write-down rules, and error effects.
This chapter covers inventory accounting, a classic FAR area where method choice and valuation adjustments significantly affect income and the balance sheet. The challenge is to keep the system, cost-flow assumption, and write-down rule separate in your reasoning.
Inventory questions often combine mechanics with cutoff and valuation judgment. The same physical goods can produce different reported income depending on whether the issue is the inventory system, cost-flow assumption, write-down rule, estimate method, or error correction.
| Inventory issue | What to decide first | Common FAR trap |
|---|---|---|
| Inventory system | Whether records are periodic or perpetual and when cost of goods sold is updated. | Mixing periodic and perpetual mechanics in the same calculation. |
| Cost flow | Which assumption assigns cost to ending inventory and cost of goods sold. | Treating FIFO, weighted average, and specific identification as interchangeable. |
| Valuation write-down | Whether cost exceeds NRV or the applicable market measure. | Applying a write-up after a prior write-down when the rules do not permit it. |
| Estimation method | Whether retail or gross profit method is appropriate and what inputs are reliable. | Using an estimate method when actual inventory records are required. |
| Cutoff or error | Which period and statement line are affected. | Correcting ending inventory without tracing the income effect. |
| Step | What to do | Why it matters on FAR |
|---|---|---|
| 1. Identify the inventory system | Determine whether the records are periodic or perpetual and when cost of goods sold is updated. | System mechanics affect the calculation before cost-flow assumptions are applied. |
| 2. Apply the cost-flow assumption | Use FIFO, weighted average, specific identification, or another allowed method based on the facts. | Ending inventory and cost of goods sold move in opposite directions. |
| 3. Test valuation | Compare cost with NRV or the applicable market measure and determine whether a write-down is required. | Inventory cannot remain above recoverable value when valuation rules require adjustment. |
| 4. Evaluate estimates and cutoff | Check retail method, gross profit method, goods in transit, consignment, and period-end cutoff. | Inventory errors often arise from timing or ownership, not arithmetic. |
| 5. Trace statement effects | Connect ending inventory errors to cost of goods sold, gross profit, net income, assets, and retained earnings. | FAR commonly tests the ripple effect across periods and statements. |