Definitions of Terms

Absorption (full) costing

Inclusion of all manufacturing costs (fixed and variable) in the cost of finished goods inventory in accordance with GAAP.

Base stock

Based on the theory that a minimal level of inventory is a permanent investment, this amount is carried on the books at its historical cost.

By-products

Goods that result as an ancillary product from the production of a primary good; often having minor value when compared to the value of the principal product(s).

Ceiling

In lower of cost or market computations, market is limited to net realizable value. Market (replacement cost) cannot be higher than the ceiling (net realizable value). Net realizable value is selling price less selling costs and costs to complete.

Consignments

Marketing method in which the consignor ships goods to the consignee, who acts as an agent for the consignor in selling the goods. The inventory remains the property of the consignor until sold by the consignee.

Direct (variable) costing

Inclusion of only variable manufacturing costs in the cost of ending finished goods inventory. This method is not acceptable for financial reporting purposes.

Dollar-value LIFO

Variation of conventional LIFO in which layers of inventory are priced in dollars adjusted by price indexes instead of layers of inventory priced at unit prices.

Double-extension

Method used to compute the conversion price index. The index indicates the relationship between the base year and current prices in terms of a percentage.

Finished goods

Completed but unsold products produced by a manufacturing firm.

First-in, first-out (FIFO)

Cost flow assumption; the first goods purchased or produced are assumed to be the first goods sold.

Floor

In lower of cost or market computations, market is limited to net realizable value less a normal profit, called the floor. Market (replacement cost) cannot be below the floor.

Goods in transit

Goods being shipped from seller to buyer at year-end.

Gross profit method

Method used to estimate the amount of ending inventory based on the cost of goods available for sale, sales, and the gross profit percentage.

Inventory

Assets held for sale in the normal course of business, or which are in the process of production for such sale, or are in the form of materials or supplies to be consumed in the production process or in the rendering of services.

Inventory layer

Under the LIFO method, an increase in inventory quantity during a period.

Joint products

Two or more products produced jointly, where neither is viewed as being more important; in some cases additional production steps are applied to one or more joint products after a split-off point.

Last-in, first-out (LIFO)

Cost flow assumption; the last goods purchased are assumed to be the first goods sold.

LIFO liquidation

Liquidation of the LIFO base or old inventory layers when inventory quantities decrease. This can distort income since old costs are matched against current revenues.

LIFO retail

Inventory costing method that combines the LIFO cost flow assumption and the retail inventory method.

Link-chain

Method of applying dollar-value LIFO by developing a single cumulative index. This method may be used instead of double-extension only when there are substantial changes in product lines over the years.

Lower of cost or market

Inventories must be valued at lower of cost or market (replacement cost). Market cannot exceed the ceiling (net realizable value) or be less than the floor (net realizable value less a normal markup).

Markdown

Decrease below original retail price. A markdown cancellation is an increase (not above original retail price) in retail price after a markdown.

Markup

Increase above original retail price. A markup cancellation is a decrease (not below original retail price) in retail price after a markup.

Moving-average

Inventory costing method used in conjunction with a perpetual inventory system. A weighted-average cost per unit is recomputed after every purchase. Goods sold are costed at the most recent moving-average cost.

Net realizable value

Estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

Periodic

Inventory system where quantities are determined only periodically by physical count.

Perpetual

Inventory system where up-to-date records of inventory quantities are kept.

Product financing arrangements

Arrangements whereby an entity buys inventory for another firm that agrees to purchase the inventory over a certain period at specified prices which include handling and financing costs; alternatively, an entity can buy inventory from another firm with the understanding that the seller will repurchase the goods at the original price plus defined storage and financing costs.

Purchase commitments

Noncancelable commitment to purchase goods. Losses on such commitments are recognized in the accounts.

Raw materials

For a manufacturing firm, materials on hand awaiting entry into the production process.

Replacement cost

Cost to reproduce an inventory item by purchase or manufacture. In lower of cost or market computations, the term market means replacement cost, subject to the ceiling and floor limitations.

Retail method

Inventory costing method that uses a cost ratio to reduce ending inventory (valued at retail) to cost.

Specific identification

Inventory system where the seller identifies which specific items are sold and which remain in ending inventory.

Standard costs

Predetermined unit costs, which are acceptable for financial reporting purposes if adjusted periodically to reflect current conditions.

Weighted-average

Periodic inventory costing method where ending inventory and cost of goods sold are priced at the weighted-average cost of all items available for sale.

Work in process

For a manufacturing firm, the inventory of partially completed products.