09.01 Inventory

Question 1

What is inventory?

Answer 1

Inventory includes resources held for resale, resources in process of production, and resources consumed in the process of production.

Question 2

What type of inventory does a manufacturing company have?

Answer 2

Raw materials, work in process, and finished goods

Question 3

What type of inventory does a merchandising company have?

Answer 3

Purchased goods (property held for resale)

Question 4

What type of inventory does a real-estate developer have?

Answer 4

Land

Question 5

What type of inventory does a construction company have?

Answer 5

Partially completed buildings, bridges, and roads.

Question 6

What costs are included in inventory?

Answer 6

The cost of inventory is capitalized to an inventory account and includes all costs of acquisition and preparation for sale. Acquisition cost (net trade discounts); warehousing cost; insurance, repacking; freight-in; transportation of consigned goods; costs to bring to saleable condition; normal spoilage.

Question 7

What costs are not included in inventory?

Answer 7

Abnormal costs; idle factory expense; unallocated overhead; excessive spoilage; freight-out; financing costs.

Question 8

How do you determine who owns goods in transit?

Answer 8

It depends on the shipping terms.

Question 9

What does FOB shipping point mean?

Answer 9

When inventory is FOB shipping point, once the goods are shipped, title transfers to the buyer, and the inventory is included on the buyer’s books. Freight-in cost to the buyer will be capitalized in the buyer’s inventory account.

Question 10

What does FOB destination point mean?

Answer 10

When inventory is FOB destination point, title does not transfer to the buyer receives the goods. Therefore, the inventory is not included on the buyer’s books until received by the buyer. Freight-out cost is considered to be a selling expense for the seller.

Question 11

What is consignment inventory?

Answer 11

In a consignment agreement, a seller (consignor) arranges for the goods to be delivered to another firm (consignee) but retains legal ownership of the goods. If the goods are sold, the consignee will keep a portion of the sale as commission and remit the remainder to the consignor. The goods are included in the consignor’s ending inventory, even though the goods are not on their premises.

Question 12

What are the two systems for measuring inventory quantities?

Answer 12

Periodic system and perpetual system.

Question 13

Under a periodic inventory system, how is inventory quantity determined?

Answer 13

Under a periodic inventory system, inventory quantity is determined by a physical count, usually done at the end of the reporting period. When inventory is purchased, the transaction is recorded as a debit to the purchases account. No adjustment is made to the inventory account until the end of the period, at which time a physical inventory count is made and ending inventory is calculated. COGS is a plug figure, and the exact amount of inventory shortages cannot be determined.

Question 14

Under a perpetual inventory system, how is inventory quantity determined?

Answer 14

Under a perpetual inventory system, inventory purchases are recorded as a debit to the inventory account. Importantly, the inventory account is updated as an ongoing, real-time count of inventory purchased and sold. COGS is recorded at time of sale. A physical count of ending inventory should be completed.

Question 15

What are the two main differences between the journal entries under a periodic system and those for a perpetual system?

Answer 15

1. Acquisition of inventory and adjustments such as returns and discounts: in a perpetual system, this is recorded in the inventory account; in a periodic system, this is recorded in the purchases account.
2. Recording of COGS: in a perpetual system, this is recorded at the time of sale; in a periodic system, this is recorded at the end of the period.

Question 16

What are examples of inventory costing methods?

Answer 16

Heterogeneous items - Specific identification
Homogeneous items - FIFO, LIFO, LIFO liquidation, Average cost - weighted average and moving average, Dollar value LIFO

Question 17

What is the specific identification inventory costing method?

Answer 17

If inventory includes heterogeneous items (i.e. items that are unique or different), the specific identification method should be used. This method is also used when items are very expensive, such as automobiles. Under this method, each inventory item must be identifiable when sold.

Question 18

What is the first in first out (FIFO) inventory costing method?

Answer 18

At the end of the accounting period, it is assumed that the ending inventory is composed of units of inventory most recently acquired. Conversely, COGS is made up of the oldest (i.e. first in) merchandise. The FIFO cost-flow assumption reflects the way most firms actually move their inventory. However, GAAP does not require that firms choose the inventory cost-flow assumption that reflects the actual movement of goods.
FIFO favors the balance sheet. The inventory value on the balance sheet is a current and relevant amount. COGS (and therefore gross margin and income) are considered to be less current/relevant because they reflect older costs.

Question 19

What is the last in first out (LIFO) inventory costing method?

Answer 19

At the end of the accounting period, it is assumed that the ending inventory is composted of the oldest inventory layers, while the COGS is composed of the units of inventory most recently acquired (i.e. last in).
LIFO favors the income statement. The inventory value on the balance sheet is considered to be less current/relevant. COGS (and therefore gross margin and income) are considered to be much more current/relevant because they reflect the most current costs.

Question 20

What are the average inventory costing methods?

Answer 20

Weighted Average - used with a periodic inventory system; a single weighted average cost per unit is used for an accounting period.
Moving Average - used with a perpetual inventory system; a new weighted average cost per unit is computer after each purchase of inventory.

Question 21

What is the dollar-value LIFO inventory costing method?

Answer 21

Under this approach, related inventory items are grouped in pools, and an overall price index is used to approximate changes in inventory costs. With this method, it is only necessary to keep track of annual layers of inventory cost and price indexes for each inventory pool, instead of retaining detailed records of each unit cost of each item purchased over the life of the company.

Question 22

When is an inventory estimation method used?

Answer 22

Companies often estimate ending inventory for a variety of purposes. For example, a company may use an estimate of ending inventory for internal purposes during interim periods when a physical count is prohibitively expensive or when inventory is destroyed as the result of a casualty. The gross margin method can be used only for estimation purposes. It may not be used for financial reporting of inventory. In contrast, the retail inventory method can be used both for internal decision purposes and for financial reporting of inventory.

Question 23

What is the gross profit (margin) method of inventory estimation?

Answer 23

Gross profit can be used to prepare interim financial statements or as an estimate if ending inventory is missing or destroyed. First, calculate an estimate of COGS by using the historical gross profit percentage, then back into ending inventory.

Question 24

What is the retail inventory method of inventory estimation?

Answer 24

The retail inventory method is a means of estimating ending inventory by relying on the relationship between the cost of inventory and the sales price. Under the retail inventory method, companies track inventory costs (e.g. beginning inventory, purchases) in both cost and retail (i.e. sales) dollars. Sales, markups, markdowns, theft losses, and employee discounts during the year are recorded at retail dollars. At the end of each period, the company converts ending inventory from retail dollars back to cost dollars by using a cost-to-retail percentage. This percentage represents the cost portion of each sales dollar.

Question 25

What are the two methods of inventory valuations?

Answer 25

Regardless of the choice of inventory costing method, a company must account for declines in the market value of unsold inventories (ASC 330).
Lower of cost or market (LCM) and Lower of cost or net realizable value (LCNRV).

Question 26

What is the LCM valuation method?

Answer 26

Lower of cost or market (LCM) applies only to inventory accounted for under the LIFO or retail inventory methods. LCM compares the historical cost (i.e. purchase price) with the current market value.

Question 27

What is the LCNRV valuation method?

Answer 27

Lower of cost or net realizable value (LCNRV) applies to all inventory methods, excluding the LIFO or retail inventory methods. Under LCNRV, the amount to be used as the market value will always be NRV. If the NRV is lower than the original cost, the inventory must be written down, and a loss will be recorded.

Question 28

What is an inventory rollforward?

Answer 28

For inventory, a rollforward starts with the beginning balance of inventory and lists all activity that increased or decreased the account during the period (i.e. monthly, quarterly, or annually), resulting in the ending balance. The inventory rollforward includes purchases and cost of goods sold and any additional adjustments needed to correctly present the inventory balance in the financial statements.