10: Inventory Flashcards
Inventory:
Ownership of goods
Determination of which items are to be included in inventory
Inventory is defined as tangible personal property…3 possibilities
1 held for sale in ordinary course of business
2 In process of production for sale
3 to be used currently in production of items for sale
Inventory:
Ownership of goods takes into account items such as…2
1 Shipping terms
2 Consignments.
Inventory:
Cost is the determination of…
Ex.
Which costs are being assigned to inventory
Ex. Freight and overhead, product costs vs. Period costs
Inventory:
Cost flow assumptions are the determination of…
Costs assigned to COGS and inventory under various cost
Flow methods
Such as FIFO and LIFO
Inventory:
Valuation is the determination of…
How and when inventories should reflect their market values
Using rules such as LCM
The primary basis of accounting for inventories is…
2) which includes…
Cost
2) the cash of FMV of consideration given in exchange for it
Inventory cost is a function of what 2 variables?
1 number of units included in inventory, and
2 costs attached to those units (COGS)
The costs to be included in inventory include…
All costs necessary to prepare goods for sale
3 normal costs included in inventory
1 freight in/transportation in
2 handling costs
3 normal spoilage
For a manufacturing entity:
The cost of inventory includes…4 costs
1 direct materials
2 direct Labor
3 direct factory overhead
4 indirect factory overhead
For a manufacturing entity: 1 direct materials 2 direct Labor 3 direct factory overhead 4 indirect factory overhead Are then allocated to...
Work in progress and finished goods inventory account
For a manufacturing entity:
Variable production overhead, is allocated to…
Each unit of production based on actual use of production
Facilities
For a manufacturing entity:
Fixed overhead is allocated based on…
The normal capacity of production of the production facilities
For a manufacturing entity:
The normal capacity of the production facility is…
The production expected to be achieved over a number of periods
Or seasons under normal circumstances
For a manufacturing entity:
Normal capacity of production takes into account…
The loss of capacity resulting from planned maintenance
For a manufacturing entity:
The range of normal capacity will vary based on…
Business and industry specific factors
For a manufacturing entity:
The actual level of production may be used if it…
Approximates normal capacity
For a manufacturing entity:
unallocated fixed overhead costs are recognized…
As an expense in period in which they are incurred
Any abnormal costs for freight in, handling costs and spoilage are treated as…
Current period expenses and aren’t allocated to inventory
Interest on inventories routinely produced or repetitively produced in large quantities is…
Not capitalized as part of inventory cost
For a merchandising concern: recording of purchases
The amount used as a purchase price for goods will vary depending on whether…
The gross profit or net method is used for recording purchases
Gross method is used to…
2) the purchase discount is netted against…
Record the purchases, then any subsequent discount taken
Is shown as purchase discount
2) the purchases account in determining COGS
If the net method is used to record purchases, then any purchase discounts offered are assumed…
Taken and purchase account reflects the net price
Net method:
If subsequent to the recording of the purchases the discount is not taken (payment is tendered after the discount period has elapsed) a…
Purchase discounts lost account is debited
Net method:
The balance in purchase discounts lost account does not enter into the…
2) the balance in purchase discounts lost account is treated as…
Determination of cost of goods sold
2) a period expense
Regardless of whether the gross method or net method is used, purchases are always recorded…
Net of allowable trade discounts
Trade discounts, are discounts that are…
Allowed to the entity because it’s a wholesaler, good customer
Or merely the item is on sale at reduced price
Is Interest paid to vendors, included in the cost of inventory?
No
The determination of cost of goods sold and inventory under each of the cost flow assumptions depends upon…
The system used to record inventory: periodic or perpetual
Periodic system
Inventory is counted periodically and then priced
In the periodic system, the ending inventory is usually recorded in…
The COGS entry
Standard journal entry under the periodic system
Ending inventory. Xxx
COGS. (Plug)
Beginning Inventory. Xxx
Purchases Xxx
Periodic calculation for COGS
purchases
- change in inventory
______
COGS
Perpetual system
Running total is kept of the units on hand and possibly their value
By recording increases and decreases as they occur
Perpetual system:
When inventory is purchased, the…
Inventory account, rather than purchases is debited
Under the perpetual system, when inventory is sold, what is the following journal entry made?
COGS. (Cost)
Inventory. (Cost)
The weighted avg. method is used under the…
Periodic system
The moving avg method is used under the…
Perpetual system
What kind of asset is inventory?
Nonmonetary asset
How do you record a $100 purchase with terms of 2/10 net 30:
Under the gross method, when a discount is taken
Purchases. 100
A/P. 100
A/P. 100
Purch. Disc. 2
Cash. 98
How do you record a $100 purchase with terms of 2/10 net 30:
Under the gross method when no discount is taken
Purchases 100
A/P. 100
A/P. 100
Cash. 100
How do you record a $100 purchase with terms of 2/10 net 30:
Under the net method when a discount is taken
Purchases. 98
A/P. 98
A/P. 98
Cash. 98
How do you record a $100 purchase with terms of 2/10 net 30:
Under the net method when no discount is taken
Purchases. 98
A/P. 98
A/P. 98
Purchase Disc. 2
Cash. 100
Under the periodic system, What is the equation for COGS?
Beg Inv. \+ COGPurchased \_\_\_\_\_\_\_\_\_\_\_\_ = COGAS - EI \_\_\_\_\_\_\_\_\_\_\_ COGS
Under the periodic system, What is the equation for COGPurchased?
Gross Purchases - Purch. Disc. - Purch. R+A \_\_\_\_\_\_\_\_\_\_\_\_ = net Purch \+ freight in/transport in \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ COGPurchased
Shrinkage
When inventory gets lower (due to theft or damage)
Specific identification
Individual inventory lots purchased or manufactured are separately
Identified
Under specific identification, when items are sold or otherwise disposed of, the actual cost of the specific item is…
Assigned to the transaction
and ending inventory consists of actual costs of specific items on
Hand
When is specific identification usually used?
High cost and individually identifiable items
Cars, appliance jewelry
The average cost flow assumption assumes that all costs and units are…
Merged so no specific item or cost can be separately identified
Under average cost both cost of goods sold and ending inventory are…
Valued at average unit cost
The average cost method may be used with either…
The periodic or perpetual inventory system
Weighted avg. - periodic:
The cost of units is calculated at…
The end of the period based on avg. price paid (including
freight, etc.), weighted by # of units purchased at each price
Calculation for the weighted number of units purchased at each price
weighted number of units purchased at each price =
Cost of goods available for sale)/(# units available for sale
Moving avg.- perpetual: how is the cost of units calculated?
In same manner as weighted avg.
Except new weighted avg. cost calculated after each purchase
Moving avg. perpetual: the averGe cost is used to determine…
The cost of each unit sold prior to the next purchase
Weighted avg. unit cost equation
2) ending inventory equation for 600 units
Weighted average unit cost = Total units/total cost
2) Ending inventory = (600 units) x (weighted avg. unit cost)
FIFO First in First out
Assumption that goods are sold in chronological order purchased
Under FIFO, What will ending inventory consist of?
The last purchases made during the accounting period
LIFO (last in first out)
Assumption that goods are sold in chronological order purchased
Under LIFO, ending inventory will consist of…
The last purchases made during accounting period
Under FIFO periodic and FIFO perpetual, ending inventory is…
The same
Under LIFO Periodic and LIFO perpetual ending inventory is…
Different
Under FIFO, first in goes to…
2) remaining goes to…
COGS
2) ending inventory
LIFO has better matching on…
The income statement
Do freight in and interest expense go into COGS?
Freight in goes into COGS
interest has no effect
Under FIFO, with rising prices, ending inventory is…
Higher
LIFO liquidation
Break everything in inventory down to $0
Under LIFO, it’s best to make calculations with…
Periodic system
If you use periodic or perpetual systems under LIFO, what happens with your calculations for EI and COGS?
They are never the same for EI and COGS
Under perpetual, after every time you make sale you must…
Recomputed avg.
During a period with rising prices what happens to 1) ending inventory, 2) COGS, 3) Net Income 4) Taxes under FIFO?
1) EI is higher
2) COGS lower
3) NI higher
4) Taxes higher
During a period with rising prices what happens to 1) ending inventory, 2) COGS, 3) Net Income 4) Taxes under LIFO
1) EI Lower
2) COGS higher
3) NI lower
4) Taxes lower
Lower of Cost or Market:
A departure from the cost basis of pricing the inventory is required when the…
Utility of goods is no longer as great as its cost
Applying lower of cost or market rule:
Determine market
Market is replacement cost limited to ceiling and floor
Ceiling
Net realizable value (selling price less selling costs and costs
To complete)
Floor
Net realizable value less normal profit
If replace,net cost is greater than net realizable value, market equals…
Net realizable value
When does market = net realizable value - normal profit?
If replacement cost is: less than net realizable value minus normal
Profit
3 steps in applying the lower cost or market rule?
1 determine market
2 determine cost
3 select lower of cost or market
Floor and ceiling have bother to do with…
Cost (of step 2)
The floor limitation on market prevents recognition of…
More than normal profit in future periods (if market is less than cost)
The ceiling limitation on market prevents recognition of…
A loss in future periods (if market is less an cost)
Cost or market applied to individual items will always be as low as, and usually lower than…
Cost or market applied to inventory as a whole
Cost or market applied to individual items will be the same as inventory as a whole, when…
All items at market or all items at cost are lower
Once inventory has been written down, there can be no recovery from the write down until…
The units are sold
Recoveries of prior writedowns for marketable securities are required to be taken into…
The income stream
Methods of recording a write down in inventory, when market is less than cost at end of period
1 ending inventory established using market figure
2 or debts the inventory account for actual cost of goods on
Hand and make separate entry for market decline
Recording write down: establish ending inventory using market figure
The difficulty with this procedure is that it…
Forces the loss to be included in COGS, thus overstating COGS
by amount of the loss
Recording a writedown:
Under the method of Establishing the ending inventory using a market figure, the loss is not…
Separately disclosed
Methods of recording a writedown:
An alternative treatment is to debit the inventory account for the actual cost (not market) of goods on hand and then make the following entry giving separate recognition to the market decline
Loss due to market decline. Xxx
Inventory. Xxx
Purchase commitments (PC)
Result from legally enforceable contracts to purchase specific
Quantities of goods at fixed prices in the future
Purchase commitments:
When there is a decline in market value below the contract price at the balance sheet date and the contracts are noncallable…
An unrealized loss has occurred and if material should be recorded
In period of decline
Loss on purchase commitments journal entry
Estimated loss on PC. (excess of PC over mkt.)
Accrued loss on PC. (excess of PC over mkt.)
Losses on Purchase Commitments:
If further declines in market value are estimated to occur before delivery is made, the amount of the loss to be accrued should…
2) the loss is take to…
Be increased to include this additional decline in market value
2) the income statement
Losses on Purchase Commitments:
The accrued loss on PC is a is a…
Liability account and shown on the balance sheet
Losses on Purchase Commitments:
What is the entry when goods are subsequently received?
Purchases. Xxx
Accrued loss on PC. XXX
Cash. Xxx
Losses on Purchase Commitments:
If a partial or full recovery occurs before the inventory is received, the accrued loss account would be…
2) likewise, an income statement account…
Reduced by the amount of the recovery
2) recovery on loss of PC would be credited
FIFO:
the goods from beginning inventory and the earliest purchases are assumed to be…
The goods sold first
FIFO:
In a period of rising prices, COGS is made up of the earlier, lower priced goods resulting in…
2) the ending inventory is made up of more recent purchases and thus represents a…
A larger profit relative to LIFO
2) more current value relative to LIFO on the balance sheet
The FIFO cost flow assumption may be used even when…
It does not match the physical flow of goods
Whenever the FIFO method is used, the results of inventory and COGS are…
The same at the end of the period under either a perpetual or
Periodic system
LIFO (last in first out)
Under this cost flow method, the most recent purchases are
assumed to be the first goods sold
Ending inventory is assumed to be composed of the oldest
Goods
Under LIFO, the COGS contains…
Relatively current costs (resulting in matching current costs
With sales)
The LIFO cost flow assumption usually does not parallel…
The physical flow of goods
LIFO is widely adopted because it is acceptable for…
Tax purposes and during periods of rising prices it reduces tax
Liability due to lower reported income + higher COGS
LIFO smooths out fluctuations in the income stream relative to FIFO because it…
Matches current costs with current revenues
The primary disadvantage of LIFO is that it results in…
2) what is this generally know as?
Large profits if inventory decreases, because earlier lower valued
layers are included in COGS
2) LIFO liquidation
Another disadvantage of LIFO is the cost involved in…
Maintaining separate LIFO records for each item in inventory
If LIFO is used for tax purposes it must be used for…
2) what is this rule known as?
Financial reporting purposes
2) LIFO conformity rule
LIFO:
Under current tax law inventory layers may be added using the…3
1 earliest acquisition costs Or 2 weighted avg, cost for period Or 3 latest acquisition costs
On the CPA exam for LIFO, use the earliest acquisition costs unless you are instructed to use one of the other…
Alternatives
LIFO:
When a company uses LIFO for external reporting purposes and another inventory method for internal purposes…
A LIFO Reserve account is used to reduce Inventory from
Internal valuation to LIFO valuation
LIFO Reserve 2
1 contra account To inventory
2 adjusted up or down at year end with a corresponding increase
Or decrease in COGS
Dollar-value LIFO is LIFO applied to…
Pools of inventory items rather than to individual items
Costs of keeping inventory records is less under which form of LIFO?
Less under dollar value LIFO, than compared to unit LIFO
LIFO conformity rule also applies to…
Dollar value LIFO
LIFO conformity rule:
Companies using dollar value LIFO define their LIFO pools so as to…
Conform with IRS regulations
Dollar value LIFO:
Under IRS regulations, a LIFO pool can contain either…2
1 all inventory items for a natural business unit
Or
2 multiple pool approach can be elected
Multiple pool approach election (dollar value LIFO)
Business can group similarly used inventory items into several
Groups or pools
Dollar value LIFO:
The advantage of using inventory pools is that…
Involuntary liquidation of LIFO layers is less likely to occur
Conversing price index equation
Conversion price index =
EI at end of year prices)/(EI at base year prices
RC
Replacement cost
4 steps of using dollar value LIFO
1 convert nominal EI to base year EI (divide)
2 change is a layer at base year
3 convert base year layers to nominal (multiply)
4 add them all up
Gross profit:
Ending inventory is estimated by using…
Gross profit percentage to convert sales to cost of goods
presumed sold
Gross profit:
Since ending inventory is only estimated, the gross method is…
Not acceptable for either tax or annual financial reporting purposes
What are 3 major uses of gross profit?
1 estimate ending inventory for internal use
2 use in interim financial statements
3 establishing amount of loss due to destruction of inventory by
Fire, flood or other catastrophes
Standard costs
Predetermined costs in a cost accounting system
Generally used for control purposes
Standard costs:
Inventory may be costed at standard only if…
Variances are reasonable (not large)
Standard costs:
Large debit (unfavorable) variances would indicate…
Inventory and cost of sales were undervalued
Standard costs:
Large credit (favorable) variances would indicate…
Inventory is over valued
Direct variable costing is not…
An acceptable method for valuing inventory
Directing costing considers only…
2) and fixed production costs as…
Variable costs as product costs
2) period costs
In contrast to direct variable costing, absorption costing considers…
Both variable and fixed manufacturing costs as product costs
2 items to include in inventory
1 Goods shipped FOB shipping point until received by carrier
2 goods shipped FOB destination until delivered to customer
Items to include in inventory:
Goods shipped FOB shipping point, which are in transit should be included in the inventory of the buyer since…
Title passes to the buyer when the carrier receives the goods
Items to be included in inventory:
Goods shipped FOB destination should be included in inventory of seller until goods are received by the buyer since…
Title passes to the buyer when the goods are received at their
Final destination
Consignors
Consign their goods to consignees, who are sales agents of
Consignors
Consigned goods remain property of…
The consignor until they are sold
Consignments:
Any unsold goods (including a proportionate share of freight costs incurred in shipping the goods to the consignees) must be…
Included in the consignor’s inventory
Consignment sales revenue should be recognized by…
The consignor when the consignee sells the consigned goods
To the ultimate customer
No revenue is recognized at the time the consignor…
Ships the goods to the consignee
Sales commission made by the consignee would be reported as…
2) it would not be…
A selling expenses by the consignor
2) not be netted against sales revenue recognized by the consignor
2 important ratios that relate to inventory
1 inventory turnover
2 number of days’ supply in average inventory
The inventory turnover ratio measures…
The number of times inventory was sold
and reflects inventory order and investment policies
Inventory turnover calculation
Inventory turnover = (COGS)/(avg. inventory)
Average inventory calculation
Average inventory = (BI + EI)/2
Number of days inventory is held…
2) this ratio reflects on…
Before sale
2) efficiency of inventory policies
Number of days’ supply in average inventory calculation
Number of days’ supply in average inventory =
365/(inventory turnover)
The faster the inventory turnover…
The better (unless the company can’t restock inventory fast enough)
FOB shipping vs FOB destination:
If not mentioned on CPA exam, assume…
FOB shipping
Long term contracts are accounted for by which 2 methods?
1 completed contract method
2 percentage of completion method
Completed contract method
Recognition of contract revenue and profit at contract completion
Completed contract method:
All related costs are…
Deferred until completion and then matched to revenues
The completed contract method is preferable in circumstances in which…
Estimates can’t meet the criteria for reasonable dependability
1 contracts executed by the parties normally include provisions that clearly specify the enforceable rights regarding foods or services to be provided and received by the parties, the consideration to be exchanged and the manner and terms of settlement
2 the buyer can be expected to satisfy obligations under contract
3 the contractor can be expected to perform contractual obligation
If any of the 3 criteria above aren’t met…
The completed contract method must be used
The advantage of the completed contract method is that it is…
It is based on results not estimates
2 Disadvantages of completed contract method
1 Current performance is not reflected
2 income recognition may be irregular
Percentage completion method
Recognition of contract revenue and profit during construction
Based on expected total profit
And estimated progress towards completion in current period
Under the percentage completion method, all related costs are…
Recognized in the period in which they occur
The use of the percentage of completion method depends on The ability to make reasonably dependable estimates of…3
1 contract Revenues
2 contract costs
3 extent of progress towards completion
Percentage of completion method:
For entities which customarily operate under contractual arrangements and for whom contracting represents a significant part of their operations, the presumption is that…
They have the ability to make estimates that are sufficiently
dependable to justify use of percentage completion method
Percentage completion method is preferable when all of the following 3 conditions exist:
1 contracts executed by parties normally include provisions that
Clearly specify the enforceable rights regarding goods or services
To be provided and received by the parties, the consideration to
Be exchanged and the manner and settlement of terms
2 the buyer can be expected to satisfy obligations under the
contract
3 the contractor can be expected to perform contractual obligation
The advantage of the percentage of completion is…
Periodic recognition of income
The disadvantage of the percentage completion method is…
Dependence on estimates
In practice, various procedures are used to measure the extent of progress toward completion under the percentage completion method, but the must widely used one is…
Cost to cost
Percentage of completion method:
Cost to cost is based on…
The assumed relationship between a unit of input and productivity
Percentage of completion method:
Under cost to cost, either revenue and/or profit to be recognized in the current period can be determined by the following formula
Revenue (profit) =
[(cost to date/total expected cost based on latest estimate)
X contract price AKA expected profit]
- Revenue (profit) recognized in previous periods
Percentage of completion method:
Revenue and profit are 2 different terms. Profit is calculated by…
2) revenue is the…
Subtracting construction expenses from revenue
2) contract price
Ledger account titles are unique to…
Long term construction contracts
Long term construction contracts:
In practice, there are numerous account titles for the same item: give example
Billings on LT contracts
vs. Partial billings on construction in progress
Long term construction contracts:
In practice there are various methodologies for journalizing the same transactions: example
Separate revenue and expense control accounts in lieu of
“Income on LT contracts account”
Completed contract method means recognize no profit until…
Contract completed
Calculation from Yaeger Video for Percentage completion method
2) how estimated GP is calculated
Profit - previous year’s profit recognized =
(Total costs incurred to date/total estimated costs to complete) x GP
2) contract price - total est. cost to complete = est. GP
Billings on contract
Contra account to construction in process
LT contracts:
Journal entry 4 is…
Different under completed contract method vs. Percentage
Completion method
Complete contract vs. Percentage completion method:
Income recognition
Timing of income recognition differs
Complete contract vs. Percentage completion method:
Completed contract method never includes…
Gross profit
LT contracts:
If billings on contracts is greater than construction in progress, how is it recognized?
As a current liability
LT construction contracts:
Losses
Must recognize loss in full when you think there will be a loss
On both completed contract and percentage completion methods
Journal entry for completed contract method and percentage completion method for: first entry costs of construction
Construction in process inventory. Xxx
Cash/payables. Xxx
Costs of construction journal entry under the completed contract method may include…
A reasonable allocation of general and administrative (G&A)
expenses for periods prior to completion
Journal entry for completed contract method and percentage completion method for: second entry progress billings
A/R. Xxx
Billings on contracts. Xxx
Journal entry for completed contract method and percentage completion method for: 3rd entry collections on billings
Cash. Xxx
A/R. Xxx
Under the completed contract method the 4th journal entry of recognition of income when there is still more construction…
No income is recognized until completion
Under the percentage completion method the 4th journal entry of recognition of income…
Construction in process inventory. Xxx
Income on construction Xxx
In the 4th journal entry for recognition of income, what account is income on construction closed to?
Closed to income summary
4th journal entry, recognition of income for both completed contract and percentage completion methods in final year
Billings on contracts. Xxx
Construction in process inventory. Xxx
Income on construction. Xxx
Alternative final 4th journal entry for percentage completion method
Construction in process inventory. Xxx
Billings on contracts. Xxx
Construction in process inventory Xxx
Income on construction. Xxx
IFRS:
IFRS accounting for inventory differs from US GAAP in what 3 areas?
1 cost flow assumption
2 valuation of inventory at year end
3 capitalization of interest
With IFRS, the LIFO cost flow assumption is…
Not permissible
IFRS:
Specific ID is required for inventory of goods that are…2
1 Not interchangeable
2 goods that are produced and segregated for specific projects
IFRS:
FIFO and weighted average method are…
Acceptable methods under IFRS
IFRS:
The retail method may…
Only be used for certain industries
IFRS:
The gross profit method can be used to…
Estimate ending inventory when a physical count is not possible
IFRS:
Inventories are carried at…
Lower cost or net realizable value (LCNRV)
IFRS:
An exception to the lower cost or net realizable value (LCNRV) rule applies to…
Agricultural inventories (biological assets) which are carried at Fair value less costs to sell at point of harvest
In US GAAP! what is used to value inventories?
Lower of cost or market (LCM)
Under US GAAP, market is defined as…
Replacement cost, subject to ceiling and floor
Under GAAP, ceiling is…
2) and floor is…
Net realizable value (NRV)
2) NRV less normal profit margin
Under GAAP, once inventory is written down…
A loss may not be recovered
IFRS VS GAAPS: valuing inventories
GAAP: NRV is calculated as estimated selling price less estimated selling price less estimated costs of completion of sale
IFRS: values inventory at lower of cost or net realizable value
(LCNRV)
Under IFRS, LCNRV is applied on…
2) however, under IFRS if there are groups of items that have similar characteristics, they may be grouped for…
An item by item basis
2) the application of LCNRV
If LCM, were applied under US standards, additional information would be need, specifically US GAAP would require…
Replacement cost and normal profit margin in order to arrive at
Ceiling and floor
IFRS VS GAAP:
Rules for capitalization of interest (1 for GAAP, 2 for IFRS)
GAAP: no capitalization of interest for inventories routinely manufactured/produced on repetitive basis
IFRS: 1 doesn’t allow interest or financing costs to be capitalized
For inventory if it is paid under normal credit terms
2 IFRS allows interest costs to be capitalized if there is a lengthy
Production period to prepare goods for sale
