2.3 Inventory

Question 1

Consigned goods

on whose books?

Answer 1

• on books of consignor (owner)
• Not included in inventory of consignee: business selling the goods

Question 2

Inventory

costs included/non included

Answer 2

INCLUDED

• purchase returns: contra-account to purchases
• freight-IN (to rec goods)
• sales tax on inventory purchsaes
• packaging costs
• insurance on transit (while on common carrier)

NOT included

• freight-OUT (selling expense)
• interest on purchase (financing)

Question 3

Shipping

2 FOB types

Answer 3

Free on board (FOB): shipping term that indicates who has risk (ownership) of inventory in transit

• Free = who has NO risk, no ownership of inv

FOB shipping point (origin): risk of loss if free to seller, point where shipment originates

• risk of loss is w/ buyer, during transit,
• Items in transit included in buyers inventory

FOB destination: risk of loss is free to buyer (place of destination)

• risk of loss is with seller
• Seller pays for shipping, packaging, handling charges (??)
• Items in trans included in seller’s inventory

Question 4

Inventory (def) and 3 types

Answer 4

• assets that a company holds for sale in the ordinary course of business
• goods that it will use or consume in the production of goods to be sold

1. Finished goods (FG) – ready to be sold, 100% completed
2. Work in Process (WIP) – items only partially processed, not completed but started
3. Raw Material (RM) – material purchased to make inventory, but not yet placed in production

Question 5

3 types of companies

(and inventory held)

Answer 5

1. Merchandising companies – purchase finished goods to resell, only hold Finished Goods on-hand. Ex: Target, Walmart, etc
2. Manufacturing companies – Hold all three: Finished Goods, Work in Process, or Raw Materials in order to make the items to sell. Ex: Caterpiller, IBM, etc.
3. Service companies – no inventory. Ex: Hair salon, university, etc

Question 6

3 types of inventory

where listed on FS

Answer 6

• Balance Sheet: Assets – RM, WIP and unsold FG
• Income Statement: Cost of Goods Sold Expense – when FG are sold

Question 7

Formula to calculate CoGS (inventory)

Answer 7

1) Beg Invent + Purchases = Cost of Goods Avail for Sale
2) Cost of Goods Avail for Sale - End Invent = Cost of Goods Sold

Question 8

How CoGS is included in Income Statement (top part)

Answer 8

Revenue – CoGS = Gross Profit Less: Operating Expenses = Net Income

Question 9

2 types of inventory systems (GAAP? And requirements)

Answer 9

both are GAAP and both require year-end physical count of inventory

1) Perpetual Inventory System – Continuously tracks changes in the Inventory account, record transactions as they occur and provides continuous feedback on balances in both the inventory account and cost of goods sold account.
2) Periodic Inventory System – The balances of the inventory and COGS accounts are determined periodically. Can be done daily –> yearly

Question 10

PERPETUAL Inv System – JE for

1) original purchase
2) Sale
3) end of period

Answer 10

*purchases go straight into inventory

1) Purchase -
(dr) Inventory (+A)
(cr) Accounts Payable (+L)
2) Sale –
(dr) Accounts Receivable (+A) (cr) Sales Revenue (+R, +SE)
(dr) CoGS Exp (+E,-SE)
(cr) Inventory (-A)
3) end of period - NONE

Question 11

PERIODIC Inv System –

JE for

1) original purchase
2) Sale
3) end of period

Answer 11

*uses Purchases account as a place holder until end of period

1) Purchase –
(dr) Purchases (+A)
(cr) Accounts Payable (+L)
2) Sale –
(dr) Accounts Receivable (+A)
(cr) Sales Revenue (+R, +SE)
3) End of Period –
(dr) Inventory, End (+A = amount counted during physical count)
(dr) CoGS Expense (+E,-SE)
(cr) Purchases (-A)
(cr) Inventory, Beg (-A, for any beginning inventory that was sold)

Question 12

Goods in transit (4 catergories)

Answer 12

FOB = free on board 1) FOB Shipping Pt – buyer owns when item reaches common carrier, buyer owns during transit = pays for shipping 2) FOB Destination – buyer owns when item reaches destination, seller owns during shipping = pay for shipping 3) FOB Buyer = title transfers when reaches buyer 4) FOB Seller = title transfers when leaves seller

Question 13

How are sales w/ buybacks valued for inventory

Answer 13

remains on seller’s inventory ONLY IF can estimate the set price, including all costs of inventory plus related holding costs ex: leasing situation w/ car

Question 14

Sales w/ high rates of returns – inventory valuation

Answer 14

on buyer’s (store’s) inventory if can estimate returns ex: bookstore having an agreement w/ publisher that can return for full credit books that students don’t buy

Question 15

Product vs. Period costs

Answer 15

1) Product costs – costs directly connected in making the inventory ready to sell **all product costs are included in Inventory costs includes: freight in, labor/production costs, raw materials: essentially – Direct Labor, Direct material, Manuf OH 2) Period costs – costs indirectly connected to making the inventory **no period costs are included in inventory costs includes: selling exp, general/admin exp, interest costs, freight out

Question 16

2 methods to treat Purchase Discounts

Answer 16

Gross Method – record discount when it occurs (at payment) Net Method – assume discount will be taken so record discount immediately **Gross is most common **choose method depending on how LIKELY are to use discount

Question 17

Gross Method – purchase discounts as buyer – JE at 1) purchase 2) payment w/in discount window 3) payment w/o discount

Answer 17

1) purchase
(dr) Purchases (+A)
(cr) Acc Payable (+L)

*at full purchase cost

2) payment w/ discount (dr) Acc Payable (-L) (cr) Purchase Discount (cr) Cash (-A) *use Purchase Discount to offset discounted cash payment 3) payment w/o discount (dr) Acc Payable (-L) (cr) Cash (-A)

Question 18

Net Method – purchase discounts as buyer – JE at 1) purchase 2) payment w/in discount window 3) payment w/o discount

Answer 18

1) purchase (dr) Purchases (+A) (cr) Acc Payable (+L) *at max discount rate 2) payment w/ discount (dr) Accounts Payable (-L) (cr) Cash (-A) 3) payment w/o discount (dr) Acc Payable (-L) (dr) Purchase Discount Lost (cr) Cash (-A) *use Purchase Discount Lost to offset the increased amount owed

Question 19

Advantages to Net Method for purchase discounts

Answer 19

1) Provides a correct reporting of the cost of the asset and related liability 2) It can measure management inefficiency by holding management responsible for discounts not taken

Question 20

Cost Flow options for Valuing Inventory (4 types)

Answer 20

, 1) Specific Identification – track the exact item when sold and purchased ex: jewelry, cars 2) Average Cost – averages the cost of all inventory together 3) First In, First Out (FIFO) – the first things purchased (older stuff) is sold first, ex: grocery store 4) Last In, First Out (LIFO) – the last things purchased (newer stuff) is sold first, ex: technology company

Question 21

FIFO – difference between Periodic and Perpetual

Answer 21

**NOTICE in FIFO, both give same Ending Inventory and CoGS, because the same costs will always be first in and therefore, first out. 1) Periodic – no continuous record, so date does NOT matter. Just know ORDER of purchases and start at TOP of inventory list and work down as you subtract CoGS 2) Perpetual – has a continuous record of inventory transactions, keep track of dates for BOTH purchases and sales, keep a running tally of remaining inventory after each sale

Question 22

LIFO – difference between Periodic and Perpetual

Answer 22

**Periodic and Perpetual will NOT equal 1) Periodic – no continuous record, so date does not matter. Just know ORDER of purchases and start at BOTTOM of inventory list. 2) Perpetual – has continuous record of inventory, keep track of dates for BOTH purchases/sales, keep a running tally of remaining inventory after each sale

Question 23

FIFO and LIFO – pro/con for each

Answer 23

FIFO pro – End Inv is close to current costs of Inv con – doesn’t match current costs to current sales revenue b/c charges oldest costs against more recent sales revenue *possibly distorting gross profit/net income LIFO pro – matches current costs to current sales revenue prices con – End Inventory is NOT close to current costs of inventory

Question 24

Average Cost method for valuing inventory (2 options)

Answer 24

1) Periodic – Weighted Average Method – total cost of all purchases in period and divide by total # units. Use new price/unit to value sales and End inventory 2) Perpetual – Moving Average Method – everytime make purchase, recalculate average price and use to value sales and remaining inventory.

Question 25

If purchase prices of inventory are increasing/decreasing, which inventory system has 1) highest net income 2) highest End Inventory

Answer 25

Increasing 1) higher Net Income – FIFO 2) higher End Inv – FIFO Decreasing 1) higher Net Income – LIFO 2) higher End Inv - LIFO

Question 26

the allowance to change inventory from another method to LIFO valuation (and why)

Answer 26

LIFO Reserve b/c use LIFO for external reporting but other method for internal records *helps to identify how much difference in value between LIFO and other method

Question 27

LIFO liquidation (def, problem, and solution)

Answer 27

1) erosion of the LIFO inventory (sell off of enough inventory) that inventory sold is valued at old/outdated prices, distorts Net Income and tax payments 2) problem – CoGS value isn’t representative of what actually cost to replace the inventory at current prices 3) Dollar-value LIFO

Question 28

Specific-goods Pooled LIFO

Answer 28

reduces recordkeeping and costs but can lead to LIFO liquidation *physical quantity is measured and valued

Question 29

Dollar-value LIFO method

Answer 29

measures any increases/decreases a pool of inventory items have in terms of TOTAL DOLLAR VALUE **not the physical quantity of the goods in the inventory pool.

Question 30

Advantages of Dollar-value LIFO method (over Specific-goods pooled LIFO)

Answer 30

1) can include a wider range of goods 2) allows replacement of goods that are similar (of use or interchangeable) - so cheaper **protects the LIFO layers from Erosion, so frequently used

Question 31

Steps of Dollar-value LIFO

Answer 31

given (A) End Inventory Value at Current year prices (2018) (B) Price Index – change in price or cost levels between the base year and the current year 1) determine End Inv Value at Base year prices (2017) = A / B 2) Find the “layers” for 2018 End Inv, will have 2 layers: a) yr 1 (2017) = End Inv at 2017 b) yr 2 (2018) = 2018 End Inv @ 2017 value (step 1) – layer yr 1 3) Return “layers” back to current year prices = step 2 layer value * (B-price index) 4) sum all current valued layers to get End Invent for B/S

Question 32

Increases/decreases in Ending Inventory Value @ Base Year (what means and what to do)

Answer 32

Increased value: purchased more than sold – handle as described Decreased value: Inventory Liquidation - sold more than purchased – no new layer for current year, need to “force a decrease” into previous year’s layer in Step 2.

Question 33

In Dollar-value LIFO, what is Price Index

Answer 33

Provides a measurement of change in price or cost levels between the base year and the current year

Question 34

How is Price Index selected

Answer 34

1) use government prepared price indexes ex: Consumer Price Index for Urban Consumers 2) use price indexes posted by organizations, ex: silver, gold, etc. 3) prepare own if not readily available – using more recent cost

Question 35

Price Index – formula

Answer 35

Price Index for current year = End Inv for the Period at Current Cost / End Inv for Period at Base-Year Cost

Question 36

3 LIFO methods (and pro/con)

Answer 36

1) Specific-goods LIFO – unrealistic b/c companies have numerous goods, pricing is costly/time consuming 2) Specific-goods pooled LIFO - Less costly and less time consuming, but can lead to LIFO Liquidation 3) Dollar-Value LIFO - most common - simple to compute and helps eliminate LIFO Liquidation **Cons – subjective pooling of inventory items

Question 37

LIFO approaches (in general) – pro/con

Answer 37

Pros 1) match current revenue to current cost 2) tax benefits – only when Price increase and Inventory Q don’t decrease 3) Future Earnings Hedge – future price DECLINES won’t substantially affect future earnings (vs. FIFO Inv vulnerable to price declines – affect Net Income) Cons 1) Reduced earnings – lower Net Income during price increases 2) Inventory understated – oldest cost remain in ending inventory on B/S 3) physical flow – most items not sold in this direction 4) Involuntary Liquidation/Poor Buying Habits – if company eliminates base or layers of old costs, it may match old costs against current sales prices.

Question 38

LIFO Conformity Rule

Answer 38

tax law requires a company to use LIFO for financial purposes if it uses LIFO for tax purposes.

Question 39

Retail Inventory Methods (5)

what costs included

Answer 39

differences (beg-Inv, net markups, net markdowns)

FIFO

• measures C/R only for current period purchsaes,
  
  • beg-Inv –> NO
  • net markups –> YES
  • net markdowns –> YES
• Assumptions: all beg-inv will sold and end-inv only of current period purchases

FIFO, LC-M

• measures C/R only for current period purchsaes,
  
  • beg-Inv –> NO
  • net markups –> YES
  • net markdowns –> NO
• more conservative ratio
  
  • denom is larger, ratio is smaller, End-Inv cost is smaller

Average

• measures C/R for both current and prior periods:
  
  • beg-Inv –> YES
  • net markups –> YES
  • net markdowns –> YES

Average, LC-M: (conventional retail inventory method )

• measures C/R for both current and prior periods:
  
  • beg-Inv –> YES
  • net markups –> YES
  • net markdowns –> NO

DV LIFO Retail

• measures C/R for both current and prior periods:
  
  • beg-Inv –> YES
  • net markups –> YES
  • net markdowns –> YES