2.x Inventory

Question 1

How is inventory valued?

Answer 1

Inventory should be recognized at the amount that includes all of the costs to acquire and get the inventory ready and available for sale (“their intended use”). Purchases - Net of any discounts.

Question 2

Are Sales Commissions an inventoriable cost?

Answer 2

No! This is a common mistake!

Question 3

When does ownership of goods transfer when shipped FOB Shipping Point?

Answer 3

Title passes to the buyer when the seller delivers goods to a common carrier (is shipped). Included in buyer’s books at year end if in hands of common carrier.

Question 4

When does ownership transfer when goods are sent FOB Destination?

Answer 4

Title passes to the buyer when the buyer actually receives the goods from the common carrier (shipper). Remains in seller’s books until received by buyer.

Question 5

Describe the periodic inventory system. What is its associated average cost method?

Answer 5

Inventory is “physically counted” at certain times throughout the period (minimum at EOY). Weighted-average cost flow method is the associated average cost method.

Question 6

Under the periodic inventory system, where do purchases go?

Answer 6

Purchases go to an intermediate “Purchases” asset account.

Question 7

Describe the perpetual inventory system. What is its associated average cost method?

Answer 7

Inventory count is continually updated, the calculation of the cost of the item of inventory sold is made after each individual sale. Moving-average cost flow method is the associated average cost method.

Question 8

Under the perpetual inventory system, where do Purchases go?

Answer 8

Purchases go straight to “Inventory”.

Question 9

What type of items is the specific identification method of inventory applicable?

Answer 9

Heterogeneous (different or unique, and thus usually rather expensive) items of inventory, such as merchandise in a jewelry store or serialized electronic merchandise where records are kept by serial number

Question 10

What type of items (heterogeneous or homogeneous) are most inventory methods applicable to?

Answer 10

Homogeneous (similar) items of inventory

Question 11

What are consigned goods?

Answer 11

Consigned goods are given by one company (the consignor) to another company (the consignee) for that second company to sell to the end consumer. Goods may be consigned because the consignee is physically closer to the consumer or because consignment enables the consignor to get a wider distribution of goods than the company could achieve on its own.

Question 12

Under a consignment system, who holds the consigned goods in inventory?

Answer 12

The CONSIGNOR holds the consigned items in their inventory count.

Question 13

Under a consignment system, does the consignee hold consignment inventory in their own inventory?

Answer 13

No. Consignment goods are maintained in the inventory of the consignor, not the consignee.

Question 14

Are costs incurred by the consignor in transferring goods to the consignee considered inventory costs? What might some of these costs be?

Answer 14

Yes. Freight on shipments, warehousing costs, and in-transit insurance would be the most likely additional costs that would be included

Question 15

How is Cost of Goods Sold calculated?

Answer 15

Beginning Inventory + Net Purchases - Ending Inventory = Cost of Goods Sold

Question 16

How is Cost of Goods Available for Sale calculated? (Provide both equations)

Answer 16

Beginning Inventory + Net Purchases = COGAS -OR- Ending Inventory + Cost of Goods Sold = COGAS

Question 17

How is Gross Profit calculated?

Answer 17

Sales - COGS (i.e. Begin Inventory + Purchases - Ending Inventory) = Gross Profit

Question 18

How is Operating Income calculated?

Answer 18

Sales - COGS (which equals Gross Profit) - SGA = Operating Income

Question 19

Under the periodic inventory system, when are Cost of Goods Sold (and changes in inventory) calculated?

Answer 19

The end of the operating period (when a physical ending inventory count is made). At a minimum, at the end of the year

Question 20

Under the periodic inventory system, what is the journal entry to determine the COGS “plug”?

Answer 20

Dr. Ending Inventory (physically counted) Cr. Beginning Inventory Cr. Purchases Dr. Cost of Goods Sold (PLUG)

Question 21

Are the newest or oldest costs included in COGS under the FIFO (first in first out) system?

Answer 21

“LISH” (Last in, Still Here). The first (oldest) inventory in stock is the first inventory recorded for COGS purposes.

Question 22

Are the newest or oldest costs included in COGS under the LIFO (last in first out) system?

Answer 22

“FISH” (First in, Still Here). The last (newest) inventory in stock is the first inventory recorded for COGS purposes.

Question 23

How does the FIFO cost flow system relate to LIFO’s regarding valuations for COGS, Inventory, and/or Profit in a time of changing prices (up or down)?

Answer 23

FIFO has an opposite relationship to LIFO in periods of rising or falling prices.

Question 24

How do LIFO and FIFO impact inventory, COGS, and Profit calculations under rising prices?

Answer 24

FIFO Higher Ending Inventory and Higher Profits (as it will have the Lowest associated COGS); LIFO will have Higher COGS (and thus lower associated Inventory and Profit).

Question 25

How do LIFO and FIFO impact inventory, COGS, and Profit calculations under falling prices?

Answer 25

LIFO Higher Ending Inventory and Higher Profits (as it will have the Lowest associated COGS); FIFO will have Higher COGS (and thus lower associated Inventory and Profit).

Question 26

In periods of rising prices, under which cost flow system would ending inventory be the same under both periodic and perpetual inventory methods?

Answer 26

Under the FIFO system, periodic and perpetual inventory methods will both have the same ending inventory.

Question 27

What effect does overstatement or understatement of beginning and ending inventory have on ending retained earnings?

Answer 27

Misstatement of beginning inventory does NOT have an effect on ending retained earnings. Misstatement of ENDING inventory does have an effect on retained earnings.

Question 28

What is a self-correcting error?

Answer 28

A self-correcting error is one that will correct itself in time, even if it is not discovered. The miscounting of inventory is a self-correcting error. While the error in ending inventory will have an effect on two balance sheets and two income statements, if inventory is correctly counted at the end of the next year, then there will be no further errors as a result of the miscounting.

Question 29

How does overstating and understating ending inventory affect Ending Retained Earnings?

Answer 29

Ending Inventory Overstated = COGS is Understated, so Profit (and Ending RE) is Overstated. Ending Inventory Understated = COGS is Overstated, so Profit (and Ending RE) is Understated.

Question 30

How is Weighted Average Cost Per Unit calculated under a weighted average inventory system?

Answer 30

Cost of Goods Available for Sale (i.e., Beginning Inventory + Purchases) ÷ Total Units

Question 31

What does the LIFO Conformity rule stipulate?

Answer 31

That if an entity uses LIFO for tax purposes, it must also use it for financial reporting purposes.

Question 32

What is a LIFO layer?

Answer 32

A LIFO layer arises when a company purchases more inventory before it sells all of its previous purchase of inventory. Because we assume in LIFO that the most recently purchased (newest) inventory item is sold, it leads to having many different individual prices for the units in ending inventory. Each time the company buys more inventory before selling all of the inventory it has on hand, a layer is added.

Question 33

What is the main benefit to using Dollar-Value LIFO?

Answer 33

Reduced record-keeping costs

Question 34

Under Dollar-Value LIFO, is inventory measured in units?

Answer 34

No. It is measured in terms of dollar value by combining like inventory into “inventory pools”

Question 35

What is used to convert inventory value(s) from FIFO to Dollar-Value LIFO?

Answer 35

A price level index, with the CPI being perhaps the most common.

Question 36

Under Dollar-Value LIFO, what are the different methods for arriving at the needed price level index?

Answer 36

1) Simplified Method 2) Double Extension Method 3) Link-Chain Method

Question 37

Under Dollar-Value LIFO, how is the index calculated using the Simplified Method?

Answer 37

Trick question! No calculation is needed. A generally available price index, such as the CPI for our respective industry is used.

Question 38

Under Dollar-Value LIFO, what steps are taken to calculate ending inventory at current cost?

Answer 38

1) Calculate the ending inventory value @ base year prices by using inflation factor (CPI) 2) Subtract base to arrive at annual increase in inventory at base year price level 3) Multiply this annual increase by the inflation factor to give us the “layer” cost 4) Add this “layer” to the older (base cost) inventory “layer”

Question 39

Under Dollar-Value LIFO, how could the inflation factor/price level index be “back-calculated” for Simplified and Double Extension methods?

Answer 39

Ending Inventory (@ curent cost) ÷ Ending Inventory (@ base year cost)

Question 40

Under Dollar-Value LIFO, how does the Double Extension Method differ from the Simplified Method?

Answer 40

Instead of using a given price index with the Simplified Method, the Double Extension Method requires calculating the base year and current year inventory costs to back derive a price level index using quantities and unit costs applicable to both the base and current years

Question 41

How are the benchmarks calculated for Lower of Cost or Market?

Answer 41

Market Ceiling = Net Realizable Value = Selling Price - Selling Costs Market = Replacement Cost Market Floor = Net Realizable Value - Normal Profit

Question 42

What is obsolete inventory and how is treated/recognized?

Answer 42

Inventory that is obsolete can no longer be sold and should not be included in the inventory balance on the balance sheet. Any inventory that becomes obsolete should be written off as a loss in the period in which it is determined to be obsolete.

Question 43

How is Gross Profit Margin calculated?

Answer 43

Gross Profit ÷ Sales

Question 44

Using the Gross Profit Method (i.e. given a gross profit margin), how does one determine Ending Inventory?

Answer 44

A Gross Profit Margin allows us to “back in” to calculating Cost of Goods Sold (1 - gross profit margin = COGS %; multiplying COGS % by sales = COGS). With the Cost of Goods Sold figure, you then plug it into the equation for Cost of Goods Sold (Begin Inv. + Purchases - Ending Inv.) to solve for Ending Inventory.

Question 45

Which inventory estimation method approximates LCM?

Answer 45

Conventional Retail Inventory Method

Question 46

Using the Conventional Retail Inventory Method, what comprises the Cost to Retail percentage?

Answer 46

The Goods Available for Sale amounts for both Cost and Retail amounts, which are calculated by: 1) The respective Beginning Inventory and Purchases figures associated with Cost and Retail amounts 2) The Cost amount includes Freight-in 3) The Purchases amount includes Net Markups

Question 47

Using the Conventional Retail Inventory Method, how is Ending Inventory at Cost calculated?

Answer 47

Beginning with the Goods Available for Sale figure from the Cost to Retail Percentage, remove any 1) Net Markdowns, 2) Losses, and 3) Sales @ Retail to arrive at Ending Inventory (@ Retail). Multiplying this figure by the Cost to Retail percentage to yield Ending Inventory (@ Cost)

Question 48

How does the Cost to Retail percentage under the LIFO Retail Inventory Method differ from the Conventional Retail Inventory Method’s Cost to Retail percentage?

Answer 48

1) Beginning inventory is excluded from the cost to retail percentage calculation. 2) Net Markdowns are included in the calculation

Question 49

How are losses stemming from firm purchase agreements recognized? What Journal Entry is used?

Answer 49

Estimate until realized. Use below JE: Dr. Estimated Loss (I/S) Cr. Estimated Liability

Question 50

What are goods out on approval?

Answer 50

Goods currently held by the customer, but have yet to be purchased by the customer. The customer physically has the product and has a period of time to decide whether to purchase or return it. Goods-out-on-approval items should be included in inventory at their original cost until the customer accepts the goods. Only when the customer accepts the goods (or the time period for return passes without the customer returning the goods) will the sale be recognized and the cost of the inventory moved to cost of goods sold.

Question 51

Is Interest on liabilities to vendors an inventoriable cost?

Answer 51

No! This is a common mistake!

Question 52

Is Shipping expense to customers an inventoriable cost?

Answer 52

No! This is a common mistake!

Question 53

Are warehousing costs prior to sale an inventoriable cost?

Answer 53

Yes

Question 54

Is insurance an inventoriable cost?

Answer 54

Yes

Question 55

Is repackaging an inventoriable cost?

Answer 55

Yes

Question 56

Are modifications an inventoriable cost?

Answer 56

Yes

Question 57

Is Freight-in paid by the buyer an inventoriable cost?

Answer 57

Yes

Question 58

Are “abnormal costs” such as idle factory expense, unallocated fixed overhead, excessive spoilage, and double freight an inventoriable cost? How are abnormal costs recognized?

Answer 58

No. They should be expensed as incurred.