8. Inventory

Question 1

What is the periodic inventory valuation method?

Answer 1

Precise records are not kept at the moment of sale. Instead, the entity determines how much it spent on acquiring new inventory (including transportation in and discounts taken) and uses this in conjunction with ending inventory and beginning inventory to determine COGS.

Question 2

How is Cost of Goods Sold calculated under the periodic inventory valuation method?

Answer 2

Beginning Inventory + Transportation In + Purchases − Purchase Returns and Allowances − Purchase Discounts = Goods Available for Sale

Goods Available for Sale − Ending Inventory = Cost of Goods Sold

Question 3

What is the perpetual method of inventory valuation?

Answer 3

The organization records any amounts associated with inventory purchases and sales directly to the inventory account when transactions take place throughout the year. This method allows companies to match the cost of sales and inventory transactions more closely with their sales and expenditures throughout the year. A perpetual inventory method is required for a moving average costing system.

Question 4

Describe the four common methods to account for the cost of raw materials and merchandise inventory.

Answer 4

• Specific Identification Method: Common for organizations with unique finished goods. Assigns actual costs to specific goods.
• First-in, First-out (FIFO): The goods purchased first are expensed as cost of sales first.
• Last-in, First-out (LIFO): The goods purchased last are expensed as cost of sales first.
• Average Cost: Cost of Goods Sold is based on a moving average cost per unit. As goods are purchased or moved from raw materials to inventory, average unit costs are recalculated.

Question 5

What are some factors that might influence the choice of inventory costing method?

Answer 5

• FIFO generally reflects the actual physical flow of goods better.
• LIFO is not allowed under International Financial Reporting Standards.
• If there is an inflationary environment, LIFO will have higher cost of sales, so the gross margins and net income will be lower, but the income tax liability will also be lower.
• If there is a deflationary environment, LIFO will have lower cost of sales, so it will have higher gross margins, net income, and income tax liability.

Question 6

What is the lower of cost or NRV principle?

Answer 6

Used for inventory valued using most cost flow assumptions, including LIFO and Retail Method.

Inventory is carried at net realizable value (NRV) if it is determined to be less than the historical cost of inventory. NRV is the value an organization would expect to receive in the current market, less any costs associated with selling the inventory.

Some factors that could cause the NRV of inventory to decrease:

• New technology.
• Fire or other natural disasters that damage or destroy inventory

Question 7

What is the lower of cost or market principle?

Answer 7

Only used for inventory valued with LIFO or Retail Method cost flow assumptions.

Inventory is carried at market if it is determined to be less than the historical cost of inventory.

Market is generally replacement cost, but can be no higher than NRV (ceiling) and no lower than NRV less is normal profit margin (floor).

Some factors that could cause the NRV of inventory to decrease:

• New technology.
• Fire or other natural disasters that damage or destroy inventory.