Accounting 6 Flashcards
Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system
the primary basis of accounting for inventories is cost. Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale. Cost of goods available for sale includes a cost of being inventory and cost of goods purchased. The inventory cost flow methods are specific identification and 3 assume cost flow methos -FIFO, LIFO, and average-cost
Explain the financial statement and tax effects of each of the inventory cost cost flow assumptions
The cost of goods available for sale may be allocated to cost of goods sold and ending inventory by specific identification or by a method based on an assumed cost flow.When prices are rising, the FIFO method results in lower cost of gods sold and higher net income than the average cost and the LIFO methods. The reverse is true when prices are falling. In the balance sheet, FIFO results in an ending inventory that is closest to current value, whereas the inventory under LIFO is the farthest from current value. LIFO results in the lowest income tax (b/c of lower taxable income)
Explain the lower of cost or market basis of accounting for inventories
Companies use the lower of cost or market (LCM) basis when the current replacement cost(market) is less than cost. Under LCM, companies recognize the loss in the period in which the price decline occurs.
Compute and interpret the inventory turnover
Inventory turnover is calculated as cost of goods sold divided by average inventory. It can be converted to average days in inventory by dividing 365 days by the inventory turnover. A higher inventory or lower average days in inventory suggests that management is trying to keep inventory levels low relative to its sales level.
Describe the LIFO reserve and explain its importance for comparing results of different companies
The LIFO reserve represents the difference between ending inventory using LIFO and ending inventory if FIFO were employed instead. For some companies this difference can be significant, and ignoring it can lead to inappropriate conclusions when using the current ration or inventory turnover.
When should the inventory costing method be used? What information do you need to know to make this decision? Where will you get this information?
1) It depends on the objective. In a period of rising prices, income and inventory are higher and cash flow is lower under FIFO. LIFO provides opposite results. Average cost can moderate the impact of changing prices
2) Are prices increasing or decreasing?
3) Income statement, balance sheet, and tax effects
How long is an item in inventory? What information do you need to make the decision? What are the formulas that you will need to use?
1)A higher inventory turnover or lower average days in inventory suggests that management is reducing the amount of inventory on hand, relative to cost of goods sold.
2)cost of goods sold; beginning and end inventory
3) Inventory turnover=(cost of goods sold/ average inventory)
days in inventory=(365 days/ inventory turnover)
What is the impact of LIFO on the company’s reported inventory? What info do you need to make a decision? What formula will you have to use?
1) If these adjustments are material, they can significantly affect such measures as the current ratio and the inventory turnover
2) LIFO reserve, cost of goods sold, ending inventory, current assets, current liabilities
3) LIFO inventory+LIFO reserve= LIFO inventory
Average cost method
an inventory costing method that uses the weighted- average unit cost to allocate the cost of goods available for sale to ending inventory and sot of goods sold
Consigned goods
goods held for sale by one party although ownership of the goods is retained by another party
Current replacement cost
the cost of purchasing the same goods at the present time from the usual suppliers in the usual qualities
Days in inventory
measure of the average number of days inventory is held; calculated as 365 divided by inventory turnover
Finished goods inventory
manufactured items that are completed and ready for sale
FIFO
an inventory costing method that assumes that the earliest goods purchased are the first to be sold
FOB destination
Freight terms indicating that ownership of goods remains with the seller until the goods reach the buyer
FOB shipping point
freight terms indicating that ownership of goods passes to the buyer when the public carrier accepts the goods from the seller
Inventory turnover
a ratio that indicates the liquidity by measuring the # of times average inventory sold during the period; computed by dividing cost of goods sold by the average inventory during the period
Just-in-time (JIT) inventory
inventory system in which companies manufacture or purchase goods just in time for use
LIFO
an inventory costing method that assumes that the latest units purchased are the first to be sold
LIFO reserve
for a company using LIFO, the difference between inventory reported using LIFO and inventory using FIFO
Lower-of-cost-or-market (LCM)
a basis whereby inventory is stated at the lower of either its cost or its market value as determined by current replacement cost
Raw materials
basic goods that will be used in production but have not yet been placed in production
Specific identification method
an actual physical-flow costing method in which particular items sold and items still in inventory are specifically costed to arrive are cost of goods sold and ending inventory
weighted-average unit cost
average cost that is weighted by the number of units purchased at each unit cost
work in progress
the proportion of manufactured inventory that had begun the production process but is not yet complete
When is a physical inventory usually taken?
- when a limited number of goods are being sold or received
- at the end of the company’s fiscal year
What are 2 important items that should be included in the physical inventory of a company
- goods shipped on consignment to another company
- goods in transit from another company shipped FOB shipping point
As a result of a thorough physical inventory, Railway Company determined that it had inventory worth $180,000 at Dec 31,2014. This count did not take consideration the following facts; Rogers Consignment store currently has goods worth $35,000 on its floor that belong to Railway, but are being sold on consignment by Rogers. The selling price of these goods is $50,000. Railway purchased $13,000 of goods that were shipped on Dec 27, FOB destination, that will be received by Railway on JAnuary 3. Determine th correct amount of inventory that Railway should report.
$215,000
(180,000+35,000)=$215,000
Kam Company has the following units and cost
Units Unit Cost
Inventory, Jan 1 8,000 $11
Purchased, June 19 13,000 $12
Purchased, Nov 8 5,000 $13
If 9,000 units ar on hand at Dec 31, what is the cost of the ending inventory under FIFO?
$113,000
((5,000x$13)+(4,000x$12))=$113,000
Kam Company has the following units and cost
Units Unit Cost
Inventory, Jan 1 8,000 $11
Purchased, June 19 13,000 $12
Purchased, Nov 8 5,000 $13
What is the cost of the ending inventory under LIFO?
$100,000
((8,000x$11)+(1,000x$12))=$100,000
Davidson Electronics has the following
Units Unit Cost
Inventory Jan1 5,000 $8
Purchase April2 15,000 $10
Purchase Aug 28 20,000 $12
If Davidson has 7,000 units on hand at December 31, the cost of ending inventory under the average-cost method is
$75,250
((5,000x$8)+(15,000X$10)+(20,000x$12))/ 40,000= $10.75;
$10.75x7,000=$75,250
In periods of rising prices, LIFO will produce
lower net income that FIFO
Considerations that affect the selection of an inventory costing method include
- tax effects
- balance sheet effects
- income statement effects
The lower-of-cost-or-market rule for inventory is an example fo the application of
the conservatism convention
What would cause inventory turnover to increase the most
decreasing the amount of inventory on hand and increasing sales
Carlos Company had beginning inventory $80,000 ending inventory $110,000 cost of goods sold $285,000 Sales $475,000 Carlos's days in inventory is?
121.7 days
($285,000/ (($80,000+$110,000)/2)=3
365/3= 121.7 days
The LIFO reserve is
the difference between the value of the inventory under LIFO and the value under FIFO
In a perpetual inventory system
FIFO cost of goods sold will be the same as in periodic inventory system
Fran Company’s ending inventory is understated by $4,000. The effects of this error on the current year’s cost of goods sold an net income, respectively, are:
cost of goods sold-overstated
net income-understated
Harold Company overstated its inventory by $15,000 at Dec 31, 2014. It did not correct the error in 2014 or 2015. As a result, Harold’s stockholders’ equity was:
-overstated at Dec 31,2014 and properly stated at Dec 31, 2015
How do you classify inventory and inventory qualities as a merchandiser and manufacturer
- Merchandisers: 1)merchandise inventory; which describe the different items making up inventory
- Manufacturers: 1)finished goods 2)work in progress 3)raw materials; determine inventory qualities by 1)taking a physical inventory of goods on hand 2)determine ownership of goods in transit or on consignment
