C. INVENTORY 02

Question 1

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Impairment losses on inventory:

Answer 1

Impairment losses on inventory:

If inventory was valued at cost, meaning cost was lower than market or NRV, but then the inventory’s market price or NRV declines below cost, the inventory’s value is written down.

Example:

ABC uses FIFO to value its inventory and carried their inventory at cost of $100,000. After an analysis, ABC determined that the NRV of its inventory was now $80,000. ABC would recognize an impairment loss of $20,000.

Journal entry:

• *Loss on inventory write down $20,000** (Income Statement)
• *Inventory $20,000** (Balance Sheet)

Question 2

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Casualty loss on inventory:

Answer 2

Casualty loss on inventory:

A loss on inventory will be equal to the amount of loss less any sales of damaged inventory and less any insurance proceeds.

If a pack of wild dogs got into ABC’s warehouse and ruined $50,000 worth of inventory, but ABC was able to sell the damaged inventory for $5,000, and ABC received insurance proceeds of $30,000, then the loss ABC would recognize is $15,000.

Question 3

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Purchase commitments

Answer 3

Purchase commitments

Companies will enter into agreements to purchase certain amounts of certain items, sometimes within a certain time period

If the market price of an item su_bject to this kind of agreement goes down,_ the buyer might have to recognize a loss on the purchase commitment.

If the terms can be modified, then the potential loss can be disclosed in a footnote but doesn’t have to be recognized in the financials.

If the terms CANNOT be modified, then the loss is probable and must be accrued and recognized on the balance sheet.

Question 4

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Shipping Transactions:

Answer 4

Free on board (FOB) destination means the “ownership” (and risk of loss) of the inventory doesn’t change until it reaches its destination (the buyer’s warehouse). The seller “owns” the inventory until it reaches the buyer.

Free on board shipping point is the opposite: As soon as the inventory is shipped, the buyer now owns it and will include it in their inventory.

Question 5

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Inventory costs

What items are included/excluded from the cost of inventory?

Answer 5

Included:

• Purchase returns
• Freight-in (shipping costs to get the inventory to the warehouse)
• Sales tax on acquisition
• Insurance on transit

Excluded:

• Freight out- this is a selling expense
• Interest on purchase - this is financing