CHAPTER 14

Question 1

Why can’t we use the selling price as the as the cost of stock

Answer 1

A valuation based on selling price would directly breach the Historical Cost principle. However, there is an additional reason not to value the stock at its selling price: there is no guarantee that the bed can be sold for this amount. To value the bed at its selling price would breach the principle of Conservatism because it would recognise a gain (the profit on the sale of the stock) before it is certain, which would overstate the value of assets; namely, stock.

Question 2

Is GST included as the cost of stock

Answer 2

Let’s start with what is not included: the GST. Any GST on the purchase of stock will be debited to the GST Clearing account, and will simply reduce the liability the business owes to the ATO. It does not affect the economic benefit to be gained when the stock
is sold.

Question 3

Cost of stock

Answer 3

All costs incurred in order to bring stock into a condition and location ready for sale.

Question 4

What is included In the cost of stock

Answer 4

In fact, any costs incurred in order to bring the stock into a condition and location ready for sale must be included in its cost price. These may include:
* the supplier’s price
* freight in (delivery to the firm from the supplier)
* modifications
* customs/import duties
* any other buying expenses.

Question 5

Importance of accurate calculation of cost price

Answer 5

Calculating an accurate cost price for stock is important not only in terms of valuing stock in the Balance Sheet, but also in terms of earning profit. Many businesses determine
their selling price by applying some sort of mark-up which is itself based on the cost price. For example, if a firm applies a 100% mark-up, its selling price will be twice its cost price. If the firm calculates the cost price of its stock incorrectly, then it may set its selling prices too high, leading to a loss of sales volume, or too low, leading to an
insufficient mark-up.

Question 6

Unit cost

Answer 6

the cost price of each individual item/unit of stock.

Question 7

Product cost

Answer 7

A cost incurred in order to bring stock into a condition and location ready for sale, which can be allocated to individual units of stock on a logical basis.

Question 8

Period cost

Answer 8

A cost incurred in order to bring stock into a condition and location ready for sale that is NOT ALLOCATED to individual units of stock because there is NO LOGICAL BASIS TO DO SO.

Question 9

Distinction between period and product costs

Answer 9

The distinction between period and product costs rests primarily on the existence of a log/cal basl.s for allocat.on. If a cost can be allocated on a per unit basis, it must be treated as a product cost. Only when this allocation is not possible should the item be treated as a period cost.

Question 10

Period cost disadvantage

Answer 10

Period costing recognises the entire cost as an expense in the Reporting Period when the stock is purchased, whereas product costing includes the cost as an expense only in the period in which the stock is sold. As a result, unless all stock is sold, and this is an important caveat, period costing will understate Cost of Goods Sold and thus understate profit and owner’s equity, and understate Stock Control and assets.

Question 11

How to determine which type of method to use

Answer 11

If a cost is incurred to get stock ready for sale, and can be allocated to individual units on a logical basis, then it is a product cost. Except where the cost is insignificant, treating a product cost as a period cost leads to the omission of information that would be useful for decision-making, and thus breaches Relevance.

Where there is no logical basis on which to allocate the cost to individual units, period costing must be used. In this situation, treating a period cost as a product cost would lead to the inclusion of information that is not useful for decision-making.

Question 12

What if the cost is so insignificant

Answer 12

Period costing may be used if the cost concerned can be allocated, but is too small to affect decision-making. Here we are talking about costs that would otherwise be, correctly, treated as product costs, but due to their insignificance may be treated as period costs. The insignificance of such items means that it should not really matter how they are treated, because, by definition, they will not affect decision-making.

Question 13

How does valuing stock at its original purchase price ensure historical cost and conservatism

Answer 13

It is usual for the cost price of the stock to be /ess than its selling price, so recording it in the stock cards at its original purchase price, which is required by the Historical Cost principle, also means the stock is not overstated, which is the goal of Conservatism.

Question 14

Lower of cost and NRV rule

Answer 14

Stock must be valued at the lower of ‘cost’ and ‘Net Realisable Value’ NRV

Question 15

Purpose of lower of cost and NRV rule

Answer 15

Applying the lower of cost and NRV rule upholds Conservatism: by recognising losses on the stock as soon as they are probable, it ensures that stock, an asset, is not overstatecl. In the process a more realistic valuation of stock will be derived, and Relevance will be upheld, as the information in the reports will be more useful for decision-making.

Question 16

Net realisable value NRV

Answer 16

the estimated selling price of stock less any costs involved in its selling, marketing or distribution.

Question 17

Reasons why NRV mY be lower than cost price

Answer 17

• PHYSICAL DETERIORATION because the stock is damaged or shop soiled meaning it can no longer be sold at a profit
• a PURPOSEFUL DECREASE in se\h’ng price, perhaps even below cost price, as a cleliberate marketing ploy to attract new customers or force a competitor out of the market
• a DECREASE IN DEMAND because the item is no longer in fashion, or is out of season. Consequently, customers may not be willing to pay high prices. This applies particularly to clothes, sporting equipment and fads.
  *OBSOLESCENCE because the item is technically obsolete superseded by a new model or, in the case of food items, out of date. Items such as these will be difficult to seII for more than their cost price.

Question 18

How does recording stock at its cost price USUALLY uphold conservatism

Answer 18

In the vast majority of cases, valuing stock at its cost price ensures that both the Historical Cost and Conservatism principles are upheld. It is usual for the cost price of the stock to be /ess than its selling price, so recording it in the stock cards at its original purchase price, which is required by the Historical Cost principle, also means the stock is not overstated, which is the goal of Conservatism.

Question 19

Stock write down

Answer 19

the expense incurred when the NRV of an item of stock falls below its original purchase price. It is a loss on the sale of stock. The asset of stock must be written down to reflect its lower value.

Question 20

Reminder regarding sales returns

Answer 20

Sales returns figure is selling price but only the cost price is deducted from the cost of sales figure

Question 21

Explain treatment of the rebadging costs

Answer 21

The rebadging is a cost incurred to get the item into a condition for sale that can be allocated logically to each individual scooter. It is also a significant dollar amount that will affect management decision-making. It should therefore be treated as part of the cost of the stock item – product cost.

Question 22

Explain treatment of gst

Answer 22

GST should never be treated as a product cost or a period cost as it is not an expense of the business. The GST paid on stock purchases will simply reduce the amount of the GST liability owed by the business to the ATO.

Question 23

Does it really matter how delivery charges are treated if profit will be the same

Refer to a principle

Answer 23

Accounting principle: Reporting period
Explanation: If delivery charges were treated as a period cost, the entire cost would be written off as an expense in the current reporting period. However, if the delivery charges were treated as a product cost, it becomes part of the cost of the stock and is only expensed when the stock is sold. This may not happen until the following reporting period. Therefore, unless all of the stock is sold, expenses will be lower in this current reporting period if delivery charges are treated as a product cost, leading to higher net profit. Profit will only be the same if all stock is sold within the current reporting period.

Question 24

Why is profit different for the two methods of costing

Answer 24

Period costing allocates all of the cartage inwards in the current reporting period, $180, while product costing has only allocated a portion of cartage inwards (2 units X $9 per unit = $18) as it is included as part of the product cost. Product costing will report higher profit than period costing due to the lower cost of sales. Note that both results will give the same profit if all units are sold in the reporting period.

Question 25

Which method produces the highest value of stock

Answer 25

The product costing method will report a higher stock control value since each unit of stock has a higher value as it includes not only the unit cost of stock (like period costing), $200, it also includes a portion of the cartage inwards, $9, thus total $209 per unit compared to only $200 per unit with period costing method.

Question 26

Are delivery to customer expense part of the value of stock

Answer 26

‘Delivery expenses’ do not meet the definition of a product cost which is … the cost of the stock plus any additional cost to get the stock into a condition and position for sale that can be logically allocated to the product cost. Delivery expenses would be classified as ‘other expenses’ in the Income Statement.

Question 27

Why is product costing preferred

Answer 27

Income Statement. Product costing works to produce a more accurate profit since it more closely matches the cost of goods sold to the revenue earned in the reporting period. Cost of sales usually includes additional product costs, such as the modifications in this exercise, that are only counted/ expensed when the units are sold, hence cost of sales is more accurate than using period costing which counts all additional product costs in the period they are incurred regardless of how many units are sold. Stakeholders get a more relevant value of cost of goods sold and profit in the Income Statement using product costing.

Balance Sheet. Value of stock control is more accurate using product costing since the value of stock includes not only the unit cost but other additional product costs, such as modifications. Stakeholders get a more relevant value of stock in the Balance Sheet.

Question 28

When answering purpose of lower of cost and NRV question and mentioning conservatism you must state

Answer 28

To ensure the asset of stock AND OWNERS EQUITY isn’t overstated.