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AFM 191 > Chapter 5: Inventory & Gross Margin Income Statement > Flashcards

Chapter 5: Inventory & Gross Margin Income Statement Flashcards

1
Q

what is the formula on the income statement for operating income

A

Total Operating Revenue - Total Operating Costs = Operating Income

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2
Q

what is the formula for product & period costs

A

total operating costs = product costs + period costs

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3
Q

what is the purpose of product and period costs

A

Prepare gross margin income statement for internal & external stakeholders

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4
Q

what are the different types of businesses

A
  • manufacturing
  • merchandisers
  • service
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5
Q

what is a manufacturing business

A
  • Makes goods
  • Sells the finished goods directly to consumers OR to merchandisers
  • They have inventory
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6
Q

who are merchandisers

A
  • Re-sellers
  • Sells finished goods they buy from manufacturers to consumers
  • They have inventory
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7
Q

what are service businesses

A
  • Provide a service to consumers
  • They don’t have inventory
  • They have supplies “inventory” (includes things that directly relate to providing the service); are generally expensed as they are incurred
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8
Q

what is a merchandising business

A

A company that purchases finished goods from manufacturing businesses and re-sells them to customers at a higher price to make a profit

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9
Q

what is inventory

A

An asset account on the balance sheet that holds the cost of merchandise before it is re-sold to customers

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10
Q

what happens when inventory is re-sold

A
  • When inventory is re-sold, revenue is recognized
  • Need to follow the matching principle; recognizing expenses when related revenue is earned
  • cost of inventory moves from the balance sheet into the income statement and becomes cost of goods sold
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11
Q

what is the value of inventory on the balance sheet

A

the cost of inventory

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12
Q

how do you calculate the cost of inventory

A

Inventory Cost = Cost of Merchandise + Merchandise Shipping & Handling Cost + Other Costs Directly Attributable to the Purchase of Merchandise - Trade Discounts or Rebates

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13
Q

what is cost of goods sold (cogs)

A

An expense in the income statement that is used to recognize the cost of inventory when it is sold to a customer

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14
Q

what is a perpetual inventory system

A
  • A system which uses computer software to keep track of goods bought, sold, & on hand
  • Inventory is manually counted at least once a year
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15
Q

how to calculate changes in inventory during a period

A

Beginning inventory + inventory purchases - cost of goods sold = ending inventory

Beginning inventory = what you had in the beginning (the ending inventory of the previous period)
Inventory purchases = any inventory bought
Cost of goods sold = any inventory sold
Ending inventory = the amount you have at the end of the period (becomes the beginning inventory for the next period)

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16
Q

how is inventory recorded

A
  • using asset recognition criteria
  • a current asset - want to sell it right away
  • Control Criteria - in asset recognition criteria:
    FOB shipping point
    FOB destination point
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17
Q

what is FOB shipping point

A
  • Title and responsibility of goods are transferred to the buyer when the goods are placed on deliver vehicle/plane/ship/etc.
  • Control criteria in asset recognition is met when goods are being shipped
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18
Q

what is FOB destination point

A
  • Title and responsibility of goods are transferred to the buyer when the goods are delivered to the buyer
  • Control criteria in asset recognition is met when the buyer physically has the goods in their hands
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19
Q

what is the journal entry for when inventory ownership is transferred and paid with cash

A

DR inventory (A)
CR cash (A)

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20
Q

what is the journal entry for when ownership is transferred and paid for later

A

DR inventory (A)
CR A/P (L)

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21
Q

what is a purchase order

A
  • A source document that represents a request to purchase goods (includes a purchase order number (to track the order), the number of units ordered, and the price per unit)
    Is when a company orders inventory
  • No journal entry for purchase order because no transaction occurred
  • When the order is shipped, the supplier will create an invoice & send it to the buyer with the payment terms
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22
Q

what is the journal entry for when you bought inventory before and you are now paying the supplier

A

DR A/P (L)
CR Cash (A)

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23
Q

what happens when a sale of inventory is made

A
  • needs to be transferred from the balance sheet to the income statement
  • Sale of inventory must meet rev rec criteria
  • When revenue is recognized, the cost of inventory sold becomes cost of goods sold on the income statement
  • Balance sheet (inventory) -> income statement (COGS)
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24
Q

what is the revenue recognition journal entry when inventory is sold

A

DR A/R or Cash (A)
CR Revenue (R)

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24
Q

what journal entries need to be made when inventory is sold

A
  • revenue recognition
  • expense recognition
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25
Q

what is the expense recognition journal entry when inventory is sold

A

DR cost of goods sold (E)
CR inventory (A)

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26
Q

what are the 3 inventory costing methods in ASPE

A
  • specific identification method
  • first-in, first-out (FIFO) method
  • weighted average cost method
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27
Q

what is the FIFO method of inventory costing

A
  • COGS is what was bought first is what is sold first
  • Appropriate to use for inventory that IS interchangeable
  • ex. Clothing stores, grocery stores
27
Q

what is the specific identification method of inventory costing

A
  • COGS is specific to each item that can be identified & tracked
  • Required for inventory that is NOT interchangeable & for specific products
  • ex. Building a custom luxury car, home, aircraft
28
Q

what is the weighted average cost method of inventory costing

A
  • COGS is the weighted cost of inventory
  • Appropriate to use for inventory that IS interchangeable
  • ex. Clothing stores, grocery stores
29
Q

what are the steps to calculate inventory costing

A
  • calculate cogs for the month
  • do the cogs journal entry
  • calculate ending inventory balance
30
Q

how do you calculate the cogs for the month using FIFO inventory costing method

A

Using the formula to calculate ending inventory (in units) for the month:

Ending inventory = beginning inventory + inventory purchases - cost of goods sold

Adding the price of inventory:
Total pairs sold - Beginning inventory sold = Purchased inventory sold

Therefore,
Beginning inventory sold = units sold x price of those beginning units
Purchased inventory sold = units sold x price of those purchased units

Total pairs sold (cost of goods sold) = beginning inventory sold + purchased inventory sold

31
Q

what is the cogs journal entry after calculating the cogs in the FIFO method

A

DR inventory COGS (E)
CR inventory (A)

32
Q

how do you calculate the ending balance using FIFO

A

ending inventory x price of ending inventory = ending inventory

if there are still left over inventory from the beginning purchase, separate the amount left, multiply the amount by the price it was paid for, do the same for the newly bought inventory and add it together to determine ending inventory

33
Q

how do you calculate the cogs for the month using weighted average cost inventory costing method

A

Using the formula to calculate ending inventory (in units) for the month:

Ending inventory = beginning inventory + inventory purchases - cost of goods sold

then calculate weighted average cost per unit:
Weighted average cost per unit = cost of goods available for sale / number of units available for sale

then calculate cogs:
COGS = Number of units sold * weighted average cost per unit

34
Q

what is the formula for ending inventory

A

in units
Ending inventory = beginning inventory + inventory purchases - cost of goods sold

35
Q

what is the formula for weighted average cost per unit (weighted average cost method)

A

Weighted average cost per unit = cost of goods available for sale / number of units available for sale

36
Q

what is the formula for cost of goods available for sale (weighted average cost method)

A

Cost of goods available for sale = beginning inventory (amount * price) + inventory purchases (amount * price)

37
Q

how do you calculate cogs using weighted average cost method

A

COGS = Number of units sold * weighted average cost per unit

37
Q

what is the formula for the number of units available for sale (weighted average cost method)

A

Number of units available for sale = beginning inventory amount + inventory purchased amount

38
Q

what is the formula for ending inventory balance (weighted average cost method)

A

Ending inventory = Number of units in ending inventory * weighted average cost per unit

39
Q

what are product costs

A
  • all costs related to purchase or producing a good
  • Product cost for merchandising businesses is only the cost to purchase the good
40
Q

how do you calculate the ending inventory balance for weighted average cost method

A

Ending inventory = Number of units in ending inventory * weighted average cost per unit

41
Q

what are the product costs for manufacturing business

A
  • direct materials
  • direct labour
  • manufacturing overhead
42
Q

what is direct labour

A

Labour costs of factory workers that can be easily traced to a finished good
ex. Wages of factory workers operating machines that make belts

42
Q

what are direct materials

A

Materials that can be easily traced to a finished good
ex. Jewels for a ring, leather for a belt

43
Q

what is manufacturing overhead

A

Indirect factory-related costs that can’t be easily traced to a finished good
- Indirect Materials: glue, oils, polishing paste
- Indirect Labour: wages of janitors, security, factory supervisors
- Other Indirect Costs: Factory utilities, factor property taxes, factory equipment depreciation, factory insurance

44
Q

what are period costs

A
  • Other costs a company incurred that are not related to purchasing or producing a good
  • Not recorded on the balance sheet
  • Expensed on the income statement in the same period they are incurred
45
Q

what are the two categories of period costs

A
  • operating expenses (OPEX)
  • non-operating expenses
46
Q

what are operating expenses

A
  • Period costs that are necessary to operate a business
  • Also referred to as Selling, General & administrative (SG&A) expenses
47
Q

what are the different operating expenses

A
  • research & development (R&D)
  • Selling & Marketing (S&M) Costs
  • General & Administrative (G&A) Costs
48
Q

what are non-operating expenses

A
  • Period costs that are not related to the core operations of a business
  • Include financing costs (ex. interest), income taxes and other income (that are not associated with core operations
  • These expenses are deducted at the end of the income statement to calculate net income
49
Q

when is gross margin income statement used

A

when costs can’t be separating into variable and fixed costs

50
Q

what is the gross margin income statement formula

A

Revenue - COGS and/or COS = Gross Margin - operating expenses = Earnings before interest and taxes (EBIT/operating income) - interest, taxes, and other income/expenses = Net income (or net loss)
“Other income” would be added to EBIT

51
Q

how to calculate cost of goods sold

A

Beginning inventory + inventory purchase - ending inventory = cost of goods sold

52
Q

what is gross margin %

A
  • Gross Margin ÷ Revenue
  • How effective a company is at generating a profit after recognizing product costs (cost to purchase/ produce a good)
53
Q

what is EBIT (or operating Income) %

A
  • EBIT ÷ Revenue
  • How effective a company is at generating a profit from its operations
54
Q

what is net income %

A
  • Net Income ÷ Revenue
  • How effective is a company at generating a profit after recognizing all expenses
55
Q

what is a cost object

A

Something that gets cost assigned to it (a product that is being produced to be sold)

56
Q

what are direct costs

A
  • Costs that can be easily traced to a cost object
    Ex. raw materials, labour to make the goods, electricity to run the machines
  • Salaries of workers operating the assembly line; Can track how many hours they work, or how many goods they produced
57
Q

what is a manufacturing business

A

A company that produces finished goods and sells them to merchandising businesses or directly to consumers

58
Q

what are the 3 inventory accounts of manufacturing companies

A
  • raw materials inventory: includes costs of raw materials before they are used to produce a good
  • Work in Process Inventory: includes the cost of direct materials, direct labour, and allocated manufacturing overhead as a good is being produced
  • Finished Goods Inventory: includes the total cost of a finished good before its sold
59
Q

what do product costs of manufacturing companies include

A
  • (raw) material purchases, direct labour, and manufacturing overhead
  • These are recorded in the separate inventory accounts on the balance sheet until the product is sold
60
Q

how does inventory move through the 3 accounts in a manufacturing business

A
  • When materials are first purchased and have not been used, they are in the raw materials inventory account
  • Once the materials are placed in production, the material cost is transferred from raw materials inventory to work in process inventory
  • When the product is completed, it is then transferred again to the finished goods inventory account
  • The product cost would remain in the finished goods inventory until the good is sold
  • When it is sold it is removed from the balance sheet, and put into the income statement as cost of goods sold
61
Q

what are service businesses

A
  • Companies that provide a service to customers
  • Service businesses don’t sell goods, so they can’t have cost of goods sold
  • Instead of cost of goods, they have cost of sales
62
Q

what are cost of sales (COS)

A
  • Include costs directly related to providing a service
  • Sometimes referred to as cost of revenue
    Usually includes:
  • Direct materials: materials that can be easily traced to providing a service
  • Direct labour: labour costs that can be easily traced to providing a service
  • Direct travel: travel costs incurred to provide a service
  • Depreciation of long-term assets: cost of long-term assets purchased to provide a service
63
Q

can service companies have inventory

A

yes
Not for resale but things they have to use for their service
Ex. fuel or spare parts and supplies for Air Canada

64
Q

what is the number of units available for sale calculated (weighted average cost method)

A

Number of units available for sale = beginning inventory amount + inventory purchased amount

AFM 191 (6 decks)

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