Chapter 6

Question 1

The company purchased the inventory at 200 on July 1, 2019. The market value of the inventory is assessed to be 100 on the fiscal-year end date on December 31, 2019. Wht should be the amount of the inventory reported on the balance sheet as at December 31, 2019?

Answer 1

Should we report historical cost or market value? In this case we do market value of 100.

Question 2

What is LCM?

Answer 2

Lower of Cost vs Market. We choose the lower cost between the two. Only specific to inventory

Question 3

The company purchased the inventory at 200 on July 1, 2019. The market value of the inventory is assessed to be 400 on the fiscal-year end date on December 31, 2019. Wht should be the amount of the inventory reported on the balance sheet as at December 31, 2019?

Answer 3

We report 200, the historical cost with no journal entry

Question 4

Valuation of inventory at the year end

Answer 4

LCM only applicable to american companies.

- Canadian companies compares historical cost with net realizable value

Question 5

What is NRV?

Answer 5

It is the estimated retail market value of inventory

= expected selling price - sum of selling costs and costs to complete

Question 6

What is a “fire” sale?

Answer 6

A fire sale cosnists of selling goods or assets at heavily discounted prices.

Question 7

Write down of inventory

Answer 7

(1) Direcr method
(Dr) COGS (Cr) Inventory

(2) Indirect method
(Dr) Loss due to market decline (Cr) Inventory

Question 8

T-Account for inventory?

Answer 8

End = beg + purchase - COGS

Question 9

What events chanfe the value of inventory?

Answer 9

• lower sale price - Maybe due to changes in market conditions
• can incur additional costs to sell
• This will have impact on NRV

Question 10

Lower of cost and NRV - Why do we have this rule?

Answer 10

Because of accounting conservatism (inventory write-up is not allowed)
Because of the definition of assets:
- Inventory is treated as an asset, since there is a future benefit related to it

Question 11

What is the cost of the inventory will not be recovered?

Answer 11

Then there is no future benefit related to a portion of the cost. Hence, inventory cost should be brought down

Question 12

The requirement to use the lower-of-cost-or-market (LCM) rule is a result of the application of which of the following generally accepted accounting principles?

Answer 12

Conservatism principle

Question 13

Suppose that the beginning and ending balances of inventories are 100 during the year. Two sales transacions take place on April 1 and October 1 for the inventory value of 100 in each event. At the end of each sales event, the company repurchased 100 inventory to fully re fill store shelves. Compute the inventory turnover ratio

Answer 13

We have 2 sales event that sold 100 each.
2 * 100 = COGS/ 100 = average inventory

so the answer is 2

Question 14

Is a higher or lower inventory turnover ratio better?

Answer 14

Higher

Question 15

Suppose that the beginning and ending balances of inventories are 100 during the year. Twelve sales transactions take place on 15th day of each month during the year, with the inventory value of 100 on each sales event. At the end of each sales event, the company repurchased 100 inventory to fully re fill store shelves. Compute the inventory turnover ratio

Answer 15

12 * 100 = COGS
Average inventory = beginning inventory + ending inventory / 2 = 100

So answer is 12

Question 16

Inventory turnover equation

Answer 16

COGS/average inventory

It is the number of times inventory is renewed each year.

Question 17

Days in inventory equation?

Answer 17

Average inventory * 365 / COGS

Same as inventory turnover but in days. Shorter, the better, but must have inventory on shelves to sell it

Question 18

A tip to memorize financial ratios

Answer 18

• If the denominator and the numerator come from the same financial statement, there is not need to use the average value. (e.g., current ratio, gross profit margin ratio)
• If the denominator and the numerator come from the different financial statements, we need to use the average value for B/S items (e.g., inventory turnover ratio, days in inventory)

Question 19

Specific identification method

Answer 19

If inventory items are unique, then company will likely track cost of each item in inventory as cost for each item is different

Question 20

Specific identification method t account

Answer 20

When item is sold, the cost of that specific item is removed from inventory:

(dr) cash (cr) sales revenue
(dr) COGS - item A (Cr) Inventory - Item A

Question 21

When does Tiffany & co use specific identification method as opposed to average cost method?

Answer 21

When item is very expensive or unique

Question 22

Can a company use multiple cost flow assumptions for different product groups of the firm?

Answer 22

Yes

Question 23

At the beginning of 2022, Move Studio plans to make three movies in 2022. The total costs for the three movies are expected to be 555 million. So the average cost per movie is estimated to be 185 million. As a CEO would you sell one movie for 190 million?

Answer 23

No. Each movie is unique so we need to keep track of each movies production cost in terms of determinign the selling price and COGS during the year.

Question 24

Cash slow assumption

Answer 24

(1) Specific identification method
(2) FIFO (first in first out)
(3) Average cost method

Question 25

What is the FIFO assumption

Answer 25

The first tiem purchased is the first item sold during the year

Question 26

What is the average cost method?

Answer 26

We take the average value to determine the inventory cost during the year. For this method, the calculation is different under perpetual & periodic.
Perpetual = moving average
Periodic = weighted average

Question 27

What are some assumptions in FIFO

Answer 27

• cost of goods sold is the cost of the units purchased FIRST
• year-end inventory is the cost of the units purchased LAST
• May have nothing to do with real physical flow of merchanidse
• Cost flow assumption is nothing but an assumption for accounting purposes so it does not have to be exactly matched with physical inventory flow. But it is preferable if matched

Question 28

If costs are increasing over time, FIFO gives higher or lower net income under the assumption that all else is equal (including total purchase price of the inventory during the year), compared to the case when costs are decreasing?

Answer 28

In order to have higher net income we need a smaller COGS expense. Inflation case will give us smaller COGS expense relative to deflation case. So smaller COGS expense gives higher net income so the answer is higher.

Question 29

If costs are rising, FIFO gives?

Answer 29

Lower cost of goods sold,
higher gross margin,
higher net income,
higher ending inventory

Question 30

Average cost method (Under perpetual)

Answer 30

• Calculates an average cost each time there is a new purchase of inventory with different price
• A moving average of the unit cost is maintained
• When a sale occurs, the average unit cost at that point is used in order to calculate COGS

Question 31

Assume that a company adopts the perpetual inventory system. If costs are rising, Average Cost method gives a higher or lower net income, comapred to FIFO?

Answer 31

Lower. In FIFO the oldest purchase are the ones we’ve sold so they must be cheaper because of inflation. When inventory is sold they are cheaper than purchased so COGS wil be smaller so FIFO has a higher net income

Question 32

Is FIFO or Average cost higher for COGS?

Answer 32

Average Cost

Question 33

Is FIFO or Average cost higher for gross profit?

Answer 33

FIFO

Question 34

Is FIFO or Average Cost higher for profit?

Answer 34

FIFO

Question 35

Is FIFO or Average Cost higher for Cash?

Answer 35

The same

Question 36

Is FIFO or Average Cost higher for ending inventory?

Answer 36

FIFO

Question 37

Is FIFO or Average Cost higher for retained earnings?

Answer 37

FIFO

Question 38

If costs are rising, Average cost method gives higher or lower net income, compared to FIFO?

Answer 38

Lower net income leading to lower tax payment. Compared to FIFO, average cost method gives lower net income with a higher amount of COGS in the case of rising purchase cost such as inflation.

Question 39

A corporation is uding FIFO as its cost flow assumption. B Corporation is using average cost method. Prices have been steadily increasing for their inventory of commodities. Both companies are similar in all other aspects. What is a True statement about the ratios of both corporations?

Answer 39

The current ratio of A is larger than the current ratio of B.

Most recent purchases will be more expensive in case of inflation so for FIFO ending inventory balance will be higher. FIFO gives smaller COGS so gross profit is higher so gros profit margin is larger.

Question 40

The accounting principle that requires that the inventory costing method (E.g., FIFO, Average cost) be conssitent with the phycial movement of goods is …?

Answer 40

Nonexistent; that is, there is no such accounting requirement

Question 41

Equation for Cost of Good available for Sale?

Answer 41

Beginning balance + Cost of goods purchased

Question 42

If all else is equal, which inventory system gives higher net income under the assumption that the costs are rising over time?

Answer 42

Perpetual

With perpetual we look at moving average and periodic we look at weighted average. If we assume inflation then perpetual. (Would be opposite if assuming deflation)