Chapter 6 Flashcards
Three categories of inventory
Finished goods inventory
Work in process
Raw materials
Finished goods inventory
Manufactured items that are completed and ready for sale
Work in process
The portion of manufactured inventory that has begun the production process but is not yet complete
Raw materials
The baic goods that will be used in production but have not yet been placed into production
Hepful hint: inventory classification
Regardless of the classification, companies report all inventories under Current Assets on the balance sheet
Just-in-time (JIT) inventory
Companies manufacture or purchase goods just in time for use
ex. Dell
Ethics note: salad oil company
Filled storage tanks with water so auditors thought they were full of oil
repainted numbers too
Ownership during FOB shipping point
ownership passes to the buyer when the public carrier accepts the goods from the seller
- buyer pays freight costs
Ownership during FOB destination
Ownership remains with the seller until thegoods reach the buyer
seller pays freight costs
Consigned goods
Goods held for sale by one party although ownership of the goods is retained by another party
ex. a company is selling my car for a fee
Ethic Note: disadvantage of specific identification
Management can manipulate net income
Boost net income by selling units bought at low cost
or reduce by selling units bought at high cost
Specific identification
An actual physical flow costing method in which items sold and items still in inventory are specifically costed to arrive at cost of goods sold and ending inventory
First in, First out (FIFO) method
An inventory costing method that assumes that the earliest goods purchased are the first to be sold
Helpful hint: FIFO
Another way of thinking about FIFO ending inventory is the LISH assumption
“Last is still here”
LIFO
An inventory costin gmethod that assumes the latest units purchased are the first to be sold
alternative: FISH “First is still here”
Average-cost method
An inventory costing method that uses weighted-average unit cost to allocate the cost of goods available for sale to ending inventory and cost of goods sold
COGS/Total Units Avilable for Sale = Weight Average Unit Cost
Companies can use _________________ under GAAP
all three assumed cost flow methods
REasons for different inventory cost flow methods
- Income statement effects
- Balance sheet effects
- Tax effects
When prices are rising, companies prefer ______________
FIFO because it results in higher net income
Helpful hint: LIFO and taxes
LIFO conformity
If companies use LIFO for taxe purposesm they must also use it for financial purposes
LIFO _____________ the quality of earnings ratio
increases
higher net cash from operating activities
lower net income
Lower-of-cost-or-market
A basis whereby inventory is stated at the lower of either its cost or its market value as determined by current replacement cost
Current replacement cost
The cost of purchasing the same goods at the present time form the usual suppliers in the usual quantities
Concept of conservitism
The best choice among accounting alternatives is the method that is least likely to overstate assets and net income
International Note: write-downs
Under GAAP - companies cannot reverse inventory write-downs if inventory increases in value in subsequent periods
IFRS - permits companies to reverse write-downs in some circumstances
Inventory turnover ratio
Cost of Goods Sold
Average Inventory
*Indicates how quickly a company sells its goods
Days in inventory
365
Inventory Turnover Ratio
*indicates the average number of days inventory is held
LIFO reserve
For a company using LIFO, the difference between inventory reported using LIFO and inventory using FIFO
Moving average method
Company computes a new average after each purchase for unit costs
Beginning inventory understated
Cost of goods sold: understated
Net income: overstated
Beginning inventory overstated
Cost of Goods Sold: Overstated
Net income: Understated
Ending inventory understated
Cost of Goods Sold: Overstated
Net income: Understated
Ending inventory overstated
Cost of Goods Sold: Understated
Net income: Overstated
Ending inventory error: Overstated
Assets: Overstated
Liabilities: No effect
Stockholder’s equity: overstated
Ending inventory error: Understated
Assets: Understated
Liabilities: No effect
Stockholders’ Equity: Understated
