Chapter 6

Question 1

Inventory

Answer 1

purchases from suppliers with the intention to sell to our customers to earn revenues

Question 2

Merchandising

Answer 2

Consists of holding merchandising inventory

They are owned by the company
They are in a form ready for sale to customers

Question 3

Manufacturing

Answer 3

Consists of holding:
finished goods inventory: goods that are completed and ready for sale
work in progress: portion of manufactured inventory that has been placed into the production process but isn’t yet complete
raw materials: basic goods used in production but haven’t been put into production

Question 4

JIT inventory

Answer 4

An inventory system in which companies manufacture or purchase goods just in time for use

Question 5

Why determine inventory quantities for perpetual system

Answer 5

To check the accuracy of their record
To determine the amount of inventory lost

Question 6

Why determine inventory quantities for periodic system

Answer 6

To determine inventory at the date of financial position statement
To determine the cost of goods sold for that period

Question 7

Goods in transit

Answer 7

FOB shipping point (Free on board) - ownership passes to the buyer when the public carrier accepts the goods from the seller

FOB destination - ownership of the goods remains with the seller until the goods reach the buyer

Question 8

Consigned goods

Answer 8

Some businesses hold goods of other companies and try to sell them for a fee - but in this case they don’t have the ownership

Question 9

Inventory is accounted for at —

Answer 9

Cost, which includes all expenditures necessary to acquire goods and place them in a condition ready for sale

Question 10

Specific identification

Answer 10

Used for businesses with unique inventory items
If a business can identify which units it has sold and which are still in the inventory
Requirement: keep track of the original cost of each individual item

Question 11

FIFO

Answer 11

assumes that oldest items will be sold first
This doesn’t necessarily mean that the oldest units are sold first, but that the costs of the oldest units are recognised first Oldest Costs → COGS; latest costs → Ending Inventory
Ending inventory consists of the most recent inventory purchase costs

Question 12

LIFO

Answer 12

most recent items are assumed to be sold first
Latest costs → COGS; oldest costs → Ending Inventory
Ending inventory consists of oldest inventory purchase costs

Question 13

Average cost

Answer 13

Allocates the cost of goods available for sale on the basis of the weighted average unit cost incurred
Cost of goods available for sale / Total units available for sale = Weighted average unit cost

Question 14

Cost of goods sold in a periodic system

Answer 14

(beginning inventory + purchase) - ending inventory

Question 15

Income statement effects of cost flow methods

Answer 15

Periods of inflation: FIFO produces a higher net income because:
–> COGS is lower: Older costs are cheaper.
–> Net Income is higher: Lower COGS results in a higher gross profit.
–> Ending Inventory is higher: Reflects the more recent, higher costs.

Periods of falling prices: Average cost will report a higher net income because:
–> COGS is reduced: Due to higher costs being partially included in Ending Inventory instead of COGS.
–> Net Income is higher: Lower COGS increases gross profit.
–> Ending Inventory is higher: Reflects the inclusion of older, higher-priced inventory in its valuation.

Question 16

Statement of financial position effects of cost flow methods

Answer 16

FIFO (in periods of rising prices) will be more accurate in evaluating the cost of ending inventory
Therefore it will give a more accurate representation of the value of inventory (assets)

Question 17

Tax effects of cost flow methods

Answer 17

FIFO reports higher net income but this exposes the company to a higher income tax
That is why some companies use average cost

Question 18

COGS formula

Answer 18

Calculated by multiplying the weighted average unit cost by the number of units sold.

Question 19

Ending inventory calculation

Answer 19

Calculated by multiplying the weighted average unit cost by the number of units remaining in inventory.

Question 20

Error in ending inventory —

Answer 20

Will have a reverse effect on net income of the next accounting period

Question 21

Overstated ending inventory

Answer 21

Overstate assets
No effect on liabilities
Overstate equity

Question 22

Understated ending inventory

Answer 22

Understate assets
No effect on liabilities Understate equity

Question 23

Lower of Cost or Net Realisable Value

Answer 23

When the value of inventory is lower than its cost, companies must “write down” the inventory to its Net realisable value

Question 24

Net realisable value

Answer 24

What a company expects to receive from the sale of inventory
- Estimated selling price - estimated costs

Question 25

Inventory turnover formula

Answer 25

Cost of goods sold / Average inventory

Question 26

Average inventory formula

Answer 26

(Beginning inventory + Ending inventory) / 2