Chapter 6

Question 1

Periodic System

Answer 1

1. Debits all inventory items to the “Purchases” account
2. Make NO entry to update “COGS” & “Inventory” accounts with each sale
3. Make physical count @ year-end to determine COGS using:

BI + NP = GAS - EI = COGS

Requires AJE
[COGS
EI
Purchases
BI

Net Purchases involve less discounts, R + A, plus freight-in (transportation expense when a buyer is responsible)

Question 2

Perpetual System

Answer 2

1. Debits all inventory items to the “inventory” account.
2. Updates “COGS” & “Inventory” account with each sale.
3. Uses physical count @ year-end to determine “loss on shrinkage”.

*keeps running total of COGS and updates inventory.

Question 3

Goods to Include in EI

Answer 3

1. Goods in Transit
   - FOB Shipping Point: title transfers to buyer when goods are accepted by common carrier.
   - FOB Destination: title transfers when goods are delivered to destination of buyer.
2. Consigned Goods: owner transfers physical goods to agent for purposes of selling without giving up legal title.
3. Goods Called In: if goods are ordered, as long as they’re identified and separate, they belong to the buyer

Question 4

Inventory Cost Flow Methods

Answer 4

1. Specific Identification - small quantity of inventory, high-priced items. Impractical for most businesses.
2. Average Cost Method (periodic) - uses weighted average of all costs for GAS, assigns average cost to EI and COGS
   - total cost of GAS/total units of GAS
   - avg. cost * units of EI/COGS
3. FIFO (perpetual) - cost of first item purchased = cost of first item sold (COGS)
   - wants oldest inventory to go first
4. LIFO (perpetual) - cost of last item purchased = cost of first item sold (COGS)

Question 5

Advantages & Disadvantages

Answer 5

1. FIFO
   ADV:
   - assigns current cost to ending inventory
   - good method when inventory turnover is rapid
   DIS:
   - fails to match most current costs with revenues (instead matches oldest costs)
   - if prices are rising, COGS is understated, NI is overstated -> “inventory profits”
2. LIFO
   ADV:
   - matches current costs with revenues
   - if prices are rising, NI is understated -> reducing income taxes -> companies must follow LIFO Conformity Rule (if you use LIFO for tax purposes, you must also use it for financial reporting)

DIS:
- gives non-current value to inventory on BS
- if international financial reporting standards are adopted in the U.S., LIFO will not be allowed as a reporting method

Question 6

Inventory Turnover Ratio

Answer 6

Measures if the company keeps excess stock of inventory. Excess stock is NOT productive.

Want high inventory turnover to keep to a minimum inventory carrying costs and risk of loss.

COGS/((BI + EI)/2)

answer = selling out inventory roughly xxx times/year