Chapter 6 Inventories & COGS Flashcards
What are inventories?
Materials or supplies to be consumed in the production process or in the rendering of services
What are the two accounts for every inventory transaction?
DR COGS
CR. Inventory
How do companies keep track of inventories?
- Periodic
2. Perpetual
Explain the concept of the periodic system
Periodic system does not have a up-to-date record of inventories during the year.
Periodic system requires a physical count at the end of each financial period
Determined using the formula :
COGS = Beginning Inventory + Purchases - Ending Inventory
Explain the concept of perpetual inventory recording system
The perpetual inventory system constantly updates the accounting records for each transaction regarding inventory. At any point in time, we can discover the cost of goods sold.
What are included in the cost of inventories?
1) All costs of purchases (purchase price, handling cost, discount rates)
2) Costs of conversions (depreciation, factory maintenance, etc.)
3) Any other costs (incurred in bringing inventories to their present location & condition)
On 16 Feb, Care Ltd purchased 50 units of iCare from its supplier. The purchase price was $1500 with terms of 2/10, n/30. The invoice was paid on 28 Feb. In addition, transport costs of $50 and costs of packaging and handling of $100 were also incurred.
Q: What is the cost per unit of iCare to be recorded in Care’s inventory records?
Answer :
Since they did not meet the sales discount period. Purchase price = 1500.
Total price = 1500 + 50 + 100
Per unit cost = 1650/50 = 33
What are the three inventory costing methods?
When are they used?
1) Specific Identification method
- used on extremely unique and valuable goods (custom made items)
2) First in first out method
- used on perishable goods such as food that requires items of inventory that are bought first to be sold first (rice, poultry)
3) Weighted average method
- used on goods that are not unique and not perishable
How does the FIFO method affect cost structure?
Items remaining at the end of the accounting period are those that are most recently purchased. COGS will include costs that are older as compared to ending inventory whose costs will be more recent.
What are the effect of constant prices on both the FIFO and Weighted average cost of inventory methods?
Under the constant prices model, both FIFO and Weighted Average will not have a difference because the prices at which they are bought remained constant
What are the effects of inflation on both the FIFO and weighted average method?
Under Inflation,
COGS Income Tax Assets
FIFO Lower Higher Higher
Weighted Average Higher Lower Lower
What are the effects of deflation on FIFO and Weighted Average method?
Under Deflation
COGS. Net Income Tax Assets (Inventory)
FIFO Higher Lower Lower
Weighted Average Lower Higher Higher
Should assets be carried in the balance sheet in excess of amounts expected to be realised from their sale or use?
No, assets should not be carried in amounts greater than their realisable sale or use of these assets.
How is inventory reported in the balance sheet?
Inventory is reported at lower of cost OR Net Realisable Value
Net realisable value is the estimated selling price in the ordinary course of business less estimated cost of completion and estimated costs necessary to make the sale.
How is NRV determined?
Estimates of NRV will be made on the most reliable information available at the time. Try to obtain evidence close to the end of the accounting period, so that this is more likely to provide the best estimate
What are the journal entry for the write down of inventory?
DR COGS
CR Inventory
What is the impact of inventory errors?
If ending inventory is overstated –> COGS understated –> Gross/Net income overstated
If ending inventory is understated –> COGS overstated ==> Gross/Net income understated
What is the ratio of gross margin?
What does gross margin tell you?
The higher the ratio, the higher the markup a business is able to charge to its customers for its product/services?
This indicates
1) Premium on quality products, the company makes better products thats why it can charge a higher margin.
2) Efficient inventory manafacturing
What is the ratio of inventory turnover
What does it tell you?
Inventory turnover = COGS/Avg Total Inventory
This ratio measures how frequently inventory is sold, the higher the ratio the greater the efficiency in selling the inventory.
What is the ratio for inventory holding period?
Inventory holding period = 365/Inventory turnover ratio
This tells you the average number of days the company needs to convert inventory into sales
