Chapter 6 - Inventory

Question 1

Key Concept: Inventory

Answer 1

Inventories are assets:

1. held for sale in the ordinary course or business;
2. in the process of production; or
3. in the form of materials or supplies to be consumed in the production process or the rendering of services.

Question 2

Key Concept: Work in progress

Answer 2

Work in progress is the term applied to products and services that are at an intermediate stage of completion; for example, if you envisage an assembly line for microcomputer, at any point in time there will be some partially assembled computers somewhere on that production line. An even more obvious example, which we can observe merely by walking round any town centre, is partially completed buildings which are work in progress for some building contractor. A less obvious but equally valid example of work in progress is the time spent to date by an architect on a half-finished drawing.

Question 3

Key Concept: Finished goods

Answer 3

Finished goods are goods that have been through the complete production or assembly cycle and are ready for sale to the customer. Examples are cars for Toyota, computers for Apple and DVD players for Sony.

Question 4

Key Concept: The importance of determining inventory levels

Answer 4

Because the cost of goods sold is, in some cases, calculated by combining the purchases with the inventory figures, the opening and closing inventory levels are vital in determining the cost of goods sold. They therefore have a dual role in the statement of financial position in determining wealth and, through the cost of goods sold, in determining profit.

Question 5

Key Concept: Operation cash flow

Answer 5

Operating cash flow is the cash inflows and outflows arising from the trading activities of the enterprise.

Question 6

Key Concept: Net realizable value (erwarteter Verkaufserlös)

Answer 6

Net realizable value is defined as the estimated proceeds from the sale of items less the costs of selling these items.

Question 7

Key Concept: The valuation rule

Answer 7

Inventory should be valued at the lower of cost and net realizable value.

Question 8

Key Concept: The prudence concept

Answer 8

Profits are not anticipated and revenue is not recognized until their realization is reasonably certain. Provision is made for all potential losses.

Question 9

Key Concept: Matching principle and accrual accounting

Answer 9

The matching principle is at the heart of accrual accounting and is based on the notion that the revenue for the period should be matched with the expenses incurred in earning that revenue. This leads to a change from cash based accounting, whereby all transaction are charged to the income statement as they are incurred, to accrual accounting whereby items are only charged to the income statement as expenses when the future benefit has been used up.

Question 10

Key Concept: Consistency

Answer 10

The international Financial Reporting Standard for Small and Medium Sized Entities is quite clear that: ‘An entity shall retain the presentation and classification of items in the financial statements from one period to the next.’ It then identifies the specific situations under which a change is allowed.