Chapter 6.2: Inventory Costing Methods Flashcards
Why is determining the cost of sales and the cost of ending inventory crucial for companies?
Determining the cost of sales and the cost of ending inventory is crucial because changes in inventory costs can significantly impact a company’s net earnings, potentially turning them into losses or profits.
It also affects the amount of taxes a company pays.
What are the three generally accepted inventory costing methods?
The three generally accepted inventory costing methods are:
Specific identification
First-in, first-out (FIFO)
Weighted average
How does the specific identification method differ from FIFO and weighted average?
The specific identification method identifies individual items in inventory and matches their actual costs to cost of sales.
In contrast, FIFO assumes the oldest inventory items are sold first, and weighted average calculates the average cost of all inventory items and applies it to cost of sales.
What requirement does International Accounting Standard 2 have regarding inventory costing methods?
International Accounting Standard 2 requires that the inventory costing method used be rational and systematic.
It should provide a faithful representation of expenses corresponding to the revenues earned during the period.
The choice of method should accurately allocate the total cost of goods available for sale to cost of sales and ending inventory on financial statements.
What does the specific identification method entail, and under what conditions is it suitable?
The specific identification method requires identifying and recording the cost of each individual item sold.
It is suitable for unique, expensive items like broadband telecommunications systems, aircraft, yachts, fine art objects, and luxury cars where each item differs from the others.
It is impractical for interchangeable items like jackets of the same size, style, and materials.
Why is the specific identification method prohibited for large numbers of interchangeable inventory items under IFRS?
The specific identification method is prohibited for large numbers of interchangeable items because it can be manipulated without electronic tracking, leading to potential inaccuracies in cost of sales and ending inventory accounts.
IFRS restricts its use when dealing with items that are identical and interchangeable.
How is technology used to implement the specific identification method, especially for expensive items?
Technology such as bar-code scanning and radio frequency identification (RFID) is employed to implement the specific identification method.
Each item is coded with a unique identifier or serial number.
Bar-code scanning and RFID technology help maintain a perpetual record of inventory costs by transmitting cost and quantity information to a central database.
This method ensures accurate tracking and matching of specific units to recorded costs.
How does the use of bar-code scanning and RFID technology impact the computation of the cost of sales and the cost of ending inventory?
Bar-code scanning and RFID technology facilitate accurate computation of the cost of sales and the cost of ending inventory.
During sales transactions, the specific unit sold is identified through the bar code or RFID tag, and its recorded cost is matched.
The remaining unsold units at the end of the period represent the cost of ending inventory, providing precise financial information for the company.
What are cost flow assumptions, and how are they related to inventory accounting?
Cost flow assumptions are assumptions made about the flow of inventory costs in and out of a company’s inventory.
These assumptions help in accounting for inventory items and determining the cost of goods sold.
The choice of an inventory costing method is not based on the physical flow of goods but on assumptions about how costs flow.
How are inventory cost flows represented visually, and why are older inventory items typically placed at the top of the stack?
Inventory cost flows can be represented visually as a stack of inventory units.
Each unit represents the cost of purchase when entering inventory and the cost of sales when sold.
The oldest inventory items are placed at the top of the stack because they are usually sold first.
Why are cost flow assumptions important in inventory accounting, and how do they impact financial reporting?
Cost flow assumptions are important in inventory accounting because they affect how a company calculates the cost of goods sold and ending inventory.
The choice of a specific cost flow assumption can impact a company’s financial statements, including net income, taxes, and overall profitability.
Can you explain how cost flow assumptions are applied in the context of the visual representation of a stack of inventory units?
Can you explain how cost flow assumptions are applied in the context of the visual representation of a stack of inventory units?
Answer 4: In the visual representation of a stack of inventory units, cost flow assumptions determine which units are considered sold (cost of goods sold) and which units remain in inventory (ending inventory). For example, under the FIFO (First-In, First-Out) method, the oldest units at the top of the stack are considered sold first, whereas under the LIFO (Last-In, First-Out) method, the newest units are considered sold first. These assumptions impact the financial representation of inventory costs on a company’s balance sheet and income statement.
