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MGMT 201: Financial Accounting > Chapter 7: Inventory > Flashcards

Chapter 7: Inventory Flashcards

1
Q

Inventory

A

Any item purchased by a company for resale to customers or to be used in the manufacture of a product that is then sold to customers

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2
Q

All companies with the exception of __________ have inventory

A

service businesses

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3
Q

merchandisers (aka retailers)

A

A company that purchases goods from manufacturers or suppliers and sells them to customers.

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4
Q

manufacturers

A

A company that makes products

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5
Q

Why Is Inventory of Significance to Users?

A

For retailers and manufacturers, inventory is often the most significant current asset; that is, the largest asset that will be converted to cash over the next year
-most significant asset on the company’s statement of financial position

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6
Q

Suppliers

A

companies that can provide the required items on a timely basis. Location of the supplier can be an important consideration because of the amount of time required between the order date and the delivery date, as well as the costs of shipping

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7
Q

Stockout

A

A situation arising when a company sells all of a specific item of inventory and has no more available

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8
Q

What Are the Major Classifications of Inventory?

A

1) raw materials,
2) work-in-process,
3) finished goods

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9
Q

Raw materials

A

All of the items required to manufacture a product

ex: wood, plastic, fabric, nails, glue

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10
Q

Work-in-process

A

A class of inventory used to record the costs of products that have been started but have not been completed at the end of the accounting period

  • The classification includes the costs of raw materials plus labour costs and overhead costs
    (ex: chairs and tables that are partially assembled but are not yet complete.)
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11
Q

Finished goods

A

Products completed by a manufacturer and ready for sale to customers.

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12
Q

Over head

A

Manufacturing costs other than the costs of raw materials and labour, such as utilities and depreciation of the manufacturing facility.

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13
Q

Four transactions as inventory moves through a manufacturer:

A
  1. Raw materials are purchased.
  2. Raw materials are used and incorporated into the manufacture of products. These are known as work-in-process until the manufacturing process has been completed.
  3. The manufacturing process is completed and the goods move from work-in-process to finished goods.
  4. The goods are sold and move from finished goods to cost of goods sold.
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14
Q

The most commonly used shipping terms are

A

FOB shipping point and FOB destination

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15
Q

FOB shipping point

A

Shipping term signifying that the buyer is responsible for paying shipping and any other costs incurred while the goods are in transit from the seller’s premises to the buyer’s premises.

-the buyer owns the inventory when it leaves the seller’s premises (the shipping point), and the buyer includes these goods in its inventory even though they have not yet arrived.

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16
Q

FOB destination

A

Shipping term signifying that the seller is responsible for paying shipping and any other costs incurred while the goods are in transit from the seller’s premises to the buyer’s premises.

-the buyer does not own the inventory until it reaches the buyer’s premises (its destination) and the buyer does not record the inventory until it arrives.

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17
Q

FOB stands for?

A

Free on board

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18
Q

Key points for FOB

A

FOB shipping point: buyer owns inventory when it leaves the seller’s premises.
FOB destination: buyer owns the inventory when it arrives at the buyer’s premises.

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19
Q

Consignment arrangements

A

The consignor continues to own the goods, and they are included as part of their inventory. The consignee must ensure that the consigned goods they hold are excluded from their inventory.

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20
Q

Inventory flows through inventory systems

A

A company starts each accounting period with the inventory that it had at the end of the previous period.

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21
Q

Is inventory permanent or temporary account

A

Permanent account!

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22
Q

Opening inventory or beginning inventory

A

Inventory is a permanent account, the account balance carries over from one period to the next.

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23
Q

Cost of goods available for sale (COGAS)

A

The cost of all of the goods that a company had available to sell to its customers during the period, calculated as the cost of the opening inventory plus the cost of purchases

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24
Q

COGAS =

A

Opening inventory + purchases

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25
Q

Periodic inventory systems

A

An inventory system in which cost of goods sold is determined by counting ending inventory, assigning costs to these units, and then subtracting the ending inventory value from cost of goods available for sale (that is, the sum of the beginning inventory plus purchases for the period)

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26
Q

Until a physical count is conducted, companies that use ______ will not know their cost of the inventory on hand nor the cost of goods sold in the period.

A

periodic inventory systems

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27
Q

These updates only happen when the company physically counts its inventory, which may be done only at the end of each month, ________

A

each quarter, or even each year

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28
Q

periodic inventory systems will use the cost of goods sold model as follows:

A

Opening inventory + purchases = Cost of goods available for sale - ending inventory = Costs of goods sold

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29
Q

Pros and cons to periodic inventory systems

A

Periodic inventory systems have the advantage of being easy to operate, they are often manual systems and do not require the use of computer hardware or software. This makes the upfront costs of these systems less expensive

but they have a significant disadvantage in that they do not provide management with up-to-date information about inventory quantities or costs.

  • Companies must have regular inventory counts conducted, which requires additional wage costs for staff or payments to outside contractors
  • Companies may also have to close for business in order to conduct counts, which can result in lost sales.
  • unable to quantify the cost of inventory that has been lost to theft
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30
Q

Companies that use periodic systems record all inventory purchases in a _______.
When goods are sold, an entry is made to record the sale to the customer, but no entries are made to the _____ until the end of the accounting period when a physical count of inventory has been performed.

A

Purchases account

Inventory or Cost of Goods Sold accounts

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31
Q

Perpetual inventory systems

A

An inventory system in which the cost of goods sold is determined at the time a unit is sold and ending inventory is always known, in both units and dollars.
-These systems are computerized and generally require the use of bar code scanners

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32
Q

Some perpetual inventory systems track the physical flow of goods and their costs:

A

the system has details on the specific goods sold or still on hand, along with their costs.

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33
Q

Other perpetual inventory systems track only the physical flow of goods:

A

the system has details on the specific goods sold or still on hand, but does not track the cost information.

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34
Q

It is important to note that, while inventory counts are not required for companies using perpetual inventory systems, they are still conducted at least

A

once per year (at year end)

They are needed for companies to determine if the actual amount of physical goods on hand is equal to the ending inventory information according to the computer

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35
Q

Inventory shrinkage

A

The losses of inventory due to spoilage, damage, theft, or waste

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36
Q

Companies using perpetual inventory systems will use the cost of goods sold model as follows:

A

Opening inventory + purchases = cost of goods available for sale - cost of goods sold = ending inventory - actual ending inventory per count = shrinkage (or theft)

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37
Q

“Cost” include for a retailer

A

Purchase price of item
Non-refundable taxes
Shipping or transportation-in
Import duties

38
Q

“cost” include for a manufacturer

A 
Purchase price of raw materials
Non-refundable taxes
Shipping or transportation-in
Import duties
Labour costs
Overhead costs
39
Q

many companies treat shipping costs as an expense in the period in which they are incurred. These costs become part of ______

A

cost of goods sold.

40
Q

Cost formulas

A

Method of allocating cost of goods available for sale to cost of goods sold and ending inventory.

41
Q

Ending inventory is on what statment?

A

Statement of financial balance

42
Q

Costs of goods sold is on what statement?

A

The statement of income

43
Q

three inventory cost formulas:

A

specific identification (specific ID),
weighted-average,
and first-in, first-out (FIFO)

44
Q

Key points on the formula’s

A

Cost formulas are necessary because inventory purchase costs change.
COGAS is the same regardless of the cost formula used.
The three cost formulas result in different allocations of COGAS between ending inventory and COGS.

45
Q

A company does not have to select a single cost formula for its entire inventory. The same cost formula must be used for all inventories of a similar nature and use, but different cost formulas can be selected for inventories with a different nature or use.

A

CWAZY

46
Q

With perpetual systems,

A

calculations must be made with each purchase of inventory, because these systems constantly update cost of goods sold and inventory information.

47
Q

With periodic systems,

A

calculations are made only at the end of each accounting period (each month, quarter, or year) after an inventory count has been completed.

48
Q

The decision to use a perpetual or periodic inventory system will:

A

have no impact on cost allocation under either the specific identification or FIFO cost formulas
result in different cost allocations under the weighted-average cost formula

49
Q

Specific Identification

A

The company knows the specific cost of the items that have been sold because they are specifically identifiable

  • Small quantity but at high prices
  • ex: art gallary (bought for 400, sold for 750, COGS = 400)
50
Q

Specific Identification

A

The company knows the specific cost of the items that have been sold because they are specifically identifiable

  • Small quantity but at high prices
  • ex: art gallery (bought for 400, sold for 750, COGS = 400)
51
Q

Specific identification (specific ID) (definition)

A

A cost formula of assigning costs to units of inventory in which the cost of a unit can be specifically identified from company records

52
Q

Weighted‐average (W/A)

A

A cost formula for assigning costs to units of inventory in which each unit is assigned the weighted‐average cost of the units available for sale at that point

53
Q

Weighted-average info

A

Company’s inventory cost is recalculated every time additional goods are purchased

  • The weighting is based on the number of goods purchased relative to the number of goods on hand.
  • Example: Gas station getting gas, it mixes with the other gas but always has some in the tank
54
Q

Homogeneous

A

A characteristic of inventory that is interchangeable (that is, where one unit of inventory cannot be distinguished from another), such as litres of fuel.

55
Q

First-In, First-Out (FIFO)

A

The cost flow formula that assigns the cost of the first unit into the inventory to the first unit sold

56
Q

When is a company required to use the specific identification cost formula

A

if a company’s inventories are not interchangeable (that is, the goods are unique and each item can be identified)

57
Q

If the goods are interchangeable (that is, they are homogeneous), then management has a decision to make,

A

as they would have to choose between the weighted-average and the first-in, first-out cost formulas.

58
Q

If management has an incentive to maximize earnings (for example, if they have a bonus based on income),

A

they would be inclined to select FIFO

-As it often results in higher gross margin and a higher net income

59
Q

If management was trying to minimize net income in order to minimize taxes,

A

then they would be inclined to select the weighted-average method. This demonstrates the impact that the choice of accounting policies can have on a company’s results.

60
Q

Inventory is normally classified as a

A

current asset because we assume that it will be sold within the next 12 months.

61
Q

net realizable value (NRV)

A

The selling price of a unit of inventory less any costs necessary to complete and sell the unit.

62
Q

Net realizable value (NRV) =

A

Expected selling price - estimated costs to make the sale

63
Q

inventory writedown

A

The reduction of an inventory item’s carrying amount when its estimated net realizable value is less than its cost. A writedown is treated as an expense (part of cost of goods sold) in that period.

64
Q

Inventory valuation errors can result for a variety of reasons, such as:

A
  • errors during the inventory count (such as errors in the number of items counted)
  • including items that should be excluded (such as goods on consignment if consignee or goods in transit if shipping terms are FOB destination)
  • excluding items that should have been included (such as consigned goods if consignor or goods in transit if shipping terms are FOB shipping point)
  • data entry errors (such as an incorrect number of units or costs)
  • not accounting for required inventory writedowns
65
Q

Inventory valuation errors will result in both

A

the statement of financial position (specifically, inventory and retained earnings) and the statement of income (specifically, cost of goods sold) being misstated

66
Q

Gross margin

A

The difference between sales revenue and the cost of goods sold. Synonym for gross profit

67
Q

The gross margin ratio is:

A

Gross margin / sales revenue

68
Q

Gross margin

A

sales revenue - COGS

69
Q

The five key elements of internal control are

A

(1) physical controls, (2) assignment of responsibility, (3) separation of duties, (4) independent verification, and (5) documentation.

70
Q

Some common internal control procedures for managing inventory include:

A
  • the use of electronic tags on items that sound an alarm when the item leaves the premises without being purchased (physical controls)
  • having different employees responsible for ordering the inventory, checking the inventory when it is received, and entering inventory information in the accounting system (separation of duties)
  • storing valuable goods in locked cabinets or behind counters (physical controls)
  • having regular inventory counts conducted (independent verification)
71
Q

just-in-time (JIT)

A

A delivery strategy where the inventory is delivered as close as possible to the time when the customer will be ready to buy it.

72
Q

Inventory turnover ratio (definition)

A

A ratio that measures how fast inventory is sold and how long it is held before it is sold. It is calculated as cost of goods sold divided by average inventory

73
Q

Inventory turnover ratio =

A

Costs of goods sold / average inventory

74
Q

Average inventory =

A

(Opening inventory + ending inventory) /2

75
Q

Do you want a high or low turnover ratio?

A

A higher inventory turnover ratio is better than a lower one. A higher ratio means that the company has sold through its inventory (sold all of its products) more times than a company with a lower turnover ratio
(but too high of a ratio may lead to a stockout)

76
Q

days to sell inventory ratio (definition)

A

The number of days, on average, that it took a company to sell through its inventory, calculated as 365 days divided by the inventory turnover ratio.

77
Q

days to sell inventory ratio =

A

365 days / inventory turnover ratio

78
Q

Is a lower or higher number better for days to sell inventory

A

Generally, a lower number is considered to be better than a higher number
-However, if this ratio is too low, it could mean that the company will experience stockouts

79
Q

Questions to consider for days to sell inventory

A

Is the business seasonal?
Does the company sell a few high-priced items or many low-priced items?
Have new competitors entered the market?
Has there been a change in economic conditions?

80
Q

gross margin estimation method (definition)

A

A method for estimating the cost of ending inventory by converting the sales amount to cost of goods sold using the gross margin ratio. The calculated cost of goods sold amount is subtracted from the goods available for sale to determine the ending inventory cost.

81
Q

Gross margin estimation method =

A

Sales revenue x cost-to-sales ratio

82
Q

cost-to-sales ratio

A

The normal cost-to-sales ratio reflects the normal markup that the company applies to its products.

For example, a company that normally marks up its products by 50% would price an item that costs $60 at $90. The cost-to-sales ratio then is 66.67% ($60 / $90).

This can also be calculated by determining the normal percentage that cost of goods sold represents of sales revenue:

83
Q

The allocation of COGAS to COGS and EI is the same under both the specific identification or first-in, first-out cost formulas regardless of which type of inventory system (periodic or perpetual) is used.

A

Know this

84
Q

Differences between the two inventory systems

A

in the periodic inventory system inventory must be physically counted in order to determine ending inventory.

85
Q

If the company were using the weighted-average cost formula, it would need to:

A
  1. Determine the weighted-average cost per unit
  2. Multiply the weighted-average cost per unit times the number of units in ending inventory (per the inventory count) to determine the cost of ending inventory.
  3. Subtract the cost of ending inventory from the cost of goods available for sale to determine the cost of goods sold for the period.
86
Q

With ___, only one weighted- average cost per unit amount is calculated for the accounting period regardless of the number of purchases during the period.

A

periodic inventory systems

87
Q

When using the weighted-average method, calculate the unit cost to a minimum of two decimal places and use the calculated unit cost to determine either the ending inventory or the cost of goods sold. Determine the other amount by subtracting your calculated amount from the cost of goods available for sale.

A

Hint hint

88
Q

First-In, First-Out (FIFO) (Periodic system)

A

at the end of each accounting period, the number of units left in inventory is determined either by a physical count or by an estimation method.

89
Q

Under the perpetual inventory system, what is the first journal entry to record a credit sale?

And the second is:

A

Debit: Accounts Receivable
Credit: Sales Revenue

Debit: COGS
Credit: Inventory

90
Q

FOB means

A

Free on board

91
Q

A higher COGS and a lower ending inventory

A

Use weighted-average formula

MGMT 201: Financial Accounting (12 decks)

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