Chapter 8 - Valuation of Inventories Flashcards
How does a PERPETUAL inventory system record purchases of merchandise or raw materials for production?
A debit to Inventory, not Purchases
How does a PERPETUAL inventory system record Freight-in?
Debited to Inventory, not Purchases
How does a PERPETUAL inventory system record Purchase Returns and Allowances and Purchase Discounts?
Credited to Inventory, not separate accounts
How does a PERPETUAL inventory system record each sale?
Debiting COGS
Crediting Inventory
How does a PERIODIC inventory system record acquisitions of Inventory and determine the total COGS?
- The company records all acquisitions of inventory during the accounting period by debiting the Purchases account.
- The company then adds the total in the Purchases account at the end of the accounting period to the Cost of the Inventory on hand at the beginning of ther period. This sum determines the total COGS available for sale during the period.
- To compute the COGS, the company then subracts the ending inventory from the COGS available for sale.
The COGS is a residual amount that depends on a physical count of ending inventory.
If a company uses a perpetual inventory system and a difference exists between the perpetual inventory balance and the physical inventory count, what is the entry to record the necessary write-down? (Assume Physical Count is lower than Perpetual Inventory)
Debit to Inventory Over and Short
Credit to Inventory
What is the difference between f.o.b. shipping point and f.o.b. destination.
If a supplier ships goods to Walgreens F.O.B. Shipping Point, title passes to Walgreens when the supplier delivers the goods to the common carrier, who acts as an agent for Walgreens. When these goods are shipped to Walgreens but are still in transit at the end of the period, the goods belong to Walgreens. Walgreens should show the purchase in its records because legal title to these goods passed to Walgreens upon shipment of the goods.
If the supplier ships the goods F.O.B. Destination, title passes to Walgreens only when it receives the goods from the common carrier.
When it comes to consigned goods, what is the relationship between consignor and consignee? Who owns title and records the inventory during the course of business?
Under this arrangement, a consignor ships inventory to the consignee who acts as the consignor’s agent in selling the consigned goods.
The consignee agrees to accept the goods without any liability, except to exercise due care and reasonale protection from loss or damage, until it sells the goods to a third party.
Goods out on consignment remain the property of the consignor. Although the consignee has physical possession of the goods, it does not have control because legal title and the risks and rewards of ownership remain with the consignor. Consignor includes the goods in its inventory. The consignee does not include any of the goods consigned as a part of inventory.
Define Product Costs
Product costs are those costs that “attach” to the inventory. As a result, a company records product costs in the inventory account. These costs are directly connected with bringing the goods to the buyer’s place of business and converting such goods to salable conditions.
Ex. freight charges on goods purchased.
direct materials, direct labor, overhead (indirect materials, indirect labor, depreciation, taxes insurances, and utilities)
Define Period Costs
Period costs are those costs that are indirectly related to the acquisition or production of goods. Period costs such as selling expenses, general and administrative expenses are therefore not included as part of inventory cost. Even though these expenses are as much a cost of the product as the initial purchase price and related freight charges are, these expenses are so indirectly related to the immediate production process that any allocation is purely arbitrary.
According to FASB, how should companies handle interest costs related to inventory: expense or capitalize?
Companies should capitalize interest costs related to assets constructed for internal use or assets produced as discrete projects (such as ships or real estate projects) for sale or lease.
Companies should NOT capitalize interest costs for inventories that it routinely manufactures or otherwise produces in large quantities on a repetitive basis.
When it comes to Purchase Discounts, what is the difference between the Gross Method and Net Method.
If a company uses the gross method, they use a Purchase Discounts account to report purchase discounts as a deduction from purchases on the income statement.
If a company uses the net method, they record the purchases and accounts payable at the amount net of the cash discounts. In this approach, the company records failure to take a purchase discount within the discount period in a Purchase Discounts Lost account. This method considers purchase discounts lost as a financial expense and reports it in the “Other expenses and losses” section of the income statement.
What is a disadvantage to the FIFO method?
The FIFO method fails to match current costs against current revenues on the income statement. A company charges the oldest costs against the more current revenue, possibly distorting gross profit and net income.
What are the advantages to the FIFO method? (2)
- FIFO approximates the physical flow of goods. When the physical flow of goods is actually first-in, first-out, the FIFO method closely approximates specific identification. At the same time, it prevents manipulation of income. With FIFO, a company cannot pick a certain cost item to charge to expense.
- The ending inventory is close to current cost. Because the first goods in are the first goods out, the ending inventory amount consists of the most recent purchases.
What are the key differences between GAAP and IFRS when it comes to Inventory? (3)
- GAAP has more detailed rules related to the accounting for inventories, compared to IFRS.
- IFRS indicates specific identification is the preferred inventory method unless it is impracticable to use.
- IFRS does not permit LIFO.
