Chapter 9: Inventories: Additional Valuation Issues Flashcards

1
Q

LIFO Reserve

A

The difference between the inventory method used for internal reporting (generally FIFO, average cost or standing cost) and LIFO

LIFO inventory + LIFO reserve = FIFO inventory

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2
Q

LIFO effect

A

Allowance account = contra asset = credit natural balance

the adjustment that companies must make to the accounting records in a given year

companies must disclose either LIFO reserve or replacement cost of inventory

Uses allowance to reduce inventory to LIFO account

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3
Q

Last-in, First-out costing method

A

Usually results in lower net income than FIFO)

  • COGS valued at the most recent purchase
  • ending inventory valued by taking the unit cost of the OLDEST purchase and working down until all units are accounted for (different ending inventory / COGS under periodic vs perpetual inventory)
  • not actually reflective of movement of goods except for piled items
  • tends to defer income tax liability
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4
Q

First-In, First-out costing method

A

FIFO
fails to match current costs with current revenue

  • ending inventory valued by taking the unit cost at the most recent purchase and working backwards till all inventory is accounting for
  • general good business practice? approximates actual flow, ending inventory near actual inventory
  • highest income of costing methods = appealing to investors + higher taxes
  • no difference between periodic + perpetual inventory COGS
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5
Q

Journaling Sale of Inventory: perpetual system

A

Debit Accounts Receivable/ Cash (increase)
Credit Sales/ Revenue (increase)

ALSO

Debit COGS (increase)
     Credit Merchandise Inventory (decrease)
  • happens when customer receives goods
  • requires invoice receipt/ backup

any shipping costs are recording separately

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6
Q

Perpetual vs Periodic inventory systems

A

Cost flow methods

PERPETUAL - record cost of good + reduce inventory at time of sale (inventory always shows current amounts)
- uses merchandise inventory account

PERIODIC - COGS recorded only at the end of the accounting period

  • uses purchases account (not merchandise inventory)
  • COGS determined at end of period
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7
Q

Moving-average method

A

Average costing method used with perpetual system

new average unit cost calculated after any purchase is made

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8
Q

Weighted Average Unit Cost

A

= Cost of goods available for sale (total) / total units available for sale

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9
Q

Average Cost costing method

A

Practical - simple to apply

All units valued at weighted average unit cost

Assumes similarity of all goods

total cost of goods available for sale / total units available for sale

in perpetual system new weighted average calculated after each purchase
in periodic system weighted average only calculated at the end of a given period

usually results in a net income between FIFO (higher) and LIFO (lower)

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10
Q

Specific Identification Costing Method

A

Preferred by IFRS wherever possible

  • rare
  • items must be individually tagged to tracked costs
  • generally large, high-value items
  • cost flow matches physical flow
  • can be difficult to allocate costs like shipping
  • can be manipulated - boost income by selling low-cost units and vise versa
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11
Q

Classification of Selling Costs

A

per GAAP must be disclosed in statements

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12
Q

Gross method for purchases

A

Uses a purchase discounts account

reports purchases and payables at gross amounts

Reports discounts in purchase discounts contra account when taken
- then shows up below purchases on income statement

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13
Q

Net method for purchases

A

use purchase discounts forfeited account

Reports purchases at net amount (with discount)

if paid too late to get discount report amount of purchase discounts forfeited (expense account)

correct reporting of asset/ liability value

also tracks management efficiency

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14
Q

Product Costs

A

Recorded to the inventory account

  • cost of bringing goods into a buyer’s place of business and converting to a salable condition
    • freight charges
    • acquisition costs
    • labor/ production costs to time of sale

Too difficult to allocate purchasing department and storage costs so not usually included.

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15
Q

Capitalizing interest costs

A

FASB ruled companies should capitalize interest costs related to assets constructed for internal use or assets produced as discrete projects for sale or lease

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16
Q

Period Costs

A

Not included as inventory costs

17
Q

Sales with high rate of return

A

Formal or informal agreements that permit purchasers to return the inventory for a full or partial refund (publishing)

requires an estimated inventory return account to recognise that some inventory will be returned

if returns are unpredictable then goods NOT removed from inventory

18
Q

Sale with repurchase agreement

A

“parking transactions”

even though one company has the title the other maintains control

inventory as collateral on a loan

should be on the books of the entity with legal control

19
Q

Consigned inventory

A

Remains in consigner’s inventory

may disclose inventory on consignment in notes or as a separate inventory item if material amount

20
Q

Which goods to include in inventory

A

Control as key deciding factor: who has ability to use benefits of ownership.

Transit FOB shipping point vs destinatio

  • shipping point: transfer occurs upon delivery to carrier
  • destination: transfer occurs upon delivery to customer

Consignment - remains property of the consigner and in their inventory(not in the inventory of the agent)

21
Q

Periodic system cost of goods sold

A
Beginning inventory 
\+ cost of goods acquired / produced in the period
= cost of goods available for sale
- ending inventory 
= cost of goods sold
22
Q

Modified perpetual inventory system

A

Records quantity increases / decreases but does not track dollar amounts

23
Q

Inventory over/short account

A

Adjusts cost of goods sold

sometimes reported in other revenues and gains or other expenses and losses

24
Q

Journaling perpetual inventory adjustment

A

to adjust book count to match physical

short:
Debit Inventory Over/Short
Credit Inventory

Over:
Debit Inventory
Credit Inventory over/short

25
Inventory accounts for manufacturing concerns
- Raw materials (goods / materials on hand but not yet placed into production) - work in progress inventory (unfinished units: Raw materials costs + direct labor costs + share of overhead) - Finished goods inventory (cost of completed but unsold units) - Supplies inventory (non-direct materials
26
Merchandise inventory
Single account for cost of unsold units for merchandising concerns
27
Inventory
Asset items a company holds for sale in the ordinary course of business or goods it will use or consume in the production of goods sold
28
Inventory Profits
When the inventory costs matched against sales are less than current replacement costs Reduced by LIFO
29
Advantages of LIFO
Matching: recent costs to current revenue (during inflation FIFO creates "paper profits" Tax benefits/ improved cashflow Future earning hedge: future price declines have less effect on earnings. Minimizes write downs of high-priced inventory
30
Disadvantages of LIFO
Reduced earnings understating inventory - working capital apparently diminished Does not generally approximate physical flow may result in poor buying habits
31
LIFO conformity rule
Tax rule: if LIFO used for tax purposes must also be used for financial reportin
32
Result of inventory misstatement on financial statements
``` if ending inventory understated: Balance sheet: - inventory: understated - Retained earnings: understated working capital: understated Current ratio: understated Income Statement: - COGS: overstated - Net income: understated ``` ``` if ending inventory overstated: Balance sheet: - inventory: overstated - Retained earnings: overstated working capital: overstated Current ratio: overstated Income Statement: - COGS: Understated - Net income: overstated ``` EFFECTS TWO years though the total will be correct
33
Affect of failure to record inventory purchase on financial statements
Inventory + purchases understated no affect on net income Current ratio overstated A/P understated
34
LIFO liquidation
Specific goods LIFO approach leads to LIFO liquidation leads to distortion of net income Costs from preceding periods are matched against current sales dollars countered with pooled LIFO approach disclose on financial statments
35
Price index
% changes in prices from one year to another often use CPI-U: consumer price index for urban consumers (or a specific industry index) alternately: Ending inventory for period @ current cost / ending inventory for the period at base year cost
36
Dollar value LIFO if ending inventory @ base prices < beginning inventory @ base prices
Company must subtract the decrease from the most recently added layer basically just removes one later and then calcuates as if this was that following year (using the change from the base year x the previous year's price index)
37
Dollar Value LIFO
Inventory at end current prices > inventory at beginning current prices Need to know the price index: percentage prices have increased End inventory / (1+ percent increase) = end inventory in terms of beginning prices End inventory at beginning prices less beginning inventory = change in inventory quantity Change (new layer) x (1 + % increase) = "real" dollar increase Real dollar increase = new layer
38
Dollar Value LIFO
End inventory at base year prices = total of laters at base year prices Determines and measures and increases and decreases in a pool of inventory in terms of total dollar value, not physical quantity of goods in the inventory pool Pools with broad range of goods New layers only added when ending inventory (at base year prices) exceeds beginning inventory at base year prices