Chapter Eight: Valuation of Inventories: A Cost-Basis Approach

Question 1

Inventory

Answer 1

assets we hold that are intended for sale in ordinary course of business

Question 2

Describe a wholesaler and retailers inventory.

Answer 2

Merchandise inventory, buy inventory and sell at a higher price

Question 3

Describe a manufacturer’s inventory.

Answer 3

raw materials, work-in-process, and finished goods, buys materials and makes something to sell

Question 4

Two inventory systems

Answer 4

Perpetual and periodic

Question 5

Perpetual Inventory

Answer 5

running record of amount of inventory (both dollars and units)

Question 6

Periodic Inventory

Answer 6

Keeps dollars only record of amount of inventory purchases

Question 7

Cost of Goods Sold Calculation

Answer 7

Beginning Inventory + Net Purchases = Goods Available for Sale - Ending Inventory (physical count) = Cost of Goods Sold

Question 8

What are the three issues with inventory?

Answer 8

1) What are physical goods included in inventory?
2) What costs are included in inventory?
3) What cost flow assumption is used?

Question 9

Physical goods included in inventory

Answer 9

Goods in transit, consignments, special sales arrangements

Question 10

Two types of goods in transit

Answer 10

F.O.B. shipping point and F.O.B. destination

Question 11

F.O.B. shipping point

Answer 11

title of inventory passes when put on truck

Question 12

F.O.B. destination

Answer 12

title transferred when taken off truck at final destination

Question 13

Consignments

Answer 13

company gives items to 3rd party with commission, return inventory if not sold but inventory still belongs to original inventory

Question 14

Special Sales Arrangements

Answer 14

financing arrangements (ex. if not sold, send back (buy-back arrangement))

Question 15

Costs included in inventory

Answer 15

Product Costs, Period Costs, and Purchase Discounts

Question 16

Product Costs

Answer 16

associated with inventory, not expense until sold

Question 17

Period Costs

Answer 17

belongs to time-frame, not normal and necessary to get asset ready for use

Question 18

Purchase discounts

Answer 18

vendors offer discounts for timely payment

Question 19

Gross Method of purchase discounts

Answer 19

easier and less costly, record purchase at full amount and if take discount credit Purchases Department

Question 20

Net Method of purchase discounts

Answer 20

Record purchase as if had taken purchase discount, if don’t take discount debit Purchase Discounts Lost

Question 21

Cost Flow Assumptions for Inventory

Answer 21

specific identification, average cost, LIFO, FIFO

Question 22

How are Goods Available for sale allocated?

Answer 22

allocated between ending inventory and cost of goods sold and the choice of how to allocate is determined by cost flow assumption

Question 23

Specific Identification

Answer 23

Keep track of each inventory item sold at quantity and price

Question 24

When do you use specific identification?

Answer 24

High dollar value, easily differentiated

Question 25

Average cost

Answer 25

Average money in system and comes out as one unit cost

Question 26

FIFO

Answer 26

first in, first out

Question 27

LIFO

Answer 27

last in, first out

Question 28

Steps to solve inventory problems

Answer 28

1) Calculate goods available for sale (same for every cost flow assumption)
2) Calculate ending inventory
3) Calculates COGS = goods available for sale - ending inventory

Question 29

LIFO layer liquidation

Answer 29

when firm dips into LIFO layers, profit distortion occurs as inventory holding gains ignored in previous years are shifted to income statements

Question 30

LIFO Conformity Rule

Answer 30

U.S. tax laws specify if company uses LIFO for tax purposes, must also use LIFO for financial reporting

Question 31

What problem do the short-term cash flow tax benefits from LIFO cause?

Answer 31

managers may be motivated to make undesirable purchasing decisions to avoid LIFO layer liquidation and lower taxes

Question 32

Steps for Dollar-Value LIFO

Answer 32

1) Determine inventory value at year end prices
2) Determine price index: published indexes or ending inventory at current cost/ending inventory at base year cost
3) Determine inventory at base year price: inventory at year end price/price index
4) Determine layers
5) Multiply each layer by respective index to find year end dollar-value ending inventory