FAR - Financial Statement Acct - Inventory

Question 1

FOB

FOB Destination - seller risk

FOB Shipping Point - buyer risk

Answer 1

free on board, goods in transit, entity w/rights has the risk of loss, “free” indicates who has no risk

title passes upon destination, include in EI, unless title has passed via arrival of destination

title passes upon shipping point, include in EI unless title has passed to the carrier

Question 2

Consignment goods

ending inventory

Answer 2

Goods sold by another entity who Doesn’t own the goods; therefore, the true owner of goods will include these goods in its ending inventory

all owned inventory, regardless of location

Question 3

Periodic inventory

Perpetual Inventory

Answer 3

periodically, number of units are counted

number of units are continuously updated

Question 4

valuation of inventory

Answer 4

acquisition cost of inventory includes all costs incurred to prep merchandise for sale.

Question 5

Costs included in inventory

costs reduce inventory

costs excluded from inventory

Answer 5

purchases, freight-in, sales/taxes on acquisition, packaging costs, transit insurance

purchase return, discounts, allowances

period expenses: promotional, interest, freight out, construction of inventory, selling, general/admin

Question 6

true/false

physical flow of goods doesn’t have to equal cost flow assumption

gross margin inventory method used to estimate value of unobserved inventory

Answer 6

true

true

Question 7

manufacturing input costs

fixed overhead (FOH)

Answer 7

fixed overhead, direct material, direct labor, and variable overhead.

doesn’t change, allocated via predetermined rate.

Question 8

inventory

common issues

Answer 8

1) property held for resale
2) RM, WIP, FG (in process of production)
3) material, labor, overhead (consumed in production)

1) costs included in inventory
2) cost flow assumption application
3) determine COGS
4) impact of inv. errors on various accounts

Question 9

elements affect fixed overhead rates

What inventory costs are required to be capitalized?

chain discount

Answer 9

Subject to estimation errors and affected by the choice of denominator measure and the budgeting horizon reflected in the denominator

All costs necessary to bring the item of inventory to salable condition.

successive trade discounts

Question 10

When allocating costs to inventory produced for the period, fixed overhead should be based upon the normal capacity of production facilities.

Answer 10

Fixed overhead is allocated based on the normal capacity of the production facilities. Normal capacity is the production expected to be achieved over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance.

Question 11

Net Purchases

COGS

Cost Flow Assumptions - assign value to EI

Answer 11

Purchases + freight in - purchase returns/discounts = NP

BI + Net Purchases = GAFS - EI = COGS

1) FIFO
2) LIFO
3) WA
4) Special Identification

Question 12

special identification

Answer 12

large, distinguishable products, entity is able to specifically identify the cost of each of the inventory items and then total the individual cost of all the inventory items. (not cost effective, allows firms to manipulate earnings).

Question 13

weighted average

Answer 13

periodic inventory system, must calculate WACPU formula. = COGAFS / # of units avail for sale

COGS = # of units sold X WACPU 
# of units in EI X WACPU

Question 14

FIFO (first in, first out)

Answer 14

COGS = oldest merchandise/low price
EI = most recent merchandise/high price

reflects the way most firms move inventory

when prices rise, net income increases b/c COGS includes low cost purchases, EI reflects recent/more expensive purchases

Question 15

LIFO (last in, first out)

Answer 15

EI = oldest inventory/low cost
COGS = most recent merchandise/high cost

when prices rise, lower net income b/c COGS includes recent high cost recent purchases -> advantage, reported gross margin reflects latest purchase costs

When purchase more than sell, layer is added with earliest costs; therefore, EI = less reliable costs.

Question 16

differences between moving and weighted average cost flow assumptions.

Answer 16

Moving average computes a new weighted average cost per unit after each purchase of inventory;

Moving average results in lower Cost of Goods Sold during period of rising prices.

Question 17

First In First Out (FIFO) cost flow assumptions.

Answer 17

EI composed of units most recently acquired

(COGS) comprised of oldest units;

closely matches most firms’ actual physical flows

Produces higher net income and higher valuation of inventory in periods of rising prices.

Question 18

differences between periodic and perpetual applications of Last In First Out (LIFO).

Answer 18

• In perpetual, each sale is costed with most recent purchase;
• Perpetual results in a lower Cost of Goods Sold in a period of rising prices.

Question 19

List the weighted average (WA) cost flow assumptions.

Answer 19

• Weighted average cost per unit is the average cost of all units held during period;
• Each item is treated as if costed at WA cost.

Question 20

true/false

It is possible to assume the sale of goods that were not owned by the firm at the time of sale, under the LIFO method.

The journal entry to recognize cost of goods sold in a periodic system debits purchases returns, allowances and discounts.

A firm selling a highly perishable good must use FIFO.

LIFO always produces the lowest net income.

Answer 20

true

true

false

false

Question 21

true/false

Under the weighted average method, if the beginning inventory of Year 2 had instead been sold in Year 1, and if prices have been steadily rising, the portion of cost of goods sold for Year 1 relating to these goods would be a smaller number than if the beginning inventory were sold in Year 2

weighted average method can be used only in a periodic system.

In a periodic system, the balance in the inventory account is the January 1 amount throughout the entire year until December 31, for a calendar-fiscal year firm.

Answer 21

true

true

true

Question 22

true/false

It is possible to assume the sale of goods that were not owned by the firm at the time of sale, under the LIFO method.

The weighted average method costs all units available for sale during the year at the same cost.

Cost of goods sold in a periodic system can be computed only after all the other inventory costs and components are known.

Inventory write-offs must be reduced from COGS

Answer 22

true

true

true

true

Question 23

perpetual inventory

perpetual 4 cost flow assumptions

Answer 23

record purchase/sales of all inventory items AS THEY OCCUR -> inventory account used for purchases

1) FIFO
2) LIFO
3) Specific Identification
4) Moving average (new WA calculated after each purchase)

Question 24

Perpetual FIFO

Perpetual LIFO

Answer 24

same for both periodic/perpetual

different for periodic/perpetual -> last items purchased, are first sold, cogs = expensive, EI = low cost, prices rise = low NI

Question 25

For which method should an ending inventory count be made?

What cost flow assumption utilizes the latest purchases at time of sale?

Answer 25

both periodic and perpetual

LIFO

Question 26

cost flow assumption is the same for both periodic/perpetual?

main differences between perpetual and periodic entries.

Answer 26

FIFO

use of the inventory account rather than purchases and recording cost of goods sold at sale.

Question 27

true/false

In a period of steadily rising prices, LIFO will generally result in lower cost of goods sold in a perpetual system as compared to a periodic system.

Purchases returns and allowances are recorded directly as credits to the inventory account in a perpetual system

If the perpetual LIFO inventory method is used, when goods are sold, they are assumed to be the goods acquired just prior to the sale.

If the periodic LIFO inventory method is used, ending inventory (and cost of goods sold) are determined only at the end of the period.

Answer 27

true

true

true

true`

Question 28

Moving average formula

LIFO effect on I/S

avoid Last In First Out (LIFO) liquidation.

attributes of Last In First Out (LIFO).

Answer 28

Cost of goods avail for sale / number of units avail for sale = moving average cost per unit X EI = EI value

Matching of revenues and expenses on the income statement become significantly improved.

• Increases taxes;
• Does not match current period expenses and revenues.
• Matching of revenues and expenses is significantly improved over FIFO;
• Income tax advantages associated with LIFO;
• Balance sheet presentation is less than ideal.

Question 29

main reason for using Last In First Out (LIFO) in periods of rising costs?

reasons for a Last In First Out (LIFO) liquidation.

attributes of First In First Out (FIFO).

Answer 29

Tax minimization

• Poor planning;
• Lack of supply.
• Most closely approximates actual physical flow of goods for most companies;
• Balance sheet valuation of inventory is at more desired current cost;
• Matching of revenues and expenses on income statement is not ideal.

Question 30

true/false

Liquidation is a reporting problem only for LIFO.

A LIFO liquidation causes taxes to increase when prices have been steadily rising.

A LIFO liquidation distorts the expected relationship of sales and cost of goods sold under LIFO.

A LIFO liquidation occurs when the number of units in ending inventory exceeds the number in beginning inventory.

Answer 30

true

true

true

false

Question 31

true/false

Cost of goods sold under LIFO generally will be less than under FIFO when prices have been in decline.

FIFO tends to provide more current balance sheet information as well as more current earnings information

LIFO assumes the sale of the most recent purchases first and thus results in cost of goods sold that is the most current value. FIFO assumes the sale of the earliest purchases first (and beginning inventory before any purchases) and thus results in ending inventory that is the most current value. FIFO is sometimes called LISH: last in still here..

Answer 31

true

false

true

Question 32

Define “base-year dollars”.

List the Dollar Valued (DV) Last In First Out (LIFO) conversion index formula.

Answer 32

Price level for the pool at the beginning of the year Dollar Valued (DV) Last In First Out (LIFO) adopted.

Ending Inventory in Current-Year Dollars / Ending Inventory in Base-Year Dollars.

Question 33

true/false

When converting the change in inventory for the period in base-year dollars to the change in inventory in current-year dollars, the ratio of base index to current year index is used.

One of the main advantages of DV LIFO is that is reduces the cost of inventory administration under LIFO.

DV LIFO is not a units-oriented approach to applying LIFO.

Answer 33

false

true

true

Question 34

true/false

It is possible for the current cost of ending inventory to exceed the current cost of beginning inventory during a period in which inventory quantities have declined.

computation of change in inventory is first performed in base-year dollars to remove the effects of price level changes.

If an internal price index is used, that index is the ratio of the current-year ending inventory as measured in current dollars, to the base-year inventory when LIFO was adopted.

Answer 34

true

true

false

Question 35

true/false

The beginning inventory in the year of converting to LIFO is the ending inventory of the previous year measured at cost.

When a liquidation occurs in DV LIFO, the earliest layer is assumed sold first.

Answer 35

true

false

Question 36

cost of ending inventory determined

steps in Lower of Cost or Market (LCM) analysis.

holding loss reported under the direct method?

Answer 36

One of the cost flow assumptions

1) calculate MKT value
2) value inventory at LCM

holding loss related to inventory is simply included in cost of goods sold.
“debit COGS, credit INVENTORY”

Question 37

formula to arrive at net realizable value.

Replacement cost?

holding loss reported under the allowance method?

Answer 37

Selling price - cost to complete

Market cost

holding loss related to inventory is separately identified in a contra inventory account with separate disclosure of the holding loss, holding loss not included in COGS.
“debt HOLDING LOSS, credit ALLOWANCE TO REDUCE INV TO LCM”

Question 38

methods of recording Lower of Cost or Market.

basis on which Lower of Cost or Market (LCM) can be applied?

ceiling value of inventory calculated?

Answer 38

1) Direct Method 2) Allowance method

1) individual (conservative, higher loss, lower inv.)
2) category 3) total

reducing the sales price by the estimated cost to complete and sell the inventory.

Question 39

true/false

When inventory is written down to market because of LCM, the overall effect on net income is less than if the inventory was not written down.

Only the direct method reports the holding loss separately.

Cost is less than both replacement cost and net realizable value. Replacement cost exceeds net realizable value. Therefore, the inventory item should be valued at cost.

Reporting inventory at the lower of cost or market is a departure from the accounting principle of Historical Cost

Answer 39

False

False

True

True

Question 40

True/False

When a company reports its inventory at replacement cost (market value), original cost must exceed replacement cost. Lower of cost or market means the inventory is reported at replacement cost when replacement cost is less than original cost.

To maximize the ending inventory, the latest possible prices must be assigned to it. With prices rising steadily during the year, the moving average (perpetual) system combined with the total inventory application of LCM will result in the highest ending inventory amount.

Answer 40

True

True

Question 41

True/False

In LCM, market value is replacement cost if replacement cost is between the ceiling value (net realizable value) and the floor value (net realizable value less normal profit margin).
This is the situation in this question. The original cost is below the floor value. Thus, market exceeds cost and the item is recorded at cost (lower of cost or market).

formula for ending inventory for the gross margin method.

Gross Margin Percentage formula.

Answer 41

True

(BI + NP) - (Sales X (Cost/Sales Ratio)) = EI

(Sales - COGS) / Sales

Question 42

methods used for estimating ending inventory.

always larger, margin on sales or margin on cost?

ratio is multiplied to Sales to estimate Cost of Goods Sold (COGS)?

Answer 42

• Gross Margin method;
• Retail Inventory method;
• Dollar Value LIFO Retail method.

Margin on Cost, b/c sales exceed cost

Cost/Sales Ratio

Question 43

Describe the relative sales value method for recording costs.

Margin on Cost Formula

Convert Margin on Cost -> Margin on Sales

Convert Margin on Sales -> Margin on Cost

Answer 43

Cost to be recorded for each item is based on its relative sales value to the total sales value of the group.

(Sales - COGS) / COGS

(MOC / 1 + MOC)

(MOS / 1 - MOS)

Question 44

true/false

The gross margin method cannot be used for general purpose reporting.

Relative Sales Value method formula (recording value) -> liquidation/distress sale

steps in the Basic Retail Method to determine EI?

Answer 44

False, cannot be used for financial reporting

( Unit Price / Total Inv. Price ) X Cost

1) EI @ Retail
2) COGAFS Cost/Retail Ratio
3) EI @ Retail X COGAFS Ratio

Question 45

included in the Conventional Retail Inventory Method cost ratio?

Answer 45

cost ratio includes BI, current period purchases, in both the numerator and denominator, but excludes net markdowns from the cost ratio calculation.

Question 46

excluded in the cost ratio of the First In First Out (FIFO) Lower of Cost or Market (LCM) Retail Method?

excluded in the cost ratio of the First In First Out (FIFO) retail method?

Original Selling Price?

Normal Spoilage handled?

Answer 46

Cost BI from numerator, Retail BI from denominator, and net markdowns.

Cost BI from numerator and Retail BI from denominator

Cost Plus Initial Markup

Subtracted along with sales from Goods Available for Sale at Retail to arrive at Ending Inventory at Retail.

Question 47

included in the cost ratio of the Average Retail Method?

Answer 47

BI, current period purchases in both the numerator/denominator of the cost to retail ratio.

Question 48

5 variations of the Retail Inventory Method

Answer 48

1) FIFO - [BI excluded]

2) FIFO, LCM
[BI excluded, markdowns not subtracted in denominator]

3) Average - [BI included]

4) Average, LCM (conventional retail inventory method)
[BI included, markdowns not subtracted in denominator]

5) Dollar Value LIFO
[(1) FIFO retail]

Question 49

True/False

if business is retail and uses LIFO, must use DV to determine LIFO layers

Answer 49

true

Question 50

Dollar Value LIFO steps

DV LIFO Numerator

DV LIFO Denominator

Answer 50

2 steps:

1) DV LIFO applied to inventory at retail, restricted to retail dollar application
2) FIFO retail c/r ratio applied yielding increase in cost at current prices. Cost layer added to BI @ DV LIFO to yield EI @ DV LIFO cost.

Net purchases at cost

Net purchases at cost, plus markups, minus markdowns

Question 51

DV LIFO retail results in a series of retail layers priced at the then-current prices for disclosure in the balance sheet.

DV LIFO applies the FIFO cost to retail ratio to the increase in retail inventory as measured in base-year dollars.

DV LIFO retail method applies the DV LIFO approach to cost values

DV LIFO retail applies DV LIFO to retail dollars, and then applies the FIFO cost to retail ratio to the increase in retail inventory as measured in current period prices.

Answer 51

False

False

False

True

Question 52

Inventory Formula

Answer 52

BI + NP = COGAFS (EI + COGS)
BI + NP - EI = COGS
COGS + EI - NP = BI 
COGAFS - BI = NP
BI + NP - COGS = EI

Question 53

Implications of inventory accounts

BI understated
EI understated
NP overstated

Answer 53

BI understated -> COGS understated -> NI overstated
EI understated -> COGS overstated -> NI/RE understated
NP overstated -> COGS overstated -> RE understated

Question 54

inventory error is discovered in year three, what is the impact on Retained Earnings?

inventory error is discovered in year two, where is the difference recorded?

An error in counting inventory at the end of Year 1 affects income in Year 2. An error in Y1, will not affect Y3 income -> autocorrect.

Answer 54

no impact on Retained Earnings, the error has self-corrected.

Beginning balance of Retained Earnings.
Dr. Respective Account
Cr. Prior Period Adjustment (RE)

True

Question 55

Purchase commitment

loss on purchase commitment

contract can be modified

contract cannot be modified

loss - journal entry

Answer 55

commit/contract purchase of materials at locked-in prices

loss occurs when market price

Question 56

required accounting for a potential loss on a Purchase Commitment when the commitment can be modified?

required accounting for a potential loss on a Purchase Commitment when the commitment cannot be modified?

account for the recovery of a Purchase Commitment loss?

Answer 56

loss is required to be footnoted as a contingent liability, but is not accrued in the accounts because the loss is not probable given that the contract can be revised.

• loss must be accrued because the loss is probable and estimable;
• Inventory is recorded at market, and a loss is recorded for the difference between contract and market;
• If contract is not executed as of the balance sheet date, loss is recognized and liability established.

gain to the extent of the previously recognized loss.

Question 57

true/false

The potential loss on a purchase commitment necessarily implies a contingent liability needs to be recorded in the balance sheet.

potential loss on a purchase commitment implies a contingent liability.

inventory cannot be recorded higher than contract price, if sold for a higher amount, than the gain is recognized then

Answer 57

false

true

true

Question 58

A corporation entered into a purchase commitment to buy inventory. At the end of the accounting period, the current market value of the inventory was less than the fixed purchase price, by a material amount. Which of the following accounting treatments is most appropriate?

Answer 58

Describe the nature of the contract in a note to the financial statements, recognize a loss in the Income Statement, and recognize a liability for the accrued loss.

Question 59

Under IFRS, which of the following inventory items are not valued at the lower of cost or net realizable value?

basis for NRV adjustments?

Answer 59

Biological inventory items are valued at fair value less the cost to sell at the point of harvest.

NRV adjustments on an item/item basis

Question 60

US. GAAP and INT’L IFRS Inventory differences

5 differences:

1) Carrying Value
2) Costing Formulas - similar inventory
3) Write-down Reversals
4) Cost flow assumptions
5) LIFO treatment

Answer 60

GAAP IFRS

LCM Lower Cost/NRV (SP - Cost)
Same cost not applied Same cost applied
No reversal Reversals permitted
LIFO permitted LIFO prohibited
all cost flows FIFO, W/A, Specific Identif.
flows don’t mirror physical movement of goods Mirrors