FAR - Financial Statement Acct - Inventory Flashcards
FOB
FOB Destination - seller risk
FOB Shipping Point - buyer risk
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
Consignment goods
ending inventory
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
Periodic inventory
Perpetual Inventory
periodically, number of units are counted
number of units are continuously updated
valuation of inventory
acquisition cost of inventory includes all costs incurred to prep merchandise for sale.
Costs included in inventory
costs reduce inventory
costs excluded from inventory
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
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
true
true
manufacturing input costs
fixed overhead (FOH)
fixed overhead, direct material, direct labor, and variable overhead.
doesn’t change, allocated via predetermined rate.
inventory
common issues
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
elements affect fixed overhead rates
What inventory costs are required to be capitalized?
chain discount
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
When allocating costs to inventory produced for the period, fixed overhead should be based upon the normal capacity of production facilities.
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.
Net Purchases
COGS
Cost Flow Assumptions - assign value to EI
Purchases + freight in - purchase returns/discounts = NP
BI + Net Purchases = GAFS - EI = COGS
1) FIFO
2) LIFO
3) WA
4) Special Identification
special identification
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).
weighted average
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
FIFO (first in, first out)
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
LIFO (last in, first out)
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.
differences between moving and weighted average cost flow assumptions.
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.
First In First Out (FIFO) cost flow assumptions.
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.
differences between periodic and perpetual applications of Last In First Out (LIFO).
- 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.
List the weighted average (WA) cost flow assumptions.
- 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.
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.
true
true
false
false
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.
true
true
true
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
true
true
true
true
perpetual inventory
perpetual 4 cost flow assumptions
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)
Perpetual FIFO
Perpetual LIFO
same for both periodic/perpetual
different for periodic/perpetual -> last items purchased, are first sold, cogs = expensive, EI = low cost, prices rise = low NI
For which method should an ending inventory count be made?
What cost flow assumption utilizes the latest purchases at time of sale?
both periodic and perpetual
LIFO
cost flow assumption is the same for both periodic/perpetual?
main differences between perpetual and periodic entries.
FIFO
use of the inventory account rather than purchases and recording cost of goods sold at sale.
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.
true
true
true
true`
Moving average formula
LIFO effect on I/S
avoid Last In First Out (LIFO) liquidation.
attributes of Last In First Out (LIFO).
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.
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).
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.
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.
true
true
true
false
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..
true
false
true
Define “base-year dollars”.
List the Dollar Valued (DV) Last In First Out (LIFO) conversion index formula.
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.
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.
false
true
true
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.
true
true
false
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.
true
false
cost of ending inventory determined
steps in Lower of Cost or Market (LCM) analysis.
holding loss reported under the direct method?
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”
formula to arrive at net realizable value.
Replacement cost?
holding loss reported under the allowance method?
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”
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?
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.
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
False
False
True
True
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.
True
True
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.
True
(BI + NP) - (Sales X (Cost/Sales Ratio)) = EI
(Sales - COGS) / Sales
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)?
- Gross Margin method;
- Retail Inventory method;
- Dollar Value LIFO Retail method.
Margin on Cost, b/c sales exceed cost
Cost/Sales Ratio
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
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)
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?
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
included in the Conventional Retail Inventory Method cost ratio?
cost ratio includes BI, current period purchases, in both the numerator and denominator, but excludes net markdowns from the cost ratio calculation.
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?
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.
included in the cost ratio of the Average Retail Method?
BI, current period purchases in both the numerator/denominator of the cost to retail ratio.
5 variations of the Retail Inventory Method
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]
True/False
if business is retail and uses LIFO, must use DV to determine LIFO layers
true
Dollar Value LIFO steps
DV LIFO Numerator
DV LIFO Denominator
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
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.
False
False
False
True
Inventory Formula
BI + NP = COGAFS (EI + COGS) BI + NP - EI = COGS COGS + EI - NP = BI COGAFS - BI = NP BI + NP - COGS = EI
Implications of inventory accounts
BI understated
EI understated
NP overstated
BI understated -> COGS understated -> NI overstated
EI understated -> COGS overstated -> NI/RE understated
NP overstated -> COGS overstated -> RE understated
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.
no impact on Retained Earnings, the error has self-corrected.
Beginning balance of Retained Earnings.
Dr. Respective Account
Cr. Prior Period Adjustment (RE)
True
Purchase commitment
loss on purchase commitment
contract can be modified
contract cannot be modified
loss - journal entry
commit/contract purchase of materials at locked-in prices
loss occurs when market price
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?
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.
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
false
true
true
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?
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.
Under IFRS, which of the following inventory items are not valued at the lower of cost or net realizable value?
basis for NRV adjustments?
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
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
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
