Financial 3 - Inventory

Question 1

F.O.B. Destination vs. F.O.B. Shipping

Answer 1

• FOB Destination means that title passes when received by the buyer, and that packaging, shipping and handling are costs of the seller
• FOB Shipping Point means that title passes when the goods leave the seller’s location and that shipping is a cost of the buyer

Question 2

LIFO vs. FIFO

Answer 2

• LIFO most closely approximates the current cost for COGS because inventory “last-in” (most recently purchased) is “first-out” (expensed currently)
• FIFO most closely approximates the current cost of ending inventory because inventory “first-in” (oldest purchases) is “first-out” (expensed currently) and the most recent purchases remain in ending inventory
• Under LIFO, ending inventory has a lower valuation than under FIFO since older, lower costs are assigned to ending inventory. Similarly, under LIFO, COGS have a higher valuation than FIFO since recent, higher costs are assigned to goods sold. This higher COGS means that Net Income under LIFO decreases

Question 3

Moving Average Method

Answer 3

This method assumes the company has perpetual records. A new weighted-average cost is computed after each purchase and issues are priced at the latest weighted average.

*** A new weighted average cost is computed after each purchase. Issues are priced at the latest weighted average cost.

Total cost / Total Units on Hand = Weighted Average

Question 4

Changing Prices Affecting Different Inventory Methods

Answer 4

• ** During periods of rising prices, if FIFO method is used:
• the perpetual inventory system results in an ending inventory cost that is the same as in a periodic inventory system
• Companies generally use a FIFO flow of goods to prevent keeping old (obsolete) inventory on hand. Therefore, periodic inventory (from a physical count) would match FIFO
• ** During periods of rising prices, if LIFO method is used:
• LIFO or Average method used? the perpetual inventory system will NOT end in the same ending inventory if periodic inventory system is used
• LIFO will normally result in the lowest ending inventory because items “Last-in” (at higher prices) are expensed to cost of goods sold, while the items “first-in” (at lower prices) make up the ending inventory.
• Specifically Dollar-value LIFO can help create lower ending inventory because with changing variety of products, new or substitute items can be used in the same pricing group rather than become a new group at a higher price

Question 5

Calculating Inventory

Answer 5

Inventory = Beginning Inv. + Purchases - Sales reduced to cost basis (COGS)

Question 6

LIFO Calculation

Answer 6

End of Year Inventory Cost / Base Year Inventory Cost = Annual Cost Index

Annual Cost Index * Annual Increment (Base Year Cost at 12/31 - Base Year Cost at 1/1) = Additional Layer

This additional layer is added to beginning inventory

*** Must add all years Base cost and Current Cost together in order to get the proper index calculated

Apply the lower of cost or market rule:
Per RULE of THUMB: Compare “floor” with “ceiling” and “replacement cost” (use middle amount) compare that middle amount with “cost”. Use the lower of the two.

Question 7

Consignment Treatment of Inventory and COGS Calculation

Answer 7

RULE: Consignor must include consigned goods (in the hands of the consignee) in their own inventory, at their cost plus warehousing costs of consignor before goods are transferred to consignee plus shipping costs to consignee

Question 8

Periodic Inventory System vs Perpetual Inventory System

Answer 8

• In a periodic inventory system, the quantity of inventory is determined only by physical count, usually at least annually. Therefore, units of inventory and the associated costs are counted and valued at the end of the accounting period and the cost of inventory sold and inventory shortages cannot be easily distinguished
• In a perpetual inventory system, the inventory record for each item of inventory is updated for each purchase and each sale as they occur. The actual cost of goods sold is determined and recorded with each sale. At year end, inventory per the perpetual records can be compared to actual inventory per a physical count and inventory shortages can be identified