Inventory Flashcards
How do companies report products held prior to sale and after sale
Prior to sale as inventory a current asset
After sale the cost of the inventory becomes expense Cost of Goods sold in the income statement
What are two main systems for keeping inventory records and explain them
Perpetual system - keeps a continuous record of inventories and cost of goods sold
Periodic system - computes cost of goods sold and an updated inventory balance only at the end of the accounting period
What are the journal entries for recording when inventory is purchased and sold
When inventory is purchased: Debit Merchandise inventory and credit Accounts payable
When inventory is sold: Debit Accounts receivable and credit Sales
Problems with perpetual inventory system
shoplifting or embezzlement or spoilage
Under periodic inventory system what is the formula for cost of goods available for sale
Beginning Inventory+Purchases=Cost of Goods available for sale
Under periodic inventory system what is the formula for cost of goods sold
COG available for Sale - Ending inventories by physical count = Cost of goods sold
When do physical counts of inventory happen - needed regardless of system at least once a year
Firms often choose fiscal accounting periods so that the year ends when inventories are low - Ex: year end of January 31st
What does FOB destination mean
When the seller bears the transportation cost, the sales invoice reads free onboard or F.O.B destination
What does FOB shipping point mean
When the buyer bears the transportation cost it reads F.O.B shipping point
Where does freight in appear on the income statement
Freight-in appears in the purchases section of an income statement as an additional cost of the goods acquired during the period
How do transportation charges, cash discounts and purchase returns or allowances affect cost of goods sold
To calculate the cost of goods sold, cash discounts on purchases and purchase returns and allowances are subtracted from purchases
Also Freight in is added to net purcahses to get total cost of merchanise acquired
What type of t account are cash discounts we give out and receive placed in?
Cash discounts we give out will be a contra revenue account
Cash discounts we receive will be a contra purchases account
What are the four inventory valuation methods
Specific identification
First-in, first-out (FIFO)
Last-in, First-out (LIFO)
Weighted average
Explain specific identification
The specific identification method concentrates on physically linking the particular items sold with the cost of goods sold that is reported
This method is relatively easy to use for expensive low-volume merchandise
also known as cherry picking
Explain FIFO
Assigns the cost of the earliest acquired units to cost of goods sold
The costs of newer units is assigned to the units in ending inventory
FIFO provides inventory valuations that closely approximate the actual market value of the inventory at the balance sheet date
Explain LIFO
Assigns the most recent cost to cost of goods sold
In a period of rising prices and constant or growing inventories, LIFO yields lower net income
The internal Revenue Code requires companies that use LIFO for tax purposes to also use it for financial reporting purposes difference
Explain the weighted average valuation
The weighted average method computes a unit cost by dividing the total acquisition cost of all items available for sale by the number of units available for sale
What are cash flow assumptions
Accountants often refer to inventory methods as cost flow assumptions - LIFO/FIFO/ Weighted average
What is the difference between LIFO and FIFO in a period of rising prices
Fifo has higher ending invenotry, lwoer COGS and higher net income
Lifo has lower ending inventory, Higher COGS, lower net income
What is the difference between LIFO and FIFO in a period of falling prices
Lifo has higher ending inventory, lower COGS and higher net income
Fifo has lower ending inventory, Higher COGS, lower net income
Can a company switch methods of valuation?
A change in market conditions may justify a change in inventory method
The firm must note the change in its financial statements - must declare the change
otherwise companies must be consistent
Where is LIFO used most and why
Has strong tax benefits for companies
- widely used int he US
LIFO and it is not permitted under IFRS
What is meant by lifo liquiidation
When the physical amount of inventory decreases and the cost of goods sold consists of old, low inventory acquisition costs associated with old LIFO layers. This means that the year’s income includes the cumulative inventory profit from years of increasing prices
What is a LIFO reserve
The difference between a company’s LIFO inventory level and what it would be under FIFO is called a LIFO reserve
Explain market price
Market price is generally considered to be the replacement cost of the inventory item-what it would cost to buy the inventory item today
Explain a write down and the appropriate journal entry
A write down reduces the recorded historical cost of an item in response to a decline in value
The required journal entry for a write-down is:
Debit Loss on write-down of inventory(COGS) and credit inventory
Formula for COGS
COGS = Beginning inventory+purchases-Ending inventory
What happens if ending inventory is understated or overstated
If ending inventory is understated retained earnings in understated
If ending inventory is overstated, retained earnings is overstated
Inventory turnover formula
Cost of Goods sold /average inventory
Average inventory formula
(Beginning inventory+ending inventory)/2
Days inventory lies around on average formula
365/inventory turnover in years
What’s the relationship between gross profit % and inventory turnover
Industries with higher gross profit percentages tend to have lower inventory turnover
Define shrinkage
difference between the cost of inventory from a physical count and the inventory balance in the general ledger
What would be the journal entry to record shrinkage under perpetual system
To adjust inventory balance:
Inventory shrinkage DR
Inventory CR
To transfer shrinkage to COGS:
Cost of goods sold DR
Inventory shrinkage CR
How does a periodic system deal with shrinkage
Cost of goods sold automatically includes inventory shrinkage by virtue of the system
Shrinkage is much more difficult to isolate in the periodic system
What is VAT
Tax payable on inputs and outputs
Journal entry for Buying goods inclusive of VAT
Inventory debit = Price minus VAT
VAT payable debit = VAT amount paid
A/P credit - Full amount paid inclusive of VAT
Journal entry selling goods inclusive of VAT
A/R debit = full price received
Revenue credited with price charged without tax
Tax payable credited = tax amount the customer paid
