Inventory Flashcards
What are the two main issues in accounting for inventory?
Determining physical quantities
Determining appropriate dollar valuation
Which costs are inventoriable?
Purchases - net of discounts
Freight - FOB Shipping point costs go to buyer, FOB Destination costs charged to seller
Warehouse expenditures
All direct materials, direct labor, and variable and fixed manufacturing overhead
When does ownership of goods transfer when shipped FOB Shipping Point?
FOB Shipping Point puts the inventory into the hands of the buyer from the loading dock
When does ownership transfer when goods are sent FOB Destination?
FOB Destination keeps the items in the seller’s inventory until it reaches the buyer
Which costs are non-inventoriable?
Sales Commissions
Interest on liabilities to vendors
Shipping expense to customers
When are discounts recorded under the gross method?
Under the gross method, discounts are recorded only when used.
Under the net method, when are discounts recorded?
Under the net method, discounts are recorded whether used or not.
Unused discounts are allocated to financing expense.
How is gross margin calculated?
Gross Margin = Sales – COGS (BI + P – EI)
Describe the periodic inventory system.
Inventory is counted at certain times throughout the period
Weighted-average cost flow method is used.
Describe the perpetual inventory system.
Inventory count continually updated
Uses a moving-average cost flow method
In periods of rising prices, under which cost flow system would ending inventory be the same under both periodic and perpetual inventory methods?
Under the FIFO system, periodic and perpetual inventory methods will both have the same ending inventory.
How is inventory turnover calculated?
COGS / Average Inventory
How is Average Day’s Sales in inventory calculated?
365 / Inventory Turnover
Under a consignment system, who holds the consigned goods in inventory?
The CONSIGNOR holds the consigned items in their inventory count. The cost includes the shipping to the consignee.
Under a consignment system, does the consignee hold consignment inventory in his own inventory?
No. Consignment goods are maintained in the inventory of the consignor, not the consignee.
How does misstatement of ending inventory affect Ending Retained Earnings?
EI Over = COGS Under = ERE Over
EI Under = COGS Over = ERE Under
Which costs are included in COGS first under the FIFO (first in first out) system?
The first (oldest) inventory you have in stock is the first inventory you record for COGS purposes. If your oldest inventory on the shelf cost you $1 when you bought it, COGS is $1
This is just for inventory pricing. It has nothing to do with physically selling the oldest item on the shelf - It is purely for accounting purposes
Is FIFO balance sheet-oriented or income statement-oriented?
Balance sheet-oriented, since it reports EI at approximate replacement cost
May misstate income since old costs match current revenues
Which costs are included in COGS under the LIFO (last in first out) system?
The last (newest) inventory you have in stock is the first inventory you record for COGS purposes. If your newest inventory on the shelf cost you $1.50 when you bought it, COGS is $1.50
What is the LIFO Reserve?
Contra-inventory account
Used for companies who use LIFO for financial reporting but some other method for internal reporting
Must be adjusted to its required balance at financial statement date
How is Weighted Average Cost Per Unit calculated under a weighted average inventory system?
COGAS / Total Units = Weighted Average Cost Per Unit
How does FIFO’s COGS relate to LIFO’s in a time of changing prices?
FIFO’s relationship to COGS will be opposite LIFO’s relationship to COGS in periods of falling/rising prices.
How do FIFO and LIFO change in a period of rising prices?
FIFO has the Lowest COGS
If COGS is Low, that means EI is High
How do FIFO and LIFO change in a period of falling prices?
FIFO has the Highest COGS
If COGS is High, that means EI is Low
Under a Lower of Cost or Market, how are the benchmarks calculated?
Market Ceiling = Net Realizable Value = Selling Price - Selling Costs
Market = Replacement Cost
Market Floor = Net Realizable Value - Normal Profit
When using LCM, what results in a lower cost, applying the method to groups of items or to separate items?
Separate items
When is the lower of cost or market (LCM) principle relevant?
If inventory is impaired or damaged, it should be valuated at the LCM
Any decline in value should be charged against revenue for the period when the decline occurred
What is the accounting principle behind LCM?
Conservatism - realistically estimating future cash flows from sale of inventory
How are acquisitions accounted for in a periodic inventory system?
Debited to Purchases - at any point in time, the balance in inventory reflects the beginning of the period
COGS is a residual amount after subtracting EI from (BI + net purchases)
What is a chain discount?
A series of discounts, applied successively (not cumulatively)
What is the relative sales value method?
A means of valuing units in a “basket purchase”/lump sum
Cost should be proportioned according to relative sales value
What exceptions are there to valuing inventory at cost?
If impaired, value is lower of cost or market
Used/damaged/repossessed inventory items may be valued at replacement cost
Losses on purchase commitments
What are losses on purchase commitments?
A firm promises to purchase goods at a set price in the future
Any loss resulting from (1) drop in market value or (2) contract cancellation should be recognized in the current period
Debit: Loss on Purchase Commitment
Credit: Allowance for Loss on Purchase Commitment
What are the two ways to apply LIFO?
Quantity LIFO - “default”/classical application
-generally limited to small number of inventory items, since records of separate prices for each lot are required
Dollar-Value LIFO - widespread use, based on dollar value of inventory pools of similar items, rather than physical units
-based on economically similar items (respond similarly to same cost change pressures)
In dollar-value LIFO, what is the base year dollar cost?
The total inventory cost for the first year of the method’s adoption (the base year) divided by the number of units
In dollar-value LIFO, what is the price index?
(EI @ current-year costs) / (EI @ base-year cost) = price index for current period
In dollar-value LIFO, when is a new layer of inventory added?
Whenever the EI at base-year dollars exceeds the BI
In dollar-value LIFO, what is the calculation for a price index?
For each pool, (EI quantity) x (base-year unit price) = base-year amount for pool
-Sum all pools together
For each pool, (EI quantity) x (current-year unit price) = current-year amount for pool
-Sum all pools together
(current-year amount) / (base-year amount) = price index
In dollar-value LIFO, how is ending inventory valuated for year 2?
(year 2 base-year amount) - (year 1 base-year amount) = year 2 layer
(year 2 layer) x (year 2 price index) = valuation
Year 1 layer still is the year 1 base-year amount
In dollar-value LIFO, how is ending inventory valuated for year 3 (etc.)?
(current-year base-year amount) - (previous years’ layers) = current-year layer
Multiply each year by its respective price index, sum to receive EI valuation
In dollar-value LIFO, what happens if the base-year amount decreases in a subsequent year?
The layers are shed off accordingly (most recent layers shed first), and then each layer is multiplied by its respective price index
How does the link-chain method for Dollar-Value LIFO inventory differ in computing its indices?
The link-chain method affects the cost index.
For double-extension method, price indices = (current year amount) / (base year amount)
For link-chain method, the link-chain cost index = (previous-year cost change index) x (current-year cost change index)
What are two inventory estimation methods?
Gross Margin Method
Retail Method
How do you valuate dollar-value LIFO inventory with the link-chain method?
(Inventory at current cost) / (inventory at base-year cost) = current-year link-chain cost index
Inventory layers = (inventory at base-year cost) - (previous year’s inventory at base-year cost)
-First year’s inventory layer is the base-year inventory
Layers are multiplied by their respective link-chain cost index and added to the base-year to get that year’s LIFO inventory
What are two different average inventory methods?
Weighted average (periodic)
Moving average (perpetual)
What is the gross margin method?
Uses GM percentage (as a % of net sales) to calculate COGS, and thus to calculate EI (since COGS = BI + NP - EI)
Not GAAP
Used to:
- verify accuracy of year-end physical count
- estimate EI and COGS for interim reporting
- estimate losses from theft and fires/floods
What does the retail method require?
Records of BI and purchases for the period, both at cost and retail
Additional markups and markdowns
Sales for the period
What are three different ways to apply the retail method?
Weighted Average, LCM
LIFO Retail
Dollar-Value LIFO Retail
How do you calculate EI using the Weighted Average, LCM method?
Calculate CGAS at cost (BI + NP) and retail (BI + NP + markup)
-Get cost/retail ratio
CGAS @ retail - sales - markdowns = EI @ retail x cost/retail ratio = EI @ cost
What is the “LCM” component of the Weighted Average, LCM method?
CGAS includes markups but not markdowns
-causes cost/retail ratio to be lower
What is the difference between the Weighted Average, LCM method and the LIFO Retail method?
LIFO retail generates two different cost/retail ratios, one for BI and another for purchases, but none for CGAS
LIFO retail includes markdowns in the CGAS
How do you calculate the cost of EI using the LIFO Retail method?
(purchases @ cost) / (net purchases @ retail (including markups and markdowns)) = purchases cost/retail ratio
For retail: BI \+ purchases \+ markups - markdowns = CGAS - net sales = EI
(EI at retail) - (BI at retail) = Purchases Inventory Layer
(BI @ cost) + [(Purchases Layer) x (Purchases cost/retail ratio)] = EI at cost
How do you calculate the cost of EI using the Dollar-Value LIFO Retail method?
Retail EI / price index = retail EI at base-year dollars - retail BI = incremental base-year layer @ retail x price index = incremental current-year layer @ retail x purchases cost/retail ratio = incremental current-year layer @ cost \+ BI @ cost = EI @ cost
How do you calculate the cost of EI using the FIFO Retail method, ignoring the LCM component?
(Purchases @ retail) + (markups) - (markdowns) = Net purchases @ retail
(Purchases @ cost) / (net purchases @ retail) = Purchases cost/retail ratio
Net purchases @ retail \+ BI @ retail = CGAS @ retail - Sales = EI @ retail x Purchases cost/retail ratio = EI @ cost
What is the main difference between the LIFO Retail method and the FIFO retail method?
For the FIFO Retail method, the goods in BI are charged to COGS, not included in the EI. Therefore, only the purchases cost/retail ratio is relevant, not the BI cost/retail ratio.
Do losses on purchase commitments result in reductions in inventory?
No, you simply need to recognize a loss
In the retail inventory method, what would be used in calculating both cost and retail amounts of goods available for sale?
Purchase returns
If a retail inventory method is described as “conventional,” what does that mean?
It uses LCM, so don’t include markdowns in calculating CGAS
