Inventory

Question 1

Ways to value inventory

Answer 1

1. Lower of cost or net realizable value

2. Lower of cost or market

Question 2

What inventory methods use lower of cost or net realizable value

Answer 2

FIFO

Average Cost

Question 3

What inventory method uses Lower of cost or market

Answer 3

LIFO

Question 4

Net realizable value (NRV)

Answer 4

Selling price - costs of completion

Question 5

Lower of cost or market

Answer 5

This is replacement cost subject to a ceiling and floor. If replacement cost is in between the ceiling and floor, then use replacement cost

Question 6

Ceiling for Lower of cost or market

Answer 6

NRV

Question 7

Floor

Answer 7

NRV - Profit margin

Question 8

Impairment losses on inventory

Answer 8

If inventory was valued at cost, meaning cost was lower than market or NRV, but then the inventory’s market price or NRV declines below cost, the inventory’s value is written down

Journal Entry:

Loss on inventory write down
Inventory

Question 9

Casualty loss on inventory

Answer 9

A loss on inventory will be equal to the amount of loss less any sales of damaged inventory and less any insurance proceeds.

Question 10

Specific identification

Answer 10

This is used with large items such as cars where each item has an individual cost.

Question 11

FIFO

Answer 11

First in, first out. When prices are rising using FIFO, COGS is the lowest and provides the highest net income, also the highest ending inventory.

Question 12

LIFO

Answer 12

Last in, First out. When prices are rising using LIFO, this gives the highest COGS and lowest net income, and lowest ending inventory.

Question 13

Perpetual inventory system

Answer 13

A perpetual system records the purchases and sales of inventory items as they occur- in other words a computer system that tracks inventory moving in and out. Physical counts still take place to verify the inventory.

Question 14

FIFO under perpetual

Answer 14

Costs are the same under both a perpetual and periodic system. Lowest COGS, highest net income, highest ending inventory.

Question 15

LIFO under perpetual system

Answer 15

Under a perpetual system LIFO will have different inventory values than a periodic system because a cost is assigned after each sale. Last item purchased is the first one sold.

Highest COGS, lowest net income, lowest ending inventory. LIFO provides tax advantages because it causes lower net income. LIFO liquidation is when the oldest layer of cost is reduced because more units were sold in the current year than purchase, which taps into the older “layers” of inventory.

Question 16

Dollar value LIFO

Answer 16

Uses LIFO ‘Pools’ to track inventory. Uses a “Conversion index” to determine inventory value for the LIFO layer added in the current year.

Question 17

Conversion Index

Answer 17

Ending inventory in current year dollars / ending inventory in base year dollars.

Then, you use that multiplier to convert current year prices to base year prices.

Question 18

Gross Margin method

Answer 18

Used to estimate COGS using gross margin.

Sales - cost = margin

Question 19

Retail Inventory Method

Answer 19

Used by retailers to estimate the cost of ending inventory.

Question 20

Steps of Retail Inventory Method

Answer 20

1. Calculate ending inventory at retail prices
2. Calculate the cost to retail ratio
3. Apply cost to retail ratio to ending inventory at retail prices to get ending inventory at cost

Question 21

Inventory equation

Answer 21

Beginning Inventory
ADD: Purchases
EQUALS: Goods available for sale
LESS: Ending inventory
EQUALS: Cost of goods sold

Question 22

Purchase Commitments

Answer 22

Companies will enter into agreements to purchase certain amounts of certain items, sometimes within a certain time period

Question 23

If the market price of an item of the purchase commitments goes down…

Answer 23

The buyer may have to recognize a loss depending on if the terms can be modified or not. If they can be modified then the potential loss can be disclosed in a footnote but doesn’t have to be recognized in the financials. If the terms cannot be modified, then the loss is probable and must be accrued and recognized on the balance sheet.

Question 24

IFRS Inventory Differences

Answer 24

Under IFRS inventory is valued at lower of cost or net realizable value

LIFO is NOT allowed at all under IFRS

Reversal of inventory write-downs IS allowed under IFRS. This is NOT allowed under GAAP

Question 25

Free on Board (FOB) destination

Answer 25

Ownership and risk of loss of the inventory doesn’t change until it reaches its destination (the buyer’s warehouse). The seller “owns” the inventory until it reaches the buyer.

Question 26

Free on board (FOB) shipping point

Answer 26

As soon as the inventory is shipped, the buyer now owns it and will include it in their inventory.

Question 27

What items are included in the cost of inventory?

Answer 27

Purchase returns
Freight-in (shipping costs to get the inventory to the warehouse)
Sales tax on acquisition
Insurance on transit

Question 28

What items are excluded from the cost of inventory

Answer 28

Freight out- this is a selling expense

Interest on purchase - this is financing