Inventory + Income Statement

Question 1

Perpetual Inventory

Answer 1

accounting system in which movements of inventory are recorded on a continuous basis throughout the reporting period.

Question 2

Inventory Cards

Answer 2

used to record the movements of each individual line of inventory.

Question 3

Advantages of Perpetual Inventory System

Answer 3

• Greater control.
  -More efficient reordering – Can order new inventory when levels are low.
• Accounting reports can be calculated at any time, not just at the time of a stocktake.
• Identification of inventory losses/gains.

Question 4

Disadvantages of Perpetual Inventory System

Answer 4

Additional record keeping.
Additional costs – Wages and training.
Does not replace the physical stocktake.

Question 5

Identified Cost

Answer 5

Identified cost method: A system of recording inventory which records the actual cost of each individual unit of inventory sold.

Question 6

FIFO

Answer 6

a system of recording inventory costs, based on the assumption that the first goods purchased are the first goods sold.
FIFO is always an assumption of inventory flow. No attempt is made to identify the actual stock being sold.

Question 7

Why would FIFO be used over IC?

Answer 7

1) It is physically impossible to identify the actual units being sold in some businesses.
2) Management prefers not to use labels or codes as it involves too much work. Instead, they simply choose to assume that the first goods purchased are the first goods sold.

Question 8

Inventory Losses

Answer 8

Undersupply by suppliers
Oversupply to customers
Theft by customers or staff
Recording errors in inventory cards
Stocktaking errors
Duplication of invoices from Suppliers

Question 9

Inventory Gains

Answer 9

Oversupply by suppliers
Undersupply to customers
Recording errors in inventory cards
Stocktaking errors

Question 10

Credit Note

Answer 10

business document used to acknowledge the return of goods.

Accounts Payable may issue us a credit note when we return inventory to a supplier.
We may issue a credit note to an accounts receivable if they return inventory to us.

NOTE: The creator of the credit note is the original seller. Hint: Just like an Invoice their name will be on the top of the Credit Note!

Question 11

Why should we offer sales return?

Answer 11

Generation of a higher number of sales.
Ethical response to goods being of poor quality or damaged.
Legal obligations to return goods when the “product is not fit for its intended use”.

Question 12

Why should we not offer sales return?

Answer 12

Reduction on Net Profit as goods are returned.
Lower future sales.
Repackaging or repare costs when returns are accepted.

Question 13

Product Cost

Answer 13

any cost incurred in bringing inventory into a condition and location ready for sale which can be allocated to each individual unit of inventory on a logical basis

Question 14

Period Costs

Answer 14

any cost incurred in bringing inventory into a condition and location ready for sale which CANNOT be allocated to each individual unit of inventory on a logical basis

Question 15

Period Costs

Answer 15

any cost incurred in bringing inventory into a condition and location ready for sale which CANNOT be allocated to each individual unit of inventory on a logical basis

Question 16

NRV formula

Answer 16

NRV = Estimated selling price less direct selling expenses due to marketing, selling and distribution of the item.

Question 17

How to calculate profit?

Answer 17

PROFIT = REVENUES – EXPENSES

Question 18

Why we close revenue and expense accounts?

Answer 18

1. To calculate profit or loss for the reporting period
2. To reset the revenue and expense accounts to zero in preparation for the next reporting period.

(note that only revenues and expenses are closed because assets and liabilities relate to future benefits or sacrifices).

Question 19

Income Statement

Answer 19

Formal accounting report used to show a business’s revenue, expenses and net profit (or loss).

Question 20

What is cost of goods sold?

Answer 20

Cost of goods sold is a classification of expenses within the income statement.
It includes the cost of sales for the period as well as all other expenses incurred in getting inventory into the business and a position and location, ready for sale. Not afterwards!!

Question 21

Why use the IS? Accrual

Answer 21

Accrual Basis Assumption – We must include revenues which have been earned and expenses which have been incurred.

Question 22

Why use the IS? Period

Answer 22

Period Assumption – The Income Statement will summarise revenues and expenses recorded during a reporting period.

Question 23

Why use the IS? Relevance

Answer 23

Relevance – The Income Statement will provide the owners useful information on which they can base decisions on.

Question 24

Why use the IS? Understandibility?

Answer 24

Understandability – The Income Statement presents financial information in a simple and clear format that non-accountants can easily understand.

Question 25

Uses of the Income Statement

Answer 25

The Income Statement is useful for decisions relating to:
The ability of the business to earn revenue
The adequacy of the firm’s mark up policy
The ability of the business to control expenses
Assessing business performance
Future budgets

Question 26

Advantages of Perpetual Inventory System

Answer 26

Greater Control
identifies slow and fast moving lines of inventory
More efficient reordering - Can order new inventory when inventory is running low
Accounting reports can be calculated at any time, not just at the time of stocktake.
Identification of losses and gains

Question 27

Disadvantages of perpetual inventory system

Answer 27

Additional Record-keeping
Additional costs- Wages and Training
Does not replace the physical stocktake

Question 28

Ethical Issues to consider when choosing a supplier

Answer 28

consider how the supplier, disposes of their waste from the manufacturing process / where they source their inputs / whether the supplier has a good reputation for treating their employees fairly.

Question 29

Ethical Considerations

Answer 29

The social and environmental consequences of a financial decision made by a business.

Question 30

Why use FIFO over IC?

Answer 30

It is physically impossible to identify the actual units being sold in some businesses.
Management prefers not to use labels or codes as it involves too much work. Instead, they simply choose to assume that the first goods purchased are the first goods sold.
Requires less time and effort.
High volumes of inventory of lower value, may be unpractical to identify the individual cost of each item of inventory.

Question 31

Why use IC over FIFO?

Answer 31

Satisfies faithful representation and thus accurately reflects the current economic circumstances of the inventory.
Accurate profit calculation.
Doesn’t have large amounts of inventory and sells more expensive lines of inventory. May be disadvantageous if benefit of accuracy is not with additional recordkeeping

Question 32

Why do we record inventory at its lower of cost and net realisable value rule?

Answer 32

Inventory is recorded at its lower of cost and net realisable value in order to satisfy faithful representation, since it would accurately reflect the current underlying economic value of the inventory, unlike if it were to be recorded at its previous value.

Question 33

What is the effect on profit when cost prices are falling or rising?

Answer 33

When cost prices are falling, the most expensive items are getting sold first, resulting in a higher cost of sales and thus a lower net profit. However, when cost prices are rising, the cheaper items are getting sold, thus resulting in a lower cost of sales and a higher net profit as well as a higher inventory value since the more expensive items are remaining on hand.

Question 34

What is FIFO?

Answer 34

FIFO is an inventory valuation method based on the assumption that the first cost price in the balance of an inventory card is the first inventory exiting the business. It is used when it is physically impossible to use identified cost or because it simply requires less time and effort.

Question 35

Ethical Considerations - Returns

Answer 35

Customers are well within their rights to return inventory that is damaged or faulty, however, it becomes harder to answer when it is not clear whether or not the damage occurred before or after the sale. Returning inventory damaged after delivery may jeopardise relationships with suppliers.

Question 36

Inventory Quality - EC

Answer 36

When purchasing inventory, a business must strike a balance between a lower price and a higher quality. Low quality inventory may result in an increase in sales returns and dissatisfied customers who may shop elsewhere.

Question 37

Ethical Purchasing EC

Answer 37

Businesses who source their inventory from suppliers who exploit their employees, or the environment must consider that this may have negative effects on their operations, as consumers may be unwilling to purchase items produced in this manner. Additionally, switching from local to overseas suppliers will have a negative impact in the local economy, potentially resulting in job losses. This can also tarnish a businesses reputation and result in a reduction of sales.
CO2 emissions.

Question 38

Inflating Profit EC

Answer 38

Inventory Write-downs – Not writing inventory down their Net Realisable Value (NRV) will in fact overstate the value of inventory and overstate net profit.
Inventory Valuation - If inventory is left unsold, a business would prefer to record a period cost as a product cost as it would result in a higher net profit.
Inventory Valuation – A business should not change between FIFO and Identified Cost to increase profits.

Question 39

Effect on profit if costs are treated as product costs rather than period costs.

Answer 39

If costs are treated as product costs and not all inventory is sold, they are included in the value of inventory since they are only expensed as cost of sales when inventory has been sold. On the other hand, costs that are treated as period costs are fully expensed at the time of the purchase, so regardless of whether all inventory has been sold, the entire expense has been recorded. As a result, when not all inventory has been sold, net profit would be higher if product costing is used. But if all inventory is sold, both methods of costing result in the same net profit.