Lecture 7: Inventory

Question 1

What is included in the cost of inventory?

Answer 1

all cost of acquisition and preparation for sale:

• warehousing costs prior to sale
• Insurance, repackaging, modifications
• Freight In paid by the buyer
• Transportation costs paid by the seller on consignment arrangements
• DO NOT include abnormal costs for idle factory expense, unallocated fixed OH costs, excessive spoilage, double freight, re-handling costs( ALL should be EXPENSED immediately)

Question 2

When goods are in transit, FOB Shipping point is recorded as:

Answer 2

title passes to the buyer when the seller delivers the goods to a common carrier or the goods are shipped. Inventory is included in the buyer’s books at year end
(Shipped)

Question 3

When goods are in transit, FOB Destination is recorded as:

Answer 3

title passes to the buyer when the buyer receives the goods from the common carrier (received or tendered to buyer)
*Included on seller’s books until received by the buyer

Question 4

Financing costs for inventory under GAAP are reported as:

Answer 4

interest expense not apart of inventory.

Question 5

consignor

Answer 5

the potential seller that retains legal ownership of goods but does not possess the goods.
Costs incurred in transferring goods to consignee are inventory costs until sold. (Cost, freight paid on shipment, warehouse, advertising, in transit insurance)

Question 6

consignee

Answer 6

the potential buyer that does not have legal ownership of the goods, but possess the goods.
Items are not included on the consignee’s BS
when items are sold, the sales price is given to the consignor after deducting reimbursable costs and commissions earned by the consiginee

Question 7

Operating Income contains:

Answer 7

Sales
(COGS)(Product Cost, capitalized until sold) 
=GM
(SGA) (period cost, expensed) 
=Operating Income

Question 8

COGS formula

Answer 8

Begin Inventory
\+Net Purchases
\+Freight In
=Goods Available for Sale
(Ending Inventory)
=COGS -Product Cost

Question 9

2 systems for measuring Inventory quantities:

Answer 9

PERIODIC AND PERPETUAL

Question 10

Periodic Inventory System

Answer 10

“physical inventory count” the quantity is determined by a physical count, usually done at year end. Purchases are dr. to purchases and no adj is made to inventory until year end when the count is made. COGS is the plus and the exact amount of shortage is not determined because it is inside COGS.

Question 11

Perpetual Inventory System

Answer 11

“ongoing, real time count” Inventory purchases are dr. to inventory and the quantity on hand can be determined at any point in time.

Question 12

Inventory Costing Methods:

Answer 12

Specific Identification, FIFO, LIFO, Moving Average, Weighted average, Dollar Value LIFO

Question 13

Specific Identification:

Answer 13

must be able to identify each unit sold, used when inventory is few in numbers, expensive and heterogenous items.

Question 14

FIFO

Answer 14

First In First Out, Last in Still Here

when prices are rising, highests ending inventory, lowest COGS and highest NI

Question 15

LIFO

Answer 15

Last In First Out, First in Still Here
NOT ALLOWED under IFRS
When prices are rising, lowest ending inventory, highest COGS, Lowest NI

Question 16

Perpetual Moving Average:

Answer 16

compute the average price after each purchase

Question 17

Periodic Weighted Average

Answer 17

takes total cost of all inventory purchases during the year and divides them by the total number of inventory units available during the year.

Question 18

Dollar Value LIFO

Answer 18

Uses approach to account for inventory in dollars rather than units. Inventory is combined into groups called inventory pools and a price level index is used to convert the inventory value from LIFO to Dollar Value LIFO.

Question 19

Formula for Dollar Value LIFO

Answer 19

Inventory at year End $ / Price Level Index = End Inventory at Base year $
then for each layer added multiply by the price index in order to calculate year end inventory at the correct prices.

Question 20

Lower of Cost or Market

Answer 20

GAAP requires that items be valued at the lower number between cost or market. The Market price is made up of a Ceiling, Floor and Replacement cost

Question 21

Ceiling

Answer 21

NRV = Sales price - Disposal costs (exg. cost to complete, freight out, sales commissions)

Question 22

Replacement Cost

Answer 22

purchase or reproduction cost

Question 23

Floor

Answer 23

NRV (Sales Price-Disposal Cost) - Normal Profit Margin ( the point when the client would make no profit)

Question 24

Inventory Estimation Method: Gross Profit Method

Answer 24

if inventory is missing or destroyed, this can be used to calculate the ending inventory. First add: Begin Inventory + Purchases= Goods Available for Sale less Ending Inventory (Unknown) = COGS (unknown)
* you use the historical Gross Profit Percentage to find COGS or vice versa, 1- Gross Profit Margin = COGS %
then Multiply COGS % by sales to get COGS and plug in Ending Inventory.

Question 25

Conventional Retail Inventory Method

Answer 25

approximates the LCM, Use both cost and retail amounts, convert ending inventory in retail to cost with a cost/retail %.

Begin Inventory
\+Purchases
\+Frieght In (ONLY COST)
\+Net Markups (Only RETAIL) 
= Goods available for sale at RETAIL and COST
*Divide Retail/Cost to get %
-Net Markdowns
=Sales price of goods available for sale
-losses
-Sales @ Retail
=Ending Inventory @ retail
X the C/R%
=Ending Inventory at Cost

Question 26

LIFO Retail Inventory Method:

Answer 26

Approximates the original cost of the merchandise. Beginning Inventory is not included and Net Mark Downs are above the % line.

Purchases
\+Frieght In (ONLY COST)
\+Net Markups (Only RETAIL) 
-Net Markdowns
= Goods available for sale at RETAIL and COST
*Divide Retail/Cost to get %
=Sales price of goods available for sale
-losses
-Sales @ Retail
=Ending Inventory @ retail
X the C/R%
=Ending Inventory at Cost

Question 27

Firm Purchase Commitment

Answer 27

a non-cancelable agreement to buy inventory in the future. If it is expected that a loss will occur in the future, the loss is recognized at the time of the decline in price. Loss is the difference between the contract price and the market price.

dr. estimated loss (IS)
cr. Estimated Liability

Question 28

Under IFRS the primary differences from GAAP in accounting for Inventory are:

Answer 28

• IFRS does not allow LIFO
• IFRS requires inventories to be reported at LCNRV rather than LCM, only looks at NRV and cost and reports the lower of the two.
• IFRS allows recoveries of the value of inventory when the NRV increases after inventory has been written down.
• IFRS allows certain borrowing costs to be capitalized as part of conversion when measuring cost of inventory