P1.A.2.2 Asset Valuation - Inventory

Question 1

Cost of goods sold (COGS) formula

P1.A.2.2 Asset Valuation - Inventory

Answer 1

Beginning inventory
\+ Add: Purchases
= Equals: Costs of goods available for sale
- Less: Ending inventory
= Equals: Costs of goods sold

Question 2

Goods to include in inventory

P1.A.2.2 Asset Valuation - Inventory

Answer 2

Consigned
Goods out on consignment - Yes
Goods held on consignment - No

Goods on Approval
Goods out on approval - Yes
Goods held on approval - No

Goods in Transit
Buyer: FOB Shipping - Yes
Buyer: FOB Destination - No
Seller: FOB Shipping - No
Seller: FOB Destination - Yes

Question 3

Effect of Inventory Errors

P1.A.2.2 Asset Valuation - Inventory

Answer 3

Beginning Inventory
Error: U COGS: U Profit: O Net Income: O
Error: O COGS: O Profit: U Net Income: U

Purchases
Error: U COGS: U Profit: O Net Income: O
Error: O COGS O Profit: U Net Income: U

Ending Inventory
Error: U COGS: O Profit: U Net Income: U
Error: O COGS: U Profit: O Net Income: O

Question 4

Price change effects on Inventory Methods

P1.A.2.2 Asset Valuation - Inventory

Answer 4

Prices Increasing
FIFO 
COGS: decrease 
Inventory: increase
Net Income: increase

LIFO
COGS: increase
Inventory: decrease
Net Income: decrease

Question 5

FIFO Advantages & Disadvantages

P1.A.2.2 Asset Valuation - Inventory

Answer 5

Advantages

1. Inventory approximates current replacement cost
2. Lower income tax when prices are decreasing

Disadvantage
1. Higher income tax when prices are increasing

Question 6

LIFO Advantages & Disadvantages

P1.A.2.2 Asset Valuation - Inventory

Answer 6

Advantages
1. Lower income tax when prices are increasing

Disadvantages

1. Higher income tax when prices are decreasing
2. Inventories are reported at prices that aren’t close to current price
3. Not permitted by IFRS

Question 7

Weighted Average Advantages & Disadvantages

P1.A.2.2 Asset Valuation - Inventory

Answer 7

Advantages

1. Simple and objective
2. Neutralizes effect of price fluctuations

Disadvantages
1. Analysis of price fluctuations may be difficult to monitor

Question 8

Specific Identification Advantages & Disadvantages

P1.A.2.2 Asset Valuation - Inventory

Answer 8

Advantages
1. Theoretically most accurate

Disadvantages

1. Subject to manipulation
2. Difficult and costly to implement

Question 9

LIFO Reserve

P1.A.2.2 Asset Valuation - Inventory

Answer 9

Inflationary environment
LIFO reserve = FIFO - LIFO

Deflationary environment
LIFO reserve = LIFO - FIFO

1. Difference between two cost inventories. May use one for internal and other for external reporting.
2. GAAP asks those using LIFO to disclose difference of LIFO & FIFO in allowance account.