SAC 2 Part 4

Question 1

Why is it important to include product costs in the valuation of inventory?

Answer 1

They uphold relevance, and assist users of financial information in decision making

Question 2

What effect does treating product costs as a period cost have on the accounting equation?

Answer 2

Assets decrease as inventory valuation decreases

Owners equity decreases as net profit decreases because cost of goods sold becomes greater

Question 3

Why is the dollar amount of a discount greater than that of GST charged at the same rate?

Answer 3

GST is charged only on the selling price, whereas a discount is applied on the selling price + GST (total amount owing to account payable)

Question 4

What does the cost of inventory refer to?

Answer 4

All costs incurred in order to bring inventory into a condition and location ready for sale

Question 5

What does the unit cost refer to?

Answer 5

The cost price of each individual item/unit of inventory

Question 6

What is the definition of a product cost?

Answer 6

A cost incurred in order to bring inventory into a condition and location ready for sale, that can be allocated to individual units of inventory on a logical basis

Question 7

What is the definition of a period cost?

Answer 7

A cost incurred in order to bring inventory into a condition and location ready for sale, that cannot be allocated to individual units of inventory on a logical basis

Question 8

What is the definition of other expenses and where is it recorded in the income statement?

Answer 8

An expense incurred after the sale of inventory, which is recorded in other expenses at the bottom of an income statement

Question 9

Where will a product cost and period cost be reported in the income statement?

Answer 9

Product Cost = Cost of Sales (under cost of goods sold)

Period Cost = Seperate Ledger (under cost of goods sold)

Question 10

How can period costs increase the total cost of goods sold compared to product costs?

Answer 10

They recognise the entire amount incurred during the period, whether inventory remains unsold or not, whereas product costs only recognise amounts charged for each individual unit of inventory sold

Question 11

If all inventory is not sold, what will period costing lead to?

Answer 11

A higher cost of goods sold, lower profit/owners equity, lower inventory/assets

Question 12

What is the net realisable value (NRV)?

Answer 12

The estimated selling price of inventory less any costs involved in its selling, marketing or distribution

Question 13

Why would valuing inventory at its cost price when it is higher than NRV breach faithful representation?

Answer 13

The original purchase price would no longer provide a valuation which was complete or free from error

Question 14

What is the difference between what the Cost and NRV of inventory represent?

Answer 14

Cost = Value at the time of purchase
NRV = Value if sold today

Question 15

What does the lower of cost and NRV rule state?

Answer 15

Inventory should be valued at either its cost, or NRV, using whichever value is lower

Question 16

What are some reasons that lead to the NRV of inventory being lower than the cost?

Answer 16

Damage, purposeful decrease in selling price, decrease in demand, obsolescence

Question 17

What does inventory write-down refer to?

Answer 17

The expense incurred when the NRV of an item of inventory falls below its cost price

Question 18

How is inventory write down calculated?

Answer 18

Cost less NRV

Question 19

What is inventory turnover?

Answer 19

The average number of days it takes for a business to sell its inventory or convert its inventory into sales

Question 20

What does a fast inventory turnover suggest?

Answer 20

Inventory is being sold quickly, which enhances the firms ability to earn profit and generate cash in order to pay off short term debts

Question 21

What benchmarks can inventory turnover be assessed against?

Answer 21

Performance in previous periods, expected performance and performance of competitors

Question 22

What can be the negatives of having a fast inventory turnover?

Answer 22

The selling price may be too low, which indicates a loss of potential revenue and profit, or the business may be holding too little inventory

Question 23

What does a slow inventory turnover suggest?

Answer 23

A decrease in sales which leads to a negative effect on profit and liquidity, as well as inventory becoming more susceptible to inventory loss or write-down

Question 24

Which goods should usually have a fast inventory turnover?

Answer 24

Perishable fresh produce, goods susceptible to changes in fashion or cheap items

Question 25

How are inventory turnover, accounts receivable turnover and accounts payable turnover all linked?

Answer 25

Inventory turnover measures the days between the purchase of inventory and sale of inventory
Accounts receivable turnover measures the days between the sale of inventory and the receipts from the accounts receivable
Accounts payable turnover measures the days between the purchase of inventory and payments to accounts payable

Question 26

At what rates will a business want each of its turnovers to ideally be?

Answer 26

Inventory turnover/accounts receivable turnover to be as fast as possible, whereas accounts payable turnover to be as slow as possible without exceeding credit terms

Question 27

What strategies can owner implement in order to mange inventory more effectively?

Answer 27

Ensure inventory is up to date and of the most current version available
Promote the sale of complementary goods to support the original items sold
Appoint an inventory manager to ensure inventory handling procedures are effective