Topic 6 - Inventories

Question 1

What is the basis of merchandising operation?

Answer 1

Sales revenue less cost of sales = gross profit

Gross profit less operating expenses = Profit (loss)

Question 2

What is the perpetual inventory system?

Answer 2

• Detailed inventory system in which the cost of inventory is maintained.
• Records continuously show the inventory that should be on hand
• Use of bar codes and optical scanners has led to wide use

Question 3

What is the periodic inventory system?

Answer 3

• Inventory system in which detailed records are not maintained.
• Cost of sales is determined only at end of accounting period by a physical inventory account.
• Used widely by small businesses:

Question 4

Explain the lower of cost and net realisable value basis of accounting for inventories.

Answer 4

• When the value of inventory is lower than its cost, the inventory is written down to its market value by valuing the inventory at the lower of cost and net realisable (LCNRV) in the period in which the price decline occurs.
• AASB 102 defines net realisable value (NRV) as the estimated proceeds of sale less costs incurred in completing the sale.

Question 5

What type of business had inventory or stock?

Answer 5

A retailer business not a service business.

Question 6

What is a retail businesses main revenue and expenditure?

Answer 6

Main revenue is Sales of goods and main expenditure is Cost of Sales.

Question 7

What is inventory?

Answer 7

Goods held for resale in the normal course of business.

Question 8

What is the management of inventory?

Answer 8

- Efficient handling of inventory:
Stock-out vs excessive stock
- Safeguarding stock:
Self-checkout 
Stocktake
- Fire-sale of inventory

Question 9

What are the two types of inventory systems?

Answer 9

Periodic and Perpetual.

Question 10

What account is used to record the cost of all inventory purchases in a periodic inventory system?

Answer 10

Purchases account.

Question 11

How do you calculate Cost of Sales in a periodic system?

Answer 11

Purchases less purchase returns and allowance add freight-in

Question 12

What entries are required to record the sales of inventory in a perpetual inventory system?

Answer 12

1. to record the sale of goods

2. to record the cost of sales

Question 13

What entries are required to record the return of inventory in a perpetual system?

Answer 13

1. To record sales return at selling price.

2. To record return to inventory at cost price.

Question 14

What are the four inventory cost flow methods/assumptions in the periodic system?

Answer 14

Specific identification
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
Average cost

Question 15

What is the specific identification method?

Answer 15

This is possible when a business sells a limited variety of high unit cost items that can be clearly identified from the time of purchase to the time of sale.

Question 16

What is the FIFO method?

Answer 16

• Assumes first goods purchased are first goods sold.

- Allocation of costs

Question 17

What is the LIFO method?

Answer 17

• Assumes last goods purchased are first goods sold.

- Allocation of costs

Question 18

What is the Average cost method?

Answer 18

• Cost of goods available for sale is calculated on weighted average unit cost incurred.
• Allocation of costs

Question 19

How is the statement of profit and loss effected by each cost flow method in periods of increasing prices?

Answer 19

• FIFO reports the highest profit.
• LIFO the lowest.
• Average cost falls in the middle.

Question 20

How is the statement of profit and loss effected by each cost flow method in periods of decreasing prices?

Answer 20

• FIFO will report the lowest profit.
• LIFO the highest.
• Average cost falls in the middle.

Question 21

How is the statement of financial position effected by each cost flow method in periods of increasing prices?

Answer 21

Costs allocated to ending inventory using:

• FIFO will approximate current costs.
• LIFO will be understated.

Question 22

What is the taxation effect of LIFO?

Answer 22

• In times of rising prices, LIFO will give lower profit and therefore lower taxes.
• But, LIFO is not allowed in Australia or New Zealand.

Question 23

What is the advantage of using inventory cash flow methods consistently?

Answer 23

• Consistent application enhances comparability of financial statements over successive periods.
• If a firm chooses to adopt a new method, it must disclose in the financial statements:
  the change; and
  the effects of the change on profit.

Question 24

What is GST?

Answer 24

a value-added tax:

i.e. tax is levied on the valued added by a business at each stage of production and distribution chain.

Question 25

What are the two exceptions where GST is not charged?

Answer 25

(1) GST-free supplies:
e.g. basic food, education, health services, exports.
(2) Input taxed supplies:
e.g. financial services and residential rents:
For input taxed supplies no input tax credits (GST paid) can be claimed back from the taxation authority for GST paid associated with providing such supplies.

Question 26

What is the basic 3 step process of GST?

Answer 26

1. Charge customers GST on sales of goods or services (GST Collected)
2. Claim back GST on purchases a business makes like expenses, purchases and capital expenditure (GST Paid). These are called Input Tax Credits.
3. Calculate the difference and either send the net amount owing to the ATO or get a refund from the ATO (GST Paid > GST Collected)