Week 2 - Inventory and Merchandising Operations

Question 1

inventries are valued at

Answer 1

lower of cost and net realizable value (NRV)

Question 2

lower-of-cost-or market rule

Answer 2

business must record the cost of inventory at whichever cost is lower - the original purchase cost or its current market value

Question 3

Why are inventories recorded at the lower of cost or NRV?

Answer 3

because of the reliability qualitative characteristic. Not revaluing the inventory to the lower NRV lends bias to the ending inventory, which violates the reliability requirements.

The entity may not be able to recover the cost of inventory if the goods are damaged or obsolete, or if their selling price has declined below cost.

Question 4

net realizable value

Answer 4

estimated selling price - estimated cost to be incurred to sell the goods

The estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale

Question 5

What is inventory referred to once it is sold?

Answer 5

Once inventory is sold, it gets shifted to the expense account, called COGS

Question 6

Selling goods on consignment

Answer 6

Consignor: The consignor may also be referred to as the shipper
Consignee: is the entity who is financially responsible (the buyer) for the receipt of a shipment

Consignment is when goods are shipped to a dealer. The dealer, who is the consignee, has the right to return the goods to you when they don’t sell.

Question 7

FOB

Answer 7

Freight on board; shipping terms that determine who owns the goods at a particular time

Question 8

FOB Shipping Point

Answer 8

Ownership of goods changes hands at the shipping point.

• buyer pays for shipping
• buyer includes the goods in its inventory while the goods are in transit

Question 9

FOB Destination

Answer 9

Ownership of goods changes hands at the destination

• the seller pays for shipping
• the seller includes the goods in its inventory while the goods are in transit

Question 10

Perpetual Inventory System

Answer 10

• used for all types of goods
• keeps a running record of all goods bought, sold, and on hand
• inventory counted at least once a year to determine any discrepancies between accounting records and inventory on hand

Question 11

Periodic Inventory System

Answer 11

• used for inexpensive goods
• does not keep a running record of all goods
• inventory counted at least once a year to determine ending inventory with any difference assumed to be used or sold

Question 12

purchase return

Answer 12

decrease in the cost of inventory because the buyer return the goods to the vendor

Question 13

purchase allowance

Answer 13

decreases the cost of inventory because the buyer got an allowance from the amount owed; A purchase allowance is a reduction in the buyer’s cost of merchandise that it had purchased. The purchase allowance is granted by the supplier because of a problem such as shipping the wrong items, the incorrect quantity, flaws in the goods, etc.

Question 14

Where are shipping costs recorded

Answer 14

as an expense, not COGS

Question 15

inventory costing methods

Answer 15

first-out (FIFO); last-in, first-out (LIFO); and weighted average cost method

Question 16

Specific identification/specific-unit-cost method

Answer 16

cost of inventory items that are not ordinarily interchangeable shall be assigned by using specific identification of the individual costs (e.g. cars, real estate)

Question 17

Inflation/when inventory costs increase:

Under which costing method are COGS highest?

Answer 17

LIFO

Question 18

Inflation/when inventory costs increase:

Under which costing method is ending inventory highest?

Answer 18

FIFO

Question 19

Deflation/when inventory costs are decreasing:

Under which costing method is ending inventory highest?

Answer 19

LIFO

Question 20

Which costing method is not allowed under IFRS

Answer 20

LIFO

Question 21

Inventory Error:

Period 1: Ending inv. overstated.

–> What happens to COGS and profit in period 1 and 2

Answer 21

Period 1:

• COGS understated
• Profit overstated

Period:

• COGS: overstated
• Profit: understated

Question 22

gross profit percentage

Answer 22

gross profit/ sales

Question 23

inventory turnover

Answer 23

COGS/ average inventory

Question 24

average inventory

Answer 24

(beginning balance + ending balance)/2

Question 25

What does inventory turnover tell us?

Answer 25

shows us how many times the company sold its average level of inventory during the year

Question 26

inventory resident period

Answer 26

365/ inventory turnover

• expressing the turnover in days

Question 27

inventory resident period: should it be high or low?

Answer 27

Less days are better

Question 28

Estimating ending inventory by the gross profit method/gross margin method

Answer 28

Beginning inv. 
\+ purchases 
= COG available
- COGS
= Ending inv.

Question 29

Types of inventory in retail companies

Answer 29

merchandise (finished goods)

Question 30

Types of inventory in manufacturing companies

Answer 30

Raw materials
Work in progress
Finished goods

Question 31

Situations in which NRV might be lower than cost of inventory

Answer 31

• when there is an increase in costs to complete or selling costs
• a fall in selling price
• Obsolescence of products
• A decision to manufacture and sell products at a loss, this can happen when management decide to gain market share
• Errors in production or purchasing

Question 32

What is obsolescence?

Answer 32

Recognition that a product is no longer fit for purpose

Question 33

Types of obsolescence?

Answer 33

• Functional obsolescence
• Economic obsolescence
• Physical deterioration

Question 34

Functional obsolescence

Answer 34

there is nothing wrong with the product, but due to new technologies a better product is available today

Question 35

Economic obsolescence

Answer 35

there is nothing wrong with the product, however there is no market demand anymore

Fashion

Question 36

Physical deterioration

Answer 36

the product is damaged

Question 37

For what is LIFO used

Answer 37

Under certain circumstances, it is allowed under the US GAAP

Often allowed for tax purposes

Question 38

Average cost of inventory

Answer 38

average purchase price over a certain period

–> often in between LIFO and FIFO in estimating COGS or ending inventory prices for

Question 39

costs of inventory should include all:

Answer 39

• Costs of purchase (including taxes, transport, and handling) net of trade discounts received
• Costs of conversion (including fixed and variable manufacturing overheads)
• Other costs incurred in bringing the inventories to their present location and condition

Question 40

Gross profit margin

Answer 40

Gross profit / sales