Accounting Chapter 6 Notes – Flashcards
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Merchandise inventory refers to goods owned by a company and held for resale. Goods in transit are reported in inventory of the company that holds ownership rights. Goods on consignment are reported in the consignor's inventory. Goods damaged or obsolete are reported in inventory at their net realizable value.
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Identify the items making up merchandise inventory.
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Costs of merchandise inventory include expenditures necessary to bring an item to a salable condition and location. This includes its invoice cost minus any discount plus any added or incidental costs necessary to put it in a place and condition for sale.
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Identify the costs of merchandise inventory.
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When purchase costs are rising or falling, the inventory costing methods are likely to assign different costs to inventory. Specific identification exactly matches costs and revenues. Weighted average smooths out cost changes. FIFO assigns an amount to inventory closely approximating current replacement cost. LIFO assigns the most recent costs incurred to cost of goods sold and likely better matches current costs with revenues.
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Analyze the effects of inventory methods for both financial and tax reporting.
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An error in the amount of ending inventory affects assets (inventory), net income (cost of goods sold), and equity for that period. Since ending inventory is next period's beginning inventory, an error in ending inventory affects next period's cost of goods sold and net income. Inventory errors in one period are offset in the next period.
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Analyze the effects of inventory errors on current and future financial statements.
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We prefer a high inventory turnover, provided that goods are not out of stock and customers are not turned away. We use days' sales in inventory to assess the likelihood of goods being out of stock. We prefer a small number of days' sales in inventory if we can serve customer needs and provide a buffer for uncertainties.
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Assess inventory management using both inventory turnover and days' sales in inventory.
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Cost of Goods Sold/Average Inventory
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Inventory Turnover=
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Ending Inventory/Cost of Goods Sold x 365
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Days Sales in Inventory=
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Costs are assigned to the cost of goods sold account each time a sale occurs in a perpetual system. Specific identification assigns a cost to each item sold by referring to its actual cost (for example, its net invoice cost). Weighted average assigns a cost to items sold by dividing the current balance in the inventory account by the total items available for sale to determine cost per unit. We then multiply the number of units sold by this cost per unit to get the cost of each sale. FIFO assigns cost to items sold assuming that the earliest units purchased are the first units sold. LIFO assigns cost to items sold assuming that the most recent units purchased are the first units sold.
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Compute inventory in a perpetual system using the methods of specific identification, FIFO, LIFO, and weighted average.
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Inventory is reported at market cost when market is lower than recorded cost, called the lower of cost or market (LCM) inventory. Market is typically measured as replacement cost. Lower of cost or market can be applied separately to each item, to major categories of items, or to the entire inventory.
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Compute the lower of cost or market amount of inventory.
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Periodic inventory systems allocate the cost of goods available for sale between cost of goods sold and ending inventory at the end of a period. Specific identification and FIFO give identical results whether the periodic or perpetual system is used. LIFO assigns costs to cost of goods sold assuming the last units purchased for the period are the first units sold. The weighted average cost per unit is computed by dividing the total cost of beginning inventory and net purchases for the period by the total number of units available. Then, it multiplies cost per unit by the number of units sold to give cost of goods sold.
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Compute inventory in a periodic system using the methods of specific identification, FIFO, LIFO, and weighted average.
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Cost of goods available for sale must be allocated between cost of goods sold and ending inventory. Cost of goods sold plus ending inventory will equal the total goods available for sale.
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What is the relationship between cost of goods sold and ending inventory?
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The retail inventory method involves three steps: (1) goods available at retail minus net sales at retail equals ending inventory at retail, (2) goods available at cost divided by goods available at retail equals the cost-to-retail ratio (3) ending inventory at retail multiplied by the cost-to-retail ratio equals estimated ending inventory at cost.
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Apply the retail inventory to estimate inventory.
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The gross profit method involves two steps: (1) net sales at retail multiplied by 1 minus the gross profit ratio equals estimated cost of goods sold (2) goods available at cost minus estimated cost of goods sold equals estimated ending inventory at cost.
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Apply the gross profit method to estimate inventory.
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June 1 at $10 and June 2 at $15 are both sold. July 4 at $20 remains in ending inventory.
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One identical unit is purchased on each of the following 3 dates and at the respective costs June 1 at $10 June 2 at $15 July 4 at $20 The company sells 2 units during the period. Conclude which inventory items are sold first and which unit remains in ending inventory based on the FIFO cost flow assumption
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purchaser; seller
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If goods are shipped FOB shipping point, then the _____________ is responsible for paying freight charges and the________________ will not include the merchandise in their inventory.
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Specific Identification Weighted Average FIFO LIFO
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Recount the methods used to assign costs to inventory and cost of goods sold under both a perpetual inventory system and a periodic system
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Answer $2700 Ending+Cost of goods sold=Total available for sale
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Given the following information, determine the total goods available for sale during a period Jan 1 Beginning Inventory $580 Jan 31 Ending Inventory $1500 Jan 1-30 Cost of goods sold $1200
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1.List the number of units of each product 2.List the cost of each item 3.List the market price of each item 4.Compute total cost and total market value for each item 5.Compare recorded cost of each inventory item with its replacement cost. List lower of cost or market 6.Adjust inventory downward when market is less than cost
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Review the steps that apply LCM to individual items of inventory. Place them in the correct order of occurrence.
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$204
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Assume that Widgets Inc uses a perpetual specific identification inventory system. During the period, it sold 4 units from beginning inventory, 8 units from the Jan 5 purchase, and 2 units from the Jan 30 purchase. Calculate the dollar value of its cost of goods sold for the period. Jan 1 Beginning Inventory 10 @ $12 Jan 5 Purchase 10 @ $15 Jan 30 Purchase 10 @ $18 Feb 8 Sale 14 units
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$151.80 Add beginning inventory amount the purchase amount and divide by total number of units. 8 x 12=$96 + 12 x $15=$180 = 276/20= $13.80 per unit x number of units sold (11)=$151.80
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ABC co uses a perpetual inventory system and uses the weighted average cost flow assumption. During the month it had 2 sales. Calculate the dollar value of its cost of goods sold for the first sale made on Jan 10. Jan 1 Beginning Inventory 8 @ $12= $96 Jan 5 Purchase 12 @ $15= $180 Jan 10 Sale 11 units x $50 each Jan 25 Purchase 10 @ $18= $180 Jan 30 Sale 3 units x $55 each
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The net income will be to low for the current year and the cost of goods sold will be to high for the current year.
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Q Mart failed to include inventory that was kept in a separate warehouse in its 12/31 end of the period inventory count. Consequently, the ending inventory on 12/31 was understated on the balance sheet. Explain how this error will affect the current years income statement.
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The years total equity will be understated The years total assets will be understated
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Q Mart failed to include inventory that was kept at a separate warehouse in its end of the period inventory count. Explain how this error will affect this year's balance sheet.
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This years net income will be too high This years cost of goods sold will be too low
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Sparky's incorrectly included inventory that was on consignment in its ending inventory count. The ending inventory balance was then overstated on the balance sheet. Explain how this error will affect this year's income statement.
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HIGHER; LOWER
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Many companies choose the LIFO inventory costing during periods of rising purchase cost because reported cost of goods sold will be__________________. This means that income taxes paid will be____________________ than if the company used FIFO or weighted average inventory costing.
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cost of goods sold
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beginning inventory + net purchases - ending inventory =
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Accounts receivable DEBITED for $560 Sales CREDITED for $560 Cost of goods sold DEBITED for $198 Merchandise Inventory CREDITED for $198
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Assume that Pickles R Us uses a perpetual LIFO inventory system. During the period, it sold 14 units on credit to 1 customer.Demonstrate the journal entry required to record the sale and the cost of the sale. Jan 1 Beginning Inventory 10 @ $12 May 5 Purchase 10 @ $15 Aug 8 Sale 14 x $40
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TRUE
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Computers and technology have made the perpetual inventory costing system affordable and timely
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Beginning inventory will be UNDERSTATED and cost of goods sold will also be UNDERSTATED
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In year 1 shell company UNDERSTATED their ending inventory what is the effect of this error on year 2?
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Cost of goods sold will be OVERSTATED and the net income will be UNDERSTATED
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If ending inventory at the end of the year in understated, what is the effect on cost of goods sold and net income
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included
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Consigned goods should be in___________________ the consignor's inventory
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XYZ Inc is more efficiently using its assets XYZ Inc turned over its inventory 16.1 times in 2010 XYZ Inc inventory may be so popular with its customers that the company may be having trouble keeping high enough inventory levels XYZ Inc inventory is turning over more frequently than competitors in its industry
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Analyze the info below and select the correct statements regarding XYZ inc inventory turnover XYZ Inc Inventory 2010 Ratio 16.1 times 10.3 times 2011 Ratio 19.2 times 11.2 times
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$500+$560+$90+$450=$1600
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Information for Q mart appears in the following table. Calculate the reported cost of inventory when LCM is applied to individual items of inventory Item Units Cost/Unit Market/Unit Tot Cost Tot Market Bikes: A 10 $50 $52 $500 $520 B 20 $30 $28 $600 $560 Scooters A 10 $10 $9 $100 $90 B 25 $20 $18 $500 $450 Totals $1700 $1620
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Companies never want to report inventory on a balance sheet that is higher than replacement cost. Accounting principles require conservatism when reporting financial information. LCM allows companies to recognize a loss in value of an asset in the period the loss occurs. Assets are not shown at an inflated value on the balance sheet, but rather at lower of cost or replacement cost.
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Why is LCM used
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Companies using FIFO will pay higher taxes than companies using LIFO, assuming that everything else is equal Weighted average cost of goods sold will be between LIFO and FIFO cost of goods sold Companies using FIFO will report the highest gross profit and net income Companies using FIFO will report the smallest cost of goods sold.
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Assuming Purchase costs are rising, determine which of the statements below are correct regarding the cost of goods sold under FIFO, LIFO, and weighted average cost flow methods
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Management can be notified more quickly of inventory shortages Gross profit per sale can be determined Inventory information is more timely Inventory levels can be reduced which reduces cost
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What are the advantages of using a perpetual inventory system
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FIFO:assigns an amount to inventory on the balance sheet that approximates its current cost and it mimics the actual flow of goods for most businesses LIFO:assigns an amount to cost of goods sold on the INCOME STATEMENT that approximates its current costs and it better matches current costs with revenues in computing gross profit Weighted average smooths out erratic changes in costs Specific identification exactly matches the costs of items with the revenues that they generate.
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What are the advantages of each cost method
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debit to cost of goods sold.
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When adjusting the merchandise inventory account the transaction is recorded as a ____________________________________
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That the notes to the financial statements describe the change, its justification, and its effect on income.
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What does the full disclosure principle prescribe if a company changes from one acceptable accounting method to another?
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The ratio estimates how many days it will take to convert inventory into accts receivable or cash The ratio is useful in evaluating liquidity of inventory The ratio measures the adequacy of inventory to meet sales demand The ratio reveals how much inventory is available in terms of the number of days sales The ratio is often viewed as a measure of the buffer against out of stock inventory
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What are some correct statements r/g the day's sale in inventory ratio?
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A company should use the same accounting methods period after period, so that financial statements are comparable.
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The statement that best describes the consistency concept as it applies to inventory costing is:
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Used to determine if there has been any theft, loss, damage, or errors in inventory Used to adjust the inventory account balance to the actual inventory available
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What is the purpose of taking a physical inventory count?
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Principle that prescribes the less optimistic estimate when two estimates are about equally likely.
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Conservatism constraint
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Receiver of goods owned by another who holds them for purposes of selling them for the owner.
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Consignee
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Owner of goods who ships them to another party who will sell them for the owner.
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Consignor
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Principle that prescribes use of the same accounting method(s) over time so that financial statements are comparable across periods
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Consistency concept
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Estimate of number of days needed to convert inventory into receivables or cash; equals ending inventory divided by cost of goods sold and then multiplied by 365; also called stock on hand.
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Days sales in inventory
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Number of times a company's average inventory is sold during a period; computed by dividing cost of goods sold by average inventory; also called merchandise turnover. It assess how quickly that a company is selling its merchandise.
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Inventory Turnover
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Procedure to estimate inventory by using the past gross profit rate to estimate cost of goods sold, which is then subtracted from the cost of goods available for sale.
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Gross profit method
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Method to assign cost to inventory that assumes items are sold in the order acquired; earliest items purchased are the first sold.
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First-in, first-out (FIFO)
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Method for assigning cost to inventory that assumes costs for the most recent items purchased are sold first and charged to cost of goods sold.
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Last-in, first-out (LIFO)
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Method for assigning cost to inventory when the purchase cost of each item in inventory is identified and used to compute cost of inventory.
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Specific identification
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Method for estimating ending inventory based on the ratio of the amount of goods for sale at cost to the amount of goods for sale at retail.
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Retail inventory method
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Expected selling price (value) of an item minus the cost of making the sale.
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Net realizable value
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Required method to report inventory at market replacement cost when that market cost is lower than recorded cost.
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Lower of cost or market (LCM)
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Method of assigning inventory cost to sales; the cost of available-for-sale units is divided by the number of units available to determine per unit cost prior to each sale that is then multiplied by the units sold to yield the cost of that sale.
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Weighted Average
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financial statements prepared for periods of less than one year
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Interim Statements
