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accounting chap 5
accounting for inventories
| Question | Answer |
|---|---|
| Merchandise inventory inclues | all goods that a company owns and holds for sale |
| Does a purchaser's inventory include goods in transit from a supplier? | Only if ownership has passed to the purchaser |
| FOB shipping point | purchaser is responsible for paying freight, ownership passes when goods are loaded on transport vehicle |
| FOB destination | ownership passes when goods arrive at their destination |
| Goods on consignment | goods shipped by the owner (consignor) to another party (consignee) |
| What does a consignee do? | Sell goods for the owner |
| How does a consignor report inventory? | they continue to own the consigned goods until they are sold so they must continue to report these items in inventory until they are sold |
| Goods damaged or obsolete | not counted in inventory if they cannot be sold. If they can be sold at reduced price, they are included in inventory at their net realizable value |
| Net realizable value | sales price minus the cost of making the sale |
| When are damaged or obsolete goods reported? | The period when damage or obsolescence occurs is the period when the loss in value is reported |
| merchandise inventory includes | invoice cost minus any discount, plus any incidental cost necessary to put it in a place and condition for sale |
| What are incidental costs? | Freight, import duties, storage, insurance and costs incurred in aging process |
| Accounting principles | prescribe that incidental costs be added to inventory |
| Matching (expense recognition) principle | states that inventory costs should be recorded against revenue in the period when inventory is sold |
| major goal in accounting for inventory | to properly match costs with sales |
| Management decisions in accounting for inventory involve... | a. items included in inventory and their costs b. costing method(specific identification, FIFO, LIFO, weighted average c. inventory system (perpetual or periodic) d. use of market values or other estimates |
| One of the most important issues in accounting for inventory is | determining the per unit cost assigned to inventory items |
| First in, first out | assumes cost flow in the order incurred |
| last in, first out | assumes costs flow in the reverse order incurred |
| Weighted average | assumes costs flow at an average of the costs available |
| specific identification | each item in inventory can be identified with a specific purchase and invoice |
| Merchandise available for sale | beginning inventory + net purchases = merchandise available for sale ending inventory + cost of goods sold = merchandise available for sale |
| FIFO assigns lowest amount to cost of goods sold-yielding highest gross profit and net income | when purchase costs regularly rise |
| LIFO assigns highest amount to cost of goods sold-yielding lowest gross profit and net income, which also yields a temp tax advantage by postponing payments of some income tax | when purchase costs regularly rise |
| weighted average yields results between FIFO and LIFO | when purchase costs regularly rise |
| Specific identification always yields results that depend on which units are sold | when purchase costs regularly rise |
| FIFO gives the highest cost of goods sold-yielding lowest gross profit and net income | when costs regularly decline |
| LIFO gives lowest cost of goods sold-yielding the highest gross profit and income | when costs regularly decline |
| Advantages of FIFO | assigns an amount to inventory on the balance sheet that approximates its current cost; also mimics the actual flow of goods for most businesses |
| Advantages of LIFO | assigns an amount to cost of goods sold on the income statement that approximates its current cost; it also better matches current costs with revenues in computing gross profit |
| Advantages of weighted average | tends to smooth out erratic changes in costs |
| specific identification | exactly matches the costs of items with the revenues they generate |
| Companies can and often do use... | different costing methods for financial reporting and tax reporting. |
| Only exception for using different costing methods for financial reporting and tax reporting | When LIFO is used for tax reporting; in this case, the IRS requires that is also be used in financial statements called LIFO conformity rule |
| Consistency concept | prescribes a company use the same accounting methods period after period so that financial statements are comparable across periods-only exception is when a change from one method to another will improve financial reporting |
| consistency concept does not require | a company to use one method exclusively |
| Lower of cost or market (LCM) | accounting principles require that inventory be reported at the market value (cost) of replacing inventory when market value is lower than cost |
| Market of LCM | defined as current replacement cost of purchasing the same inventory items in the usual manner |
| How is LCM applied? | To each individual item separately, to major categories of items or to the whole of inventory |
| accounting rules require that inventory be adjusted to market when market is | less than cost, but inventory normally cannot be written up to market when market exceeds cost |
| Conservatism constraint | prescribes the use of less optimistic amounts when more than one estimate of the amount to be received or paid exists and these estimates are equally likely |
| Beginning inventory + net purchases - ending inventory = | cost of goods sold |
| A lower cost of goods sold | yields a higher income |
| A higher cost of goods sold | yields a lower income |
| understating equity inventory understates | both current and total assets |
| understating ending inventory | understates equity because of the understatement in net income |
| errors in beginning inventory | do not yield misstatements in the end of period balance sheet, but they do affect the current period's income statement |
| inventory turnover = | cost of goods sold/average inventory |
| days' sales in inventory = | ending inventory/cost of goods sold * 365 |
| Steps of retail inventory method | 1.goods avail for sale at retail-net sales at retail=ending inventory at retail 2.goods avail for sale at cost/goods avail for sale at retail=cost to retail ratio 3.ending inventory at retail*cost to retail ratio=estimated ending inventory at cost |
| steps of gross profit method | 1.net sales at retail*1.0-gross profit ratio = estimated cost of goods sold 2. goods available for sale at cost- estimated cost of goods sold = estimated ending inventory at cost |
Created by:
sjnelson86
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