ACCT Ch 8.txt

  1. What items include inventory?
    Inventory refers to the assets a company (1) intends to sell in the normal course of business, and (2) has in production for future sale (work in process), or (3) uses currently in the production of goods to be sold (raw materials).
  2. How do the perpetual and period inventory systems differ?
    The perpetual inventory system continuously tracks and records both changes in inventory quantity and inventory cost. the periodic inventory system adjusts inventory and records cost of goods sold only at the end of each period
  3. For merchandise shipped f.o.b. destination, when are the goods included in the purchaser's inventory
    Merchandise shipped f.o.b destination (seller is responsible for the shipping costs) is included in the purchaser's inventory only after it reaches the purchaser's location
  4. How is the weighted-average unit cost determined in a periodic system?
    in a periodic system, the weighted-average unit cost is determined by dividing the cost of goods available for sale by the quantity available for sale.
  5. What cost flow assumption is made when employing the first in, first out (FIFO) inventory method?
    The first-in, first-out (FIFO) method assumes that items sold are those that were acquired first. Therefore, ending inventory applying FIFO consists of the most recently acquired items.
  6. What cost flow assumption is made when employing the last-in, first-out (LIFO) inventory method?
    The last-in, first-out (LIFO) method assumes that items sold are those that were most recently acquired. Therefore, ending inventory applying LIFO consists of the items acquired first.
  7. If inventory quantity is stable and the unit costs paid for inventory are rising, which method, FIFO or LIFO, will result in a lower ending inventory balance.
  8. How is the gross profit ratio computed?
    The gross profit ratio is computed by dividing gross profit (sales - cost of goods sold) by net sales.
  9. How is the inventory turnover ratio computed?
    The inventory turnover ratio is computed by dividing costs of goods sold by average inventory
  10. what are the three steps used to determine ending inventory and cost of goods sold using the dollar-value LIFO approach?
    • The three step process used to determine ending inventory and costs of goods sold using the dollar-value approach are:
    • Step 1. Convert ending inventory valued at year-end cost to base year cost. this is accomplished by dividing the ending inventory at year-end cost by the current year's cost index.
    • Step 2. Identify the layers of ending inventory and the years they were created.
    • Step 3. Convert each layer's base year cost to layer year cost using the cost index for the year it was acquired
  11. Inventory
    inventory represents the quantities of goods acquired, manufactured, or in the process of being manufactured

    freight charges on incoming goods borne by the buyer

    insurance costs incurred by the buyer while goods are in transit (if f.o.b shipping point)

    costs of unloading, unpacking and preparing merchandise inventory for sale or raw materials for used

    • Called Product Costs
    • - expensed as costs of goods sold only when the related products are sold.
  12. Merchandise inventory
    The cost of merchandise inventory includes the purchase price plus any other costs necessary to get the goods in condition and location for sale.
  13. Raw Materials, Direct labor and Manufacturing overhead
    • debit raw materials purchases, credit raw materials used
    • debit direct labor incurred, credit direct labor applied
    • debit manufacturing overhead incurred, credit manufacturing overhead applied

    • Work in process:
    • Debit work in process(raw mats, direct labor, overhead), credit work in process transferred to finished goods

    • Finished goods:
    • debit work in process, credit finished goods sold

    • Cost of goods sold:
    • debit finished goods sold
  14. Perpetual Inventory System
    cost of goods sole account, along with the inventory account, is adjusted each time goods are sold or are returned by a customer

    Purchase return - for buyer

    sales return - for the seller

    track inventory quantity from acquisition to sale
  15. Periodic inventory system
    merchandise purchases, purchase returns, purchase discounts, and freight-in (purchase plus freight-in less returns and discounts equals net purchases) are recorded in temporary accounts and the period's cost of goods sold is determined at the end of the period by combining the temporary accounts with the inventory account

    Beginning inventory + net purchases - ending inventory = cost of goods sold
  16. Periodic inventory to determine cost of goods sold
    • Beginning inventory
    • add: Purchases
    • =
    • Cost of goods available for sale
    • less: ending inventory (per physical count)
    • =Cost of goods sold
  17. Periodic inventory Journal entry
    • Debit cost of goods sold
    • debt inventory (ending)

    • Credit Inventory (beginning)
    • Credit purchases

    to adjust inventory, close the purchases acount, and record cost of goods sold.
  18. Perpetual Inventory System
    • more accurate during the year.
    • facilitate accurate information without the necessity of a physical count of inventory

    more expensive

    better with high cost items
  19. Periodic inventory system
    makes preparation of interim financial statements more costly unless an inventory estimation technique is used.
  20. Goods on consignment
    because risk is retained by the consignor, the sale is not complete (revenue is not recognized) until an eventual sale to a third party occurs
  21. Sales returns journal entry
    An adjusting entry for estimated sales returns reduces sales revenue and accounts receivable.

    cost of goods sold is reduced and inventory is increased.
  22. Freight-in on purchases under Periodic and Perpetual systems
    Perpetual - costs are added to the inventory account

    periodic - generally added to temporary account - Freight in or transportation in (added to purchases in determining net purchases

    account is closed to cost of goods sold along with purchases and other components of cost of goods sold at the end of the reporting period
  23. Purchase returns - from buyers point of view
    buyer views return as reduction to net purchases

    Perpetual - reduction in both inventory and accounts payable

    Periodic - account called purchase returns temporarily accumulates these amounts. Purchase returns are subtracted from purchases when determining net purchases. account is closed to cost of goods sold at end of period
  24. Purchase discounts - buyers point of view
    represent reductions in amount to be paid by the buyer in the event payment is made within a specified period of time.
  25. Purchase discounts - gross method and net method
    Gross method: views discount not taken as part of the cost of inventory. subtracted from purchases when determining net purchases. it is a temporary account that is closed to cost of goods sold at end of period

    Net method - considers cost of inventory to include the net, after-discount amount, and any discounts not taken as reported as interest expense

    under perpetual inventory system - purchase discounts are treated as a reduction in the inventory account
  26. Perpetual system journal entries
    • Debit Inventory (purchases x (100%-discount %))
    • Credit accounts payable

    • debit inventory (freight charges)
    • credit cash

    • debit accounts payable (merch. returned net of discount)
    • credit inventory

    • debit accounts receivable
    • credit sales revenue
    • debit cost of goods sold
    • credit inventory
  27. Periodic system journal entries
    • Purchases:
    • debit purchases (merch. cost x (100%-discount%))
    • credit accounts payable

    • Freight:
    • Debit freight in
    • credit cash

    • Returns:
    • Debit accounts payable
    • credit purchase returns

    • Sales:
    • Debit account receivable
    • credit sales revenue
  28. Periodic system to determine cost of goods sold
    • Cost of Goods Sold:
    • Beginning Inventory
    • add Purchases
    • less returns
    • add freight in
    • =net purchases (add to beginning inventory)
    • = cost of good available for sale
    • less ending inventory
    • = cost of goods sold
  29. End of period cost of goods sold journal entries under periodic system
    • debit costs of goods sold
    • debit inventory (ending)
    • debit purchase returns

    • credit inventory (beginning)
    • credit purchases
    • credit freight-in
  30. Specific Identification
    matching each unit sold during period or each unit on hand at the end of the period to be matched with its actual cost.

    usually for unique, expensive products with low sales volume

    not feasible for many types of productes because items are not uniquely identifiable or because it is too costly to match a specific purchase price with each item sold or each item remaining in ending inventory
  31. Periodic average cost
    weighted average unit cost = cost of goods available for sale / quantity available for sale
  32. Perpetual average costs
    a new weighted average unit cost is calculated each time additional units are purchased

    new average determined by 1) summing the cost of the period inventory balance and the cost of the new purchase 2) dividing this new total cost (cost of goods available for sale) by the number of units on hand (the inventory units that are available for sale.

    this average is then used to cost any units sold before the next purchase is made
  33. paper profits (losses) from LIFO
    the paper profit (losses) caused by including out of date, low (high) costs in cost of goods sold is referred to as the effect on income of liquidations of LIFO inventory

    must disclose any material effect of LIFO liquidation on net income
  34. What influences inventory flow method?
    • 1)actual physical flow of inventory
    • 2) effect of inventory method on reported net income and the amount of income taxes payable currently
    • 3) desire to provide a better match of expenses with revenues
  35. LIFO Reserves:
    Companies use LIFO for external reporting and income tax purposes, but maintain internal records using FIFO or average cost
    Companies use LIFO for external reporting and income tax purposes, but maintain internal records using FIFO or average cost

    • 1) bc high recordkeeping costs of the LIFO method
    • 2) the existence of contractual agreements such as bonus or profit sharing plans that prohibit use of LIFO in the calculation of net income
    • 3) the need for FIFO or average cost information for pricing decisions
  36. Why may management closely monitor inventory levels?
    management may closely monitor inventory levels to

    • 1) ensure that the inventories needed to sustain operations are available
    • 2) hold the cost of ordering and carrying inventories to the lowest possible layer
  37. What is the Just in time system
    JIT is a system used by a manufacturer to coordinate production with suppliers so that raw materials or components arrive just as they are needed in the production process

    allows company to maintain relatively low inventory balances

    with efficient production techniques, excellent relationship with suppliers - can meet customer demands
  38. Gross profit ratio
    Gross profit ration = gross profit (cost - sales price) / net sales

    the higher the ration, the higher is the markup a company is able to achieve on its products- then more dollars are available to cover expenses other than cost of goods sold

    declining ratio can indicate 1) company is unable to offset rising costs with corresponding increases in sale price 2) sales prices are declining without a commensurate reduction in costs

  39. Inventory turnover ratio
    Inventory turnover ratio = cost of good sold / average inventory

    usually, highter the ratio the more profitable a company will be

    declining ratio is generally unfavorable and could be caused by the presence of obsolete or slow-moving products, or poor marketing and sales efforts.
  40. Inventory issues
    inventory increases that outrun increases in cost of goods sold might indicate difficulties in generating sales.

    may indicate that a company has obsolete or slow moving inventory
  41. Earnings quality issues
    slowing turnover ratio combined with higher than normal inventory levels may indicate the potential for decreased production, obsolete inventory, or need to decrease prices to sell inventory (which will then decrease gross profit ratios and net income
  42. What inventory methods does Ford use to value its inventories? is this permissible according to GAAP?
    Ford uses the LIFO inventory method to value about one-fourth of its inventories. the cost of the remaining inventories is determined primarily by the FIFO method. Yes, both of these methods are permissible according to GAAP
  43. What is the purpose of reporting the entire inventory as if valued on a FIFO basis and then adjusting this amount to reflect the use of LIFO for a portion of the inventory?
    The LIFO conformity rule requires that if a company uses LIFO to measure taxable income, it also must use LIFO for external reporting. Ford does this. However, in 1981, the LIFO conformity rule was liberalized to allow LIFO users to provide supplement disclosure of the effect on inventories of using another method on inventory valuation rather than LIFO. Fords disclosure note offers this additional information.
  44. Why would a reduction of LIFO inventory quantities cause a $12 million decrease in 2005 cost of sales?
    Inventory costs in the balance sheet using LIFO generally are out of date because they reflect old purchase transactions. When inventory quantities decline during a period, these out of date inventory layers are then liquidated, and cost of goods sold will partially match noncurrent costs with current selling prices. IF costs have been rising, LIFO liquidations produce lower cost of goods sold and higher net income than would have resulted if the liquidated inventory were included in cost of goods sold at current costs.
  45. Is your friend correct in his assertion that by using LIFO, ford was able to report lower profits in 2006?
    Yes. If ford had used FIFO instead of LIFO for its LIFO inventories, income before taxes in all prior years, including 2006, would have been higher by $1,015 million (the increase in 2006 ending inventory). In 2006, alone, income before taxes would have been higher by $6 million. Here's why. The increase in ending inventory of $1,015 million decreases cost of goods sold, but the increase in beginning inventory of $1,009 million increases cost of goods sold, resulting in a net decrease in cost of goods sold of $6 million
Card Set
ACCT Ch 8.txt
accounting fifth edition spiceland ch 8