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What are the 6 primary inventory cost flow methods?
- Specific Identification
- First In First Out (FIFO)
- Last In First Out (LIFO)
- Moving Average
- Weighted Average
- Dollar Value LIFO
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What are the 4 types of inventory that are tracked?
- If Retail
- Retain Inventory
- If Manufacturing
- Raw Materials
- Work in Process
- Finished Goods
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Why would an entity choose to use LIFO vs FIFO in an era of rising costs?
- LIFO lowers the profits made (the most expensive items are put into COGS) thus lowering the tax bill
- FIFO lowers the COGS (the least expense items are put into COGS) thus increasing profits and looking good for investors
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What is the concept behind how IFRS requires an entity to account for inventory? As such, which of the inventory cost flow methods allowed by GAAP is not allowed by IFRS?
IFRS expects the accounting of inventory to follow the order in which products are sold. Specific Identification is preferred b/c it tracks inventory one-to-one. LIFO is not allowed because it violates this concept.
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What is the specific identification inventory cost flow method?
A unique or rather expensive item (car, yacht, diamond ring) is tracked for exact costs to create and then the sales price when sold.
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When calculating ending inventory and COGS, using the FIFO method, do the balances differ when using the perpetual vs periodic inventory system?
Costs and Inventory balances are the same using either system.
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For LIFO and FIFO, which balance approximates replacement cost (1) COGS, or (2) ending inventory?
- LIFO: COGS
- FIFO: ending inventory
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When would an entity choose to use the weighted average method? How are the ending inventory and COGS balances calculated?
- This is best used with homogeneous products using the period inventory system. Inventory is thus determined at the end of the period.
- Total costs incurred to obtain inventory / (total number of units in inventory + purchased or made) = avg cost per unit.
- Inventory ending balance: avg cost per unit x number of units remaining in inventory
- COGS balance: avg cost per unit x number of units sold
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When would an entity choose to use the moving average method? How are the ending inventory and COGS balances calculated?
- This can only be used with the perpetual inventory system.
- After each purchase that adds to inventory
- The total costs incurred to obtain inventory / (total number of units in inventory + purchased or made) = avg cost per unit.
- Use this avg cost to determine COGS and inventory after each sale.
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Why would an entity choose to use the LIFO method? How are the ending inventory and COGS balances calculated?
- When the entity wants to minimize net income to reduce the tax burden.
- Whatever price was paid for the last items purchased for inventory becomes the price for the first items sold until that purchase batch is used up and then the price used on the next most recent batch of inventory purchased is used.
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When calculating ending inventory and COGS, using the LIFO method, do the balances differ when using the perpetual vs periodic inventory system?
Yes
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When calculating ending inventory and COGS, using the weighted average method, do the balances differ when using the perpetual vs periodic inventory system.
Yes
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When calculating ending inventory and COGS, using the moving average method, do the balances differ when using the perpetual vs periodic inventory system?
Yes
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In a period of rising prices, which inventory system results in the highest Inventory balance, vs the highest COGS
- FIFO = highest inventory balance
- LIFO = highest COGS
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When would an entity choose to use the FIFO method? How are the ending inventory and COGS balances calculated?
- When the entity wants to maximize the profit.
- Whatever price was paid for the first items purchased for inventory becomes the price for the first items sold until that purchase batch is used up and then the price used on the next oldest batch of inventory purchased is used.
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What is the purpose of using Dollar Value LIFO? When is a layer created?
- Instead of tracking inventory by particular item, and by each purchase batch, all items of inventory purchased during the year are placed into the same cost pool. That year's cost pool is then adjusted for the effects of inflation.
- The total adjusted dollar amount = inventory balance at end of year.
- Layers are created year-by-year (instead of batch by batch purchase). A layer is only created if the value of the inventory at the end of the year is larger than the value at the beginning of the year. If no layer is created, then the index of the previous year is used.
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How is the price index for the dollar-value LIFO calculated? How is the yearly layer calculated?
- Price Index = ending inventory at current year cost / ending inventory at base year cost
- Layer’s adjusted value = base year cost x price index
- Each layer’s adjusted value is added to the previous year’s layer to calculate the total balance (value) of the final inventory
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Your company enters into a futures contract to purchase 100 gal of vegetable oil for $1.00/gal. Unfortunately the price of veg. oil is dropping and you expect the market rate at the time the contract must be executed will be $0.50/gal. How is this accounted?
The expected loss (contract cost - expected market price) is entered to the Income Statement at the time of the decline. A disclosure in the notes is required.
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If the company carries 50% as safety stock, what does this mean when using FIFO, and how does this affect COGS for an error correction?
- Of the inventory purchased, only 50% is sold in the year of purchase, the remaining 50% carries to the next year and is then sold first.
- COGS (and Inventory) are adjusted based on these carryovers. For an error correction, start with year 1, take the COGS x50%, carry the remainder to the next year and as reduction, subtract another 50% of that year's purchases, etc.
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Inventory Impairment or Write-Down is captured in which section of the Income Statement?
Other Gains/Losses (not operating expense)
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When a loss is expected on inventory (such as loss on sale of Christmas ornaments that don't sell by CMas time). How is this inventory accounted?
Determine the lower of cost or net realizable value, which is market price expected to be received after the holiday, minus shipping or disposal costs.
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