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44 Cards in this Set
- Front
- Back
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Identify Major classifications of inventory
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Only one inventory account, merchandise inventory, appears in the financial statements of a merchandising concern. A manufacturer normally has three inventory accounts: Raw materials, Work in Progress, and finished goods. Companies report the cost assigned to goods and materials on hand but not yet placed into production as raw materials inventory. They report the cost of raw materials on which production has been started but not completed, plus the direct labor cost applied specifically to this material and a ratable share of manufacturing overhead costs, as work in progress. Finally, they report the costs identified with the completed but unsold units on hand at the end of the fiscal period as finished goods inventory.
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Distinguish between perpetual and period inventory systems.
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A perpetual inventory system maintains a continuous record of inventory changes in the Inventory account. That is, a company records all purchases and sales (issues) of goods directly in the Inventory account as they occur. Under a periodic inventory system, companies determine the quantity of inventory on hand only periodically. A company debits a Purchases account, but the inventory account remains the same. It determines the cost of goods sold at the end of the period by subtracting ending inventory from the cost of goods available for sale. A company ascertains ending inventory by a physical count.
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Identify the effects of inventory errors on the financial statements.
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If the company misstates ending inventory: 1. In the balance sheet, the inventory and retained earnings will be misstated, which will lead to miscalculation of the working capital and current ratio, and 2. in the income statement the cost of goods sold and net income will be misstated. If the company misstates purchases (and related accounts payable) and inventry 1., The balance sheet the inventory and accounts payable will be misstated, which will lead to miscalculation of the current ratio and 2. in the income statement, purchases and ending inventory will be misstated.
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Understand the items to include as inventory cost.
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Product costs are those costs that attach to the inventory and are recorded in the inventory account. Such charges include freight charges on goods purchased, other direct costs of acquisition, and labor and other production costs incurred in processing the goods up to the time of sale. Period costs are those costs that are indirectly related to the acquisition or production of the goods. These changes, cush as selling expense and general and admin expenses are therefore not included as part of inventory cost.
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Describe and compare the cost flow assumptions used to account for inventories.
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1. Average cost: Prices items in the inventory on the basis of the average cost of all similar goods available in the period. 2. First in first out (FIFO) assumes that a company uses goods in the order in which it purchases them. The inventory remaining must therefore represent the most recent purchases. 3. Last in First out (LIFO):matching the cost of the last goods purchased against revenue.
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Explain the significance and use of a LIFO reserve
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The difference between the inventory method used for internal reporting purposes and LIFO is referred to as the Allowance to Reduce Inventory to LIFO, or the LIFO reserve. The change in LIFO reserve is referred to as the LIFO effect. Companies should disclose either the LIFO reserve or the replacement cost of the inventory in the financial statements.
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Understand the effect of LIFO liquidations.
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LIFO liquidations match costs from preceding periods against sales revenues reported in current dollars. This distorts net income and results in increased taxable income in the current period. LIFO liquidations can occur frequently when using a specific goods LIFO approach.
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Explain the Dollar value LIFO method.
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For the dollar value LIFO method companies determine and measure increases and decreases in a pool in terms of total dollar value, not the physical quantity of the goods in the inventory pool.
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Identify the major advantages and disadvantages of LIFO
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The major advantages of LIFO are the following 1. It matches recent costs against current revenues to provide a better measure of current earnings. 2. As long as the price level increases and inventory quantities do not decrease,m a deferral of income tax occurs in LIFO. 3. Because the deferral of income tax, cash flow improves. Major disadvantages: 1. Reduced earnings. 2. Understated inventory. 3. Does not approximate physical flow of the items except in peculiar situations, and 4. Involuntary liquidation.
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Understand why companies select given inventory methiods.
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Companies ordinarily prefer LIFO in the following circumstances: 1. If selling prices and revenues have been increasing faster than costs and 2. If a company has a fairly consistant "base stock". Conversely, LIFO would not be appropriate 1. If sale prices tend to lag behind costs. If specific identification is traditional and 3. When unit costs tend to decrease as production increases, thereby nullifying the tax benefit LIFO might provide.
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Average cost Method
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prices items in inventory on the basis of the average cost of all similar goods available during the period. In the periodic method *the amount of inventory is computed at the end of the period.) Take the total amount of money spent on purchases divided by the total number of units to figure the avg. price.
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Consigned goods
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Goods that are shipped to someone who does not get title of it. They just sell it for other people. Williams ships art to Sotheby who acts as William's agent in selling the consigned goods. When Sotheby sells the goods it remits the revenue less a selling commission and expenses incurred to complete the sale to Williams. Williams remains the owner. So they include it in their inventory account at purchase price or production cost.The cosignee shouldn't include them in inventory.
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Cost Flow Assumptions
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Specific Identification, Average cost, FIFO, and LIFO.
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Dollar Value LIFO
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The Dollar value LIFO method overcomes the problems of redefining pools and eroding layers. The dollar value LIFO method determines and measures any increases and decreases in a pool in terms of total dollar value, not the physical quantity of the goods in the inventory pool. Advantage is that you can include a broader range of goods and it permits replacement with similar items that are interchangeable.
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Double Extension method
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When a company has to determine its price index the value of units in inventory is extended at both base year prices and current year prices. Formula: ending inventory for period at current cost divided by ending inv. at base year cost=price index for the current year.
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Finished goods inventory
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Companies report costs identified with the completed but unsold units on hand at the end of the fiscal period.
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FIFO
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Assumes that a company uses goods in the order in which it purchases them. It assumes that the first goods purchased are the first uesd or first sold. The inventory remaining must represent the most recent purchases. If it uses the periodic system it determines the cost of the ending inventory by taking the cost of the most recent purchase and working back until it accounts for all units in the inventory. In all cases where FIFO is used, the inventory and COGS would be the same at the end of ht month whether a perpetual or periodic system is used.
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FOB Destination
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If the supplier ships the goods FOB destination the title passes to the receiver only when it receives the goods from the common carrier.
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FOB Shipping Point
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If the shipper ships the goods FOB shipping point title passes when the supplier delivers the goods to the common carrier. That is as soon as the goods are on the truck and while they are in transit they belong to the receiving company.
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Gross method
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IF a company uses the gross method it reports purchase discounts as a deduction from purchases on the income statement.
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Inventories
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Asset items that a company holds for sale in the ordinary course of business or goods that it will use or consume in the production of goods to be sold.
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LIFO
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Matches cost of the last goods purchased against revenue. If using a periodic system, the cost of the total quantity sold or issued during the month comes from the most recent purchases. Prices the ending inventory by using the total units as a basis of computation and disregards the exact dates for sales or issuances. For example it would assume that the cost of 4000 units withdrawn absorbed the 2000 purchased on March 30 and 2000 of the 6000 purchased on March 15. Different ending inventory based on whether using FIFO or LIFO.
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LIFO effect
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The change in the allowance balanec from one period to the next is tha LIFO effect. entry to recognize difference between inventory and LIFO debit COGS credit Allowance to reduce inventory to LIFO
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LIFO liquidation
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Erosion of the LIFO inventory can easily occur. Referred to as LIFO liquidation, tihs often distorts net income and leads to substantial tax payments.
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LIFO reserve
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Sometimes companies use LIFO for tax purposes but they maintain FIFO or Avg. cost methods for internal reporting purposes. The difference between the inventory method used for internal reporting and external reporting is the Allowance to Reduce Inventory to LIFO or the LIFO reserve.
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Inventories
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Asset items that a company holds for sale in the ordinary course of business or goods that it will use or consume in the production of goods to be sold.
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LIFO
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Matches cost of the last goods purchased against revenue. If using a periodic system, the cost of the total quantity sold or issued during the month comes from the most recent purchases. Prices the ending inventory by using the total units as a basis of computation and disregards the exact dates for sales or issuances. For example it would assume that the cost of 4000 units withdrawn absorbed the 2000 purchased on March 30 and 2000 of the 6000 purchased on March 15. Different ending inventory based on whether using FIFO or LIFO.
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LIFO effect
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The change in the allowance balanec from one period to the next is tha LIFO effect. entry to recognize difference between inventory and LIFO debit COGS credit Allowance to reduce inventory to LIFO
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LIFO liquidation
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Erosion of the LIFO inventory can easily occur. Referred to as LIFO liquidation, tihs often distorts net income and leads to substantial tax payments.
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LIFO reserve
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Sometimes companies use LIFO for tax purposes but they maintain FIFO or Avg. cost methods for internal reporting purposes. The difference between the inventory method used for internal reporting and external reporting is the Allowance to Reduce Inventory to LIFO or the LIFO reserve.
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Merchandise Inventory
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Cost assigned to unsold units left on hand is reported here.
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MOdified perpetual inventory system
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System provides detailed inventory records of increases and decreases in quantities only. Not dollar amounts. It is merely a memorandum device outside the double entry system which helps in determining the level of inventory at any point and time.
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Moving Average method
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used with perpetual inventory systems under Average cost. In this method they compute a new average unit cost each time it makes a purchase. Also have to refigure after making a sale.
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Net Method
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Treatement of purchase discountsapproach to record purchases and accounts payable at an amount net of the cash discounts. The company records a failure to take a purchase discount in the discount period in a Purchase Discounts Lost account. If it uses this net method it consideres discounts lost as a financial expense and reports it in Other expenses nad losses. This method is better.
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Period costs
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Costs that are indirectly related to the acquisition or production of goods. These are like selling and admin costs. Not included as part of inventory cost.
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Periodic inventory system
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A company determines the quantity of inventory on hand only periodically. It records all acquisitions of inventory in a purchases account. Then add total purchases to the cost of inventory on hand at the beginning. This determines Cost of Goods Available for Sale. To compute COGS the company thne subtracts the endinv inventory from the cost of goods available.
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Perpetual Inventory System
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Continuously tracks changes in Inventory account. Records al purchases and sales of goods directly in the inventory account as they occur. Provides a continuous record of the balances in both the inventory accnoutna and cost of goods sold account.
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Product Costs
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thos costs that "attach" to the inventory. These costs are directly connected with bringing the goods to the buyer's place of business. Such charges include freight charges on goods purchased, other direct costs of acquisition, and labor and other production costs incurred in processing the goods up to the time of sale. These costs are included in inventory.
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Purchase Discounts
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The use of a purchase discounts account in a periodic inventory system indicates that the company is reporting its purchases and accounts payale at the gorss amount.
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Raw Materials Inventory
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Costs assigned to goods and materials on hand but not yet placed into production.
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Specific Goods Pooled LIFO approach
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To alleviate the LIFO Liquidation problems and simplify accounting companies can combine goods into pools. A pool groups items of a smiliar nature. This method results in fewer lifo liquidations.
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Specific Identification
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Calls for identifyng each item sold and each item in inventory. Company includes in COGS the cost of the specific items sold. This method can only be used where practical. Under specific ID the cost flow matches the physical flow of goods.
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Weighted Average Method
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Periodic inventory Average costing method. Computes the ending inventory and COGS using weighted average. In computing this it includes the beginning inventory if any both in the total units available and in the total cost of goods availabl.e
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Work in Process Inventory
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The cost of the raw material for unfinished units plue direct labor cost applied specifically to this material and a ratable share of manufacturing overhead cost.
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