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Terms in this set (79)
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.
Purchases its merchandise in a form ready for sale.
Account used to report the cost assigned to unsold units left on hand
Produces goods to sell to merchandising firms
What inventory accounts does a manufacturer typically have?
Raw materials, work in process, and finished goods.
Raw materials inventory
Account used to report the cost of goods and materials on hand but not yet placed in production.
Work in process inventory
Account used to report the cost of the raw material for unfinished units, plus the direct labor cost applied specifically to this material and a ratable share of manufacturing overhead costs.
Finished goods inventory
Account used to report the costs identified with the completed but unsold units on hand at the end of the fiscal period.
Account used for supplies that are used in production but are not the primary material being processed.
What are the two types of systems for maintaining accurate inventory records?
Perpetual system and periodic system
Perpetual inventory system
System that continuously tracks changes in the Inventory account. The company records all purchases and sales of goods directly in the Inventory as they occur.
What are the steps in the perpetual inventory system?
1-Purchase of merchandise or raw materials are debited to Inventory.
2-Freight-in debited to Inventory and purchase returns are credited to inventory.
3-COGS recorded at the time of each sale by debiting COGS and crediting Inventory
Periodic Inventory System
A company determines the quantity of inventory on hand only periodically.
What are the steps in the periodic inventory system?
1-All acquisitions of inventory during the accounting period recorded by debiting Purchases account.
2-Adds total in Purchases account at end of period to the cost of inventory on hand at the beginning of the period-this sum determines total cost of goods available for sale in the period.
3-Subtracts the Ending Inventory from the cost of goods available for sale to get COGS.
How is the journal entry done when adjusting inventory at the end of the period for write offs?
Inventory Over and Short xxx
What is the Inventory Over and Short account used for?
Difference in recorded inventory and actual count due to normal and expected shrinkage, breakage, shoplifting, incorrect record keeping. The Inventory Over and Short accounts adjusts Cost of Goods Sold.
Modified perpetual inventory system
Provides detailed inventory records of increases and decreases in quantities only no dollar amounts.
Cost of goods available for sale
The sum of cost of goods on hand at the beginning of the period and the cost of goods acquired during the period.
Cost of goods sold calculation
The difference between the cost of goods available for sale during the period and the cost of goods on hand at the end of the period.
What items must be determined to value inventories?
1-Physical goods to include in inventory
2-The costs to include in inventory
3-The cost flow assumption to adopt
An inventory belongs to the buyer except in what situations?
FOB shipping point
Sales with buybacks
Sales with a high rate of return
Sales on installment
FOB Shipping point
Title to goods passes to the buyer when goods delivered to common carrier.
Title to goods passes to buyer when the goods are received from the common carrier.
Goods on consignment remain the property of the consigner-the one who is consigning the goods.
What are the three special sales situations?
Sales with buyback agreement
Sales with high rate of return
Sales on installment
Product financing agreement
Occurs when an enterprise finances its inventory without reporting either the liability or the inventory on its balance sheet. Can either be sale with implicit or explicit buyback.
Arrangement where company parks their inventory on another companies balance sheet for a short period of time. Repurchase agreement exists that states set price and price covers cost of inventory plus holding costs.
Under what circumstances should a company consider inventory sold?
When the company can consider inventory sold when they can reasonable estimate the returns. If returns are unpredictable should not consider goods sold.
What are goods sold on installment?
Any type of sale in which the sale agreement requires payment in periodic installments over an extended period.
When can a seller of goods sold on installment exclude goods from inventory?
The seller should exclude the goods from inventory if it can reasonably estimate the percentage of bad debts.
How do companies generally account for the acquisition of inventories?
Costs that attach to the inventory, costs must be directly connected with bringing the goods to the buyer's place of business and converting them to salable condition.
What are some charges that could be product costs?
Freight charges on goods purchased, direct cost of acquisition, and labor and other production costs incurred in processing the goods up to the time of sale.
What are a manufacturing companies costs included in inventory?
Direct materials, direct labor, and manufacturing overhead
What is included in manufacturing overhead?
Indirect materials, indirect labor, and various costs such as depreciation, taxes, insurance, heat and electricity.
Costs that are indirectly related to the acquisition or production of goods. Not typically included in inventory costs.
Interest costs associated with inventory
Account used in a periodic inventory system that indicates that the company is reporting its purchases and accounts payable at the gross amount.
How are purchase discounts treated if a company uses the gross method?
It reports the purchase discounts as a deduction from purchases on the income statement.
Net of the cash discounts approach-Net method
Company records failure to take a purchase discount within the discount period in a Purchase Discounts Lost account. -which will be under other expenses and losses on income statement
Cost flow assumptions
Companies should choose the method that most clearly reflects periodic income. Cost flow assumption does not have to be consistent with the physical flow of goods.
System where each item that is sold and each item in inventory is identified separately. Can only be used in instances where it is practical to physically separate purchases.
Advantage to specific identification method
Matches actual costs against actual revenues
Cost flow matches the physical flow of goods.
Disadvantage to specific identification
Allows a company to manipulate net income.
Average cost method
Prices items in the inventory on the basis of the average cost of all similar goods available during the period.
What inventory timing is the weighted average method used with?
Used with periodic inventory method
What inventory timing is the moving-average method used with?
Perpetual inventory method
What are the advantages to the average cost method?
Simple to apply and objective
Not subject to income manipulation
FIFO-first in last out method
Assumes that a company uses goods in the order in which it purchases them. First goods purchased are the first ones used.
How does ending inventory and cost of goods sold vary when using FIFO based on perpetual or periodic?
When FIFO is used, the inventory and cost of goods sold would be the same at the end of the month whether perpetual or periodic system used.
What is a disadvantage of FIFO?
Fails to match current costs to current revenues on the income statement.
LIFO-Last in first out method
Matches the cost of the last goods purchased against the revenue.
When using the periodic inventory system and the LIFO method what assumptions can be made?
The cost of the total quantity sold or issued during the month comes from the most recent purchases.
When using the perpetual inventory system and the LIFO method what assumptions can be made?
With the perpetual inventory system and LIFO, it will result in different ending inventory and cost of goods sold amount than the amount calculated under the periodic method.
What circumstances are both LIFO and another inventory system used?
LIFO is often used for tax and external reporting, while FIFO, average cost, or standard costing system is used for internal reporting purposes.
Why do companies use two different inventory methods?
1-Companies base pricing decisions on FIFO, average cost, or standard cost assumption, rather than on LIFO.
2-Recordkeeping easier on some other basis than LIFO because LIFO does not approximate the physical flow of goods.
3-Profit sharing and other bonuses often depend on non-LIFO inventory assumptions
4-Use of pure LIFO system does not work well in interim periods.
The difference between the inventory method used for internal reporting purposes and LIFO, also called the Allowance to Reduce Inventory to LIFO
The adjustment that companies must make to the accounting records in a given year or the change in the allowance balance from one period to another.
Why is traditional LIFO often unrealistic?
1-When a company has many different inventory items, the accounting cost of tracking each inventory item is expensive.
Erosion of the LIFO inventory system, distorts net income and leads to substantial tax payments.
Increases from period to period in inventory costs
Under what approach to inventory do LIFO liquidations occur frequently?
Specific-goods LIFO approach
What is one way that LIFO liquidation problems can be alleviated?
By combining goods into pools
What is a pool?
Groups items that are similar in nature.
Specific-goods pooled LIFO approach
A company combines and counts as a group a number of similar units or products, results in fewer LIFO liquidations
Disadvantage of specific-goods LIFO approach
1-Companies must continually redefine pools, which is time consuming and costly.
2-Results in erosion of the layers, which loses the LIFO costing benefit.
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.
What are advantages of the dollar value LIFO method over the specific-goods pooled approach?
1-Companies may include a broader range of goods in a dollar-value LIFO pool.
2-Dollar-value LIFO pool permits replacement of goods that are similar items, similar in use, or interchangeable, Specific goods LIFO approach only allows replacement of items substantially identical.
3-Helps protect layers from erosion
Why do companies use several pools in the dollar-value LIFO method?
In general, the more goods included in a pool the more likely that increases in the quantities of some goods will offset decreases in other goods in the same pool.
When does a new layer form?
A new layer forms only when the ending inventory at base-year prices exceeds the beginning inventory at base-year prices
When must a company remove a layer?
If ending inventory at base-year prices is less than beginning inventory at base-year prices, a company must subtract the decrease from the most recent layer added. When a decrease occurs the company peels off previous layers at the prices in existence when they were added.
Can a layer be rebuilt?
Once a layer is removed it is gone forever.
What must the inventory at base year prices always be equal to?
The total of the layers at base-year prices.
How do companies determine the price indexes?
Most companies use the general price-level index that the federal gov. prepares and publishes monthly.
How is the price index computed?
Ending inventory for the period at current cost/ ending inventory for the period at base year cost=Price index for current year
Major advantages of LIFO
2-Tax benefits/improved cash flow
3-Future earnings hedge
Major disadvantages of LIFO
4-Involuntary liquidation/poor buying habits
What are preferable conditions for using LIFO?
1-Selling prices and revenues increasing faster than costs
2-In situations where LIFO typically used-ex. department stores
What are some conditions in which LIFO would be inappropriate?
1-When prices are lagging behind costs
2-When specific identification method is typically used in industry
3-Where unit costs tend to decrease as production increases.
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