Financial Accounting Quiz Chapter 6

Regardless of classification, companies report all inventories under…

current assets on the balance sheet

Raw Materials

steel, glass, tires, and other components on hand waiting to be used in production

Work in Process

tractors on the assembly line in various stages of production

Finished Goods

earth-moving tractors completed and ready for sale

Just-in-Time (JIT) Inventory Method

method in which companies have significantly lowered inventory levels and costs; results when companies manufacture or purchase goods only when needed

Purpose of Physical Count in Perpetual System

to check accuracy of inventory records and to determine amount of inventory lost due to wasted materials, shoplifting, or employee theft

Purpose of Physical Count in a Periodic System

to determine the inventory on hand at the balance sheet date and determine COGS for the period

Taking a Physical Inventory

counting, weighing, or measuring each kind of inventory on hand; occurs at end of accounting period

Goods in Transit

considered part of inventory ownership if legal title determined by terms of sale is owned; includes purchased goods not yet received and sold goods not yet delivered to customer

FOB Shipping Point

buyer pays freight costs; ownership passes to buyer when loaded on the truck

FOB Destination

seller pays freight costs; ownership remains with seller until goods reach buyer

Consigned Goods

goods held for sale by a holder who is trying to sell for a fee; holder does not own the goods or include in their inventory because ownership has not passed

Financial Effects of Inventory

includes all expenditures necessary to acquire goods and place them in condition ready for sale

Inventory Methods

• specific identification

• cost flow assumptions

  • first-in first-out (FIFO)

  • last-in first-out (LIFO)

  • average-cost

Specific Identification

used when a company is able to positively identify which particular items of inventory are sold; costs of specific items are assigned to units sold and units in ending inventory

COGS Calculation: Periodic

inventory is counted at the end of the period and COGS is determined using inventory method

beginning inv. + cost of goods purchased - ending inv

First-In, First-Out (FIFO)

assumes that the earliest goods purchased are the first to be sold

COGS for FIFO

cost of the earliest goods purchased are recognized

Ending Inv. for FIFO

begin with unit cost of most recent purchase and work backwards until all units of ending inventory have been costed

Last-In, First-Out (LIFO)

assumes latest goods purchased are the first to be sold

COGS for LIFO

costs of latest goods purchased are recognized

Ending Inv. for LIFO

begin with unit cost of earliest goods available for sale and work forward until all units of ending inventory have been costed

Average-Cost

used by companies that sell items similar in nature; allocates cost of goods available for sale on the basis of the weighted-average unit cost incurred

Weighted-Average Unit Cost

average cost that is weighted by the number of units purchased at each unit cost; applied to units on hand to determine cost of ending inventory

Factors Affecting Inventory Method Decisions

income statement, balance sheet, and tax effects

Income Statement Effects

net income changes with each method

Costs are RISING

FIFO has high net income and LIFO has low net income

Costs are FALLING

FIFO has low net income and LIFO has high net income

Consistency Concept

requires that companies use their chosen cost flow method consistently each period, making financial statements more comparable over successive time periods; does not prevent a company from changing method

When a company adopts different cost flow method…

must disclose in financial statement notes what change was made and its effects on net income

Why do some companies prefer LIFO?

results in lowest income taxes during times of rising costs because of lower net income

Which method typically leads to a lower inventory value?

LIFO

Which method usually results in higher net income and income taxes?

FIFO

inventory on the Balance Sheet

classified as a current asset immediately below receivables

Financial statements disclose…

• major inventory classifications

• basis of accounting (cost, or lower-of-cost-or net realizable value

• cost method (FIFO, LIFO, or Average-Cost)

Lower-of-Cost-or-Net Realizable Value

rule used to estimate and record current value of company’s inventory; when value of inventory is lower than its cost; companies must “write down” inventory to its net-realizable value

Net Realizable Value

the net amount that a company expects to realize from the sale of inventory

Conservatism

approach where losses are recognized immediately and gains are recognized only when realized

Applying LCNRV

applied to items in inventory after company has used a cost flow method to determine cost

Inventory Turnover

measures the number of times, on average, the inventory is sold during the period; indicates the liquidity of the inventory

Inventory Turnover Equation

COGS / average inventory

Average Inventory Equation

(beginning inventory + ending inventory) / 2

Days in Inventory

measures the average number of days inventory is held before it is sold

Days in Inventory Equation

365 / inventory turnover

LIFO Reserve

the difference between inventory reported using LIFO and inventory using FIFO; must be reported in financial statement notes

LIFO in Perpetual System

latest costs are removed from inventory at the time of each sale

FIFO in Perpetual System

same result as periodic, but recorded after each sale

Moving-Average Method in Perpetual

a new weighted-average unit cost is computed after each purchase

Common Causes of Inventory Errors

failure to count or price inventory correctly; not properly recognizing the transfer of legal title to goods in transit

Inventory errors affect the computation of COGS and net income in…

two periods

Understating ending inventory will overstate…

COGS

Overstating ending inventory will overstate…

assets and stockholders’ equity