Intermediate 1 Exam 3
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210 Terms
What is finished goods inventory?
Completed products ready to be sold.
What is an example of finished goods inventory?
Completed computers produced by HP that are ready to be sold to customers.
What is work-in-process inventory?
Goods that are in production but not yet complete.
What is an example of work-in-process inventory?
Partially assembled computers on HP’s production line.
What is raw materials inventory?
Components and materials used in the production of goods.
What is an example of raw materials inventory?
Computer chips and memory modules used by HP to build computers.
What is Cost of Goods Sold (COGS)?
The expense related to inventory that has been sold.
How does the type of business affect what counts as inventory?
It depends—office furniture is inventory for Staples but not for KPMG.
What is merchandising inventory?
Goods purchased in finished form for resale.
What does the cost of merchandise inventory include?
Purchase price plus all costs needed to get goods ready for sale.
How do manufacturing companies disclose inventory?
They report dollar amounts of raw materials, work-in-process, and finished goods in notes or on the balance sheet.
What is a perpetual inventory system?
Continuously updates inventory and COGS with each transaction.
What are advantages of the perpetual inventory system?
Real-time tracking of goods on hand and items sold.
What technologies support perpetual systems?
Barcodes and RFID tags.
What causes inventory shrinkage?
Theft, spoilage, or system errors.
What is a periodic inventory system?
Updates inventory and COGS only at the end of the period.
What is the formula for COGS under a periodic system?
Beginning Inventory + Net Purchases – Ending Inventory.
What temporary accounts are used in a periodic system?
Purchases, Freight-in, Purchase Returns, Purchase Discounts.
When is COGS recorded under a periodic system?
At the end of the accounting period after a physical count.
What items are included in physical inventory?
Company’s possessions, goods in transit, goods on consignment, and anticipated sales returns.
What determines ownership of goods in transit?
Shipping terms—FOB shipping point or FOB destination.
When does title transfer under FOB shipping point?
When goods are shipped; buyer owns during transit.
When does title transfer under FOB destination?
When goods arrive; seller owns until delivery.
Who records inventory under FOB shipping point?
Buyer includes goods in transit in ending inventory.
Who records inventory under FOB destination?
Seller keeps goods in inventory until delivered.
What is a consignment arrangement?
Goods held by one party (consignee) but owned by another (consignor).
Who records consigned goods in inventory?
The consignor, until the consignee sells them.
How are sales returns treated in accounting?
Reduce sales revenue and COGS; increase inventory.
Why estimate sales returns at period-end?
To include the cost of goods expected to be returned in ending inventory.
What costs are included in the cost of inventory?
All necessary costs to acquire and prepare goods for sale or use.
What is freight-in?
Shipping cost to bring goods to the buyer’s location; added to inventory cost.
How is freight-in recorded under a perpetual system?
Added directly to the Inventory account.
How is freight-in recorded under a periodic system?
Recorded in a temporary Freight-in account and later added to Purchases.
How are outgoing freight costs treated?
As operating expenses, not part of inventory.
What are purchase returns?
Reductions in inventory or purchases when goods are returned to the supplier.
Under a perpetual system, how is a purchase return recorded?
Decrease Inventory and Accounts Payable.
Under a periodic system, how is a purchase return recorded?
In a temporary “Purchase Returns” account.
What are purchase discounts?
Reductions offered for early payment (e.g., 2/10, n/30).
What are the two methods to record purchase discounts?
Gross method and net method.
How does the gross method record discounts?
Records full cost initially; recognizes discount only if taken.
How does the net method record discounts?
Assumes discount will be taken; records loss if not.
What is “Purchase Discount Lost”?
Expense recorded when discount period is missed under net method.
What are examples of costs included in “Net Purchases”?
Total purchases + freight-in – returns and discounts.
How is freight on outgoing goods treated?
As an operating expense or selling cost, not part of inventory.
What is the general formula for Net Purchases?
Total Purchases + Freight and Other Costs – Returns and Discounts.
What is the key difference between perpetual and periodic systems?
Perpetual tracks continuously; periodic records at period-end.
Why do companies need inventory cost flow methods?
Because inventory is purchased at different costs over time, so we must decide which costs go to COGS and which stay in ending inventory.
What are the four GAAP inventory cost flow methods?
Specific Identification, Average Cost, FIFO, and LIFO.
What is the purpose of inventory cost flow methods?
To assign costs to goods sold and goods remaining when units are bought or produced at different prices.
Specific Identification method
Tracks the exact cost of each individual item sold or remaining.
Who uses the Specific Identification method?
Companies selling unique, high-value, low-volume items such as car dealers or jewelers.
Advantage of Specific Identification
Provides precise cost matching for each item.
Disadvantage of Specific Identification
Impractical for firms with high sales volume or identical goods.
Average Cost method
Uses a weighted-average unit cost for all units, smoothing cost fluctuations.
How to calculate Weighted-Average Unit Cost
Total cost of goods available ÷ total units available.
When is the weighted-average computed under the periodic method?
Only at the end of the accounting period.
Perpetual (moving) average method
Recomputes a new average cost after every purchase.
When is Average Cost most realistic physically?
When items are mixed or indistinguishable, like liquids or grains.
FIFO meaning
First-In, First-Out.
What cost flow does FIFO assume?
The oldest inventory costs are sold first; the newest remain in ending inventory.
Effect of FIFO in rising prices
Lower COGS, higher ending inventory, higher net income.
Effect of FIFO in falling prices
Higher COGS, lower ending inventory, lower income.
Real-world FIFO examples
Grocery stores, pharmacies, and perishable-goods businesses.
Why FIFO periodic and FIFO perpetual give same results
Both assume the oldest units sold first, so timing doesn’t affect totals.
LIFO meaning
Last-In, First-Out.
What cost flow does LIFO assume?
The newest costs are sold first; the oldest stay in inventory.
Effect of LIFO in rising prices
Higher COGS, lower ending inventory, lower income (lower taxes).
Why companies choose LIFO
To reduce taxable income during inflation and defer taxes.
Why LIFO periodic and perpetual differ
They sell different layers depending on when purchases occur.
Real-world LIFO examples
Oil, steel, and auto-parts companies in the U.S.
Is LIFO allowed under IFRS?
No, only under U.S. GAAP.
Comparison of FIFO, LIFO, and Average under rising prices
FIFO → lowest COGS, highest EI; LIFO → highest COGS, lowest EI; Average → middle.
Comparison of FIFO, LIFO, and Average under falling prices
FIFO → highest COGS, lowest EI; LIFO → lowest COGS, highest EI; Average → middle.
When inventory costs rise, which method gives highest income?
FIFO.
When inventory costs rise, which gives lowest income and taxes?
LIFO.
Why can tax savings from LIFO be temporary?
They’re deferred, not eliminated.
LIFO conformity rule
If a company uses LIFO for taxes, it must also use LIFO for financial reporting.
LIFO Reserve (LIFO Allowance)
The difference between FIFO (or average) inventory and LIFO inventory balance.
How the LIFO Reserve is shown
As a contra-account reducing inventory to LIFO value.
Journal entry to increase the LIFO Reserve
Debit COGS, credit LIFO Reserve.
Meaning of an increase in the LIFO Reserve
Prices are rising and LIFO inventory value is lower.
Meaning of a decrease in the LIFO Reserve
Prices fell or older inventory layers were sold.
Why keep internal FIFO or Average records
For management bonuses, profit-sharing, and pricing analysis.
LIFO Liquidation
When sales exceed purchases, causing older inventory layers to be sold.
Effect of a LIFO Liquidation during inflation
Temporarily increases income because cheaper old costs are matched with current prices.
Why companies disclose LIFO liquidations
To clarify if profits rose from operations or from selling old inventory.
Why LIFO-liquidation profits are low quality
Because they are temporary and not sustainable.
LIFO-liquidation example result (National Distributors)
COGS was $840,000 instead of $900,000, creating a $60,000 temporary pre-tax income increase.