Chapter 6 - Fin. Acct.

Inventory

What is safeguarding inventory?

Protecting merchandise from theft, damage, and loss.

What is reporting inventory?

Accurately reporting inventory quantities and costs in financial statements

What three documents are used for inventory control?

• Purchase order: Authorizes a purchase.

• Receiving report: Records merchandise received.

• Vendor's invoice: The supplier's bill.

What is a subsidiary inventory ledger?

Tracks individual inventory items and helps maintain proper stock levels

What are examples of inventory security measures?

Locked cabinets, restricted storage, cameras, security tags, and guards

Why are physical inventory counts necessary?

To verify inventory records and identify shrinkage or errors

What are inventory cost flow assumptions?

Methods used to decide which inventory costs go to COGS or ending inventory.

What is the specific identification method?

Uses the actual cost of the specific item sold.

What is FIFO (First-In, First-Out)?

Oldest costs go to COGS first; newest costs stay in inventory.

What is LIFO (Last-In, First-Out)?

Newest costs go to COGS first; oldest costs stay in inventory.

What is the weighted average method?

Uses the average cost per unit to value sold and unsold inventory.

How do FIFO and LIFO compare when costs are rising?

• FIFO: lower COGS, higher gross profit and inventory.

• LIFO: opposite. ⇒ LiFO = Low Profit

What is the difference between physical flow and cost flow?

• Physical flow → how goods actually move

• Cost flow → how costs are assigned

What is a perpetual inventory system?

A system that updates inventory and COGS every time a sale occurs.

How does FIFO work under a perpetual system?

Oldest costs go to COGS; newest costs remain in inventory.

How does LIFO work under a perpetual system?

Newest costs go to COGS; oldest costs remain in inventory

What is the weighted-average method under a perpetual system?

A moving average that recalculates the average unit cost after each purchase.

How is the moving weighted-average cost calculated?

Total cost of inventory on hand ÷ Total units on hand

When is the weighted-average cost recalculated?

After each new purchase, not after each sale

What is an inventory cost layer?

A group of inventory units purchased at the same cost

How is COGS calculated (formula) under each perpetual costing method?

• Units sold × Assigned unit cost

• (FIFO, LIFO, or moving average)

How is ending inventory calculated?

Add the costs of all units remaining in inventory

What is the journal entry to record COGS when merchandise is sold?

• Debit → Cost of Goods Sold

• Credit → Inventory

Why do FIFO, LIFO, and weighted average produce different results?

They assign different costs to COGS and ending inventory.

What four financial amounts are affected by inventory costing methods?

COGS, gross profit, net income, and ending inventory

During rising prices, how do FIFO and LIFO affect COGS?

• FIFO = Lower COGS

• LIFO = Higher COGS

During rising prices, how do FIFO and LIFO affect ending inventory?

• FIFO = Higher inventory

• LIFO = Lower inventory

During rising prices, how do FIFO and LIFO affect gross profit and net income?

• FIFO = Higher profit

• LIFO = Lower profit (all else equal)

Where does weighted average fall compared to FIFO and LIFO?

Generally between the two methods when inventory costs are rising

What happens when inventory costs are falling?

The FIFO and LIFO results reverse

When do all 3 inventory costing methods produce the same results?

When inventory costs remain the same

What is inventory valuation?

Determining the dollar value of inventory reported in financial statements

What is lower-of-cost-or-market (LCM)?

Reporting inventory at the lower of its original cost or market value (NRV)

What is net realizable value (NRV), and how is it calculated?

Estimated selling price − Direct selling costs

When might inventory need to be written down?

When damage, spoilage, or obsolescence reduces its value below cost

How does an inventory write-down affect COGS and gross profit?

• COGS increases

• Gross profit decreases.

Where is inventory reported on the balance sheet?

Under Current Assets

What inventory accounting methods must companies disclose?

• Costing method (FIFO, LIFO, weighted average)

• Valuation method (cost or LCM)

What happens when ending inventory is overstated?

• COGS is understated

• Gross profit, net income, assets, and equity are overstated.

• Opposite is true → Understated

Who owns inventory under FOB shipping point, FOB destination, and consignment?

• Shipping point = buyer when shipped

• Destination = buyer when delivered; consignment = consignor until sold

What two measurements evaluate inventory management?

Inventory turnover and days' sales in inventory

How are average inventory and inventory turnover calculated? (formulas)

• Average inventory = (Beginning + Ending) ÷ 2

• Turnover = COGS ÷ Average inventory

What is days' sales in inventory, and how is it calculated?

Average days inventory is held; 365 ÷ Inventory turnover

What do higher inventory turnover and lower days' sales generally indicate?

Inventory sells faster and is managed more efficiently

Why might a company need to estimate inventory?

Missing records, destroyed inventory, or financial statements prepared before a physical count

What is the retail inventory method?

Estimates ending inventory cost using retail prices and a cost-to-retail ratio

How is the cost-to-retail ratio calculated?

Goods available at cost ÷ Goods available at retail

How is ending inventory estimated using the retail method?

(Goods available at retail − Sales) × Cost-to-retail ratio.

What is the gross profit method?

Estimates ending inventory using sales and an expected gross profit percentage

How is ending inventory estimated using the gross profit method?

Goods available at cost − [Sales − (Sales × Gross profit rate)].