Accounting Chapter 6: Inventories

Two Primary Objectives of Control of Inventory

-Safeguarding the inventory from theft

-Reporting inventory in the financial statements

When do the controls for inventory begin

as soon as the inventory is purchased

Primary documents used for inventory control

-Purchase Order

-Receiving Report

-Vendor's Invoice

Purchase Order

Authorizes the purchase of the inventory from an approved vendor

Receiving Report

Establishes an initial record of the receipt of inventory

When is the receiving report completed?

As soon as the inventory is received

What is the receiving report compared with?

the purchase order

Why is the purchase order compared with the receiving report?

to make sure everything that was received is what was ordered

What is the vendor's invoice compared with?

Price, quantity, and description of the item on the purchase order and receiving report is compared with the vendor's invoice

When is the inventory purchased recorded in the accounting records

If everything on the purchase order, receiving report, and vendor's invoice agrees

What inventory system is an effective means of inventory control?

Perpetual Inventory System

Why is the perpetual inventory system an effective means of inventory control?

The amount of inventory is always available in the subsidiary inventory ledger, which keeps inventory at proper levels

How does the perpetual inventory system keep inventory at proper levels?

Comparing inventory quantities with maximum and minimum levels allows for the timely reordering of inventory and prevents ordering excess inventory

Security Measures for inventory control should include:

Storing inventory in areas that are restricted to only authorized employees

Locking high-priced inventory in cabinets

Using two way mirrors, cameras, security tags, and guards

Why should security measures for inventory control be used to safeguard inventory?

to prevent damage to inventory or customer or employee theft

When should a physical inventory be taken?

At year-end

What is a physical inventory also called?

count of inventory

Why should a physical inventory be taken at year-end

to make sure that the quantity of inventory reported in the financial statements is accurate

Process of reporting inventory at year-end

the physical count of inventory is taken, then the cost of inventory is assigned for reporting in the financial statements using a cost flow method

What accounting issue arises when merchandise is purchased?

Accounting issue arises when identical units of merchandise are acquired at different unit costs during a period

What is necessary when an item is sold

When an item is sold, it is necessary to determine its cost using a cost flow assumption and related inventory costing method

Three common cost flow assumptions and their related inventory costing method

Cost flow is in the order in which the costs were incurred

(First-In, First-Out Method)

Cost flow is in the reverse order in which the costs were incurred

(Last-In, Last-Out Method)

Cost flow is an average of the cost

(Weighted Average Cost)

Specific Identification Inventory Cost Flow Method

Inventory method in which the unit sold is identified with a specific purchase.

What is the ending inventory made up of when using the Specific Identification Inventory Cost Flow Method?

Ending inventory is made up of the remaining units on hand

What can vary when using the Specific Identification Inventory Cost Flow Method?

gross profit, cost of goods sold, and ending inventory

Why is the Specific Identification Inventory Cost Flow Method not practical?

Not practical unless each inventory unit can be separately identified, which most businesses cannot do

Who would use the Specific Identification Inventory Cost Flow Method?

An automobile dealer may use the specific identification method because each automobile has a unique serial number

What is the ending inventory made up of under the FIFO method?

the most recent purchases

What units are assumed to be sold when using the FIFO method?

the first units purchased

What is the ending inventory made up of under the LIFO method?

the first purchases

What units are assumed to be sold when using the LIFO method?

the last units purchased are assumed to be sold

What is the Weighted Average Inventory Cost Flow Method sometimes called?

The Average Cost Flow Method

Under the Weighted Average Inventory Cost Flow Method, what is the weighted average of the purchase costs?

Cost of units sold and the ending inventory is a weighted average of the purchase costs

What does weighted average mean?

The purchases costs are weighted by the quantities purchased at each cost

When must a cost flow method be used?

When identical units of an item are purchased at different costs.

true regardless of whether or not a business uses a perpetual or periodic inventory system

FIFO Method Under the Perpetual Inventory System:

How are costs included?

Costs are included in the cost of goods sold in the order in which they were purchases

Which cost flow method under the Perpetual Inventory System is the most similar to the physical flow of goods?

FIFO

Why is FIFO under the perpetual inventory system the most similar to the physical flow of goods?

Costs are included in the cost of goods sold in the order in which they were purchases

Which cost flow method under the Perpetual Inventory System is about the same as the specific identification method and why?

FIFO

because it is the most similar to the physical flow of goods

An example of a business that would use FIFO under the Perpetual Inventory System is:

A grocery store, Grocery stores need to sell things that have the soonest expiration dates, so the oldest products (earliest purchases) are sold first

What is the cost of the unit sold when using LIFO under the Perpetual Inventory System?

The cost of the units sold is the cost of the most recent purchases

How was LIFO originally used under the Perpetual Inventory System?

Was originally used in those rare cases where the units sold were taken from the most recent purchased units

Why is LIFO under the Perpetual Inventory System now widely used?

for tax purposes

Why is LIFO under the Perpetual Inventory System used even though it doesn't represent the physical flow of goods?

for tax purposes

Subsidiary Ledger using the LIFO Method under the Perpetual Inventory System

The subsidiary ledger is sometimes maintained in units only

Units are converted to dollars when the financial statements are prepared at the end of the period

Weighted Average Cost Method under the Perpetual Inventory System:

When is a weighted average unit cost for each item is computed?

each time a purchase is made

Weighted Average Cost Method under the Perpetual Inventory System:

What is used to determine the cost of each sale?

the unit cost

Moving average

The cost of sale changes every time a purchase is made

Under the periodic inventory system, what is recorded when a sale is made?

only revenue, no record of the cost of goods sold

When is a physical count of inventory made under the periodic inventory system?

at the end of the accounting period

What is the physical count of inventory under the periodic inventory system used to determine?

the cost of the inventory

cost of goods sold

Periodic FIFO:

what is the cost of the goods on hand at the end of the accounting period made up of?

the most recent costs

Periodic FIFO:

what is the cost of the ending inventory made up of?

the most recent costs

Periodic FIFO:

what is the cost of goods sold made up of?

the beginning inventory and the earliest costs

Periodic FIFO:

How is the cost of the physical inventory determined?

You take the remaining physical units, and the last purchases are taken until you have the total physical count.

for example, if you have 800 remaining units, the most recent 800 units purchased are used.

Periodic FIFO:

what is the cost of the goods on hand at the end of the accounting period made up of?

the earliest costs

Periodic LIFO:

What is the cost of the ending inventory made up of?

the earliest costs

Periodic LIFO:

What is the cost of goods sold made up of?

the most recent costs

Periodic LIFO:

How is the physical inventory determined?

You take the earliest units purchased until you have the total remaining units

Periodic Weighted Average Cost Method:

What does the weighted average unit cost used to determine?

the cost of goods sold and the ending inventory

Periodic Weighted Average Cost Method:

What happens if the purchases are relatively uniform during the period?

the weighted average cost method provides the results that are similar to the physical flow of goods

When does the periodic weighted average method provides results that are similar to the physical flow of goods?

if the purchases are relatively uniform during the period

What cost flow method provides results that are most similar to the physical flow of goods under the periodic inventory system?

The weighted average cost flow method

Periodic Weighted Average Cost Method:

How is the weighted average unit cost determined?

dividing total cost of units available for sale by units available for sale

Periodic Weighted Average Cost Method:

How is the cost of the ending inventory determined by?

The cost of the ending inventory is determined by multiplying the physical count of inventory by the weighted average unit cost

Periodic Weighted Average Cost Method:

How is the cost of goods sold determined?

The cost of goods sold is determined by subtracting the ending inventory from the cost of goods available for sale during the period

What method is better under times of decreasing costs?

LIFO

What method is better under times of increasing costs?

FIFO

Why is LIFO better under times of decreasing costs?

Because LIFO values inventory based on the most recent purchases, under times of decreasing costs, LIFO the cost of goods sold is less, yielding a higher gross profit, yielding a higher net income.

Why is FIFO better under times of increasing costs?

Because FIFO values inventory based on the earliest purchases, the earliest purchases are less expensive. Therefore, the cost of goods sold is less, yielding a higher gross profit, yielding a higher net income.

Effects of Increasing Costs

Highest Amount of Cost of Goods Sold

LIFO

Why is LIFO yield higher amounts of cost of goods sold under times of increasing costs?

The costs of goods sold under LIFO is made up of the most recent purchases, and if costs are increasing, the most recent purchases are more expensive

Effects of Increasing Costs:

Lowest Amount of Cost of Goods Sold

FIFO

Why does FIFO yield a lower amount of cost of goods sold under times of increasing costs?

The cost of goods sold under FIFO is made up of the earliest purchases, and if costs are increasing, the earliest costs are cheaper than the most recent

Effects of Increasing Costs:

Highest Amount of Gross Profit

FIFO

Why does FIFO yield a higher amount of gross profit under times of increasing costs?

Gross profit is made up of sales minus cost of goods sold. Under FIFO, the cost of goods sold is made up of the earliest purchases. If costs are increasing, the earliest costs would be the cheapest, therefore there is less to subtract from sales.

Effects of Increasing Costs:

Lowest Amount of Gross Profit

LIFO

Why does LIFO yield a lower amount of gross profit under times of increasing costs?

Gross profit is made up of sales minus cost of goods sold. Under LIFO, the cost of goods sold is made up of the the most recent purchases. If costs are increasing, the most recent purchases are more expensive than the earliest purchases. Therefore, there is more to subtract from sales.

Effects of Increasing Costs:

Highest Amount of Net Income

FIFO

Why does FIFO yield the highest amount of net income under times of increasing costs?

Net income is determined by subtracting expenses from gross profit. In times of increasing costs, FIFO yields the highest gross profit, therefore a higher net income.

Effects of Increasing Costs:

Lowest Amount of Net Income

LIFO

Why does LIFO yield the lowest amount of net income under times of increasing costs?

Net income is determined by subtracting expenses from gross profit. In times of increasing costs, LIFO yields the lowest gross profit, therefore a lower net income.

Effects of Increasing Costs:

Highest Amount of Ending Inventory

FIFO

Why does FIFO yield the highest amount of ending inventory under times of increasing costs?

Under FIFO, ending inventory is made up of the most recent purchases. If prices are increasing, the ending inventory, made up of the most recent purchases, would be more expensive than the earliest purchases.

Effects of Increasing Costs:

Lowest Amount of Ending Inventory

LIFO

Why does LIFO yield the lowest amount of ending inventory under times of increasing costs?

Under LIFO, ending inventory is made up of the most recent purchases. If prices are increasing, the ending inventory, made up of the earliest purchases, would be less expensive than the most recent purchases.

Decreasing Costs:

Highest Amount of Cost of Goods Sold

FIFO

Why does FIFO have yield the highest amount of cost of goods sold during times of decreasing costs?

The cost of goods sold under FIFO is made up of the most earliest purchases. If prices are declining, the earliest purchases are more expensive than the most recent purchases.

Decreasing Costs:

Lowest amount of costs of goods sold

LIFO

Why does LIFO yield a lower amount of cost of goods sold during times of decreasing costs?

The cost of goods sold under LIFO is made up of the most recent purchases. If prices are declining, the most recent purchases are more expensive than the earliest purchases.

Decreasing Costs:

Highest gross profit

LIFO

Why does LIFO yield a higher gross profit during times of decreasing costs?

Gross profit is made up of sales minus cost of goods sold. Under LIFO, the cost of goods sold is made up of the the most recent purchases. If prices are decreasing, LIFO yields the lowest cost of goods sold. Therefore, there is less to subtract from sales revenue.

Decreasing Costs:

Lowest amount of Gross Profit

FIFO

Why does FIFO yield a lower amount of gross profit during times of decreasing costs?

Gross profit is made up if sales minus the cost of goods sold. Under FIFO, the cost of goods sold is made up of the earliest purchases. If prices are decreasing, FIFO yields a higher amount of cost of goods sold. Therefore, there is more to subtract from sales revenue

Decreasing Costs:

highest amount of net income

LIFO

Why does LIFO yield a higher net income during times of decreasing prices?

LIFO yields a higher gross profit under times of decreasing costs, therefore net income is higher.

Decreasing Prices:

lowest amount of net income

FIFO

Why does FIFO yield a lower net income during times of decreasing costs?

FIFO yields a lower gross profit under times of decreasing costs, therefore net income is lower.

Decreasing Costs:

highest amount of ending inventory

LIFO

Why does LIFO yield a higher amount of ending inventory during times of decreasing prices?

Under LIFO, ending inventory is made up of the most recent purchases. If costs are decreasing, the ending inventory under LIFO is less expensive because the earliest purchases are more expensive than the most recent