ACCT 3311 Exam 3 (Ch 9-12)

Inventory

Goods controlled by a company and held for use in manufacturing, for sale as merchandise, or to be consumed in producing goods or services for sale

Inventory recognition

Recognize inventory when the company controls the goods; analyze goods in transit, goods on consignment, and goods under repurchase agreements to determine who has control

Goods in transit

Goods being shipped between locations; determine which party controls the goods under the shipping terms to decide who records inventory

Goods on consignment

Goods held by another party for sale; the consignor generally retains control and reports the goods as inventory until they are sold

Goods under repurchase agreements

Goods transferred under an agreement requiring or allowing repurchase; analyze the agreement to determine whether control has actually transferred

Initial inventory measurement

Record inventory at cost, including expenditures directly or indirectly incurred to bring it to its existing condition and location

Costs included in inventory

Include costs to acquire goods and prepare them for sale, such as purchase price, freight-in, transportation insurance, sales tax, and storage fees

Purchase discounts

Reduce the initial cost of inventory for purchase or cash discounts

Costs excluded from inventory

Do not capitalize abnormal costs such as unusual rush-delivery shipping or excessive spoilage; expense period costs such as selling, general, and administrative costs when incurred

Periodic inventory system

A system in which a physical inventory count is taken at the end of the reporting period and cost of goods sold is determined after the count

Perpetual inventory system

A system that maintains detailed inventory records as goods are purchased and sold; Inventory and COGS are adjusted continually, and physical counts verify recorded quantities

Periodic system — purchase recording

Record purchases in the temporary Purchases account rather than directly increasing the Inventory account

Periodic system — sale recording

Record the sale revenue when a sale occurs; do not record the related cost of goods sold until the period-end inventory calculation

Periodic system — period-end COGS formula

Beginning inventory + net purchases + freight-in − ending inventory = cost of goods sold

Net purchases formula

Purchases − purchase returns and allowances − purchase discounts = net purchases

Purchases account

Debit balance. Temporary account used in a periodic system to accumulate the cost of inventory purchased during the period

Freight-in account

Debit balance. Temporary periodic-system account used to accumulate transportation costs to bring purchased inventory to the company

Purchase Discounts account

Credit balance. Temporary periodic-system contra-purchases account used to record discounts earned for paying suppliers within the discount period

Purchase Returns and Allowances account

Credit balance. Temporary periodic-system contra-purchases account used to record inventory returned to suppliers or reductions granted by suppliers

Inventory account — perpetual system

Debit balance. Asset account that continuously records the cost of inventory on hand; purchases increase it and sales reduce it at cost

Accounts Payable

Credit balance. Liability account recording amounts owed to suppliers for inventory or other purchases made on account

Cost of Goods Sold (COGS)

Debit balance. Expense account recording the cost of inventory sold during the period

Purchase discount terms 2/10, n/30

The buyer may deduct 2% if payment is made within 10 days; otherwise the full net amount is due within 30 days

Gross method for purchase discounts

Initially record the purchase at the full invoice amount; record the discount when payment is made within the discount period

Gross method — discount earned

Debit Accounts Payable for the full amount owed; credit Cash for the amount paid and credit Purchase Discounts in a periodic system or Inventory in a perpetual system for the discount

Gross method — discount missed

If payment occurs after the discount period, pay the full recorded payable; no purchase discount is recorded

Net method for purchase discounts

Initially record the purchase net of the available cash discount, assuming the discount will be taken

Net method — discount earned

Pay the net payable within the discount period; debit Accounts Payable and credit Cash for the net amount

Net method — discount missed

When the discount is not taken, record the additional amount paid as interest expense or as Purchase Discount Lost, depending on the accounting approach used

FOB shipping point

Ownership generally transfers to the buyer when goods are shipped; the buyer generally includes goods in transit in inventory and pays freight-in

FOB destination

Ownership generally transfers to the buyer when goods reach the destination; the seller generally retains the goods in inventory while they are in transit

Specific identification method

Uniquely identify and value each inventory item; ending inventory and COGS use the actual cost of the specific units on hand and sold

Average cost method — periodic

Compute one weighted-average cost per unit for the period by dividing total cost of goods available for sale by total units available; apply it to ending inventory and COGS

Weighted-average unit cost — periodic

Cost of goods available for sale ÷ total units available for sale

FIFO — periodic

Assumes the first goods purchased or manufactured are the first units sold; COGS uses the earliest costs and ending inventory uses the most recent costs

LIFO — periodic

Assumes the last goods purchased or manufactured are the first units sold; COGS uses the most recent costs and ending inventory uses the earliest costs

Inventory flow assumption

An assumed cost-flow pattern used to assign costs to ending inventory and COGS; it does not have to match the physical movement of goods

FIFO in periods of rising prices

Generally produces higher ending inventory closer to current costs and matches older, lower costs with current revenue

LIFO in periods of rising prices

Generally matches more current costs with current revenue, produces lower income and taxes, and leaves ending inventory at older costs

Specific identification — limitation

May allow income manipulation through arbitrary selection of which specific items are treated as sold and is often impractical

Average cost — limitation

Applies a systematic average cost, but the average may differ from current replacement costs

Perpetual inventory sale entries

Record the sale revenue and separately debit COGS and credit Inventory for the cost of the goods sold

Perpetual inventory purchase entry

Debit Inventory and credit Cash or Accounts Payable for the cost of purchased goods

Perpetual inventory freight-in

When freight is paid by the buyer under FOB shipping point, debit Inventory and credit Cash or Accounts Payable

Perpetual inventory purchase return

Debit Accounts Payable or Cash and credit Inventory for the cost of inventory returned to the supplier

Perpetual inventory purchase discount — gross method

When earned, debit Accounts Payable and credit Cash and Inventory for the discount amount

Perpetual inventory inventory shortage

If the physical count is less than the recorded inventory, debit COGS (or an inventory-shrinkage expense account, if used) and credit Inventory for the shortage cost

Moving-average method — perpetual

Recalculate the average cost per unit after each inventory purchase; use the current moving-average cost to value subsequent sales and remaining inventory

Moving-average unit cost

Cost of inventory available immediately after a purchase ÷ units available immediately after that purchase

FIFO — perpetual

Assign the cost of each sale using the earliest available inventory costs; ending inventory consists of the most recent purchases

LIFO — perpetual

Assign the cost of each sale using the latest available inventory costs; ending inventory consists of the earliest purchases

Periodic vs. perpetual FIFO

FIFO generally produces the same ending inventory and COGS under periodic and perpetual systems when the same costs and quantities are used

Periodic vs. perpetual LIFO

Periodic LIFO applies the newest costs available during the entire period to units sold; perpetual LIFO applies the newest costs available at each individual sale, so results can differ

LIFO reserve

The difference between inventory measured using FIFO (or another inventory method) and inventory measured using LIFO

LIFO reserve account

A contra-inventory allowance account used to record the difference between the non-LIFO inventory amount and the LIFO amount; it has a Credit balance

LIFO inventory amount formula

Inventory under FIFO − LIFO reserve = inventory under LIFO

Increasing the LIFO reserve

If the LIFO reserve increases, the adjustment generally increases COGS and decreases inventory; debit COGS and credit the LIFO reserve

Decreasing the LIFO reserve

If the LIFO reserve decreases, the adjustment generally decreases COGS and increases inventory; debit the LIFO reserve and credit COGS

LIFO liquidation

Occurs when ending inventory is lower than beginning inventory and prior-year LIFO layers are eliminated

LIFO liquidation during rising prices

Lower-cost prior-year inventory is matched with current higher selling prices, increasing income and taxable income compared with maintaining the layers

LIFO liquidation disclosure

Disclose the income effect of a LIFO liquidation, such as in a footnote or parenthetically on the income statement

Dollar-value LIFO

A LIFO approach that groups inventory into pools measured in dollar values to reduce the risk of LIFO liquidation

Dollar-value LIFO — Step 1

Restate ending inventory at base-year dollars by removing the effect of current-year price changes using the price index

Dollar-value LIFO — Step 2

Arrange the restated inventory amount into layers, identifying increases or decreases from prior-year base-year inventory

Dollar-value LIFO — Step 3

Match each inventory layer to its applicable price index

Dollar-value LIFO — Step 4

Restate each layer into current-year dollars by multiplying the layer by its applicable price index, then total the layers

Inventory turnover ratio

COGS ÷ average inventory; measures the number of times, on average, inventory is sold during the period

Average days in inventory

365 ÷ inventory turnover; estimates how many days, on average, resources are tied up in inventory before sale

Inventory impairment

A decline in inventory utility caused by damage, deterioration, obsolescence, price changes, or other factors; recognize the loss in the period the utility is impaired

Net realizable value (NRV)

Estimated selling price less reasonably predictable costs of completion, disposal, and transportation, such as sales commissions and shipping costs

Lower of cost or NRV (LCNRV)

For inventory measured using methods other than LIFO or the retail inventory method, report inventory at the lower of its cost or net realizable value

LCNRV — eligible cost methods

Applies when inventory is measured using methods such as FIFO, average cost, or specific identification; LIFO and the retail inventory method use lower of cost or market instead

LCNRV — application levels

Apply separately to each inventory item, each inventory classification, or inventory in total; choose the approach that most clearly reflects periodic income and apply it consistently

LCNRV adjustment

When NRV is below cost, reduce the reported inventory amount to NRV and recognize an inventory loss or increase in COGS

Allowance to reduce inventory to NRV

Contra-inventory account used to reduce inventory from cost to NRV; Credit balance. ;Inventory write-down loss

LCNRV journal entry — direct approach

Debit COGS or Inventory Loss and credit Inventory directly for the write-down

Lower of cost or market (LCM)

For inventory measured using LIFO or the retail inventory method, adjust inventory to the lower of cost or market when utility is impaired

Market under LCM

Current replacement cost, limited by a ceiling and a floor

LCM ceiling

Net realizable value; market cannot exceed this amount

LCM floor

Net realizable value less a normal profit margin; market cannot fall below this amount

Relative sales value method

Allocates a lump-sum cost among multiple items based on each item's relative sales value

Relative sales value allocation formula

Allocated cost for an item = total lump-sum cost × (item's estimated sales value ÷ total estimated sales value of all items)

Gross profit method

An inventory-estimation method that assumes the gross profit rate on recent sales can estimate COGS on current sales; the slides state that it is not an acceptable method under GAAP

Gross profit percentage of sales

Gross profit ÷ sales; also called markup on sales

Markup on cost

Gross profit expressed as a percentage of cost; convert it to gross profit as a percentage of sales before using the gross profit method

Convert markup on cost to gross profit percentage of sales

If markup on cost is given as a rate m, gross profit percentage of sales = m ÷ (1 + m)

Gross profit method — estimated COGS

Sales × (1 − gross profit percentage of sales) = estimated COGS

Gross profit method — estimated ending inventory

Cost of goods available for sale − estimated COGS = estimated ending inventory

Gross profit method — uses

Can test the reasonableness of inventory valuation, estimate inventory for interim reporting, estimate inventory destroyed, and develop budgets

Gross profit method — limitations

The estimate may be inaccurate; historical gross profit rates may be unreliable and rates may vary widely across inventory types

Purchase commitment

A firm agreement to purchase inventory in the future

Purchase commitment disclosure

Disclose a purchase commitment when it is noncancelable and material

Purchase commitment loss recognition

Recognize a loss when the contract price exceeds market for LIFO or retail-method inventory, or exceeds NRV for other inventory methods

Purchase commitment recovery

Do not recognize a subsequent recovery of an estimated loss on a purchase commitment

Voluntary change in inventory accounting principle

Generally apply the new accounting principle retrospectively to all financial statements presented

Retrospective application

Apply the new accounting method to prior periods presented and adjust the opening retained earnings balance of the earliest year presented for the cumulative effect before the periods shown

Retrospective inventory-method change entry

Adjust Inventory and beginning Retained Earnings for the cumulative effect of changing to the new accounting principle, with related tax effects when applicable

Exception — change to LIFO

A change from another inventory method to LIFO may be applied prospectively because reconstructing prior LIFO layers is often impractical

Prospective change to LIFO

Beginning inventory becomes the LIFO base inventory; use LIFO for current and future periods, and no entry is required on the date of change

Inventory error discovered before statements are issued

Correct the financial statements before they are issued