Inventory

Question 1

How do companies report products held prior to sale and after sale

Answer 1

Prior to sale as inventory a current asset

After sale the cost of the inventory becomes expense Cost of Goods sold in the income statement

Question 2

What are two main systems for keeping inventory records and explain them

Answer 2

Perpetual system - keeps a continuous record of inventories and cost of goods sold

Periodic system - computes cost of goods sold and an updated inventory balance only at the end of the accounting period

Question 3

What are the journal entries for recording when inventory is purchased and sold

Answer 3

When inventory is purchased: Debit Merchandise inventory and credit Accounts payable
When inventory is sold: Debit Accounts receivable and credit Sales

Question 4

Problems with perpetual inventory system

Answer 4

shoplifting or embezzlement or spoilage

Question 5

Under periodic inventory system what is the formula for cost of goods available for sale

Answer 5

Beginning Inventory+Purchases=Cost of Goods available for sale

Question 6

Under periodic inventory system what is the formula for cost of goods sold

Answer 6

COG available for Sale - Ending inventories by physical count = Cost of goods sold

Question 7

When do physical counts of inventory happen - needed regardless of system at least once a year

Answer 7

Firms often choose fiscal accounting periods so that the year ends when inventories are low - Ex: year end of January 31st

Question 8

What does FOB destination mean

Answer 8

When the seller bears the transportation cost, the sales invoice reads free onboard or F.O.B destination

Question 9

What does FOB shipping point mean

Answer 9

When the buyer bears the transportation cost it reads F.O.B shipping point

Question 10

Where does freight in appear on the income statement

Answer 10

Freight-in appears in the purchases section of an income statement as an additional cost of the goods acquired during the period

Question 11

How do transportation charges, cash discounts and purchase returns or allowances affect cost of goods sold

Answer 11

To calculate the cost of goods sold, cash discounts on purchases and purchase returns and allowances are subtracted from purchases

Also Freight in is added to net purcahses to get total cost of merchanise acquired

Question 12

What type of t account are cash discounts we give out and receive placed in?

Answer 12

Cash discounts we give out will be a contra revenue account

Cash discounts we receive will be a contra purchases account

Question 13

What are the four inventory valuation methods

Answer 13

Specific identification
First-in, first-out (FIFO)
Last-in, First-out (LIFO)
Weighted average

Question 14

Explain specific identification

Answer 14

The specific identification method concentrates on physically linking the particular items sold with the cost of goods sold that is reported
This method is relatively easy to use for expensive low-volume merchandise

also known as cherry picking

Question 15

Explain FIFO

Answer 15

Assigns the cost of the earliest acquired units to cost of goods sold
The costs of newer units is assigned to the units in ending inventory
FIFO provides inventory valuations that closely approximate the actual market value of the inventory at the balance sheet date

Question 16

Explain LIFO

Answer 16

Assigns the most recent cost to cost of goods sold
In a period of rising prices and constant or growing inventories, LIFO yields lower net income
The internal Revenue Code requires companies that use LIFO for tax purposes to also use it for financial reporting purposes difference

Question 17

Explain the weighted average valuation

Answer 17

The weighted average method computes a unit cost by dividing the total acquisition cost of all items available for sale by the number of units available for sale

Question 18

What are cash flow assumptions

Answer 18

Accountants often refer to inventory methods as cost flow assumptions - LIFO/FIFO/ Weighted average

Question 19

What is the difference between LIFO and FIFO in a period of rising prices

Answer 19

Fifo has higher ending invenotry, lwoer COGS and higher net income

Lifo has lower ending inventory, Higher COGS, lower net income

Question 20

What is the difference between LIFO and FIFO in a period of falling prices

Answer 20

Lifo has higher ending inventory, lower COGS and higher net income

Fifo has lower ending inventory, Higher COGS, lower net income

Question 21

Can a company switch methods of valuation?

Answer 21

A change in market conditions may justify a change in inventory method
The firm must note the change in its financial statements - must declare the change
otherwise companies must be consistent

Question 22

Where is LIFO used most and why

Answer 22

Has strong tax benefits for companies
- widely used int he US
LIFO and it is not permitted under IFRS

Question 23

What is meant by lifo liquiidation

Answer 23

When the physical amount of inventory decreases and the cost of goods sold consists of old, low inventory acquisition costs associated with old LIFO layers. This means that the year’s income includes the cumulative inventory profit from years of increasing prices

Question 24

What is a LIFO reserve

Answer 24

The difference between a company’s LIFO inventory level and what it would be under FIFO is called a LIFO reserve

Question 25

Explain market price

Answer 25

Market price is generally considered to be the replacement cost of the inventory item-what it would cost to buy the inventory item today

Question 26

Explain a write down and the appropriate journal entry

Answer 26

A write down reduces the recorded historical cost of an item in response to a decline in value
The required journal entry for a write-down is:
Debit Loss on write-down of inventory(COGS) and credit inventory

Question 27

Formula for COGS

Answer 27

COGS = Beginning inventory+purchases-Ending inventory

Question 28

What happens if ending inventory is understated or overstated

Answer 28

If ending inventory is understated retained earnings in understated
If ending inventory is overstated, retained earnings is overstated

Question 29

Inventory turnover formula

Answer 29

Cost of Goods sold /average inventory

Question 30

Average inventory formula

Answer 30

(Beginning inventory+ending inventory)/2

Question 31

Days inventory lies around on average formula

Answer 31

365/inventory turnover in years

Question 32

What’s the relationship between gross profit % and inventory turnover

Answer 32

Industries with higher gross profit percentages tend to have lower inventory turnover

Question 33

Define shrinkage

Answer 33

difference between the cost of inventory from a physical count and the inventory balance in the general ledger

Question 34

What would be the journal entry to record shrinkage under perpetual system

Answer 34

To adjust inventory balance:
Inventory shrinkage DR
Inventory CR

To transfer shrinkage to COGS:
Cost of goods sold DR
Inventory shrinkage CR

Question 35

How does a periodic system deal with shrinkage

Answer 35

Cost of goods sold automatically includes inventory shrinkage by virtue of the system
Shrinkage is much more difficult to isolate in the periodic system

Question 36

What is VAT

Answer 36

Tax payable on inputs and outputs

Question 37

Journal entry for Buying goods inclusive of VAT

Answer 37

Inventory debit = Price minus VAT
VAT payable debit = VAT amount paid
A/P credit - Full amount paid inclusive of VAT

Question 38

Journal entry selling goods inclusive of VAT

Answer 38

A/R debit = full price received
Revenue credited with price charged without tax
Tax payable credited = tax amount the customer paid