Acct 351 Chapter 08

Question 1

allowance method

Answer 1

A method of estimating uncollectible accounts receivable whereby bad debt expense is recorded in the same period as the sale to obtain a proper matching of expense and revenues and to achieve a proper carrying value for accounts receivable. (Synonym: indirect method)

Question 2

asset retirement costs

Answer 2

These are costs recognized at the same time as the liability associated with the retirement of an asset is recognized

Question 3

average days to sell inventory

Answer 3

A variable of the inventory turnover ratio that represents the average age of the inventory on hand or the number of days it takes to sell inventory once purchased

Question 4

basket purchase

Answer 4

When a group of units with different characteristics is purchased at a single lump-sum price

Question 5

consigned goods

Answer 5

Goods that are sold on consignment yet remain the consignor’s property and therefore must be included in inventory

Question 6

conventional retail inventory method

Answer 6

A method to value inventory that uses the cost-to-retail ratio incorporating net markups but excluding net markdowns. This method is designed to approximate the lower of average cost and market.

Question 7

Conversion costs

Answer 7

A type of product cost that includes labour and allocated fixed and variable production overhead costs incurred in processing materials into finished goods

Question 8

cost formula

Answer 8

A method of assigning inventory costs incurred during the accounting period to inventory that is still on hand at the end of the period. The three acceptable formulas are: specific identification; first-in, first-out (FIFO); and weighted average cost

Question 9

cost of goods available for sale or use

Answer 9

This is the total of (1) the cost of goods on hand at the beginning of the period and (2) the cost of the goods acquired or produced during the period

Question 10

cost of goods manufactured

Answer 10

The costs of goods that are completed and transferred to Finished Goods Inventory

Question 11

cost of goods sold

Answer 11

This is the difference between those goods available for sale during the period and those on hand at the end of the period

Question 12

cost-to-retail ratio

Answer 12

A ratio used in the retail inventory method determined by dividing goods available for sale at cost, by the goods available for sale at retail

Question 13

current ratio

Answer 13

The ratio of total current assets to total current liabilities

Question 14

cut-off schedule

Answer 14

Prepared by the accountant for the end of the period to ensure that goods received from suppliers around the end of the year are recorded in the appropriate period

Question 15

direct method

Answer 15

Where cash flow is derived from operating activities directly by identifying the sources of the cash receipts and payments

Question 16

executor contract

Answer 16

An agreement requiring continuing performance by both parties

Question 17

f.o.b. destination

Answer 17

The legal title of an asset does not pass to the buyer until the goods reach the customer’s location

Question 18

f.o.b. shipping point

Answer 18

The legal title of an asset belongs to the buyer when the goods leave the shipping dock.

Question 19

finished goods inventory

Answer 19

The reporting of the costs associated with the completed but unsold units at the end of the fiscal period

Question 20

first-in, first-out (FIFO) cost formula

Answer 20

The method that assigns cost to inventory assuming that goods are used in the order in which they are purchased

Question 21

gross method

Answer 21

The use of a Purchase Discounts account indicates that the company is reporting its purchases and accounts payable at the gross amount

Question 22

gross profit method

Answer 22

A method for estimating inventory where taking a physical count is impractical or impossible. It is based on three assumptions: (1) the beginning inventory plus purchases equal total goods to be accounted for; (2) goods not sold must be on hand; (3) and when the net sales, reduced to cost, are deducted from the total goods to be accounted for, the result is the ending inventory

Question 23

gross profit percentage

Answer 23

The gross profit expressed as a percentage of sales.

Question 24

indirect method

Answer 24

Where cash flow is derived from operating activities indirectly by making the necessary adjustments to net income reported on the income statement

Question 25

inventory turnover ratio

Answer 25

A ratio that measures the number of times, on average, the inventory was sold during the period

Question 26

joint cost

Answer 26

A cost of purchasing or producing multiple items that must be allocated between the multiple products

Question 27

last-in, first-out (LIFO) cost formula

Answer 27

A method no longer permitted under PE GAAP and IFRS that assigns inventory costs on the assumption that the cost of the most recent purchase is the first cost to be charged to cost of goods sold

Question 28

lower of cost and market (LCM)

Answer 28

A basis for stating inventory at the lower of its original cost and the net realizable value at the end of the period

Question 29

lower of cost and net realizable value

Answer 29

A basis for stating inventory at the lower of its original cost and the net realizable value at the end of the period

Question 30

lower of cost and net realizable value (LC&NRV) standard

Answer 30

A basis for stating inventory at the lower of its original cost and the net realizable value at the end of the period.

Question 31

Markdown cancellations

Answer 31

When markdowns are offset by the increase in the prices of goods that had been previously marked down.

Question 32

Markdowns

Answer 32

A decrease in price below the original selling price

Question 33

market

Answer 33

There are several meanings possible for this use of the term market, including net realizable value, replacement cost, or net realizable values less a normal profit margin. Canadian GAAP and IFRS now strictly define “market” as net realizable value

Question 34

markup

Answer 34

An increase in the price above the original selling price

Question 35

Markup cancellations

Answer 35

Decreases in the price of items that had been marked up above the original retail price.

Question 36

markup on cost

Answer 36

The selling price is determined by a rate being equal to the gross profit as a percentage of cost

Question 37

merchandise inventory

Answer 37

Inventory purchased in a form ready for sale

Question 38

moving-average cost formula

Answer 38

An inventory pricing method that prices inventory items based on the moving-average cost of the goods available for sale in the period

Question 39

net markdowns

Answer 39

Markdowns less markdown cancellations

Question 40

Net markups

Answer 40

Markups less markup cancellations

Question 41

net method

Answer 41

When purchases and accounts payable are recorded at an amount net of cash discounts

Question 42

net realizable value (NRV)

Answer 42

The net amount expected to be received in cash for an asset

Question 43

normal production capacity

Answer 43

The usual amount of goods that a company can produce in a year, and the basis for allocating fixed production costs

Question 44

onerous contract

Answer 44

A contract where the unavoidable costs of completing the contract are higher than the benefits expected from receiving contracted goods or services. A loss provision is recognized for such a contract under IFRS, though such a provision is not stipulated under GAAP in Canada

Question 45

period costs

Answer 45

Costs, such as selling and administrative, that are not considered directly related to the acquisition or production of goods and, therefore, are not considered a part of inventory

Question 46

periodic inventory system

Answer 46

The inventory recording system where a Purchases account is used and the Inventory account is unchanged during the period. At the end of the accounting period, the Inventory account must be adjusted by closing out the beginning inventory amount and recording the ending inventory amount. Cost of goods sold is, therefore, determined by adding the beginning inventory to the net purchases and deducting ending inventory

Question 47

perpetual inventory system

Answer 47

The inventory recording system where purchases and sales are recorded in the Inventory account as they occur

Question 48

Product costs

Answer 48

Those costs that “attach” to the inventory and are recorded in the Inventory account

Question 49

product financing arrangement

Answer 49

An inventory financing arrangement without reporting either the liability or the inventory on its balance sheet such as a “sale” with either an implicit or explicit “buyback” agreement. (Synonym: parking transactions)

Question 50

purchase commitments

Answer 50

When a company agrees to buy inventory weeks, months, or even years in advance

Question 51

purchase discounts

Answer 51

A reduction in the price of inventory in order to induce prompt payment

Question 52

quantities only system

Answer 52

A system of tracking inventory that records increases and decreases in quantities only—not dollar amounts

Question 53

raw materials inventory

Answer 53

The costs assigned to goods and materials on hand, but not yet placed into production

Question 54

relative sales value method

Answer 54

A method used to apportion a total cost or sales amount to individual components. Commonly used whenever there is a joint product cost that needs to be allocated or in a “basket” purchase or sale.

Question 55

retail inventory method

Answer 55

A method of valuing inventory when necessary, where inventory taken at its selling price (retail) can be converted to inventory at cost by applying the cost-to-retail formula

Question 56

specific identification

Answer 56

Where each inventory item is identified separately, the costs of the specific item sold are included in cost of goods sold, and the cost of the specific items on hand is included in inventory

Question 57

standard cost system

Answer 57

A system that predetermines unit costs for material, labour and manufacturing overhead based on costs that should be incurred at normal levels of efficiency and capacity

Question 58

vendor rebate

Answer 58

A retroactive discount on goods if the buyer meets certain criteria, such as purchasing a target quantity within a year

Question 59

weighted average cost formula

Answer 59

A cost formula that determines the average cost of inventory weighted by the number of units purchased at each unit cost. It is calculated as the cost of goods available for sale divided by the number of units available for sale

Question 60

work-in-process inventory

Answer 60

The cost of the raw material on which production has been started but not completed, plus the direct labour cost applied specifically to this material, and an applicable share of manufacturing overhead costs.

Question 61

Define inventory and identify inventory categories

Answer 61

Only one inventory account, Merchandise Inventory, appears in the financial statements of a merchandising concern. A manufacturer normally has three inventory accounts: Raw Materials, Work in Process, and Finished Goods. There may also be an inventory account for factory or manufacturing supplies

Question 62

Identify the decisions that are needed to determine the inventory value to report on the balance sheet under a lower of cost and net realizable value model

Answer 62

To determine the balance sheet inventory amount, you need to decide which physical goods are included in inventory, what expenditures are included in “cost,” what cost formula to apply, and finally, whether there has been any impairment in value

Question 63

Identify the physical inventory items that should be included in ending inventory

Answer 63

Generally, inventory is included on the balance sheet of the entity that has legal title to the goods; i.e., the company that has the risks and rewards of ownership. Consigned goods remain the property of the consignor. Exceptions to the general rule of legal title are made when the risks and rewards associated with ownership have been transferred and title has

Question 64

Determine the components of inventory cost

Answer 64

Inventory costs include all costs of purchase, conversion, and other costs incurred in bringing the inventories to the present location and condition necessary for sale. Such charges include freight charges on goods purchased, other direct costs of acquisition, and labour and other direct production costs incurred in processing the goods up to the time of sale. Manufacturing overhead costs are allocated to inventory based on the normal capacity of the production facilities

Question 65

Distinguish between perpetual and periodic inventory systems and account for them

Answer 65

Under a perpetual inventory system, a continuous record of changes in inventory is maintained in the Inventory account. That is, all purchases into and transfers of goods out of the account are recorded directly in the Inventory account as they occur. No such record is kept under a periodic inventory system. Under the periodic system, year-end inventory is determined by a physical count, and the amount of ending inventory and cost of goods sold is based on this count. Even under the perpetual system, an annual count is needed to test the accuracy of the records

Question 66

Identify and apply GAAP cost formula options and indicate when each cost formula is appropriate

Answer 66

The specific identification method is used to assign costs for items of inventory that are not ordinarily interchangeable or that are produced for specific projects. The weighted-average or first-in, first-out cost formula is used to assign costs to other types of inventory. All inventory items that have a similar nature and use to the entity apply the same cost formula.

Question 67

Explain why inventory is measured at the lower of cost and market, and apply the lower of cost and net realizable value standard

Answer 67

Current assets should not be reported on the balance sheet at a higher amount than the net cash that is expected to be generated from their use or sale. When this amount is less than “cost,” inventory is written down and the loss in value is recognized in the same period as the decline. Net realizable value is the estimated selling price in the ordinary course of business reduced by the expected costs to complete and sell the goods. Ordinarily, each item’s cost and NRV are compared and the lower value is chosen. However, items that are related to each other and have similar purposes, that are produced and marketed in the same geographical area, and that cannot be evaluated separately from other items may be grouped and the lower of the group’s cost and net realizable value is chosen

Question 68

Explain the accounting issues for purchase commitments

Answer 68

Generally if purchase commitments are significant relative to the company’s financial position and operations, they should be disclosed in a note to the financial statements. At the balance sheet date, if a contract requires future payments in excess of its future economic benefits, a loss is recognized, offset by a liability. This accounting treatment is similar to recognizing impairments on inventory

Question 69

Identify inventories that are or may be valued at amounts other than the lower of cost and net realizable value

Answer 69

Inventories of financial instruments, construction contract work in process, biological assets related to agricultural activity, agricultural produce at the point of harvest and after harvest, inventories held by producers of agricultural and forest producers, mineral products, and inventories of commodity broker-traders all may be accounted for at other than the lower of cost and net realizable value

Question 70

Identify the effects of inventory errors on the financial statements and adjust for them

Answer 70

If the ending inventory is misstated, (1) the inventory, retained earnings, working capital, and current ratio in the balance sheet will be incorrect; and (2) the cost of goods sold and net income in the income statement will be incorrect. If purchases and inventory are misstated, (1) the inventory, accounts payable, and current ratio will be incorrect; and (2) purchases and ending inventory will be incorrect

Question 71

Apply the gross profit method of estimating inventory

Answer 71

Ending inventory is determined by deducting an estimate of cost of goods sold from the actual cost of goods available for sale. Cost of goods sold is estimated by multiplying net sales by the percentage of cost of goods sold to sales. This percentage is derived from the gross profit percent: 100% – gross profit percentage = cost of goods sold percentage.

Question 72

Identify the type of inventory disclosures required by accounting standards for private enterprises (private entity GAAP) and IFRS

Answer 72

Private entity GAAP requires disclosure of how cost is determined, inventory that is pledged as security, the amount charged to the income statement as expense in the period, and the inventories’ carrying value by category. Additional information is required by IFRS, including details about inventory impairment writedowns and any recoveries, the circumstances responsible for these, and the carrying amounts and reconciliations of items measured at NRV or fair value.

Question 73

Explain how inventory analysis provides useful information and apply ratio analysis to inventory

Answer 73

Common ratios that are used in the management and evaluation of inventory levels are the inventory turnover and a related measure, average days to sell the inventory, often called the average age of inventory. This is useful information as excessive investment in inventory is expensive to carry, yet too little inventory results in lost sales and dissatisfied customers

Question 74

Identify differences in accounting between accounting standards for private enterprises (private entity GAAP) and IFRS, and what changes are expected in the near future

Answer 74

Recent changes to both IAS 2 and CICA Handbook standards on inventory (Section 3031) result in Canadian and international standards being substantially harmonized. There are international but not Canadian standards on the measurement of agricultural and construction inventories, on the capitalization of borrowing costs on qualifying assets, and on onerous contracts, but no major differences in how these costs are accounted for between the two jurisdictions. No major changes are expected in the near future

Question 75

Apply the retail method of estimating inventory

Answer 75

The retail inventory method is based on converting the retail price of ending inventory by a cost-to-retail percentage (derived from information in the accounting and supplementary records). To use this method, records must be kept of the costs and retail prices for beginning inventory, net purchases, and abnormal spoilage, as well as the retail amount of net markups, net markdowns, and net sales. Which items go into the numerator and denominator of the cost-to-retail ratio depends on the type of inventory valuation estimate that is wanted