303 Exam 2- CH. 7

Question 1

Beginning inventory plus the cost of goods purchased or manufactured is the

Answer 1

cost of goods available for sale

Question 2

The total cost of inventory that remains on hand that will be reported on the Balance Sheet as a current asset

Answer 2

Ending inventory

Question 3

The total cost of the items that were sold that will be reported as an expense on the income statement

Answer 3

Cost of Goods Sold

Question 4

Computation of COGS

Answer 4

Beginning Inventory
+ COG Purchased
= Total COG available for sale
- Ending Inventory
= COGS during the year

Question 5

Perpetual Inventory System

Answer 5

continuously tracks inventory (Walmart); records all purchases and sales as they occur

Question 6

Accounting features of a Perpetual Inventory System

Answer 6

1. Purchases of merchandise for resale or raw materials for production are debited to Inventory rather than to Purchases.
2. Freight-in is debited to Inventory, not Purchases. Purchase returns and allowances and purchase discounts are credited to Inventory rather than to separate accounts.
3. Cost of goods sold is recorded at the time of each sale by debiting Cost of Goods Sold and crediting Inventory.
4. A subsidiary ledger of individual inventory records is maintained as a control measure. The subsidiary records show the quantity and cost of each type of inventory on hand.

Question 7

Periodic Inventory System

Answer 7

a company determines the quantity of inventory on hand only periodically (Courthouse);
provides a continuous record of the balances in the COGS and Inventory accounts

Question 8

It is rare that inventory would ever have a 0 balance

Question 9

Companies sometimes report the difference in Inventory Over and Short rather than the Cost of Goods Sold account.

Answer 9

Inventory Over and Short is reported on the income statement in the “Other revenue and gains” or “Other expenses and losses” section.

Question 10

A company using the periodic inventory system does not report the account Inventory Over and Short.

Answer 10

The reason: The periodic method does not have accounting records against which to compare the physical count.
As a result, a company buries inventory overages and shortages in Cost of Goods Sold.
This is a disadvantage of the periodic method because a company may not be aware that goods are being stolen, spoiling, or being thrown away. The company can only count what is on hand and assume that the rest of the goods were sold.

Question 11

A company recognizes inventory and accounts payable at the time it controls the asset

Answer 11

Control therefore is the key factor in determining when purchases and sales are recognized

Question 12

Passage of title rule

Answer 12

f.o.b. shipping point- title passes to buyer when supplier delivers the goods to the common carrier
f.o.b. destination- title passes to the buyer only when it receives the goods from the common carrier

Question 13

Consignment Shipment

Answer 13

a company (the consignor) ships various merchandise to another company (the consignee) which acts as an agent in selling the consigned goods- vendor situation

Question 14

Goods on consignment remain the property of the consignor:

Answer 14

Although the consignee has physical possession of the goods, it does not have control because legal title (and risk and rewards) is still the consignors

Question 15

The consignee makes no entry to the inventory account for goods received

Question 16

Product Costs

Answer 16

costs directly connected with bringing the inventory to the buyer’s place of business and converting the goods to a salable condition

Question 17

Period costs

Answer 17

indirectly related to the acquisition of goods and are generally more difficult to assign to specific inventory items

Question 18

Product cost examples

Answer 18

freight charges on goods purchased
insurance costs incurred by buyer while goods are in transit
unpacking and unloading costs
preparing goods for sale

Accounting Treatment: Including in the inventory asset account in the balance sheet

Question 19

Period cost examples

Answer 19

Selling expenses related to inventory
Interest costs related to financing inventory purchases
General and administrative costs related to inventory

Accounting Treatment: Expensed as incurred in the income statement

Question 20

Purchase Discounts from purchaser’s perspective

Answer 20

a recorded discount if the company pays within the discount period; accounted for using gross or net methods; company reports discount as a deduction from purchases when determining COGS

Question 21

Gross method under periodic inventory system

Answer 21

records the purchases and accounts payable at the invoice price (gross amount)

Question 22

Net method

Answer 22

company recognizes the purchase and related accounts payable at the invoice price less the cash discount

if the company does not take the discount within the discount period it records a “Purchase Discount Loss” which is a financial expense and is reported in the “Other expenses and losses” of the Income Statement

Question 23

Net method is considered better for 2 reasons

Answer 23

1. it provides a correct reporting of the cost of the asset and related liability
2. It can measure management inefficiency by holding management responsible for discounts not taken

Question 24

Companies record purchases of inventory at historical cost when they obtain control of the goods

Answer 24

COGS is recorded at the time of the sale

Question 25

Record COGS using one of three cost flow assumptions:

Answer 25

1. Average-cost 2. First-in, first-out (FIFO) 3. Last-in, first out (LIFO) In many cases, companies that use the LIFO method follow an approach called dollar-value LIFO

Question 26

Determine ending inventory and COGS using 4 cost flow assumptions

Answer 26

1. Specific Identification 2. Average-cost 3. FIFO 4. LIFO

Question 27

Specific Identification

Answer 27

identifying the specific cost of each item sold and each item left in inventory; used only in instances where it is practical to separate physically the different purchases made; companies only use this method when handling a relatively small number of costly, easily distinguishable items Examples: some jewelry, cars, and furniture or special orders, or contract orders

Question 28

Under specific identification the cost flow matches the physical flow of the goods- matches actual cost against actual revenue and reports ending inventory at actual cost

Answer 28

a business manager can manipulate net income by delivering to the customer the higher or lower cost item, depending on whether the company seeks lower or higher reported earnings for the period

Question 29

Average Cost Method

Answer 29

tracks inventory items on the basis of the average cost of a similar goods available during the period; varies depending on use of periodic or perpetual inventory system

Question 30

When using the perpetual inventory method

Answer 30

companies use the moving-average method; since the inventory account is continuously updated for purchases of inventory, the average inventory cost will change each time a purchase is made resulting a "moving-average"

Question 31

Average cost methods have these advantages

Answer 31

They are both simple to apply and objective They are not as subject to income manipulation as some of the other inventory costing methods

Question 32

It is better to cost items on a average-price basis

Answer 32

measuring a specific physical flow of inventory is often impossible, especially when dealing with similar inventory items

Question 33

FIFO method

Answer 33

assumes a company sells goods in the order in which it purchased them; inventory remaining is most recent purchases

Question 34

LIFO method

Answer 34

matches the cost of the last goods purchased against revenue; amounts calculated for ending inventory and COGS will be different when using a perpetual system vs periodic Periodic system matches the total withdrawals for the month with the total purchases for the month in applying the LIFO method

Question 35

when a sale occurs, a perpetual system assigns the cost from the immediately preceding purchase

Question 36

LIFO

Answer 36

results in the lowest gross profit, income tax, and net income because the higher inventory costs are included in the cost of goods sold. The lower inventory costs are left in ending inventory on the balance sheet

Question 37

FIFO

Answer 37

results in the highest gross profit, income tax, and net income because the lower inventory costs are included in cost of goods sold. The higher inventory costs are left in ending inventory on the balance sheet

Question 38

Average Cost

Answer 38

result in gross profit, income tax, net income, and inventory amounts that are between FIFO and LIFO

Question 39

If the inventory costs are declining during the period

Answer 39

FIFO would have the lowest net income, and LIFO would have the highest

Question 40

If a company uses LIFO for the tax benefit of paying less income tax

Answer 40

it must also use LIFO for financial reporting purposes (LIFO conformity rule) Essentially if a company wants to take advantage of lower taxes, it must also report lower income and inventory in its financial statements

Question 41

Once a company selects a costing method it must apply it consistently thereafter

Answer 41

if conditions indicate that the inventory costing method in use id unsuitable, the company must seriously consider all other possibilities before selecting another method and it should clearly explain any change and disclose its effect in the financial statements

Question 42

Switching between FIFO and LIFO methods

Answer 42

will trigger tax consequences

Question 43

FIFO and Average-cost methods better reflect the current value of inventory on the balance sheet

Question 44

Companies that use LIFO for tax and external reporting purposed often maintain a FIFO or average-cost system for internal reporting

Question 45

companies often base their sales pricing decisions on a FIFO or average-cost assumption, rather than on a Lifo basis

Question 46

recordkeeping on some other basis is easier because the LIFO assumption usually does not approximate the physical flow of the product

Question 47

profit-sharing and other bonus arrangements often depend on a non-LIFO inventory assumption

Question 48

the use of a pure LIFO system is troublesome for interim periods, which require estimates of year-end quantities and prices

Question 49

at the end of the period when it's time to prepare financial statements, a company makes an entry to adjust the internal reporting system to the LIFO amounts for ending inventory and COGS

Answer 49

Companies use an allowance account to record this adjustment, rather than adjusting the inventory account directly- Allowance to Reduce Inventory to LIFO (LIFO Reserve)

Question 50

LIFO Reserve

Answer 50

change in the allowance balance from one period to the next is the LIFO Effect

Question 51

current ratio

Answer 51

current assets / current liabilities; shows companies liquidity; higher ratio indicates that a company is better able to meet it current obligations when they are due

Question 52

Inventory Adjustment

Answer 52

LIFO Inventory + LIFO Reserve = FIFO Inventory

Question 53

Traditional LIFO is unrealistic because

Answer 53

1. When a company has many different inventory items, the accounting cost of tracking each inventory item is expensive 2. A rapid decline in a company's LIFO Inventory levels can occur. This results in considerably older inventory being matched with current revenues which distorts net income and leads to substantial tax payments- LIFO Liquidation

Question 54

To alleviate the LIFO liquidation

Answer 54

companies can combine goods into pools

Question 55

a pool groups items of a similar nature

Answer 55

instead of only identical units, company combines and counts as a group, a number of similar units or products

Question 56

Specific-goods pooled LIFO approach

Answer 56

results in fewer LIFO liquidations because the reduction of one quantity in the pool may be offset by an increase in another

Question 57

Specific-goods pooled LIFO approach

Answer 57

eliminates some of the disadvantages of the specific-goods (traditional) accounting for LIFO inventories

Question 58

this pooled approach, using quantities as its measurement basis, created two main problems:

Answer 58

1. most companies continually change the mix of their products, materials, and production methods. As a result, in employing a pooled approach using quantities, companies must continually redefine the pools. 2. Approach often results in "erosion" (LIFO liquidation) of the layers, losing much of the LIFO costing benefit. Erosion of the layers occurs when a specific good or material in the pool is replaced with another good or material. the new item may not be similar enough to be treated as a part of the old pool. a company may need to recognize any inflationary profit deferred on the old goods as it replaces them

Question 59

Dollar-Value LIFO

Answer 59

overcomes the problems of redefining pools and eroding layers; determines and measures any increases and decreases in a pool in terms of total dollar value, no the physical quantity of the goods in the inventory pool.

Question 60

Approach has two important advantages over the specific-goods pooled

Answer 60

1. Companies may include a broader range of goods in a dollar-value LIFO pool 2. A dollar-value LIFO pool permits replacement of goods that are similar items, similar in use, or interchangeable In contrast, a specific-goods LIFO pool only allows replacement of items that are substantially identical

Question 61

Dollar-Value LIFO helps protect LIFO layers of erosion.

Answer 61

companies frequently use the dollar-value LIFO method in practice; companies use the more traditional LIFO approaches only when dealing with few goods and expecting little change in product mix

Question 62

The following holds true

Answer 62

the more goods included in a pool, the more likely that increases in the quantities of some goods will offset decreases in other goods in the same pool which avoids liquidation of the LIFO layers Fewer pools means less cost and less chance of a reduction of a LIFO layer

Question 63

If the ending inventory at base-year prices is less than the beginning inventory at base-year prices, a company must subtract the decrease from the most recently added layer.

Answer 63

When a decrease occurs, the company "peels off" previous layers at the prices in existence when it added the layers

Question 64

The ending inventory at base-year prices must always equal the total of the layers at base-year prices.

Question 65

Many companies use the general price-level index that the federal government prepares and publishes each month

Answer 65

the most popular general external price-level index is the Customer Price Index for Urban Consumer (CPI-U)

Question 66

Companies also use more-specific external price indexes

Question 67

Double-Extension method

Answer 67

the desired approach is to price ending inventory at the most current cost

Question 68

General formula for computing the index

Answer 68

Ending Inventory for the Period at Current Cost / Ending Inventory for the Period at Base-Year Cost = Price Index for Current Year

Question 69

Primary issue with dollar value LIFO

Answer 69

selection of items to be put in a pool can be subjective and lead to income manipulation

Question 70

If ending inventory is understated

Answer 70

working capital (CA - CL) and current ratio (CA/CL) are understated

Question 71

If COGS is overstated

Answer 71

Net income is understated

Question 72

Omission of goods from purchases and ending inventory results in an understatement of inventory and accounts payable in the balance sheet