Ch. 9 Flashcards Preview

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Flashcards in Ch. 9 Deck (82):
1

When inventory declines whatever the reason (damage, physical deterioration, obsolescence, changes in price levels and other causes) a company should write down

The inventory to net realizable value to report loss

2

When does the company abandon the historical cost principle?

When the future utility (revenue producing ability) of the asset drops below its original cost

3

Cost is

Acquisition price of inventory computed using one of the historical cost based methods - specific identification, average cost, LIFO or FIFO

4

NRV

Is the net amount that a company expects to realize from the sale of inventory

5

NRV is the estimated selling price

In the ordinary course of business less reasonably predictable costs of completion disposal and transportation

6

LCRNV

Companies estimate NRV based on

Most predictable evidence of inventories realizable amounts (expected selling price, expected costs of completeion, disposal and transportation)

7

Companies usually value inventory on

Item by item basis

8

Individual item approach gives the most

Conservative valuation for balance sheet purposes

9

Company values inventory on total inventory basis when

It offers only one end product (comprised of many different raw materials)

10

A category approach is used when it

Produces several end products

11

Whatever method is used, the method should be

Consistent from one period to another

12

2 methods to record income effect of valuing inventory at NRV.

1
2

1. COGS method
2. LOSS method

13

COGS method

Debits COGS sold for write down of inventory to NRV

As a result the company does not report a loss on income statement bc COGS already includes the amount of loss

14

Loss method

Debits loss account for write down of inventory to NRV

15

Loss method is more preferable bc

It clearly discloses the loss resulting from a decline in inventory to NRV

16

With respect to accounting for allowance in the subsequent period of the company still has merchandise on hand, it should

Retain the allowance account

17

If the allowance account is not kept then the company will

Overstate beginning inventory and cogs

18

If the company has sold the goods then it should

Close the account

19

A new allowance account is established for any

Decline in inventory value that takes place in the current year

20

Use of an allowance, multiple periods. In general accountants leave allowance account on the books. They adjust the balance at the next year end to agree with

Discrepancy between cost and LCNRV at balance sheet date

21

The use of the lower of cost or NRV method works well to measure?

The decline in value of a company's inventory for most companies

22

LCNRV is designed to ?

Simplify and reduce the cost and complexity of inventory measurement under GAAP.

23

When using LIFO or retail inventory methods, the change to LCNRV would result in significant cost upon

Transitions and would not simplify their subsequent measurement of inventory

24

LCM

Compare a designated market value of inventory to cost

This approach begins with replacement cost and two additional limitations are applied to ending inventory NRV AND NRV less normal profit margin

25

General lower of cost or market rule is

A company values inventory at the lower of cost or market, with market limited to an amount that is no more than NRV or less than NRV less than normal profit margin

26

Upper limit (ceiling)

NRV of inventory

27

Lower limit (floor)

NRV less a normal profit margin

28

What is the rationale for upper limit and lower limit?

Prevents companies from over and understating inventory

29

Maximum limitation not to exceed NRV (ceiling) prevents overstatement of

Value of obsolete damanaged or shopworn inventories

30

If replacement cost of item exceeds its net realizable value a company should not

Report inventory at replacement cost

The company can only receive the selling price less cost of disposal

31

The minimum floor is to not be

Less than NRV reduced by an allowance for approximately normal profit margin

32

Minimum Floor measures

What the company can receiver for the inventory and still earn normal profit

33

Designated market value

Amount company compares to cost

34

Designated market value is always

Middle value of three amounts , replacement cost, NRV and NRV less a normal profit margin

35

Support exists for recording inventory at NRV even if

Amount is above cost

36

GAAP permits exception to normal recognition rule under following conditions:

1. Controlled market with quoted price applicable to all quantities
2. When no significant costs of disposal are involved
3. Product is available for immediate delivery

37

Until items of inventory meet the NRV 3 conditions they are accounted for

Based on accumulated historical costs

38

NRV is allowed when it is too difficult to

Obtain cost figures

39

Lump sum purchase also called basket purchase

When a company buys a group of varying units

40

Company's survival and continued profitability depend on

It's having sufficient stock of merchandise to meet customer demand

41

Purchase commitments

Which are agreements to buy inventory weeks months or even years in advance

42

In the purchase commitments who retains title to merchandise or material?

Seller

43

It's usually not necessary for buyer to make any entries reflect commitments for purchases of goods that seller has not shipped

True

44

Ordinary orders for which buyer and seller will determine prices at the time of shipment and which are subject to cancellation do not represent either an asset or liability to buyer so therefore the buyer does not need to record

Such ourchase commitments or report them in financial statements

45

What happens though if buyers enter to a formal noncanceable purchase contract ?

Even then the buyer recognizes no asset or liability at the date of inception because the contract is "executory" in nature: neither party has fulfilled its pet of contract

46

If contract price > market price

Buyer expects that losses will occur when purchase is effected

47

Purchases can protect themselves against the possibility of market price declines of goods under contract by

Hedging

48

In hedging

The purchaser in the purchase commitment simultaneously enters into contract in which it agrees to sell in the future the same quantity or similar goods at fixed price


This the company holds a buy position in purchase commitment and a sell position in a futures contract in the same commodity

49

Gross profit method

One substitute method of verifying or determine the inventory amount

50

Gross profit method relies on 3 assumptions

1. Beginning inventory + purchases = goods to be accounted for

2. Goods not sold must be ok hand

3. Sales reduced to cost - sum of opening inventory + purchases = ending inventory

51

Gross profit percentage

Stated as % of selling price

52

Gross profit on selling price is the most common method for quoting profit for several reasons

1. Most companies state goods on retail basis not cost basis

2. A profit quoted on selling price is lower than one based on cost

53

Bc selling price exceeds cost and with gross profit amount being same for both, gross profit on

Selling price will always be less than related % based on cost

54

Gross profit method is normally unacceptable for financial reporting purposes bc

It provides only an estimate

55

GAAP permits gross profit method to determine

Ending inventory for interim reporting purposes, provided a company discloses the use of method

56

Gross method relies on

Historical records

57

Retail inventory method

Retailer uses formula to convert retail prices to cost

58

Retail inventory method requires the retail to keep a record of

1. Total cost and retail value of goods purchased


2. The total cost and retail value of goods available for sale

3. Sales for the period

59

Different versions of retail inventory method and it includes

Convential method (lower of average cost or msrket) , cost method , LIFO retail method and dollar value LIFO

60

Advantages of retail method is

Inventory balance can be approximated without physical count

61

To avoid potential ovrrstament of inventory, what is to be taken?

Periodic inventory counts

62

Retail inventory method is useful for any time of

Interim report bc the reports usually need a fairly quick and realiable measure of inventory

63

Retail inventory is used for

Estimate losses from fire flood or type of causality

Acts as control device bc company will have to explain deviations from physical count st end of year

It expedites physical inventory count @ end of yr

64

Markup

Additional markup of original retail price

65

Markup cancellations

Decrease in price of merchandise that a retailer had marked up above the original retail price

66

Markdowns

Decreases in original sale prices

67

Markdown cancellations occur when

Markdowns are later offset by increases in the prices of goods that retailer had marked down

68

Neither the markup cancellation nor markdown cancellation can exceed

Original Markup or markdown

69

Conventional retail inventory method

Approximates lower of average cost or market

70

To approximate the lower of cost or market we would consider markdowns a current loss and so it will

Not be include in calculating cost to retail ratio

71

Special items relating to retail method

Freight costs: part of purchase cost

Purchase returns: ordinarily considered as reduction of price at both cost and retail

Purchase discounts and allowances: considered as reduction of cost of purchases

Transfer ins: from another department are reported same way as purchases from outside of company

Normal shortages: reduce retail column because no longer for sale

Abnormal shortages: deducted from both cost and retail columns and reported as special inventory amount or as a loss

Employee discounts: deducted from retail columns in same way as sales

72

Use retail method of computing inventory for the following reasons:

1. To permit computation of net income without physical count of inventory

2. Control measure in determining inventory shortages

3. Regulating quantities of merchandise on hand

4. Insurance information

73

One characteristic of retail inventory method is

That is has an averaging effect on varying rates of gross profit

74

Inventories must be

Managed

75

Inventory turnover measures

Number of times on average company sells the inventory during the period .

Measure sthe liquidity of inventory

76

A variant of inventory turnover is

Average days to sell inventory

77

LIFO results in

Better matching costs and revenues

78

LIFO retail is made under two assumptions

1. Stable prices
2. Fluctuating prices

79

LIFO method is concerned only with additional layer or amount that should be subtracted from previous layer, beginning inventory should be

Excluded from cost to retail %

80

Major assumption of LIFO retail method

Markup and markdowns apply only to goods purchases during the current period and not beginning inventory

81

Dollar value LIFO retail method

If price level does change the company must eliminate price change so as to measure the teal increase in inventory not dollar increase

82

Changing from conventional retail to LIFO

Conventional retail is a lower of cost or market approach and the company must restate beginning inventory to a cost basis when changing from conventional retail to the LIFO method