chap 8- inventory

Question 1

What is a trading firm?

Answer 1

A firm that purchases goods in order to resell them at a profit.

Question 2

What is inventory?

Answer 2

Goods purchased by a trading firm and held for the purpose of resale at a profit.

Question 3

Why is inventory important?

Answer 3

• main source of revenue for a trading firms and thus the key to its ability to earn profit. A
  trading firm that cannot sell its inventory will not survive.
• Inventory is likely to be one of the most significant assets the firm controls (It can be the largest asset on the balance sheet)

Question 4

Why is inventory vulnerable?

Answer 4

• is susceptible to damage, spoilage, theft and even changes in tastes and fashions, all of which can undermine its value.

Question 5

The purpose of inventory card?

Answer 5

It details all transactions of inventory for an individual inventory item

Question 6

What is identified cost?

Answer 6

Each item of inventory is physically marked or labelled in some way (such as a sticker with a colour or a code) and this is checked against a record of which cost price relates to that code.

Question 7

Why should inventory valuation methods not change between periods? (QC)

Answer 7

We need to be able to compare reports across different time periods to identify similarities and differences between same and similar entities. This requires that method to be used consistently from one period to the next.

Otherwise, changes in the reports may turn out to be the result of changes in the valuation methods, rather than changes in performance.

Question 8

What is inventory used for advertising?

Answer 8

Inventory may be used for advertising purposes to try and promote the business to generate sales. (eg: donations to school and charities who may use in raffle or for display purposes)

Question 9

How does identified cost help ensure faithful rep?

Answer 9

• Because it requires each item of inventory to be marked or labelled, and also coded against the specific purchase price of that item,
• accurate to economic event occuring as specific price is known
• thus is complete, accurate & free from error or bias

Question 10

Costs of identified cost system

Answer 10

• Adminstration costs in labelling individual items and recording codes and cost prices (eg. stationery, additional packaging, wages)
• costs of computer recording systems

Question 11

What info do inventory cards v inventory account provide?

Answer 11

• Inventory cards: provide specific info which is necessary for managing each line of inventory
• Inventory account: provide summary info used in accounting reports

Question 12

What is the perpetual inventory system?

Answer 12

• A system of recording movements of inventory on a continual basis throughout a reporting period

Question 13

What is the process of perpetual inventory system?

Answer 13

1. Purchase inventory
2. Sell inventory
3. Other movement of inventory
4. Inventory count
5. Compare against inventory card
6. Adjust inventory card to uphold faithful rep

Question 14

Advantages of perpetual inventory system

Answer 14

• greater control
• identifies speed of turnover
• more efficient reordering
• interim profit reports
• identifies inventory gain/loss

Question 15

Benefits- perpetual inventory system

Answer 15

• Reordering of inventory is assisted by maintaining a continuous record of the number of units of inventory on hand, enabling the business to avoid lost sales.
• Inventory losses and gains can be detected by comparing the balances of the inventory cards against the physical inventory count
• Fast and slow moving lines of inventory can be identified so that inventory can be rotated or the inventory mix adjusted.

Question 16

Disadvantages- perpetual inventory system

Answer 16

• additional record keeping
• additional costs
• does not replace physical inventory count

Question 17

Costs- perpetual inventory system

Answer 17

• The cost of wages of staff to record or monitor what has been recorded.
• The cost of staff training in the system used to record inventory transactions.
• The cost of technology (set-up and maintenance).

Question 18

What is an inventory count?

Answer 18

A physical count of the number of units of each line of inventory on hand.

(Then checked against inventory card to ensure movements recorded correctly)

Question 19

What is inventory loss?

Answer 19

An expense incurred when the inventory count shows a figure for inventory on hand less than the balance shown in the inventory card.

Question 20

What is inventory gain?

Answer 20

A revenue earned when the inventory count shows a figure for inventory on hand greater than balance shown in the inventory card.

Question 21

Purpose of inventory count (QC)

Answer 21

The role of an inventory count is to verify the accuracy of the inventory
cards and, in the process, detect any inventory losses and inventory
gains. This ensures the reports provide a Faithful representation of the amount of inventory on hand.

Question 22

How does FIFO value inventory at time of sale?

Answer 22

FIFO assumes that the inventory that was purchased first will be sold first (even though the business may have no way of knowing for certain)

Question 23

Under FIFO, explain how inventory is valued when it is returned to
a supplier as a purchase return.

Answer 23

Inventory returned to a supplier as a purchase return does not need to be valued using FIFO, because just like Identified Cost, its cost price is determined by that supplier and identified on the credit note they issue.

Question 24

FIFO- sales return (when cost price not given)

Answer 24

Last out first in (therefore last transaction in OUT column).

Question 25

How to value inventory loss and gain according to FIFO?

Answer 25

Inventory loss- FIFO Inventory gain- last in IN column

Question 26

Explain the effect of FIFO on the valuation of Inventory loss and Inventory on hand when prices are rising.

Answer 26

Because it assumes that the older, cheaper items of inventory are lost, FIFO leads to: * the lowest possible valuation of Inventory loss and * the highest possible valuation of Inventory on hand

Question 27

Referring to one QC, explain how the cost price of an inventory gain is determined if the business is using FIFO.

Answer 27

* Faithful Representation * The latest price in the IN Column is the price we assume as the valuation that gives the most Faithful representation of the value of inventory on hand * most recent cost prices reflect what the business would be charged if it was to purchase those items at the time of the inventory count and are likely to be more accurate and less subject to bias.

Question 28

Explain the effect of FIFO on the valuation of Inventory gain and Inventory on hand when prices are rising.

Answer 28

Because it assumes that the newer, more expensive items of inventory are gained, FIFO leads to: * the highest possible valuation of Inventory gain and * the highest possible valuation of Inventory on hand

Question 29

Discuss the extent to which the FIFO assumption ensures Faithful representation in the reports.

Answer 29

* As it still uses cost prices that are Verifiable by reference to the source document, FIFO still provides a Faithful representation of the value of inventory. * However, under FIFO there is no way of knowing if the cost prices allocated at the time of the sale were in fact those which applied to those individual items of inventory at the time of their purchase. * Further, the valuation of Cost of Sales is biased towards the inclusion of the inventory purchased first * Inventory on hand biased towards the inclusion of the inventory purchased last.

Question 30

Advantages- FIFO

Answer 30

* Can be applied to all items of inventory, regardless of practicality of items * Less time consuming * Cheaper (no set up fees)

Question 31

Disadvantages- FIFO

Answer 31

* If not all items are sold, then the cost of sales and inventory values may not be as accurate as under the identified cost method.