chap 9- period & product cost, ITO Flashcards
(20 cards)
What is the cost price of inventory?
Costs of inventory include all costs incurred to get inventory into condition and location ready for sale
Importance of accurate inventory cost
- valuing inventory in B.S- so faithful rep is provided
- earning a profit- so when business applies markup cost price accurate so selling prices not too low/high
What is a product cost?
A cost incurred in order to bring inventory into location and condition ready for sale which can be allocated to individual units of inventory as it is logical to do so
What is a period cost?
A cost incurred in order to get inventory to location and condition ready for sale that is not allocated to individual units of inventory because there is no logical basis to do so.
Types of recording
product cost- combined with inventory on inventory card & general journal
product cost with separate cash payment on same day- combine on inventory card but separate general journal
product cost with separate cash payment on different day- separate on both (add totals of inventory card together)
Why use product cost?
This will give a more accurate profit for the period as it matches the cost incurred with the revenue earned.
Also, a more accurate valuation of inventory to assist in price setting and measuring performance.
Referring to one QC, explain why the
correct inventory valuation
method should be applied.
Treating a product cost as a period cost leads to the omission of information that would be useful for decision making, and thus breaches
Relevance
What is net realisable value?
Net Realisable Value estimated selling price of inventory less any costs involved in its selling, marketing or distribution.
Possible reasons why selling price may fall below cost
- physical deterioration
- a purpose decrease in selling price (tactic to increase sales volume)
- a decrease in demand (no longer in fashion)
- obsolescence (taken over by new superior product)
Lower of ‘Cost’ and ‘Net Realisable Value’ rule?
Whichever is lowest out of cost and NRV, this must be the price recorded
What is inventory write-down?
the expense incurred when the NRV of an item of inventory falls below its original purchase price.
Explain how an Inventory Write-down affects Adjusted Gross Profit.
As Inventory Write-down is related to inventory, and will affect the overall margin that the business will earn from the sale of inventory, it is reported as a deduction from Gross Profit to determine Adjusted Gross Profit.
What is inventory turnover?
The average number of days it takes for a business to convert its inventory into sales.
How is ITO calculated?
average inventory/cogs times 365
Benefits of fast ITO?
Profitability:
* Fast Inventory Turnover indicates higher sales, leading to higher profit.
* It could also indicate effective inventory management techniques that are leading to inventory moving quickly through the store,
* reducing the chances of inventory losses and/or write-downs.
Liquidity:
* fast ITO increases cash inflows inflows as either cash sales or (depending on ARTO) receipts from Accounts receivable
* generation of cash from the sale of inventory will mean the firm has cash available to meet its short-term debts as and when they fall due
ITO- too fast
- selling price is too low, and this would be a loss of potential revenue and profit.
- firm holding too little inventory (costs such as delivery higher and business losing possibility of earning discounts by buying in bulk)
ITO- too slow
- low sales, leading to a negative effect on profit
- worsening liquidity, as cash is collected slower (as cash sales or cash received from Accounts Receivable) and thus less readily available to meet its short term debts as and when they fall due
Limitations- ITO
- an average- some lines of inventory may be selling faster or slower (better to check individual inventory cards to see which one selling better/worse)
- historical measure (measure of the past does not guarantee what will occur in the future)
Strategies to improve ITO?
- maintain an appropriate inventory mix
- promote the sale of complementary goods (add on sales to support og item sold)
- ensure inventory is up to date
- rotate inventory
- determine an appropriate level of inventory on hand (should not be so high that additional storage costs or inventory write-down issues)
- market strategically and effectively (and ethically)
- appoint an inventory manager
Importance of the inventory cards in managing inventory
- provide more detailed info abt speed at which specific lines of inventory are selling so appropriate decisions made:
- discounting or discontinuing slow-moving lines of inventory
- re-ordering fast moving lines
