Chapter 6

Question 1

COGS & Inventory: 2 accounts

Answer 1

1. COGS- cost of goods sold (also called cost of sales)- the amount we paid for the goods we have sold, an operating expense on income statement
2. Inventory- goods held for resale, current asset on balance sheet

Question 2

COGS Formula

Answer 2

Beginning Inventory. $ xx
+ Net Purchases xx
= Goods available for sale. xx
- (Ending Inventory). ( xx )
= COGS $ xx

Question 3

How to determine COGS

Answer 3

1. Periodic System
2. Perpetual System

Question 4

Periodic System

Answer 4

1. debits all inventory items to “purchases” account
2. Make NO entry to update COGS & “Inventory” accounts with each sale
3. Make a physical count @ year end to determine “COGS” using COGS formula

Question 5

Perpetual System

Answer 5

1. debits all inventory to “Inventory” account
2. updates “COGS” & “Inventory” account with each sale (when we make a sale need 2 entires 1. record sale, 2. Update the inventory
3. uses physical count @ year end determine “loss of shrinking”

Question 6

Net purchases Formula

Answer 6

purchases $ xx
- Purchase R&A. ( xx )
- Purchase Discount. ( xx )
+ freight- in xx
= Net purchases $ xx

Question 7

Freight In

Answer 7

Transportation cost

Question 8

purchase discount

Answer 8

incentives for us to pay early and get a discount

Question 9

Periodic system

Answer 9

all items purchases for resale are debited to a “purchases” (not an asset), uses COGS formula, requires an adj. entry at year end to record COGS

Question 10

Perpetual System

Answer 10

keeps a running total of the inventory on hand, the ONLY system that identifies “losses” due to theft/ shrinkage/ spoilage

Question 11

Goods to include in Ending Inventory

Answer 11

1. Goods in transit: goods orders but not yet received
2. Consigned Goods- the owner (consigner) transfers physical goods to agent (consignee) for purposes of selling without giving up legal title (TITLE NEVER TRANSFERS)

Question 12

Inventory Cost Flow Methods (perpetual method) 4 methods

Answer 12

1. Specific Identification
2. Average Cost Method
3. First in First Out method (FIFO)
4. Last in First Out (LIFO)

Question 13

Specific Identification

Answer 13

small quantity of inventory, high priced items
- this method tracks the actual physical flow of the goods, each item of inventory is marked, tagged, or coded with a specific unit cost

Question 14

Average (simplified) Cost Method

Answer 14

• uses weighted average of all costs for GAS (“ Goods Available for Sale”)
• assigns average cost to both Ending Inventory & COGS

advantage: assigns cost on an equal unit basis to both ending inventory and COGS and its easy to calculate

formula:
average cost= total cost of GAS / Total # units GAS

Question 15

First in First Out (FIFO)

Answer 15

cost of first item purchased = cost of first item sold

advantage: assigns current cost to ending inventory (current cost on bal. sheet) and good method when invt. turnover is rapid

disadvantage:
- fails to match most recents costs with revenues
- if prices are rising matching oldest unit costs with current revenues, making net income higher (overstated) called “Inventory Profits”

Question 16

Last In First Out (LIFO)

Answer 16

cost of last item purchased = cost of first item sold

Advantage:
- matches current cost with current revenues
- in periods of rising prices net income is always less (reduces income taxes) because of the effect on taxes, companies follow the LIFO Conformity Rule

Disadvantage:
- gives non current value to inventory on balance sheet (old cost on bal. sheet)
- if/when International Financial Reporting Standards (IFRS) are adopted in the U.S. LIFO will NOT be allowed as a reporting method

Question 17

LIFO Conformity Rule

Answer 17

if you use LIFO for tax purposes, you MUST ALSO use this method for financial reporting purposes

Question 18

Inventory turnover ratio

Answer 18

measures if company keeps excess stock of inventory, excess stock is NOT productive

Invt. turnover ratio = COGS/ Average Inventory
average inventory= (BI+ EI)/2

Question 19

Income Statement

Answer 19

Sales Revenue. $ xx
- Sales R&A ( xx )
- Sales discounts ( xx )
= Net Sales Revenue. xx
- COGS ( xx )
= Gross Profit. xx
- expenses ( xx )
- freight out ( xx )
= Net Income xx