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ACT 230 - Principles of Accounting > Chapter 6: Accounting for Inventory > Flashcards

Chapter 6: Accounting for Inventory Flashcards

1
Q

Merchandising companies generally have one type of inventory- what is it?

A

Inventory that is finished and ready for sale

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2
Q

Although merchandising companies usually only have one type of inventory, what are the three inventory categories?

A
  1. Raw materials inventory
  2. Work-in-progress inventory
  3. Finished goods inventory
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3
Q

What is “raw materials inventory”?

A

Items to be used in the production of products

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4
Q

What is a “work-in-progress” inventory?

A

Items partially completed, not fully ready for sale

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5
Q

What is “finished goods” inventory?

A

Items fully manufactured and ready for sale

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6
Q

What is “just in case” inventory?

A

Inventory that is held as a buffer just in case unexpected problems occur

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7
Q

What are the cons of just-in-case inventory?

A

Costly to maintain because of insurance, building usage, capital investing, and holding cost

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8
Q

What is just-in-time inventory?

A

Inventory that seeks to eliminate, or at least minimize, the amount of inventory on hand- but is challening to obtain (ready to sell when it arrives, takes up less space, etc.)

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9
Q

What does F.O.B. mean?

A

Free on board, it’s regarding the shipment of materials from retailer to merchandiser

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10
Q

Who owns the inventory using a FOB Shipping point transit?

A

Once it’s shipped, it is now the buyer’s (purchaser’s) property (even on the road)

Think of the “P” in Point as “P” for Purchaser

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11
Q

Who owns the inventory using FOB destination?

A

The seller owns the inventory until it is physically in the hands of the buyer.

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12
Q

How is inventory calculated?

A

By physically counting what you have

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13
Q

What are 4 reasons that actual inventory may differ from accounting records?

A
  1. Periodic inventory method is used
  2. Theft
  3. Spoliage
  4. Errors
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14
Q

Regarding inventory costing methods, there are two types of “flow.” What are they?

A
  1. Goods flow (physical flow of goods)
  2. Cost flow (accounting cost flow assumption)
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15
Q

What does “Goods flow” mean?

A

The actual flow of goods from acquisition to sale (order of what sells first)

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16
Q

What does “cost flow” mean?

A

An assumed flow of the cost of goods from acquisition to sale

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17
Q

Do goods flow and cost flow need to be equal?

A

No

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18
Q

What are the 4 methods of costing inventory?

A
  1. Specific identification
  2. First-in, first-out (FIFO)
  3. Last-in, first-out (LIFO)
  4. Weighted-average cost
19
Q

What is the “specific identification method”?

A

The cost of specific items sold becomes the cost of goods sold amount when an item is sold.

20
Q

Which kind of manufacturers would benefit from using the specific identification method?

A

Manufacturers producing high-value products that can be easily identified separately

21
Q

How does the specific identification method look on a balance sheet?

A

The cost written on the balance sheet is the cost of specific items still on hand

22
Q

What two asusmptions does the FIFO (first-in, first-out) method have?

A
  1. Assumes that the units purchased more recently remain on hand
  2. Assumes the earliest units purchased are the first units sold
23
Q

What two assumptions does LIFO (last-in, first-out) method make?

A
  1. Assumes that the first units purchased remain on hand
  2. Assumes that the later units purchased are the first units sold
24
Q

What is the LIFO conformity rule?

A

Any company that chooses LIFO for tax reporting must also use LIFO for financial reporting

25
Q

What are the benefits of using FIFO?

A

Gross profit is larger when prices are rising- looks better for reporting to shareholders

26
Q

What are the benefits of using LIFO?

A

Gross profit is smaller when prises are rising- looks better for reporting on the company’s income tax return

27
Q

What is the weighted-average cost method?

A

A method that is in-between the FIFO and LIFO method

28
Q

How do inventory count errors affect costs?

A

The company will believe they have more or less money than they do.

Ex: If you have less money than you do, you risk spending too much and going into debt, while if you have more money than you think you do, you risk losing profit from spending that money to make money.

29
Q

The ending inventory cost must not exceed the net realizable value. T/F?

A

True

30
Q

What should you do if the net realizable value is LESS than recorded book value?

A

Write down inventory to the lower net realizable value

31
Q

What is “net realizable value”?

A

An item’s estimated selling price

32
Q

If the net realizable value is GREATER than the recorded book value, what should be done?

A

Inventory value remains at its cost.

33
Q

What is inventory turnover?

A

How many times a year, on average, a firm sells its inventory

34
Q

How is inventory turnover calculated?

A

Inventory turnover = cost of goods sold / average inventory

35
Q

Inventory turnover calculation example (for those who need it- like myself)

A

Assume Kanzu Co. maintained an average inventory level of $300, and it’s cost of goods sold for the year was $7,500. Then Kanzu’s inventory turnover would be…

Inventory turnover = $7,500 / $300 = 25 times

36
Q

What are Days’ sales in inventory?

A

A ratio that indicates how many days, on average, it takes a company to sell its inventory

37
Q

How to calculate Days’ sales in inventory?

A

Days’ sales in inventory = 365 / inventory turnover

38
Q

Example of days’ sales inventory.

A

Kanzu’s company has an inventory turnover of 25 times a year. Calculate days’ sales in inventory.

Days’ sales in inventory = 365 / 25
Days’ sales in inventory = 14.6 days

39
Q

What is the periodic inventory method?

A

Inventory balance and the cost of goods sold are only calculated at the end of the accounting period using a physical count of the ending inventory

40
Q

What is the perpetual inventory system?

A

The inventory account and the cost of goods sold are kept perpetually up-to-date, with updates occurring after every purchase and every sale

41
Q

What is the inventory reserve?

A

A measure of the difference between the value of a company’s ending inventory reported under LIFO and what the inventory would have been valued under FIFO

42
Q

Companies using LIFO must disclose the value of the inventory reserve in their financial statements. Why is this important?

A
  1. Enables users to use the LIFO reserve to determine the fair market value of the LIFO ending inventory
  2. Enables users to restate gross profit under LIFO
43
Q

What is the merchandising equation? (2 parts)

A
  1. Sales revenue - cost of goods sold = gross profit
  2. Gross profit - operating expenses = net income

ACT 230 - Principles of Accounting (8 decks)

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