F3 Module 3

Question 1

legal title of inventory

Answer 1

any goods or materials that a company has title should be included in inventory

Question 2

goods in transit

Answer 2

-title passes from the seller to the buyer agreed to by the parties
-if no agreement ahead of time, title passes from seller to buyer where delivery of goods is complete

Question 3

free on board (FOB)

Answer 3

-requires seller to deliver the goods to the location indicated

Question 4

FOB shipping point

Answer 4

-title passes to the buyer when the seller delivers the goods to a common carrier
-goods shipped in this way are included in buyer’s inventory upon shipment

Question 5

FOB destination

Answer 5

-title passes to the buyer when the buyer receives the goods from a common carrier

Question 6

shipment of nonconforming goods

Answer 6

-if seller ships the wrong goods, title goes back to seller upon rejection of buyer
-thus goods not included in buyer’s inventory even if buyer has possession prior to returning to seller

Question 7

consigned goods

Answer 7

-seller (consignor) delivers goods to agent (consignee) to hold and sell on consignor behalf
-consignor holds title of inventory even if sold goods to consignee
-revenue for consignor is recognized when consignee sells goods
-title passes to buyer at point of sale and not with the consignee

Question 8

sales with a mandatory buyback

Answer 8

-sometimes as part of financing arrangement, seller is required to repurchase goods from buyer
-thus, seller should include goods in inventory though title passes to buyer

Question 9

installment sales

Answer 9

-sells goods on installment basis but retains title as security of a loan
-goods included in seller’s inventory if % of uncollectible debts cannot be estimated
-if it can be estimated, transaction treated as a sale, and allowance for uncollectible debts would be recorded

Question 10

inventory

Answer 10

-recorded at cost per U.S. GAAP (what you purchased it for)
-no loss recognized even though replacement or reproduction costs are lower

Question 11

inventories at NRV

Answer 11

-gold, silver, meat, agricultural products
-when inventory stated at a value > cost, fully disclosed on financial statements
-reported at NRV when precious metals are in an effective gov. controlled market at fixed monetary value
-inability to determine appropriate costs
-unit interchangeability
-immediate marketability at quoted prices

Question 12

when is LOCM or LOCNRV used?

Answer 12

-when the utility or value of goods no longer exceeds their costs
-it shows probable loss sustained (conservatism) in period in which loss occurred (matching principle)
-not for LIFO or retail inventory method costed inventories

Question 13

write-down of inventory

Answer 13

-usually reflected in COGS unless amount is material, in which case, loss should be identified separately in I/S
-reversals of write-downs are prohibited

Question 14

when does LOCM or LONRV not applicable?

Answer 14

1) subsequent sales price of an end product not affected by its market value
2) company has firm sales price contract

Question 15

net realizable value (market ceiling)

Answer 15

net selling price less costs to complete or dispose of inventory
also known as market ceiling in LOCM method

Question 16

lower of cost or market (LOCM)

Answer 16

-used for inventory costed at LIFO or retail inventory method

Question 17

market value

Answer 17

-generally means current replacement cost (whether by purchase or reproduction)
-provided current replacement cost does not exceed NRV (market ceiling) OR fall below NRV - normal profit margin (market floor)
-the median of an inventory item’s replacement cost, market ceiling, and market floor

Question 18

market floor

Answer 18

NRV - normal profit margin

Question 19

replacement cost

Answer 19

the cost to purchase the item of inventory as of the valuation date

Question 20

disclosure for substantial or unusual losses

Answer 20

-significant losses from subsequent measurement of inventory disclosed in F/S
-small losses included in COGS
-basic principle consistency applied and method disclosed in F/S
-if significant, disclose nature of change and impact on income

Question 21

periodic inventory system

Answer 21

-quantity of inventory determined only by physical count
-units of inventory counted at end of accounting period

Question 22

COGS calc under periodic inventory system

Answer 22

beginning inventory
+ purchases
= cost of goods available for sale
- ending inventory (physical count)
= COGS

Question 23

perpetual inventory system

Answer 23

-inventory is updated for each purchase and each sale that occurs
-keeps running total of inventory balances

Question 24

units of inventory on hand

Answer 24

-record of units on hand maintained on perpetual basis
-changes in quantities are recorded after each sale and purchase (modified perpetual system)

Question 25

perpetual with periodic at year-end

Answer 25

-still perform complete periodic physical inventories or test count inventories on random or cyclical basis

Question 26

objective of cost flow assumption

Answer 26

-inventory dependent on cost flow assumption because it helps to most clearly reflect periodic income
-difficulty with matching principle as costs lost between time of acquisition and time of sale

Question 27

specific identification method

Answer 27

-cost of each item in inventory uniquely identified to that item
-cost follows physical flow of item in and out of inventory to COGS
-usually used for physically large or high value items can allow for greater manipulation of income

Question 28

first in first out method

Answer 28

-ending balance approximates replacement cost because includes most recent incurred costs
-ending inventory and COGS are the same whether periodic or perpetual inventory system used
-in periods of rising prices, results in highest ending inventory, lowest COGS, and highest net income
-current costs not matched with current revenues

Question 29

weighted average method

Answer 29

the average cost of each item in inventory would be weighted average of costs of all items in inventory
-divide total costs of inventory available by total number of units of inventory available
-beginning inventory is included in both totals
-suitable method for homogenous products and periodic inventory system

Question 30

moving average method

Answer 30

-computes weighted average cost after each purchase by dividing total cost of inventory available after each purchase (inventory + current purchase) by total units available after each purchase
-perpetual inventory system uses it

Question 31

last in first out

Answer 31

-will not calculate replacement cost
-does not relate to actual flow of goods because sell or use oldest goods first to prevent holding old or obsolete items
-is used for tax, must use for GAAP
-better matches revenues and expenses, reduces holding gains and net income during inflation
-if sales > production, LIFO distort net income because old inventory costs (lifo layers) matched with current revenue
-susceptible to income manipulation because intentionally reduce purchases to use old layers at lower costs
-in rising prices, lower ending inventory, higher cogs and lower net income

Question 32

LIFO Layers

Answer 32

-contains records as to base year of inventory and any layers added onto inventory
-LIFO base year can either increase or decrease based on amt of ending inventory
-LIFO layer is created when ending inventory > beginning inventory
-added LIFO layer is priced at earliest costs of year created to match current costs to current revenues

Question 33

dollar value LIFO

Answer 33

-measured in dollars and adjusted for changing price levels
-use price index formula to convert from LIFO inventory to dollar value LIFO to get the value for changes in price levels, because LIFO inventory is measured in units, not dollars

Question 34

internally computed price index

Answer 34

ending inventory at current cost/ending inventory at base year cost

Question 35

LIFO added layer computation in CY and dollar value LIFO

Answer 35

LIFO layer at base year cost * internally generated price index

Question 36

when price index is supplied

Answer 36

price index at year end * LIFO layer at base year cost to calculate LIFO layer added at dollar-value LIFO

Question 37

gross profit method

Answer 37

-used for interim financial statements as part of a periodic inventory system
-inventory valued at retail
-average gross profit % used to determine inventory cost for F/S
-gross profit % known and used to calculate cost of sales
-Sales - (1-gp %) = COGS

Question 38

firm purchase commitments

Answer 38

-a legally enforceable agreement to purchase a specified amount of goods at some time in the future
-all material ones should be disclosed in the F/S or notes
-if contracted price > market price and expected losses will occur when purchase made, loss should be recognized at time of decline in price
-description of losses recognized on these commitments should be disclosed in CY income statement

Question 39

JE for loss on firm purchase commitments

Answer 39

Dr. Estimated loss on purchase commitment (price of purchase commitment - market price at YE)
Cr. Estimated liability on purchase commitment (same amt)

-amt should be recorded under other expense and losses on I/S

Question 40

LOCM determination

Answer 40

-after you determine the middle value between RC, NRV, and MF, to figure out what to price ending inventory for LOCM, compare the middle number to historical cost to see which one is the lesser value