Inventory

Question 1

Trading organization - flow of inventory

Answer 1

buys and sells goods. does not produce goods.

opening finished goods
+ purchases
- units sold
= closing finished goods

Question 2

Manufacturing organization - flow of inventory

Answer 2

produces goods from raw materials

opening raw materials
+ purchases
- UNITS TRANSFERRED TO PRODUCTION
= ending raw materials units

opening WIP
\+ UNITS TRANSFERRED FROM PRODUCTION
\+ freight-in
\+ insurance
\+ warehouse
\+ labor
\+ overheads
- UNITS PRODUCED
= ending WIP

opening finished goods
+ UNITS PRODUCED
- units sold
= closing finished goods

Question 3

What is capitalized in inventory?

Answer 3

Capitalized:
direct material
direct labor
overheads (fixed & variable; aka indirect costs)
freight-in
inventory handling costs (insurance, warehouse cost)

Not capitalized:
freight-out
interest paid on loans to finance inventory
discount lost when using net method on purchases with credit discounts.

Question 4

Inventory purchased on credit terms

Answer 4

If inventory is purchased and there are credit terms (e.g. 2/10 net 30), the expense needs to be recorded gross or net.

Gross - you do not expect to utilize the discount.

Net - you do expect to utilize the discount. If you record at net, but do not end up taking the discount the additional expense is treated as a financing expense. It is NOT added to inventory costs (capitalized)

Question 5

When is revenue recognized and inventory derecognized?

Answer 5

When risks and rewards of ownership is transferred, revenue is recognized and inventory is derecognized.

Question 6

FOB Destination

inventory policies

Answer 6

“freight-on-board” destination

risk transferred to buyer when the inventory REACHES the buyer’s destination

Question 7

FOB Shipping Point

inventory policies

Answer 7

risk transferred to buyer when the inventory is handed over to the common carrier

Question 8

Sales with right to return

inventory policies

Answer 8

Sale where the buyer has the right to return the goods.

If the amount of returns can be reasonably estimated, then sales s/b recorded with an allowance for expected returns.

Question 9

Consignment sales

inventory policies

Answer 9

Goods are shipped from the consignor to a 3rd party (consignee) who holds and sells the inventory on the consignor’s behalf.
Unsold inventory held by the consignee is included in the consignor’s inventory.
Freight costs for shipping to consignee, in-transit insurance, and warehousing costs by consignee are all included in inventory costs (capitalized).

Question 10

Specific identification method

inventory costing methods

Answer 10

Used for unique (not homogenous) goods. Cost and selling price of the individual goods varies. E.g. airplane

Question 11

Specific identification method

inventory costing methods

Answer 11

Used for unique (heterogeneous) goods. Cost and selling price of the individual goods varies. E.g. airplane

Cost for the specific item sold is identified and booked to the IS.

Question 12

First in first out

inventory costing methods

Answer 12

used for homogeneous units; selling price for each unit is the same. the oldest cost is booked to the IS first.

Question 13

Last in first out

inventory costing methods

Answer 13

used for homogeneous units; selling price for each unit is the same. the newest cost is booked to the IS first.

Question 14

Weighted average cost method

inventory costing methods

Answer 14

used for homogeneous units; selling price for each unit is the same. the average of price of all the inventory is booked to the IS.

Question 15

Periodic system - weighted average cost

inventory costing methods

Answer 15

At the end of the period, the weighted average price is calculated and assigned to the inventory sold.

aka…average inventory method

Question 16

Perpetual system - weighted average cost

inventory costing methods

Answer 16

At every point of sale, the average of all previous inventory purchases is calculated. This cost amount is assigned to the inventory sold.

aka…moving average inventory method

Question 17

Periodic system

inventory systems

Answer 17

Inventory and cost of goods sold balance is known only at the year end.

During the year, all inventory purchases are accumulated into purchase account(s).

At the year end, all units sold are removed from purchases and transferred to cost of goods sold.

Remaining purchases are transferred to the inventory.

Question 18

Difference between COGS valued using FIFO perpetual and periodic?

inventory systems

Answer 18

FIFO perpetual = FIFO periodic

none; cogs calculated under both systems will be the same. they are both pulling from the oldest purchases first.

Question 19

Difference between COGS valued using LIFO perpetual and periodic?

inventory systems

Answer 19

LIFO perpetual != LIFO periodic
under perpetual system, the cogs will be valued using the most recent purchase.
under periodic, cogs will be valued using the last purchase of the year.

Question 20

FIFO objective

Answer 20

to match the accounting with the actual flow of inventory

Question 21

LIFO objective

Answer 21

to make sure the COGS is at current prices

Question 22

IFRS v. LIFO

Answer 22

IFRS wants COGS to match the flow of inventory, so FIFO is allowed.
Because LIFO does not necessarily match the flow of inventory, it is not allowed in IFRS.

Question 23

Period of rising prices - FIFO & LIFO effects

Answer 23

FIFO: cogs lower, net income higher, taxes higher
LIFO: cogs higher, net income lower, taxes lower

Question 24

Period of falling prices - FIFO & LIFO effects

Answer 24

FIFO: cogs higher, net income lower, taxes lower
LIFO: cogs lower, net income higher, taxes higher

Question 25

LIFO conformity rule

Answer 25

If LIFO is used for taxes, then it must be used for accounting as well. LIFO generally produces a lower tax burden, which mgmt wants. However, it also results in lower value of inventory on the balance sheet, which mgmt does not want. Can't have cake and eat it too. HOWEVER - you can use LIFO for accounting and FIFO for taxes.

Question 26

LIFO reserve

Answer 26

Using LIFO method for accounting, but other method for taxes (FIFO, weighted average, specific identification) LIFO reserve is the difference between COGS per the accounting financials (higher) and the tax financials (lower). Tax COGS + LIFO reserve = LIFO cogs Tax inventory - LIFO reserve = LIFO inventory

Question 27

Dollar Value LIFO v. LIFO (standard)

Answer 27

Normally under LIFO, inventory is valued in units, then converted to dollars. In dollar value LIFO, inventory is immediately valued in dollars.

Question 28

Dollar Value LIFO - calculation method

Answer 28

Count only the layers of inventory added in the current year. Measure at CPI (current price index). The balance of inventory is measured at base yer prices.

Question 29

Dollar Value LIFO - example

Answer 29

Year EB Inv(CY$) CPI EB Inv(Base$) Layer 2015 10,000 / 1.0 10,000 -0- 2016 12,100 / 1.1 11,000 1,000 2017 15,000 / 1.2 12,500 1,500 2018 13,500 / 1.25 10,800 (1,700) Year Layer(B$) Used Bal(B$) Bal(CY$) 2015 -0- -0- -0- X1.0 -0- 2016 1,000 (200) 800 X1.1 880 2017 1,500 (1,500) -0- X1.2 -0- 2018 (1,700) 1,700 -0- X1.25 -0- ``` Year Layer Bal(CY$) 2015 -0- 2016 880 2017 -0- 2018 -0- --------------------------- Net Layer 880 Base Layer + 10,000 = 10,880 2018 Inventory EB ```

Question 30

Dollar Value LIFO - steps

Answer 30

1) convert inventory to standard unit (BY$ base yr) 2) calculate increase (decrease) in inv for each year 3) calculate what portion of each year's inc(dec) was utilized (when there is a decrease, aka "LIFO liquidation") 4) calculate the balance of each years inc(dec) 5) convert each year's remaining amt back to CY$ 6) sum the amounts in #5 7) add the base layer = EB inventory CY$ ``` COLUMNS IN SPREADSHEET A) EB inv CY$ B) CPI C) EB inv BY$ (A / B) D) Increase(Decrease) BY$ 2020 EB - 2019 EB year over year E) Utilized BY$ from newest to oldest, subtract the portion of the layer utilized F) Balance BY$ Net coulmn D and E G) Convert back to CY$ (BY$ X CPI) H) Sum amounts in column G I) Add base year inventory ```

Question 31

Inventory Valuation - US GAAP

Answer 31

Purpose: revalue the inventory every year to account for losses in inventory value. (Account for future losses now - matching) LIFO methods or Retail Inventory Method --> must value using Lower of Cost or Market Value (LCM) FIFO or Specific Identification Method --> must value using Lower of Cost or Net Realizable Value (LCNRV)

Question 32

Net realizable value Inventory Valuation - US GAAP

Answer 32

Selling price - selling cost used in revaluing inventory at LCNRV for FIFO or specific identification methods

Question 33

Market value Inventory Valuation - US GAAP

Answer 33

Median value of... ceiling NRV floor NRV - normal profit margin replacement cost cost to replace inv now used in revaluing inventory at LCM for LIFO or Retail Inventory Method

Question 34

Ceiling Inventory Valuation - US GAAP

Answer 34

ceiling equals net realizable value | selling price - selling cost

Question 35

Floor Inventory Valuation - US GAAP

Answer 35

floor equals net realizable value less the normal profit margin NRV - Normal Profit Margin (selling price - selling floor) - normal profit margin

Question 36

LIFO/Retail Identification Method Inventory Valuation - US GAAP

Answer 36

``` 1) Find median of NRV NRV - profit margin Replacement cost = MARKET ``` 2) Find lower of COST MARKET = inventory valuation amount

Question 37

FIFO/Specific Identification Inventory Valuation - US GAAP

Answer 37

1) Find NRV (selling price - selling cost) 2) Find lower of NRV COST = inventory valuation amount

Question 38

Inventory valuation adjustment - journal entries Inventory Valuation - US GAAP

Answer 38

Loss on inventory write-down XXX Inventory XXX US GAAP does NOT allow a reversal of a loss

Question 39

Inventory Valuation - IFRS

Answer 39

Regardless of inventory method, ALWAYS use LCRNV Loss on inventory write-down XXX Inventory XXX Reversal of loss on inventory write-down is ALLOWED (only to the extent of the reversal though, not more)

Question 40

Inventory Estimation - steps

Answer 40

Allowed only for interim financial statements ``` COGS + PROFIT = SALES 1) Estimate COGS: using profit mark-up or margin mark-up (profit is % of cost) margin (profit is % of sales) 2) Calculate Inventory: BB inv + purchases - COGS (estimated above) = EB inv ```

Question 41

Mark-up Inventory Estimation

Answer 41

Profit, expressed as a percentage of cost E.g. Sales = Y Cost = X Profit = 0.25X COGS + 0.25COGS = SALES 1.25 COGS = SALES COGS = SALES / 1.25

Question 42

Margin Inventory Estimation

Answer 42

Profit, expressed as a percentage of sales E.g. Sales = Y Cost = X Profit = 0.25Y SALES - 0.25 SALES = COST COST = 0.75 SALES

Question 43

Retail inventory method

Answer 43

Businesses in the retail industry might have to keep inventory at two prices, cost and sales. Prior to computers, this would have been cumbersome and costly. Instead of maintaining two sets of inventory prices, businesses keep inventory at retail price and calculate a cost-to-retail ratio to estimate the cost of inventory.

Question 44

Conventional method retail inventory method

Answer 44

To calculate the cost-to-retail ratio calculate the total inventory available for sale at both cost and retail prices. Divide cost price by retail price. COST RETAIL BB inv xxx yyy + purchases xxx yyy + freight-in xxx ---- + net-markups ---- yyy = Inv available for sale XXX / YYY (XXX / YYY) cost-to-retail ratio = inv available for sale XXX YYY - net markdowns ----- (yyy) = total inv AFS @ retail ----- YYY - sales ----- (yyy) = EB inv @ retail ZZZ ZZZ * cost-to-retail ratio = EB inv @ cost

Question 45

LIFO retail method retail inventory method

Answer 45

COST RETAIL purchases xxx yyy + freight-in xxx ---- + net markups ---- yyy - net markdowns ---- (yyy) = inventory XXX / YYY (XXX / YYY) cost-to-retail ratio = inventory XXX YYY + beginning inv @ retail ---- yyy = total inv AFS @ retail ----- YYY - sales ----- (yyy) = EB inv @ retail ZZZ

Question 46

Differences b/w conventional and LIFO retail methods

Answer 46

1) LIFO does not start with BB inv (PY EB). Conventional does start w/ PY EB, which is based on the PY cost-to-retail ratio 2) LIFO includes markups and markdowns in the cost-to-retail ratio

Question 47

Total list of inventory calculation methods

Answer 47

total of eleven methods a) perpetual periodic specific identification x x FIFO x x LIFO x x weighted average x x b) dollar value LIFO method c) retail method: conventional LIFO

Question 48

Purchase commitment

Answer 48

Forward contract to set price for purchase in the future contracted price > market price = probable loss in future, so have to recognize estimated loss (contract price - market price) estimated loss on purchase commitment XXX accrued loss on purchases commitment XXX at time of actual purchase, accrued loss is reversed purchases XXX accrued loss on purchase commitment XXX accounts payable or cash XXX