SAC 2 Part 4 Flashcards
Why is it important to include product costs in the valuation of inventory?
They uphold relevance, and assist users of financial information in decision making
What effect does treating product costs as a period cost have on the accounting equation?
Assets decrease as inventory valuation decreases
Owners equity decreases as net profit decreases because cost of goods sold becomes greater
Why is the dollar amount of a discount greater than that of GST charged at the same rate?
GST is charged only on the selling price, whereas a discount is applied on the selling price + GST (total amount owing to account payable)
What does the cost of inventory refer to?
All costs incurred in order to bring inventory into a condition and location ready for sale
What does the unit cost refer to?
The cost price of each individual item/unit of inventory
What is the definition of a product cost?
A cost incurred in order to bring inventory into a condition and location ready for sale, that can be allocated to individual units of inventory on a logical basis
What is the definition of a period cost?
A cost incurred in order to bring inventory into a condition and location ready for sale, that cannot be allocated to individual units of inventory on a logical basis
What is the definition of other expenses and where is it recorded in the income statement?
An expense incurred after the sale of inventory, which is recorded in other expenses at the bottom of an income statement
Where will a product cost and period cost be reported in the income statement?
Product Cost = Cost of Sales (under cost of goods sold)
Period Cost = Seperate Ledger (under cost of goods sold)
How can period costs increase the total cost of goods sold compared to product costs?
They recognise the entire amount incurred during the period, whether inventory remains unsold or not, whereas product costs only recognise amounts charged for each individual unit of inventory sold
If all inventory is not sold, what will period costing lead to?
A higher cost of goods sold, lower profit/owners equity, lower inventory/assets
What is the net realisable value (NRV)?
The estimated selling price of inventory less any costs involved in its selling, marketing or distribution
Why would valuing inventory at its cost price when it is higher than NRV breach faithful representation?
The original purchase price would no longer provide a valuation which was complete or free from error
What is the difference between what the Cost and NRV of inventory represent?
Cost = Value at the time of purchase NRV = Value if sold today
What does the lower of cost and NRV rule state?
Inventory should be valued at either its cost, or NRV, using whichever value is lower
What are some reasons that lead to the NRV of inventory being lower than the cost?
Damage, purposeful decrease in selling price, decrease in demand, obsolescence
What does inventory write-down refer to?
The expense incurred when the NRV of an item of inventory falls below its cost price
How is inventory write down calculated?
Cost less NRV
What is inventory turnover?
The average number of days it takes for a business to sell its inventory or convert its inventory into sales
What does a fast inventory turnover suggest?
Inventory is being sold quickly, which enhances the firms ability to earn profit and generate cash in order to pay off short term debts
What benchmarks can inventory turnover be assessed against?
Performance in previous periods, expected performance and performance of competitors
What can be the negatives of having a fast inventory turnover?
The selling price may be too low, which indicates a loss of potential revenue and profit, or the business may be holding too little inventory
What does a slow inventory turnover suggest?
A decrease in sales which leads to a negative effect on profit and liquidity, as well as inventory becoming more susceptible to inventory loss or write-down
Which goods should usually have a fast inventory turnover?
Perishable fresh produce, goods susceptible to changes in fashion or cheap items
