Chapter 6 - Cost of Goods Sold and Inventory

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the phrase _____________ differentiates inventory from other operational assets

"intended for resale"

The earliest purchases ________ are assumed to be the first sold _________, and the more recent purchases are in ending inventory.

(the first in) (the first out)

Under the _______, as purchase transactions occur, they are recorded in one of four temporary accounts, which are:

- Periodic Inventory System (1) purchases (2) purchase discounts (3) purchase returns and allowances (4) transportation-in

With rising purchase prices, FIFO produces:

- highest ending inventory - lowest cost of goods sold - highest income

falling purchase prices, LIFO produces:

- highest ending inventory - lowest cost of goods sold - highest income

With rising purchase prices, LIFO produces:

- lowest ending inventory - highest cost of goods sold - lowest income

falling purchase prices, FIFO produces:

- lowest ending inventory - highest cost of goods sold - lowest income

if a customer returns an item for some reason, the company will decrease sales by debiting a contra revenue account called ______ and decrease ______ or ______

1. "Sales Returns & Allowances" 2. accounts receivable 3. cash

The federal income tax code requires businesses that use ______ for tax purposes to use _____ for financial reporting purposes as well. This is known as the _______

1. LIFO 2. LIFO conformity rule.

Choosing _____ to minimize current taxes does not avoid the payment of taxes; it merely ________ it, temporarily reducing the company's capital requirements for a period of time.

1. LIFO 2. postpones

To determine the cost of inventory sold, companies can use one of the following methods:

1. Specific Identification 2. FIFO 3. LIFO 4. Average Cost

the proper recording of freight costs depends upon whether the ____ or the _____ pays for the transportation

1. buyer 2. seller

Every time inventory is sold, the cost of the earliest (oldest) purchases that make up cost of goods available for sale is allocated to ______ and the cost of the most recent purchases is allocated to ________.

1. cost of goods sold 2. ending inventory

In addition, using a perpetual inventory system, the company must make a second entry to decrease _____ and increase ______ to reflect the return of the merchandise.

1. cost of goods sold 2. inventory

In a periodic inventory system, the inventory records are not kept continually, or perpetually, up to date. Instead, under a periodic inventory system, the inventory account is updated at the _____ of the period based on a _______

1. end 2. physical count of the inventory on hand.

A key feature of the cost of goods sold model is that the determination of cost of goods sold requires an allocation of the cost of goods available for sale between _______ and ________

1. ending inventory 2. cost of goods sold.

manufacturing companies class inventory into 3 categories: 1. 2. 3.

1. raw materials 2. work-in-process 3. finished goods

In periods of ____, companies may choose _____ because it produces the lowest current taxable income and the lowest current income tax payment.

1. rising prices 2. LIFO

The recording of sales revenue under the perpetual inventory system involves two journal entries:

1. sales rev is recognized 2. recognizes the cost of goods that are sold; it also reduces the inv account

In dealing with sales to customers, it is important to remember to record revenues at the ______ and to record expenses (and inventory) at the _______

1. selling price 2. cost.

Average days to sell inventory =

365 days/inventory turnover ratio

Cost of Goods Sold Model:

Beginning Inventory + Net Purchases = Cost of Goods available for sale - Ending Inventory = Cost of Goods Sold

Inventory Turnover Ratio =

Cost of Goods Sold/Average Inventory

Because a new average is computed after each purchase, the Average Cost method is often called the moving-average method. This weighted average cost per unit is then used to calculate ending inventory and cost of goods sold as follows:

Ending Inventory = Units on Hand x Weighted Average Cost per Unit Cost of Goods Sold = Units Sold x Weighted Average Cost per Unit

Cost of Ending Inventory =

Ending Inventory x Cost per Unit

Analysts and other users often wish to compare companies that use different inventory costing methods. To assist in these comparisons, companies that use LIFO are required to report the amount that inventory would increase (or decrease) if the company had used _____

FIFO.

ownership of the inv passes when the goods are delivered to the buyer

FOB Destination

ownership of the inventory passes from the seller to the buyer at the shipping point

FOB Shipping Point

indicates the extent to which the resources generated by sales can be used to pay operating expenses (selling and administrative expenses) and provide for net income

Gross margin (or gross profit)

the difference between the inventory reported on the balance sheet on LIFO basis and what inventory would be if reported on FIFO basis.

LIFO reserve

If the market value (replacement cost) of a company's inventory is lower than its historical cost, the company reduces the amount recorded inventory to its market value. This rule is an exception to the cost principle.

Lower of Cost or Market Rule (LCM)

Gross Margin =

Net Sales - Cost of Goods Sold

Cost of goods sold updated with each sale

Perpetual (inv system)

Periodic Inventory System: accumulates the amount of discounts on purchases taken during the period.

Purchase Discounts

Periodic Inventory System: accumulates the cost of returned merchandise or reductions in selling prices granted.

Purchase Returns and Allowances

Periodic Inventory System: accumulates the cost of the inventory acquired during the periodP

Purchases

LIFO Inventory Value =

Reported FIFO Inventory - LIFO Reserve

If ending inventory is understated: Ending Inv/Current Period

Understated

Cost of Goods Sold =

Units Sold x Cost per Unit

For the Average Cost method, the weighted average cost per unit is calculated after each purchase of inventory as follows:

Weighted Average Cost per Unit = Cost of Goods Available for Sale/Units Available for sale

What is inventory?

a tangible resource (current asset) that is held for resale in the normal course of operations

inventory is recorded at its _________ cost

acquisition

Because the ending inventory of one period is the beginning inventory of the next period, errors in the measurement of ending inventory _______

affect two accounting periods

The _____ allocates the cost of goods available for sale between ending inventory and cost of goods sold based on a weighted average cost per unit.

average cost method

If ending inventory is understated: Ending Inventory/next period

correct

If ending inventory is understated: total assets/next period

correct

if ending inventory is overstated: ending inv/next period

correct

if ending inventory is overstated: total assets/next period

correct

In the long run, all inventory costs will find their way to ______ and the income statement.

cost of goods sold

when companies sell their inventory to customers, the cost of the inventory becomes an expense called _________

cost of goods sold

Under the LIFO method, the most recent purchases (newest costs) are allocated to the ______ and the earliest purchases (oldest costs) are allocated to _____

cost of goods sold inventory

However, typically, the price paid for a good changes over time and the cost of goods available for sale may include units with different ___________

costs per unit

Using the perpetual inventory system, the buyer will _________ the inventory account for the amount of a purchase discount.

credit

using the perpetual inv system, the buyer will _____ the inventory account for the amount of a purchase return or allowance

credit

the ______ specify the amount and timing of payments

credit terms

using a perpetual inv system, the buyer will _______ the inventory account for the transp. costs paid

debit

all costs incurred to get the inventory are included in the acquisition cost; these include _________

delivered, or prepared for resale

It requires that ______ so that a company knows exactly which items were sold and the cost of those items.

detailed records of each purchase and sale be maintained

a period when prompt payment is rewarded by offering a discount

discount period

The ______ is based on the assumption that costs move through inventory in an unbroken stream, with the costs entering and leaving the inventory

first-in, first-out (FIFO) method

transportation, or _________, costs are expenditures made to move the inventory from the seller's location to the purchaser's location

freight

the buyer normally pays the transportation costs termed

freight in

the seller is usually responsible for paying the transportation costs termed as ______

freight-out

The _____ method allocates the cost of goods available for sale between ending inventory and cost of goods sold based on the assumption that the most recent purchases are the first to be sold

last-in, first-out (LIFO)

companies that buy and transform raw materials into a finished product which is then sold

manufacturers

inventory held by merchandisers

merchandise inventory

Because a perpetual inventory system is being used, the __________ is also affected.

merchandise inventory account

companies (either retailers or wholesalers) that purchase inventory in a finished condition and hold it for resale without further processing

merchandisers

If ending inventory is understated: cost goods sold/current period

overstated

If ending inventory is understated: net income/next period

overstated

if ending inventory is overstated: cost goods sold/next period

overstated

if ending inventory is overstated: ending inv/current period

overstated

if ending inventory is overstated: net income/current period

overstated

if ending inventory is overstated: total assets/current period

overstated

cost of goods sold are recorded only at the end of a period

periodic (inv system)

In many instances, FIFO is an accurate representation of the _____ flow of goods.

physical

Except for companies that stockpile inventory (e.g., piles of coal, stacks of hay, stacks of rock), FIFO rarely coincides with the actual _____ of inventory

physical flow

Under a periodic inventory system, the inventory costing methods are applied as if all purchases during an accounting period take place _______

prior to any sales of the period.

in some instances, the buyer may choose to keep the merchandise if the seller is willing to grant a deduction (allowance) from the purchase price; this is called a _________

purchase allowance

Companies that sell goods on credit often offer their customers sale discounts to encourage prompt payment. From the viewpoint of the buyer (customer), such price reductions are called __________

purchase discounts

the cost of inventory includes the ________ of the merchandise plus any cost of bringing the goods to salable condition and location

purchase price

the cost of merchandise returned to suppliers is called a

purchase return

refer to the cost of merchandise acquired for resale during the accounting period

purchases

merchandisers that sell directly to consumers

retailers

In addition to purchase transactions, merchandising companies must also account for the inventory effects of _______

sales and sales returns.

Companies recognize ____ when it is earned and the collection of cash is reasonably assured.

sales revenue

the point at which ownership, or title, of the inventory changes hands depends on the _______ of the contract

shipping terms

The _____ determines the cost of ending inventory and the cost of goods sold based on the identification of the actual units sold and in inventory.

specific identification method

Periodic Inventory System: accumulates the costs paid by the purchaser for inventory from suppliers.

transportation-in

If ending inventory is understated: cost goods sold/next period

understated

If ending inventory is understated: net income/current period

understated

If ending inventory is understated: total assets/current period

understated

if ending inventory is overstated: cost goods sold/current period

understated

if ending inventory is overstated: net income/next period

understated

merchandisers that sell to other retailers

wholesalers


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