Financial Accounting Chapter 6

If a customer returns an item for some reason, the company will decrease sales by debiting a contra revenue account called___________ and decrease accounts receivable or cash.

"Sales Returns & Allowances"

The phrase ____ differentiates inventory from other operational assets.

"intended for resale"

As purchase transactions occur, they are recorded in one of four temporary accounts, which are

(1) purchases, (2) purchase discounts, (3) purchase returns and allowances, and (4) transportation-in.

Credit terms of "2/10, n/30" mean that a 2% discount may be taken on the invoice price if payment is made within

10 days of the invoice date.

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

Seller (_____) Earns a fee for selling

Consignee

Original Owner (______) Retains Ownership

Consignor

Inventory Turnover Ratio =

Cost of Goods Sold / Average Inventory

A period when prompt payment is rewarded by offering a discount

Discount period:

If the prices paid for goods are constant over time, this allocation is easy to compute:

Ending Inventory x Cost per Unit = Cost of Ending Inventory Units Sold x Cost per Unit = Cost of Goods Sold

ownership of the inventory passes when the goods are delivered to the buyer and the seller is usually responsible for paying the transportation costs termed as freight-out.

F.O.B. destination:

ownership of the inventory passes from the seller to the buyer at the shipping point and the buyer normally pays the transportation costs termed as freight-in.

F.O.B. shipping point:

Sales - Perpetual System: The recording of sales revenue under the perpetual inventory system involves two journal entries:

First, sales revenue is recognized. The second journal entry recognizes the cost of goods that are sold.

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

Inventory

Transportation Costs -Perpetual System: Using a perpetual inventory system, the buyer will debit the _____ for the transportation costs paid.

Inventory account

Under ____, 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.

LCM

In periods of rising prices, companies may choose ____because it produces the lowest current taxable income and the lowest current income tax payment.

LIFO

Reported FIFO Inventory - LIFO Reserve =

LIFO Inventory Value

LCM

Lower of Cost or Market Rule

The inventory held by merchandisers

Merchandise inventory:

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

Merchandisers:

Types of Companies

Merchandisers: Merchandise inventory: Retailers: Wholesalers: Manufacturers:

Gross Margin=

Net Sales - Cost of Goods Sold

accumulates the amount of discounts on purchases taken during the period.

PURCHASE DISCOUNTS:

accumulates the cost of returned merchandise or reductions in selling prices granted.

PURCHASE RETURNS & ALLOWANCES:

accumulates the cost of the inventory acquired during the period.

PURCHASES:

Cost of goods sold are recorded only at the end of a period.

Periodic -

Cost of goods sold updated with each sale

Perpetual -

Types of Inventory Systems

Perpetual - Periodic -

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

Purchases

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

Specific Identification FIFO LIFO Average Cost

Given this assumption, the following steps can be applied to determine ending inventory and cost of goods sold:

Step 1: Calculate the cost of goods available for sale for the period. Step 2: Apply the inventory costing method to determine ending inventory and cost of goods sold.

accumulates the costs paid by the purchaser for inventory from suppliers.

TRANSPORTATION -IN:

This 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

Merchandisers that sell to other retailers

Wholesalers:

Inventory is recorded at its

acquisition cost.

LIFO: Except for companies that stockpile inventory (e.g., piles of coal, stacks of hay, stacks of rock), this cost flow assumption rarely coincides with the

actual physical flow of inventory.

The credit terms specify the __&___ of payments.

amount and timing

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

Choosing LIFO to minimize current taxes does not avoid the payment of taxes; it merely postpones it, temporarily reducing the company's

capital requirements for a period of time.

Sales - Perpetual System: Companies recognize sales revenue when it is earned and the collection of

cash is reasonably assured.

Incorrect counts, mistakes in costing, or errors in identifying items are

common.

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

cost flow assumption

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

cost of goods sold

FIFO: 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

cost of goods sold ending inventory.

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.

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

ending inventory and cost of goods sold.

The _____ requires businesses that use LIFO for tax purposes to use LIFO for financial reporting purposes as well.

federal income tax code

The _____ method 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)

Falling Purchase Prices: LIFO produces-

highest ending inventory lowest CGS highest income

Rising Purchase Prices: FIFO produces-

highest ending inventory lowest CGS highest income

The purchase of inventory is recorded by

increasing the inventory account.

Sales - Perpetual System: It also reduces the _____ so that the perpetual inventory system will reflect an up-to-date balance for inventory.

inventory account

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.

Historically, this method was practical only for high-cost items with unique identifiers (e.g., serial numbers) that were sold in

low numbers—for example, automobiles.

Falling Purchase Prices: FIFO produces-

lowest ending inventory highest CGS lowest income

Rising Purchase Prices: LIFO produces-

lowest ending inventory highest CGS lowest income

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

merchandise inventory account

Because a new average is computed after each purchase, this method is often called the

moving-average method.

Gross margin 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

Transportation Costs -Perpetual System: The proper recording of transportation costs depends upon whether the buyer or the seller

pays for the transportation.

Gross margin (or gross profit) is a key

performance measure.

The balance in the inventory account remains unchanged during the

period

In a ______, 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 end of the period based on a physical count of the inventory on hand.

periodic inventory system

Using the _____, the buyer will credit the Inventory account for the amount of a purchase return or allowance.

perpetual inventory system

Using the _______, the buyer will credit the inventory account for the amount of a purchase discount.

perpetual inventory system

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.

Companies that sell goods on credit often offer their customers sale discounts to encourage

prompt payment.

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.

From the viewpoint of the buyer (customer), such price reductions are called

purchase discounts.

The cost of merchandise returned to suppliers is called a

purchase return.

Manufacturing companies classify inventory into three categories:

raw materials, work-in-process, and finished goods.

Transportation Costs -Perpetual System: Transportation, or freight, costs are expenditures made to move the inventory from the

seller's location to the purchaser's location.

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

selling price cost.

Transportation Costs -Perpetual System: The point at which ownership, or title, of the inventory changes hands depends on the

shipping terms of the contract.

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

With the introduction of bar coding, electronic scanners, and radio frequency identification, the specific identification method has become easier to implement, but its application is

still relatively rare.

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.

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.

This includes all costs incurred to get the inventory:

Delivered, or Prepared for resale

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

Transportation Costs -Perpetual System: The shipping terms can be either:

F.O.B. shipping point: F.O.B. destination:

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

LIFO conformity rule.

____ is 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

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

Manufacturers:

Merchandisers that sell directly to consumers

Retailers:

Sometimes goods owned by one party are held and offered for sale by another. This arrangement is called a

consignment.

in the long run, all inventory costs will find their way to

cost of goods sold and the income statement.

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

cost of goods sold.

The _____ includes the purchase price of the merchandise plus any cost of bringing the goods to salable condition and location.

cost of inventory

Effects of Inventory Errors: Even with recent technological advances, it is easy to make errors in determining the

cost of the hundreds of items in a typical ending inventory.

The earliest purchases (the first in) are assumed to be the first sold (the first out), and the more recent purchases are in

ending inventory.

In addition to purchase transactions, merchandising companies must also account for the

inventory effects of sales and sales returns.

specific identification method requires that detailed records of each purchase and sale be maintained so that a company knows exactly which

items were sold and the cost of those items.

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 (the last in) are the first to be sold (the first out).

last-in, first-out (LIFO)