getting that A part 1

FIFO (first in, first out)

assumes that a company uses goods in the order in which it purchases them. Assumes that first goods purchased are the first used or are the first sold. The inventory remaining must therefore represent the most recent purchases.

Work in process inventory

at any point in a continuous production process, some units are only partially processed. The cost of the raw material for these unfinished units, plus the direct labor cost applied specifically to this material and a ratable share of manufacturing overhead costs

specific identification

calls for identifying each item sold and each item in inventory. A company includes its cost of goods sold of the specific items sold. It includes in inventory the cost of the specific items on hand. This method may be used only in instances where it is practical to separate physically the different purchases made. Companies only use this method when handling a relatively small number of costly, easily distinguishable items. matches actual cost against actual revenue. reports ending inventory at actual cost.

The FASB ruled that companies should _______ interest costs related to assets constructed for internal use or assets produced as discrete projects(such as ships or real estate projects) for sale or lease

capitalize

companies generally account for the acquisition of inventories like other assets on a

cost basis

Beginning inventory+ Cost of goods purchased =

cost of goods available for sale

As goods are sold they are assigned to ____ __ ___ ____ and those that are not sold by the end of the accounting period represent ending inventory

cost of goods sold

product costs

costs that "attach" to the inventory. Records these costs in the inventory account these costs are directly connected with bringing the goods to the buyers place of business and converting such goods to a salable condition.

Period costs

costs that are indirectly related to the acquisition or production of goods. Costs such as selling expenses and under ordinary circumstances, general and administrative expenses not included as part of inventory costs

In times of rising costs, by expensing the most recently purchased items, cost of goods sold is _______ (compared to FIFO and average cost) and taxable income is _______

higher, lower

LIFO results in the ______ cash balance at year end (because taxes are lower) when prices are rising. the opposite occurs when prices are declining

highest

In practice, companies sometimes report inventory over and short in the "other revenues and gains" or "other expenses and losses" section of the _____ _____

income statement

If a company overstates ending inventory, working capital, current ratio, and net income are _______ and cost of goods sold is ________. The effect of error on net income will be counterbalanced in 2014, but the income statement misstates both years net income figures

overstated, understated

Perpetual inventory overages and shortages generally represent a _______ of cost of goods sold. The diference results from normal and expected shrinkage, breakage, shoplifting, incorrect recordkeeping, and the like. It adjusts cost of goods sold.

misstatement

While not intended to override the basic LIFO method adopted for financial reporting, these disclosures may be useful in comparing ______ ______ and _____ ______ with companies not on LIFO

operating income, working capital

Dollar value Lifo method

overcomes the problems of redefining pools and eroding layers. determines and measures any increases and decreases in a pool in terms of total dollar value, not the physical quantity of the goods in the inventory pool.

If ending inventory is understated, working capital (current assets-current liabilities) and the current ratio (current assets/current liabilities) is understated. If cost of goods sold is ______, then the net income is _______.

overstated, understated

In all cases where FIFO is used, the inventory and cost of goods sold would be the same at the end of the month whether a _______ or _________ system is used. Why? because the same costs will always be first in and therefore first out. This is true whether a company computes cost of goods sold as it sells goods throughout the accounting period (perpetual system) or as a residual at the end of the accounting period (periodic system)

perpetual, periodic.

under specific identification the cost flow matches the

physical flow of the goods

There is no requirement that the cost flow assumption adopted be consistent with the ______ _______ of goods. A companys major objective in selecting a method should be to choose the one that, under the circumstances, most clearly reflects periodic income

physical movement

Because of the liquidation problem, LIFO may cause ____ _____ _____. A company may simply purchase more goods and match these goods against revenue to avoid charging the old costs to expense. Furthermore, recall that with LIFO, a company may attempt to manipulate its net income at the end of the year simply by altering its pattern of purchases

poor buying habits

Average-cost method

prices items in the inventory on the basis of the average cost of all similar goods available during the period.

Advantage of LIFO approaches

1) LIFO cost flow often apporximates the physical flow of goods in and out of inventory. 2) LIFO matches the more recent costs against current revenues to provide a better measure of current earnings

Features of the perpetual inventory system are

1) Purchase of merchandise for resale or raw materials for production are debited to inventory rather than to purchases 2) Freight-in is debited to inventory, not purchases. Purchase returns and allowances and purchase discounts are credited to inventory rather than to separate accounts 3) Cost of goods sold is recorded at the time of each sale by debiting cost of goods sold and crediting inventory 4) a subsidiary ledger of invdividual records is maintained as a control measure. The subsidiary records show the quantity and cost of each type of inventory on hand.

Deficiencies of specific identification

1) can allow a company to manipulate net income 2) arbitrary allocation of costs that sometimes occurs with specific inventory problems

problems with specific goods pooled LIFO approach

1) companies continually change the mix of their products, materials, and production methods. As a result in employing a pooled approach using quantities companies must continually redefine the pools. This can be time consuming and costly. 2) even when practical, the apporach often results in erosion of the layers thereby losing much of the LIFO costing benefit. the new item may not be similar enough to be treated as part of the old pool. therefore, a company may need to recognize any inflationary profit deferred on the old goods as it replaces them

advantages of dollar value lifo method over the specific goods approach

1) companies may include a broader range of goods in a dollar value LIFO pool and 2) a dollar-value LIFO pool permits replacement of goods that are similar items, similar in use, or interchangeable. In contrast, a specific-goods LIFO pool only allows replacement of items that are substantially identical.

Companies usually choose LIFO when

1) if selling prices and revenues have been increasing faster than costs, thereby distoring income, and 2) in situations where LIFO has been traditional, such as department stores and industries where a fairly constant "base stock" is present (such as refining, chemicals, and glass)

the net method is considered better for 2 reasons

1) it provides a correct reporting of the cost of the asset and related liability and 2) it can measure management inefficiency by holding management responsible for discounts not taken

Major disadvantages of LIFO

1) reduced earnings. Many managers view the lower profits reported under LIFO in inflationary times as a distinct disadvantage. They would rather have a higher reported profits than lower taxes. 2) inventory understated. may have distorting effects on the company's balance sheet. The inventory valuation is normally outdated because the oldest costs remain in inventory. this understatement makes the working capital position of the company appear worse than it really is. 3) physical flow. LIFO does not approximate the physical flow of items except in specific situations. 4) Involuntary liqudiation/poor buying habits. If a company eliminates the base of layers of old costs, it may match old irrelevant costs against current revenues. A distortion is reported in net income for a given period may result as well as detrimental income tax consequences.

Valuing inventories can be complex. It requires determining the following:

1) the physical goods to include in inventory (Who owns the goods?-goods in transit, consigned goods, special sales agreements) 2) the cost to include in inventory (product v. period costs) 3) the cost flow assumption to adopt (specific identification, average-cost, FIFO, LIFO, retail, etc)

traditional LIFO is often unrealistic for 2 reasons

1) when a company has many different inventory items, the accounting cost of tracking each inventory item is expensive. 2) Erosion of the LIFO inventory can easily occur. Referred to as LIFO liquidation, this often distorts net income and leads to substantial tax payments.

LIFO is probably not appropriate in these situations

1) where prices tend to lag behind costs 2) in situations where specific identification is traditional, such as in sale of automobiles, farm equipment, art, and antique jewelry; or 3) where unit costs tend to decrease as production increases, thereby nullifying the tax benefit that LIFO might provide

Advantages of the FIFO method is

1)approximates the physical flow of goods. It closely approximates specific identification at the same time it prevents manipulation of income. (a company cannot pick a certain cost of item to charge to expense) 2) ending inventory is closer to current cost. ending inventory consists of most recent purchases. This approach generally approximates replacement cost on the balance sheet when price changes have not occured since the most recent purchases.

Periodic inventory system

A company determines the quantity of inventory on hand only periodically, as the name implies.

Raw materials inventory

A company reports the costs assigned to goods and materials on hand but not yet placed into production. Include such things as the wood to make a baseball bat or the steel to make a car. These materials can be traced directly to the end product

Finished goods inventory

Companies report the costs identified with the completed but unsold units on hand at the end of the fiscal period as _____ ___ ____.

Companies market certain products through consignment shipping

Company A (consignor) ships various art merchandise to company B (consignee), who acts as company A's agent in selling the consigned goods. Company B agrees to accept the goods without any liability except to exercise due care and reasonable protection from loss or damage until it sells the goods to a 3rd party. When Company B sells the goods, it remits the revenue, less a selling commission and expenses incurred in accomplishing the sale to Company A

Parking transactions

Company A parks the inventory on company B's balance sheet for a short period of time. Generally when this repurchase agreement exists, Company A should report the inventory and related liability on its books because company A has retained the risks and rewards of ownership

Companies should disclose either the LIFO reserve or the replacement cost of the inventory

Ex: At december 31, $31,516,000 of inventories were valued using the LIFO method. This amount is less than the corresponding replacement value by $3765000 Ex2: Inventories are valued at the lower of cost or market determine principally by the last-in, first out method. If the FIFO cost method has been used, inventories would have been $11,709 higher in the current year and $13,424 higher in the previous year

f.o.b shipping point

If a supplier ships goods to company A using ______ _____ _____, title passes to company A when the supplier delivers the goods to the common carrier, who acts as an agent for company A

The difference between the inventory method used for internal reporting purposes and LIFO is the allowance to reduce inventory to LIFO account or the ______ _______. the chance in the allowance from one period to the next is the ______ ______.

LIFO reserve, LIFO effect

When a company uses a perpetual inventory system and a difference exists between the perpetual inventory balance and the physical inventory account, it needs a separate entry to adjust the perpetual inventory account.

Inventory over and short XXX Inventory XXX

Specific goods pooled LIFO approach

It groups items of a similar nature into pools. Why? results in fewer lifo liquidiations.because the reduction of one quantity in the pool may be offset by an increase in another. uses quantities at its measurement basis

LIFO effect

It is an adjustment that companies make to the accounting records in a given year

Features of a periodic inventory system

It records all acquisitions of inventory during the accounting period by debting the purchases account. A company then adds the total in the purchase account at the end of the accounting period to the cost of inventory on hand at the beginning of the period. The sum determines the total cost of goods available for sale during the period. To compute cost of goods sold, the company then subtracts the ending inventory from the cost of goods available for sale. The cost of goods sold is a residual amount that depends on physical count of ending inventory. This process is referred to as "taking a physical inventory" Companies that use this system take a physical inventory at least once a year

Share prices are the same under FIFO and LIFO, and in some cases even higher under _______ in spite of lower ____ ______

LIFO, reported earnings

Issues related to LIFO

Many companies use LIFO for tax and external reporting purposes. However they maintain a FIFO, average-cost or standard cost system for internal reporting purposes. reasons why: 1) companies often base their pricing decisions on FIFO, AverageCOt or standard cost assumption rather than LIFO basis 2) recordkeeping on some other basis is easier because the LIFO assumption usually does not approximate the physical flow of product 3) profit-sharing and other bonus arrangements often depend on a non-lifo inventory assumption 4) the use of pure LIFO system is troublesome for intermin periods, which require estimates of year-end quantities and prices

Sales with high rates of returns

Under what circumstances should companies consider the inventory sold? When the company can reasonably estimate the amount of returns it should consider the goods sold but establish a return liability for the amount of estimated returns. Conversly, if returns are unpredictable, a company should not consider the goods sold and it should not remove the goods from its inventory.

LIFO Liquidation

a compant matches costs from preceding periods against sales revenues reported in current dollars. Leads to a distortion in net income and increased taxable income in the current period

the price index provides

a measure of change in price or cost levels between the base year and the current year. The company then computes the index for each year after the base year.

The periodic method does not report inventory over and short because it does not have ______ ______ against which to compare the physical count. As a result, a company buries inventory overages and shortages in cost of goods sold

accounting records

all companies need periodic verification of the inventory records by ______ _____, weight or measurement, with the counts compared with the detailed inventory records. A company corrects the records to agree with the quantity actually on hand

actual count

Inventories are

asset items that a company holds for sale in the ordinary course of business, or goods that i will use or consume in the production of goods to be sold.

in dollar-value LIFO, the ending inventory at base year prices must always equal the total of the layers at _____ ______ prices

base-year

Why does an omission of purchases and inventory not affect net income? total working capital is unchaged, but the current ratio is overstated because of the omission of equal amounts of inventory and accounts payable

because both purchases and ending inventory is understated by the same amount and the error is thereby offset in cost of goods sold

When ending inventory is understated the two year effect on net income is decreased in 2013 and increased in 2014. The error is counterbalanced (offset) in 2014 because _____ ______ is understated and net income is overstated. The total for 2013 and 2014 will be correct even with the error

beginning inventory

Another approach is to record the purchases and accounts payable at an amount net of the cash discounts

company records failure to take a purchase discount within the discount period in a purchase discounts lost account. If a company uses this net method, it considers purchase discounts lost as a financial expense and reports it in other expenses and losses in the income statement.

Companies often use the average-cost methods for practical rather than ________ reasons. These methods are both simple to apply and objective. They are not subject to income manipulation as some of the other inventory pricing methods. In addition pronenets of average cost method reasons that measuring a specific physical flow of inventory is often impossible, therefore it is better to cost items on an average price basis

conceptual

In a perfect world, companies would like a_______ record of both their inventory levels and their cost of goods sold

continuous

Perpetual inventory system

continuously tracks changes in the inventory account. A company records all purchases and sales (issues) of goods directly in the inventory account AS THEY OCCUR. Provides a continous record of the balances in both the inventory account and the cost of goods sold account

with LIFO, future price declines will not substantially affect a company's future reported earnings. The reason: since the company records the most recent inventory as sold first, there is not much ending inventory at high price vulnerable to a price ______. thus LIFO eliminates or substantially minimizes write-downs to market as a result of price _____. in contrast, inventory costed under FIFO is now more vulnerable to price declines, which can reduce net income substantially

decline, decrease

If a company uses this gross method, it reports purchase discounts as a

deduction from purchase on the income statement

LIFO's popularity mainly stems from its tax benefits. As long as the price level increases and inventory quantities do not decrease, a ______ of income tax occurs. why? because a company matches the items it most recently purchased (at the higher price level) against revenues.

deferral

Some companies combine inventory methods. Reasons for this is that certain product lines can be highly susceptible to _______ instead of inflation. In addition, if the level of inventory is _____, unwanted involuntary liquidations may result in certain product lines using LIFO. Finally, for high inventory turnover in certain product lines, a company cannot justify LIFO's additional recordkeeping and expenses. In such cases, a company often uses average-cost because it is easier to compute.

deflation, unstable

the cost of goods sold is the

difference between 1) the cost of goods available for sale during the period and 2) the cost of goods on hand at the end of the period

A manufacturers product costs include

direct materials, direct labor, and manufacturing overhead costs. Manufacturing overhead costs include indirect materials, indirect labor, and various costs such as depreciation, taxes, insurance, and heat and electricity.

Most companies using a LIFO system employ the

dollar-value LIFO

General formula for computing the index (price index for current year)

ending inventory for the period at the current cost/ ending inventory for the period at the base-year cost

In dollar-value LIFO, a layer forms only when the ______ _______ at base-year prices ________ the beginning inventory at base-year prices

ending inventory, exceeds

Under the dollar value LIFO method, one pool may contain the _______ inventory. However companies generally use several pools. In general, the more goods included in a pool, the more likely that increases in the quantities of some goods will offset decreases in other goods in the same pool. Thus, companies avoid ________ of the LIFO layers. It follows that having fewer pools means less cost and less chance of a reduction of a lifo layer

entire, liquidation

Deficiencies of the FIFO method

fails to match current costs against current revenues on the income statement. A company charges the oldest costs against the more recent revenue, possibly distorting gross profit and net income

Companies use the more traditional LIFO approaches only when dealing with ___ _______ and expecting ____ _____ in the product mix

few goods, little change

Tax law requires that if a company uses LIFo for tax purposes, it must also use LIFO for _______ _______ purposes. This requirement is often referred to as the LIFO conformity rule.

financial accounting

examples of product costs are

freight charges on goods purchased, other direct costs of acquisition, and labor and other product costs incurred in processing the goods up to the time of sale

Erosion of the layers occurs when a specific good or material in the pool is replaced with another _____ or ______-

good, material

The use of a purchase discounts account in a periodic inventory system indicates that the company is reporting its purchases and accounts payable at the

gross amount

f.o.b destination

if a supplier ships the goods _______ _______, title passes to company A only when it receives the goods from the common carrier.

Supplies inventory

include such items as machine oils, nails, cleaning material, and the like-supplies that are used in production but are not primary materials being processed.

. During periods of ________, many challenge the quality of non-LIFO earnings, noting that failing to match current costs against current revenues creates transitory or "paper" profits ("_____ ______") . Inventory profits occur when the inventory costs matched against sales are less than the inventory replacement cost. This results in understating the cost of goods sold and overstating profit. Using LIFO matches current costs against revenues, thereby reducing inventory profits.

inflation, inventory profits

LIFO provides a more useful income measure, however, other methods such as FIFO and average cost better reflect the current value of _________ on the balance sheet

inventory

To make the current ratio comparable on an apple-to-apples basis, analysts use the LIFO reserve. these adjustments do the trick

inventory adjustment: LIFO inventory+ LIFO reserve= FIFO inventory

If a company overstates both purchases (on account) and ending inventory, then financial statements overstate ______and _____ _____ and understate current ratio. This overstatement does not affect cost of goods sold and net income because the errors offset one another. simiarily, working capital is not affected

inventory, accounts payable

The _______ in inventories is frequently the largest current asset of merchandising (retail) and manufacturing businesses

investing

Technically a company should record purchases when it obtains _____ _____ to the goods. In practice, however a company records acquisitions when it recieves the goods. WHy? because it is difficult to determine the exact time of legal passage for every purchase. In addition, no material error likely results from such a practice if consistently applied

legal title

In dollar-value LIFO, if the ending inventory at base-year prices is ______ than the beginning inventory at base-year prices, a company must ________ the decrease from the most recently added layer. When a decrease occurs, the company "peels off" previous layers at the prices in existence when it added the layers

less, subtract

Gross profit and net income are _____ under LIFO, ______ under FIFO, and somewhere in the ______ for average cost

lower, higher, middle

Price changes are critical in dollar-value LIFO. How do companies determine price indexes?

many companies use the general price-level index that the federal government prepares and publishes each month. Companies also use more-specific external price indexes. For instance, various organizations compute and publish daily indexes for most commodities (gold,silver, other metals, corn, wheat, and other farm products). Many trade associations prepare indexes for specific product lines or industries. Any of these indexes may be used for dollar-value LIFO purposes

LIFO (last in, first out) method

matches the cost of the last goods purchased against revenue. Under a periodic system it assumes that the cost of the total quantity sold or issued during the month comes from the most recent purchases. Under a perpetual inventory this method results in different ending inventory and cost of goods sold amounts than the amounts calculated under the periodic method.

A merchandising concern (Walmart Stores) usually purchases its merchandise in a form of ready sale. It reports the cost assigned to unsold units left on its hand as ________ ________. Only one inventory account, inventory, appears in the financial statements

merchandise inventory

Consumer Price Index for Urban consumers (CPI-U)

most popular general external price-level index

Sometime an enterprise finances its inventory without reporting either the liability or the inventory on its balance sheet. This apporach is often referred to as a _____ _____ _______, and usually involves a "sale" with either an implicit or explicit "buy back" agreement

product financing arrangement

In consignment shipping, the consignee makes no entry to the inventory account for the goods received. These goods remain the _______ of the consignor until sold. Because the goods are still belong to the cosignor, the consignor includes the goods in its inventory at purchase price or production cost

property

Modified perpetual inventory system

provides detailed inventory record of increases and decreases in quantities only- not dollar amounts. It is merely a memorandum device outside the double-entry system, which helps in determining the level of inventory at any point in time.

When a company obtains legal title to goods, it must record them as _______ in that fiscal period, assuming a periodic inventory system. To disregard such purchases results in understating inventories and accounts payable in the balance sheet, and understating purchases and ending inventory in the income statement

purchases

Manufacturing concerns produce goods to sell to merchandising firms. Although products they produce may differ, manufacturers normally have 3 inventory accounts- ______ _______, ______ __ _______, and _______ ______

raw materials, work in process, finished goods

The specific goods pooled LIFO approach reduces _______ and ______ costs. In addition, it is more difficult to erode the layers because the reduction of one quantity in the pool may be offset by an increase in another. Nonetheless, the pooled approach uses quantities as its measurement basis can lead to untimely LIFO liquidations

recordkeeping, clerical

Recognizing revenue at the time the inventory is "parked" violates the ____ ____ ______. that is, a performance obligation is met when the risks and rewards of ownership are transferred to the buyer

revenue recognition principle

A company should NOT capitalize interest costs for inventories that is ________ manufactures or otherwise produces in large quantities. informational benefit does not justify the cost

routinely

LIFO liquidations can occur frequently when using a ______ ______ LIFO approach

specific goods

When a relevant specific external price index is not readily available, a company may compute its own ______ _____ _____ ______. The desired approach is to price ending inventory at the most current cost. Therefore, a company that chose to compute its own specific internal price index would ordinarily determine current cost by referring to the actual cost of goods it most recently had purchased.

specific internal price index

IRS has relaxed the LIFO conformity rule which requires a company employing LIFO for tax purposes to use it for book purposes as well and also reduced restrictions against providing non-LIFO income numbers as ______ _____. As a result, companies now provide supplemental non-LIFO disclosures

supplementary information

Switching from FIFO to LIFO usually results in an immediate ____ ______. However, switching from LIFO to FIFO can result in a substantial ____ _____

tax benefit, tax burden

The higher the inventory balance, the higher the additional ______ _______ will be upon the switch to FIFO

tax payment

Goods in tranist: sometimes purchased merchandise remains in transit-not yet received-at the end of the physical period.

the accounting of these shipped goods depends on who owns them

Inventory is understated in LIFO

the magnitude and direction of this variation between the carrying amount of inventory and its current price depends on the degree and direction of the price changes and the amount of inventory turnover. The combined effect of rising product prices and avoidance of inventory liquidations increases the difference between the inventory carrying value at LIFO and current prices of that inventory. This magnifies the balance sheet distortion attributed to the use of LIFO

Problems that exist with dollar value LIFO system

the selection of items to be put in a pool can be subjective. Such a determination, however, is extemely important because manipulation of these items in a pool without conceptual justification can affect reported net income. for example: SEC noted that some companies have set up pools that are easy to liquidate. as a result, to increase income, a company simply decreases inventory, thereby matching low-cost inventory items to current revenues

The cost of goods available for sale or use is

the sum of 1) the cost of goods at hand at the beginning of the period and 2) the cost of goods acquired or produced during the period

Omission of goods from purchases and inventory results in an _______ of inventory and accounts payable on the BS. It also results in understatement of purchases and ending inventory in the income statement. However, the omission of such goods does not affect net income for the period

understatement

Although a company may use a variety of inventory methods to assist in accurate computation of net income, once it selects a pricing method, it must apply it consistently thereafter. If conditions indicate that the inventory pricing method in use is ________, the company must seriously consider all other possibilities before selecting another method. It should clearly explain any change and ______ its effect in the financial statements

unsuitable, disclose

double-extension method

value of the units in inventory is extended at both base year prices and current year prices . Use of this method is time consuming and difficult where substantial technological change has occured or where many items are involved. That is, as time passes, the company must determine a new base year cost for new products, and must keep a base year cost for each inventory item