Ch. 6

Balance Sheet Effects

-A major advantage of the FIFO method is that in a period of inflation, the costs allocated to ending inventory will approximate their current cost. -A major shortcoming of the LIFO method is that in a period of inflation, the costs allocated to ending inventory may be significantly understated in terms of current cost.

Average-Cost

-Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred. -Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory

Tax Effects

-Both inventory and net income are higher when companies use FIFO in a period of inflation. -LIFO results in the lowest income taxes (because of lower net income) during times of rising prices. -A tax rule, often referred to as the LIFO conformity rule, requires that if companies use LIFO for tax purposes they must also use it for financial reporting purposes.

Inventory is accounted for at cost.

-Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale. -Unit costs are applied to quantities to compute the total cost of the inventory and the cost of goods sold using the following costing methods: ► Specific identification ► First-in, first-out (FIFO) ► Last-in, first-out (LIFO) ► Average-cost

First-In, First-Out (FIFO)

-Costs of the earliest goods purchased are the first to be recognized in determining cost of goods sold. -Often parallels actual physical flow of merchandise. -Companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed.

Last-In, First-Out (LIFO)

-Costs of the latest goods purchased are the first to be recognized in determining cost of goods sold. -Seldom coincides with actual physical flow of merchandise. -Exceptions include goods stored in piles, such as coal or hay.

Specific Identification

Actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of the ending inventory.

Inventory Errors:

Affects both the income statement and balance sheet

Presentation

Balance Sheet - Inventory classified as current asset. Income Statement - Cost of goods sold is subtracted from sales. There also should be disclosure of the: 1) major inventory classifications, 2) basis of accounting (cost or LCM), and 3) costing method (FIFO, LIFO, or average-cost).

Lower-of-Cost-or-Market (LCM): When the value of inventory is lower than its cost

Companies value the inventory at the lower-of-cost-or-market in the period in which the price decline occurs, thereby recognizing the loss in the period the price declines Market = Replacement Cost Example of conservatism: recognizing expenses and liabilities as soon as possible when there is uncertainty about the outcom

Analysis

Inventory management is a double-edged sword 1. High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage). 2. Low Inventory Levels - may lead to stock-outs and lost sales.

Consigned Goods

To hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of the goods.

Under the lower-of-cost-or-market basis in valuing inventory, market is defined as a current replacement a. cost. b. selling price. c. historical cost plus 10%. d. selling price less markup.

a. cost.

Pappy's Staff Junkets has the following inventory information. July 1 Beginning Inventory 10 units at $90 July 5 Purchases 60 units at $92 July 14 Sale 40 units July 21 Purchases 30 units at $95 July 30 Sale 28 units Assuming that a perpetual inventory system is used, what is the ending inventory a. $2,924 b. $2,930 c. $3,034 d. $6,346

b. $2,930

In a period of increasing prices, which inventory flow assumption will result in the lowest amount of income tax expense? a. FIFO b. LIFO c. Average Cost d. Income tax expense for the period will be the same under all assumptions

b. LIFO

Overstating ending inventory will overstate all of the following except a. assets. b. cost of goods sold c. net income. d. stockholders' equity

b. cost of goods sold

Pappy's Staff has the following inventory information. July Beginning Inventory 10 units at $90 July 5 Purchases 60 units at $92 July 14 Sale 40 units July 21 Purchases 30 units at $95 July 30 Sale 28 units Assuming that a perpetual inventory system is used, what is the ending inventory (rounded) under the average-cost method? a. $2,930 b. $2,966 c. $2,987 d. $3,054

c. $2,987

Assuming that a perpetual inventory system is used, what is the ending inventory on a FIFO basis? a. $2,924 b. $2,930 c. $3,034 d. $6,346

c. $3,034

As a result of a thorough physical inventory, Horace Company determined that it had inventory worth $270,000 at December 31, 2018. This count did not take into consideration the following facts: Herschel Consignment currently has goods worth $47,000 on its sales floor that belong to Horace but are being sold on consignment by Herschel. The selling price of these goods is $75,000. Horace purchased $22,000 of goods that were shipped on December 27. FOB destination that will be received by Horace on January 3. Determine the correct amount of inventory that Horace should report. a. $270,000 b. $290,000 c. $317,000. d. $337,000.

c. $317,000.

Which of the following should be included in the ending inventory of a company a. Goods held on consignment from another company b. Goods in transit to another company shipped FOB shipping point. c. Goods in transit from another company shipped FOB shipping point. d. Both b and c

c. Goods in transit from another company shipped FOB shipping point.

Inventory errors affect a. only the balance sheet. b. only the income statement c. both the balance sheet and the income statement. d. neither the balance sheet nor the income statement.

c. both the balance sheet and the income statement.

The cost of goods available for sale is allocated between a. beginning inventory and ending inventory b. beginning inventory and cost of goods on hand. c. ending inventory and cost of goods sold. d. beginning inventory and cost of goods purchased.

c. ending inventory and cost of goods sold.

net sales - CoGS =

gross profit

gross profit - operating expenses =

net income

sales rev - (sales returns & allow) (sales discounts) =

net sales