ch6

As some indicate, net income computed using FIFO creates _______—that is, earnings that do not really exist.

"paper or phantom profits"

Determining inventory quantities involves two steps:

(1) taking a physical inventory of goods on hand and (2) determining the ownership of goods.

In a multiple‐step income statement, cost of goods sold is subtracted from net sales. There also should be disclosure of

(1) the major inventory classifications, (2) the basis of accounting (cost, or lower‐of‐cost‐or‐market), and (3) the cost method (FIFO, LIFO, or average‐cost).

calculate cost of goods sold

(beginning inventory+purchases)-ending inventory

current ratio=

(current assets ÷ current liabilities)

If using a perpetual system, companies take a physical inventory for the following reasons. The first is to

1) check the accuracy of their perpetual inventory records. 2) second is to determine the amount of inventory lost due to wasted raw materials, shoplifting, or employee theft.

Hasbeen Company completed its inventory count. It arrived at a total inventory value of $200,000. You have been given the information listed below. Discuss how this information affects the reported cost of inventory. 1. Hasbeen included in the inventory goods held on consignment for Falls Co., costing $15,000. 2. The company did not include in the count purchased goods of $10,000, which were in transit (terms: FOB shipping point). 3. The company did not include in the count inventory that had been sold with a cost of $12,000, which was in transit (terms: FOB shipping point).

1. shouldn't be added to inventory goods (subtract) 2. add 3. correct thus inventory is 195,000

which one's liquidity appears stronger? 1.48:1 or 1:39:1

1.48:1

Early in 2017, Westmoreland Company switched to a just‐in‐time inventory system. Its sales, cost of goods sold, and inventory amounts for 2016 and 2017 are shown below. Determine the inventory turnover and days in inventory for 2016 and 2017. Discuss the changes in the amount of inventory, the inventory turnover and days in inventory, and the amount of sales across the two years.

2016 IT: 4 2016: 91.3

days in inventory=

365/inventory turnover

To management, higher net income is an advantage. It causes external users to view the company more favorably. In addition, management bonuses, if based on net income, will be higher. Therefore, when prices are rising (which is usually the case), companies tend to prefer ____ because it results in higher net income.

FIFO

both inventory on the balance sheet and net income on the income statement are higher when companies use _____ in a period of inflation.

FIFO

If prices are falling, the results from the use of FIFO and LIFO are reversed.

FIFO will report the lowest net income and LIFO the highest.

The value assigned to the ending inventory does not depend on which cost flow method we use.

False! The value assigned to the ending inventory depends on which cost flow method we use.

There are three assumed cost flow methods:

First‐in, first‐out (FIFO) Last‐in, first‐out (LIFO) Average‐cost

consigned goods

In some lines of business, it is common 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.

LOWER‐OF‐COST‐OR‐MARKET

LCM is a basis whereby inventory is stated at the lower of either its cost or market value as determined by current replacement cost. LCM is an example of the accounting convention of conservatism.

____ results in the lowest income taxes (because of lower net income) during times of rising prices.

LIFO lowest income (taxes)

Each of the three assumed cost flow methods is acceptable for use under GAAP.

T

High inventory turnover (low days in inventory) indicates the company has minimal funds tied up in inventory—that it has a minimal amount of inventory on hand at any one time. Although minimizing the funds tied up in inventory is efficient, too high an inventory turnover may indicate that the company is losing sales opportunities because of inventory shortages.

T

Houston Electronics calculates cost of goods sold by subtracting the cost of the units not sold (ending inventory) from the cost of all goods available for sale.

T

LIFO has the highest quality of earnings ratio for two reasons. (1) It has the highest net cash provided by operating activities, which increases the ratio's numerator. (2) It reports a conservative measure of net income, which decreases the ratio's denominator. As discussed earlier, LIFO provides a conservative measure of net income because it does not include the phantom profits reported under FIFO.

T

The effect of ending inventory errors on the balance sheet can be determined by using the basic accounting equation: Assets = Liabilities + Stockholders' Equity .

T

There is no accounting requirement that the cost flow assumption be consistent with the physical movement of the goods.

T

Under the LCM basis, market is defined as current replacement cost, not selling price.

T

We assume a periodic system because very few companies use perpetual LIFO, FIFO, or average‐cost to cost their inventory and related cost of goods sold.

T

The accounting records of Shumway Ag Implement show the following data. Beginning inventory 4,000 units at $3 Purchases 6,000 units at $4 Sales 7,000 units at $12 Determine (a) the cost of goods available for sale and (b) the cost of goods sold during the period under a periodic system using (i) FIFO, (ii) LIFO, and (iii) average‐cost.

a. 36,000 b. i. 24,000 ii. 27,000 iii. ($36,000/10,000) = 3.60 $36,000- (3,000 x3.60) = 25,200

The average‐cost method

allocates the cost of goods available for sale on the basis of the weighted‐average unit cost incurred.

Balance sheet: 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.

ending inventory overstated

assets overstated; no affect on liabilities; stockholder's equity overstated

ending inventory understated

assets understated; no effect on liabilities; stockholder's equity understated

companies that use perpetual systems often use an _______ to record cost of goods sold at the time of sale. Then, at the end of the period when they count their inventory, they recalculate cost of goods sold using ________ as shown in this chapter and adjust cost of goods sold to this recalculated number.1

assumed cost (called a standard cost); periodic FIFO, LIFO, or average‐cost

Regardless of whether prices are rising or falling, average‐cost produces net income

between FIFO and LIFO.

Under a just‐in‐time method,

companies manufacture or purchase goods only when needed.

most companies make assumptions, called ______, about which units were sold.

cost flow assumptions

weighted‐average unit cost

cost of goods available for sale/ total units available for sale = weighted-average unit cost (the wauc takes the place of the "calculating ending inventory part,, subtract this from cost of goods available for sale)

inventory turnover is calculated as

cost of goods sold divided by average inventory. COGS/Ai cogs over an iguana

If ending inventory is understated,

cost of goods sold will be overstated.

If beginning inventory is understated,.

cost of goods sold will be understated

Inventory is accounted for at cost. Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale. For example, freight costs incurred to acquire inventory are added to the _____________, but the cost of shipping goods to a customer is a _________

cost of inventory; selling expense.

Under the LIFO method, the ___ of the latest goods purchased are the first to be recognized in determining cost of goods sold.

costs;

under LIFO, companies obtain the cost of the ending inventory by taking the unit cost of the _________ and working forward until all units of inventory have been costed.

earliest goods available for sale

Under the FIFO method, therefore, the costs of the earliest goods purchased are the ___ to be recognized in determining cost of goods sold, regardless of which units were actually sold.

first

Another way of thinking about the calculation of LIFO ending inventory is the FISH assumption—

first in still here. lit f

Gross Profit Rate

gross profit/net sales

On the balance sheet, FIFO will result in ____ reported inventory.

higher

With increasing prices, FIFO will result in __ income than LIFO.

higher

In a period of inflation, FIFO produces a _____ because lower unit costs of the first units purchased are matched against revenue.

higher net income

merchandising company

inventory consists of many different items. For example, in a grocery store, canned goods, dairy products, meats, and produce are just a few of the inventory items on hand. These items have two common characteristics: (1) they are owned by the company, and (2) they are in a form ready for sale to customers in the ordinary course of business.

Another way of thinking about the calculation of FIFO ending inventory is the LISH assumption—

last in still here.

It indicates the ____ of inventory by measuring the number of times the average inventory "turns over" (is sold) during the year. Inventory turnover can be divided into 365 days to compute days in inventory, which indicates the average number of days inventory is held.

liquidity

In a period of inflation, LIFO produces a ______ because higher unit costs of the last goods purchased are matched against revenue.

lower net income

LIFO has the highest net cash provided by operating activities because it results in the

lowest tax payments.

low levels of raw materials and high levels of finished goods suggest that

management believes it has enough inventory on hand, and production will be slowing down—perhaps in anticipation of a recession.

high levels of raw materials and low levels of finished goods probably signal that

management is planning to step up production.

The average‐cost method in a perpetual inventory system is called the

moving‐average method. Under this method, the company computes a new average after each purchase.

LIFO also impacts the quality of earnings ratio. Recall that the quality of earnings ratio is

net cash provided by operating activities divided by net income.

Gross Profit

net sales - cost of goods sold

Thus, merchandisers need only __ inventory classification, _______, to describe the many different items that make up the total inventory.

one; merchandise inventory

Conservatism means that the approach adopted among accounting alternatives is the method that is least likely to

overstate assets and net income.

When the terms are FOB (free on board) shipping point,

ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. (Ownership passes to buyer before getting on the truck)

When the terms are FOB destination,

ownership of the goods remains with the seller until the goods reach the buyer.

The success of a JIT system depends on

reliable suppliers.

LIFO conformity rule, requires that if companies use LIFO for tax purposes, they must also use it for financial reporting purposes. This means that if a company chooses the LIFO method to reduce its tax bills, it will also have to

report lower net income in its financial statements.

An error in the ending inventory of the current period will have a ____ on net income of the next accounting period.

reverse effect

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.

manufacturing company

some inventory may not yet be ready for sale. As a result, manufacturers usually classify inventory into three categories: finished goods, work in process, and raw materials. m.a.n

If Crivitz can positively identify which particular units it sold and which are still in ending inventory, it can use the ______ of inventory costing

specific identification method

the sum of cost of goods sold plus the cost of the ending inventory must equal

the cost of goods available for sale

For a merchandising company, current replacement cost is

the cost of purchasing the same goods at the present time from the usual suppliers in the usual quantities.

LIFO reserve

the difference between inventory reported using LIFO and inventory using FIFO

first‐in, first‐out (FIFO) method assumes that

the earliest goods purchased are the first to be sold. (often parallels the actual physical flow of merchandise because it generally is good business practice to sell the oldest units first.)

last‐in, first‐out (LIFO) method assumes that

the latest goods purchased are the first to be sold. LIFO seldom coincides with the actual physical flow of inventory.

under FIFO, companies determine the cost of the ending inventory by taking the unit cost of ______ and working backward until all units of inventory have been costed.

the most recent purchase

Companies using a periodic inventory system must take a physical inventory for two different purposes:

to determine the inventory on hand at the balance sheet date, and to determine the cost of goods sold for the period.

average‐cost.

wauc= cost of goods available for sale/number of units afs then multiply wauc by number of units afs to get A A - (BxC) = ___ B=(beg inventory+purchases)-sales C=WAUC