ACC 261: Chapter 6: Inventory and Cost of Goods Sold

Basil Company had the following activity in its inventory account during March 2019: dated Activity Units Cost per unit Total unit costs March 1 Beginning Inventory 100 $ 4.00 $ 400.00 March 3 Purchase 1 45 4.05 182.25 March 5 Dirty 1 50 9.00 450.00 March 9 Purchase 2 60 4.75 285.00 March 12 Dirty 2 70 10.00 700.00 March 14 Purchase 3 10 5.00 50.00 March 15 Dirty 3 30 12.00 360.00 March 30 Purchase 4 35 5.05 176.75 Based on this information, what is the cost of goods sold for the month ended March 31, 2019, for Basil Company if the company uses perpetual LIFO as its inventory valuation method?

$ 657.25 Under LIFO, we theoretically sell the newest items first leaving the oldest items in beginning inventory

Donovan Company projects sales for the year 2019 to be $32,000,000. For the past 5 years, Donovan's gross profit margin has averaged 45%. What amount should Donovan Company project for gross profit for 2019?

$14,400,000

Which US GAAP principle or rule would apply if the net realizable value of a company's inventory is below its originated cost?

$7,200

What 2 accounts do merchandisers have that service entities need?

-cost of goods sold on the income statement -inventory on the balance sheet

What two entries are needed to record the sale?

-debit cash or accounts receivable and credit sales revenue -debit cost of goods sold and credit inventory

FIFO method

-first costs into inventory are the first costs assigned to COGS -shows lowest COGS

perpetual system

-high-unit-cost items -expensive merch -cannot control inventory by visual inspection

gross profit percentage

-key indicator of company's ability to sell inventory at a profit -merchandisers strive to increase this ratio -gross profit states as a percentage of sales -watched carefully by managers and investors

LIFO liquidation

-quantities fall below the level from the previous period -must dip into older layers of inventory costs, shifting older, lower costs into cost of goods sold

perpetual inventory system

-used for all types of goods -keeps a running record of all goods bought, sold, and on hand -inventory counted at least once a year

specific-identification method

-used for businesses with unique inventory items (automobiles, antique furniture, and real estate) -businesses cost their inventories at the specific cost of the particular unit -too expensive for inventories with common characteristics

Carson Industries had inventory of $ 18,000 on January 1, 2018, and $ 22,000 on December 31, 2018. Cost of Goods Sold for 2018 was $ 238,000. What was the inventory turnover for Carson Industries for 2018?

11.9 times

Renee's Radios overstated 2018 ending inventory by $ 15,000. What effect, if any, will this error have on Renee's 2019 income statement?

2019 net income is understated by $ 15,000

Bennett Bowling Supplies had Sales of $175,000 and Cost of Goods Sold of $90,000. What is Bennett's gross profit ratio?

48.6%

Basil Company had the following activity in its inventory account during March 2019: Date Activity Units Cost per unit Total unit costs March 1 Beginning Inventory 100 $4.00 $400.00 March 3 Purchase 1 45 4.05 182.25 March 5 Sale 1 50 9.00 450.00 March 9 Purchase 2 60 4.75 285.00 March 12 Sale 2 70 10.00 700.00 March 14 Purchase 3 10 5.00 50.00 March 15 Sale 3 30 12.00 360.00 March 30 Purchase 4 35 5.05 176.75 Based on this information, what is the cost of goods sold for the month ended March 31, 2019, for Basil Company if the company uses perpetual FIFO as its inventory valuation method?

606

Buddy's Backyard Supplies reported the following inventory related information: Sales revenue $915,000 Beginning inventory 210,000 Ending inventory 300,000 Purchases of inventory 900,000 Using the above information, what is the cost of goods sold?

810,000

gross margin percentage

another name for the gross profit percentage

Days Inventory Outstanding (DIO)

average amount of time inventory was on the shelves

How is COGS classified in the financial statements? a. as a revenue b. as an expense c. as an asset d. as a liability

b

Ravenna Candles recently purchased candleholders for resale in its shops. Which of the following costs would be part of the cost of the candleholder inventory? a. advertising costs b. freight in c. freight out d. purchasing agents wages

b

Lower of Cost or Market (LCM) rule

based on principles of relevance and representational faithfulness

average-cost method

based on the average cost of inventory during the period (aka weighted-average method)

The excess of sales over cost of goods sold is ________.

big profit

Which inventory system maintains a running record of inventory on hand, purchased, and sold? a. accrued b. periodic c. consigned d. perpetual

d

How is average cost determined when calculating by the average-cost method?

dividing the cost of goods available by the number of units available

disclosure principle

financial statements should report enough information for outsiders to make informed decisions

consigned goods

goods held for sale by one party although ownership of the goods is retained by another party

average

middle-of-the-road approach or income tax and reported income

specific identification inventory method

most appropriate for very small businesses or businesses with very expensive items and unique items (ie, jewelry store, art store)

fifo

most current cost of ending inventory maximizes reported income when costs are rising

lifo

most current measure of COGS and net income minimizes income tax when costs are rising

specific unit cost

one-of-a-kind objects b/c they are unique inventory items

FOB destination

ownership changes hands when the goods are delivered to the customer

FOB shipping point

ownership changes hands when the goods leave the seller's shipping dock

representational faithfulness

property disclosing inventory methods and substance of all material transactions

Reasons for using the LIFO inventory valuation method include:

reporting the most up-to-date inventory values ​​on the balance sheet; using more current costs in calculating cost of goods sold; and usually results in a lower income tax

gross profit

sales revenue minus cost of goods sold. Also called gross margin

periodic system

small, low-value items can control inventory by visual inspection

purchase allowance

A decrease in the cost of purchases because the seller has granted the buyer a subtraction (an allowance) from the amount owed.

FIFO

stands for First-in-First-out; this means that we sell the first items that came in, first. If prices are falling, then under FIFO we would be selling our most expensive items first producing the highest Cost of Goods Sold. Because Cost of Goods Sold is an Expense, it is deducted on the income statement, thus the highest Cost of Goods Sold results in the lowest net income.

gross profit method

A way to estimate ending merchandise inventory on the basis of the cost of goods sold formula: Beginning Inventory + Net purchases = Cost of good available - Cost of goods sold = Ending inventory and the gross profit percentage.

consignment

An inventory arrangement where the seller sells inventory that belongs to another party. The seller does not include consigned merchandise on hand in its balance sheet, because the seller does not own this inventory.

specific identification method

An inventory costing method based on the specific cost of particular units of inventory

average-cost method

An inventory costing method that uses the weighted-average unit cost to allocate the cost of goods available for sale to ending inventory and cost of goods sold.

Which of the following items would most likely be accounted for using the specific identification inventory method?

Artistic painting

Donovan Company projects that sales for the year 2019 will be $ 32,000,000. For the past 5 years, Donovan's gross profit margin has averaged 45%. What amount should Donovan Company project for cost of goods sold for 2019?

Because gross profit is 45% for the past 5 years, that means that Cost of Goods Sold has average 55% of Sales (100% - 45%). Projected Cost of Goods Sold is then calculated as ($ 32,000,000 x 55%)

Ending balance

Beginning balance + Purchases - Cost of Goods Sold

What does ending inventory do to COGS?

subtracted

Gross profit or gross margin is calculated as:

Sales - COGS = Gross Profit

What is cost of goods sold based on?

the cost of inventory sold

What is inventory on the balance sheet based on?

the cost of inventory still on hand

Inventory Turnover

Cost of Goods Sold / Average Inventory refers to the number of times inventory is completely sold during the period

cost of goods sold

the cost of the inventory a business has sold to customers

Inventory would be found in ________.

the current assets section of the balance sheet

If a company's inventory was destroyed by fire, but the accounting records were saved, the method that would probably be used to estimate the amount of inventory lost would be ________.

the gross profit method Beginning inventory + Purchases - COGS = Ending inventory.

During periods of falling prices, which inventory valuation method produces the lowest reported net income?

FIFO

Which of the four methods is most used by companies?

FIFO

LIFO or FIFO: which one is better for measuring ending inventory?

FIFO -> provides more up-to-date inventory cost more recent costs on the balance sheet

cost-of-goods-sold (COGS) model

Formula that brings together all the inventory data for the entire accounting period: Beginning inventory + Purchases = Cost of goods available (i.e. cost of goods available for sale). Then, Cost of goods available -- Ending inventory = Cost of goods sold

inventory

the merchandise that a company sells to customers

Gross profit percentage

Gross Profit / Sales

gross profit percentage

Gross profit divided by net sales revenue. Also called the gross margin percentage.

Projected gross profit is calculated using the gross profit ratio as follows:

Gross profit percentage * Sales

What is the effect of using FIFO during a period of rising prices under a perpetual inventory system?

Higher gross profit than LIFO

LIFO

In a time of rising prices, the most recent purchases will be the most expensive items in inventory. If we are valuing what we sell based on the LIFO valuation method, the cost of goods sold will be highest under this method and the ending inventory will be the lowest under this method.

Which of the following accounting treatments violates the matching principle?

Inventory is expensed in the period when it is purchased.

During a period of rising prices, which inventory valuation method produces the lowest reported net income?

LIFO

In a time of rising prices, which inventory valuation method will report higher cost of goods sold?

LIFO

LIFO or FIFO: which one is better for measuring COGS?

LIFO -> more realistic net income figure most recent costs assigned to COGS

What is sales revenue based on?

the sale price of inventory sold

freight out

the seller's expense of delivering merchandise to customers

What is the cost of any asset, such as inventory?

the sum of all the costs incurred to bring the asset to its intended use, less any discounts

The gross profit ratio for Profits, Inc., increased from 45% in 2018 to 50% in 2019. Which of the following must be true?

Profits cost of goods sold was lower relative to sales in 2019 than in 2018.

freight in

the transportation cost, paid by the buyer to move goods from the seller to the buyer

consistency

use comparable methods from period to period

inventory turnover

Ratio of cost of goods sold to average inventory. Indicates how rapidly (in terms of times per year) inventory is sold.

inventory turnover

Ratio of cost of goods sold to average inventory. Indicates how rapidly inventory is sold. Varies from industry to industry

Basil Company had the following activity in its inventory account during March 2019. dated Activity Units Cost per unit Total unit costs March 1 Beginning Inventory 100 $ 4.00 $ 400.00 March 3 Purchase 1 45 4.05 182.25 March 5 Dirty 1 50 9.00 450.00 March 9 Purchase 2 60 4.75 285.00 March 12 Dirty 2 70 10.00 700.00 March 14 Purchase 3 10 5.00 50.00 March 15 Dirty 3 30 12.00 360.00 March 30 Purchase 4 35 5.05 176.75 Based on this information, what is the ending inventory balance at March 31, 2019, for Basil Company if the company uses perpetual FIFO as its inventory valuation method?

The ending inventory at March 31, 2019 for Basil Company using perpetual FIFO as its inventory valuation method is $ 488.

Which of the following problems might explain an unusually high inventory turnover ratio?

The inventory may be too low, causing goods to be out of stock and sales to be lost.

Buddy's Backyard Supplies reported the following information related to inventory: Sales revenue $915,000 Beginning inventory 210,000 Cost of Goods Sold 815,000 Purchases of inventory 905,000 Using the above information, what is ending inventory?

To determine ending inventory, simply do the math in the T-account, taking the beginning balance, $210,000, plus the purchases, $905,000, less the cost of goods sold, $815,000, resulting in ending inventory of $300,000.

last-in, first-out (LIFO) cost method

an inventory costing method that assumes the last cost into inventory are the first costs out to cost of goods sold. This method leaves the oldest costs - those of beginning inventory and the earliest purchases of the period - in ending inventory.

periodic inventory system

an inventory system that does not keep a continuous record of the inventory on hand. Instead, the business records inventory purchased. At the end of the period, it makes a physical count of the inventory on hand and applies the appropriate unit costs to the items to determine the cost of the ending inventory. Then, cost of goods sold is determined by applying the model for cost of goods sold

gross margin

another name for gross profit

weighted-average method

another name for the average-cost method

When does the cost of inventory become an asset to an expense?

When inventory is delivered to a customer

gross margin method

another name for the gross profit method

An understatement of ending inventory by $2 million in one period results in a. an overstatement of gross profit by $2 million in the next period b. an understatement of gross profit by $2 million in the next period c. no effect on net income of the next period d. an overstatement of the beginning inventory by $2 million in the next period

a

lower-cost-of-market (LCM) rule

a US GAAP rule that requires inventory be reported in financial statements at whichever is lower - its historical cost or its market value

purchase return

a decrease in the cost of purchases because the buyer returned the goods to the seller

purchase discount

a decrease in the cost of purchases earned by making an early payment to the vendor

debit memorandum

a document issued to the seller (vendor) when an item of inventory that is unwanted or damaged is returned. The document informs the seller that the buyer debited its accounts payable (reduced it) by the amount of the return

days' inventory outstanding (DIO)

a measure that converts inventory turnover to days to show how many days an average item of inventory remains on shelves before being sold. The DIO is calculated as 365 / inventory turnover

disclosure principle

a principle that states that a business's financial statements must reported enough information for outsiders to make knowledgeable decisions about the business. The company should report relevant and representationally faithful information about its financial statements

periodic inventory system

a system whereby goods are counted by hand and then priced at certain levels (monthly, quarterly, or yearly)

What does beginning inventory do to COGS?

added

The lower-of-cost-or-market rule requires a company to ________.

adjust the inventory balance downward if its replacement cost is lower than its historical cost

first-in, first-out (FIFO) method

an inventory costing method by which the first costs into inventory are the first costs out to costs of goods sold. Ending inventory is based on the cost of the most recent purchases