Chapter 6 - Cost of Goods Sold and Inventory
the phrase _____________ differentiates inventory from other operational assets
"intended for resale"
The earliest purchases ________ are assumed to be the first sold _________, and the more recent purchases are in ending inventory.
(the first in) (the first out)
Under the _______, as purchase transactions occur, they are recorded in one of four temporary accounts, which are:
- Periodic Inventory System (1) purchases (2) purchase discounts (3) purchase returns and allowances (4) transportation-in
With rising purchase prices, FIFO produces:
- highest ending inventory - lowest cost of goods sold - highest income
falling purchase prices, LIFO produces:
- highest ending inventory - lowest cost of goods sold - highest income
With rising purchase prices, LIFO produces:
- lowest ending inventory - highest cost of goods sold - lowest income
falling purchase prices, FIFO produces:
- lowest ending inventory - highest cost of goods sold - lowest income
if a customer returns an item for some reason, the company will decrease sales by debiting a contra revenue account called ______ and decrease ______ or ______
1. "Sales Returns & Allowances" 2. accounts receivable 3. cash
The federal income tax code requires businesses that use ______ for tax purposes to use _____ for financial reporting purposes as well. This is known as the _______
1. LIFO 2. LIFO conformity rule.
Choosing _____ to minimize current taxes does not avoid the payment of taxes; it merely ________ it, temporarily reducing the company's capital requirements for a period of time.
1. LIFO 2. postpones
To determine the cost of inventory sold, companies can use one of the following methods:
1. Specific Identification 2. FIFO 3. LIFO 4. Average Cost
the proper recording of freight costs depends upon whether the ____ or the _____ pays for the transportation
1. buyer 2. seller
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 ________.
1. cost of goods sold 2. ending inventory
In addition, using a perpetual inventory system, the company must make a second entry to decrease _____ and increase ______ to reflect the return of the merchandise.
1. cost of goods sold 2. inventory
In a periodic inventory system, 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 _____ of the period based on a _______
1. end 2. physical count of the inventory on hand.
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 _______ and ________
1. ending inventory 2. cost of goods sold.
manufacturing companies class inventory into 3 categories: 1. 2. 3.
1. raw materials 2. work-in-process 3. finished goods
In periods of ____, companies may choose _____ because it produces the lowest current taxable income and the lowest current income tax payment.
1. rising prices 2. LIFO
The recording of sales revenue under the perpetual inventory system involves two journal entries:
1. sales rev is recognized 2. recognizes the cost of goods that are sold; it also reduces the inv account
In dealing with sales to customers, it is important to remember to record revenues at the ______ and to record expenses (and inventory) at the _______
1. selling price 2. cost.
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
Inventory Turnover Ratio =
Cost of Goods Sold/Average Inventory
Because a new average is computed after each purchase, the Average Cost method is often called the moving-average method. 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
Cost of Ending Inventory =
Ending Inventory x Cost per Unit
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.
ownership of the inv passes when the goods are delivered to the buyer
FOB Destination
ownership of the inventory passes from the seller to the buyer at the shipping point
FOB Shipping Point
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
Gross margin (or gross profit)
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
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.
Lower of Cost or Market Rule (LCM)
Gross Margin =
Net Sales - Cost of Goods Sold
Cost of goods sold updated with each sale
Perpetual (inv system)
Periodic Inventory System: accumulates the amount of discounts on purchases taken during the period.
Purchase Discounts
Periodic Inventory System: accumulates the cost of returned merchandise or reductions in selling prices granted.
Purchase Returns and Allowances
Periodic Inventory System: accumulates the cost of the inventory acquired during the periodP
Purchases
LIFO Inventory Value =
Reported FIFO Inventory - LIFO Reserve
If ending inventory is understated: Ending Inv/Current Period
Understated
Cost of Goods Sold =
Units Sold x Cost per Unit
For the Average Cost method, the 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
What is inventory?
a tangible resource (current asset) that is held for resale in the normal course of operations
inventory is recorded at its _________ cost
acquisition
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
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
If ending inventory is understated: Ending Inventory/next period
correct
If ending inventory is understated: total assets/next period
correct
if ending inventory is overstated: ending inv/next period
correct
if ending inventory is overstated: total assets/next period
correct
In the long run, all inventory costs will find their way to ______ and the income statement.
cost of goods sold
when companies sell their inventory to customers, the cost of the inventory becomes an expense called _________
cost of goods sold
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
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
Using the perpetual inventory system, the buyer will _________ the inventory account for the amount of a purchase discount.
credit
using the perpetual inv system, the buyer will _____ the inventory account for the amount of a purchase return or allowance
credit
the ______ specify the amount and timing of payments
credit terms
using a perpetual inv system, the buyer will _______ the inventory account for the transp. costs paid
debit
all costs incurred to get the inventory are included in the acquisition cost; these include _________
delivered, or prepared for resale
It requires that ______ so that a company knows exactly which items were sold and the cost of those items.
detailed records of each purchase and sale be maintained
a period when prompt payment is rewarded by offering a discount
discount period
The ______ 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) method
transportation, or _________, costs are expenditures made to move the inventory from the seller's location to the purchaser's location
freight
the buyer normally pays the transportation costs termed
freight in
the seller is usually responsible for paying the transportation costs termed as ______
freight-out
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 are the first to be sold
last-in, first-out (LIFO)
companies that buy and transform raw materials into a finished product which is then sold
manufacturers
inventory held by merchandisers
merchandise inventory
Because a perpetual inventory system is being used, the __________ is also affected.
merchandise inventory account
companies (either retailers or wholesalers) that purchase inventory in a finished condition and hold it for resale without further processing
merchandisers
If ending inventory is understated: cost goods sold/current period
overstated
If ending inventory is understated: net income/next period
overstated
if ending inventory is overstated: cost goods sold/next period
overstated
if ending inventory is overstated: ending inv/current period
overstated
if ending inventory is overstated: net income/current period
overstated
if ending inventory is overstated: total assets/current period
overstated
cost of goods sold are recorded only at the end of a period
periodic (inv system)
In many instances, FIFO is an accurate representation of the _____ flow of goods.
physical
Except for companies that stockpile inventory (e.g., piles of coal, stacks of hay, stacks of rock), FIFO rarely coincides with the actual _____ of inventory
physical flow
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.
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
Companies that sell goods on credit often offer their customers sale discounts to encourage prompt payment. From the viewpoint of the buyer (customer), such price reductions are called __________
purchase discounts
the cost of inventory includes the ________ of the merchandise plus any cost of bringing the goods to salable condition and location
purchase price
the cost of merchandise returned to suppliers is called a
purchase return
refer to the cost of merchandise acquired for resale during the accounting period
purchases
merchandisers that sell directly to consumers
retailers
In addition to purchase transactions, merchandising companies must also account for the inventory effects of _______
sales and sales returns.
Companies recognize ____ when it is earned and the collection of cash is reasonably assured.
sales revenue
the point at which ownership, or title, of the inventory changes hands depends on the _______ of the contract
shipping terms
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
Periodic Inventory System: accumulates the costs paid by the purchaser for inventory from suppliers.
transportation-in
If ending inventory is understated: cost goods sold/next period
understated
If ending inventory is understated: net income/current period
understated
If ending inventory is understated: total assets/current period
understated
if ending inventory is overstated: cost goods sold/current period
understated
if ending inventory is overstated: net income/next period
understated
merchandisers that sell to other retailers
wholesalers