ACCT 210 SDSU Chapter 6

We assign the most recent costs to the units sold. That leaves the older costs to be used to value ending inventory.

LIFO

debit for $5,000 to the Cost of Goods Sold account

After assigning costs to its ending inventory using the FIFO method, a company's Merchandise Inventory account showed a total cost of $300,000. When the company applied the lower of cost or market rule to the individual items of inventory, it determined that the market value (replacement cost) of its inventory totaled $295,000. The entry if any to adjust the cost of its inventory to market includes a _____

understated.

A company overstated its ending inventory at the end of Year 1. If the error was not detected, cost of goods sold would be ____ for year 1.

overstated.

A company overstated its ending inventory at the end of Year 1. If the error was not detected, cost of goods sold would be ____ for year 2

overstated

A company overstated its ending inventory at the end of Year 1. If the error was not detected, equity would be ____ for year 1

correctly stated

A company overstated its ending inventory at the end of Year 1. If the error was not detected, equity would be ____ for year 2

understated.

A company overstated its ending inventory at the end of Year 1. If the error was not detected, net income would be ____ for year 2

overstated.

A company overstated its ending inventory at the end of Year 1. If the error was not detected, total assets would be ____ for year 1

correctly stated

A company overstated its ending inventory at the end of Year 1. If the error was not detected, total assets would be ____ for year 2

Net income for the current year is understated. Net income for the next year will be overstated by $5,000, but the balance in the owner's equity account will be correct at the end of year 2. Feedback: Most errors, if not discovered, will have a permanent effect on the owner's equity. However, errors in the inventory account are self-correcting over two successive accounting periods since the dollar amount of inventory at the end of one accounting period carries over to the next accounting period as the value of the beginning inventory. Thus, an understatement of the ending inventory by $5,000 will overstate cost of goods sold for the current year. Because last year's ending inventory becomes next year's beginning inventory, the cost of goods sold will be understated in the second year. The error will correct itself by the end of the second year and the balance in the owner's equity account will be correct from that point forward.

A company understates its ending inventory by $5,000. It never discovers this error. The company is a sole proprietorship. Which statement accurately describes the company's permanent situation?

$126

A company uses a period inventory system . On August 1, the company had 6 items of beginning inventory with a cost of $7 per unit. On August 3, the company purchased 16 units at $14 per unit. Then, on August 5, the company sold 12 units. Using FIFO, the cost of the 12 units sold is:

$191

A company uses a periodic inventory system. On April 1 , the company had 9 items of beginning inventory with a cost of $13 per unit. On April 18, the company purchased 15 units at $14 per unit. Then, on April 29, the company sold 14 units. Using LIFO, the cost of the 14 units sold is:

$401

A company uses a periodic inventory system. On November 1 , the company had 8 items of beginning inventory with a cost of $22 per unit. On November 2, the company purchased 10 units at $21 per unit. Then, on November 6, the company sold 18 units. Using LIFO, the cost of the 18 units sold is:

Cost of Goods Sold is understated by $10,000 and Net Income is overstated by $10,000. Feedback: Ending inventory is subtracted in the calculation of cost of goods sold (an expense account). If ending inventory is overstated, the cost of goods sold is too low or understated, and when an expense is understated, net income is overstated

A company's ending inventory amount is overstated by $10,000. What will be the effect of this overstatement on Cost of Goods Sold and Net Income?

Cost of goods sold is understated and net income is overstated. Feedback: Ending inventory is deducted in the calculation of cost of goods sold. If the ending inventory is overstated by $5,000, cost of goods sold will be understated (rather than overstated) by $5,000.

A merchandising business discovers that its ending inventory is overstated by $5,000. If the company does not correct this error, what will the effect be on the company's Cost of Goods Sold and Net Income?

Total expenses are overstated and net income is understated. Feedback: Ending inventory is deducted in the calculation of cost of goods sold. If the ending inventory is understated by $6,000, cost of goods sold (and total expenses) will be overstated (rather than understated) by $6,000.

A merchandising business discovers that its ending inventory is understated by $6,000. If the company does not correct this error, what will the effect be on the company's Total Expenses and Net Income?

$870 Feedback: Item 1: $225 LCM applied to items + Item 2: $420 LCM applied to items + Item 3: $225 LCM applied to items = $870

Applying the lower of cost or market method, the reported value of this company's ending inventory if LCM is applied to individual items is

Weighted Average

Assumes costs flow at an average of the cost available.

FIFO

Assumes costs flow in the order incurred.

LIFO

Assumes costs low in the reverse order incurred.

6.0 Feedback: Cost of goods sold of $360,000 divided by the average inventory of $60,000 equals an inventory turnover of 6.0.

Beginning inventory is $50,000 and ending inventory is $70,000. Net sales totals $600,000 and cost of goods sold is $360,000. What is the inventory turnover ratio?

***

Both U.S. GAAP and IFRS allow companies to use specific identification, FIFO, and Weighted Average. IFRS does not currently allow use of LIFO.

***

Both U.S. GAAP and IFRS include in inventory all items that a company owns and holds for sale plus all cost expenditures necessary to bring those items to a salable condition and location.

***

Both U.S. GAAP and IFRS require companies to write down inventory when its value falls below recorded cost. U.S. GAAP prohibits any later increase in value. IFRS does allow reversals of write downs up to the original acquisition cost. Neither allow inventory to be adjusted upward beyond the original cost.

Market value

Defined as current replacement cost (not sales price). Consistent with the conservatism principle

LIFO

During a period of regularly rising purchase costs, the _____ method yields the lowest income tax expense

LIFO

During a period of regularly rising purchase costs, the ______ method yields the highest reported cost of goods sold amount on the income statement.

FIFO

During a period of rising prices, the inventory costing method that will result in the lowest amount of net income is:

FIFO

During a period of steadily rising costs, the _____ method results in the highest amount of inventory reported on the balance sheet.

The amount of cost of goods available for sale. Feedback: The portion of the cost of goods available for sale that is allocated to cost of goods sold and to the ending inventory of one period (which becomes the beginning inventory of the next period) will differ depending on the cost flow assumption that is used.

Even though the amount of cost of goods sold and the amount of ending inventory can vary dramatically depending on which inventory cost flow assumption is used, which one of the following amounts will always be the same, regardless of which inventory cost flow assumption is used?

Goods in transit shipped by Abbey (seller) FOB shipping point Goods in transit shipped to Abbey (purchaser) FOB destination Damaged inventory that cannot be resold Goods on consignment (Abbey is consignee)

Exclude from inventory count:

We assign the older costs to the units sold. That leaves the more recent costs to be used to value ending inventory.

FIFO

Because prices change, inventory methods nearly always assign different cost amounts.

Financial Statement Effects of Costing Methods

Weighted Average --> Smoothes out price changes FIFO --> Ending inventory approximates current replacement cost. LIFO --> Better matches current costs in cost of goods sold with revenues

Financial Statement Effects of Costing Methods: Advantages of Methods

Goods in transit Goods on Consignment Goods Damages or Obsolete

Items requiring special attention for inventory items

$81,000 Feedback: Beginning inventory of $75,000 + purchases of $160,000 = cost of goods available for sale of $235,000. Sales of $220,000 - gross profit on sales $66,000 (or sales of $220,000 x gross profit percentage of 30%) = cost of goods sold of $154,000. Cost of goods available for sale of $235,000 - cost of goods sold of $154,000 = ending inventory of $81,000.

Heavenly Interiors had beginning merchandise inventory of $75,000. It made purchases of $160,000 and recorded sales of $220,000 during November. Its estimated gross profit on sales was 30%. On November 30, the store was destroyed by fire. What was the value of the merchandise inventory loss?

The IRS requires it be used in financial statements.

If LIFO is used for tax purposes...

gross profit in period 2 will be understated

If merchandise inventory at the end of period 1 is overstated and at the end of period 2 is correct:

Net income will be understated

If merchandise inventory at the end of the period is understated:

reduces gross profit for the period in which the decline occurred

If the replacement price of an item of inventory is lower than its cost, the use of the lower of cost or market method:

LIFO Feedback: The LIFO method assumes that the cost of the last items added to the company's inventory are the costs that are first assigned to Cost of Goods Sold. Thus, for a calendar year accounting period, the cost of items purchased in December might be the very costs used to calculate the Cost of Goods Sold for items actually sold during the previous January.

In theory, when a periodic system is in use, which inventory cost flow assumption could assign inventory cost to cost of goods sold even though the inventory has not yet been purchased by the merchandiser?

Goods in transit shipped to Abbey (purchaser) FOB shipping point Goods on consignment (Abbey is consignor) Goods in transit shipped by Abbey (seller) FOB destination Obsolete inventory that can be sold

Include in inventory count:

Cost of inventory

Includes all expenditures necessary to bring an item to a salable condition and location.

Merchandise Inventory

Includes all goods that a company owns and holds for sale, regardless of where the goods are located when inventory is counted.

Cost of Goods Sold: Overstated Net Income: Understated

Inventory Error: Overstate beginning Inventory

Assets: Overstated Equity: Overstated

Inventory Error: Overstate ending inventory

Cost of Goods Sold: Understated Net Income: Overstated

Inventory Error: Overstate ending inventory

Cost of Goods Sold: Understated Net Income: Overstated

Inventory Error: Understate Beginning Inventory

Assets: Understated Equity: Overstated

Inventory Error: Understate ending inventory

Cost of Goods Sold: Overstated Net Income: Understated

Inventory Error: Understate ending inventory

lower

Inventory must be reported at market value when market is ______ than cost.

interim statements or if some casualty such as fire or flood makes taking a physical count impossible.

Inventory sometimes requires estimations for..

the balance sheet and the income statement.

Inventory transactions impact both..

1) Separately to each individual item 2) to major categories of assets 3) to the whole inventory

Lower of cost of market can be applied three ways:

Goods on Consignment

Merchandise is included in the inventory of the consignor, the owner of the inventory.

Invoice Cost

Minus discounts and allowances, Plus import duties, Plus freight, Plus storage, Plus insurance

Goods Damaged or Obsolete

Not coin ted in inventory if they cannot be sold. Cost should be reduced to net realizable value if they can be sold.

Ending inventory

Reported as a current asset on the balance sheet and cost of goods sold is reported on the income statement.

Consistency principle

Requires a company to use the same accounting methods period after period so that financial statements are comparable across periods.

Matching principle

Requires matching costs with sales.

True

T or F? Companies can change accounting methods occasionally only for good reasons.

Goods in Transit

The FOB terms designate when title passes and who pays the transportation costs. FOB stands for "Free On Board." So, if the shipping terms are Free On Board shipping point, that means that ownership transfers from the seller to the buyer when the seller provides the goods to the carrier. It also means the buyer will pay all transportation costs. In this case, the transportation costs will be added to the merchandise inventory account. On the other hand, if the shipping terms are Free On Board destination, that means that ownership transfers from the seller to the buyer when the buyer receives the goods. It also means the seller will pay the transportation costs.

Tax Effects of Costing Methods

The Internal Revenue Service (IRS) identifies several acceptable inventory costing methods for reporting taxable income.

consistency concept

The _____________ prescribes that a company use the same accounting methods period after period so that financial statements are comparable across periods

Net realizable value

The sales price minus the cost of making the sale.

$99

The total cost of the 15 units on hand at the end of the period, as determined under a periodic inventory system and the average costing method, is $99 (15 units x $6.60).

$120

The total cost of the 15 units on hand at the end of the period, as determined under a periodic inventory system and the fifo costing method, is $120 (15 units x $8).

$80

The total cost of the 15 units on hand at the end of the period, as determined under a periodic inventory system and the lifo costing method, is $80 [(5 units x $6) + (10 units x $5)].

$120

The total cost of the 15 units on hand at the end of the period, as determined under a perpetual inventory system and the fifo costing method, is $120 (15 units x $8).

$80

The total cost of the 15 units on hand at the end of the period, as determined under a perpetual inventory system and the lifo costing method, is ____ [(5 units x $6) + (10 units x $5)].

Be reversed. Feedback: Under IFRSs, if inventory that previously had been written down to market subsequently increases in value, the write down is reversed.

Under IFRSs, if inventory that previously had been written down to market subsequently increases in value, the write down should:

Merchandise Inventory, Income Summary. Feedback: The adjusting entry involves the Merchandise Inventory and Income Summary accounts.

Under the periodic inventory system, which accounts are adjusted at the end of the period?

we assign the average cost of the goods available for sale to cost of goods sold. The average cost is determined by dividing the cost of goods available for sale by the units on hand. Cost of Goods Available for sale / Units on hand on the date of sale

Weighted Average

LIFO conformity rule. Feedback: The going-concern principle (discussed in Chapter 1) means that the accounting information reflects an assumption that the business will continue operating instead of being closed or sold.

When a firm uses the LIFO method on its GAAP financial statements because it wants to use the LIFO method on its annual tax returns, such a procedure is an application of the:

LIFO Feedback: The highest amount of income tax expense will result when net income is the highest. The method that results in the highest net income when inventory prices are increasing (rather than falling) is FIFO.

When inventory prices are decreasing, which of the following will result in the highest amount of income tax expense?

at any time during a period the number of units of a commodity sold exceeds the number previously purchased during the same period

When lifo is strictly applied to a perpetual inventory system, the unit cost prices assigned to the ending inventory will not necessarily be those associated with the earliest unit costs of the period if:

LIFO will assign higher inventory costs to cost of goods sold than will FIFO, and LIFO will assign lower inventory costs to the ending inventory than will FIFO Feedback: If inventory purchase prices are increasing, costs of goods sold will be higher using LIFO because the most recent prices (the higher prices) are the ones being assigned to cost of goods sold. Thus, the older and lower inventory costs are the ones being assigned to the ending inventory.

When the cost of buying an item of inventory from a supplier is steadily increasing or steadily decreasing, it is possible to make some generalizations as to what will be the effects on cost of goods sold, given the use of any particular cost flow assumption. In periods of rising prices, which of the following statements is true?

After each new purchase of the same inventory item. Feedback: The new weighted average inventory cost per unit is calculated after each new purchase of an inventory item

When the weighted average method of perpetual inventory tracking is used, at what point is the new average cost calculated?

E) Both A and B Feedback: To check the accuracy of the perpetual inventory records (answer A) and to determine the cost of goods sold (answer B) are both legitimate reasons to take a physical inventory.

Which of the following objectives are legitimate reasons for taking a physical inventory count? A) To check the accuracy of the perpetual inventory records. B) To determine cost of goods sold. C) To keep employees busy during a slow time in the business. D) Both A and C. E) Both A and B.