A200 ch5
5-39: Which inventory cost flow method produces the highest amount of net income in a deflationary period?
A deflationary period, i.e., a period of falling prices, would produce results opposite of those for an inflationary period. FIFO would produce the lowest amount of net income, because the goods purchased first would cost more than the goods purchased last. This would cause a larger amount of cost to be expensed resulting in a lower net income. LIFO would produce the highest net income.
5-1: What is the difference between accounts receivable and notes receivable?
Accounts receivable are the expected future receipts that arise when a company permits its customers to buy now and pay later. The amounts are usually small with a short term to maturity. Notes Receivable have longer terms to maturity and are usually for larger amounts. The note specifies the maturity date, interest rate, and other credit terms.
5-29: What are some advantages or disadvantages of using FIFO method of inventory valuation?
FIFO allocates the cost of the first units purchased to the first units sold; consequently, in a period of rising prices, this would produce a higher net income. This may be an advantage for the purpose of financial reporting if reporting a higher profit is desired. However, this is a disadvantage for tax reporting because a higher profit means paying more tax. FIFO also tends to best match physical flow for most products.
5-33: What is the difference between the flow of costs and the physical flow of goods?
Flow of costs refers to the assumption that is made for the purpose of determining the cost of inventory items that are sold when preparing financial statements. The cost flow assumption that a business makes may have nothing to do with the actual flow of inventory into and out of the business. The physical flow of goods refers to the actual timing of when goods are sold. For example, a grocery store may use a FIFO cost flow assumption for financial statement purposes and this may reflect the physical flow of some inventory items but not others. The grocer will put the newer items at the back on the shelf and pull the oldest items to the front for the customer to purchase (FIFO) but the customer may look for the freshest item at the back of the shelf (e.g. milk) to purchase (LIFO).
5-32: In an inflationary period, which inventory cost flow method will produce the largest amount of total assets on the balance sheet? Explain.
In an inflationary period, FIFO will produce the largest amount of total assets. (Refer to the discussion for Question 31.) The unsold items, inventory, are the highest cost items. Consequently, assuming rising prices, FIFO flow produces a higher inventory amount than would be the case under a LIFO flow.
5-38: In an inflationary period, which cost flow method, FIFO or LIFO, produces the largest cash flow? Explain.
In an inflationary period, for a business subject to income tax, LIFO would produce the larger amount of cash flow because the lower net income (higher cost of goods sold) would result in a smaller amount of income tax being paid.
5-31: In an inflationary period, which inventory cost flow method will produce the highest net income? Explain.
In an inflationary period, i.e., a period where prices are consistently rising, FIFO will produce the highest amount of income. This is true because the items purchased first (and at the lowest cost) are the items that are deemed sold first whose cost is charged to expense. The highest cost items remain in the asset account inventory. Since the lowest cost items have been expensed, net income will be higher than it would be assuming a LIFO flow.
5-37: Refer to 5-35 and 5-36. Which method might be preferable for financial statements? For income tax reporting? Explain.
It may be advantageous to use FIFO for financial statement purposes because it produces the smallest cost of goods sold and consequently, the highest gross margin and net income. It also produces the largest amount of assets. However, a larger net income produces a higher income tax expense, so LIFO would be more desirable strictly from an income tax perspective in that the cost of goods sold would be higher, and consequently the net income and income tax paid will be lower. Since each cost flow method is desirable for a specific group of users, the cost flow assumptions chosen must be the best for the overall business. A part of that consideration is the ease of applying each method.
5-35: Assume that Key Co. purchased 1.000 units of merchandise in its first year of operations for $25 per unit. The company sold 850 units for $40. What is the amount of costs of goods sold using FIFO? LIFO? Weighted average?
Key Company (first year of operations): Beginning inventory $ -0- Merchandise purchased 1,000 units @ $25 25,000 Cost of Goods Sold 850 units @ $25 21,250 Ending Inventory 150 units @ $25 3,750 Cost of goods sold will be the same for all methods because all items were purchased for the same cost. Consequently, it will not make any difference whether the first unit sold is assumed to be the first or last purchased. Weighted average will also be the same.
5-30: What are some advantages and disadvantages of using the LIFO method of inventory valuation?
LIFO allocates the cost of the last units purchased to the first units sold; consequently, in a period of rising prices, this would produce a lower net income. This may be a disadvantage for the purpose of financial reporting if reporting a higher profit is desired. However, for tax reporting, a lower profit means paying less tax. LIFO also matches current cost with current revenues.
5-28: What are some advantages and disadvantages of the specific identification method of accounting for inventory?
One advantage of the specific identification method is that both the inventory account and cost of goods sold reflect the actual amounts on hand and sold. This method is usually required for high cost items such as automobiles, boats, etc. One disadvantage of this method is that record keeping can become burdensome for high-volume, lower-priced items.
5-9: What is the affect on the accounting equation of recognizing uncollectible accounts expense?
Recognizing uncollectible accounts expense reduces accounts receivable on the asset side and reduces retained earnings on the equity side.
5-36: Assume that Key Co. purchased 1,500 units of merchandise in its second year of operation for $27 per unit. Its beginning inventory was determined in 5-35. Assuming that 1,500 units are sold, what is the amount of costs of goods sold using FIFO? LIFO? Weighted average?
The amount of cost of goods sold for Key Company will be different using different cost flow assumptions because the units purchased during the second year have a different cost than those purchased the previous year. Beginning inventory: 150 units @ $25= $ 3,750 Merchandise purchased: 1,500 units @ $27= 40,500 Total: 1,650 units (150x25)+(1500x27)= $44,250 Units sold: 1,500 FIFO: 150 units @ $25= $ 3,750 1,350 units @ $27= 36,450 Cost of Goods Sold: 1,500 units (150x25)+(1350x27)= $40,200 LIFO: 1,500 units @ $27= $40,500 Cost of Goods Sold: $40,500 Weighted Average: Total Cost /Total Units = Cost per unit 44,250/1,650 = $26.82 per unit Cost of Goods Sold: 1,500 units @ $26.82 = $40,230
5-2: What is the net realizable value of receivables?
The net realizable value is the amount expected to be collected from accounts receivable. It is the face value of receivables less an allowance for estimated uncollectible accounts.