BUS165A CHAPTER 8

Periodic Inventory System

(1) It records all acquisitions of inventory during the accounting period by debiting the Purchases account. (2) A company then adds the total in the Purchases account at the end of the accounting period to the cost of the inventory on hand at the beginning of the period. This sum determines the total cost of the goods available for sale during the period. (3) To compute the cost of goods sold, the company then subtracts the ending inventory from the cost of goods available for sale.

Accounting Features of Perpetual Inventory Systems

1.Purchases of merchandise for resale or raw materials for production are debited to Inventory rather than to Purchases. 2.Freight-in is debited to Inventory, not Purchases. Purchase returns and allowances and purchase discounts are credited to Inventory rather than to separate accounts. 3.Cost of goods sold is recorded at the time of each sale by debiting Cost of Goods Sold and crediting Inventory. 4.A subsidiary ledger of individual inventory records is maintained as a control measure. The subsidiary records show the quantity and cost of each type of inventory on hand.

Sales with High Rates of Return

1.Record sales revenue at the amount it expects to receive from the transaction. This transaction involves variable consideration and therefore the transaction price is adjusted to recognize that a portion of these textbooks will be returned. 2.Establish an estimated inventory return account to recognize that some of its textbooks will be returned. The reason for recording estimated inventory is that control over a significant number of the textbooks has not passed to Campus Bookstore.

Types of Special Sales Agreement

1.Sales with repurchase agreement. 2.Sales with high rates of return.

Why is the specific goods approach to LIFO unrealistic

1.When a company has many different inventory items, the accounting cost of tracking each inventory item is expensive. 2.Erosion of the LIFO inventory can easily occur. Referred to as LIFO liquidation, this often distorts net income and leads to substantial tax payments.

double-extension method

A method for computing a specific internal price index, when a relevant external price index is not readily available, by determining current costs with reference to the actual cost of the goods most recently purchased. The price measure provides a measure of the change in the price or cost levels between the base year and the current year. The company then computes the index for each year after the base year.

net method

A method in which a company considers purchase discounts lost as a financial expense and reports it in the "Other expenses and losses" section of the income statement.

net of the cash discounts

A method in which a company records the failure to take a purchase discount within the discount period in a Purchase Discounts Lost account.

gross method

A method in which a company reports purchase discounts as a deduction from purchases on the income statement

specific-goods pooled LIFO approach

A method used to alleviate LIFO liquidation problems and to simplify LIFO accounting, by grouping goods into pools of similar items. Thus, instead of tracking specific inventory units, a company combines, and accounts for together, a number of similar units or products, which usually results in fewer LIFO liquidations

dollar-value LIFO

A variation of the LIFO inventory-costing method; it determines and measures any increases and decreases in a pool in terms of total dollar value, not the physical quantity of the goods in the inventory pool. The dollar-value LIFO method overcomes the problems of redefining pools and eroding layers that occur with the regular LIFO method

Purchase Discounts

An account in a periodic inventory system that indicates the company is recording its purchases and accounts payable at the gross amount

Inventories

Asset items that a company holds for sale in the ordinary course of business, or goods that it will use or consume in the production of goods to be sold. The investment in inventories is frequently the largest current asset of merchandising (retail) and manufacturing businesses.

Formula for Cost of Goods avialable for sale

Beginning inventory + cost of goods purchased or manufactured = Cost of Goods available for sale OR COGAS = COGS+ EI

Which of the following costs should not be charged against revenue in the period in which costs are incurred?

Costs of normal shrinkage and scrap incurred for the manufacture of a product in ending inventory

Product Costs

Costs that "attach" to the inventory and are directly connected with bringing the goods to the buyer's place of business and converting such goods to a salable condition. Such costs include direct materials, direct labor, and manufacturing overhead costs (indirect materials, indirect labor, and various costs incurred in the manufacturing process such as depreciation, taxes, insurance, and heat and electricity). Companies record product costs as part of the inventory cost.

period costs

Costs that attach to a specific accounting period. Examples are officers' salaries and other administrative expenses. Companies charge off such period costs in the immediate period even though benefits associated with these costs may occur in the future. Period costs are not included as part of inventory cost; instead, they are recorded in same period as the related revenue of a specific time period and expensed as incurred. include selling expenses and general expenses.

Formula: Price Index for Current Year

EI for Period at Current Cost/ EI for Period at Base-Year Cost

LIFO liquidation

Erosion of the LIFO inventory under a specific-goods (unit LIFO) approach. Such erosion matches costs from preceding periods against sales revenues reported in current dollars, which in times of rising prices, often distorts net income and leads to substantial tax payments.

T or F Inventory profits often occur when the inventory costs are more than the inventory replacement cost.

False

two advantages of Dollar- Value LIFO

First, companies may include a broader range of goods in a dollar-value LIFO pool. Second, a dollar-value LIFO pool permits replacement of goods that are similar items, similar in use, or interchangeable. (In contrast, a specific-goods LIFO pool only allows replacement of items that are substantially identical.)

merchandise inventory

For a merchandising business, the cost assigned to unsold units left on hand, but ready for sale. Only one inventory account, Inventory, appears in a merchandiser's financial statements.

f.o.b. destination

Freight term indicating that shipped goods are placed free on board ("f.o.b.") to the buyer's place of business and the seller pays the freight costs; the goods belong to the seller while in transit and title passes to the buyer when the buyer receives the goods from the shipping carrier.

f.o.b. shipping point

Freight term indicating that shipped goods are placed free on board ("f.o.b.") to the shipping carrier by the seller and the buyer pays the freight costs; the goods belong to the buyer while in transit.

consigned goods

Inventory held by one party (the consignee) who acts as the agent for the owner of the goods (the consignor) in selling the goods. The consignee accepts and holds the consigned goods without any liability, except to exercise due care and reasonable protection from loss or damage until it sells the goods to a third party. When the consignee sells the goods, it remits the revenue to the consignor, less a selling commission and expenses incurred in accomplishing the sale.

specific identification

Inventory-costing method in which companies identify and cost each item sold and each item in inventory. Retailers use this method only when handling a relatively small number of costly, easily distinguishable items, such as fur coats, automobiles, some furniture; manufacturers use it for special orders and many products manufactured under a job cost system under specific identification the cost flow matches the physical flow of the goods

FIFO

Inventory-costing method that assumes that a company uses goods in the order in which it purchases them. Thus, the costs of the earliest goods purchased are the first to be allocated to cost of goods sold. FIFO often approximates the physical flow of goods, prevents manipulation of income, and prices ending inventory close to current cost, but it fails to match current costs against current revenues on the income statement, possibly distorting gross profit and net income. In all cases where FIFO is used, the inventory and cost of goods sold would be the same at the end of the month whether a perpetual or periodic system is used.

LIFO

Inventory-costing method that assumes that a company uses the latest goods purchased before it uses the earlier goods purchased. Thus, the costs of the latest goods purchased are the first to be allocated to cost of goods sold. LIFO provides a good matching of recent costs against current revenues and tax benefits, but generally reports lower earnings, which some managers see as a disadvantage

Average-Cost

Inventory-costing method that prices items in the inventory on the basis of the average cost of all similar goods available during the period. Companies that use the periodic inventory method use weighted averages and those that use the perpetual method use moving averages.

moving-average method

Inventory-costing method, used by companies that use the perpetual inventory method. In this method, a company computes a new average unit cost (a "moving average") each time it makes a purchase

weighted-average method

Inventory-costing method, used in the periodic inventory method, that prices items in the inventory on the basis of the average cost of all similar goods available during the period. The method calculates the total cost of inventories of similar goods, divides the total cost by the number of inventory units, and applies the weighted-average cost per unit to the items in ending inventory

The Corton Company's accountant is preparing the income statement for 2017 and the balance sheet at December 31, 2017. Corton uses the periodic inventory system. Which of the following is true of the January 1, 2017 merchandise inventory balance?

It will appear only in the cost of goods sold section of the income statement

A product financing agreement occurs when inventory is financed without reporting the _____________ or the inventory on the balance sheet.

LIABILITY

formula for FIFO Inventory

LIFO inventory + LIFO reserve = FIFO inventory

Major Advantages of LIFO

Matching - Using LIFO (rather than a method such as FIFO) matches current costs against revenues, thereby reducing inventory profits. Taxes Future Earning Hedge - eliminates or substantially minimizes write-downs to market as a result of price decreases. In contrast, inventory costed under FIFO is more vulnerable to price declines, which can reduce net income substantially

Types of Inventory

Merchandise Inventory Raw materials Inventory Work-In-Progress Inventory Finished Goods Inventory Supplies/Manufacturing Inventory

two types of systems for maintaining accurate inventory records for these costs

Perpetual and Periodic Systems

Major Disadvantages of LIFO

Reduced Earnings Inventory Understated - inventory valuation is normally outdated because the oldest costs remain in inventory. Physical Flow Involuntary Liquidation/Poor Buying Habits- If a company eliminates the base or layers of old costs, it may match old, irrelevant costs against current revenues. A distortion in reported income for a given period may result, as well as detrimental income tax consequences.

cost flow assumptions

Several systematic assumptions about the flow of inventory, used by companies to value their inventory. The main cost flow assumptions are specific identification, average-cost, FIFO, and LIFO. The actual physical movement of goods need not match the cost flow assumption a company adopts, but the company must use its selected cost flow assumption consistently from one period to the next. The objective should be to choose a cost flow assumption that most clearly reflects periodic income.

Cost Flow Assumptions

Specific Identification Average- Cost FIFO LIFO

LIFO effect

The change from one period to the next in the balance of the account (Allowance to Reduce Inventory to LIFO, also called the LIFO reserve) that companies use to record the difference between the non-LIFO inventory method used for internal-reporting purposes and LIFO used for tax or external-reporting purposes.

raw materials inventory

The cost assigned to goods and materials on hand but not yet placed into production. Raw materials can be traced directly to the end product. This category of inventory appears on the balance sheets of manufacturing companies.

work in process inventory

The cost of partially processed units in a continuous production process, consisting of the raw material for these unfinished units, plus the direct labor cost applied specifically to this material and a ratable share of manufacturing overhead costs. This category of inventory appears on the balance sheets of manufacturing companies.

finished goods inventory

The costs identified with the completed but unsold units on hand at the end of the fiscal period. This category of inventory appears on the balance sheets of manufacturing companies.

LIFO Reserve

The difference between the inventory amount reported using LIFO for tax- or external-reporting purposes and the inventory amount using FIFO or some other method for internal-reporting purposes

Which of the following statements is not valid as it applies to inventory costing methods?

The use of FIFO permits some control by management over the amount of net income for a period through controlled purchases, which is not true with LIFO.

When an enterprise finances its inventory without reporting the inventory or the liability on the balance sheet, it is generally referred to as a product financing arrangement.

True

Sales with repurchase agreement

a company finances its inventory without reporting either a liability or the inventory on its balance sheet. This approach, often referred to as a repurchase (or product financing) agreement, usually involves a transfer (sale) with either an implicit or explicit repurchase agreement.

Perpetual Inventory Systems

a company records all purchases and sales (issues) of goods directly in the Inventory account as they occur.

In the double-extension method, how is the value of the units in inventory extended

at both base-year prices and current-year prices

In situations where there is a rapid turnover, which of the following inventory methods produces a balance sheet valuation similar to the first-in, first-out method?

average cost

cost of goods sold

cost of goods available for sale during the period - cost of goods on hand at the end of the period

cost of goods available for sale or use

cost of the goods on hand at the beginning of the period + cost of the goods acquired or produced during the period.

working capital

current assets - current liabilities

Supplies./Manufacturing Inventory

include such items as machine oils, nails, cleaning material, and the like—supplies that are used in production but are not the primary materials being processed.

Proctor & Gamble, Boeing, and IBM are all examples of ________ concern

manufacturing

A store has a number of items left over that have not been sold. The cost of these unsold items will be reported as ________ inventory.

merchandise

Which of the following represents how freight charges on goods sold are accounted for?

period costs

Modified Perpetual Inventory Systems

provides detailed inventory records of increases and decreases in quantities only—not dollar amounts. It is merely a memorandum device outside the double-entry system, which helps in determining the level of inventory at any point in time.

The arrangement that is also referred to as "parking transactions" is

sales with buyback agreement.