chapter 6 accounting

LIFO provides the most accurate comparison of

cost of goods sold valuation to replacement cost of inventory sold

Inventory turnover ratio

cost of goods sold/average inventory -want this number to be high

FOB destination point

seller owns the goods during transit

goods we ship on consignment to another company

should be included in our inventory

A company uses the periodic inventory method. An error in the physical count of goods on hand at the end of a period resulted in a $10,000 overstatement of the ending inventory. The effect of this error in the current period is that (i) gross profit is ________________ and (ii) retained earnings is ___________________. a. (i) Overstated and (ii) Overstated b. None of these c. (i) Understated and (ii) Overstated d. (i) Overstated and (ii) Understated e. (i) Understated and (ii) Understated

(i) Overstated and (ii) Overstated

What are the three assumptions:

1. FIFO 2. LIFO 3. Weighted average cost -notice that the assumptions do not need to match the actual flow of goods

What will companies take into consideration before selecting a method?

1. Tax effects 2. Balance sheet effects (EI) 3. Income statement effects (COGS)

Days in inventory ratio

365/ inventory turnover ratio -want this number to be low

Which of the following companies would employ the specific identification method to determine COGS a. car dealer b. jewelry store c. grocery store d. all of the above

All of the above -places can choose whatever they want -just added grocery store to screw with me

Inventory is accounted for at cost. After a company has determined the quantity of units of inventory, it applies unit costs to the quantities to determine the total cost of inventory and the cost of goods sold. Which of the following statements is not a method for computing the cost of inventory? a. Specific identification b. Average-cost c. Allowance estimation d. First-in, first-out e. Last-in, first-out

Allowance estimation

LIFO (last in first out)

An inventory costing method that assumes that the costs of the latest goods purchased are the first to be allocated to cost of goods sold.

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.

LIFO will always more closely align with

COGS (for both rising and falling prices)

What accounting concept is employed when using the lower-of-cost-or-market valuation? a. Going concern assumption b. Cost constraint c. Economic entity concept d. Conservatism e. Revenue recognition

Conservatism

Understating ending inventory will overstate the following: a. Assets b. Net income c. Stockholders' equity d. Cost of goods sold

Cost of Goods Sold

FIFO will always more closely align with

EI (for both rising and falling prices)

In the real world, the ACTUAL flow of goods would most closely match up with

FIFO

LIFO Reserve formula

FIFO EI= LIFO EI + LIFO Reserve

In a period of inflation, the costs allocated to ending inventory will approximate their current cost if the a. accelerated method is used. b. LIFO method is used. c. FIFO method is used. d. specific identification method is used. e. average cost method is used.

FIFO method is used

How does a manufacturing company account for inventory?

For a manufacturing company (a company that makes goods), there are three classifications of inventory: raw materials, work in process, and finished goods

Consignment goods

Goods held for sale by one party although ownership of the goods is retained by another party. (goods sold by another party)

FIFO (first in first out)

Inventory cost method where the oldest inventory is considered to be sold first.

In a period of inflation, the cost flow method that results in the lowest income taxes is the a. FIFO method. b. LIFO method. c. average cost method. d. gross profit method. e. None of these

LIFO method (Inflation prices go up)

Days in Inventory

Measure of the average number of days inventory is held; calculated as 365 divided by inventory turnover ratio.

Which is true if the ending inventory is overstated? a. Net income will be overstated and the stockholders' equity will be understated. b. Net income will be understated and the stockholders' equity will be understated. c. Net income will be overstated and the stockholders' equity will be overstated. d. Net income will be understated and the stockholders' equity will be overstated. e. None of these

Net income will be overstated and the stockholders' equity will be overstated.

What are the effects of inventory errors on income statement accounts?

Physical inventory counts are usually taken at the end of the company's business year. These counts are prone to error.

What is the specific identification method?

The cost of each individual good can be identified easily at any time. This type of inventory accounting method is used for high cost items that can be tracked from time of purchase through the time of sale. -Ex) vin numbers

What is replacement cost?

The current value of the inventory

All of the following statements are true regarding the LIFO reserve except: a. To adjust LIFO inventory to FIFO inventory requires adding the LIFO reserve from LIFO inventory. b. Current ratios and the inventory turnover can be significantly affected if a company has a large LIFO reserves. c. Companies using LIFO are required to report the LIFO reserve. None of these d. The LIFO reserve normally decreases the longer a company uses LIFO.

To adjust LIFO inventory to FIFO inventory requires adding the LIFO reserve from LIFO inventory.

What is the lower-of-cost-or-market principle?

When the value of inventory is lower than its cost, then the company should wrote down its costs to market value (to follow the principle of conservatism). This would be done after COGS has been determined for the period -companies would write down the value of their inventory when the replacement cost (market value) has decreased

consignor

always the owner of the goods

Average inventory formula

beg. inventory + end. inventory / 2

FOB shipping point

buyers own the goods during transit

A company can switch methods, but

if a company chooses LIFO/FIFO in one period, it should continue to use that method to enhance comparability across different time periods. We (as investors) want to be able to understand the numbers as easily as possible. Switching methods creates unnecessary confusion.

Inventory costing methods place primary reliance on assumptions about

the flow of costs

consignee

the person that holds and sells the goods

Periodic system

the system that calculates COGS at the end of the period Two main reasons this occurs: -determine the inventory on hand -determine COGS for the period

Weighted average cost formula

total price / total quantity