Chapter 7 Practice Material
Explain why an error in ending inventory in one period affects the following period.
they are felt in more than one period because the ending inventory for the current period becomes the beginning inventory of the next period.
which inventory cost flow method is most similar to the flow of products involving (a) a gumball machine, (b) bricks off a stack, and (c) gasoline out of a tank?
(a) FIFO- the gumballs placed first are the first ones out (b) LIFO- Bricks placed last on the stack are the first off (c) Weighed Average Cost- even though the gas may have been purchased at different times, it still mixes around in the tank together
contrast the effects of LIFO versus FIFO on ending inventory when (a) costs are rising and (b) costs are falling.
(a) when costs are rising, FIFO produces a larger inventory value (making the balance sheet appear to be stronger) and a smaller cost of goods sold (resulting in a larger gross profit, which makes the company look more profitable. (b) when costs are falling, FIFO produces a smaller ending inventory value and a larger cost of goods sold - a double whammy. LIFO is the opposite for both.
contrast the income statement effect of LIFO versus FIFO (on Cost of Goods Sold and Gross Profit) when (a) costs are rising and (b) costs are falling.
(a)FIFO will give a lower cost of goods sold and a higher gross profit (b) FIFO will give a higher cost of goods sold and a lower gross profit
describe the specific types of inventory reported by merchandisers and manufacturers.
- Merchandise inventory: products acquired in a finished condition, ready for sales without further processing. - Raw materials inventory: plastic, steel, fabrics - work in process inventory: goods that are in the process of being manufactured - finished goods inventory: ready for sale - consignment inventory: goods a company is holding on behalf of the goods' owner. - goods in transit: inventory items being transported.
several managers in your company are experiencing personal financial problems and have asked that your company switch from LIFO to FIFO so that they can receive bigger bonuses, which are tied to the company's chief financial officer (CFO)? would such a switch help the managers? who could it hurt?
- The switch from LIFO to FIFO would increase the company Gross Profit and Net Income. It is only causable to switch if it improves the accuracy of the company's financial results across periods. The accounting rules discourage it. - Saying that this would help the managers is debatable - It is likely to hurt the Stockholders bc an inc. in Gross Profit would lead to greater Income Tax.
explain briefly the application of the LCM/NRV rule to ending inventory. Describe its effect on the balance sheet and income statement when inventory value is lower than cost.
- when inventory value falls below its cost, GAAP requires the inventory to be written down to its lower value. Insure inventory is reported at no more than its worth. "market value" focuses on how much the inventory would cost to replace in current market conditions (replacement cost). "Net realizable value" focuses on the inventory value likely to be realized when sold (selling price minus selling costs such as delivery). FIFO&weighted average cost compare inventory cost to net realizable value. LIFO compare cost to market value. - BS: reduces inventory amount - IS: reduces net income
what are three goals of inventory management?
1. maintain a sufficient quantity of inventory to meet customers' needs. 2. ensure inventory quality meets customers' expectations and company standards. 3. minimize the cost of acquiring and carrying inventory (including costs related to purchasing, production, storage, spoilage, theft, obsolescence, and financing).
the chapter discussed four inventory costing methods. list the four methods and briefly explain each
1. specific identification method: individually identifies and records the cost of each item sold as Cost of Goods Sold. 2. First-in, first-out (FIFO): assumes the inventory costs flow out in the order the goods are received. 3. Last-in, first-out (LIFO): assumes the inventory costs flow out in the opposite of the order the goods are received 4. Weighted average cost: uses the weighted average of the costs of goods available for sale for both the cost of each item sold and those remaining in inventory.
"where possible, the inventory costing method should mimic actual product flows." do you agree? explain
Inventory costing does not have to follow the actual flow of a company's products. due to market prices income tax effects, and other variables, some companies might want to have more recent costs reported on the balance sheet (FIFO) while others might want more recent costs reported on the income statement (LIFO)
distinguish perpetual inventory systems from periodic inventory systems by describing when and how cost of goods sold is calculated when using LIFO
Numbers are calculated using the cost of goods last purchased as of the date of sale. This differs from Periodic system where the cost of goods sold is calculated as if all the sales occurred at the end of the period
