2 Inventory

Question 1

Inventory

Costs included / NOT included

Answer 1

Included

• purchase returns: contra account to purchases
• freight-in
• sales tax on inventory purchases
• packaging costs
• insurance on transit

NOT included

• freight out
• interest on purchase (cost of financing)

Question 2

Inventory

JE: Purchases / CoGS

• periodic
• perpetual

Answer 2

Periodic

Purchases

(dr) Purchases
(cr) Cash/Acc Pay

Year end

(dr) Ending Inventory
(dr) CoGS (year-end plug)
(cr) Beg Inventory
(cr) Purchases

Perpetual

Purchases

(dr) Inventory
(cr) Cash/Acc Payable

Sale: COGS recorded at time of sale

(dr) Cash or A/R
(cr) Sales
(dr) CoGS
(cr) Inventory

Question 3

Net Purchases

(calculation)

Answer 3

Gross Purchases

+ Transportation (freight in)

– Purchase returns/allowances

– Purchase Discounts

= Net Purchases

Question 4

Cost Flow Assumptions

Compare FIFO vs LIFO

Answer 4

FIFO

Pro

• flow of costs = flow of physical goods
• BS value of inventory –> approximates current cost (more relevant than HC)

Con

• I/S matching rev/exp –> not ideal b/c often rev = current year, CoGS exp = prior period
• Phantom/illusory profits: lower CoGS (prior period) = more income, but NOT disposable income b/c nec next period when prices higher

LIFO

Pro

• I/S matching rev/exp –> both current year
  
  • Less phantom/illusory profits
• Income tax advantage
  
  • Rising prices = higher CoGS / lower tax burden
  • Must also use for books if use for tax

Con

• BS value inventory: less ideal b/c valued at “oldest” prices, less match to current cost
• LIFO liquidation: when # units sold > units purchased/produced
  
  • move to a lower priced invenotry
  • From poor planning or lack of supply
  • Want to avoid b/c removes benefits of LIFO (lower NI, lower tax, matching Rev/Exp

Question 5

Dollar Value LIFO

• def
• calc

Answer 5

Why use Dollar Value LIFO:

• using pools of inventory, NOT tracking indiv purch/sales
• Permits using FIFO internally* (mgt reports), but *LIFO external reporting
• Provides efficiencies: reduces clerical costs, likelihood of liquid layer
• Inventory pools: group similary items into pools an use a price index to determine LIFO layer added in currenty year
• Essentially a measure of inflation

Calculation

• Index = end-Inv @current - end-Inv @base
• convert end-Inv @ current –> base

= end-I @curr / index

• find layer @ base

= end-I @base - beg-I @base

• covert layer to current

= layer @base * index

• end-I @current

= beg-Inv @base + layer @ current

Question 6

Other methods of estimating ending Inventory / CoGS

Answer 6

• gross margin (gross profit)
  
  • on sales
  • on cost
• relative sales method (basket purchase)
• retail inventory method

Question 7

Gross margin method

Answer 7

• uses historical gross profit rates on sales or cost

Cost + Profit Margin = Sales

• given gross profit on sales –> set sales to 100%
  
  • = gross margin
  • = gross profit / sales
• given gross profit on cost –> set cost to 100%
  
  • = gross profit / cost

Question 8

Inventory

Relative Sales Method

Answer 8

Allocates initial cost in a basket purchase

• Sometimes multiple invenotry items are purchased together at a significant discount
• Inventory value is allocated to indiv items based on relative selling price

inventory cost

= (item selling price / total selling prices) * basket purchse price

Question 9

Retail Inventory Method

what/why

basic calculation

Answer 9

• Used to estimate cost of ending inventory (End-Inv @cost)
  
  • b/c often stored at retail prices

basic calculations

1. cost/retail ratio = AFS @cost / AFS @retail
2. end-Inv @cost = end-Inv @retail * c/r ratio
3. CoGS = AFS @cost - end-Inv @cost

Question 10

original selling price

Answer 10

cost + initial markup

Question 11

net additional markups

net markdowns

Answer 11

net additional markups: net increase in original selling price

= markups – additional markup cancellations

• Markup cancellation: reduction of additional markup, NOT reduction below original selling price

Net markdowns: net decrease in original selling price

= markdowns (reductions in original selling price) – markdown cancellations

• Markdown cancellations: reduction of original markdown, NOT increase above original selling price

Question 12

2 types Shortage

Answer 12

• Normal shortage (spoilage):
• Abnormal shortage( losses): amt of merchandise avail for sale haas declined, usually recoverable through insurance

Question 13

Retail Inventory

variations

Answer 13

FIFO

• ratio only uses current period purchases
• assumes all beg-Inv will be sold, and end Inv only current purchases
• includes
  
  • Net markups
  • Net markdowns

FIFO, LC-M

• same as FIFO
• ONLY includes net markups
• NO net markdowns -> more conservatibe
  
  • give larger denom –> smaller ratio –> End-Inv small

Average

• includes both beg-Inv AND current period purchases
• includes both net markup/net markdown

Average, LC-M = conventional retail inventory method

• same as avg
• excludes net markdown
• only use net markup

DV LIFO

• DV LIFO applied to End-Inv @ retail
  
  • determine current yr layer @cost-retail
  • convert to current yr layer @ current-retail
  • add layer to beg-Inv @retail –> end-Inv @retail
• Retail method:
  
  • Calculate cost/retail ratio
  • Apply ratio to DV LIFO end-Inv @retail
  • –> end-Inv @cost

Question 14

Decline in Inventory value

write down - general

Answer 14

• write down if value inventory < cost
• Amount of write-down depends on value used for subsequent measurement
• immeidate recognition of a loss
• No write back up

Question 15

Inventory

2 methods for subsequent valuation

• how
• Journal entries

Answer 15

Lower cost or net realizable value:

• Used for FIFO or Wtd Avg
• determine if write down nec
  
  • If cost < NRV –> no write down
  • If cost > NRV –> write down to NRV
• Net realizable value = selling price – costs:
  
  • to ship
  • complete
  • dispose
• write down

(dr) Loss on Inventory Impairment
(cr) Inventory

lower cost or market:

• Used for LIFO or Retail methods
• determine if devalued
  
  • uses 3 values
    
    • replacement cost
    • net realizable value = ceiling
    • floor = NRV - profit margin
  • select market value = middle of 3 (above)
• if cost > market value –> write off
• Journal entry

direct method

(dr) Cost of Goods Sold
(cr) Inventory

allowance method

(dr) Holding loss
(cr) Allowance to reduce inventory to LC-M

Question 16

Inventory Errors

Ending Inventory is Undervalued

• impact current yr
• impact next yr

Answer 16

Current yr: End-Inv undervalued

• CoGS – overvalued
• NI – under
• RE – under

Next yr

• Beg-Inv – Under
• Goods AFS – Under
• CoGS – Under
• NI – Over
• RE – OK

Question 17

Purchase Commitments

def and general

Answer 17

(def) commitment to purchase goods at a locked in price

• Not recorded when contracted
• If mkt price of item declines below contract price: might need to recog loss on purchase commitment

Question 18

Purchase Commitments

• effect of modification
• Journal entry

Answer 18

If can be modified

• loss on purchase commitment is disclosed in footnote
• b/c loss is not probable and should not be accrued

if cannot be modified

• loss is probable –> recognize
  (dr) Loss on purchase commitment
  (cr) liability on purchase commitment

Question 19

Inventory

GAAP v IFRS

Answer 19

GAAP IFRS

Subsequent LC-NRV LC-NRV only

valuation or LC-M

cost flow no requirment apply same cost flow

requirement to similar inventory

write down no reversal reversal permitted

up to original cost

LIFO permitted NOT allowed