Accounting 201 Chapter 6

Classifying Inventory
Merchandising Company

One Classification: Inventory

Classifying Inventory
Manufacturing Company

Three Classifications: Raw Materials Work in Process Finished Goods

Determining Inventory Quantities
Perpetual System

1. Check accuracy of inventory records. 2. Determine amount of inventory lost due to wasted raw materials, shoplifting, or employee theft.

Determining Inventory Quantities
Periodic System

1. Determine the inventory on hand. 2. Determine the cost of goods sold for the period.

Taking a Physical Inventory

1. Involves counting, weighing, or measuring each kind of inventory on hand. 2. Companies often "take inventory" — when the business is closed or business is slow. — at the end of the accounting period.

Goods in Transit

1. Purchased goods not yet received. 2. Sold goods not yet delivered.

Goods in Transit
FOB Shipping Point

Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller.

Goods in Transit
FOB Destination Point

Ownership of the goods remains with the seller until the goods reach the buyer.

Goods in transit should be included in the inventory of the buyer when the:
A: public carrier accepts the goods from the seller.
B: goods reach the buyer.
C: terms of sale are FOB destination.
D: terms of sale are FOB shipping point.

D: terms of sale are FOB shipping point.

Consigned Goods

To hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of the goods. Many car, boat, and antique dealers sell goods on consignment, why?

Inventory is accounted for at cost.

Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale.

Inventory Costing Methods

Cost Flow Assumptions: Specific identification First-in, first-out (FIFO) Last-in, first-out (LIFO) Average-cost

Specific Identification

Actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of the ending inventory. (RARE)

FIFO: First-In, First-Out

1. Costs of the earliest goods purchased are the first to be recognized in determining cost of goods sold. 2. Often parallels actual physical flow of merchandise. 3. Companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed.

LIFO: Last-In, First-Out

1. Costs of the latest goods purchased are the first to be recognized in determining cost of goods sold. 2. Seldom coincides with actual physical flow of merchandise. 3. Exceptions include goods stored in piles, such as coal or hay.

Average Cost

1. Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred. 2. Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory.

Balance Sheet Effects

— A major advantage of the FIFO method is that in a period of inflation, the costs allocated to ending inventory will approximate their current cost. — A major shortcoming of the LIFO method is that in a period of inflation, the costs allocated to ending inventory may be significantly understated in terms of current cost

Tax Effects

Both inventory and net income are higher when companies use FIFO in a period of inflation. LIFO results in the lowest income taxes (because of lower net income) during times of rising prices.

The cost flow method that often parallels the actual physical flow of merchandise is the:
A: FIFO method.
B: LIFO method.
C: average cost method.
D: gross profit method.

A: FIFO method.

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.

B: LIFO method.

Lower-of-Cost-or-Market

*When the value of inventory is lower than its cost 1. Companies value the inventory at the lower-of-cost-or-market in the period in which the price decline occurs. 2. Market = Replacement Cost 3. Example of conservatism.

Inventory Errors

Common Cause: 1. Failure to count or price inventory correctly. 2. Not properly recognizing the transfer of legal title to goods in transit. 3. Errors affect both the income statement and balance sheet.

Cost Of Goods Sold =

Beginning Inventory + Cost of Goods Purchased – Ending Inventory

When an inventory error:
Understates beginning inventory
Overstates beginning inventory
Understates ending inventory
Overstates ending inventory

Cost Of Goods Sold is: Net Income: Understated Overstated Overstated Understated Overstated Understated Understated Overstated

Understating ending inventory will overstate:
A: assets.
B: cost of goods sold.
C: net income.
D: stockholders’ equity

B: cost of goods sold.

Effects of Inventory Errors on Balance sheet

Ending inventory overstated: Assets (overstated), Liabilities (no effect), Stockholders’ Equity (overstated) Ending inventory understated: Assets (understated), Liabilities (no effect), Stockholders’ Equity (understated)

Inventory turnover

measures the number of times on average the inventory is sold during the period inventory turnover = cost of goods sold/average inventory

Manufacturing companies usually classify inventory into three categories.
A. True
B. False

A. True

Inventory items on an assembly line in various stages of production are classified as
A.
finished goods.
B.
work in process.
C.
raw materials.
D.
merchandise inventory.

B. work in process.

Which of the following should not be included in the physical inventory of a company?
A.
Goods held on consignment from another company
B.
Goods shipped on consignment to another company
C.
Goods in transit from another company shipped FOB shipping point
D.
None of these answer choices are correct

A. Goods held on consignment from another company

As a result of a thorough physical inventory, Railway Company determined that it had inventory worth $180,000 at December 31. This count did not take into consideration the following facts: Rogers Consignment store currently has goods worth $35,000 on its sales floor that belong to Railway but are being sold on consignment by Rogers. The selling price of these goods is $50,000. Railway purchased $13,000 of goods that were shipped on December 27, FOB destination, that will be received by Railway on January 3. Determine the correct amount of inventory that Railway should report.
A.
$230,000
B.
$215,000
C.
$228,000
D.
$193,000

B. $215,000

All of the following would be classified as inventory except
A.
finished goods.
B.
raw materials.
C.
supplies.
D.
work in process.

C. supplies.

Companies using a periodic inventory system take a physical inventory for each of the following purposes except to determine the
A.
cost of goods sold for the period.
B.
inventory on hand at the balance sheet date.
C.
amount of inventory lost due to shoplifting or employee theft.
D.
All of these answer choices are correct.

C. amount of inventory lost due to shoplifting or employee theft.

Goods in transit should be included in the inventory of the buyer when the
A.
public carrier accepts the goods from the seller.
B.
goods reach the buyer.
C.
terms of sale are FOB destination.
D.
terms of sale are FOB shipping point.

D. terms of sale are FOB shipping point.

When the terms of sale are FOB destination, ownership of the goods remains with the seller until the goods
A.
are accepted by the public carrier.
B.
are shipped.
C.
reach the buyer.
D.
are paid for by the buyer.

C. reach the buyer.

There is an accounting requirement that the cost flow assumption be consistent with the physical movement of the goods.
A. True
B. False

B. False

Inventory costing methods place primary reliance on assumptions about the flow of
A.
goods.
B.
costs.
C.
resale prices.
D.
values.

B. costs.

Which of the following statements is correct with respect to inventories?
A.
The FIFO method assumes that the costs of the earliest goods acquired are the last to be sold.
B.
It is generally good business management to sell the most recently acquired goods first.
C.
Under FIFO, the ending inventory is based on the latest units purchased.
D.
FIFO seldom coincides with the actual physical flow of inventory.

C. Under FIFO, the ending inventory is based on the latest units purchased.

Cost of goods available for sale consists of two elements: beginning inventory and
A.
ending inventory.
B.
cost of goods purchased.
C.
cost of goods sold.
D.
All of these answer choices are correct.

B. cost of goods purchased.

Tinker Bell Company has the following:

Inventory, Jan. 1
Units:
8,000
Unit Cost:
$11
Purchase, June 19
Units:
13,000
Unit Cost:
$12
Purchase, Nov. 8
Units:
5,000
Unit Cost:
$13

If Tinker Bell has 9,000 units on hand at December 31, the cost of the ending inventory under FIFO is
A.
$99,000.
B.
$108,000.
C.
$113,000.
D.
$117,000.

C. $113,000.

Tinker Bell Company has the following:

Inventory, Jan. 1
Units:
8,000
Unit Cost:
$11
Purchase, June 19
Units:
13,000
Unit Cost:
$12
Purchase, Nov. 8
Units:
5,000
Unit Cost:
$13

If Tinker Bell has 9,000 units on hand on December 31, the cost of the ending inventory under LIFO is
A.
$113,000.
B.
$108,000.
C.
$99,000.
D.
$100,000.

D. $100,000.

Davidson Electronics has the following:

Inventory, Jan. 1
Units:
5,000
Unit Cost
$ 8
Purchase, April 2
Units:
15,000
Unit Cost:
$10
Purchase, Aug. 28
Units:
20,000
Unit Cost
$12

If Davidson has 7,000 units on hand at December 31, the cost of ending inventory under the average-cost method is
A.
$84,000.
B.
$70,000.
C.
$56,000.
D.
$75,250.

D. $75,250.

The cost flow method that often parallels the actual physical flow of merchandise is the
A.
FIFO method.
B.
LIFO method.
C.
average-cost method.
D.
gross profit method.

A. FIFO method.

The first costs assigned to ending inventory are the costs of the beginning inventory under the
A.
FIFO method.
B.
LIFO method.
C.
average-cost method.
D.
gross profit method.

B. LIFO method.

Hudson Company started its year with 600 units of beginning inventory at a cost of $4 per unit. During the year, the company made the following purchases: May, 900 units at $5 per unit and July, 500 units at $6 per unit. A physical count of inventory at year-end indicates that there are 700 units in ending inventory. What is the cost of the ending inventory if Hudson Company uses the FIFO method for valuing inventory?
A.
$2,900
B.
$4,000
C.
$3,465
D.
$5,900

B. $4,000

Sheldon’s Jewelers uses the specific identification method of inventory costing. During May, Sheldon purchased 3 gemstones for $4,000, $5,000, and $6,000 respectively. During May, Sheldon sold two of the gemstones for $6,500 each. At the end of May, Sheldon determined that the $6,000 gemstone was still in his inventory. What is Sheldon’s gross profit for the month of May?
A.
$500
B.
$4,000
C.
$2,000
D.
$3,000

B. $4,000

In a period of rising prices, FIFO will result in
A.
lower net income than LIFO.
B.
lower cost of goods sold than LIFO.
C.
lower income tax expense than LIFO.
D.
lower net purchases than LIFO.

B. lower cost of goods sold than LIFO.

In periods of rising prices, LIFO will produce
A.
higher net income than FIFO.
B.
the same net income as FIFO.
C.
lower net income than FIFO.
D.
higher net income than average costing.

C. lower net income than FIFO.

Factors that affect the selection of an inventory costing method do not include
A.
tax effects.
B.
balance sheet effects.
C.
income statement effects.
D.
perpetual vs. periodic inventory system.

D. perpetual vs. periodic inventory system.