Cpa Review- Far 4-2 (Inventories)

Front 1

Types of Inventory

Back 1

Inventories of goods must be periodically counted, valued, and recorded in the books of account of a business. 4 Types:

Hint 1

1. Retail (finished goods only)
2. Raw Materials
3. Work in Process
4. Finished Goods

Front 2

Included in Inventory

Back 2

General Rule: any goods and materials in which the company has legal title should be included in inventory.

Hint 2

Legal title typically follows possession of the goods. (There are many exceptions to the general rule)

Front 3

Goods in Transit

Back 3

-If no conditions are explicitly agreed upon, title passes from the seller to the buyer at the time and place where the seller's performance regarding delivery of goods is complete.

Hint 3

-F.O.B. means "free on board" and requires the seller to deliver the goods to the location indicated as F.O.B.

Front 4

F.O.B. Shipping Point

Back 4

-Buyer pays, title passes to the buyer when the seller delivers the goods to a common carrier.

Hint 4

-Should be included in buyer's inventory upon shipment.
-"Freight in" added to the cost of inventory.

Front 5

F.O.B. Destination

Back 5

-Seller pays, title passes to the buyer when the buyer receives the goods from the common carrier.

Hint 5

-Still in seller's inventory during shipment.
-"Freight out" is a selling expense for the seller.

Front 6

Non-Conforming Goods

Back 6

-If the seller ships the wrong goods, the title reverts to the seller upon rejection by the buyer.

Hint 6

-The goods should not be included in the buyer's inventory even though the buyer possesses them.

Front 7

Sales With a Right to Return

Back 7

General Rule: if the buyer has the right to return the goods, the goods should be included in the seller's inventory if the amount of goods likely to be returned cannot be estimated (no sale yet).
-If the amount of goods likely to be returned can be estimated, the transaction will be recorded as a sale with an allowance for estimated returns recorded.
-Revenue will be recognized only if all the following conditions are met:

Hint 7

1. The sales price is substantially fixed at the date of sale
2. The buyer assumes all risks of loss b/c the goods are in the buyer's possession
3. The buyer has paid some form of consideration
4. The product sold is substantially complete
5. The amount of future returns can be reasonably estimated

Front 8

Consigned Goods

Back 8

-The seller (the "consignor") delivers goods to a sales agent (the "consignee") to hold and sell on the consignor's behalf. The consignor should include the consigned goods in its inventory b/c the title and risk of loss is retained by the consignor.

Hint 8

If all the conditions (above) are not met, there is no revenue recognition from a sale. Revenue will be recognized when the goods are sold to a third party. Title passes directly to the third-party at the point of sale.

Front 9

Public Warehouses

Back 9

-Goods stored in a public warehouse and evidenced by a warehouse receipt should be included in the inventory of a company holding the warehouse receipt.

Hint 9

-The reason is that the warehouse receipt evidences title even thought the owner does not have possession.

Front 10

Sales with a Mandatory Buyback

Back 10

-Occasionally, as part of a financing arrangement, a seller has a requirement to repurchase goods from a buyer.

Hint 10

-If so, the seller should include the goods in inventory even though title has passed to the buyer.

Front 11

Installment Sales

Back 11

-If the seller sells good on an installment basis but retains title as security for the loan, the goods should be included in the seller's inventory if the percentage of uncollectible debts cannot be estimated.

Hint 11

-However, is the percentage of uncollectible debts can be estimated, the transaction would be accounted for as a sale, and an allowance for uncollectible debts would be recorded.

Front 12

Valuation of Inventory

Back 12

GAAP requires that inventory be stated at its cost. Where evidence indicates that cost will be recovered with an approximately normal profit in the ordinary course of business, no loss should be recognized even though replacement or reproduction costs are lower.

Hint 12

Cost: defined as the price paid or consideration given to acquire an asset. In inventory accounting, cost is the sum of the expenditures and charges, direct and indirect, in bringing goods to their required condition or location. (selling expenses, freight out, and abnormal spoilage not considered inventory costs.)

Front 13

Lower of Cost or Market (GAAP)

Back 13

-When the utility of goods is no longer as great as their cost, a departure from the cost basis principle of measuring inventory is required.

Hint 13

-This is usually accomplished by stating such goods at a lower level designated as market value, or the lower-of-cost-or-market principle.

Front 14

Precious Metals and Farm Products

Back 14

-Gold, silver, and other precious metals, and meat and some agricultural products are valued at NRV (net selling price less costs of disposal). Inventories reported at NRV include:

Hint 14

1. Inventories or gold and silver when there is effective government-controlled market at a fixed monetary value.
2. Inventories of agriculture or other products meeting all the following criteria: (1) Immediate marketability at quoted prices, (2) Unit interchangeability, (3) Inability to determine appropriate costs.

Front 15

Lower of Cost or Market

Back 15

-Purpose is to show the probable loss sustained (conservatism) in the period in which the loss occurred (matching).

Hint 15

-May be applied to a single item (results in most conservative ending inventory), a category, or total inventory, provided that the method most clearly reflects periodic income.

Front 16

LCM- Recognize Loss in Current Period

Back 16

-The difference in inventory should be recognized as a loss for the current period no matter the cause.
-The write-down of inventory to market is usually reflected in COGS, unless the amount is material, in which case the loss should be identified separately in the I/S.

Hint 16

-Under GAAP, "market" generally means current replacement cost (whether by purchase or reproduction), provided the current replacement cost does not exceed NRV (the "market ceiling") or fall below NRV reduced by normal profit margin (the "market floor")

Front 17

Reversal of Inventory Write-Downs

Back 17

-Under U.S. GAAP, reversals of inventory write-downs are prohibited.
-IFRS allow the reversal of inventory write-downs for subsequent recoveries in inventory value.*

Hint 17

*Reversal is limited to the amount of the original write-down and is recorded as a reduction of total inventory on the I/S (COGS) in the period of reversal.

Front 18

Market Value

Back 18

-Is the median (middle value) of an inventory item's replacement cost, its market ceiling, and its market floor (under GAAP).

Hint 18

-Replacement Cost: the cost to purchase the item of inventory as of the valuation date.

Front 19

Market Ceiling & Floor

Back 19

-Market ceiling is an item's net selling price (net of discounts) less the costs to complete and dispose (called the NRV)

Hint 19

-Market floor (NRV) is the market ceiling less a normal profit margin (based on selling price only)

Front 20

Exceptions to LCM

Back 20

-The lower of cost or market rule will not apply if:
1. The company has a firm sales price contract.

Hint 20

2. The subsequent sales price of an end product is not affected by its market value.

Front 21

Disclosure

Back 21

-When losses are both substantial and unusual from the application of the LCM principle, the amount of the loss is disclosed in income from continuing operations in the I/S and identified separately from the consumed inventory costs (COGS). Small losses from decline in value are included in COGS.

Hint 21

-Basic principle of consistency must be applied in the valuation of inventory and the method should be disclosed in the F/S's. In the event that a significant change takes place, adequate disclosure of the nature of the change and, if material (materiality), the effect on income should also be disclosed.

Front 22

Lower of Cost or NRV (IFRS)

Back 22

-IFRS requires inventory to be reported at the lower of cost or NRV.
-Like GAAP, cost is the sum of expenditures and charges (direct and indirect) in bringing goods to their required conniption or location.

Hint 22

-Selling expenses, including marketing costs and freight out, as well as abnormal spoilage and idle plant capacity costs should not be considered a part of inventory costs.
-Recognize loss in the current period but IFRS doesn't specify where an inventory write-down should be reported on the I/S.

Front 23

NRV (IFRS)

Back 23

-An item's net selling price less the costs to complete and dispose of the inventory.

Hint 23

-NRV under IFRS is the same as the "market ceiling" under GAAP.

Front 24

Periodic Inventory System

Back 24

-Quantity of inventory is determined only be physical count, usually at least annually. Therefore, units of inventory and their associated costs are counted and valued at the end of the accounting period.
-COGS for the period is determined after each count by "squeezing" (COGS "plug") the difference between beginning inventory plus purchases less ending inventory.

Hint 24

-Does not keep a running total of the inventory balances.
-Disadvantage: shortages "lumped in" with COGS

-Beginning Inventory + Purchases = Cost of Goods Available for Sale - (Ending Inventory) = COGS
-If E.I. is overstated, COGS is understated, Gross Profit is overstated.

Front 25

Perpetual Inventory System

Back 25

-The inventory record for each item of inventory is updated for each purchase and each sale as they occur.

Hint 25

-The actual COGS is determined and recorded with each sale. Therefore, the perpetual system keeps a running total of inventory balances.

Front 26

Hybrid Inventory Systems

Back 26

1. Units of Inventory on Hand (Quantities Only): some companies maintain a perpetual record of quantities only (for units on hand). This is often referred to as the "modified perpetual system" and changes in quantities are recorded after each sale and purchase.

Hint 26

2. Perpetual with Periodic at Year-End: most companies that maintain a perpetual inventory system still perform either complete periodic physical inventories or test count inventories on a random (cyclical) basis.

Front 27

Inventory Cost Flow Assumptions

Back 27

-Inventory valuation is dependent upon the cost flow assumption underlying the computation. Under GAAP, the cost flow assumption used by a company is not required to have a rational relationship with the physical inventory flows; however, the primary objective is the selection of the method that will most clearly reflect periodic income.

Hint 27

-Frequently, the identity of goods and their specific related costs are lost between the time of acquisition and the time of sale. This has resulted in the general acceptance of several cost flow assumptions (FIFO, LIFO, & Average Cost) to provide practical bases for the measurement of periodic income.

Front 28

IFRS vs. GAAP- Inventory Cost Flow

Back 28

-Under IFRS, the accounting method used to account for inventory should be based on the order in which the products are sold relative to when they were put in inventory.

Hint 28

-Specific identification should be used whenever possible.
-The LIFO method is prohibited under IFRS b/c it rarely reflects actual physical inventory flows.

Front 29

Specific Identification Method

Back 29

-The cost of each item in inventory is uniquely identified to that item. The cost follows the physical slow of the item in and out of inventory to COGS.

Hint 29

-Usually used for physically large or high value items and allows for greater opportunity for manipulation of income.

Front 30

First In, First Out (FIFO) Method

Back 30

-The first costs inventoried are the first costs transferred to COGS. Ending inventory includes the most recently incurred costs; thus, the ending balance approximates replacement cost.

Hint 30

-Ending inventory and COGS are the same whether a periodic or perpetual inventory system is used.
-In periods of inflation, the FIFO method results in highest ending inventory, lowest COGS, and the highest net income (current costs are not matched w/ current revenues).

Front 31

Weighted Average Method

Back 31

-At the end of the period, the average cost of each item in inventory would be the weighted average of the costs of all items in inventory. Particularly suitable for homogenous products and a periodic inventory system.

Hint 31

-Determined by dividing the total costs of inventory available by the total number of units of inventory available, remembering that beginning inventory is included in both totals.

Front 32

Moving Average Method

Back 32

-Computes the weighted average cost after each purchase by dividing the total cost of inventory available after each purchase (inventory + current purchases) by the total units available after each purchase.

Hint 32

-More current than the weighted average method. A perpetual inventory system is necessary to use this method.

Front 33

Last In, First Out (LIFO) Method

Back 33

-Prohibited under IFRS
-Last costs inventoried are the first costs transferred to COGS. Ending inventory includes the oldest costs and ending balance typically won't approximate replacement cost.

Hint 33

-Doesn't generally relate to actual flow of goods in a company b/c most companies sell or use their oldest goods first to prevent holding old or obsolete items.
-If LIFO is used for tax purposes, it must also be used in the GAAP F/S's.

Front 34

LIFO F/S Effect

Back 34

-Generally better matches expenses against revenues b/c it matches current costs with current revenues; thus, LIFO eliminates holding gains and reduces net income during times of inflation.
--If sales exceed production (or purchases) for a given period, LIFO will result in a distortion of net income b/c old inventory costs (called "LIFO layers") will be matched with current revenue.

Hint 34

-LIFO is also susceptible to income manipulation by intentionally reducing purchases in order to use old layers at lower costs.
-In periods of rising inflation, the LIFO method generally results in the lowest ending inventory, the highest COGS, and the lowest income (& thus the lowest taxes).

Front 35

LIFO Layers

Back 35

-Requires that records be maintained as to the base year inventory amount and additional layers that may be added yearly. After an original LIFO amount is created (base year), it may decrease, or additional layers may be created in each year according to the amount of ending inventory.

Hint 35

-An additional LIFO layer is created in any year where the ending inventory is created than the beginning inventory. An additional LIFO layer is priced at the earliest costs of the year in which it was created.
-Unlike FIFO, LIFO periodic doesn't = LIFO perpetual.

Front 36

Comparison of Inventory Methods

Back 36

-In a period of rising prices, FIFO results in the highest ending inventory and the lowest COGS.
-LIFO results in the lowest ending inventory and the highest COGS.

Hint 36

-The average method falls between the LIFO and FIFO balances.
-The moving average method results in higher ending inventory and lower COGS than the weighted average method.

Front 37

Dollar-Value LIFO

Back 37

-Under the regular LIFO method inventory is measured in units and is priced at unit prices.
-Under the dollar-value LIFO method inventory is measured in dollars and is adjusted for changing price levels. When converting to dollar-value LIFO (from regular), a price index will be used to adjust the inventory value.

Hint 37

Price Index = Ending Inventory at current year cost ÷ Ending Inventory at base year cost

-To compute the LIFO layer added in the current year at dollar-value LIFO, the LIFO layer at base year cost is multiplied by the internally generated price index.

Front 38

Firm Purchase Commitments

Back 38

-Legally enforceable agreement to purchase a specified amount of goods at some time in the future. All material firm purchase commitments must be disclosed in either the F/S's or notes thereto.

Hint 38

-If the contracted price exceeds the market price and if it is expected that losses will occur when the purchase is actually made, the loss should be recognized at the time of the decline in price.