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UWL ACC 221 - Exam 3 Study Guide

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ACC 221Exam # 3 Study Guide Lectures: 10 - Chapter 6 Reading NotesClassifying Inventory:For merchandising companies inventory consists of:1. Items owned by the company2.Items that are in a form ready for sale to customers in the ordinary course of businessThe only inventory classification is Merchandise InventoryFor manufacturing companies:- Some inventory may not be ready for sale- Inventory is classified into:o Finished Goods Inventory: manufactured items that are completed and ready for saleo Work in Progress: manufactured items that have begun the production progress but are not yet completeo Raw Materials: the basic goods that will be used in production but have not yet been placed into production- By observing the levels and changes in the 3 inventory types, financial statement users cangain insight into management’s production plansJust In time (JIT) Inventory- Companies manufacture or purchase goods just in time for useDetermining Inventory Quantities: - Perpetual System: companies take a physical inventory to1. Check the accuracy of their perpetual inventory records2. Determine the amount of inventory lost due to wasted raw materials, shoplifting,or employee theft- Periodic System: companies take a physical inventory to1. Determine the inventory on hand at the balance sheet date2. Determine cost of goods sold for the periodDetermining Ownership of Goods:1. Do all of the good included in the count belong to the company?2.Does the company own any good that were not in the count?Goods in Transit- SHOULD be included in the inventory of the company that has legal title to the goods (determined by terms of sale)- Terms of Saleo FOB shipping point: Ownership of goods basses to the buyer when they leave theseller to be shippedo FOB destination: ownership of goods remains with the seller until goods reach the buyerConsigned goods- hold goods for other partiers and try to tell them at a fee- do not take ownership of the goodsInventory Costing- Specific Identification Method:o Positively identify which particular units were sold and which are still in ending inventoryo Requires companies to keep records of the individual cost of each inventory item- Cost flow assumptions: assume flows of costs that may be unrelated to the actual physical flow of goodso FIFO: First in, First outo LIFO: Last in, First outo Average Cost (Beginning Inventory + Purchases) – Ending Inventory = Cost of Goods Sold (COGS)FIFO (Periodic)- Assumes the earliest goods purchased are the first to be sold- Cost of the earliest goods purchased are the first to be recognized in determining COGS (regardless of which units were actually sold)- Companies determine cost of Ending inventory by taking the unit coast of the most recent purchase and working backward until all units of inventory have been costed- COGS = Coast of goods available for sale (COGAS) – Ending InventoryLIFO (Periodic)- Assumes latest goods purchased are the first to be sold - Cost of latest good purchased is first to be recognized in determining COGS- Ending inventory is based on prices of the oldest units purchased- Companies obtain cost of ending inventory by taking unit cost of the earliest goods available for sale and working forward until all units of inventory have been costed- All goods purchased during the period are assumed to be available for the first sale, regardless of date of purchaseAverage Cost (Periodic)- Allocates the cost of goods available for sale (COGAS) on the basis of the weighted average unit cost (WAUC)- COGAS / total units available for sale = WAUC- WAUC applied to units on hand to determine cost of ending inventory- Ending Inventoryo Total cost/ units = unit costo Units x unit cost = total cost- COGSo COGAS – Ending Inventory Financial Statement and Tax Effects of Cost Flow MethodsReasons companies adopt different inventory cost flow methods:1.Income Statement Effects2.Balance Sheet Effects3.Tax EffectsIncome Statement Effects:- Ending inventory and COGS are different for each method- During inflation (rising prices)o FIFO produces highest net income because lower unit costs of the first units purchased and matched against revenueso Next highest income in Average Costo LIFO produces lowest net incomeBalance Sheet Effects:- Advantage of FIFO method:o During inflation, the costs allocated to ending inventory will approximate their current cost- Disadvantage of LIFO: o During inflation, the costs allocated in ending inventory may be understated in terms of current costTax Effects- LIFO results in lowest income taxes because of lowest net incomeLower-of–Cost-or-Market (LCM)- Whereby inventory is states at the lower of its cost or market value- Inventory should be valued at LCM when a price decline occurs- Convention of Conservatism: the method least likely to overstate assets and net income- Current Replacement Cost: The cost of purchasing the same goods at present time from usual suppliersAnalysis of Inventory- Inventory turnover= COGS / Average Inventory- Average number of days inventory is held = 365 / inventory turnoverAnalyst’s Adjustment for LIFO Reserve- Companies using LIFO must report difference of inventory between LIFO and FIFO- Known as the LIFO ReserveAPPENDIX: Perpetual Inventory SystemsFIFO- Cost of earliest goods on hand prior to each sale is charged to COGS- Results are the same as periodicLIFO- Cost of more recent purchase prior to sale is allocated to units sold- Results are different than periodic- The latest units purchased prior to each sale are allocated to COGSAverage Cost (“Moving Average Method”)- Company Computes a new average after each purchase- Average cost = COGS/ units on hando Applied to units sold to determine COGSo Applied to the remaining units on hand to determine Ending InventoryInventory ErrorsIncome Statement Effects (Periodic)- Beginning Inventory + Cost of Goods Purchased – Ending Inventory = COGSo If beginning inventory is understated, COGS will be understatedo If Ending Inventory is understated, COGS will be overstatedInventory Error COGS Net IncomeBeginning Inventory Overstated Understated OverstatedBeginning Inventory Understated Overstated UnderstatedEnding Inventory Understated Overstated UnderstatedEnding Inventory Overstated Understated OverstatedAn error in Ending Inventory of current period will have a reverse effect on net income of next period (See


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UWL ACC 221 - Exam 3 Study Guide

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