Questions and Answers
The cost of merchandise available for sale consists of the cost of the beginning inventory and the purchases added to inventory during the fiscal period.
True
If the cost of the ending merchandise inventory is overstated, the net income will be understated.
False
If the cost of the ending merchandise inventory is understated, the cost of merchandise sold will be overstated.
True
If the cost of ending merchandise inventory is understated, the cost of merchandise sold will be overstated.
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Calculating an accurate merchandise inventory cost to adequately report a business's financial progress and condition is an application of the accounting concept Adequate Disclosure.
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At the end of each fiscal period, the cost of merchandise available for sale is divided into the ending inventory and net purchases.
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Typically, a business counts as part of its inventory all goods for sale legally owned by the business.
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When the terms of sale for goods in transit are FOB shipping point, the title to the goods passes to the buyer when the goods are received by the buyer.
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When the terms of sale for goods in transit are FOB destination, the title to the goods passes to the buyer when the goods are received by the buyer.
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When goods are sent to a business on consignment, title to the goods passes to the business accepting the consignment when the consignor delivers the goods to a transportation business.
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A perpetual inventory provides day-to-day records about the quantity of merchandise on hand.
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Because of the expense, many businesses take a periodic inventory only once a year.
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Businesses using a perpetual inventory method never need to take a periodic inventory.
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The weighted-average inventory costing method is based on the assumption that each item in the ending inventory has a cost equal to the average price paid for similar items.
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In the lower of cost or market inventory costing method, if the unit price is higher than the current market price, the inventory cost is reduced to the market price.
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During a period of increasing prices, the weighted-average inventory costing method usually will give the lowest total inventory cost.
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During a period of decreasing prices, the FIFO inventory costing method usually will give the lowest total inventory cost.
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Taking a periodic inventory once a month for interim monthly financial statements is usually too expensive to be worthwhile.
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Businesses that need an ending inventory cost for monthly interim financial statements usually take a monthly periodic inventory.
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A business keeping a perpetual inventory and also preparing monthly interim financial statements will need to estimate monthly ending inventory.
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Using the retail method of estimating inventory is more expensive than the gross profit method because more records must be kept.
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A merchandise inventory turnover ratio expresses a relationship between an average inventory and the cost of merchandise sold.
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Study Notes
Merchandise Inventory Basics
- Cost of merchandise available for sale includes beginning inventory plus purchases made during the fiscal period.
- Correct calculation of ending merchandise inventory is crucial for accurate financial reporting.
Inventory Valuation Impacts
- Overstating ending merchandise inventory leads to understated net income.
- Understating ending merchandise inventory results in an overstated cost of merchandise sold.
Inventory Accounting Concepts
- Adhering to the Adequate Disclosure concept ensures accurate reporting of merchandise inventory costs.
- Goods owned legally by a business are counted as part of its inventory, regardless of their location.
Title Transfer in Sales
- Under FOB shipping point, title transfer to the buyer occurs when goods are shipped, not upon receipt.
- Under FOB destination, title passes to the buyer when the goods are received.
Consignment Goods
- Title does not transfer to the business accepting goods on consignment until the goods are sold, not at the time they are delivered.
Inventory Management Methods
- Perpetual inventory systems offer daily records of merchandise quantities on hand, aiding in real-time inventory management.
- Some businesses opt for periodic inventory counts only once a year due to associated costs.
Inventory Calculation Methods
- The weighted-average inventory costing method averages the costs of similar items for valuation.
- The lower of cost or market method requires inventory cost reduction to market price when market price is lower than the unit cost.
- During inflation, the weighted-average costing method typically does not yield the lowest inventory costs.
Financial Statement Preparation
- FIFO (First In, First Out) typically results in the lowest total inventory cost during price declines.
- Conducting monthly periodic inventories solely for interim financial statements can be too costly for most businesses.
Inventory Estimation Techniques
- Businesses with monthly financial statements may find it more cost-effective to use estimated inventory methods rather than perform frequent physical counts.
- The retail method of estimating inventory incurs higher costs due to the necessity of maintaining extensive records compared to the gross profit method.
Inventory Turnover Ratio
- The merchandise inventory turnover ratio establishes the relationship between average inventory held and the cost of merchandise sold, reflecting inventory efficiency.
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Test your knowledge with these true/false flashcards based on Accounting Chapter 6. Dive into key concepts about merchandise inventory and its impact on net income and cost of goods sold. Perfect for reviewing essential accounting principles.
