Accounting Chapter 7: Cost of Sales and Inventories

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Questions and Answers

A company has 5 items in inventory, each with a different cost and NRV. The company should _____________.

Value each inventory item separately at the lower of cost and NRV. (correct)

Ignore the NRV for each item and value each item at the cost because the cost represents the amount paid.

Compare the total cost of all inventory items with their total NRV, and value the inventory at the lower amount.

Calculate the average cost of all inventory items and value the inventory at the average cost.

A trader buys an item for CU100 and expects to sell it for CU140 with CU5 in selling expenses. The market slumps, and the expected selling price drops to CU95. What is the NRV of the item?

CU90 (correct)

CU100

CU95

CU85

If a business has goods in inventory that are worth less than their original cost at the end of a reporting period, what should be done with the value of the inventories?

The value should be written down to their original cost, regardless of their current market value.

The value should be written down to their net realizable value if this is less than their original cost. (correct)

The value should be left unchanged, as the original cost is still relevant.

The value should be increased to reflect the current market value.

Why is it important to value inventory at the lower of cost and NRV?

All of the above. Signup and view all the answers

Why does the cost of inventory written off or written down not usually cause problems in calculating the gross profit of a business?

Because the cost of sales already includes the cost of inventories written off or written down. Signup and view all the answers

Which of the following are included in the cost of inventory?

Purchase price, delivery, import taxes and duties, and conversion costs. Signup and view all the answers

If the NRV of an inventory item is lower than the cost of the item, what impact will this have on the financial statements?

All of the above. Signup and view all the answers

What are the reasons why a business might be unable to sell all the goods purchased?

Goods might be damaged, become obsolete, or be lost or stolen. Signup and view all the answers

What is the net realizable value of an inventory item?

The estimated selling price of the inventory item less any estimated costs of completion and selling. Signup and view all the answers

If Wagg had sold the fashion goods at a sale price of CU1,500 instead of CU400, how would this have affected the gross profit calculation?

The gross profit would be higher. Signup and view all the answers

What is the cost of goods sold for Wagg for the year ended 31 March 20X6?

CU50,100 Signup and view all the answers

How would the write-down of the fashion goods affect the cost of goods sold?

The cost of goods sold would be increased by CU1,700. Signup and view all the answers

If the fashion goods were sold for CU1,000 instead of CU400, how would this affect the gross profit?

The gross profit would be lower by CU600. Signup and view all the answers

What is the gross profit for Wagg for the year ended 31 March 20X6?

CU29,300 Signup and view all the answers

What is the impact of closing inventory on the calculation of cost of sales?

It is deducted from the cost of sales. Signup and view all the answers

What type of entry is made to move opening inventory from the inventory account to the cost of sales account?

DEBIT to Cost of sales, CREDIT to Inventory account. Signup and view all the answers

How does the formula for cost of sales represent the relationship between inventories and purchases?

Purchases and opening inventory combine to determine total available inventory for sale. Signup and view all the answers

Which of the following accurately represents the adjustments made for opening inventories?

Transferred from inventory account to cost of sales. Signup and view all the answers

What is one complication that arises when calculating the cost of sales?

Estimating total inventory without precise counts. Signup and view all the answers

What is the main purpose of accounting for opening and closing inventories as described?

To match costs against revenue in the correct reporting period. Signup and view all the answers

What entry is made when inventory is purchased?

DEBIT: Cost of sales, CREDIT: Purchases account. Signup and view all the answers

Which financial statement is affected by the opening inventory adjustment?

Statement of profit or loss. Signup and view all the answers

Why is it important for businesses to accurately manage inventory accounting?

To ensure accurate expense reporting and profitability assessment. Signup and view all the answers

What is one of the three basic problems associated with inventory accounting as noted?

Establishing a precise valuation of inventory. Signup and view all the answers

In the context of Clockers, which of the following would NOT be considered a cost of sales?

Delivery outwards costs incurred to transport clocks from the business premises to customers. Signup and view all the answers

If Clockers had paid for the delivery of the clocks from its supplier in Switzerland, how would this have impacted its statement of profit or loss?

The delivery outwards cost would have been higher, resulting in a lower net profit. Signup and view all the answers

Why is the cost of delivery inwards included in the calculation of cost of sales?

Because it is a direct cost incurred in making the goods available for sale. Signup and view all the answers

Which of the following correctly represents the formula for calculating Gross Profit?

Sales - Cost of Sales Signup and view all the answers

What is the key difference in calculating the cost of sales for businesses selling products versus those providing services?

Product businesses must account for opening and closing inventories, while service businesses do not. Signup and view all the answers

Which of the following scenarios would necessitate a greater emphasis on managing delivery outwards costs?

A business selling heavy machinery with high transportation costs. Signup and view all the answers

In which of the following situations would the cost of delivery inwards be irrelevant in the calculation of cost of sales?

A service provider acquiring equipment to deliver a service. Signup and view all the answers

If the initial trial balance includes opening inventory and purchases, what does this indicate about the accounting system?

The accounting system is using a periodic inventory system. Signup and view all the answers

What is the purpose of adjusting the initial trial balance for closing inventory?

To accurately represent the value of inventory on hand at the end of the period. Signup and view all the answers

What is a key difference between a perpetual inventory system and a periodic inventory system in regard to the initial trial balance?

A periodic inventory system requires the initial trial balance to be adjusted for closing inventory, while a perpetual system does not. Signup and view all the answers

Why is the initial trial balance adjusted to reflect the transfer of opening inventory to cost of sales?

The opening inventory represents unsold goods from previous periods, which have been sold in the current period. Signup and view all the answers

What is the primary outcome of adjusting the initial trial balance for closing inventory and purchases?

A more accurate computation of the company's net income. Signup and view all the answers

The journal entry to adjust the initial trial balance for closing inventory and purchases typically involves debiting what account?

Cost of Sales Signup and view all the answers

Which of the following is NOT a reason why the initial trial balance needs to be adjusted for closing inventory?

To calculate the balance of the purchases account. Signup and view all the answers

How does the periodic inventory system affect the calculation of cost of goods sold?

Cost of goods sold is calculated at the end of the period based on the initial inventory balance and purchases. Signup and view all the answers

The initial trial balance reflects opening inventory and purchases. Which of the following statements is TRUE?

The adjustment of the initial trial balance will increase the cost of goods sold account balance. Signup and view all the answers

What is the primary reason for adjusting the initial trial balance in the context of closing inventory?

To determine the accurate cost of goods sold for the period, which affects the profit or loss calculation. Signup and view all the answers

Study Notes

Chapter 7: Cost of Sales and Inventories

Introduction: Learning outcomes, syllabus links, and examination context are provided.
Learning Topics: IAS 2, Inventories, Cost of sales, Accounting for opening and closing inventories, Adjusting the initial trial balance, Counting inventories, Valuing inventories, Using mark-up/margin percentages to establish cost, Inventory drawings, Summary and further question practice.
Introduction (Page 2): Learning outcomes detail recording transactions and events, identifying statement components, preparing financial statements (statement of financial position, statement of profit or loss, statement of changes in equity, and statement of cash flows), and providing specific syllabus learning outcomes. Syllabus links show related Accounting topics. Examination context information includes question types, double-entry, specified components of calculations, and accounting principles for inventory.
IAS 2, Inventories (Page 3): Objective is to provide accounting treatment for inventories. Inventories are defined as assets held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process. Includes various categories of inventory, such as finished goods, work in progress, and raw materials.
Cost of Sales (Page 4): Cost of sales is a key figure in financial statements, calculated by subtracting opening inventory, plus purchases and delivery inwards, less closing inventory from revenue. Unsold goods at the end of a reporting period are not included in cost of sales.
Worked Example (Page 4): The scenario explains how gross profit for the year is calculated for the Umbrella Shop example, noting purchase details, sales, closing inventory, and related costs.
Inventory written off or written down (Page 8): A business may be unable to sell all goods because losses, theft, damage, or obsolescence may occur. The cost of these items is written down to either zero or their net realizable value if the latter is lower than their original cost. This adjustment to the cost of sales doesn't affect gross profit calculation.
Inventory Written Off/Written Down (Page 9): Explanation of scenarios where inventory is written off due to loss, theft, damage, or obsolescence. The cost of the inventory is removed from gross profit in cost of goods sold.
Delivery Costs (Page 6): Delivery costs are categorized as delivery outwards or outwards. Delivery costs paid by the supplier are deducted whilst those paid by the customer are added to the cost of purchases.
Cost of Sales for Service Organisations (Page 7): Cost of sales in service organizations differs from merchandise companies, which don't include opening/closing stock. Direct labour, sales commission are included.
Inventory Accounting (Page 11): Journal entries for opening and closing inventory and adjustments to the trial balance. Opening inventory, which is transferred in the opening inventory account, is carried out after calculation or after the initial trial balance.
Inventory Drawings (Page 28): Details accounting for inventory drawings as business owner's drawings in a business is recorded as drawings (debit), debit drawings and credit cost of sales as a cost of sales .
Summary (Page 29): Flowcharts of the accounting for inventories with opening and closing inventory, purchases, and cost of sales.
Further Question Practice (Page 30): Knowledge diagnostic questions regarding cost of sales calculations, journal entries, stock count types, acceptable cost estimation techniques, and margin/markup calculations.
Self-Test Questions (Page 31): Questions to assess understanding of cost of sales calculation, inventory calculation, FIFO and LIFO methods, and general accounting entries.
Valuing Inventories (Pages 19, 20): Inventory is valued at the lower of cost or net realizable value, and examples of determining this value for different scenarios, including those involving a comparison of cost and net realizable value (NRV) of an item.
Using Mark-up/Margin percentages to Establish Cost (Page 27): Standard gross profit percentages help estimate cost from selling price, and a detailed explanation of calculation process.
Inventory Valuation and Profit (Page 24): Applying various inventory valuation methods (FIFO and AVCO) and their different impacts on profitability. FIFO assumes the cost of goods sold reflect the earliest inventory purchases whilst AVCO is the weighted average of all inventory costs. Worked example provides specific values and calculation steps for costing inventory under these methods.
Inventory Drawings (Page 28): Inventory drawings are debits against drawings and credit against cost of sales.
Interactive Questions (Pages 15 to 16, 20 to 21, 27, 31 to 32): Interactive questions to assess student comprehension on inventory valuation using FIFO and AVCO.

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Description

Dive into Chapter 7, focusing on the Cost of Sales and Inventories. This quiz covers key concepts such as IAS 2, the accounting for inventories, and the adjustment of trial balances. Prepare to enhance your understanding and practical application of financial statement preparation related to inventory management.