Questions and Answers
What is inventory?
Includes items a company intends for sale to customers in the ordinary course of business. Inventory also includes items that are not yet finished products. Generally reported as a current asset in the balance sheet.
Is inventory a current or long-term asset?
False
What is cost of goods sold (COGS)?
Cost of goods sold is the carrying value of goods sold during a particular period, reported in the income statement.
What is the structure of a multiple-step income statement?
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What is the characteristic of operating income?
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What is the relation of inventory and COGS?
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What is FIFO?
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What is LIFO?
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When cost is rising, which method results in the highest COGS?
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Which method results in the highest balance of ending inventory?
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What is the lower of cost and net realizable value method?
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What is accumulated depreciation?
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What is Book Value of a PPE asset?
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Which kind of subsequent expenditure after the purchase of a PPE asset should be capitalized?
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How to determine the gain or loss of the sale of a PPE asset?
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What is intangible asset amortization?
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How should a company recognize research and development (R&D) costs?
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What kind of account is COGS?
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Study Notes
Inventory Overview
- Inventory includes items for sale and unfinished products.
- Reported as a current asset on the balance sheet.
Inventory Classification
- Inventory is classified as a current asset.
Cost of Goods Sold (COGS)
- COGS represents the carrying value of goods sold during a specific period.
- Reported in the income statement.
Multiple-Step Income Statement
- Structure includes multiple profitability levels:
- Gross profit = Net revenues - COGS.
- Operating income = Gross profit - Operating expenses.
- Net income = Total revenues - Total expenses.
Operating Income Characteristics
- Indicates profit derived from business operations.
- Calculated as gross income minus operating expenses.
Operating vs. Non-Operating Income
- Operating income includes revenues and expenses directly related to primary business activities.
- Non-operating income includes revenues and expenses not related to core operations.
Inventory and COGS Relationship
- COGS is determined using the equation:
- Beginning Inventory + Purchases = COGS + Ending Inventory.
Inventory Valuation Methods
- FIFO: First In, First Out method where oldest inventory is sold first.
- LIFO: Last In, First Out method where most recent inventory is sold first. Used only in the U.S.
- Weighted Average Cost: Averages the cost of all inventory items.
- Specific Identification: Tracks the actual cost of each item sold.
COGS Calculations Under Different Methods
- COGS is highest using the LIFO method when costs are rising.
- FIFO results in the highest balance of ending inventory.
Popularity of LIFO
- LIFO is favored in certain economic environments due to tax advantages during inflation.
Inventory Systems
- Perpetual Inventory System: Continuously updates inventory records.
- Periodic Inventory System: Updates inventory records at regular intervals.
Journal Entries for Perpetual Systems
- Two journal entries required for inventory sales: one for purchasing inventory and another for sales.
Lower of Cost and Net Realizable Value
- Method used for assessing inventory value, ensuring inventory is not overstated on the balance sheet.
Property, Plant, and Equipment (PPE)
- PPE includes land, buildings, and equipment, recorded as capitalized costs in the balance sheet.
Natural Resources Characteristics
- Unique features including depletion and consumption characteristics.
Accumulated Depreciation
- Represents the total depreciation expense allocated to an asset over time. It is a contra asset account.
Book Value of PPE
- Book value indicates the value of a PPE asset after accounting for depreciation.
- Residual (salvage) value is the estimated value at the end of a PPE asset's useful life.
Subsequent Expenditure Treatment
- Capitalized costs enhance the value of PPE and are added to the asset's book value.
- Expenses are costs incurred that do not extend the asset's useful life.
Depreciation Expense Calculation
- Calculated through various methods:
- Straight-line method: Equal expense over useful life.
- Declining balance method: Accelerated depreciation based on a percentage of book value.
- Units of activity method: Based on actual usage.
Gain or Loss on Sale of PPE
- Determined by comparing the sale proceeds to the book value of the asset.
Intangible Assets
- Categories include copyrights, patents, trademarks, franchises, and goodwill, each with specific legal definitions and implications.
Amortization of Intangible Assets
- Intangible assets are amortized over their useful life, reflecting their consumption and reducing the asset's value.
Research and Development Costs
- Typically expensed as incurred, as per accounting standards, rather than capitalized.
COGS Classification
- Recognized as an expense in the Income Statement, reflecting the cost associated with goods sold during a period.
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Description
This quiz covers essential concepts related to inventory classification, cost of goods sold (COGS), and the multiple-step income statement. Test your understanding of how inventory and COGS impact financial statements and the distinction between operating and non-operating income. Perfect for accounting students!
