ACCTG 311 Intermediate Accounting & Analytics I Exam 3 Review PDF

ACCTG 311 – Intermediate Accounting & Analytics I Exam 3 Review STRUCTURE: 30 multiple choice (60 points): Chapter 8 – 15 questions Chapter 9 – 15 questions 4 problems: Problem 1 (10 points) – Chapter 8 Problem 2 (10 points) – Chapter 8 Problem 3 (10 points) – Chapter 9 Problem 4 (10 points)...

ACCTG 311 – Intermediate Accounting & Analytics I Exam 3 Review STRUCTURE: 30 multiple choice (60 points): Chapter 8 – 15 questions Chapter 9 – 15 questions 4 problems: Problem 1 (10 points) – Chapter 8 Problem 2 (10 points) – Chapter 8 Problem 3 (10 points) – Chapter 9 Problem 4 (10 points) – Chapter 9 CONTENT: Chapter 8 – Inventories: Measurement Inventory Overview Inventory refers to the assets a company: Intends to sell in the normal course of business Has in production for future sale or Uses currently in production of goods to be sold Cost of goods sold is the expense related to inventory Perpetual Inventory System Continually adjust the inventory account for each change in inventory caused by a: Purchase, Sale, or Return of inventory Continually adjust the cost of goods sold account each time goods are: Sold Returned by a customer Allows management to: Determine goods on hand on any date Determine the number of items sold during a period Periodic Inventory System Adjusts the inventory account and records cost of goods sold only at the end of each reporting period Records merchandise purchases, purchase returns, purchase discounts, and freight-in in temporary accounts Determines period’s cost of goods sold by combining temporary accounts with the inventory account: Physical Units Included in Inventory: Transactions Affecting Net Purchases Costs of inventory includes necessary expenditures to: 1. Acquire the inventory and 2. Bring it to its desired condition and location for sale or for use in the manufacturing process Common costs included in inventory are freight charges on incoming goods, as well as insurance costs during transit and costs of unloading, unpacking, and preparing merchandise inventory Purchase returns and purchase discounts reduce the cost of net purchases Freight-in on Purchases Costs to get the inventory in location for sale or use In perpetual system: – Freight costs are added to the inventory account In periodic system: – Freight costs are added to a temporary account, called freight-in or transportation-in, and later added to purchases Shipping charges on outgoing goods Costs are not included in the cost of inventory – Treated as a part of cost of goods sold or as an operating expense – If not in cost of goods sold, amounts incurred and income statement classification must be disclosed Purchase Returns A buyer views a purchase return as a reduction of purchases In a perpetual inventory system, a return of inventory previously purchased on account is recorded as: – Reduction in both inventory and accounts payable – If original purchase was for cash, then increase cash for refund In a periodic system: – The purchase returns account used to accumulate the amount of the return – Purchase returns are then subtracted from total purchases to calculate net purchases Inventory Cost Flow Assumptions Specific Identification Method Refers to matching each unit sold during the period or each unit on hand at the end of the period with its actual cost Used by companies selling unique, expensive products with low sales volume – This makes it relatively easy and economically feasible to associate each item with its actual cost Example: Automobiles have unique serial numbers that can be used to match a specific auto with the invoice identifying the actual purchase price LIFO Liquidations Under LIFO, the last units purchased are assumed to be sold first In some periods, the number of units sold will be greater than the number of units purchased In these instances, previous years’ layers of inventory are recorded as sold These instances are known as LIFO liquidations LIFO liquidations result in old costs being matched with current selling prices If costs have been increasing (decreasing), LIFO liquidations produce higher (lower) net income. Dollar-Value LIFO The DVL inventory pool is viewed as comprising layers of dollar value from different years A pool that is made up of items that are likely to face the same cost change pressures The inventory is viewed as a quantity of value instead of a physical quantity of goods Companies are allowed to combine a large variety of goods into one pool Dollar-Value LIFO Advantages Advantages: Simplifies the recordkeeping procedures Minimizes the probability of the liquidation of LIFO inventory layers The acquisition of the new items is viewed as replacement of the dollar value of the old items In Class Exercises: P 8-1, P8-2, and P 8-5 Homework: E 8-1, E 8-2, E 8-7, E 8-19, and E 8-27 Chapter 9 – Inventories: Additional Issues Subsequent Measurement of Inventory Circumstances arise after purchase or production of inventory that indicate the company will sell inventory for less than cost GAAP requires that companies evaluate their unsold inventory at the end of each reporting period Two Approaches to Inventory Write-Down  When the expected benefit of unsold inventory is estimated to have fallen below cost, companies must make an adjusting entry known as an inventory write-down to reduce inventory and net income for the period  The approach chosen by a company depends on which inventory costing method it uses – The financial statement effects are the same – The difference is the amount of the inventory write-down Gross Profit Method The gross profit method, also known as the gross margin method, is useful in situations where estimates of inventory are desirable: 1. In determining cost of inventory that has been lost, destroyed, or stolen 2. In estimating inventory and cost of goods sold for interim reports, avoiding the expense of a physical inventory count 3. In auditors’ testing of the overall reasonableness of inventory amounts reported by clients 4. In budgeting and forecasting Gross Profit Method—A Word of Caution The key to obtaining good estimates is the reliability of the gross profit ratio The accuracy of the estimate can be improved by grouping inventory into pools of products that have similar gross profit relationships The company’s cost flow assumption should be implicitly considered when estimating the gross profit ratio Suspected theft or spoilage would require an adjustment to estimates obtained using the gross profit method The Retail Inventory Method Used by high-volume retailers selling many different items at low unit prices Companies track purchases during year at cost and retail prices to estimate ending inventory and cost of goods sold Cost refers to purchase cost; retail refers to current selling prices. Advantages of the Retail Inventory Method Provides a more accurate estimate than gross profit method Different cost flow methods can be incorporated into estimation technique – FIFO – LIFO – Average cost Can be used to estimate the cost of lost, stolen, or destroyed inventory – For testing the overall reasonableness of physical counts – In budgeting and forecasting & generating information for interim financial statements A physical count of inventory is still usually performed at least once a year to verify accuracy and detect spoilage, theft, and other irregularities The LIFO Retail Method The last-in, first-out (LIFO) method assumes that units sold are those most recently acquired – When there’s a net increase in inventory quantity, LIFO results in ending inventory that includes the beginning inventory as well as one or more additional layers added during the period – When there’s a net decrease in inventory quantity, LIFO layer(s) are liquidated  In applying LIFO to the retail method, we assume that the retail prices of goods remained stable during the period – Compare beginning and ending inventory in dollars to determine if quantity has increased or decreased Change to the LIFO Method When a company changes to the LIFO inventory method from any other method, it usually is impossible to calculate the income effect on prior years – To do so would require assumptions as to when specific LIFO inventory layers were created in prior years A company changing to LIFO usually does not report the change retrospectively – LIFO method is used from that point on – Base year inventory is the beginning inventory in the year the LIFO method is adopted Earnings Quality Inventory write-downs often are cited as a method used to shift income between periods By overstating write-downs, profits are increased in future periods as the inventory is used or sold A financial analyst must carefully consider the effect of any significant asset write-down on the assessment of a company’s permanent earnings In Class Exercises: E 9-2, E 9-4, E 9-14, and P 9-15 Homework: E 9-3, E 9-6, E 9-8, E 9-13, and E 9-26