Sheet (8)

Intermediate accounting

INVENTORIES

: Prepared by
Dr. Magdy Kamel
Tel/ 01273949660

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1. Inventories are:
 Are asset items held for sale, or
 goods to be used in the production of goods to be sold
 it classified as current assets

2. merchandising company
 One inventory account.
 Purchase goods in form ready for sale.
3) Manufacturing company has three accounts
 Raw materials
 Work in process
 Finished goods

MCQ
1. Morgan Manufacturing Company has the following account balances at year end:
 Office supplies $ 4,000
 Raw materials 27,000
 Work-in-process 59,000
 Finished goods 82,000
 Prepaid insurance 6,000
What amount should Morgan report as inventories in its balance sheet?
a. $82,000.
b. $86,000. $168,000 = $82,000 + $59,000 + $27,000
c. $168,000.
d. $172,000.

2. Lawson Manufacturing Company has the following account balances at year end:
 Office supplies $ 4,000
 Raw materials 27,000
 Work-in-process 59,000
 Finished goods 97,000
 Prepaid insurance 6,000
What amount should Lawson report as inventories in its balance sheet?
a. $97,000.
b. $101,000.
$183,000 = $97,000 + $59,000 + $27,000
c. $183,000.
d. $187,000.

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Companies use one of two types of systems for maintaining inventory records
perpetual system or periodic system

1) Perpetual inventory system

 Purchases of merchandise are debited to Inventory.

 Freight-in is debited to Inventory.
 Purchase returns and allowances and purchase discounts are credited to
Inventory.
 Cost of goods sold is debited and Inventory is credited for each sale.
 Subsidiary records show quantity and cost of each type of inventory on
hand
 For each sale, cost of goods sold is debited and inventory is credited
 The perpetual inventory system provides a continuous record of Inventory
and Cost of Goods Sold.

Periodic System
1. Purchases of merchandise are debited to Purchases.
2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:
Beginning inventory ………………. 600
(+) Purchases, net ………………………….. 5,400
= Goods available for sale …………… 6,000
(-) Ending inventory . …………………….. (2,400)
= Cost of goods sold …………………….. 3,600

Example (1)
A company had the following transactions during the current year.
1. Beginning inventory 100 units at $6 = 600
2. Purchases 900 units at $6 = 5,400
3. Sales 600 units at $12 = 7,200
4. Ending inventory 400 units at $6 = 2,400

Required
Record these transactions using the perpetual and periodic inventory systems.
Solution
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 Perpetual inventory system Periodic inventory system
1.
beginning No entry No entry
Inventory
2. Inventory …………………. 5,400 Purchases …………… 5,400
Purchase Accounts payable 5,400 Accounts payable 5,400

3. 1.Sale 1. sale
sale Accounts receivable 7,200 Accounts receivable 7,200
Sales revenue 7,200 Sales revenue 7,200
2.Cost
Cost of goods sold 3,600 No entry
Inventory 3,600

4. Ending No entry necessary Ending inventoy 2,400

The inventory account shows the Cost of goods sold 3,600
of period ending balance of 2,400 Purchase 5,400
Beginning inventory 600

Example (2)
Assume that at the end of the reporting period, the perpetual inventory account
reported an inventory balance of $4,000. However, a physical count indicates
inventory of $3,800 is actually on hand.
The entry to record the necessary write-down is as follows.

Journal entry
Inventory over and short 200
Inventory 200

Note:
Inventory Over and Short adjusts Cost of Goods Sold. In practice, companies
sometimes report Inventory Over and Short in the
“Other income and expense” section of the income statement.

Which goods included in inventory

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(1) Goods in transit
 If a supplier ships goods to LG f.o.b. shipping point, title passes to LG
when the supplier delivers the goods to the common carrier,
who acts as an agent for LG (buyer).
 If the supplier ships the goods f.o.b. destination, title passes to LG only
when it receives the goods from the common carrier

(2) Consigned Goods

 Goods held on consignment remain the property of the consignor

Sales with repaurchase agreement

The seller should report the inventory on its books.

Use the following information for questions 35 and 36.
During 2012 Carne Corporation transferred inventory to Nolan Corporation and agreed to
repurchase the merchandise early in 2013. Nolan then used the inventory as collateral to
borrow from Norwalk Bank, remitting the proceeds to Carne. In 2013 when Carne
repurchased the inventory, Nolan used the proceeds to repay its bank loan.

35. This transaction is known as a(n)

a. consignment.
b. installment sale.
c. assignment for the benefit of creditors.
d. product financing arrangement.

36. On whose books should the cost of the inventory appear at the December 31, 2012
balance sheet date?
a. Carne Corporation
b. Nolan Corporation
c. Norwalk Bank
d. Nolan Corporation, with Carne making appropriate note disclosure of the
transaction

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Sales with rights of return
Quality Publishing Company sells textbooks to Campus Bookstores
with an agreement that Campus may return for full credit any books not sold.

MCQ
88. Bell Inc. took a physical inventory at the end of the year and determined that $780,000
of goods were on hand. In addition, Bell, Inc. determined that $60,000 of goods that were in
transit that were shipped f.o.b. shipping point were actually received two days after the
inventory count and that the company had $90,000 of goods out on consignment. What
amount should Bell report as inventory at the end of the year?
a. $780,000.
b. $840,000.
c. $870,000. .$930,000 = $90,000 + $60,000 + $780,000
d. $930,000.

89. Bell Inc. took a physical inventory at the end of the year and determined that $760,000
of goods were on hand. In addition, the following items were not included in the physical
count. Bell, Inc. determined that $96,000 of goods were in transit that were shipped f.o.b.
destination (goods were actually received by the company three days after the inventory
count).The company sold $40,000 worth of inventory f.o.b. destination. What amount
should Bell report as inventory at the end of the year?
a. $760,000.
b. $856,000.
.$800,000 = $40,000 + $760,000
c. $800,000.
d. $896,000.

Effect of Inventory Errors

Items incorrectly included or excluded in determining cost of goods sold through inventory
misstatements will result in errors in the financial statements

Statement of Financial Position Income Statement

 Inventory Understated  Cost of goods sold Overstated

 Retained earnings Understated
 Net income Understated
 Working capital Understated
 Current ratio Understated

If ending inventory is understated, working capital and the current ratio are understated.
If cost of goods sold is overstated, then net income is understated.

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Example:

ABC Corp. understates its ending inventory by $10,000 are correctly stated.
Incorrect recording Correct recording
2015 2016 2015 2016
Revenues 100,000 100,000 100,000 100,000
Cost of goods sold
 Beginnings inventory 25,000 20,000 25,000 30,000
 Purchased or produced 45,000 60,000 45,000 60,000
 Goods available for sale 70,000 80,000 70,000 90,000

 Less: ending inventory (20,000) (40,000) (30,000) (40,000)

(-) Cost of goods sold 50,000 40,000 40,000 50,000

= Gross profit 50,000 60,000 60,000 50,000

(-) Administrative and selling expenses (40,000) (40,000) (40,000) (40,000)

= Net income 10,000 20,000 20,000 10,000

assume that the errors was understated its ending inventory by 10,000 in 2015,
what is the effect of errors on the cost of goods sold and net income

 if the ending inventory is understated , the COGS is overstated and the net income and
retained earnings will be understated.
 Notes that the effect of errors is to decrease net income 2015 and to increase net
income 2016
 Because The beginning inventory in the next year is understated, COGS is understated
and net icome is overstated
 The effect of the error on net income will be counterbalanced in 2016

Cost flow assumption methods

1. specific identification method
 The IASB requires use of the specific identification method in cases
inventory turnover is low, unit price is high, or inventory quantities are
small are the specific identification criteria met
 identifying each item sold and each item in inventory.

 Specific identification matches actual costs against actual revenue.

Thus, a company reports ending inventory at actual cost.
2. FIFO method (First in first out) method
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 ‫الوارد اوال يباع اوال بمعنى البضاعة اللى تدخل المخزن االول تباع فى االول‬

 In a period of rising prices,

the inventory method which tends to give the highest net income with lower
COGS
 The inventory remaining must represent the most recent purchases.
 In all cases where FIFO is used, the inventory and cost of goods sold would be
the same at the end of the month whether a perpetual or periodic system is
used

3.The LIFO method (last in first out) ‫الوارد اخيرا يباع اوال‬

 the last items purchased are the first items sold.

 This method matches the costs of the most recently purchased items with
revenues in the period.
 In times of rising prices, use of the LIFO method results in lower net income
and income taxes and higher cash flow

MULTI CHOOSE QUESTION

MCQ
1. Which of the following inventories carried by a manufacturer is similar to the
merchandise inventory of a retailer?
a. Raw materials. b. Work-in-process.
c. Finished goods. d. Supplies.

2. Where should raw materials be classified on the balance sheet?

a. Prepaid expenses. b. Inventory.
c. Equipment. d. Not on the balance sheet.

3. Which of the following accounts is not reported in inventory?

a. Raw materials. b. Equipment.
c. Finished goods. d. Supplies

4. Which of the following is a characteristic of a perpetual inventory system?

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 a. Inventory purchases are debited to a Purchases account.
b. Inventory records are not kept for every item.
c. Cost of goods sold is recorded with each sale.
d. Cost of goods sold is determined as the amount of purchases less the change in
inventory.

5. Why are inventories included in the computation of net income?

a. To determine cost of goods sold.
b. To determine sales revenue.
c. To determine merchandise returns.
d. Inventories are not included in the computation of net income.

6. When using a perpetual inventory system,

a. no Purchases account is used.
b. a Cost of Goods Sold account is used.
c. two entries are required to record a sale.
d. all of these.

7. Where should goods in transit that were recently purchased f.o.b. destination be
included on the balance sheet?
a. Accounts payable. b. Inventory.
c. Equipment. d. Not on the balance sheet.

8. How is a significant amount of consignment inventory reported in the balance sheet?

a. The inventory is reported separately on the consignor's balance sheet.
b. The inventory is combined with other inventory on the consignor's balance sheet.
c. The inventory is reported separately on the consignee's balance sheet.
d. The inventory is combined with other inventory on the consignee's balance sheet.

9. What is consigned inventory?

a. Goods that are shipped, but title transfers to the receiver.
b. Goods that are sold, but payment is not required until the goods are sold.
c. Goods that are shipped, but title remains with the shipper.
d. Goods that have been segregated for shipment to a customer.

10. Goods in transit which are shipped f.o.b. shipping point should be
a. included in the inventory of the seller.
b. included in the inventory of the buyer.
c. included in the inventory of the shipping company.
d. none of these.

11. Goods in transit which are shipped f.o.b. destination should be

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 a. included in the inventory of the seller.
b. included in the inventory of the buyer.
c. included in the inventory of the shipping company.
d. none of these.

12. Which of the following items should be included in a company's inventory at the
balance sheet date?
a. Goods in transit which were purchased f.o.b. destination.
b. Goods received from another company for sale on consignment.
c. Goods sold to a customer which are being held for the customer to call for at his or
her convenience.
d. None of these.

13. Goods on consignment are

a. included in the consignee's inventory.
b. recorded in a Consignment Out account which is an inventory account.
c. recorded in a Consignment In account which is an inventory account.
d. all of these

14. Valuation of inventories requires the determination of all of the following except
a. the costs to be included in inventory.
b. the physical goods to be included in inventory.
c. the cost of goods held on consignment from other companies.
d. the cost flow assumption to be adopted.

15. Which inventory costing method most closely approximates current cost for each of the
following:

Ending Inventory Cost of Goods Sold

a. FIFO FIFO
b. FIFO LIFO
c. LIFO FIFO
d. LIFO LIFO

16. The pricing of issues from inventory must be deferred until the end of the accounting
period under the following method of inventory valuation:
a. moving average.
b. weighted-average.
c. LIFO perpetual.
d. FIFO.

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17. An inventory pricing procedure in which the oldest costs incurred rarely have an effect
on the ending inventory valuation is
a. FIFO.
b. LIFO.
c. base stock.
d. weighted-average.

18. Which method of inventory pricing best approximates specific identification of the
actual flow of costs and units in most manufacturing situations?
a. Average cost
b. First-in, first-out
c. Last-in, first-out
d. Base stock

19. In a period of rising prices, the inventory method which tends to give the highest
reported net income is
a. base stock.
b. first-in, first-out.
c. last-in, first-out.
d. weighted-average.

20. In a period of rising prices, the inventory method which tends to give the highest
reported inventory is
a. FIFO.
b. moving average.
c. LIFO.
d. weighted-average.

21. In a period of rising prices, the inventory method which tends to give the highest
reported cost of goods sold is
a. FIFO.
b. average cost.
c. LIFO.
d. none of these.

22. The acquisition cost of a certain raw material changes frequently. The book value of the
inventory of this material at year end will be the same if perpetual records are kept as it
would be under a periodic inventory method only if the book value is computed under the
a. weighted-average method. b. moving average method.
c. LIFO method. d. FIFO method.

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23. Which of the following is a reason why the specific identification method may be
considered ideal for assigning costs to inventory and cost of goods sold?
a. The potential for manipulation of net income is reduced.
b. There is no arbitrary allocation of costs.
c. The cost flow matches the physical flow.
d. Able to use on all types of inventory.

24. In a period of rising prices which inventory method generally provides the greatest
amount of net income?
a. Average cost.
b. FIFO.
c. LIFO.
d. Specific identification.

25. In a period of falling prices, which inventory method generally provides the greatest
amount of net income?
a. Average cost.
b. FIFO.
c. LIFO.
d. Specific identification.

True or false
(T) 1. A manufacturing concern would report the cost of units only partially processed as
inventory in the balance sheet.
(F) 2. Both merchandising and manufacturing companies normally have multiple inventory
accounts.
(F) 3. When using a perpetual inventory system, freight charges on goods purchased are
debited to Freight-In.
(F) 4. If a supplier ships goods f.o.b. destination, title passes to the buyer when the
supplier delivers the goods to the common carrier.
(T) 5. If ending inventory is understated, then net income is understated.
(T) 6. If both purchases and ending inventory are overstated by the same amount, net
income is not affected.
(T) 10. In all cases when FIFO is used, the cost of goods sold would be the same whether a
perpetual or periodic system is used.

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