Learning Questions and Answers for Financial Accounting, Lesson 8.3 – Expert Level

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Here are a series of inventory questions from Chapter Eight just to provide you with one final review. Go through the questions and see how many you can answer. Mark any question or topic that you do not know.

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As always, the answers are at the end. Go through each answer carefully. Pay close attention to any questions that you do not know. Then, go back through the questions (without answers) and see if you can get them all. You want to keep doing this until you can move through all of the questions smoothly.

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1 – What costs are capitalized for inventory?

2 – In a perpetual inventory system, what information is the company recording?

3 – In a periodic inventory system, what information is the company recording?

4 – In a periodic inventory system, how is cost of goods sold determined?

5 – In the cost of goods sold formula, what is actually being computed?

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6 – Many companies use a combination of a periodic and a perpetual inventory system (a hybrid system). What does that mean?

7 – A company buys a piece of inventory for $18 cash and also pays $1 for transportation. This unit is then sold for $40 in cash. How is this recorded in a periodic inventory system?

8 – A company buys a piece of inventory for $18 cash and also pays $1 for transportation. This unit is then sold for $40 in cash. How is this recorded in a perpetual inventory system?

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9 – In buying and selling inventory, what is the FOB point?

10 – Normally, neither buyer nor seller cares about the FOB point. Under what circumstance does this designation become important?

11 – A company buys inventory for $100. Later it is damaged or gets old or goes out of fashion and can only be sold for $90. In addition, the company will have to spend $8 to fix the item and advertise it for sale. On the company’s balance sheet, how is this inventory item reported?

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The answers for these questions are provided in the following cards. Go through and read each one very carefully. Make special note of any cards for which your knowledge was not completely perfect.

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1 – What costs are capitalized for inventory?

Any costs which are normal and necessary to get the company’s inventory item into position and condition to be sold should be capitalized. All other costs should be expensed.

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2 – In a perpetual inventory system, what information is the company recording?

In a perpetual system, the company keeps up with the current inventory and the current cost of goods sold (both the units and the costs). In a perpetual system, a company official can probably push a computer button and find the number of units on hand and the number of units sold during the period as well as the actual cost of those units. The information is easily available for decision making purposes.

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3 – In a periodic inventory system, what information is the company recording?

In a periodic system, the company keeps up with the various inventory costs such as the price, assembly costs, transportation costs, and the like. For example, a company official can look at the records in a periodic system and know how much was spent to date on certain costs such as transportation. However, in a periodic system, company officials cannot know how much inventory is on hand or has been sold without taking a physical count.

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4 – In a periodic inventory system, how is cost of goods sold determined?

First, the ending inventory is determined by a physical count at (or near) the end of the year. Second, cost of goods sold is determined by a formula: Beginning inventory plus purchases (includes all normal and necessary costs to get the items in position and condition to be sold). Ending inventory is then subtracted to get the cost of goods sold for the current period which is reported on the income statement.

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5 – In the cost of goods sold formula, what is actually being computed?

The company is determining the cost of goods that are no longer being held. Company officials then make the assumption that anything missing must have been sold.

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6 – Many companies use a combination of a periodic and a perpetual inventory system (a hybrid system). What does that mean?

Some companies use a perpetual inventory system to keep up with the number of units but use a periodic system to keep up with inventory costs. The system is cheaper and easier to maintain and it provides the information that most companies want to know.

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7 – A company buys a piece of inventory for $18 cash and also pays $1 for transportation. This unit is then sold for $40 in cash. How is this recorded in a periodic inventory system?

“Purchases of inventory” is debited for $18 and transportation is debited for $1 while cash is credited for $19. Cash is debited for $40 and sales revenue is credited for $40. It is a periodic system so no cost of goods sold entry is made at this time. Cost of goods sold is not determined until financial statements are to be prepared.

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8 – A company buys a piece of inventory for $18 cash and also pays $1 for transportation. This unit is then sold for $40 in cash. How is this recorded in a perpetual inventory system?

Inventory is debited for $19 and cash is credited for $19. Cash is then debited for $40 and sales revenue is credited for $40. In addition, cost of goods sold is debited for $19 and inventory is credited for $19. It is a perpetual system so both inventory and cost of goods sold are recorded for all changes. All balances should be up to date.

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9 – In buying and selling inventory, what is the FOB point?

The FOB point is the point at which title to the goods being sold or bought legally changes hands. For example, if a purchase was made FOB shipping point, the buyer gains title as soon as the goods are shipped by the seller.

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10 – Normally, neither buyer nor seller cares about the FOB point. Under what circumstance does this designation become important?

The FOB point is important in three situations. First, at the end of the year, you need the FOB point to know in which year the purchase (by the buyer) and the sale (by the seller) are to be recorded. Second, if goods are lost or damaged, the FOB point indicates who must pay for the loss. Third, the FOB point indicates which party has to pay for transportation costs if that has not been separately settled. Whichever party holds title to good during transit is responsible for losses and transportation unless a different agreement is specified.

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11 – A company buys inventory for $100. Later it is damaged or gets old or goes out of fashion and can only be sold for $90. In addition, the company will have to spend $8 to fix the item and advertise it for sale. On the company’s balance sheet, how is this inventory item reported?

For conservative purposes, inventory is reported at the lower of cost or net realizable value. Net realizable value is what the owner can sell the item for after deducting any costs necessary to create that sale. Here, the cost is $100 and the net realizable value is $90 less $8 or $82. Because $82 is lower than $100, the $82 figure is the amount reported on the balance sheet. The value of the inventory item has been impaired.

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If you still have any uncertainty about any of these questions and answers, take a few minutes to go back through one more time.

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