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FINANCIAL ACCOUNTINGTHEORY & PRACTICEINVENTORIES – COST ESTIMATION & BIOLOGICAL ASSETSQUIZZERFINANCIAL ACCOUNTINGEssay Questions: Inventory – Cost Estimation Page 4INVENTORY VALUATIONEssay QuestionsInventory Estimation Methods What are the reasons for making an estimate of inventory?...

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FINANCIAL ACCOUNTING THEORY & PRACTICE INVENTORIES – COST ESTIMATION & BIOLOGICAL ASSETS QUIZZER

FINANCIAL ACCOUNTING INVENTORY VALUATION Essay Questions Inventory Estimation Methods 1. What are the reasons for making an estimate of inventory? 1. Determination of inventory loss due to fire and other catastrophe or theft of merchandise. 2. Proof of the reasonable accuracy of a physical count. This is popularly known as the "gross profit test." 3. Preparation of interim statements or statements of less than one year. Interim statements are usually for a quarter. However, year-end statements require physical count, not a mere estimate of inventory value. Gross profit method 2. Explain the gross profit method of estimating the cost of ending inventory. Under the gross profit method, the ending inventory is computed as "goods available for sale minus cost of sales". The cost of sales is determined through the use of the gross profit rate and this is the reason the gross profit method is called as such. This method is based on the major assumption that the rate of gross profit remains approximately the same from period to period and therefore the ratio of cost of goods sold to net sales is relatively constant from period to period. Retail inventory method 3. Explain the retail method of estimating the cost of ending inventory. The retail inventory method came to its name because the selling price or retail price is tagged to each item and therefore the ending inventory is stated at selling price. The ending inventory is computed as follows: Goods available for sale at selling price minus net sales equals ending inventory at selling Essay Questions: Inventory – Cost Estimation

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Inventory – Cost Estimation price which is multiplied by the cost ratio to get the inventory at cost. The cost ratio under the retail method is computed by dividing the goods available for sale at cost by the goods available for sale at selling price. 4.

What are the four applications of the retail inventory method? 1. Conservative approach - The cost ratio is determined by including markups and excluding markdowns in computing the goods available for sale at retail. This approach is also known as the conventional or lower of average cost or market approach. 2. Average cost approach - The markups and markdowns are both included in the computation of the cost ratio. 3. FIFO approach - A cost ratio is computed for the current year. Thus, only the current purchases are considered together with markups and markdowns. The beginning inventory is excluded in the computation. 4. LIFO approach - The cost ratio is computed following the same procedure under FIFO approach. Thus, the FIFO and LIFO would have the same cost ratio for the current year.

5.

Which approach is followed in measuring inventory under the retail inventory method? PAS 2, paragraph 22, provides that the percentage used under the retail method shall take into consideration inventory that has been marked down to below its original selling price. An average percentage for each retail department is often used. This means that the average cost approach shall be applied in conjunction with the retail inventory method. Of course, PAS 2 requires either the FIFO or average method as a cost formula.

6.

Define the following: 1. 2. 3. 4.

Original retail Initial markup Additional markup Markup cancelation

Essay Questions: Inventory – Cost Estimation

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FINANCIAL ACCOUNTING 5. 6. 7. 8.

Net markup Markdown Markdown cancelation Net markdown

1. Original retail - is the sales price at which the goods are first offered for sale. 2. Initial markup - the original markup on the cost of goods or the amount added to the original cost to get the original retail price. 3. Additional markup - is an increase in the sales price above the original sales price or the amount added to the original retail price. 4. Markup cancelation - is a decrease in the sales price that does not reduce the sales price below the original sales price. 5. Net markup - additional markup minus markup cancelation. 6. Markdown - is a decrease in the sales price below the original price. 7. Markdown cancelation - is an increase in sales price that does not raise the sales price above the original sales price. 8. Net markdown - markdown minus markdown cancelation. BIOLOGICAL ASSETS Essay Questions 1.

What is the scope of PAS 41 on "agriculture"? PAS 41 shall be applied to account for the following when they relate to agricultural activity: a. Biological assets b. Agricultural produce c. Government grant related to a biological asset Note that PAS 41 is applied to agricultural produce at the point of harvest. Thereafter, PAS 2 on inventories shall be applied. PAS 41 does not deal with the processing of agricultural produce after harvest. For example, the processing of grapes into wine is covered by PAS 2.

2.

Define biological assets, agricultural produce and harvest. Biological assets are "living animals and living plants". Agricultural produce is the harvested product of the entity's biological assets.

Essay Questions: Biological Assets

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Biological Assets Harvest is the detachment of produce from a biological asset or the cessation of a biological asset's life processes. 3.

Give examples of biological assets, agricultural produce and products that are the result of processing after harvest. The following table provides examples of biological assets, agricultural produce and products that are the result of processing after harvest. Biological asset 1. 2. 3. 4. 5. 6. 7. 8.

Sheep Trees in plantation forest Plant Dairy cattle Pigs Bushes Vines Fruit trees

Agricultural produce Wool Felled trees Harvested cane Milk Carcass Leaf Grapes Picked fruit

Product after harvest Yarn, carpet Logs, lumber Sugar Cheese Sausage, cured ham Tea, cured tobacco Wine Processed fruit

Again, the measurement of biological assets and agricultural produce is covered by PAS 41 and the measurement of products after harvest is covered by PAS 2 on inventories. 4.

Define agricultural activity and biological transformation. Agricultural activity or simply "agriculture" is the management by an entity of the biological transformation and harvest of biological assets for sale or for conversion into agricultural produce or into additional biological assets. Biological transformation comprises the processes of growth, degeneration, production and procreation that cause qualitative or quantitative changes in a biological asset.

5.

Give examples of agricultural activity. Agricultural activity covers a diverse range of activities such as the following: 1. Raising livestock 2. Annual or perennial cropping 3. Cultivating orchards and plantations 4. Floriculture

Essay Questions: Biological Assets

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FINANCIAL ACCOUNTING 5. Aquaculture, including fish farming 6.

What are the common features of agricultural activity? The common features of agricultural activity are as follows: a. Capability to change b. Management of change c. Measurement of change Capability to change Living animals and plants are capable of biological transformation. Management of change The agricultural activity must be "managed" to facilitate biological transformation by enhancing or at least stabilizing conditions necessary for the process to take place. Such management distinguishes agricultural activity from other activities. For example, harvesting from "unmanaged" sources, such as ocean fishing and deforestation, is not agricultural activity. Measurement of change The change in quality or quantity brought about by biological transformation or harvest is measured and monitored as a routine management function.

7.

Give examples of biological transformation. Biological transformation results from the following types of outcome: 1. Asset changes through: a. Growth - an increase in quantity or improvement in quality of an animal or plant. b. Degeneration - a decrease in quantity or deterioration in quality of an animal or plant. c. Procreation - creation of additional living animal or plant. 2. Production of agricultural produce such as latex, tea leaf, wool and milk.

8.

What are the conditions for the recognition of a biological asset or agricultural produce? An entity shall recognize a biological asset or an agricultural produce when: 1. The entity controls the asset as a result of past event. 2. It is probable that future economic benefits associated with the asset will flow to the entity.

Essay Questions: Biological Assets

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Biological Assets 3. The fair value or cost of the asset can be measured reliably. 9.

Explain the measurement of biological asset and agricultural produce. A biological asset shall be measured on initial recognition and at the end of each reporting period at fair value less cost of disposal. Agricultural produce shall be measured at fair value less cost of disposal at the point of harvest.

10. What is the meaning of "cost of disposal"? "Cost of disposal" is the incremental cost directly attributable to the disposal of an asset. In other words, cost of disposal is a necessary cost for a sale to occur that would not otherwise arise. Examples include commission to brokers and dealers, levy by regulatory agency and commodity exchanges, and transfer tax and duty. Under the Basis for Conclusions on PAS 41, cost of disposal specifically excludes transport cost, finance cost and income tax. 11. Explain the fair value measurement of biological asset. There is a presumption that fair value can be measured reliably for a biological asset. However, this presumption can be rebutted only on initial recognition for a biological asset for which market-determined prices are not available or estimates of fair value are determined to be clearly unreliable. In such a case, the biological asset shall be measured at cost less accumulated depreciation and any accumulated impairment loss. However, once the fair value of such biological asset becomes clearly measurable, the entity shall measure the biological asset at fair value less cost of disposal. 12. Explain the fair value measurement of agricultural produce. In all cases, an entity shall measure agricultural produce at the point of harvest at fair value less cost of disposal. Essay Questions: Biological Assets

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FINANCIAL ACCOUNTING The prevailing view is that the fair value of agricultural produce at the point of harvest can always be measured reliably. The fair value measurement of agricultural produce stops at the time of harvest. After that date, PAS 2 on inventory shall apply. In other words, the harvested product becomes an inventory and shall be measured subsequently at the lower of cost and net realizable value. The harvested product is recorded by debiting inventory and crediting gain from change in fair value. 13. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. PFRS 13, paragraph 72, enumerates the fair value hierarchy or best evidence of fair value as follows: 1. Level 1 inputs are the quoted prices in an active market for identical assets. An active market is a market in which transactions for the asset or liability take place with sufficient regularity and volume to provide pricing information on an ongoing basis. A principal market is the market with the greatest volume and level of activity for the asset or liability. 2. Level 2 inputs are observable inputs either directly or indirectly. Level 2 inputs include quoted prices for similar assets in an active market and quoted prices for identical or similar assets in an inactive market. 3. Level 3 inputs are unobservable inputs for the asset usually developed by the entity using the best available information from the entity's own data. An example is the financial forecast of expected cash inflows from the asset. 14. Explain the treatment of gain or loss from the fair value measurement of biological asset and agricultural produce. A gain or loss arising on initial recognition of a biological asset at fair value less cost of disposal and any subsequent changes in fair value cost of disposal shall be included in profit or loss. A loss may arise on initial recognition of a biological asset because cost of disposal is deducted in determining fair value loss cost of disposal of a biological asset. A gain may arise on initial recognition of a biological asset, for example, when a calf is born. A gain or loss arising from initial recognition of agricultural produce at fair value less cost of disposal shall also be included in profit or loss. Essay Questions: Biological Assets

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Biological Assets A gain or loss may arise on initial recognition of agricultural produce as a result of harvesting. An entity shall disclose the aggregate gain or loss arising on the initial recognition of biological asset and agricultural produce and from the change in fair value less cost of disposal of biological asset. 15. Is agricultural land a biological asset? Agricultural land is not a biological asset. The principles espoused in PAS 41 for biological assets and agricultural produce do not apply to agricultural land. The requirements of PAS 16 which are applicable to property, plant and equipment apply equally to agricultural land for purposes of measurement. 16. Explain the fair value measurement of biological assets physically attached to land. Biological assets are often physically attached to land, for example, trees in a plantation forest. There may be no separate market for biological assets that are attached to the land but an active market may exist for the combined assets, that is, for the biological assets and land as a package. An entity may use information regarding the combined assets to determine the fair value of the biological assets. For example, the fair value of the land may be deducted from the fair value of the combined assets to arrive at the fair value of the trees in the plantation forest. 17. Explain the treatment of a government grant related to: 1. Biological asset measured at fair value less cost of disposal. 2. Biological asset measured at cost less any accumulated depreciation and any accumulated impairment losses. 1. An unconditional government grant related to a biological asset that has been measured at fair value less cost of disposal shall be recognized in profit or loss when the grant Essay Questions: Biological Assets

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FINANCIAL ACCOUNTING becomes receivable. If a government grant related to a biological asset measured at fan value less cost of disposal is conditional, the grant shall be recognized in profit or loss only when the conditions attaching to the grant are met. 2. If a government grant relates to a biological asset measured at cost less any accumulated depreciation and any accumulated impairment losses, PAS 20 on "government grant" is applied.

Essay Questions: Biological Assets

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Inventory – Cost Estimation MCQ – Theory: Inventories – Cost Estimation Gross profit method 1. The gross profit method assumes that A. The amount of gross profit is the same as in prior years. B. Inventory values have not increased from previous years. C. Sales and cost of goods sold have not changed from previous years. FA © 2014 D. The relationship between selling price and cost of goods sold is similar to prior years. 2.

Which of the following is not a basic assumption of the gross profit method? A. Goods not sold must be hand. B. The beginning inventory plus purchases equal total goods to be accounted for. C. The amount of purchases and the amount of sales remain relatively unchanged from the comparable previous period. D. The sales reduced to cost basis when deducted from the sum of beginning inventory and purchases would result to inventory on hand. FA © 2014

3.

How is the gross profit method used in relation to inventory valuation? A. To provide a FIFO inventory value B. To estimate the cost of goods sold C. To verify the accuracy of the physical inventory D. To verify the accuracy of the perpetual inventory record

FA © 2014

4.

The gross margin method of estimating ending inventory may be used for all of the following, except A. Internal as well as external interim reports B. Internal as well as external year-end reports C. Estimate of inventory destroyed by fire or other casualty D. Rough test of the validity of an inventory cost determined under either periodic or perpetual system. FA © 2014

5.

Which would not require an estimate of inventory? A. Inventory destroyed by typhoon B. Interim financial statements are prepared C. Proof of the reasonable accuracy of the physical count D. Determination of the ending inventory to be reported in the statement of financial position at year-end FA © 2014

MCQ – Theories: Inventory – Cost Estimation

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FINANCIAL ACCOUNTING 6.

The gross profit method of estimating inventory would not be useful when A. There is a significant change in the mix of products being sold. B. The relationship between gross profit and sales remains stable over time. C. A periodic system is in use and inventories are required for interim statements. D. Inventories have been destroyed or lost by fire, theft or other casualty, and the specific data required for inventory valuation are not available. FA © 2014

7.

The gross profit method of inventory valuation is not valid when A. All ending inventory is destroyed by fire before it can be counted. B. The gross margin percentage changes significantly during the year. C. There is substantial increase in the cost of inventory during the year. D. There is substantial increase in the quantity of inventory during the year.

FA © 2014

8.

The gross profit method of inventory valuation is invalid when A. A portion of inventory is destroyed. B. There is a substantial increase in inventory during the year. C. There is no beginning inventory because it is the first year of operation. D. The gross profit percentage applicable to the goods in ending inventory is different from the percentage applicable to goods sold during the period. FA © 2014

9.

If the gross profit rate is based on sales, the cost of goods sold is computed as A. Gross sales divided by sales ratio C. Net sales divided by sales ratio B. Gross sales times cost ratio D. Net sales times cost ratio TOA © 2013

10. If the gross profit rate is based on cost, the cost of goods sold is computed as A. Gross sales divided by sales ratio C. Net sales divided by sales ratio B. Gross sales times cost ratio D. Net sales times cost ratio FA © 2014 11. Which statement is not valid about the gross profit method? A. It may be used by auditors. B. It is an acceptable accounting procedure. C. It may be used to estimate inventory for annual statements. D. It may be used to estimate inventory for interim statements.

FA © 2014

Retail inventory method 12. The retail method is based on the assumption that A. Ratio of cost to retail changes at a constant rate. B. Ratio of gross margin to sales is approximately the same each period. C. Proportions of markup and markdown to selling price are the same. MCQ – Theories: Inventory – Cost Estimation

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Inventory – Cost Estimation D. Final inventory and the total of goods available for sale contain the same proportion of high cost and low cost ratio goods. FA © 2014 13

A major advantage of the retail inventory method is that it A. Hides costs from cu...