Question

What are the inventory methods and the tax effects of each one of them? (pg 255 – 261)

·        How do we account for Notes Payable and record the related transactions?

·        What is Bonds Payable? What accounts are used to record bonds payable transactions?

Answer 1

1.  There are four accepted methods of costing inventory items:

• specific identification;
• first-in, first-out (FIFO);
• last-in, first-out (LIFO); and.
• weighted-average.

Specific Identification

The specific identification method of inventory costing attaches the actual cost to an identifiable unit of product. Firms find this method easy to apply when purchasing and selling large inventory items such as cars. Under the specific identification method, the firm must identify each unit in inventory, unless it is unique, with a serial number or identification tag.

FIFO (first-in, first-out)

The FIFO (first-in, first-out) method of inventory costing assumes that the costs of the first goods purchased are those charged to cost of goods sold when the company actually sells goods. This method assumes the first goods purchased are the first goods sold. In some companies, the first units in (bought) must be the first units out (sold) to avoid large losses from spoilage. Such items as fresh dairy products, fruits, and vegetables should be sold on a FIFO basis. In these cases, an assumed first-in, first-out flow corresponds with the actual physical flow of goods.

LIFO (last-in, first-out)

The LIFO (last-in, first-out) method of inventory costing assumes that the costs of the most recent purchases are the first costs charged to cost of goods sold when the company actually sells the goods.

Weighted-average

The weighted-average method of inventory costing is a means of costing ending inventory using a weighted-average unit cost. Companies most often use the weighted-average method to determine a cost for units that are basically the same, such as identical games in a toy store or identical electrical tools in a hardware store. Since the units are alike, firms can assign the same unit cost to them.

ax benefit of LIFO The LIFO method results in the lowest taxable income, and thus the lowest income taxes, when prices are rising. The Internal Revenue Service allows companies to use LIFO for tax purposes only if they use LIFO for financial reporting purposes. Companies may also report an alternative inventory amount in the notes to their financial statements for comparison purposes. Because of high inflation during the 1970s, many companies switched from FIFO to LIFO for tax advantages.

The disadvantages of FIFO include (1) the recognition of paper profits and (2) a heavier tax burden if used for tax purposes in periods of inflation. We discuss these disadvantages later as advantages of LIFO.

2.

with Notes Receivable we learned we need to know 3 things about a note:

1. Principal (the amount of money we borrowed)
2. Interest Rate (typically an annual interest rate)
3. Maturity term (or frequency of the year — how many days or months for the note)

In Notes Receivable, we were the ones providing funds that we would receive at maturity. Now, we are going to borrow money that we must pay back later so we will have Notes Payable. Interest is still calculated as Principal x Interest x Frequency of the year (use 360 days as the base if note term is days or 12 months as the base if note term is in months).

Interest-bearing notes To receive short-term financing, a company may issue an interest-bearing note to a bank. An interest-bearing note specifies the interest rate charged on the principal borrowed. The company receives from the bank the principal borrowed; when the note matures, the company pays the bank the principal plus the interest.

3.

When bonds are issued for cash, the accounting entry will include a debit to Cashfor the amount of cash received, and a credit to Bonds Payable for the face ormaturity amount.

If the amount received for the bonds (excluding any accrued interest received and any bond issue costs) is more than the face amount of the bonds, there will be a credit to Premium on Bonds Payable. If the amount received for the bonds is less than the bonds' face amount, there will be a debit to Discount on Bonds Payable. The Premium or Discount accounts are reported next to the account Bonds Payable. The amount of the Premium or Discount is then amortized to Bond Interest Expense over the life of the bonds.

Bonds payable that mature (or come due) within one year of the balance sheetdate will be reported as a current liability if the issuer of the bonds must use a current asset or will create a current liability in order to pay the bondholders when the bonds mature.