Defining “depreciation expense”
A depreciation expense is a non-cash item and is added back to the operating activities of the cash flow statement using the in-direct presentation method. Briefly discuss why this activity takes place and its impact on operating activities.
What equation describes the periodic inventory system? Briefly discuss and compare the four major alternative cost-flow assumptions for inventory.
Sample Solution
Defining “depreciation expense”
The periodic inventory system does not update the general ledger account inventory when a company purchases goods to be resold. Rather than debiting inventory, the company debits the temporary account Purchases. Under the periodic inventory system the cost of goods sold is computed as follows: beginning inventory (previous year`s ending inventory cost) + net purchases = cost of goods available – costs computed for the ending inventory = cost of goods sold. The inventory cost flow assumption states that the cost of an inventory item changes from when it is acquired or built and when it is sold. Because of this cost differential, management needs a formal system for assigning costs to inventory as they transition to sellable goods. There are several possible ways to interpret the cost flow assumption: FIFO cost flow assumption; LIFO cost flow assumption; specific identification method; and weighted average cost flow assumption.
