10.08.2 Flashcards
Choose the correct inclusions to the cost-to-retail ratio computation under the dollar-value LIFO retail method.
Beginning Inventory
Net Markdowns
Beginning Inventory-NO
Net Markdowns-YES
**DV LIFO retail uses the FIFO (not LCM) cost-to-retail ratio. Under LIFO, a layer added during a period should reflect only the cost and retail amounts pertaining to that period. Thus, beginning inventory amounts are not used in calculating the ratio. Also, because LIFO may contain inventory layers for several preceding periods, excluding net markdowns is not an effective way to accomplish the LCM valuation objective. Thus, net markdowns are included in the cost to retail computation.
A firm uses the dollar value LIFO retail method and has $2,000 in beginning inventory at retail at the beginning of the current year. The base year equivalent of this amount is $1,600. The base year index is 1.00. The beginning inventory reported in the Balance Sheet is $800. During the current year, the firm purchased $12,000 of inventory at cost and marked that up to $40,000. Sales for the year were $28,000. The relevant ending price index is 1.60. What amount does this firm report as inventory in its Balance Sheet at the end of the current year? $4,286 $13,440 $4,232 $4,200
$4,232
**This is a two-step process. First, DV LIFO is applied to retail dollars to determine the layer added in current-year retail dollars. Then, the FIFO cost-to-retail ratio (C/R) is applied to convert that layer to cost. Finally, this layer is added to beginning inventory at cost to yield ending inventory at cost. The calculation is:
EI retail, current index = $2,000 + $40,000-$28,000 = $14,000
EI retail, base = $14,000/1.6 = $8,750
Increase in EI retail, base = $8,750-$1,600 = $7,150
Increase in EI retail, current = $7,150(1.6) = $11,440
C/R (use FIFO, not LCM) = $12,000/$40,000 = .30
Increase in EI, cost = .30($11,440) = $3,432
EI, cost = $800 + $3,432= $4,232
When an inventory overstatement in year one counterbalances in year two, this means:
- There are no reporting errors, even if the overstatement is never discovered.
- A prior period adjustment is recorded if the error is discovered in year three.
- The year one Balance Sheet does not need to be restated if the error is discovered in year three.
- A prior period adjustment is recorded if the error is discovered in year two
A prior period adjustment is recorded if the error is discovered in year two.
**Counterbalancing simply means that the effect of the inventory error in the second year is opposite that of the first year. Discovery in year two provides an opportunity for the firm to correct year two beginning retained earnings, which is overstated by the error in year one. The overstatement of inventory in year one caused cost of goods sold to be understated and income overstated in year one. The prior period adjustment, dated as of the beginning of year two, is a debit to retained earnings for the after-tax effect of the income overstatement in year one. Inventory is credited for the amount of the overstatement. This allows year two to begin with corrected balances.
If ending inventory for 20x5 is understated because certain items were missed in the count, then:
Net income for 20x5 will be overstated.
CGS for 20x5 will be understated.
Net income for 20x5 will be understated, but net income for 20x6 will be unaffected.
Net income for 20x5 will be understated and CGS for 20x6 will be understated.
Net income for 20x5 will be understated and CGS for 20x6 will be understated.
**Use the equation BI + PUR = EI + CGS. When EI is understated, CGS must be overstated to maintain the equation. Net income, therefore, is understated (20x5). Then next year, BI is also understated because BI for 20x6 is EI for 20x5. Using the equation, if BI is understated, CGS is also understated to maintain the equation.
A corporation entered into a purchase commitment to buy inventory. At the end of the accounting period, the current market value of the inventory was less than the fixed purchase price, by a material amount. Which of the following accounting treatments is most appropriate?
- Describe the nature of the contract in a note to the financial statements, recognize a loss in the Income Statement, and recognize a liability for the accrued loss.
- Describe the nature of the contract and the estimated amount of the loss in a note to the financial statements, but do not recognize a loss in the Income Statement.
- Describe the nature of the contract in a note to the financial statements, recognize a loss in the Income Statement, and recognize a reduction in inventory equal to the amount of the loss by use of a valuation account.
- Neither describe the purchase obligation nor recognize a loss on the Income Statement or Balance Sheet.
Describe the nature of the contract in a note to the financial statements, recognize a loss in the Income Statement, and recognize a liability for the accrued loss.
**The firm has committed to a fixed price but must recognize the loss in the period the decline in price occurred, much like under lower-of-cost-or-market. Inventory is not reduced because the firm has not purchased the inventory under contract. There is no asset to reduce, but the decrease in net assets is accomplished by recording the liability for the portion of the purchase price that has no value.
Losses on purchase commitments are recorded at the end of the current year when:
- The current cost of the inventory is less than the inventory cost in the purchase contract.
- The purchase contract is irrevocable.
- The contractual cost of the inventory in an irrevocable purchase contract exceeds the current cost.
- The buyer purchased a quantity of inventory that was not sufficient to avoid a LIFO liquidation.
The contractual cost of the inventory in an irrevocable purchase contract exceeds the current cost.
**Both qualities are required for a loss to be recognized. The firm must honor a contract in a later period by paying more than current cost and, thus, is in a loss position at the end of the current year.
As of December 31, Year 2, a company has an inventory item that was originally purchased for $80 in Year 1. The inventory item was written down to its net realizable value of $60 as of December 31, Year 1. As of December 31, Year 2, the inventory item had a net realizable value of $75 and a replacement cost of $65. Normal profit margins for this company are 20%. Under IFRS, what is the carrying amount of the inventory item as of December 31, Year 2? $60 $65 $75 $80
$75
**Under IFRS, the inventory would be carried at the lower of cost or NRV. The NRV at the end of Year 2 is $75.
On December 31, a company has the following bank accounts and corresponding cash balances: California Bank Operating – Summit Ridge ($400,000) Operating – Bakersville 300,000 Operating – Smithville 50,000 Savings 500,000 Sedona Bank Checking ($375,000) How should the company report the above bank account balances in the balance sheet at December 31?
- Cash of $75,000.
- Cash of $450,000 and a liability of $375,000.
- Cash of $850,000 and a liability of $775,000.
- Cash of $800,000 and a liability of $725,000.
Cash of $450,000 and a liability of $375,000.
**The entity can net the overdraft of $400,000 in the California Bank with the positive balances held at the same bank. The net value in the California Bank is $850,000 less $400,000 or $450,000. The $375,000 overdraft in the Sedona Bank is reported as a liability.
On October 31, Dingo, Inc. had cash accounts at three different banks. One account balance is segregated solely for a November 15 payment into a bond sinking fund. A second account, used for branch operations, is overdrawn. The third account, used for regular corporate operations, has a positive balance.
How should these accounts be reported in Dingo’s October 31 classified balance sheet?
- The segregated account should be reported as a noncurrent asset, the regular account should be reported as a current asset, and the overdraft should be reported as a current liability.
- The segregated and regular accounts should be reported as current assets, and the overdraft should be reported as a current liability.
- The segregated account should be reported as a noncurrent asset, and the regular account should be reported as a current asset net of the overdraft.
- The segregated and regular accounts should be reported as current assets net of the overdraft.
The segregated account should be reported as a noncurrent asset, the regular account should be reported as a current asset, and the overdraft should be reported as a current liability.
**The accounts are with different banks. Thus, the accounts cannot be offset against one another.
The overdraft is a liability because the bank honored a check or withdrawal causing the account to be negative. The firm owes the bank this amount.
The regular corporate account is part of the cash account, a current asset. The segregated account is a long-term investment. The cash in this asset is set aside for a specific purpose. There is no intent to use the cash for ordinary operating purposes.
Cook Co. had the following balances on December 31, 20X4:
Cash in checking account $350,000
Cash in money market account 250,000
U.S. Treasury bill, purchased 12/1/X4, maturing 2/28/X5 800,000
U.S. Treasury bond, purchased 3/1/X4, maturing 2/28/X5 500,000
Cook’s policy is to treat as cash equivalents all highly liquid investments with a maturity of three months or less when purchased. What amount should Cook report as cash and cash equivalents in its December 31, 20X4, balance sheet?
$600,000
$1,150,000
$1,400,000
$1,900,000
$1,400,000
** The first three items in the list are included in cash and cash equivalents. If no restrictions apply, cash in checking accounts ($350,000) is always included in cash. Per ASC Topic 305, cash equivalents are short-term, highly liquid investments that are readily convertible into cash and have maturities of three months or less from the date of purchase by the entity. Common examples are Treasury bills, commercial paper, and money market funds. In this case, the cash equivalents are the money market account ($250,000) and the Treasury bill ($800,000). Therefore, total cash and cash equivalents is $1,400,000 ($350,000 + $250,000 + $800,000). The maturity of the Treasury bond was at least 12 months (3/1/X4 to 2/28/X5) from the date of purchase; therefore, it should not be reported in cash and cash equivalents. The reason for the three-month rule is to minimize price fluctuations due to interest rate changes. A security with a fluctuating price is not “equivalent” to cash. One year is too long a time to expect interest rates to remain stable.
