C. INVENTORY 01

Question 1

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Inventory equation:

Answer 1

Inventory equation:

Beginning inventory

ADD: Purchases

EQUALS: Goods available for sale

LESS: Ending inventory

EQUALS: Cost of goods sold

Question 2

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Cost Flow Assumptions (3)

Answer 2

Cost flow assumptions refers to the manner in which costs are removed from inventory:

• FIFO - First In, First Out (use lower of cost or NRV)
• LIFO - Last In, First Out (uses lower of cost or market)
• Average-Cost (use lower of cost or NRV)

Question 3

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Net realizable value (NRV): define

Answer 3

Net realizable value (NRV) = Selling price - Costs of completion

Question 4

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Lower of cost or market: define

Answer 4

Lower of cost or market: This is replacement cost subject to a ceiling and floor. If replacement cost is in between the ceiling and floor, then use replacement cost.

• Ceiling = NRV
• Floor = NRV - profit margin

Question 5

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If ABC uses FIFO to value its inventory:

Answer 5

ABC’s inventory at year-end has the following values:

• Purchased for: $100,000
• Selling price: $130,000
• Current replacement cost: $90,000
• Normal profit margin: $20,000
• Costs of completion: $5,000

If ABC uses FIFO to value its inventory:

FIFO will be the lower of cost or net realizable value.

Cost is $100,000 and NRV is $130,000 - $5,000 or $125,000, so carrying value would be the $100,000 cost.

Note: Using the average cost method also uses the lower of cost or NRV, so the inventory would be valued at the same $100,000 historical cost.

Question 6

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If ABC uses LIFO to value its inventory:

Answer 6

ABC’s inventory at year-end has the following values:

• Purchased for: $100,000
• Selling price: $130,000
• Current replacement cost: $90,000
• Normal profit margin: $20,000
• Costs of completion: $5,000

If ABC uses LIFO to value its inventory:

LIFO will be the lower of cost or market value, which is the current replacement cost, subject to a floor of NRV less profit margin, and a ceiling of NRV.

Cost: $100,000

Replacement cost: $90,000

Ceiling: $130,000 - $5,000 = $125,000

Floor: $125,000 - $20,000 = $105,000

So the lower of cost ($100,000) or market (the $105,000 floor) will be the historical cost of $100,000.

Question 7

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Inventory Basics

FIFO & LIFO

Answer 7

FIFO: First in, first out.
When prices are rising using FIFO:

• Highest Ending Inventory.
• Lowest COGS
• Highest Net Income

Costs are the same under both a perpetual and periodic system.

LIFO: Last in, first out.
When prices are rising using LIFO:

• Lowest Ending Inventory
• Highest COGS
• Lowest Net Income

Under a perpetual system LIFO will have different inventory values than a period system because a cost is assigned after each sale.

Provides tax advantages because it causes lower net income.