Chapter 6

Question 1

How does the specific identification method work and when should it be used?

Answer 1

each item is marked or tagged with each unit so that COGS and cost of inventory can be determined
used when small number of costly items that can be distinguished by physical characteristics

Question 2

How does the first in, first out (FIFO) method work?

Answer 2

Assumed that oldest goods are the first to be purchased. Does not mean that first units are actually sold first. Just means they are recognized first under COGS.

Question 3

How does the average cost method work?

Answer 3

COGS is based on weighted average unit cost of merchandise available for sale.
Weighted average taken by dividing cost of goods available for sale by the units available for sale at date of purchase.

Question 4

How is the method of keeping track of cost chosen?

Answer 4

If goods are not easily interchangeable they have to use specific identification method otherwise they have a choice between FIFO and average cost method.

Question 5

What are the financial statement effects of the specific identification method?

Answer 5

Exactly tracks costs and revenues on the income statement

Tracks the actual physical flow

Question 6

What are the financial statement effects of the FIFO method?

Answer 6

Ending inventory on balance sheet includes most current costs
approximates the physical flow of most retailers

Question 7

What are the financial statement effects of the average cost method?

Answer 7

COGS on income statement includes more current costs than FIFO
smooths the effects of price changes by assigning units all the same average costs

Question 8

What happens if merchandise inventory is overstated?

Answer 8

COGS is understated so gross profit is overstated then profit before income tax is overstated then retained earnings is overstated.

Question 9

What happens if merchandise inventory is understated?

Answer 9

COGS overstated so gross profit is understated and profit before income tax is understated and then retained earnings is understated.

Question 10

What are the characteristics of LCNVR

Answer 10

Assets should NOT be carried in excess of amounts expected to be realized from their sale or use
When the net realizable value of inventory is lower than its cost, inventory is written down to is net realizable value
The LCNRV rule is applied to the inventory at the end of an accounting period and results in an adjusting journal entry if the NRV is lower than the cost