Chapter 7 Flashcards
Inventories
On January 1, Year 4, Card Corp. signed a 3-year, noncancelable purchase contract that allows Card to purchase up to 500,000 units of a computer part annually from Hart Supply Co. The price is $.10 per unit, and the contract guarantees a minimum annual purchase of 100,000 units. During Year 4, the part unexpectedly became obsolete. Card had 250,000 units of this inventory at December 31, Year 4, and believes these parts can be sold as scrap for $.02 per unit. What amount of probable loss from the purchase commitment should Card report in its Year 4 income statement? A. $20,000 B. $24,000 C. $8,000 D. $16,000
Answer (D) is correct.
The entity must accrue a loss in the current year on goods subject to a firm purchase commitment if their market price declines below the commitment price. This loss should be measured in the same manner as inventory losses. Disclosure of the loss also is required. Consequently, given that 200,000 units must be purchased over the next 2 years for $20,000 (200,000 × $.10), and the parts can be sold as scrap for $4,000 (200,000 × $.02), the amount of probable loss for Year 4 is $16,000 ($20,000 – $4,000).
The following information was derived from the current year accounting records of Clem Co.: Clem’s Clem’s Goods Central Held By Warehouse Consignees Beginning inventory $110,000 $12,000 Purchases 480,000 60,000 Freight-in 10,000 Transportation to consignees 5,000 Freight-out 30,000 8,000 Ending inventory 145,000 20,000 Clem’s cost of sales was A. $512,000 B. $485,000 C. $507,000 D. $455,000
Answer (A) is correct. Cost of sales is equal to beginning inventory, plus purchases, plus additional costs (such as freight-in and transportation to consignees) necessary to prepare the inventory for sale, minus ending inventory. Cost of sales for inventory in the central warehouse and for inventory held by consignees are calculated below: Central Warehouse Consigned Inventory Inventory Beginning inventory $110,000 $12,000 Purchases 480,000 60,000 Freight-in 10,000 Transportation to consignees 5,000 Cost of sales (455,000) (57,000) Ending inventory $145,000 $20,000 Hence, total cost of sales equals $512,000 ($455,000 + $57,000). Freight-out is a selling cost. It is not included in the determination of cost of sales.
A flash flood swept through Hat, Inc.’s warehouse on May 1. After the flood, Hat’s accounting records showed the following: Inventory, January 1 $ 35,000 Purchases, January 1 through May 1 200,000 Sales, January 1 through May 1 250,000 Inventory not damaged by flood 30,000 Gross profit percentage on sales 40% What amount of inventory was lost in the flood? A. $55,000 B. $85,000 C. $120,000 D. $150,000
Answer (A) is correct.
Gross profit is 40% of sales. Thus, cost of goods sold is $150,000 [$250,000 sales × (1.0 – .40)]. Because cost of goods sold equals beginning inventory, plus purchases, minus ending inventory, the inventory at the time of the flood must have been about $85,000 ($35,000 BI + $200,000 P – $150,000 COGS). Accordingly, the estimated amount lost was $55,000 ($85,000 – $30,000 not damaged).
act Pattern: On November 1, Year 1, Iba Co. entered into a contract with a customer to sell 150 machines for $75 each. The customer obtains control of the machines at contract inception. Iba’s cost of each machine is $45. Iba allows the customer to return any unused machine within 1 year from the sale date and receive a full refund. Iba uses the expected value method to estimate the variable consideration. Based on Iba’s experience and other relevant factors, it reasonably estimates that a total of 20 machines (12 machines in Year 1 and 8 machines in Year 2) will be returned. Iba estimates that (1) the machines are expected to be returned in salable condition and (2) the costs of recovering the machines will be immaterial. During Year 1, 10 machines were returned. At the end of Year 1, Iba continues to estimate that a total of 20 machines will be returned within 1 year from the sale date.
Question: 4 What amount of revenue from this contract will be recognized by Iba in Year 1? A. $9,750 B. $11,250 C. $3,900 D. $10,500
Answer (A) is correct.
Given a right of return, the consideration received from the customer is variable. Revenue from variable consideration is recognized only to the extent that it is probable that a significant reversal will not occur. Iba estimates that 20 machines will be returned. Thus, in Year 1 Iba recognizes revenue only for the sale of 130 machines (150 – 20), and the revenue recognized is $9,750 (130 × $75).
eck Co.’s inventory is as follows:
Beginning inventory
10 trees at
$ 50
March 4
purchased
6 trees at
55
March 12
sold
8 trees at
100
March 20
purchased
9 trees at
60
March 27
sold
7 trees at
105
March 30
purchased
4 trees at
65
What was Beck’s cost of goods sold using the last-in, first-out (LIFO) perpetual method?
A. $910
B. $808
C. $775
D. $850Answer (D) is correct.
LIFO assumes that the newest items of inventory are sold first. Thus, the items remaining in inventory are recognized as if they were the oldest. In a perpetual system, purchases are directly recorded in inventory. Cost of goods sold is calculated when a sale occurs and consists of the latest purchases. The cost of goods sold on the sale on (1) March 12 is $430 [(6 × $55) + (2 × $50)] and (2) March 27 is $420 (7 × $60). The total cost of goods sold is $850 ($430 + $420).
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? A. $60 B. $75 C. $65 D. $80
Answer (B) is correct.
Under IFRS, inventories are measured at the lower of cost or net realizable value (NRV). NRV is assessed each period. Accordingly, a write-down may be reversed but not above original cost. Thus, the inventory is reported on 12/31/Year 2 at its NRV of $75. The $15 ($75 NRV on 12/31/Year 2 – $60 reported on 12/31/Year 1) of the write-down recognized in Year 1 of $20 ($80 historical cost – $60 NRV on 12/31/Year 1) is reversed in Year 2 and recognized in Year 2 profit or loss.
During the current year, the Guileman Manufacturing Company signed a noncancelable contract to purchase 1,000 lbs. of a direct material at $32 per lb. during the forthcoming year. On December 31, the market price of the direct material is $26 per lb., and the selling price of the finished product is expected to decline accordingly. The financial statements prepared for the year should report
A. An appropriation of retained earnings for $6,000.
B. A note describing the expected loss on the purchase commitment.
C. Nothing regarding this matter.
D. A loss of $6,000 in the income statement.
Answer (D) is correct.
A material loss on a purchase commitment is recognized in the income statement as if the inventory were already owned. Losses on firm purchase commitments are measured in the same way as inventory losses. If the cost is $32,000 and the market price is $26,000, a $6,000 loss should be shown.
The UNO Company was formed on January 2, Year 1, to sell a single product. Over a 2-year period, UNO’s costs increased steadily. Inventory quantities equaled 3 months’ sales at December 31, Year 1, and zero at December 31, Year 2. Assuming the periodic system and no accounting changes, the inventory cost method that reports the highest amount for each of the following is
Inventory 12/31/Year 1
Cost of Sales Year 2
A. LIFO FIFO B. LIFO LIFO C. FIFO FIFO D. FIFO LIFO
Answer (C) is correct.
In a period of rising prices, FIFO inventory is higher than LIFO inventory. FIFO assumes that the latest and therefore the highest priced goods purchased are in inventory. But LIFO assumes that these goods were the first to be sold. Accordingly, the inventory at December 31, Year 1 (beginning inventory for Year 2), is higher for FIFO than LIFO. Given zero inventory at December 31, Year 2, the units sold in Year 2 must have equaled the sum of Year 2 purchases and beginning inventory. Because beginning inventory for Year 2 is reported at a higher amount under FIFO than LIFO, the result is a higher cost of goods sold under FIFO.
Herc Co.’s inventory at December 31, Year 1, was $1.5 million based on a physical count priced at cost, and before any necessary adjustment for the following:
Merchandise costing $90,000 was shipped FOB shipping point from a vendor on December 30, Year 1, and was received and recorded on January 5, Year 2.
Goods in the shipping area were excluded from inventory although shipment was not made until January 4, Year 2. The goods, billed to the customer FOB shipping point on December 30, Year 1, had a cost of $120,000.
What amount should Herc report as inventory in its December 31, Year 1, balance sheet?
A. $1,590,000
B. $1,620,000
C. $1,500,000
D. $1,710,000
Answer (D) is correct.
The inventory balance prior to adjustments was $1.5 million. The merchandise shipped FOB shipping point to Herc should be included because title passed when the goods were shipped. The goods in the shipping area should be included because title did not pass until the goods were shipped in Year 2. Thus, inventory reported at December 31, Year 1, should be $1,710,000 ($1,500,000 + $90,000 + $120,000).
Simm Co. has determined its December 31 inventory on a LIFO basis to be $400,000. Information pertaining to the inventory follows: Estimated selling price $408,000 Estimated cost of disposal 20,000 Normal profit margin 60,000 Current replacement cost 390,000 At December 31, what should be the amount of Simm’s inventory?
A. $388,000
B. $328,000
C. $390,000
D. $400,000
Answer (A) is correct.
Inventory accounted for using the LIFO or retail inventory method must be written down to market if its utility is less than its cost. The excess of cost over market is recognized as a loss on write-down in the income statement. Market is the current cost to replace inventory, subject to limitations. Market should not (1) exceed a ceiling equal to net realizable value (NRV) or (2) be less than a floor equal to NRV reduced by an allowance for an approximately normal profit margin. NRV is the estimated selling price in the ordinary course of business minus reasonably predictable costs of completion, disposal, and transportation. Cost ($400,000 LIFO basis) exceeds market ($390,000 current replacement cost). But market exceeds the ceiling ($408,000 estimated selling price – $20,000 estimated cost of disposal = $388,000 NRV) and the floor ($388,000 NRV – $60,000 normal profit margin = $328,000). Inventory therefore is $388,000, and the loss on write-down is $12,000 ($400,000 cost – $388,000 market ceiling).
Lia Co.’s December 31 balance sheet reported the following current assets: Cash $ 35,000 Accounts receivable 60,000 Inventories 30,000 Total $125,000 An analysis of the accounts disclosed that accounts receivable comprised the following: Trade accounts $48,000 Allowance for uncollectible accounts (1,000) Selling price of Lia’s unsold goods sent to Jax Co. on consignment at 130% of cost and not included in Lia’s ending inventory
13,000 Total $60,000 At December 31, the correct total of Lia’s current assets is A. $122,000 B. $112,000 C. $135,000 D. $115,000
Answer (A) is correct.
Under a consignment sales agreement, the consignor ships merchandise to the consignee, who acts as agent for the consignor in selling the goods. The goods are in the physical possession of the consignee but remain the property of the consignor and are included in the consignor’s inventory account. Accordingly, sales revenue from these consigned goods should be recognized by the consignor when the merchandise is sold (delivered to the ultimate customer). Thus, the unsold consigned goods should be included in inventory at cost ($13,000 ÷ 130% = $10,000), not in receivables at their sales price. Current assets should therefore be $122,000 ($35,000 cash + $47,000 net receivables + $40,000 inventory).
Question: 24 On December 1, Alt Department Store received 505 sweaters on consignment from Todd. Todd’s cost for the sweaters was $80 each, and they were priced to sell at $100. Alt’s commission on consigned goods is 10%. At December 31, 5 sweaters remained. In its December 31 balance sheet, what amount should Alt report as payable for consigned goods? A. $49,000 B. $45,000 C. $40,400 D. $45,400
Answer (B) is correct.
Consignment-in is a receivable/payable account used by consignees. It is the amount payable to the consignor if it has a credit balance. The amount of the payable equals total sales minus 10% commission on the goods sold, or $45,000 [(500 × $100) sales – (500 × $100 × 10%)].
Assuming constant inventory quantities, which of the following inventory-costing methods will produce a lower inventory turnover ratio in an inflationary economy? A. LIFO (last-in, first-out). B. FIFO (first-in, first-out). C. Weighted average. D. Moving average.
Answer (B) is correct.
The inventory turnover ratio equals cost of goods sold divided by the average of beginning and ending inventory. Under FIFO, ending inventory is assumed to contain the most recently purchased items, and cost of goods sold is assumed to contain the costs of the earliest purchased items. Under LIFO, the opposite assumptions are made. In an inflationary economy, costs are increasing. Thus, FIFO cost of goods sold is lower, and FIFO ending or average inventory is higher than under LIFO. The inventory methods based on average costs produce results that lie between those of FIFO and LIFO. Accordingly, inventory turnover is lowest under FIFO because the numerator is lower and the denominator is higher than under other methods.
