FAR 2C - Inv

Question 1

What are the main inventory cost flow assumptions?

Answer 1

LIFO, FIFO, Average Cost, and Specific Identification are the primary methods for determining the cost flow of inventory.

Question 2

What is Dollar-Value LIFO, and how is it calculated?

Answer 2

Dollar-Value LIFO approximates LIFO using dollar amounts rather than physical units.

Multiply the base-year layer by the price index to adjust inventory to the current dollar value.

Question 3

What is FOB Shipping Point?

Answer 3

The buyer takes ownership of the goods when they leave the seller’s dock, and the buyer is responsible for shipping costs and risks.

Question 4

What is FOB Destination?

Answer 4

Free on board or Freight on board. The seller retains ownership of the goods until they are delivered to the buyer, and the buyer records inventory when received.

Question 5

How is inventory measured under FIFO and Average Cost methods?

Answer 5

Inventory is measured at the lower of cost and net realizable value (NRV).

Question 6

What is the ceiling and floor in the LIFO lower of cost or market (LCM) method?

Answer 6

The ceiling is NRV, and the floor is NRV minus a normal profit margin.

Question 7

How are inventory and COGS determined under the periodic inventory system?

Answer 7

Inventory and COGS are determined at the end of the period based on a physical count.

COGS = Beginning Inventory + Purchases - Ending Inventory.

Question 8

What is the key difference between LIFO and FIFO in a perpetual inventory system?

Answer 8

Under LIFO, perpetual results in a lower ending inventory than periodic. Under FIFO, perpetual and periodic systems produce the same ending inventory.

Question 9

How are Freight In and Freight Out costs treated?

Answer 9

Freight In is capitalized as part of inventory costs and included in COGS when inventory is sold, while Freight Out is classified as a selling expense.

Question 10

What is the gross profit method, and when is it used?

Answer 10

The gross profit method estimates ending inventory without a physical count and is typically used for interim reporting.

Question 11

What is the perpetual inventory system?

Answer 11

The perpetual system continuously tracks inventory levels as units are received and sold.

Question 12

What is the periodic inventory system?

Answer 12

The periodic system calculates inventory and COGS at the end of the period based on a physical count.

Question 13

How is the COGS calculated under the periodic inventory system?

Answer 13

COGS = Beginning Inventory + Purchases - Ending Inventory

Question 14

How does LIFO affect the calculation of inventory in the perpetual system?

Answer 14

LIFO results in a lower ending inventory under the perpetual system compared to the periodic system due to the timing of purchases and sales.

Question 15

What is the retail method of inventory valuation?

Answer 15

The retail method converts retail prices to cost using a cost-to-retail ratio and can be applied under LIFO, FIFO, or average cost.

Question 16

What is the treatment for goods owned on consignment in the consignor’s inventory?

Answer 16

Goods owned by the consignor (e.g., XYZ) on consignment should be included in the consignor’s inventory until sold.

Question 17

What is the treatment for goods held on consignment in the consignee’s inventory?

Answer 17

Goods held by the consignee (e.g., XYZ) on consignment should be excluded from the consignee’s inventory, as they are owned by another entity.

Question 18

What is LIFO’s designated market in lower of cost or market (LCM) valuation?

Answer 18

The designated market under LIFO is the replacement cost, as long as it falls between the ceiling (NRV) and the floor (NRV minus normal profit margin).

Question 19

How is the retail method calculated?

Answer 19

1) Calculate the cost-to-retail ratio.
2) Determine ending inventory by subtracting sales, normal losses, and markdowns from retail.
3) Multiply ending inventory at retail by the cost-to-retail ratio.

Question 20

How is the weighted average cost per unit calculated?

Answer 20

Weighted Average Cost per Unit = Total Cost of Units Available for Sale / Total Units Available for Sale.

If total units available for sale = 1,000 units and total cost = $5,000, then the weighted average cost per unit is $5.

Question 21

LIFO Periodic Method (COGS Calculation): Formula:

Answer 21

COGS = Total Units Sold × Cost of Most Recent Purchases

If 100 units are sold, and the last purchase was at $10 per unit, then COGS = 100 × $10 = $1,000.

Question 22

LIFO Inventory Calculation (Layers): Formula:

Answer 22

Inventory = Oldest Layer × Unit Cost + Newer Layer × Unit Cost

If 50 units are left from the first layer at $8/unit and 30 units from the second layer at $9/unit, inventory = (50 × 8) + (30 × 9) = $670.

Question 23

Average Cost Method for Inventory: Formula:

Answer 23

Weighted Average Cost per Unit = Total Cost of Goods Available for Sale / Total Units Available for Sale

If total cost of goods available is $5,000 for 1,000 units, weighted average cost = $5,000 / 1,000 = $5 per unit.

Question 24

Lower of Cost or Market (LCM) - LIFO Designated Market: Formula:

Answer 24

LCM = Replacement Cost, but limited by the NRV ceiling and NRV minus normal profit margin as the floor

If NRV is $50, normal profit margin is $10, and replacement cost is $40, then LCM = $40 because it’s between the ceiling ($50) and the floor ($40).

Question 25

How does LIFO affect inventory valuation versus equity trading?

Answer 25

For inventory, LIFO affects both the income statement (through COGS) and the balance sheet (as older inventory remains at outdated prices). In equity trading, LIFO influences capital gains or losses on the income statement, but securities are still marked to fair value on the balance sheet

Question 26

How does LIFO influence gains or losses in inventory accounting vs. equity trading?

Answer 26

In inventory accounting, LIFO affects the cost of goods sold (COGS), influencing gross profit and net income. In equity trading, LIFO impacts capital gains or losses on the income statement, but does not affect gross profit or operational results.

Question 27

What is the LIFO Reserve, and why is it important?

Answer 27

The LIFO Reserve is a contra-inventory account that shows the difference between inventory under FIFO (or average cost) and LIFO. Many companies: a) Use FIFO or Average Cost internally for management decision-making (because it better reflects current costs). b) Use LIFO for financial reporting and tax purposes (because it reduces taxable income during inflation). Formula:LIFO Reserve = Inventory (FIFO/Avg Cost) – Inventory (LIFO)

Question 28

What FSLI are included when calculating inventory using the retail method?

Answer 28

📦 Beginning Inventory (Cost & Retail) 🛒 Purchases (Cost & Retail) 🔼 Markups (Net) 🔽 Markdowns (Net) 💲 Sales 🚨 Normal Shoplifting Losses 💡 Key: Use these to calculate Ending Inventory at Retail and apply the Cost-to-Retail Ratio.

Question 29

How do you calculate the Cost-to-Retail Ratio under the retail method (lower of cost or market)?

Answer 29

📦 Add Beginning Inventory and Purchases (Cost) 🛒 Add Beginning Inventory, Purchases, and Net Markups (Retail) 🔄 Divide Cost of Goods Available by Retail of Goods Available 💡 Key: Do not include net markdowns when calculating the ratio! The ratio reflects cost compared to initial retail value before markdowns.

Question 30

How do you calculate the Ending Inventory using the retail method after finding the cost-to-retail ratio?

Answer 30

🔽 Subtract Sales, Normal Losses, and Markdowns (Retail): Retail Goods Available − Sales − Normal Shoplifting Losses − Net Markdowns 📏 Multiply Ending Inventory (Retail) by Cost-to-Retail Ratio: Ending Inventory (Retail) × Cost-to-Retail Ratio 💡 Key: Only subtract markdowns when calculating ending inventory at retail. Do not include markdowns when calculating the cost-to-retail ratio.

Question 31

When a question refers to LIFO or FIFO without specifying the inventory system, which method should you assume?

Answer 31

Assume the periodic method. Unless the question explicitly states "perpetual," FIFO and LIFO are interpreted as periodic by default — especially in exams and financial reporting contexts.

Question 32

How do you adjust reported COGS when beginning inventory is understated by $20,000 and ending inventory is overstated by $12,000?

Answer 32

🧾 COGS formula with errors: COGS_reported = (BB_actual - 20,000) + Purchases - (EB_actual + 12,000) 🧮 Simplify: COGS_reported = BB_actual - 20,000 + Purchases - EB_actual - 12,000 = COGS_correct - 32,000 🔁 Rearranged: COGS_reported = COGS_correct - 32,000 ⇒ COGS_correct = COGS_reported + 32,000 COGS_correct is the normal formula 📊 Final Answer (Example): COGS_correct = 1,050,000 + 32,000 = 1,082,000

Question 33

What are the main inventory cost flow assumptions?

Answer 33

FIFO (First-In, First-Out): Oldest inventory costs are assigned to COGS first. LIFO (Last-In, First-Out): Newest inventory costs are assigned to COGS first. Average Cost: Uses a weighted average cost per unit. Specific Identification: Tracks actual cost of each unique item, used for high-value or unique goods.

Question 34

What is FOB Shipping Point?

Answer 34

the buyer takes ownership when goods leave the seller’s dock. Buyer pays shipping and assumes risk during transit. Inventory is recorded by the buyer when shipped, not when received.

Question 35

What is FOB Destination?

Answer 35

seller retains ownership until the goods are delivered to the buyer. Seller is responsible for shipping risks and costs. Buyer records the inventory when received, not when shipped.

Question 36

How is inventory measured under FIFO and Average Cost methods?

Answer 36

inventory is measured at the lower of cost and net realizable value (NRV). NRV = Estimated selling price – Costs of completion/disposal No need to consider ceiling, floor, or replacement cost (those apply to LIFO only).

Question 37

When using the LIFO Retail Method, how are markdowns treated when calculating the cost-to-retail ratio?

Answer 37

Markdowns are excluded from the denominator

Question 38

When applying the LIFO retail method, how is ending inventory determined after markdowns and sales?

Answer 38

Subtract sales and markdowns (and normal losses if applicable) from retail goods available. Determine whether a new price level layer was added. Apply the appropriate cost-to-retail ratio to each layer (base layer and incremental layer). ⚠️ Use a separate cost-to-retail ratio for each layer, and apply markdowns only after determining if a new layer was created.

Question 39

How is inventory measured under the Lower of Cost or Market (LCM) rule, and how is the designated market determined?

Answer 39

**📈 Ceiling = Net Realizable Value (NRV):** = Selling Price – Costs to Complete & Dispose **📉 Floor = NRV – Normal Profit** **⚙️ Replacement Cost = Current purchase price** **🏷️ Designated Market:** - If Replacement Cost is **within** floor and ceiling → use Replacement Cost - If above Ceiling → use Ceiling - If below Floor → use Floor - **📊 Example:** - NRV = $388,000 - Floor = $328,000 - Replacement Cost = $390,000 → above ceiling - Cost = $400,000 - **Inventory = Lower of Cost ($400K) or Market ($388K) → $388,000**

Question 40

How do you calculate ending inventory using the Dollar-Value LIFO method?

Answer 40

1 **📅 Start with Base-Year Cost of Ending Inventory:** - Convert current-year inventory to **base-year dollars** using the **price index** 2 **📊 Identify Real Increase (New Layer):** - Subtract beginning base-year inventory from ending base-year inventory - If there's an increase → it's a **new LIFO layer** 3 **📈 Apply Price Index to New Layer:** - Multiply the new layer (base-year $) by the **price index** for the year 4 **➕ Add to Base Layer:** - **Dollar-Value LIFO Ending Inventory = Base Layer + Inflated New Layer** ## Footnote **📊 Example:** - Beginning Inventory (Base-Year): $500,000 - Ending Inventory (Base-Year): $525,000 - Price Index: 1.10 **New Layer =** $25,000 × 1.10 = $27,500 **Dollar-Value LIFO Inventory =** $500,000 + $27,500 = **$527,500**

Question 41

How does IFRS differ from U.S. GAAP in inventory accounting?

Answer 41

- 🚫 **IFRS prohibits the use of LIFO**, while **U.S. GAAP permits LIFO**. - 🔄 Both allow FIFO and weighted average cost methods. - 🔧 Inventory write-downs can be **reversed under IFRS** if conditions improve, but **cannot be reversed under U.S. GAAP**.

Question 42

How is a change from FIFO to weighted-average inventory method reported under GAAP?

Answer 42

A change in inventory cost flow assumption (e.g., FIFO to weighted-average) is a change in accounting principle. - It must be applied retrospectively, unless impracticable. - The cumulative effect on beginning retained earnings (net of tax) is disclosed and adjusted in the earliest period presented. - Inventory balances are restated, and the tax impact is reflected in the adjustment.

Question 43

How do you calculate the cumulative effect of a change in inventory method (e.g., FIFO to weighted-average)?

Answer 43

- Compare beginning inventory under both methods: New method – Old method = Cumulative difference - Multiply the difference by (1 – tax rate) to get the after-tax effect - Report the result as an adjustment to beginning retained earnings ## Footnote Example: If FIFO = $71,000, Weighted-Average = $77,000, tax rate = 30% Cumulative effect = $6,000 × 70% = $4,200 increase to retained earnings

Question 44

What is the NRV in FIFO calc?

Answer 44

Sales Value – Cost to Complete = Ceiling

Question 45

When can revenue be recognized under a bill-and-hold arrangement?

Answer 45

Revenue can be recognized only when the customer has obtained control of the product. All of the following must be met: - The customer has a substantive reason for the arrangement (e.g., requested delayed delivery) - The product is separately identified as belonging to the customer - The product is ready for physical transfer - The seller cannot use the product or redirect it to another customer

Question 46

How do you value inventory under LCM for LIFO or the retail method?

Answer 46

1. Identify Net Realizable Value (NRV) and subtract normal profit margin to get the floor 2. Identify Replacement Cost 3. Set Market = Replacement Cost, unless: - Replacement Cost > NRV → Market = NRV (Ceiling) - Replacement Cost < NRV – Profit Margin → Market = Floor 4. Compare Original Cost to Market 5. Inventory is valued at the lower of Original Cost or Market

Question 47

How does the moving average method work under a perpetual inventory system?

Answer 47

After every purchase, recalculate a new weighted average cost per unit: New Avg. Cost = (Cost of Beginning Inventory + Cost of Purchase) / (Units on Hand after Purchase) - Use this new average cost to value COGS for any sales that follow - Repeat the process after each purchase to maintain updated inventory valuation - Sales after the date in question are irrelavant under the perpetual inventory system

Question 48

Example: Using the moving average method under a perpetual system, calculate the COGS if a company has: - Beginning inventory: 30,000 units @ $10 - Purchase: 10,000 units @ $12 - Sale: 20,000 units

Answer 48

A: Step 1: Recalculate average after purchase: - Total cost = $300,000 + $120,000 = $420,000 - Total units = 40,000 - New avg. cost = $420,000 / 40,000 = $10.50 Step 2: Sale of 20,000 units @ $10.50 - COGS = 20,000 × $10.50 = $210,000

Question 49

How does the weighted average method work under a periodic inventory system?

Answer 49

Wait until the end of the period to calculate the average cost - Use this formula: Average Cost per Unit = Total Cost of Goods Available / Total Units Available - Apply that average to all units sold during the period to calculate COGS: COGS = Units Sold × Average Cost per Unit - Ending Inventory = Units Remaining × Average Cost per Unit

Question 50

Example: Under the **periodic weighted average method**, Carver Co. has: - Beginning inventory: 30,000 units @ $10 - Purchase on 3/5: 10,000 units @ $12 - Purchase on 3/20: 20,000 units @ $13 - Sale on 3/10: 20,000 units What is COGS?

Answer 50

Step 1: Total units = 30,000 + 10,000 + 20,000 = 60,000 Total cost = (30,000×10) + (10,000×12) + (20,000×13) = 300,000 + 120,000 + 260,000 = $680,000 Step 2: Average cost per unit = 680,000 / 60,000 = $11.33 Step 3: COGS = 20,000 × $11.33 = $226,667

Question 51

How is freight treated for consigned inventory held by the consignor (e.g., inventory shipped to a consignee)?

Answer 51

Freight paid by the consignor to deliver goods to the consignee is treated like freight-in - It is capitalized as part of inventory, not expensed - This is because the consignor still owns the inventory and no sale has occurred - Freight-out is only a selling expense when goods are sold and delivered to a customer

Question 52

When do you apply Lower of Cost and Market (LCM) vs. Lower of Cost and Net Realizable Value (LCNRV)?

Answer 52

Use **LCNRV** for inventory valued under: - FIFO - Average Cost - Specific Identification Use **LCM** for inventory valued under: - LIFO - Retail Inventory Method (if LIFO or not specified) LCM uses: - Market = Replacement Cost (within NRV ceiling and NRV – profit margin floor) LCNRV = Cost compared directly to NRV (no floor or replacement cost)

Question 53

How do you calculate the cumulative effect on retained earnings when changing inventory methods (e.g., FIFO to Weighted-Average)?

Answer 53

- Step 1: Focus on the **beginning inventory balances** under both methods (do not use ending balances) - Step 2: Calculate the difference: Cumulative Difference = New Method Beginning Inventory – Old Method Beginning Inventory - Step 3: Apply the tax impact: After-Tax Adjustment = Difference × (1 – Tax Rate) - Step 4: Report this after-tax amount as a **direct adjustment to beginning retained earnings** Example: - Beginning Inventory: FIFO = $71,000, Weighted-Average = $77,000 - Difference = $6,000 - After-tax effect = $6,000 × 70% = $4,200 increase in retained earnings

Question 54

What is the difference between margin and markup in inventory calculations, and what should you watch for on the exam?

Answer 54

**Margin** = Gross Profit ÷ Sales - **Markup** = Gross Profit ÷ Cost - Margin is based on selling price, markup is based on cost - Exam Tip: - If the question gives you a **gross profit margin**, use sales as the denominator - If it gives you a **markup**, use cost as the denominator - Misreading this is a common CPA exam trap—always check the base of the percentage ## Footnote Example: 25% Margin when Sales is 600K, then COGS is $600K*0.75. If 25% markup COGS is $600/1.25