Inventories

Question 1

Ajax Factories produces pencils at a factory designed to produce 10 million pencils per year. In 2007, the fixed production overhead related to the factory was $1 million and the factory produced 9 million pencils. The inventory cost for each pencil related to the fixed production cost is closest to:

A. 0.00$
B. 0.10$
C. 0.11$

Answer 1

B is correct. Normal capacity is 10 million pencils, and fixed production costs are $1 million. So, capitalized inventory costs will include 90% (9 million pencils produced divided by 10 million capacity) of the fixed production overhead costs of $1 million.
The inventory cost for each pencil related to the fixed production overhead allocated to each pencil is thus $0.10. The remaining $100,000 would be expensed as incurred.

Question 2

Compared to using the FIFO method to account for inventory, during periods
of rising prices a company that uses the LIFO method is most likely to report higher…
A. net income.
B. cost of sales.
C. income taxes.

Answer 2

B is correct. The LIFO method increases cost of sales, thus reducing profits and the taxes thereon

Question 3

Zimt AG wrote down the value of inventory in 2007 and reversed the write-
down in 2008. Compared to results reported if the write-down had never occurred, Zimt’s reported 2008.
A. profit was overstated.
B. cash flow from operations was overstated.
C. year-end inventory balance was overstated.

Answer 3

A is correct. The reversal shifted cost of sales from 2008 to 2007. As a result, the reported 2008 profits were overstated. Inventory balance would have been the same because the write-down and reversal cancel each other out. Cash flow from operations is not affected by the non-cash write-down, but the higher profits in 2008 likely resulted in higher taxes and thus lower cash flow from operations.