Unit 7 - Inventory

Question 1

The following information is available for a company that uses a specific identification inventory system:

• October 1: Beginning inventory consisted of 200 units at a cost of $7.00 each.
• October 7: 500 units were purchased at a cost of $8.00 each.
• October 18: 250 units were sold from the October 7 purchase.
• October 22: 600 units were purchased at a cost of $8.50 each.
• October 24: 300 units were purchased at a cost of $9.00 each.
• October 26: 350 units were sold from the October 22 purchase.

What are the cost of goods sold (COGS) and the value of ending inventory for October?

Answer 1

$4,975 = CGS: (350 x $8.50) + (250 x $8.00). Ending Inventory: $8,225 = (200 x $7) + ((500 -250) x 8) + ((600 - 350) x $8.5) + (300 x $9)

Accounting Rule: The specific identification inventory valuation method tracks every single item in an inventory individually from the time it enters the inventory until the time it leaves it. This inventory method is suitable for companies with expensive, easily distinguishable low-volume merchandise such as jewelry, fur coats, automobiles, unique furniture, special manufactured made products.

Question 2

Consider the following inventory activity:

The 9 units of ending inventory are identified with the purchase of May 20.

Using the specific identification method, what is the value of the ending inventory and the cost of goods sold.
a. $126 and $430, respectively.
b. $126 and $530, respectively.
c. $126 and $544, respectively.
d. $56 and $474, respectively.

Answer 2

c. $126 and $544, respectively.

Question 3

A company that used the periodic inventory system overstated its beginning inventory but correctly stated its ending inventory.
What will be the effect of this error on the financial statements at the end of the period?

Answer 3

The cost of goods sold will be overstated and gross profit/net income will be understated. The ending inventory on the balance sheet is correct according to the facts.

Accounting Rule: Inventory errors come in two form: understatements or overstatements.
Beginning inventory errors affect only the income statement because cost of goods sold is calculated using beginning inventory + purchases – ending inventory.
Ending inventory errors affect both the income statement and the balance sheet, and will affect two periods because 1) the ending inventory of one period will become the beginning inventory for the following period, and 2) the calculation of the cost of goods sold is beginning inventory + purchases – ending inventory.
As shown in the table below, errors in calculating beginning inventory have a direct effect on cost of goods sold and inverse effect on gross profit and net income. On the other hand, errors in calculating ending inventory have an inverse effect on cost of goods sold and a direct effect on gross profit and net income. Errors in purchases have the same effect as errors in beginning inventory, that is a direct effect on cost of goods sold and inverse effect on gross profit and net income

Question 4

A company mistakenly understated ending inventory by $25,000 in a year but verified the correct ending inventory was recorded in the following year.
What is the effect of this on the total net income for the two years combined?

Answer 4

No effect at the end of year 2. The error counterbalances each other as net income will be understated by $25,000 in Year 1 and overstated by $25,000 in Year 2: $25,000 + ($25,000).
Accounting Rule: Inventory errors come in two form: understatements or overstatements.
Beginning inventory errors affect only the income statement because cost of goods sold is calculated using beginning inventory + purchases – ending inventory.
Ending inventory errors affect both the income statement and the balance sheet, and will affect two periods because 1) the ending inventory of one period will become the beginning inventory for the following period, and 2) the calculation of the cost of goods sold is beginning inventory + purchases – ending inventory.
As shown in the table below, errors in calculating beginning inventory have a direct effect on cost of goods sold and inverse effect on gross profit and net income. On the other hand, errors in calculating ending inventory have an inverse effect on cost of goods sold and a direct effect on gross profit and net income. Errors in purchases have the same effect as errors in beginning inventory, that is a direct effect on cost of goods sold and inverse effect on gross profit and net income

Question 5

A company did not record the credit purchases of inventory and did not include this item in the ending inventory balance.
What is the effect of this on the financial statements?
Inventory is understated; net income is unaffected. Since both the purchases and ending inventory are understated, the two errors cancel each other out, and there is no effect on cost of goods sold and net income.

Answer 5

Beginning Inventory not affected
(+) Purchases understated
(-) Ending Inventory understated
Cost of Goods Sold not affected

Question 6

A company uses a periodic inventory system. A $100 purchase is not recorded in the purchase account for the year but is included in the ending inventory count.
What is the effect of this error on the company’s income statement?

Answer 6

Beginning Inventory Not affected
(+) Purchases Understated by $100
(-) Ending Inventory Not affected
Cost of Goods Sold Understated by $100
Income Overstated by $100

Question 7

A company uses a periodic inventory system. A $100 purchase is properly recorded in the purchase account for the year but is excluded in the ending inventory count.

What is the effect of this error on the company’s financial statements?

Answer 7

Beginning Inventory Not affected
(+) Purchases Not affected
(-) Ending Inventory Understated by $100
Cost of Goods Sold Overstated by $100
Income Understated by $100

Question 8

A company uses a periodic inventory system. A $100 purchase on account is inadvertently recorded in the purchase account as $200 for the year but is correctly included in the ending inventory count as $100.

What is the effect of this error on the company’s financial statements?

Answer 8

Beginning Inventory Not affected
(+) Purchases Overstated by $100
(-) Ending Inventory Not affected
Cost of Goods Sold Overstated by $100
Income Understated by $100
Accounts Payable Overstated by $100

Question 9

A company uses a periodic inventory system. The company is holding $100 of consigned goods and incorrectly includes them in its ending inventory count. The company discovers the error the following year and excludes the goods in its inventory count for that year.

What is the effect of this error on the company’s financial statements?

Answer 9

Year 1 Year 2
Beginning Inventory Not affected Overstated by $100
(+) Purchases Not affected Not affected
(-) (Ending Inventory Overstated by $100 Not affected
Cost of Goods Sold Understated by $100 Overstated by $100
Income Overstated by $100 Understated by $100

The overstatement of ending inventory in the first-year results in the understatement of cost of goods sold in that year. Because beginning inventory in the second year is overstated, cost of goods sold will be overstated in the second year by the same amount that it was understated in the first year. Consequently, the impact on net income over the two-year period nets to zero.

Question 10

A company uses a periodic inventory system. The company incorrectly records inventory item purchases that were not received by the company’s warehouse as of the last day of the most recent reporting period. The items were purchased under free on board (FOB) destination terms. Therefore, they were not legally owned by the company on the period-ending date. The cost of the inventory purchased was $100,000.

The company balance sheet reports the following balances at the end of the reporting period:

Current assets: $600,000
Current liabilities: $300,000

What are two effects of the error on the company’s balance sheet
a. retained earnings are overstated.
b. net working capital is understated.
c. the current ratio is understated.
d. total purchases are overstated.

Answer 10

c. the current ratio is understated.
d. total purchases are overstated.

Beginning Inventory Not affected
(+) Purchases Overstated by $100,000
(-) Ending Inventory Overstated by $100,000
Cost of Goods Sold Not affected
Income Not affected
Accounts Payable Overstated by $100,000

The error resulted in the overstatement of purchases, inventory, and accounts payable. Because purchases (goods available for sale) and ending inventory are overstated by the same amount, cost of goods sold is unaffected. Therefore, net income is not affected.

The current ratio is understated. The current ratio formula is current assets /current liabilities. Ending inventory is a current asset and accounts payable is a current liability. Since both are understated by the same amount, the current ratio is smaller. For example, assume a correct current ratio of 50 / 20 = 2.5. Now, assume both current assets and current liabilities is overstated by 10. The current ratio now is 60 / 30 =2. Increasing the numerator and denominator by the same amount lowers the current ratio.

Question 11

A company uses the periodic inventory costing system. The company includes goods shipped to them f.o.b. shipping point in purchases, but not ending inventory.
What is the effect on the current ratio?
a. no effect.
b. understated.
c. overstated.
d. there is not enough information to determine the effect.

Answer 11

b. understated.

Beginning Inventory Not affected
(+) Purchases Not affected
(-) Ending Inventory) Understated
Cost of Goods Sold Overstated
Income Understated
Accounts Payable Not affected

Ending inventory is understated because the purchase items were not included in the ending inventory count. Accounts payable is not affected since the items were recorded in the Purchases account and Accounts Payable account.

The current ratio is understated. The current ratio formula is current assets/current liabilities. Ending inventory is a current asset and accounts payable is a current liability. Since the numerator is understated and the denominator is correct, the current ratio is understated. For example, assume a correct current ratio of 50 / 20 = 2.5. Now, assume current assets is understated by 10. The current ratio now is 40 / 20 =2. Decreasing the numerator lowers the current ratio.

Question 12

A company uses the periodic inventory costing system and has a calendar year-end. The company starts the year with a beginning inventory that is understated. There are no other errors in the year.

What is the effect of this inventory error on the company’s net income for the calendar year?
a. no effect.
b. understated.
c. overstated.
d. there is not enough information to determine the effect.

Answer 12

c. overstated.

Beginning Inventory Understated
(+) Purchases Not affected
(-) Ending Inventory Not affected
Cost of Goods Sold Understated
Income Overstated
Accounts Payable Not affected

Question 13

A company uses the periodic inventory costing system and has a calendar year-end. The company’s ending inventory is overstated by $12,000 for 2019.

What is the effect of this misstatement on the company’s net income for years 2019 and 2020?
a. 2019 -understated; 2020 - understated.
b. 2019 - understated; 2020 - overstated.
c. 2019 - overstated; 2020 - understated.
d. 2019 - overstated; 2020- overstated.

Answer 13

c. 2019 - overstated; 2020 - understated.

Question 14

A company underestimates its ending inventory for a year.

What effect will this have on the company’s working capital and current ratio?
a. understatement of working capital and overstatement of current ratio.
b. overstatement of working capital and understatement of current ratio.
c. understatement of working capital and current ratio
d. overstatement of working capital and current ratio

Answer 14

c. understatement of working capital and current ratio

The formula for working capital is current assets minus current liabilities. Assume current assets is 12 and current liabilities is 5. Working capital would be 7. If inventory is understated, this would decrease the numerator from 12 to say 10. Working capital would now be 5. Hence, working capital is understated.

The current ratio formula is current assets/current liabilities. Assume current assets is 12 and current liabilities is 5. The current ratio would be 2.4. If inventory is understated, this would decrease the numerator from 12 to say 10. The current would now be 2. Hence, the current ratio is understated.

Question 15

A company overestimates its ending inventory for a year.

What effect will this have on the company’s working capital and current ratio?
a. understatement of working capital and overstatement of current ratio.
b. overstatement of working capital and understatement of current ratio.
c. understatement of working capital and current ratio
d. overstatement of working capital and current ratio

Answer 15

d. overstatement of working capital and current ratio

The formula for working capital is current assets minus current liabilities. Assume current assets is 12 and current liabilities is 5. Working capital would be 7. If inventory is overstated, this would increase the numerator from 12 to say 14. Working capital would now be 9. Hence, working capital is overstated.
The current ratio formula is current assets/current liabilities. Assume current assets is 12 and current liabilities is 5. The current ratio would be 2.4. If inventory is overstated, this would increase the numerator from 12 to say 14. The current ratio would now be 2.8. Hence, the current ratio is overstated.

Question 16

A company that is using the periodic inventory system correctly records purchases but double counts some items in ending inventory.

What will be the effect on the financial statements at the end of this period?
a. current ratio will be understated.
b. cost of goods sold will be understated.
c. accounts payable will be understated.
d. net income will be understated

Answer 16

b. cost of goods sold will be understated.

Ending inventory on the balance sheet would be overstated.

Beginning Inventory not affected
(+) Purchases not affected
(-) Ending Inventory overstated
Cost of Goods Sold understated

There is an inverse relationship between ending inventory and cost of goods sold. If ending inventory is overstated, then cost of goods sold is understated. If ending inventory is understated, then cost of goods sold is overstated.
The following table shows the effect of understated/overstated inventory errors. Please study and memorize the material.

Question 17

The failure to record a purchase of merchandise on account even though the goods are properly included in the physical inventory results in
a. an overstatement of assets and net income.
b. an understatement of assets and net income.
c. an understatement of cost of goods sold and liabilities and an overstatement of assets.
d. an understatement of liabilities and an overstatement of net income.

Answer 17

d. an understatement of liabilities and an overstatement of net income.

Question 18

A company received merchandise on consignment. As of March 31, the company recorded the transaction as a purchase on account and included the goods in its perpetual inventory.

The effect of this on the company’s financial statements for March 31st is
a. no effect.
b. net income was correct and current assets and current liabilities were overstated.
c. net income, current assets, and current liabilities were overstated.
d. net income and current liabilities were overstated.

Answer 18

b. net income was correct and current assets and current liabilities were overstated.

Question 19

A company recorded the purchase of 500 units on December 28, Year 1, free on board (FOB) shipping point. The units were shipped immediately and expected to arrive on January 3, Year 2. The company did not include these units in December’s ending inventory.

Which effect does this action have on the financial statements for December 31, Year 1?

a. Cost of goods sold is understated.
b. Inventory is understated.
c. Net income is overstated
d. Working capital is overstated.

Answer 19

b. Inventory is understated.

Question 20

A company has the following balances in its accounts:

• beginning inventory: $2,000
• purchases: $3,300
• ending inventory: $1,400

If the periodic system is used, what is the amount of cost of goods sold for the year?

Answer 20

$3,900 = $2,000 + $3,300 - $1,400

Accounting Rule: The cost of goods sold is calculated as beginning inventory plus purchases minus ending inventory.

Make sure you know the following formula
Beginning Inventory
(+) Net Purchases1
(=) Goods Available for Sale
(-) Ending Inventory
(=) Cost of Goods Sold
1 Net Purchases = Purchases + Freight In- Purchase Discounts – Purchase Returns and Allowances

Question 21

A company has the following balances in its accounts:

• beginning inventory: $2,000
• purchases: $3,300
• ending inventory: $1,400

If the periodic system is used, what is the amount of goods available for sale for the year?

Answer 21

$5,300 = $2,000 + $3,300
Accounting Rule: The cost of goods sold is calculated as beginning inventory plus purchases minus ending inventory.
Make sure you know the following formula
Beginning Inventory
(+) Net Purchases1
(=) Goods Available for Sale
(-) Ending Inventory
(=) Cost of Goods Sold
1 Net Purchases = Purchases + Freight In- Purchase Discounts – Purchase Returns and Allowances

Question 22

Beginning inventory of $40,000 plus purchases of $30,000 equals which of the following?
a. cost of sales of $70,000.
b. cost of goods sold of $70,000.
c. cost of goods available for sale of $70,000.

Answer 22

c. cost of goods available for sale of $70,000.

Accounting Rule: Beginning inventory plus purchases equals goods available for sale. Cost of sales and cost of goods sold mean the same thing and are used interchangeably.

Make sure you know the following formula
Beginning Inventory
(+) Net Purchases1
(=) Goods Available for Sale
(-) Ending Inventory
(=) Cost of Goods Sold
1 Net Purchases = Purchases + Freight In- Purchase Discounts – Purchase Returns and Allowances

Question 23

The ending inventory of a merchandiser is $50,000. The beginning inventory was $200,000.

If the income statement for the year reported cost of goods sold of $350,000, how much were purchases during the year?

Answer 23

200,000+P=350,000+50,000, and thus P=$200,000

Accounting Rule: Purchases is calculated as beginning inventory minus ending inventory plus cost of goods sold.
Make sure you know the following formula
Beginning Inventory
(+) Net Purchases1
(=) Goods Available for Sale
(-) Ending Inventory
(=) Cost of Goods Sold
1 Net Purchases = Purchases + Freight In- Purchase Discounts – Purchase Returns and Allowances

Question 24

A manufacturing company incurred the following costs:

• direct materials: $2,000
• depreciation on factory equipment: $600
• selling expenses: $1,000
• freight charges on direct materials: $500

What are the total period costs?

Answer 24

$1,000

Accounting Rule: Period costs include any costs not related to the manufacture or acquisition of a product, i.e. nonmanufacturing costs. Sales commissions, administrative costs, advertising and rent of office space are all period costs. These costs are not included as part of the cost of either purchased or manufactured goods, but are recorded as expenses on the income statement in the period they are incurred.

Question 25

A manufacturing company incurred the following costs:

• direct materials: $2,000
• depreciation on factory equipment: $600
• selling expenses: $1,000
• freight charges on direct materials: $500

What are the total product costs?

Answer 25

$3,100

Accounting Rule: Product Costs include any cost of acquiring and producing a product. These costs include direct materials, direct labor, and manufacturing overhead. Manufacturing overhead costs include indirect materials, indirect labor, and various manufacturing related costs such as depreciation, taxes, insurance, and utilities.

Question 26

Which of the following is a period cost?
a. direct costs.
b. freight in.
c. production costs.
d. selling costs.

Answer 26

d. selling costs.

Accounting Rule: Period costs include any costs not related to the manufacture or acquisition of a product, i.e. nonmanufacturing costs. Sales commissions, administrative costs, advertising and rent of office space are all period costs. These costs are not included as part of the cost of either purchased or manufactured goods, but are recorded as expenses on the income statement in the period they are incurred.

Question 27

Which of the following is a product cost as it relates to inventory?
a. freight out.
b. interest costs.
c. raw materials.
d. abnormal spoilage.

Answer 27

c. raw materials.

Accounting Rule: Product Costs include any cost of acquiring and producing a product. These costs include direct materials, direct labor, and manufacturing overhead. Manufacturing overhead costs include indirect materials, indirect labor, and various manufacturing related costs such as depreciation, taxes, insurance, and utilities. Costs of normal shrinkage and scrap incurred in the manufacture of a product is a product cost. Interest cost incurred in the production process is a product cost but the question would have to specifically indicate this. Freight out is a selling cost and a period cost but freight in is a product cost.

Question 28

Which of the following is correct?
a. selling costs are product costs.
b. manufacturing overhead costs are product costs.
c. interest costs for routine inventories are product costs.
d. all of these answers are correct.

Answer 28

b. manufacturing overhead costs are product costs.

Question 29

A manufacturing company has the following inventory-related costs:

• direct materials: $10,000
• direct labor: $3,000
• indirect labor: $2,000
• indirect materials: $1,000
• manufacturing depreciation: $1,500
• manufacturing utilities: $2,500
• storage costs: $1,600
• purchasing department costs: $1,700
• interest expense: $800

How much is included in inventory?

Answer 29

$20,000 = $10,000 + $3,000 + $2,000 + $1,000 + $1,500 + $2,500

Accounting Rule: Another way of asking the question is how much is product costs? Inventory includes all costs except storage, purchasing department, and interest expense.
Accounting Rule: Product Costs include any cost of acquiring and producing a product. These costs include direct materials, direct labor, and manufacturing overhead. Manufacturing overhead costs include indirect materials, indirect labor, and various manufacturing related costs such as depreciation, taxes, insurance, and utilities. Costs of normal shrinkage and scrap incurred in the manufacture of a product is a product cost. Interest cost incurred in the production process is a product cost but the question would have to specifically indicate this. Freight out is a selling cost and a period cost but freight in is a product cost.

Question 30

A grocery store that uses a perpetual inventory system purchases goods on account for resale.

What is the journal entry to record this purchase?

Answer 30

Debit merchandise inventory
Credit accounts payable

Question 31

A grocery store that uses a periodic inventory system purchases goods on account for resale.

What is the journal entry to record this purchase?

Answer 31

Debit purchases
Credit accounts payable

Question 32

In a perpetual inventory system, the cost of purchases is debited to:
a. Purchases.
b. Cost of goods sold.
c. Inventory.
d. Accounts payable.

Answer 32

c. Inventory.

Make sure you know the journal entries for a perpetual and periodic inventory system.

Question 33

In a periodic inventory system, the cost of purchases is debited to:
a. Purchases.
b. Cost of goods sold.
c. Inventory.
d. Accounts payable.

Answer 33

a. Purchases.

Make sure you know the journal entries for a perpetual and periodic inventory system.

Question 34

In a perpetual inventory system, the cost of inventory sold is:
a. Debited to accounts receivable.
b. Credited to cost of goods sold.
c. Debited to cost of goods sold.
d. Not recorded at the time goods are sold.

Answer 34

c. Debited to cost of goods sold.

Question 35

In a perpetual inventory system, which of the following is recorded at the time of the sale?
a. Sales revenue only.
b. Both sales revenue and cost of goods sold.
c. Cost of goods sold only.
d. Neither sales revenue or cost of goods sold.

Answer 35

b. Both sales revenue and cost of goods sold.

Question 36

In a periodic inventory system, the cost of inventories sold is:
a. Debited to accounts receivable.
b. Credited to cost of goods sold.
c. Debited to cost of goods sold.
d. Not recorded at the time goods are sold.

Answer 36

d. Not recorded at the time goods are sold.

Question 37

One difference between periodic and perpetual inventory systems is:
a. Cost of goods sold is not recorded under a perpetual system until the end of the period.
b. Cost of goods sold is not recorded under a periodic system until the end of the period.
c. Cost of goods sold is always significantly higher under a perpetual system.
d. Cost of goods sold is always significantly higher under a periodic system.

Answer 37

b. Cost of goods sold is not recorded under a periodic system until the end of the period.

Question 38

On January 10, a company purchased $5,000 of inventory on terms 1/10, net 30. Payment was made on January 18. The company uses the periodic system.

What is the journal entries to record the purchase and the payment using the gross method?

Answer 38

Jan 10 debit purchases for $5,000; credit accounts payable for $5,000
Jan 18 debit accounts payable for $5,000; credit cash for $4,950; credit purchase discounts for $50

Accounting Rule: The gross method records purchase at full price without regard to the cash discounts offered. In other words, the gross method assumes that the customer will not take advantage of the cash or early payment discount.

Question 39

On January 10, a company purchased $5,000 of inventory on terms 1/10, net 30. Payment was made on January 18. The company uses the periodic system.

What is the journal entries to record the purchase and the payment using the net method?

Answer 39

Jan 10 debit purchases for $4,950; credit accounts payable for $4,950
Jan 18 debit accounts payable for $4,950; credit cash for $4,950

Accounting Rule: The net method records the purchase net of the cash discount. In other words, the net method assumes that the customer will take advantage of the cash or early payment discount.

Question 40

On January 10, a company purchased $5,000 of inventory on terms 1/10, net 30. Payment was made on January 30. The company uses the periodic system.

What is the journal entries to record the purchase and the payment using the net method?

Answer 40

Jan 10 debit purchases for $4,950; credit accounts payable for $4,950
Jan 18 debit accounts payable for $4,950; debit purchase discounts lost $50; credit cash for $5,000

Accounting Rule: The failure to take the discount within the discount period is recorded in a purchase discounts lost account and reported in the “other expenses and losses” section of the income statement.

Question 41

On the first day of a period, $20,000 of purchases were made on an account with terms 2/10, n/30. The company uses the gross method and has the following payment history:

• $10,000 was paid on day 5
• $4,000 was paid on day 9
• $6,000 was paid on day 28

What is the total amount of purchase discounts at the end of the 30-day period?

Answer 41

$280 = ($10,000 x 2%) + ($4,000 x 2%)

Make sure you fully understand the gross and net method for recording purchase discounts.

Question 42

A company purchased dresses on July 17th and received an invoice with a list price amount of $6,000 and payment terms of 2/10, n/30. The company uses the net method to record purchases. The company should record the purchase at
a. $5,940.
b. $5,880.
c. $6,000.
d. $6,120.

Answer 42

b. $5,880.

$5,880 = $6,000 – ($6,000 x 2%)

Question 43

The following information is available for a company that uses a perpetual inventory system:

October 1: Beginning inventory consisted of 300 units at a cost of $5 each.
October 5: 200 units were sold for $12 each.
October 15: 250 units were purchased at a cost of $6 each.
October 21: 75 units were purchased at a cost of $7 each.
October 25: 150 units were sold for $15 each.

What is the cost of goods sold and ending inventory using the last-in, first-out (LIFO) method?

Answer 43

$1,975 = CGS: (75 x $7) + (75 x $6) + (200 x $5). $1,550 = Ending Inventory: (175 x $6) + (100 x $5)

Accounting Rule: LIFO is the acronym for last-in, first-out, which is a cost flow assumption. Under LIFO, the most recent costs of products purchased (or manufactured) are the first costs to be removed from inventory and matched with the sales revenues reported on the income statement. This means that the oldest costs remain in inventory.

Question 44

The following information is available for a company that uses a perpetual inventory system:

October 1: Beginning inventory consisted of 300 units at a cost of $5 each.
October 5: 200 units were sold for $12 each.
October 15: 250 units were purchased at a cost of $6 each.
October 21: 75 units were purchased at a cost of $7 each.
October 25: 150 units were sold for $15 each.

What is the cost of goods sold and ending inventory using the first-in, first-out (FIFO) method?

Answer 44

$1,800 = CGS: (200 x $5) + (100 x $5) + (50 x $6).

$1,725 = Ending Inventory: (200 x $6) + (75 x $7)

Accounting Rule: FIFO is the acronym for first-in, first-out, which is a cost flow assumption. Under FIFO, the older costs of products purchased (or manufactured) are the first costs to be removed from inventory and matched with the sales revenues reported on the income statement. This means that the most recent costs remain in inventory.

Question 45

A company uses the periodic inventory system and the last-in, first-out (LIFO) cost flow assumption method to account for inventory.

The following information is given:

What is the cost of goods sold (COGS) and the value of ending inventory for January 2019?

Answer 45

COGS = $5,250; ending inventory = $7,950. A total of 600 units were sold (250 + 350) so COGS is $5,250 = (300 x $9) + (300 x $8.50). There are a total of 1,000 in ending inventory (200 + 500 - 250 + 600 + 300 - 350) so ending inventory is $7,950 = (300 x $8.50) + (500 x $8) + (200 x $7).

Accounting Rule: The LIFO method of inventory valuation for a periodic inventory system assumes that the last items purchased are used to value the items sold and the earliest items purchased are used to value ending inventory.

Question 46

A company uses the periodic inventory system and the first-in, first-out (FIFO) cost flow assumption method to account for inventory.
The following information is given:

What is the cost of goods sold (COGS) and the value of ending inventory for January 2019?

Answer 46

COGS = $4,600; ending inventory = $8,600. A total of 600 units were sold (250 + 350) so COGS is $5,250 = (200 x $7) + (400 x $8.00). There are a total of 1,000 in ending inventory (200 + 500 - 250 + 600 + 300 - 350) so ending inventory is $8,600 = (100 x $8) + (600 x $8.50) + (300 x $9).

Accounting Rule: The FIFO method of inventory valuation for a periodic inventory system assumes that the earliest items purchased are used to value the items sold and the last items purchased are used to value ending inventory.

Question 47

A company is an online retailer that sells video game equipment. The figure below shows the company’s beginning inventory and purchases of game controllers during the year ended December 31, 2018.

As shown below, the company sold 7,000 controllers to various customers during the year. The retail price of each controller was $60.

What is the company’s ending inventory and cost of goods sold for the year ended December 31, 2018, using the periodic weighted average method?

Answer 47

COGS = $227,500; ending inventory = $65,000. A total of 9,000 units were purchased at a total cost of $292,500 ((1,000 x $30) + (1,000 x $31) + (2,000 x $32) + (3,000 x $33) + (1,500 x $34) + (500 x $35)) for an average unit cost of $32.50 = ($292,500 / 9,000). So COGS is $227,500 = (7,000 x $32.50) . There are a total of 2,000 in ending inventory (9,000 – 7,000)) so ending inventory is $65,000 = (2,000 x $32.50).

Accounting Rule: When using the weighted average method in a periodic inventory system, cost of goods available for sale is divided by the number of units available for sale, which yields the weighted-average cost per unit. The cost of goods available for sale is the sum of beginning inventory and net purchases. This weighted average figure is then used to assign a cost to both ending inventory and cost of goods sold.

Question 48

A company using the moving-average method has the following information for a month:

• no beginning inventory
• purchases of 10,000 units at $1 per unit in the first week
• purchases of 15,000 units at $1.50 per unit in the third week
• purchase of 12,000 units at $1.40 per unit and sales of 13,000 units on the last day of the month

What is this month’s ending balance in the inventory account, rounded to the nearest hundred?

Answer 48

$32,000

Question 49

As of March 1, a company had an inventory balance of $100,000. During March, purchases were $40,000, and inventory was sold for $50,000 that had an original purchase price of $30,000. The company uses a perpetual inventory system.

What is the amount in the inventory account as of March 31st?

Answer 49

$110,000 = $100,000 + $40,000 - $30,000

Accounting Rule: To calculate the ending balance in inventory, start with the beginning add purchases and subtract the goods sold using their cost value.

Question 50

As of March 1, a company had an inventory balance of $100,000. During March, purchases were $40,000, and inventory was sold for $50,000 that had an original purchase price of $30,000. The company uses a perpetual inventory system.

What was the amount transferred from the inventory account to the cost of goods sold account during March?

Answer 50

$30,000
The company sold inventory with an original cost of $30,000. The journal entry to record the sale is
Debit cost of goods sold 30,000
Credit inventory 30,000

The journal entry to record the sale assuming it was on account is
Debit A/R 50,000
Credit Sales 50,000

Question 51

A company has the following information related to its ending inventory:

• owned inventory on shelves: $20,000
• goods out on consignment: $50,000
• goods purchased and in transit free on board (FOB) destination: $10,000
• goods sold and in transit free on board (FOB) destination: $5,000

What amount is included as the final inventory value for this company?

Answer 51

$75,000 = $20,000 + $50,000 + $5,000

Accounting Rule: In a FOB destination, the seller retains title of ownership until the product reaches the buyer’s location. In a consignment, the seller retains title of ownership until the product is sold.

Question 52

A company has the following information related to its ending inventory:

• owned inventory on shelves: $20,000
• goods out on consignment: $50,000
• goods purchased and in transit free on board (FOB) shipping point: $10,000
• goods sold and in transit free on board (FOB) shipping point: $5,000

What amount is included as the final inventory value for this company?

Answer 52

$80,000 = $20,000 + $50,000 + $10,000

Accounting Rule: In a FOB shipping point, the seller transfers title of ownership to the buyer upon the product leaving the seller’s location. In a consignment, the seller retains title of ownership until the product is sold.

Question 53

A buyer purchased goods f.o.b. destination. The goods are in transit.

Where should the buyer include the goods on the balance sheet?
a. accounts payable.
b. inventory.
c. equipment.
d. not on the balance sheet.

Answer 53

d. not on the balance sheet.

Accounting Rule: Goods in transit that were purchased FOB destination are not included in the balance sheet of the purchaser. The seller retains title of ownership until the goods reach the purchaser’s location.

Question 54

What is consigned inventory?
a. goods that are shipped, but title transfers to the receiver.
b. goods that are sold, but payment is not required until the goods are sold.
c. goods that are shipped, but title remains with the consignor.
d. goods that have been segregated for shipment to a customer.

Answer 54

c. goods that are shipped, but title remains with the consignor.

Accounting Rule: In a consignment, the seller (consignor) retains title of ownership until the product is sold.

Question 55

Goods in transit which are shipped f.o.b. shipping point should be
a. included in the inventory of the seller.
b. included in the inventory of the buyer.
c. included in the inventory of the shipping company.
d. none of these answer choices are correct.

Answer 55

b. included in the inventory of the buyer.

Accounting Rule: In a FOB shipping point, the seller transfers title of ownership to the buyer upon the product leaving the seller’s location.

Question 56

Goods in transit which are shipped f.o.b. destination should be
a. included in the inventory of the seller.
b. included in the inventory of the buyer.
c. included in the inventory of the shipping company.
d. None of these answers are correct.

Answer 56

a. included in the inventory of the seller.

Accounting Rule: In a FOB destination, the seller retains title of ownership until the product reaches the buyer’s location.

Question 57

Goods on consignment are
a. included in the consignee’s inventory.
b. included in the consignor’s inventory.
c. included in the consignee’s revenue.
d. included in both the consignee’s and the consignor’s inventory.

Answer 57

b. included in the consignor’s inventory.

Accounting Rule: In a consignment, the seller (consignor) retains title of ownership until the product is sold.

Question 58

Company A received a $6,000 shipment of inventory designated free on board (FOB) shipping point on November 1. The details for the shipment include the following:

• Shipment was in transit on October 31.
• The shipping costs were $200.
• Company A added $3,000 in direct labor to complete the finished product.

How much should be included in Company A’s October 31 inventory?

Answer 58

$6,200 = $6,000 + $200

Accounting Rule: In a FOB shipping point, the seller transfers title of ownership to the buyer upon the product leaving the seller’s location. Shipping costs, freight-in is also included. The direct labor is not because it occurred after October 31st.

Question 59

A company is analyzing its inventory and wants to apply the lower-of-cost-or-market rule to the value of its inventory given below:

What is the inventory adjustment for the period assuming this company applies the lower-of-cost-or-market rule to the total amount of inventory?

Answer 59

$2,000 ($36,000 - $34,000); total cost = $36,000; total replacement costs = $34,000; total net realizable value = $39,000; total net realizable value less a normal profit margin = $32,000

Accounting Rule: Normally, ending inventory is stated at historical cost. However, there are times when the original cost of the ending inventory is greater than the net realizable value (market value), and thus the inventory has lost value. If the inventory has decreased in value below historical cost, then its carrying value is reduced and reported on the balance sheet.
The term “lower of cost or market” is now obsolete and is officially replaced by “lower of cost and net realizable value” for companies that use the FIFO (first-in, first-out) and average-cost inventory valuation methods. Companies that use the LIFO (last-in, first-out) inventory valuation method still use “lower of cost or market”.
The market value can be replacement cost, net realizable value (ceiling) or floor.
The net realizable value (NRV) is the expected selling price of an item minus any selling costs or costs to complete the item. The floor is the NRV minus a normal profit on the item. Normal profit is calculated by taking sales value times normal gross profit percentage.
The middle value becomes the designated market value and is compared to historical cost. The lower of these two amounts becomes the inventory value.
The amount by which the inventory item is written down is recorded under cost of goods sold if nonmaterial or loss beneath gross profit on the income statement if material.
The lower of cost or market (LCM) can be applied to the entire inventory, or group of inventory items, or individual inventory items.

Question 60

A company is analyzing its inventory and wants to apply the lower-of-cost-or-market rule to the value of its inventory given below:

What is the inventory value for Groups 1 and 2 applying the lower-of-cost-or-market rule?

Answer 60

Group 1: $25,000 = total cost = $25,000; total replacement costs = $26,000; total net realizable value = $30,000; total net realizable value less a normal profit margin = $27,000
Group 2: $9,000 = total cost = $11,000; total replacement costs = $9,000; total net realizable value = $10,000; total net realizable value less a normal profit margin = $7,000

Accounting Rule: Normally, ending inventory is stated at historical cost. However, there are times when the original cost of the ending inventory is greater than the net realizable value (market value), and thus the inventory has lost value. If the inventory has decreased in value below historical cost, then its carrying value is reduced and reported on the balance sheet.
The term “lower of cost or market” is now obsolete and is officially replaced by “lower of cost and net realizable value” for companies that use the FIFO (first-in, first-out) and average-cost inventory valuation methods. Companies that use the LIFO (last-in, first-out) inventory valuation method still use “lower of cost or market”.
The market value can be replacement cost, net realizable value (ceiling) or floor.
The net realizable value (NRV) is the expected selling price of an item minus any selling costs or costs to complete the item. The floor is the NRV minus a normal profit on the item. Normal profit is calculated by taking sales value times normal gross profit percentage.
The middle value becomes the designated market value and is compared to historical cost. The lower of these two amounts becomes the inventory value.
The amount by which the inventory item is written down is recorded under cost of goods sold if nonmaterial or loss beneath gross profit on the income statement if material.
The lower of cost or market (LCM) can be applied to the entire inventory, or group of inventory items, or individual inventory items.

Question 61

A company is analyzing its inventory and wants to apply the lower-of-cost-or-market rule to the value of its inventory given below:

What is the inventory value for items A, B, C, and D applying the lower-of-cost-or-market rule?

Answer 61

A: $10,000
B: $13,000
C: $5,000
D: $4,000

Accounting Rule: Normally, ending inventory is stated at historical cost. However, there are times when the original cost of the ending inventory is greater than the net realizable value (market value), and thus the inventory has lost value. If the inventory has decreased in value below historical cost, then its carrying value is reduced and reported on the balance sheet.
The term “lower of cost or market” is now obsolete and is officially replaced by “lower of cost and net realizable value” for companies that use the FIFO (first-in, first-out) and average-cost inventory valuation methods. Companies that use the LIFO (last-in, first-out) inventory valuation method still use “lower of cost or market”.
The market value can be replacement cost, net realizable value (ceiling) or floor.
The net realizable value (NRV) is the expected selling price of an item minus any selling costs or costs to complete the item. The floor is the NRV minus a normal profit on the item. Normal profit is calculated by taking sales value times normal gross profit percentage.
The middle value becomes the designated market value and is compared to historical cost. The lower of these two amounts becomes the inventory value.
The amount by which the inventory item is written down is recorded under cost of goods sold if nonmaterial or loss beneath gross profit on the income statement if material.
The lower of cost or market (LCM) can be applied to the entire inventory, or group of inventory items, or individual inventory items.

Question 62

A company is analyzing its inventory and wants to apply the lower-of-cost-or-market rule to the value of its inventory given below:

Inventory sales value $ 120,000
Cost to complete for sale $ 15,000
Inventory costs $ 84,000
Replacement costs $ 82,000
Normal profit margin 30%

What inventory value should this company report for the period?

Answer 62

$82,000

NRV (ceiling) = $120,000 - $15,000 = $105,000
Floor = $105,000 – ($120,000 x 30%) = $69,000
Replacement = $82,000

The middle value is replacement cost ($82,000) and becomes the designated market value.

This value ($82,000) is compared to cost ($84,000) and the lower of becomes the inventory value.

Question 63

A company has inventory with a sales value of $5,000 that requires $1,000 of cost to complete. The company’s normal profit margin is 10%. What are the ceiling and floor values
Ceiling Floor
a. $5,000 $4,000
b. $5,000 $4,500
c. $4,000 $3,600
d. $4,000 $3,500

Answer 63

d. $4,000 $3,500

NRV (ceiling) = sales value minus cost to complete ($5,000 - $1,000)
Floor = NRV (ceiling) – normal profit margin ($4,000 – ($5,000 x 10%))

Question 64

A company determined its year-end inventory is $600,000. Information pertaining to that inventory is as follows:

Selling price		$720,000
Costs to sell		  $30,000
Norman profit margin	  $80,000
Replacement cost	$620,000

What is the reported value of the company’s inventory
a. $600,000.
b. $620,000.
c. $690,000.
d. $610,000.

Answer 64

a. $600,000.

NRV = $720,000 − $30,000 = $690,000
NRV – NPM = $690,000 – $80,000 = $610,000
Designated market = $620,000

Cost of $600,000 is lower than designated market of $620,000

Question 65

Which of the following is the formula for the inventory turnover rate?
a. net sales/cost of goods sold.
b. cost of goods sold/average inventory.
c. cost of goods sold/ending Inventory.
d. average inventory/cost of goods sold.

Answer 65

b. cost of goods sold/average inventory.

Question 66

A company currently uses a periodic inventory system and reports the following activity for a month:

• beginning inventory: 500 units at $10 per unit
• mid-month purchases: 300 units at $12 per unit
• mid-month sales: 200 units at $22 per unit
• end-of-month purchases: 400 units at $13 per unit
• end-of-month sales: 100 units at $25 per unit

Which method will produce the highest ending inventory if the 300 units sold came from the mid-month purchases?
a. Specific identification .
b. Weighted average.
c. Last-in, first-out.
d. First-in, first-out.

Answer 66

d. First-in, first-out.

Accounting Rule: When prices are rising, FIFO results in the highest net income, highest ending inventory valuation, and lowest cost of goods sold. On the other hand, LIFO results in the lowest net income, lowest ending inventory valuation, and highest cost of goods sold when prices are rising.
Remember that FIFO uses the oldest unit costs to calculate cost of goods sold and the most recently purchased inventory unit costs to calculate ending inventory. LIFO uses the most recently purchased inventory unit costs to calculate cost of goods sold and the oldest unit costs to calculate ending inventory.

Question 67

In a period when costs are rising, and inventory quantities are stable, the lowest taxable income would be reported by using the inventory method of
a. average cost.
b. last-in, first-out.
c. first-in, first-out.
d. specific identification.

Answer 67

b. last-in, first-out.

Accounting Rule: When prices are rising, and inventory quantities are stable, net income is lower under LIFO because the most recent inventory purchases are included in the determination of cost of goods sold.
LIFO provides a better match of expenses with revenues, lower inventory valuation, lower tax liability resulting in deferral of income taxes, improves cash flows, margin reduction, and earnings are not vulnerable to future price decreases.

Question 68

In a period when costs are rising, and inventory quantities are stable, the inventory method that would result in the lowest ending inventory is:
a. average cost.
b. specific identification.
c. first-in, first-out.
d. last-in, first-out.

Answer 68

d. last-in, first-out.

Accounting Rule: When prices are rising, and inventory quantities are stable, net income is lower under LIFO because the most recent inventory purchases are included in the determination of cost of goods sold.
LIFO provides a better match of expenses with revenues, lower inventory valuation, lower tax liability resulting in deferral of income taxes, improves cash flows, margin reduction, and earnings are not vulnerable to future price decreases.