Chapter 8 - Valuation of Inventories: A Cost-Basis Approach

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Intermediate Accounting Chapter 8 -- Valuation of Inventories: A Cost-Basis Approach

Manufacturing companies have two inventory accounts: Work in Process and Finished Goods.

T or F

F
Manufacturing companies have three inventory accounts: Work in Process, Finished Goods and Raw Materials

Merchandising concerns report the cost assigned to unsold units left on hand as finished goods inventory.

T or F

F
Response: Merchandising firms call their unsold units Merchandise Inventory.

Which of the following would be included in the balance sheet of a merchandiser?


a. Work in Process Inventory.
b. Merchandise Inventory.
c. Raw Materials Inventory.
d. Finished Goods Inventory.

b. Merchandise Inventory

Only Merchandise Inventory would be included in the balance sheet of a merchandiser; the others are inventory accounts for a manufacturer.

Which of the following would not be included in a manufacturing company's balance sheet?

a. Finished goods inventory.
b. Merchandise inventory.
c. Raw materials inventory.
d. Work in process inventory.

b. Merchandise inventory

All of the options would be included in a manufacturer's balance sheet except merchandise inventory.

A physical inventory is only required at year-end if the company has a periodic inventory system.

T or F

F

Regardless of the type of inventory system used, the company should take a physical count of inventory at the end of the fiscal year.

Which of the following accounts does not exist in a perpetual inventory system?

a. Inventory.
b. Cost of Goods Sold.
c. Sales Returns and Allowances.
d. Purchases.

d. Purchases

The Purchases account exists in a periodic inventory system, not a perpetual inventory system.

All of the following accounts are used under a perpetual inventory system except:

a. Inventory.
b. Cost of Goods Sold.
c. Sales.
d. Purchase Discounts Lost.

d. Purchase Discounts Lost

The Purchase Discounts Lost account is only used in a periodic inventory system.

Under a perpetual which accounts should be debited the each time a sale on account is made?

a. Accounts Payable and Purchases.
b. Accounts Receivable and Purchases.
c. Accounts Receivable and Cost of Goods Sold.
d. Inventory and Cost of Goods Sold.

c. Accounts Receivable and Cost of Goods Sold.

When a sale on account is made under a perpetual inventory system, Accounts Receivable is debited for the selling price of the goods and Cost of Goods Sold is debited for the cost of the goods.

If ending inventory is overstated, net income, retained earnings and working capital are overstated in that period as well.

T or F

T

If ending inventory is overstated, cost of goods sold will be understated and thus net income and retained earnings are overstated. If a current asset account balance is overstated, working capital is overstated.

If the beginning inventory is overstated:

a. cost of goods sold is understated.
b. retained earnings is understated.
c. working capital is understated.
d. the current ratio is overstated.

b. retained earnings is understated.

If beginning inventory is overstated, cost of goods sold is overstated and net income and retained earnings are understated.

Drago Inc. is a calendar-year corporation. Its financial statements for the years 2012 and 2011 contained errors as follows:

2012:
Ending inventory $6,000 overstated
Depreciation expense $4,000 understated
2011:
Ending inventory $12,000 overstated
Depreciation expense $9,000 overstated

Assume that the proper correcting entries were made at December 31, 2011. By how much will 2012 income before taxes be overstated or understated?

a. $10,000 overstated
b. $2,000 understated
c. $5,000 overstated
d. $7,000 overstated

a. $10,000 overstated

Overstating ending inventory by $6,000 plus the understatement of depreciation expense by $4,000 overstates net income by $10,000. The 2011 errors are contained in retained earnings.

On December 30, Crane Co. accepted delivery of merchandise which it purchased on account. As of December 31, Crane had recorded the purchase, but did not include the merchandise in its physical count of ending inventory. The effect of this on its financial statements for December 31 would be


a. net income was correct and current assets were understated.
b. net income was understated and current liabilities were overstated.
c. net income was overstated and current assets were understated.
d. net income, current assets, and retained earnings were understated.

d. net income, current assets, and retained earnings were understated.

Through excessive cost of goods sold the net income is understated, therefore retained earnings is understated, and by the omission of the merchandise, inventory is also understated, a current asset.

Storage costs are usually included in the value of the inventory.

T or F

F

Because of the practical difficulties in allocating storage costs to inventory, these items are generally not included in valuing the inventory.

Interest incurred while getting inventories ready for sale is a product cost.

T or F

F

Interest is an indirect cost of financing and is thus treated as a period cost.

Both U.S. GAAP and IFRS permit the use of the LIFO method to account for inventories.

T or F

F

LIFO is not permitted under IFRS.

Which of the following should be not included in a company's ending inventory?

a. In-transit goods purchased and shipped FOB shipping point.
b. In-transit goods sold and shipped FOB destination.
c. Goods held on consignment.
d. Goods out on consignment.

c. Goods held on consignment.

The company does not have legal title to goods held on consignment and therefore should not include them in ending inventory.

When goods are shipped FOB shipping point, title passes to the buyer when the seller delivers the goods to a common carrier.

T or F

T

For goods shipped FOB destination, title does not pass until the buyer receives the goods from a common carrier.

A sale with a "buyback" agreement allows the seller to finance their inventory and retain the risks of ownership even though the technical title has been transferred.

T or F

T

The buyback agreement is a sales arrangement that includes an agreement to repurchase the goods at a specified price over a specified period of time.

Which of the following items should be included in a company's inventory at the balance sheet date?


a. Goods in transit which were purchased f.o.b. shipping point.
b. Goods received from another company for sale on consignment.
c. Goods sold to a customer that was shipped f.o.b. shipping point.
d. Goods sold to a customer that is being held for the customer to call for at his or her convenience.

a. Goods in transit which were purchased f.o.b. shipping point.

Goods in transit which were purchased f.o.b. shipping point should be included in the company's inventory.

Birmingham Corporation uses the perpetual inventory method. On May 1, it purchased $22,000 of inventory, terms 2/10, n/30. On May 3, Birmingham returned goods that cost $2,000. On May 9, Birmingham paid the supplier. On May 9, the company should credit

a. purchase discounts for $440.
b. inventory for $440.
c. inventory for $400.
d. purchase discounts for $400.

c. inventory for $400.

($22,000 - $2,000) X 2% = $400.

All of the following costs should be charged against revenue in the period in which the costs were incurred except for

a. costs from idle manufacturing capacity resulting from an unexpected plant shutdown.
b. costs of normal shrinkage and scrap incurred for the manufacture of a product in ending inventory.
c. manufacturing overhead costs for a product manufactured and sold in the same accounting period.
d. costs which will not benefit any future period.

b. costs of normal shrinkage and scrap incurred for the manufacture of a product in ending inventory.

All of the selections except for the costs of normal shrinkage and scrap incurred for the manufacture of a product in ending inventory should be charged to the current period expenses.

The buyer would report the inventory in its balance sheet for items:

a. received on consignment.
b. shipped f.o.b. destination and in transit.
c. purchased with a buyback agreement.
d. purchased f.o.b. shipping point and in transit.

d. purchased f.o.b. shipping point and in transit.

Inventory purchased f.o.b. shipping point and in transit should be included in the buyer's balance sheet.

Freight charges on goods sold are accounted for as:

a. manufacturing costs.
b. period costs.
c. variable costs.
d. product costs.

b. period costs.

Period costs include freight charges on goods sold.

The use of a Purchase Discounts Lost account implies that the recorded cost of a purchased inventory item is its

a. invoice price.
b. invoice price less the purchase discount taken.
c. invoice price plus the purchase discount lost.
d. invoice price less the purchase discount allowable whether taken or not.

d. invoice price less the purchase discount allowable whether taken or not.

A Discounts Lost account implies that the purchased inventory item is recorded at price less discount whether taken or not.

In a period of rising prices, LIFO will result in a higher income tax expense than FIFO.

T or F

F

LIFO will result in a lower net income and income tax expense because Cost of Goods Sold will be higher by including more recent costs.

Jamison Manufacturing Company has the following account balances at year end:

Office supplies $ 6,000
Raw materials 21,000
Work-in-process 44,000
Finished goods 52,000
Prepaid insurance 8,000

What amount should Jamison report as inventories in its balance sheet?

a. $123,000.
b. $52,000.
c. $117,000.
d. $96,000.

c. $117,000.

$21,000 + $44,000 + $52,000 = $117,000

An inventory pricing procedure in which the oldest costs incurred rarely have an effect on the ending inventory valuation is

a. base stock.
b. FIFO.
c. LIFO.
d. weighted-average.

b. FIFO.

Since FIFO charges the oldest costs to cost of goods sold, they have the least affect on the ending inventory valuation.

Jersey Company had 500 units of "CL-10" in its inventory at a cost of $4 each. It purchased, for $2,800, 300 more units of "CL-10". Jersey then sold 400 units at a selling price of $10 each, resulting in a gross profit of $1,600. The cost flow assumption used by Jersey

a. is weighted average.
b. cannot be determined from the information given.
c. is FIFO.
d. is LIFO.

a. is weighted average.

$2,000 for the first 500 "CL-10" units plus $2,800 for the second 300 "CL-10" units results in $4,800 for 800 "CL-10" units or $6 each as a weighted average. 400 units sold at a cost of $6 each results in a cost of goods sold of $2,400 which proves $4,000 less $2,400 equals a $1,600 gross profit.

An inventory method that makes it possible to manipulate net income is the:

a. specific identification method.
b. FIFO method.
c. LIFO method.
d. average cost method.

a. specific identification method.

One argument against specific identification is that it makes it possible to manipulate net income.

The ending inventory and cost of goods sold will be the same whether a perpetual or periodic system is used under the:

a. FIFO method.
b. weighted-average method.
c. moving-average method.
d. LIFO method.

a. FIFO method.

Under the FIFO method, ending inventory and cost of goods sold is the same whether a perpetual or periodic system is used.

In a period of rising prices, the inventory method that produces the lowest ending inventory is the:

a. LIFO perpetual method.
b. average cost method.
c. FIFO perpetual method.
d. LIFO periodic method.

d. LIFO periodic method.

In a period of rising prices, the LIFO method always produces the lowest ending inventory and LIFO periodic results in a lower inventory than LIFO perpetual.

Smiley Manufacturing Company has the following account balances at year end:

Office supplies $ 3,000
Raw materials 21,000
Work-in-process 32,000
Finished goods 46,000
Prepaid insurance 5,000

What amount should Smiley report as inventories in its balance sheet?

a. $46,000.
b. $78,000.
c. $99,000.
d. $104,000.

c. $99,000.

$21,000 + $32,000 + $ 46,000 = $99,000

A business whose inventory consists of similar items would be most likely to use which of the following cost flow assumptions?

a. Specific identification.
b. Average.
c. FIFO.
d. LIFO.

b. Average

The average method is used when an inventory consists of similar items.

Which cost flow assumption would be most appropriate when a relatively small number of costly, easily distinguishable items are sold?

a. Specific identification.
b. LIFO.
c. FIFO.
d. Average.

a. Specific identification

Specific identification is the most appropriate cost flow assumption to use in such circumstances.

When a company uses LIFO for external reporting purposes and FIFO for internal reporting purposes, an Allowance to Reduce Inventory to LIFO account is used. This account should be reported

a. on the income statement in the Other Revenues and Gains section.
b. on the income statement in the Cost of Goods Sold section.
c. on the income statement in the Other Expenses and Losses section.
d. on the balance sheet in the Current Assets section.

d. on the balance sheet in the Current Assets section.

This account should be reported on the balance sheet in the Current Assets section.

Halston Corporation uses the FIFO method for internal reporting purposes and LIFO for external reporting purposes. The balance in the LIFO Reserve account at the end of 2012 was $60,000. The balance in the same account at the end of 2013 is $90,000. Halston's Cost of Goods Sold account has a balance of $450,000 from sales transactions recorded during the year. What amount should Halston report as Cost of Goods Sold in the 2013 income statement?

a. $540,000.
b. $480,000.
c. $420,000.
d. $450,000.

b. $480,000.

$450,000 + ($90,000 - $60,000) = $480,000.

The change in the Allowance to Reduce Inventory to LIFO balance from one period to the next is called the LIFO

a. Reduction.
b. Reserve.
c. Allowance.
d. Effect.

d. Effect

The LIFO effect is the change in the allowance balance from one period to the next.

When a company uses LIFO for external reporting purposes and FIFO for internal reporting purposes, an Allowance to Reduce Inventory to LIFO account is used. This account should be reported:

a. on the income statement in the Other Expenses and Losses section.
b. on the income statement in the Cost of Goods Sold section.
c. on the balance sheet in the Current Assets section.
d. on the income statement in the Other Revenues and Gains section.

c. on the balance sheet in the Current Assets section.

The Allowance to Reduce Inventory to LIFO is a contra asset account. The amount would be deducted from the FIFO cost to reduce the Balance Sheet amount for inventory to its LIFO value.

Select the correct statement concerning LIFO liquidations from the following:

a. LIFO liquidations often distort net income and may result in substantial tax payments.
b. LIFO liquidations often distort net income and do not result in substantial tax payments.
c. LIFO liquidations seldom distort net income and do not result in substantial tax payments.
d. LIFO liquidations seldom distort nets income and may result in substantial tax payments.

a. LIFO liquidations often distort net income and may result in substantial tax payments.

LIFO liquidations often distort net income and may result in substantial tax payments.

An erosion of LIFO inventory layers is referred to as a LIFO

a. allowance.
b. reserve.
c. effect.
d. liquidation.

d. liquidation

A liquidation occurs when there is an erosion of LIFO inventory layers.

Which of the following statements is not true as it relates to the dollar-value LIFO inventory method?

a. Under the dollar-value LIFO method, it is possible to have the entire inventory in only one pool.
b. It is easier to erode LIFO layers using dollar-value LIFO techniques than it is with specific goods pooled LIFO.
c. Several pools are commonly employed in using the dollar-value LIFO inventory method.
d. Under dollar-value LIFO, increases and decreases in a pool are determined and measured in terms of total dollar value, not physical quantity.

b. It is easier to erode LIFO layers using dollar-value LIFO techniques than it is with specific goods pooled LIFO.

It is NOT easier to erode LIFO layers using dollar-value LIFO techniques than it is with specific goods pooled LIFO.

The method employed by most companies that use a LIFO system is:

a. specific goods LIFO.
b. specific goods pooled LIFO.
c. dollar-value LIFO.
d. weighted-average LIFO.

c. dollar-value LIFO.

The dollar-value LIFO method is the most commonly used LIFO method because it does the best job of protecting LIFO layers from erosion and is relatively simple to implement.

Under dollar-value LIFO each layer in ending inventory at LIFO cost is calculated by:

a. multiplying the layer at base-year prices by the price index for the year the layer was added.
b. multiplying the layer at current-year prices by the current year price index.
c. dividing the layer at current-year prices by the current year price index.
d. dividing the layer at base-year prices by base-year price index.

a. multiplying the layer at base-year prices by the price index for the year the layer was added.

Each year's layer is first expressed at base-year prices and then extended to current LIFO cost by multiplying by the year's price index.

Under the dollar-value LIFO method, increases and decreases in an inventory pool are determined and measured in terms of:

a. total dollar value.
b. physical quantity.
c. unit layers.
d. dollar value per unit.

a. total dollar value.

Increases and decreases in inventory pools are determined and measured in terms of total dollar value under the dollar-value LIFO method.

A new layer is formed under dollar-value LIFO when the ending inventory at:

a. end-of-year prices exceeds the beginning inventory at base-year prices.
b. end-of-year prices exceeds the beginning inventory at end-of-year prices.
c. base-year prices exceeds the beginning inventory at base-year prices.
d. current cost exceeds the beginning inventory at base-year cost.

c. base-year prices exceeds the beginning inventory at base-year prices.

Under dollar-value LIFO, a new layer is formed when the ending inventory exceeds the beginning inventory in base-year prices.

The approach employed by most companies that currently use the LIFO method is:

a. unit LIFO.
b. dollar-value LIFO.
c. specific goods LIFO.
d. specific goods pooled LIFO.

b. dollar-value LIFO.

Dollar-value LIFO is the method employed by most companies that use LIFO.

Ellis Company had January 1 inventory of $150,000 when it adopted dollar-value LIFO. During the year, purchases were $900,000 and sales were $1,500,000. December 31 inventory at year-end prices was $189,750, and the price index was 110. What is Ellis Company's gross profit?

a. $624,750.
b. $450,000.
c. $550,250.
d. $600,000.

a. $624,750

$1,500,000 - [{($150,000 * 110%) + $900,000} - $189,750] = $624,750

All of the following are major disadvantages of using LIFO, except:

a. future earnings will not be affected substantially by future price declines.
b. lower profits reported in inflationary times.
c. doesn't approximate the physical flow of inventory.
d. inventory is understated.

a. future earnings will not be affected substantially by future price declines.

Future earnings will increase if there are future price declines.

Which of the following is not considered an advantage of LIFO when prices are rising?

a. The more recent costs are matched against current revenues.
b. There will be a deferral of income tax.
c. A company's future reported earnings will not be affected substantially by future price declines.
d. The inventory will be overstated.

d. The inventory will be overstated.

Due to LIFO containing the oldest values possible, inventory is unlikely to be overstated.

Which of the following statements related to the LIFO method is incorrect?

a. LIFO is not appropriate in situations where specific identification is traditional.
b. LIFO is preferable if revenues have been increasing faster than costs.
c. LIFO is appropriate where prices tend to lag behind costs.
d. LIFO is preferable in situations where it has been traditional.

c. LIFO is appropriate where prices tend to lag behind costs.

LIFO would not be appropriate when prices lag behind costs.

If inventory levels are stable or increasing, an argument which is not an advantage of the LIFO method as compared to FIFO is

a. cost of goods sold tends to be stated at approximately current cost on the income statement.
b. income taxes tend to be reduced in periods of rising prices.
c. cost assignments typically parallel the physical flow of goods.
d. income tends to be smoothed as prices change over time.

c. cost assignments typically parallel the physical flow of goods.

If inventory levels are stable or increasing, an argument which is not an advantage of the LIFO method as compared to FIFO is cost assignments typically parallel the physical flow of goods.

All of the following are advantages of LIFO except

a. a deferral of income tax occurs as long as the price level increases.
b. an improvement of cash flow.
c. recent costs are matched against current revenues.
d. an approximation of the physical flow of goods is achieved.

d. an approximation of the physical flow of goods is achieved.

All of the options are advantages of LIFO except it does not approximate the physical flow of goods.

Which of the following statements related to the LIFO method is incorrect?

a. LIFO is preferable in situations where it has been traditional.
b. LIFO is appropriate where prices tend to lag behind costs.
c. LIFO is not appropriate in situations where specific identification is traditional.
d. LIFO is preferable if revenues have been increasing faster than costs.

b. LIFO is appropriate where prices tend to lag behind costs.

LIFO would not be appropriate when prices lag behind costs.

Both U.S. GAAP and IFRS exclude which of the following from the cost of inventory?

a. Most storage costs.
b. General administrative costs.
c. Selling costs.
d. All of these are excluded by U.S. GAAP and IFRS.

c. Selling costs.

Most storage costs, general administrative costs, and selling costs are excluded from the cost of inventory under both U.S. GAAP and IFRS.

Which of the following statements related to the FIFO method is incorrect?

a. FIFO is preferable if revenues have been increasing slower than costs.
b. FIFO is appropriate where prices tend to lead costs.
c. FIFO is not appropriate in situations where specific identification is traditional.
d. FIFO is not preferable in situations where it has been traditional.

b. FIFO is appropriate where prices tend to lead costs.

FIFO is NOT appropriate where prices tend to lead costs.

LIFO would be appropriate when prices charged to customers tend to lag behind costs paid to suppliers.

T or F

F

LIFO is most appropriate when prices do not lag behind costs; this allows a better matching of current costs with current revenues.

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