Chapter 5

Average Number of Days To Sell Inventory

365/inventory turnover

Which inventory cost flow method will produce the highest income and asset values in an inflationary environment

FIFO

Assume that the amount of ending inventory is overstated in Year 1. Further assume the overstatement in Year 1 is not discovered and the ending inventory in Year 2 is reported accurately. Under these circumstances,

the Year 2 ending balance in retained earnings will be accurate.

Four acceptable methods for determining the amount of cost to transfer (product cost flow method):

1. Specific identification; 2. first-in, first-out (FIFO); 3. Last-in, first-out (LIFO); and weighted average.

Which of the following formulas is used to calculate the number of days to sell inventory?

365 ÷ Inventory turnover

Which of the following statements is true?

A high inventory turnover ratio produces a low number of days to collect inventory.

Lower-of-Cost-or-Market Rule

Accounting principle of reporting inventory at its replacement cost (market) if replacement cost has declined below the inventory's original cost, regardless of the cause.

Inventory Cost Flow Methods

Alternative ways to allocate the cost of goods available for sale between cost of goods sold and ending inventory.

Assume a company paid $800 for a computer that it plans to sell to its customers. Suppose that as a result of new technology the company could buy the same computer today for $600. Which of the following journal entries would be required to show the inventory at the lower of cost or market?

COGS $200 (DEBIT); Inventory $200 (CREDIT)

Which of the following formulas is used to calculate the inventory turnover ratio?

Cost of goods sold ÷ Inventory

Inventory Turnover

Cost of goods sold/average inventory

Financial statement analysis is not affected by the inventory cost flow method used by a company.

False

GAAP requires that inventory be shown on the balance sheet at its cost (the price paid) regardless of its current value

False

GAAP requires that inventory be shown on the balance sheet at its cost (the price paid) regardless of its current value. This statement is

False

First-In, First-Out (FIFO)

Inventory cost flow method in which cost of goods sold is computed as if the earliest items purchased are the first sold.

Last-In, First-Out (LIFO)

Inventory cost flow method in which cost of goods sold is computed as if the most recently purchased items are the first items sold.

Weighted-Average

Inventory cost flow method in which the cost allocated between inventory and cost of goods sold is based on the weighted average cost per unit, which is determined by dividing the total cost of goods available for sale during the accounting period by the total units available for sale during the period.

The cost flow method that will result in the lowest gross margin is

LIFO

Which of the following cost flow methods would provide the lowest amount of net income in an inflationary environment?

LIFO

Which of the following statements is true?

LIFO may be the preferred cost flow method even when its results in lower reported income and asset values

Physical Flow of Goods

Physical movement of goods through a business, normally on a FIFO basis so that the first goods purchased are the first goods delivered to customers, reducing the likelihood of inventory obsolescence.

Gross Margin Method

Technique for estimating the ending inventory amount without a physical count; useful when the percentage of gross margin to sales remains relatively stable from one accounting period to the next.

Full Disclosure

The accounting principle that financial statements should include all information relevant to an entity's operations and financial condition. Full disclosure frequently requires adding footnotes to the financial statements.

Which of the following would raise suspicion that a manager may be attempting to overstate net income by falsifying the physical count of ending inventory?

The amount of estimated inventory calculated using the gross margin method was lower than the amount determined by the physical count.

Consistency

The generally accepted accounting principle that a company should, in most circumstances, continually use the same accounting method(s) so that its financial statements are comparable across time.

Specific Identification

The inventory costing method in which cost of goods sold and ending inventory are computed using the actual costs of the specific goods sold or those on hand at the end of the period.

A company may use LIFO or weighted average for financial reporting even if its goods flow physically on a FIFO basis:

True

Because of its size, cost of goods sold normally has a significant impact on the amount of net income that is reported on the income statement. Since the reported balance in the inventory account has a direct effect on the amount of cost of goods sold, inventory manipulation is a target for unscrupulous managers seeking to control the amount of reported earnings. These statements are

True

The cash flow associated with buying and selling inventory is not affected by the inventory cost flow method. This statement is

True

The cash flow associated with buying and selling inventory is not effected by the inventory costs flow?

True

When sales and purchases occur intermittently, the cost of the items purchased is frequently at the time a sale occurs. Even so, companies can still use the perpetual inventory method

True

Which of the following industries is likely to have the highest number of days to sell inventory?

Wine producers

All other things being equal, the profitability is maximized when a company sells inventory with

a high gross margin per unit and a high inventory turnover.

Cost of goods available for sale is the amount of

beginning inventory plus all purchases made during an accounting period

When inventory is written down to comply with the lower of cost or market rule, total

cash flow from operating activities is not affected

When inventory is sold, inventory cost methods (FIFO, LIFO, weighted average) are used to determine how much cost to assign to

cost of goods sold

If the amount ending inventory is overstated, the amount of

cost of goods sold will be understated

If the amount of ending inventory is overstated, the amount of

cost of goods sold will be understated.

The inventory turnover ratio equals

cost of goods sold/average inventory

A key component of estimating the amount of ending inventory is to determine the gross margin percentage for prior years. The gross margin percentage is calculated by

dividing gross margin by net sales.

Cost of goods available for sale is allocated between

ending inventory and cost of goods sold

If cost of goods sold is intentionally understated,

ending inventory will be overstated

When inventory is written-down with the lower of cost or market rule, total

equity decreases

The journal entry to recognize the write down of inventory based on the lower of cost or market rule will

increase the amount of expenses.

The journal entry to recognize the write down of inventory based on the lower of cost or market rule will?

increase the amount of expenses.

The specific identification cost flow method is most likely to be used when the cost per unit of inventory

is high and sales volume is low

Other things being equal, a company would prefer that its average days to sell inventory be

low

If the amount of ending inventory is overstated, the amount of

net income will be overstated, total assets will be overstated, and retained earnings will be overstated.

To avoid the risk of fraud associated with inventory manipulation

the employee in charge of counting inventory should be different from the employee in charge of recording inventory transactions.

The gross margin method of estimating ending inventory is frequently used

to check the accuracy of a physical count of inventory on hand.