CFA 29: Quiz 8

Carrying inventory at a value above its historical cost would most likely be permitted if: the inventory was held by a producer of agricultural products. financial statements were prepared using US GAAP. the change resulted from a reversal of a previous write-down.

A is correct. IFRS allow the inventories of producers and dealers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products to be carried at net realisable value even if above historical cost. (US GAAP treatment is similar.)

Fernando's Pasta purchased inventory and later wrote it down. The current net realisable value is higher than the value when written down. Fernando's inventory balance will most likely be: higher if it complies with IFRS. higher if it complies with US GAAP. the same under US GAAP and IFRS.

A is correct. IFRS require the reversal of inventory write-downs if net realisable values increase; US GAAP do not permit the reversal of write-downs.

For questions 6-17, assume the companies use a periodic inventory system. Nutmeg, Inc. uses the LIFO method to account for inventory. During years in which inventory unit costs are generally rising and in which the company purchases more inventory than it sells to customers, its reported gross profit margin will most likely be: lower than it would be if the company used the FIFO method. higher than it would be if the company used the FIFO method. about the same as it would be if the company used the FIFO method.

A is correct. LIFO will result in lower inventory and higher cost of sales in periods of rising costs compared to FIFO. Consequently, LIFO results in a lower gross profit margin than FIFO.

For questions 6-17, assume the companies use a periodic inventory system. Zimt AG wrote down the value of its inventory in 2007 and reversed the write-down in 2008. Compared to the results the company would have reported if the write-down had never occurred, Zimt's reported 2008: profit was overstated. cash flow from operations was overstated. year-end inventory balance was overstated.

A is correct. The reversal of the write-down shifted cost of sales from 2008 to 2007. The 2007 cost of sales was higher because of the write-down, and the 2008 cost of sales was lower because of the reversal of the write-down. As a result, the reported 2008 profits were overstated. Inventory balance in 2008 is 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.

For questions 6-17, assume the companies use a periodic inventory system. Carey Company adheres to US GAAP, whereas Jonathan Company adheres to IFRS. It is least likely that: Carey has reversed an inventory write-down. Jonathan has reversed an inventory write-down. Jonathan and Carey both use the FIFO inventory accounting method.

A is correct. US GAAP do not permit inventory write-downs to be reversed.

For questions 6-17, assume the companies use a periodic inventory system. Zimt AG uses the FIFO method, and Nutmeg Inc. uses the LIFO method. Compared to the cost of replacing the inventory, during periods of rising prices, the cost of sales reported by: Zimt is too low. Nutmeg is too low. Nutmeg is too high.

A is correct. Zimt uses the FIFO method, so its cost of sales represents units purchased at a (no longer available) lower price. Nutmeg uses the LIFO method, so its cost of sales is approximately equal to the current replacement cost of inventory.

For questions 6-17, assume the companies use a periodic inventory system. Cinnamon Corp. started business in 2007 and uses the weighted average cost method. During 2007, it purchased 45,000 units of inventory at €10 each and sold 40,000 units for €20 each. In 2008, it purchased another 50,000 units at €11 each and sold 45,000 units for €22 each. Its 2008 cost of sales (€ thousands) was closest to: €490. €491. €495.

B is correct. Cinnamon uses the weighted average cost method, so in 2008, 5,000 units of inventory were 2007 units at €10 each and 50,000 were 2008 purchases at €11. The weighted average cost of inventory during 2008 was thus (5,000 × 10) + (50,000 × 11) = 50,000 + 550,000 = €600,000, and the weighted average cost was approximately €10.91 = €600,000/55,000. Cost of sales was €10.91 × 45,000, which is approximately €490,950.

For questions 6-17, assume the companies use a periodic inventory system. Like many technology companies, TechnoTools operates in an environment of declining prices. Its reported profits will tend to be highest if it accounts for inventory using the: FIFO method. LIFO method. weighted average cost method.

B is correct. In a declining price environment, the newest inventory is the lowest-cost inventory. In such circumstances, using the LIFO method (selling the newer, cheaper inventory first) will result in lower cost of sales and higher profit.

For questions 6-17, assume the companies use a periodic inventory system. Compared to using the weighted average cost method to account for inventory, during a period in which prices are generally rising, the current ratio of a company using the FIFO method would most likely be: lower. higher. dependent upon the interaction with accounts payable.

B is correct. In a rising price environment, inventory balances will be higher for the company using the FIFO method. Accounts payable are based on amounts due to suppliers, not the amounts accrued based on inventory accounting.

Mustard Seed PLC adheres to IFRS. It recently purchased inventory for €100 million and spent €5 million for storage prior to selling the goods. The amount it charged to inventory expense (€ millions) was closest to: €95. €100. €105.

B is correct. Inventory expense includes costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. It does not include storage costs not required as part of production.

For questions 6-17, assume the companies use a periodic inventory system. Compared to a company that uses the FIFO method, during periods of rising prices a company that uses the LIFO method will most likely appear more: liquid. efficient. profitable.

B is correct. LIFO will result in lower inventory and higher cost of sales. Gross margin (a profitability ratio) will be lower, the current ratio (a liquidity ratio) will be lower, and inventory turnover (an efficiency ratio) will be higher.

For questions 6-17, assume the companies use a periodic inventory system. Zimt AG uses the FIFO method, and Nutmeg Inc. uses the LIFO method. Compared to the cost of replacing the inventory, during periods of rising prices the ending inventory balance reported by: Zimt is too high. Nutmeg is too low. Nutmeg is too high.

B is correct. Nutmeg uses the LIFO method, and thus some of the inventory on the balance sheet was purchased at a (no longer available) lower price. Zimt uses the FIFO method, so the carrying value on the balance sheet represents the most recently purchased units and thus approximates the current replacement cost.

For questions 6-17, assume the companies use a periodic inventory system. Compared to using the FIFO method to account for inventory, during periods of rising prices, a company using the LIFO method is most likely to report higher: net income. cost of sales. income taxes.

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

Eric's Used Book Store prepares its financial statements in accordance with IFRS. Inventory was purchased for £1 million and later marked down to £550,000. One of the books, however, was later discovered to be a rare collectible item, and the inventory is now worth an estimated £3 million. The inventory is most likely reported on the balance sheet at: £550,000. £1,000,000. £3,000,000.

B is correct. Under IFRS, the reversal of write-downs is required if net realisable value increases. The inventory will be reported on the balance sheet at £1,000,000. The inventory is reported at the lower of cost or net realisable value. Under US GAAP, inventory is carried at the lower of cost or market value. After a write-down, a new cost basis is determined and additional revisions may only reduce the value further. The reversal of write-downs is not permitted.

For questions 6-17, assume the companies use a periodic inventory system. Zimt AG wrote down the value of its inventory in 2007 and reversed the write-down in 2008. Compared to the ratios that would have been calculated if the write-down had never occurred, Zimt's reported 2007: current ratio was too high. gross margin was too high. inventory turnover was too high.

C is correct. The write-down reduced the value of inventory and increased cost of sales in 2007. The higher numerator and lower denominator mean that the inventory turnover ratio as reported was too high. Gross margin and the current ratio were both too low.

Inventory cost is least likely to include: production-related storage costs. costs incurred as a result of normal waste of materials. transportation costs of shipping inventory to customers.

C is correct. Transportation costs incurred to ship inventory to customers are an expense and may not be capitalized in inventory. (Transportation costs incurred to bring inventory to the business location can be capitalized in inventory.) Storage costs required as part of production, as well as costs incurred as a result of normal waste of materials, can be capitalized in inventory. (Costs incurred as a result of abnormal waste must be expensed.)

For questions 6-17, assume the companies use a periodic inventory system. Zimt AG started business in 2007 and uses the FIFO method. During 2007, it purchased 45,000 units of inventory at €10 each and sold 40,000 units for €20 each. In 2008, it purchased another 50,000 units at €11 each and sold 45,000 units for €22 each. Its 2008 ending inventory balance (€ thousands) was closest to: €105. €109. €110.

C is correct. Zimt uses the FIFO method, and thus the first 5,000 units sold in 2008 depleted the 2007 inventory. Of the inventory purchased in 2008, 40,000 units were sold and 10,000 remain, valued at €11 each, for a total of €110,000.