Intermediate Accounting I - Final Exam Review

Smith Company's inventory cost is $100. The expected sales price is $110, estimated selling costs are $6. The normal gross profit ratio is 20% of selling price. The replacement cost of the inventory is $106. Smith Company uses the LIFO inventory method so must use the lower of cost or market approach and this inventory item should be valued at

$100 Reason: Ceiling is NRV = $110 - 6 = $104. Floor is NRV less normal profit of 20% so $104 - 22 = $82. Replacement cost is $106. Market is the middle of these three values so = $104 compared to cost of $100. Cost is lower so record at cost.

Smith Company's inventory cost is $100. The expected sales price is $110, estimated selling costs are $6. The normal gross profit ratio is 20% of selling price. The replacement cost of the inventory is $102. Smith Company uses the LIFO inventory method so must use the lower of cost or market approach and this inventory item should be valued at

$100 Reason: Ceiling is NRV = $110 - 6 = $104. Floor is NRV less normal profit of 20% so $104 - 22 = $82. Replacement cost is $102. Market is the middle of these three values so = $102 compared to cost of $100. Cost is lower so record at cost.

Smith Company's inventory cost is $100. The expected sales price is $110, estimated selling costs are $6. Consistent with the lower of cost and net realizable value approach, this inventory item should be valued at

$100 Reason: Lower of cost and net realizable value is required. The NRV is $104, but the cost of $100 is lower.

Berta Company recently lost its entire inventory in a fire. The following information is available from its accounting records: Beginning inventory: $1,000; purchases: $13,000; net sales: $20,000. The company's average gross profit percentage is 40%. Using the gross profit method, a reasonable estimate of cost of goods sold for this past period would be

$12,000. Reason: $20,000 x (1 - 40%) = $12,000

Western Company recently lost its entire inventory in an earthquake. The following information is available from its accounting records: Beginning inventory: $5,000; purchases: $18,000; net sales: $40,000. The company's average gross profit percentage is 40%. Using the gross profit method, a reasonable estimate of cost of goods sold for this past period would be

$24,000. Reason: $40,000 x (1 - 40%) = $24,000

Linden Company has three inventory items. Utilizing the lower of cost and net realizable value rule, Linden determines the following: Item A: cost is $40; net realizable value is $20 Item B, cost is $10; net realizable value is $20 Item C, cost is $5; net realizable value is $10 If Linden applies the rule to its entire inventory, it should recognize a loss of

$5. Reason: Item A has a cost higher than net realizable value and B and C have a cost lower than NRV. -$20 + $10 + $5 = $5 loss. Total cost is $55, total NRV is $50

Smith Company's inventory cost is $100. The expected sales price is $110, estimated selling costs are $6. The normal gross profit ratio is 20% of selling price. The replacement cost of the inventory is $95. Smith Company uses the LIFO inventory method so must use the lower of cost or market approach and this inventory item should be valued at

$95 Reason: Ceiling is NRV = $110 - 6 = $104. Floor is NRV less normal profit of 20% so $104 - 22 = $82. Replacement cost is $95. Market is the middle of these three values so = $95 compared to cost of $100. Market is lower so record at market.

Feather Company's inventory is recorded at its historical cost of $100,000. The replacement cost currently is $95,000; estimated selling price is $102,000; estimated selling cost is $5,000; normal profit is $10,000. The estimated net realizable value of the inventory is

$97,000 Reason: $102,000 - $5,000

Jones Company's inventory cost is $100. The expected sales price is $110. The company estimates sales cost as 10% of the sales price. Consistent with the lower of cost and net realizable value approach, this inventory item should be valued at

$99. Reason: Lower of cost and net realizable value is required. The NRV is $110-11 = 99 and is lower than cost.

If gross profit is 30%, then what is the markup on cost?

42.86% Reason: =30%/(100%-30%)

Amber is in charge of preparing an annual budget for her company. As part of the budgeting process, she must estimate cost of goods sold and ending inventory. Which of the following statements is correct regarding the use of the gross profit method?

Amber may utilize the gross profit method to estimate ending inventory and cost of goods sold.

Which of the following require inventory to be valued at the lower of cost and net realizable value?

Both U.S. GAAP and IFRS

Which of the following statements regarding inventory valuation is correct?

Both U.S. GAAP and IFRS require that inventory is valued at the lower of cost or net realizable value.

Which of the following is correct regarding changes in accounting methods?

Changes are permitted if they are made in response to changes in the company's business environment.

The practice of recognizing decreases in inventory but not increases is consistent with what?

Conservatism

The retail inventory method can be modified to estimate which of the following using FIFO, LIFO, or average cost? (Select all that apply.)

Cost of goods sold Ending inventory

When inventory is adjusted down to reflect net realizable value, which of the following can occur? (Select all that apply.)

Debit cost of goods sold Credit inventory

True or false: Most changes in inventory method are accounted for prospectively.

False Reason: Changes in inventory method, other than a change to LIFO, are accounted for retrospectively.

True or false: Reversals of inventory write-downs are not permitted under either U.S. GAAP or IFRS.

False. Reason: Under IFRS, if an inventory write-down is no longer appropriate, it must be reversed.

Identify the accounting standard(s) that permit reversal of inventory value write-downs.

IFRS

When a material inventory error is discovered in a period subsequent to when the error was made, which of the following must occur? (Select all that apply.)

Incorrect balances are corrected. Previous year's financial statements are retrospectively restated. A correction of retained earnings is reported as a prior period adjustment.

Which of the following must be known to apply the retail inventory method? (Select all that apply.)

Inventory and purchases based on cost. Inventory and purchases based on retail value.

A special form must be filed with the IRS when a company intends to adopt the _____ inventory method.

LIFO

When a company changes to the _____ inventory method from any other method, it usually is impossible to calculate the income effect on prior years.

LIFO

The lower of cost or market approach is required under GAAP for companies that use _____.

LIFO or the retail inventory

Which of the following represents a criticism of the lower of cost and net realizable value rule?

Losses that have not actually occurred are recognized.

Which method can be applied to individual inventory items, categories of inventory, or the entire inventory?

Lower of cost or market and lower of cost and net realizable value

Which of the following inventory-related events typically cause financial statement misstatements? (Select all that apply.)

Mistakes in the cutoff relating to purchases of inventory. Mistakes in the physical count. Mistakes in pricing inventory quantities.

Correctly match the effect of each error with the specific error scenario.

Net income is overstated -> During the physical inventory, certain inventory items were double counted. Net income is understated. -> Inventory currently out on consignment was not included in the inventory count. Net income is not affected. -> A purchase in transit that was shipped f.o.b. shipping point was neither counted nor recorded.

When using the retail method to approximate average cost, the cost-to-retail percentage is applied to which goods?

Only the ending inventory

Ziegler Company properly applies the lower of cost and net realizable value rule and determines that its inventory value has declined below cost. Which of the following methods may Ziegler use to adjust its inventory to market value? (Select all that apply.)

Recognize the write-down as an addition to cost of goods sold. Recognize the write-down as a separate line item.

Smart Company rarely had to write down inventory. In the past, when inventory write-downs were necessary, the company debited cost of goods sold. Recently, write-downs have become more common and Smart is concerned about the distortion of its gross profit percentage. What alternative is available under GAAP?

Smart Company could debit a separate loss account and include it as an operating expense.

Which of the following must be included in the disclosure note related to a change in inventory method? (Select all that apply.)

The effect of the change on items not reported on the face of the primary statements. The cumulative effect of the change on retained earnings. Justification that the change is preferable.

Which of the following statements is correct regarding the accuracy of the estimates derived under the gross profit method?

The gross profit ratio must be reliable.

Which of the following are included in the disclosure note related to an inventory error? (Select all that apply.)

The impact of the correction on net income. The impact of the correction on earnings per share. The nature of the error.

Which of the following must be considered when applying the gross profit method? (Select all that apply.)

The inventory cost flow assumption used by the company. Conditions that may have changed the current year gross profit margin.

Identify the situations for which ending inventory and cost of goods sold may be estimated utilizing the gross profit method. (Select all that apply.)

To determine reasonableness of inventory amounts during an audit. For interim reporting periods. When inventory was lost, destroyed, or stolen.

True or false: For financial reporting purposes, the lower of cost and net realizable value method can be applied to individual inventory items, categories of inventory, or the entire inventory.

True Reason: GAAP allows LCNRV to be applied to individual, categories of, or the entire inventory.

True or false: Both U.S. GAAP and IFRS require inventory to be valued at the lower of cost and net realizable value.

True Reason: Lower of cost and net realizable value are required under both sets of standards.

Werner Company's accountant discovered that the prior-year financial statements were misstated due to a material inventory-related error. Werner must (Select all that apply.)

adjust account balances that are incorrect as a result of the error. restate its prior-year financial statements.

The ending inventory balance determined using the gross profit method is _____ and is not acceptable according to GAAP.

an estimate

The inventory value determined using the gross profit method represents

an estimate of ending inventory.

By overstating an inventory write-down, profits _____ in future periods as the inventory is sold.

are increased

GAAP requires companies to report inventory (Select all that apply.)

at the lower of cost or market value for companies using LIFO. at the lower of cost and net realizable value for companies using FIFO.

The _____ method assumes that cost of goods sold and ending inventory each consist of a mixture of all the goods available for sale.

average cost

The lower of cost and net realizable value method was developed to

avoid reporting inventory at an amount that exceeds the cash it can provide.

Advantages of the retail inventory method include that it can (Select all that apply.)

be adjusted to approximate the different cost flow assumptions. be used to estimate inventory lost, stolen, or destroyed.

The base year inventory for all future LIFO determinations is the

beginning inventory in the year the LIFO method is adopted.

The cost-to-retail percentage is found by dividing goods available for sale at -blank- by goods available for sale at current selling price. (Enter one word per blank.)

cost

Beginning inventory plus net purchases equals

cost of goods available for sale.

Ending inventory plus cost of goods sold equals

cost of goods available for sale.

In the retail inventory method, a -blank- percentage is used to estimate ending inventory and cost of goods sold. (Enter one word per blank.)

cost-to-retail

The retail inventory method tends to be more accurate than the gross profit method because it relies on the

current relationship between cost and selling prices

Western Company determines the cost of its inventory is $410,000 and net realizable value is $400,000. Western Company should (Select all that apply.)

debit cost of goods sold $10,000 credit inventory $10,000

Omar Company uses a periodic inventory system and erroneously overstates ending inventory by $10,000 for the year ended December 2016. If Omar discovers this error in 2017, it should

debit retained earnings and credit inventory.

On January 2, Allison Corp. changes from the LIFO to the FIFO method. Its prior-year financial statement notes show a LIFO reserve of $20,000 if it had utilized FIFO in prior years. Allison should make a journal entry that includes a

debit to inventory.

On March 31, Oscar Corp. changes from the LIFO to the FIFO method. Its financial statement notes indicate that beginning inventory would have been $50,000 higher if it had utilized FIFO during prior years. Oscar's journal entry should include a

debit to inventory.

Merger Company applies the lower of cost and net realizable value rule to individual inventory items. If the company were to apply the rule to the entire inventory balance, the chance of recording an inventory loss would

decrease.

Prior period adjustments

directly adjust retained earnings.

Vogel Company changed its inventory method from FIFO to LIFO during the current year. Vogel must disclose the following information in its notes (Select all that apply.)

effect on current year earnings per share and income amounts nature of and the justification for the change reason why retrospective treatment was impracticable

Which of the following are estimated when using the gross profit method? (Select all that apply.)

ending inventory cost of goods sold

Inventory related note disclosures _____ earnings quality.

enhance

Net realizable value of inventory is determined by subtracting selling cost from the

expected sales price

Accounting principles should be applied consistently because this practice enhances

financial statement comparability.

Under IFRS, the lower of cost and net realizable value rule typically is applied to

individual inventory items.

For financial reporting, the lower of cost or net realizable value approach can be applied to (Select all that apply.)

individual inventory items. the entire inventory. groups of inventory items.

When a company changes from LIFO for tax purposes,

it cannot change back to LIFO until five tax returns have been filed.

When an inventory error is discovered in the period it occurred,

it is corrected in the current period.

Consistent with U.S. GAAP, the lower of cost and net realizable value rule can be applied to (Select all that apply.)

logical inventory categories. the entire inventory. individual inventory items.

When gross profit is stated as a percentage of cost, it is referred to as the on -blank- cost. (Enter only one word.)

markup

Accounting errors

must be corrected when they are discovered.

If inventory values recover after a lower of cost and net realizable value write-down, the write-down must

not be reversed.

Doris Company wrote down its inventory under the lower of cost and net realizable value rule by $10,000. Subsequent to the write-down, inventory values recover by $8,000. Doris Company must

not recognize the increase. Reason: GAAP does not allow inventory to be written up once the cost basis is reduced

Which of the following information is needed to utilize the gross profit method? (Select all that apply.)

purchases net sales beginning inventory estimated gross profit ratio

Which of the following are required in the note disclosure of a company changing to the LIFO inventory method? (Select all that apply.)

reason why retrospective application was impracticable justification for the change effect on current year earnings per share and income amounts the nature of the change

In Year 2, Stetson Inc. discovers a material inventory error that was made in Year 1. In this case, Stetson should

record a prior period adjustment that flows directly through retained earnings.

Accounting errors that are discovered during the same accounting period that they occurred must be corrected by (Select all that apply.)

recording the correct entry. reversing the incorrect entry.

Under the LCM approach, market generally is defined as ______ cost.

replacement

To use the _____ method, a company must maintain records of inventory and purchases at cost and at current selling price.

retail inventory

When a company applies a retrospective change in inventory method, they must revise beginning -blank- to reflect the cumulative income effect of the difference in inventory methods for all prior years.

retained earnings

Otto Company uses a periodic inventory system and erroneously understates ending inventory by $10,000 for the year ended December 2016. This error is not discovered until 2018. The company should

retroactively restate its 2016 and 2017 financial statements.

Changes in inventory method generally are accounted for

retrospectively

When accounting changes are applied retrospectively, the first step is to

revise prior years' financial statements.

In applying the lower of cost or market rule, market value (Select all that apply)

should not be greater than net realizable value should not be less than net realizable value less normal profit margin

The retail inventory method, unlike the gross profit method, is acceptable for financial reporting purposes because it

tends to be more accurate.

Multi Company changed its inventory method from LIFO to FIFO. Multi must disclose the following information in its notes (Select all that apply.)

the cumulative effect of the change on retained earnings the effect on earnings per share amounts

Note disclosures relating to the correction of prior-year errors include information about (Select all that apply.)

the effect on earnings per share. the nature of the error. each line item affected.

For financial reporting of companies using LIFO, the lower of cost or market approach can be applied to (Select all that apply.)

the entire inventory. individual inventory items. groups of inventory items.

If a company discovers an inventory error two years after the error occurred,

the financial statements for the two previous years are restated.

The lower of cost and net realizable value rule causes income to be reduced in the period when

the inventory value declines below cost.

If beginning inventory is overstated then cost of goods sold would be overstated and net income would be _____.

understated

Omar Company uses a periodic inventory system and erroneously overstates ending inventory by $10,000 for the year ended December 31, 2017. Ignoring the tax effect, the effect on the 2017 financial statement includes an (Select all that apply.)

understatement of cost of goods sold by $10,000. overstatement of net income by $10,000.