Chapter 9 Inventories: Additional Issues SmartBook

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)

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.)

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.

Mauser Company properly applies the lower of cost or net realizable value rule and determines that its inventory value has declined by $10,500 below cost. Which of the following could be debited for this write-down? (Select all that apply.)

-cost of goods sold -other loss or expense

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

The dollar-value LIFO retail method (Select all that apply.)

-eliminates the effect of any price changes when comparing beginning and ending inventory. -allows the company to determine if there is an increase in the quantity of inventory.

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

False

The original amount a company adds to cost to determine the selling price is known as ___ ___.

Initial markup

The _____ method assumes that units sold are those most recently acquired.

LIFO

A LIFO liquidation occurs when there is _____ in inventory quantity.

a net decrease

Inventory related note disclosures _____ earnings quality.

enhance

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

retail inventory

Generally, voluntary changes in accounting principles are accounted for

retrospectively.

The LIFO method assumes that units sold are

those most recently purchased.

When the retail inventory method is used to approximate average cost, the cost-to-retail percentage is calculated by dividing _____ by _____. (Select all that apply.)

total cost of goods available for sale; total goods available for sale at retail

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. 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)

Tore Company's records reveal the following information regarding its inventory. Beginning inventory was $100,000 at cost and 160,000 at retail. Purchases during the year were $300,000 at cost and $500,000 at retail. Markups were $10,000 and markdowns, $20,000. Assuming the conventional retail method is used and net sales were $500,000, ending inventory at retail would be (round the cost-to-retail percentage to two digits after the decimal point)

$150,000. (Reason: $160,000 + $500,000 + $10,000 - $20,000 - $500,000 = $150,000)

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 the lost inventory would be

$2,000 (Reason: $1,000 + 13,000 = $14,000 goods available for sale, Net sales $20,000 less gross profit 40% = $12,000, $14,000 - 12,000 = 2,000)

Goose Company utilizes the LIFO retail inventory method. Its cost-to-retail percentage is 60% based on beginning inventory and 64% based on current-period purchases. The company determined that during the current period a new layer was added with retail value of $50,000. The new layer at cost should be

$32,000 (Reason: $50,000 x 64%)

Tore Company's records reveal the following information regarding its inventory. Beginning inventory was $100,000 at cost and 160,000 at retail. Purchases during the year were $300,000 at cost and $500,000 at retail. Markups were $10,000 and markdowns, $20,000. Assuming the conventional retail method and net sales of $500,000, ending inventory at cost would be

$89,550 (Reason: Markdowns are excluded from the calculation of the cost-to-retail percentage Cost $400,000 ($100,000+$300,000) divided by Retail of $670,000 ($160,000+$500,000+$10,000) =59.7% x estimated ending inventory at retail = ($160,000 + $500,000 + $10,000 - $20,000 - $500,000) = 59.7% x $150,000 = $89,550)

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.)

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

-Credit inventory -Debit cost of goods sold

The dollar-value LIFO retail method is a combination of which of the following? (Select all that apply.)

-Dollar-value LIFO method -LIFO retail method

Match the terms relating to the retail inventory method to the correct explanation. Instructions

-Initial markup - Original amount of markup from cost to selling price -Additional markup - Increase in selling price subsequent to initial markup -Markup cancellation - Elimination of an additional markup -Markdown - Reduction in selling price below the original selling price -Markdown cancellation - Elimination of a markdown

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

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

Which of the following can be used to write-down inventory according to the lower of cost and net realizable value rule? (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 on the income statement.

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.

Which of the following are included in a purchase commitment? (Select all that apply.)

-Specific amount of material -Set purchase deadline -Specific price of material

Why do companies enter into purchase commitment agreements? (Select all that apply.)

-To protect against increases in purchase price. -To make sure they will be able to obtain important inventory.

Match each scenario with the most logical accounting treatment for recognizing an inventory market adjustment.

-Write-downs are rare - Loss is recognized as a separate item in operating expense. -Write-downs are common - Loss is included as part of cost of goods sold.

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

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

Retail inventory markdowns occur because of (Select all that apply.)

-obsolescence. -competition. -spoilage. -price declines.

If the purchase price decreases before a purchase commitment is exercised (Select all that apply.)

-the company must purchase the inventory at a higher than market price. -a loss on the purchase commitment is recorded.

Tore Company's records reveal the following information regarding its inventory: Beginning inventory was $100,000 at cost and 160,000 at retail. Purchases during the year were $300,000 at cost and $500,000 at retail. Net markups were $10,000 and net markdowns, $20,000. Assuming the conventional retail method, the cost-to-retail ratio will be

59.7%. (Reason: Cost $400,000 ($100,000+$300,000) divided by Retail of $670,000 ($160,000+$500,000+$10,000) =59.7%)

Using the LIFO retail method, a new layer at retail is determined by subtracting what from ending inventory at retail?

Beginning inventory at retail

Using the LIFO retail method, we determine if a new layer at retail has been added by comparing beginning inventory at retail to what?

Ending inventory at retail

True or false: The conventional retail method gives an exact amount of what ending inventory value should be.

False (Reason: The conventional retail method approximates ending inventory.)

A contract that obligates a company to purchase a specific amount of merchandise, at a specific price, on or before a specific date is referred to as what?

Purchase commitment

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.

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.)

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 retail inventory method is also referred to as the ___ retail method.

conventional

Applying the retail inventory method to approximate the lower of average cost or market value is often referred to as the

conventional retail method.

The cost to retail percentage is found by dividing goods available for sale at _____ by goods available for sale at _____.

cost; current selling price

Under the LIFO retail inventory method, the cost of a new layer added during the period is determined by multiplying the retail value of the layer by the

current-period cost-to-retail percentage.

The variety of inventory cost flow assumptions that can be utilized by companies typically does not impair earnings quality because

detail about the methods must be disclosed in the financial statement notes.

Using the _____ method allows a company to determine if there has been a "real" increase in quantity of inventory.

dollar-value LIFO retail

An inventory ___ can occur due to a mistake in physical count or a mistake in pricing inventory quantities.

error

The conventional retail method gives a(n) _____ measurement for ending inventory than the lower of cost and net realizable value method.

less precise

When using the conventional retail method with markdowns present, the cost approximation of ending inventory will always be _____ the retail inventory method.

less than

Reduction in selling price below the original selling price is known as ___.

markdown

The selling price of inventory less any costs of completion, disposal, and transportation is

net realizable value.

Purchase commitments carry the potential disadvantage or risk that

prices decrease after the commitment was made.

Companies utilize purchase agreements primarily to

protect against price increases.

The lower of cost or net realizable value approach is _____ for companies that use _____.

required under GAAP; a method other than LIFO or retail inventory

The ___ ___ method uses the cost-to-retail percentage based on a current relationship between cost and selling price.

retail inventory