Chapter 9 SmartLearn

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.

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.

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

Both U.S. GAAP and IFRS

Correctly match the elements that should be considered before calculating the cost-to-retail percentage with the correct treatment in applying the retail method. purchase returns

Deducted in both the cost and retail columns

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.

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

LIFO

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

LIFO

When using the LIFO retail method, how many inventory layers can be added per year if inventory increases?

No more than one inventory layer per year.

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

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

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.

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

True

On January 2, Otto Corp. entered into a purchase commitment to buy 1,000 units of raw materials for $25 per unit. On January 31, the company purchased 1,000 units when the market price was $24 per unit. Otto should recognize

a loss of $1,000.

The _____ ____ method uses the cost-to-retail percentage based on a current relationship between cost and selling price. (Enter one word per blank.)

retail inventory

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

retail inventory

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

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

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.

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

average cost

Inventory related note disclosures ______ earnings quality.

enhance

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

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

Changes in inventory method generally are accounted for

retrospectively

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 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. Market is lower so record at market.

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.

A product purchased for $20 is listed with a $25 sales price. Later, the selling price is marked up to $30. When the product does not sell, the sales price is decreased to $27. What is the net markup amount?

$2

A product purchased for $10 is listed with a $15 sales price. Later, the selling price is increased to $17. When the product does not sell, the sales price is decreased to $16. What is the net markup amount?

$2 Reason: Net markup is the difference between the original sales price and any mark up or down, but not below the original selling price

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

Western Company recently lost its entire inventory in an earthquake. The following information is available from its accounting records: Beginning inventory: $5,000; purchases: $20,000; 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

Warren 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 retail inventory method is used to approximate average costs, what is the amount of goods available for sale at cost?

$400,000 Reason: $100,000 + $300,000

Thompson Company utilizes the LIFO retail inventory method. Its cost-to-retail percentage is 50% based on beginning inventory and 55% based on current-period purchases. The company determined that during the current period a new layer was added with retail value of $100,000. The new layer at cost should be

$55,000.

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

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.

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. $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 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

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

-LIFO retail method -Dollar-value LIFO method

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

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

Which of the following can create inventory errors? (Select all that apply.) Multiple select question.

-Mistakes in the cutoff relating to purchases of inventory. -Overstatement of ending inventory due to physical count mistake. -Understatement of ending inventory due to pricing mistake.

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.)

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

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.

On January 2, Lucky Corp. entered into a purchase commitment to buy 1,000 units of raw materials for $25 per unit. On January 31, the company purchased 1,000 units with cash when the market price was $26 per unit. Lucky should (Select all that apply.)

-credit cash $25,000 -debit inventory $25,000

Warren 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 retail inventory method is used to approximate average costs, what is the cost to retail percentage?

61.54% Reason: ($100,000 + $300,000)/($160,000 + $500,000 + $10,000 - $20,000)

Correctly match the elements that should be considered after calculating the cost-to-retail percentage with the correct treatment in applying the retail method. Employee discounts (sales recorded net of discounts)

Added to net sales

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 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.

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

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

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

Credit inventory Debit cost of goods sold

Correctly match the elements that should be considered before calculating the cost-to-retail percentage with the correct treatment in applying the retail method. purchase discounts taken (gross method)

Deducted in both the cost and retail columns

Correctly match the elements that should be considered after calculating the cost-to-retail percentage with the correct treatment in applying the retail method. normal shortages

Deducted in the retail column

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

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.

Smith Company has several current product lines. In the past, the company applied the lower of cost and net realizable value method to individual inventory items. The company wants to make the process less time consuming and is exploring alternatives. What alternatives does the company have? (Select all that apply.)

Smith could apply the lower of cost and net realizable rule to its entire inventory. Smith could apply the lower of cost and net realizable value rule to each product line.

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.

When a company records a loss on purchase commitment and the inventory market price later recovers, what occurs?

The recovery of value is ignored.

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.

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

a net decrease

Correctly match the elements that should be considered before calculating the cost-to-retail percentage with the correct treatment in applying the retail method. freight-in

added in the cost column

Correctly match the elements that should be considered after calculating the cost-to-retail percentage with the correct treatment in applying the retail method. Employee discounts (sales recorded net of discounts)

added to net sales

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

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

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

are increased

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

beginning inventory at retail

Under US GAAP, losses on purchase commitments ________ be recovered if the market price of the inventory increases.

cannot

The exclusion of net markdowns from the calculation of the cost-to-retail percentage occurs in the _____ retail method. (Enter only one word.)

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.

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

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

cost; current selling price

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.)

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

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 31. If Omar discovers this error in the following year, it should

debit retained earnings and credit inventory.

Panther Company's bookkeeper debited supplies expense for the cost of goods sold during that month. The bookkeeper discovered the error prior to closing the books. The correcting entry would include (Select all that apply.)

debit to cost of goods sold. credit to supplies expense.

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.

Correctly match the elements that should be considered after calculating the cost-to-retail percentage with the correct treatment in applying the retail method. Normal shortages

deducted in the retail column

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

dollar-value LIFO retail

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

dollar-value LIFO retail

When using the LIFO retail method

each inventory layer will carry its own cost-to-retail percentage.

When using the LIFO retail method,

each inventory layer will carry its own cost-to-retail percentage.

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

The gross profit method is useful in situations where Blank______ of inventory are desirable.

estimates

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

false

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.

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

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

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

it is corrected in the current period.

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

less precise

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

markdown

If the retail inventory method is used, which of the following are included in the calculation of goods available for sale at retail to approximate average costs?

markups and markdowns

Accounting errors

must be corrected when they are discovered.

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

net realizable value.

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.

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

obsolescence. competition. price declines. spoilage.

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

only the ending inventory

Companies utilize purchase agreements primarily to

protect against price increases.

Which of the following must be considered to calculate net purchases? (Select all that apply.)

purchase discounts purchase returns freight-in

Otto Company uses a periodic inventory system and erroneously understates ending inventory by $10,000 for the year ended December 31. This error is not discovered until two years later. The company should

retrospectively restate financial statements for the previous two years

Changes in inventory methods, other than a change to LIFO, are treated

retrospectively.

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

the financial statements for the two previous years are restated.

When a company changes to the LIFO inventory method,

they do not restate prior year financial statements.

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 Blank______ by Blank______. (Select all that apply.) Multiple choice question.

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

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

true

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