Chapter 9: Inventories: Additional Issues

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 -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.

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%

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 $100,000 + $300,000

Which of the following are included in a purchase commitment?

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

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

A net decrease

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 is correct regarding changes in accounting methods?

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

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 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

Current Period Layer

Current-period purchases cost-to-retail percentage

When inventory is adjusted down to reflect net realizable value, which of the following can occur?

Debit cost of goods sold Credit Inventory

Purchase Returns

Deducted in both the cost and retail columns

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

Markdown Cancellation

Elimination of a markdown

Markup Cancellation

Elimination of an additional markup

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: Most changes in inventory method are accounted for prospectively.

False

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

False

Additional Markup

Increase in selling price subsequent to initial markup

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

Only the ending inventory

Purchase commitments carry the potential disadvantage or risk that

Prices decrease after the commitment was made

A retrospective change in inventory method would normally cause changes to

Prior income statements and balance sheets

Companies utilize purchase agreements primarily to

Protect against price increases

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

Tends to more accurate

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

The recovery of value is ignored

The LIFO method assumes that units sold are

Those most recently purchased

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

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 _______ by goods available for sale at current selling price

cost

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

cost current selling price

Write-downs are rare

loss is recognized as a separate item in operating expense

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

retail inventory

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

retained earnings

Changes in inventory method generally are accounted for

retrospectively

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

Beginning inventory at retail

Beginning Inventory

Beginning-inventory cost-to-retail percentage

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

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

estimates

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

expected sales price

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 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 $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 $160,000 + $500,000 + $10,000 - $20,000 - $500,000 = $150,000

Geese 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 beginning inventory at retail was $200,000 and that during the current period a new layer was added with retail value of $50,000. The cost of ending inventory should be

$152,000 $200,000 x 60% = $120,000 $50,000 x 64% = $32,000

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 -$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

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

$20 When applying the rule to individual items, only item A has a market value below cost so a $20 loss is recorded.

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 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

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 $100,000 x 55%

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 retail?

$650,000 $160,000 + $500,000 + $10,000 - $20,000 = $650,000

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 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

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 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

Jones Company's inventory cost is $100. The expected sales price is $110, estimated selling costs are $12. Consistent with the lower of cost and net realizable value approach, this inventory item should be valued at

-$98 Lower of cost and net realizable value is required. The NRV is $110-12 = 98 and is lower than cost.

When a material inventory error is discovered in a period subsequent to when the error was made, which of the following must occur?

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

Freight-in

-Added to gross purchases -Added in the cost column

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?

-Cost of goods sold -Other loss or expense

Identify the situations for which ending inventory and cost of goods sold may be estimated utilizing the gross profit method

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

For financial reporting, the lower of cost or net realizable value approach can be applied to

-Individual inventory items -The entire inventory -Groups of inventory items

The dollar-value LIFO retail method is a combination of which of the following?

-LIFO retail method -Dollar-value LIFO method

Retail inventory markdowns occur because of

-Obsolescence -Competition -Spoilage -Price declines

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

-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

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?

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

Accounting errors that are discovered during the same accounting period that they occurred must be corrected by

-Reversing the incorrect entry -Recording the correct entry

Purchase Discounts take (gross method)

-Subtracted from gross purchases -Deducted in the cost column

Which of the following are included in the disclosure note related to an inventory error?

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

Identify the situations for which ending inventory and cost of goods sold may be estimated utilizing the gross profit method.

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

Why do companies enter into purchase commitment agreements?

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

The dollar-value LIFO retail method

-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

Advantages of the retail inventory method include that it can

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

Which of the following must be considered to calculate net purchases?

-freight-in -purchase discounts -purchase returns

The retail inventory method

-is used to generate information for interim financial statements -is used to test the overall reasonableness of physical counts -is used in budgeting and forecasting

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

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

If the purchase price decreases before a purchase commitment is exercised

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

Note disclosures relating to the correction of prior-year errors include information about

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

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

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

Which of the following can create inventory errors?

-understatement of ending inventory due to pricing mistake -overstatement of ending inventory due to physical count mistake -mistakes in the cutoff relating to purchases of inventory

A loss relating to a purchase commitment must be recognized when the market price is lower than the contract price

-when the product is purchased -at the end of the reporting period if the commitment is outstanding

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

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

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

Both U.S. GAAP and IFRS

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

Both U.S. GAAP and IFRS

The retail inventory method can be modified to estimate which of the following using FIFO, LIFO, or average cost?

Cost of Goods sold Ending Inventory

Ending inventory plus cost of goods sold equals

Cost of goods available for sale

On January 2, Neumann Corp. changes from the LIFO to the FIFO method. Its financial statement notes indicate that beginning inventory would have been $10,000 higher if it had utilized FIFO during prior years. Neumann's journal entry should include a

Credit to retained earnings

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

Credit to retained earnings

Western Company determines the cost of its inventory is $410,000 and net realizable value is $400,000. Western Company should

Debit cost of goods sold $10,000 Credit Inventory $10,000

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

Debit loss on purchase commitment $1,000 Debit inventory $24,000 Credit cash $25,000

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

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

Normal shortages

Deducted in the retail column

Accounting principles should be applied consistently because this practice enhances

Financial statement comparability

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

The ______ method assumes that units sold are those most recently acquired

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

When there is a net increase in the physical quantity of inventory during a period, the use of _____ results in an additional layer of inventory.

LIFO

In a purchase commitment, if market price at acquisition is less than the contract price, the purchase is recorded at what price?

Market price

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

Initial Markup

Original amount of markup from cost to selling price

Markdown

Reduction in selling price below the original selling price

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

Retrospectively

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

Revise prior years' financial statements

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 account and include it as an operating expense

When the retail inventory method is used to approximate average cost, the cost-to-retail percentage is calculated by dividing _____ by _____.

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

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

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

are increased

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

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

cannot

The retail inventory method is also referred to as the ______ retail method

conventional

In the retail inventory method, a ______-_____-_____ percentage is used to estimate ending inventory and cost of goods sold

cost-to-retail

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

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

debit inventory $25,000 Credit cash $25,000

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

debit to cost of goods sold credit to supplies expense

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

When using the LIFO retail metho

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

Inventory related note disclosures _____ earnings quality.

enhance

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

error

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) _____ 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

Sandra Company entered into a purchase commitment. At the end of the accounting period, the contract is still outstanding and the contract price exceeds the current market price. Sandra expects that a loss will be incurred. Sandra should recognize a

loss at the end of the accounting period

write-downs are common

loss is recognized as a separate item in operating expense

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

markdown

When the commitment price exceeds the market price, inventory should be recorded at _______ price

market

Accounting errors

must be corrected when they are discovered

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

required under GAAP a method other than LIFO or retail inventory

The lower of cost or market approach is____ for companies that use ____

required under GAAP LIFO or the retail inventory

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

the inventory value declines before cost