Intermediate Accounting Chapter 9

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.

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

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

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%

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

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 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.

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

Which of the following are required in the note disclosure of a company changing to the LIFO inventory method?

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

Which of the following must be considered when applying the gross profit method?

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

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.

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

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

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

Beginning inventory at retail

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.

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

Conservatism

Markdown cancellation

Elimination of a markdown.

Markup cancellation

Elimination of an additional markup.

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

IFRS

Inventory currently out on consignment was not included in the inventory count.

Net income is understated.

Initial markup

Original amount of markup from cost to selling price.

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

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

Markdown

Reduction in selling price below the original selling price.

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

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

a net decrease

_________________ shortages should be deducted in both the cost and retail columns before the calculation of the cost-to-retail percentage.

abnormal

The inventory value determined using the gross profit method represents

an estimate of ending 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 lower of cost and net realizable value method was developed to

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

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

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

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.

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

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.

Prior period adjustments

directly adjust retained earnings.

When using the LIFO retail method,

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

Which of the following are estimated when using the gross profit method?

ending inventory cost of goods sold

Inventory related note disclosures _____ earnings quality.

enhance

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

When gross profit is stated as a percentage of cost, it is referred to as the _________ on cost.

markup

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

not be reversed GAAP does not allow inventory to be written up once the cost basis is reduced

Under the retail inventory method, sales discounts are not deducted from sales because it would cause inventory to be ______.

overstated

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

overstated; understated

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

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

retrospectively.

Under the LIFO retail method, we determine that a new layer of inventory has been added during the period if

the ending inventory at retail is greater than the beginning inventory at retail.

When a company changes to the LIFO inventory method,

they do not restate prior year financial statements.

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.

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

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. Reason: $200,000 x 60% = $120,000 $50,000 x 64% = $32,000

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 Reason: Net markup is the difference between the original sales price and any mark up or down, but not below the original selling price. $5 markup - $3 markup cancellation = $2 net markup

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

A product purchased for $40 is marked up to a $50 sales price. Later, the selling price is decreased to $45. Eventually, the sales price is increased to $47. What is the net markdown amount?

$3

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 Reason: $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. 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 (estimated selling price - estimated selling cost)

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 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. - Incorrect balances are corrected. - Previous year's financial statements are retrospectively restated.

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

- 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 are required in the note disclosure of a company changing to the LIFO inventory method?

- income from continuing operations - net income - each line-item affected - earnings per share -cumulative effect of the change on retained earnings

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?

-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 included in the disclosure note related to a change in inventory method?

-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.

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. -For interim reporting periods. -When inventory was lost, destroyed, or stolen.

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

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

Advantages of the retail inventory method include that it can

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

Vogel Company changed its inventory method from FIFO to LIFO during the current year. Vogel must disclose the following information in its notes

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

The retail inventory method

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

Which of the following information is needed to utilize the gross profit method?

-purchases -estimated gross profit ratio -beginning inventory -net sales

In applying the lower of cost or market rule, market value

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

Multi Company changed its inventory method from LIFO to FIFO. Multi must disclose the following information in its notes

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

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

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

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)

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.

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

Additional markup

Increase in selling price subsequent to initial markup.

Which of the following is an important limitation of the gross profit method?

It does not explicitly consider possible theft or spoilage of inventory.

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

LIFO

The conventional retail method is not generally used in combination with _____.

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

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

A purchase in transit that was shipped f.o.b. shipping point was neither counted nor recorded.

Net income is not affected.

Which of the following must be included in the determination of ending inventory at retail when applying the retail inventory method?

Net markups and net markdowns

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.

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.

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.

Under the retail inventory method, if sales are recorded net of employee discounts, the discounts are _____ before sales are deducted in the retail column.

added to net sales

Normal shortages are deducted in the retail column _____ the calculation of the cost-to-retail percentage when applying the retail inventory method.

after

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

are increased

The base year inventory for all future LIFO determinations is the

beginning inventory in the year the LIFO method is adopted.

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 current selling price.

cost

Ending inventory plus cost of goods sold equals

cost of goods available for sale.

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

In the retail inventory method, a ________-__________-_________ percentage is used to estimate ending inventory and cost of goods sold

cost-to-retail

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

cost; current selling price

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

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. credit retained earnings

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.

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.

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

initial markup

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

initial markup

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.

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

When determining ending inventory at retail, a company should include both net __________ and _____________ net .

markup; markdowns

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

During the physical inventory, certain inventory items were double counted.

net income is overstated

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

net realizable value.

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

A retrospective change in inventory method would normally cause changes to

prior income statements and balance sheets.

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

purchase discounts purchase returns freight-in

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.

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

replacement

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

retail inventory

Which of the following estimation methods is acceptable for purposes of annual financial reporting?

retail inventory method

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

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.

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

revise prior years' financial statements.

Retail inventory markdowns occur because of

spoilage. obsolescence. competition. price declines.

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

tends to be more accurate

Consistent with U.S. GAAP, the lower of cost and net realizable value rule can be applied to

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

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.

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.

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

True or false: Approximating lower of cost or market using the conventional retail method is not used in combination with LIFO because LIFO ending inventory includes lower-priced items whose costs are likely to be lower than current market.

true

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.