Inventory – Other Issues

Medium Test

Key Things to Know

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Practice as You Learn

Self Test

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Easy Test

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Medium Test

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Hard Test

1. When applying lower of cost or market, market can not be lower than

a. replacement cost
b. historical cost
c. net realizable value
d. net realizable value less normal profit

Answer
D. Market can not be lower than net realizable value less normal profit. If this occurs, more expense is taken in the current period resulting in more gross profit in future periods when sold than normal. This does not follow the matching principle.
2. When applying lower of cost or net realizable value, cost cannot be greater than

a. replacement cost
b. historical cost
c. sales price less cost to sell
d. appraised value

Answer
D. Net realizable value is equal to sales price less the cost to sell. Inventory cannot be reported at an amount greater than net realizable value.  
3. When using the retail inventory method, which of the following is not reported in both the cost and the retail column?

a. beginning inventory
b. purchase returns
c. sales returns
d. abnormal spoilage

Answer
C. Sales returns is reported in the retail column only. All items related to selling inventory are recorded in the retail column only.  
4. Which one of the following situations would cause a company to use the gross profit method?

a. the use of a perpetual inventory system
b. a physical count is taken at the end of every month
c. a physical count is taken at the end of the year only
d. a retail company

Answer
C. The gross profit method is used to estimate the value of inventory when it is not known. It is typically used at the end of each monthly or quarterly period when the periodic method is used and the company does not want to incur the cost of a physical count.
5. The difference in the average cost and the FIFO retail inventory methods is

a. how much ending inventory is included in sales
b. how much beginning inventory is included in the cost to retail ratio
c. the average cost ratio is always higher than the FIFO ratio
d. the average cost ratio is always lower than the FIFO ratio

Answer
B. When using the FIFO method, beginning inventory is not included when determining the ratio of cost to retail. Taking beginning inventory out of the ratio does not make it higher or lower. It will be higher or lower depending on how the cost ratio was different in prior periods than in the current period.  
6. The company sells inventory at 30% gross profit. Company purchases were $100,000 and sales were $400,000. Beginning inventory was $250,000. Under the gross profit method ending inventory is estimated to be

a. 120,000
b. 70,000
c. 350,000
d. 280,000

Answer
B. Compute the gross profit as 30% x 400,000. Plug CGS to get estimated gross profit. Subtract CGS to get the ending inventory value.

Sales                                        400,000
-CGS                                         280,000
Gross Profit                             120,000 (30%)
    Beginning Inventory          250,000
+ Purchases                             100,000
= Available                                350,000
– CGS                                       (280,000)
= Ending Inventory                   70,000
7. Which of the following use the same format as the weighted average method when using the retail inventory method?

a. lower of cost or market (conventional)
b. FIFO
c. LIFO
d. both b. and c.

Answer
D. All methods use the average format (markdowns are included in available) with the exception of lower of cost or market. Lower of cost or market does not include markdowns in the ratio.  
8. When determining the cost to retail percentage

a. net sales are included
b. net markups are always included
c. net markdowns are always included
d. all of the above

Answer
B. The cost to retail percentage is computed from the available row. The available row includes beginning inventory + net purchases + – price adjustments. Markups are always included. Markdowns are not included for lower of cost or market. Sales are always recorded below the available row.
9. If the cost to retail percentage using the average cost retail method is 65%, the cost to retail percentage using lower of cost or market (conventional) must be

a. lower than 65%
b. higher than 65%
c. equal to 65%
d. it depends on how large markups are as a percentage of available

Answer
A. Markdowns are not considered in goods available, (not part of the ratio), when using the lower of cost or market (conventional) method. Markdowns occur when there is loss of value and not including them in the ratio will give a lower ratio and a lower inventory value.
10. In times of inflation, dollar value LIFO will give a

a. higher inventory value than FIFO
b. lower inventory value than FIFO
c. the same value as FIFO
d. the same value as LIFO

Answer
B. LIFO gives a higher cost of goods sold and a lower inventory value in times of inflation. Dollar value LIFO is the same as LIFO with the exception that all purchases that occur during a particular year are considered one purchase.

11. The company uses the retail inventory method to value its inventory.
The following information is available for the current year.

Cost Retail
Inventory – January 1 190,000 270,000
Purchases 550,000 850,000
Net Mark-ups 20,000                
Net Mark-downs 5,000                
Freight-in 8,000                
Net Sales 700,000                
Abnormal Spoilage 11,000 16,000
Normal Spoilage 18,000 26,000

Estimate the value of ending inventory using
A. Average cost
B. Lower of Cost or Market (Conventional)
C. FIFO
D. LIFO

Answer

1st Set up the format using average cost.

Cost Retail
Beginning Inventory 190,000 270,000
+ Purchases 550,000 850,000
+ Freight In 8,000
– Abnormal Spoilage (11,000) (16,000)
+ Markups, net 20,000
– Markdowns, net ( 5,000)
= Available (65.9%) 737,000 / 1,119,000
– Sales, net (700,000)
– Normal Spoilage (26,000)
= Ending Inventory ???? 393,000

 

A. Average Cost

Retail Ending Inventory                            393,000
x Cost to Retail %                                           .659
= Ending Inventory at Cost                      258,987

 

B. Lower of Cost or Market (Conventional):

Do not rewrite the entire calculation.
Adjust from average to lower of cost or market:

Available at Average Cost – retail 1,119,000
+ Markdowns, net                          5,000
Available at Lower of Cost or Market –retail 1,124,000

 

Then compute the cost to retail percentage

Available at Cost      737,000     =    0.656
Available at Retail    1,124,000

 

Ending Inventory at Retail            393,000
x Cost to Retail %                              .656
= Ending Inventory at Cost           257,808

 

C. FIFO  Assume Beginning Inventory is sold

Compute the cost to retail % excluding beginning inventory using the average setup

Cost Available – Cost Beg. Inventory
Retail Available – Retail Beg. Inventory
737,000 – 190,000 = 547,000     =   0.644
1,119,000 – 270,000 = 849,000
Ending Inventory at Retail           393,000
x Cost to Retail %                            0.644   
= Ending Inventory at Cost          253,092

 

D. LIFO use the average set up

1st Set up a retail column and a cost column and put beginning amounts

2nd Put the total retail amount in the retail column

3rd Subtract beginning inventory from total inventory to get current purchases

4th Multiply the retail amount from current period by the FIFO ratio

5th Add the beginning + current period in the cost column to get inventory at cost

Retail Cost Cost/Retail %
Beginning Inventory 1st 270,000 190,000
+ Current period layer 123,000 3rd 79,212 4th use FIFO .644
Ending Inventory 393,000 2nd 269,212 5th under LIFO

12. At the beginning of year dollar value LIFO was adopted inventory was revalued at $40,000. Inventory values using last cost (FIFO) on December 31st was:

Inventory Price Index
Year 1 $49,488 1.07
Year 2 $53,288 1.12
Year 3 $46,983 1.15

Calculate the ending inventory for year 3 using dollar value LIFO.

Answer

You can not value inventory for year 3 without valuing all prior years and determining the layers (value of that year) that is left after considering LIFO sales.

                      Inventory at            Price               Inventory at                          Price
Date              Last Cost        /        Index     =      First Cost             From         Index  =  Value of EI

 

Base              40,000                      1.0                 40,000                  40,000  x  1.0              40,000

Year 1            49,488                     1.07               46,250                  40,000  x  1.0              40,000
                                                                                                 plug      6,250  x  1.07              6,688
                                                                                                             46,250                         46,688

Year 2           53,288                      1.12               47,579                  40,000  x  1.0              40,000
                                                                                                               6,250  x  1.07              6,688
                                                                                                 plug      1,329  x  1.12              1,488
                                                                                                             47,579                         48,176

Year 3           46,983                      1.15              40,855                   40,000  x  1.0              40,000
                                                                                                plug          855  x  1.07                 915
                                                                                                            40,855                          40,915

Year 3 is less than years 1 and 2 indicating that all inventory purchased during years 1 and 2 has been sold.
The inventory is gone and the inflation index for those years is not used in the future.

13. Following is inventory information related to all the company’s products

 

Product Cost Sales Price Cost to  Sell Replacement Cost Normal Profit
W 1200   2,500      50        1,100     1,250
X 1,800   2,000      50        1,600       150
Y 1,900   2,400    100         2,000        400
Z   800     900    100           650        400

1. Record the required adjustment to inventory using Lower of Cost or Market
A. By individual product
B. In Groups, W & Z and Y & X
C. In total for the company

2. Record the required adjustment to inventory using Lower of Cost or Net Realizable Value
A. By individual product
B. In Groups, W & Z and Y & X
C. In total for the company

Answer

1st Set up a table that allows you to compare the 3 “market” prices and determine market.

2nd Compare cost to market and select the lower of cost or market (LCM)

3rd Compare cost to LCM and determine if there is a necessary write-down

A. By Individual Product: Determine market and LCM for each individual product

Product Replacement
Cost		 (Ceiling)
NRV		 (Floor)
NRV – Profit **		 Market Cost LCM
W 1,100       2,450    1,200 1,200 1,200 1,200
X 1,600       1,950    1,800 1,800 1,800 1,800
Y 2,000       2,300    1,900 2,000 1,900 1,900
Z 650       800       400    650    800    650
Total 5,700 5,550

LCM is lower than cost by 150 so inventory must be adjusted down to LCM

Loss on market value (CGS)             150
              Inventory                                        150

Leave only two blank row space on the webpage

B. By Group, W & Z, Y & X:
Determine market and LCM for each group of products

Product Replacement
Cost		 (Ceiling)
NRV		 (Floor)
NRV – Profit **		 Market Cost LCM
W 1,100 2,450 1,200 1,200
Z    650   800   400    800
Group 1,750 3,250 1,600 1,750 2,000 1,750
Y 2,000 2,300 1,900 1,900
X 1,600 1,950 1,800 1,800
Group 3,600 4,250 3,700 3,700 3,700 3,700
Total  5,700  5,450

LCM is lower than cost by 250 so adjust inventory down to LCM

Loss on market value (CGS)             250
             Inventory                                           250

When doing for groups, go through the same steps as you did for individual products.

Total market and cost for each group and than put an amount in LCM only for the group.

Total LCM and total cost and compare the totals to determine the write-down.

C. In Total: Determine market and LCM for the total only

Product Replacement
Cost		 (Ceiling)
NRV		 (Floor)
NRV – Profit **		 Market Cost LCM
W 1,100 2,450 1,200 1,200
X 1,600 1,950 1,800 1,800
Y 2,000 2,300 1,900 1,900
Z      650    800   400 800
5,350 7,500 5,300 5,350 5,700 5,350

LCM is lower than cost by 350 so adjust inventory down to LCM

Loss on market value (CGS)              350
               Inventory                                          350

2.A. By Individual Product:  Determine Lower of cost or net realizable value for each individual product

Product NRV – Profit ** Cost L of C or NRV
W 1,200 1,200 1,200
X 1,800 1,800 1,800
Y 1,900 1,900 1,900
Z   400   800   400
Total 5,700 5,300

LCM is lower than cost by 400 so adjust inventory down to LCM

Loss on market value (CGS)          400
               Inventory                                      400

2.B. By Group: Determine Lower of cost or net realizable value by groups

Product NRV – Profit ** Cost L of C or NRV
W 1,200 1,200
Z    400    800
1,600 2,000 1,600
X 1,800 1,800
Y 1,900 1,900
3,700 3,700 3,700
Total 5,700 5,300

LCM is lower than cost by 400 so adjust inventory down to LCM

Loss on market value (CGS)            400
              Inventory                                             400

2.C. In Total: Determine Lower of cost or net realizable value by total

Product NRV – Profit ** Cost L of C or NRV
W 1,200 1,200
X 1,800 1,800
Y 1,900 1,900
Z   400    800
Total 5,300 5,700 5,300

LCM is lower than cost by 400 so adjust inventory down to LCM

Loss on market value (CGS)          400
              Inventory                                        400
14. A company started the year with $1,460,000 in beginning inventory. During the year net purchases totaled $3,856,000. Sales for the year totaled $6,450,000 and product was sold for approximately 150% of the cost of inventory. Estimate the value of ending inventory.
Answer

Divide sales by 1.50 to get the cost of goods sold

$6,450,000 / 1.5 = $4,300,000

   Beginning Inventory                   1,460,000
+ Purchases                                     3,856,000
= Available                                       5,316,000
– CGS from below                         (4,300,000)
= Ending Inventory                        1,016,000