Inventory – Other Issues

Easy 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. Companies cannot report inventory on the balance sheet at higher than

a. expected future cash flows generated from the inventory
b. the sales price of the inventory
c. the original cost of the inventory
d. both a. and c.

Answer
D. Assets may not be reported at an amount greater than future benefit. Future benefit is often defined as future cash flows generated from the asset. When future cash flows are greater than historical cost, inventory cannot be increased above cost. The gain can not be recorded until the inventory is sold (conservatism).
2. “Net Realizable Value” is computed as

a. cost less selling costs
b. sales price less selling costs
c. sales price less normal profit
d. cost less normal profits

Answer
B. Net realizable value = Sales price less cost to sell. It is the amount the company is expected to realize from selling the inventory.
3. Market when applying lower of cost or market may be defined as

a. higher than replacement cost and lower than net realizable value
b. higher than historical cost and lower than replacement cost
c. lower than replacement cost and lower than net realizable value
d. appraised value

Answer
A. “Market” is defined as the middle of one of three choices: Net realizable value (ceiling), replacement cost, and net realizable value less normal profit (floor).
4. When determining lower of cost or market by groups of inventory products

a. determine a lower of cost or market for each item
b. determine a lower of cost or market in total for all items only
c. compare cost and market at the group level only
d. follow the same procedures for individual items

Answer
C. Lower of cost or market is determined for each group total only. Total each of the 3 items that may be market and select only one market for the group. Total cost for the group. Then select the lowest of the total cost or the market for the group. You will not have a LCM for each item when using the group method. 
5. When using the gross profit method, the gross profit % is multiplied by

a. cost of goods sold
b. goods available
c. sales
d. purchases

Answer
C. The gross profit % is multiplied by sales to get gross profit dollars. Sales less the gross profit dollars gives cost of goods sold that is used to determine ending inventory.
6. Which of the following is not used when using the gross profit method to estimate the value of ending inventory?

a. purchase returns
b. freight in
c. selling expenses
d. sales

Answer
C. Only items related to purchasing inventory and sales are used in the gross profit method. Operating expenses are not considered when estimating inventory values.
7. When determining the value of ending inventory under dollar value LIFO a company keeps inventory records as if which method is used?

a. FIFO
b. LIFO
c. Weighted average
d. Specific Identification

Answer
A. The company keeps inventory records at last cost. Last cost is easiest to determine. The FIFO method values inventory at last purchase cost.
8. Dividing inventory values by the price index will

a. give the value of inventory at last cost
b. give the value of inventory at first cost
c. give the value of inventory at replacement cost
d. none of the above

Answer
B. When using dollar value LIFO, inventory valued at last cost is divided by the inflation index to give the estimated value of inventory. First costs are considered to be in ending inventory when using LIFO.
9. Which of the following is not included in goods available when using the lower of cost or market (conventional method) retail inventory method?

a. abnormal spoilage
b. markups
c. markdowns
d. purchases

Answer
C. 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. When using the retail inventory method, average cost will always give a ______ value of ending inventory than lower of cost or market.

a. higher
b. lower
c. the same as
d. you can’t determine until you know the value of ending inventory at retail

Answer
A. Average cost will always give a higher ratio then LCM and therefore a higher value of ending inventory. 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.

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

Product Replacement
Cost		 NRV Cost Normal Profit
1 1,200 1,400 1,000 160
2 1,800 1,500 1,600 100
3 1,900 2,000 2,100 220
4    400     600    900 125

1. Determine the amount that inventory will be reported on the balance sheet and the required adjustment to inventory using “Lower of Cost or Market”
A. By individual product
B. In total for the company

2. Determine the amount that inventory will be reported on the balance sheet and the required adjustment to inventory using “Lower of Cost or Net Realizable Value”
A. By individual product
B. 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 determine the lower of cost or market (LCM)

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

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

Product Replacement
Cost		 (Ceiling)
NRV		 (Floor)
NRV – Profit **		 Market Cost LCM
1 1,200 1,400 1,240 1,240 1,000 1,000
2 1,800 1,500 1,400 1,500 1,600 1,500
3 1,900 2,000 1,780 1,900 2,100 1,900
4    400     600    475    475    900    475
Total 5,600 4,875

LCM is lower than cost by 725 and inventory must be adjusted down to LCM

Loss on market value (CGS)           725
               Inventory                                          725

Inventory will be reported on the balance sheet at $4,875.

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

Product Replacement
Cost		 (Ceiling)
NRV		 (Floor)
NRV – Profit **		 Market Cost LCM
1 1,200 1,400 1,240 1,000
2 1,800 1,500 1,400 1,600
3 1,900 2,000 1,780 2,100
4    400    600    475    900
Total 5,300 5,500 4,895 5,300 5,600 5,300

LCM is lower than cost by 300 and inventory must be adjusted down to LCM

Loss on market value (CGS)              300
            Inventory                                             300

Inventory will be reported on the balance sheet at $5,300.

2.A. By Individual Product: Lower of cost and net realizable value

Product Cost NRV LC or NRV
1 1,200 1,400 1,200
2 1,800 1,500 1,500
3 1,900 2,000 1,900
4  400     600    400
Total 5,300 5,000

LC or NRV is lower than cost by 300 and inventory must be adjusted to LCM

Loss on market value (CGS)              300
            Inventory                                                 300

Inventory will be reported on the balance sheet at $5,000.

B. In Total: Determine LC or NRV for the total only

Product Cost NRV LC or NRV
1 1,200 1,400
2 1,800 1,500
3 1,900 2,000
4    400    600
Total 5,300 5,500 5,300

Cost is lower than NRV – no adjustment is necessary

12. The following information was taken from the records of the Company for the period from January 1st to March 31st:

Sales 2,000,000
Beginning Inventory 580,000
Administrative Expenses 600,000
Purchases 1,160,000
Freight-in 80,000
Purchase Returns 20,000
Selling Expense 350,000
Shipping Expense 135,000

The company sells it products to earn 30% gross profit. Using the gross profit method, estimate the value of ending inventory on March 31st .

Answer

1st: Calculate goods available for sale (GAS) 

(beginning inventory + all purchase related accounts)

2nd: Compute CGS by multiplying sales x GP% to get GP and back into CGS

3rd: GAS less CGS = EI at cost (reported on the balance sheet.)

Sales                                            2,000,000
– CGS must be                            1,400,000
= GP / Sales = GP 30%               600,000
Beginning Inventory                           580,000
+ Purchases                                        1,160,000
+ Freight-In                                            80,000
+ Purchase Returns                            (20,000)
= Available                                         1,800,000
– CGS from below                      (1,400,000)
= Ending Inventory                        400,000

13. The following data is available for the company for the current year:

Markups, net 37,000 Markdowns, net 45,000
Freight In 16,000 Purchases, cost 252,000
Purchases, retail 375,000 Normal Spoilage 12,000
Beginning Inventory, cost 123,000 Selling Expenses 125,000
Sales, net 289,000 Beginning Inventory, retail 174,000

Compute the estimated value of ending inventory using the retail inventory method and
A. Average Cost
B. Lower of Cost or Market
C. FIFO
D. LIFO

Answer

1st Set up the format using average cost.

Cost Retail
Beginning Inventory 123,000 174,000
+ Purchases 252,000 375,000
+ Freight In 16,000
+ Markups, net 37,000
– Markdowns, net ( 45,000)
= Available (72.3%) 391,000 / 541,000
– Sales, net (289,000)
– Normal Spoilage (12,000)
= Ending Inventory ???? 240,000

 

Retail Ending Inventory                        240,000
x Cost to Retail %                                        .723
= Ending Inventory at Cost                   173,520

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 541,000
+ Markdowns, net                                              45,000
Available at Lower of Cost or Market –retail 586,000

Then compute the cost to retail percentage

Available at Cost 391,000    =    0.667
Available at Retail 586,000

 

Ending Inventory at Retail                     240,000
x Cost to Retail %                                      0.667
= Ending Inventory at Cost                    160,080

C. FIFO
Do not include beginning inventory (assume BI was sold)

Use the average cost setup and then remove BI

Cost Available – Cost Beg. Inventory
Retail Available – Retail Beg. Inventory

391,000 – 123,000 = 268,000  =  0.730
541,000 – 174,000 = 367,000

Ending Inventory at Retail              240,000
x Cost to Retail %                                0.730
= Ending Inventory at Cost            175,200

D. LIFO
Use the average cost set up and

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      174,000            123,000
+ Current period layer           66,000 3rd       48,180 4th     use FIFO   .730
= Ending Inventory               240,000 2nd    171,180 5th     under LIFO

14. The company converted to dollar value LIFO during the base year.
The following information is available:

Inventory at FIFO $ Inflation Index
Base Year 500,000 1.00
End of Year 1 570,000   .96
End of Year 2 690,000 1.03
End of Year 3 725,000 1.06

Calculate the value of ending inventory using dollar value LIFO for all years given.

Answer

Value Inventory at last cost, FIFO inventory, and convert to LIFO.
Divide the last cost by the inflation index to get first cost value of inventory (LIFO).
Then determine which layer (year) the first cost inventory is from, beginning with the first base layer.
Multiply the amount related to each layer by the inflation index for the layer to get the value of inventory back to first cost for the year of the purchase.

 

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

 

Base           500,000                   1.0                       500,000            500,000   x   1.0            500,000

Year 1         570,000                   .96                       593,750            500,000   x   1.0            500,000
                                                                                                  plug    93,750   x   .96              90,000
                                                                                                            593,750                         590,000

Year 2         690,000                 1.03                     669,903              500,000   x  1.0             500,000
                                                                                                              93,750   x   .96               90,000
                                                                                                 plug     76,153   x   1.03             78,438
                                                                                                            669,903                          668,438

Year 3         725,000                1.06                      683,962              500,000   x   1.0             500,000
                                                                                                               93,750   x   .96               90,000
                                                                                                               76,153   x   1.03             78,438
                                                                                                  plug     14,059   x   1.06             14,903
                                                                                                             683,962                           683,341