Inventory
Self Test
Financial Accounting
Inventory
Self Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. The definition of inventory is
a. goods held for use in the company
b. assets held by the company
c. goods held only for sale to customer
d. assets that will be used to manufacture the product
Check Your Answer
C. Inventory is items held only for resale to customers. A company has many assets used in the business that are not for resale to customers.
2. When inventory is shipped to the customer F.O.B shipping
a. the customer owns the inventory when received
b. the customer owns the inventory when ordered
c. the customer owns the inventory when shipped
d. the customer does not own the inventory in transit
Check Your Answer
C. F.O.B. shipping means the customer owns the inventory on the date it is shipped and is the owner during transit. The word that follows FOB is when the buyer/customer takes title and is the owner.
3. Cost of goods sold is
a. the cost of making product
b. the cost of making or purchasing inventory sold this period
c. the cost of delivering goods to customers
d. the cost of selling goods to customers
Check Your Answer
B. Cost of goods sold is the cost of making/purchasing inventory that is sold this period. It must be sold this period to be part of cost of goods sold. If it is not sold this period it is still the asset inventory. The costs of delivering and selling goods are operating expenses reported as selling expenses.
4. Inventory that appreciates in value is reported on the balance sheet at
a. historical cost
b. lower of cost or market
c. either a. & b.
d. fair market value or replacement cost
Check Your Answer
C. Inventory is never reported at fair market value when fair market value is greater than historical cost. Lower of cost or market requires the inventory to be reported at replacement cost (market) if inventory is losing value. Inventory is never increased to fair market value.
5. When the same inventory items are purchased at different costs per item
a. FASB gives you a choice of FIFO, LIFO or Weighted average
b. cost is easy to determine and no method is required
c. the highest cost is used for inventory for conservatism
d. the lowest cost is used for inventory for conservatism
Check Your Answer
A. In this situation, the company does not know which cost was paid for the items sold because all items look the same on the warehouse shelf. Since a company can’t determine the exact cost of the items sold, one of the three methods must be used to estimate the cost of items sold.
6. When using the FIFO inventory method:
a. items purchased last are assumed to be sold first
b. items purchased first are assumed to be sold first
c. items purchased first are assumed to be sold last
d. net income will always be higher than when LIFO is used
Check Your Answer
B. FIFO means first purchased (in) are the first sold (out). Whether or not net income is higher or lower depends on if inventory items are incurring inflation or deflation.
7. When using the LIFO inventory method
a. items purchased last are assumed to be sold first
b. items purchased first are assumed to be sold first
c. items purchased last are assumed to be sold last
d. net income will always be higher than when FIFO is used
Check Your Answer
A. LIFO means last purchased (in) is the first sold (out). Whether or not net income is higher or lower depends on if inventory items are incurring inflation or deflation.
8. The weighted average inventory method uses the average of
a. items purchased during the period
b. items available any time during the period
c. prior period ending inventory balances
d. items sold during the period
Check Your Answer
B. The average is the average of what was available during the period. Beginning inventory plus all purchases equals available.
9. Which of the following businesses would use the specific identification method to
value inventory?
a. a grocery store
b. Walmart
c. a jewelry store
d. a convenience store
Check Your Answer
C. Specific identification can only be used when each item purchased has a different description and is easily identified. This occurs with jewelry inventory. The other types of retailers will purchase the same items at different costs during the period and will not be able to tell the difference in cost for what was sold.
10. Which method gives a higher cost of goods sold in times of inflation?
a. FIFO
b. LIFO
c. Weighted average
d. The same inventory is sold so the cost of goods sold is the same under all methods.
Check Your Answer
B. Cost of goods sold is the cost of items sold. LIFO means the last ones purchased are sold first. Last ones purchased have a higher cost in times of is inflation.
11. Why is it necessary to use a method to value inventory?
a. every item is the same and has the same cost
b. the same item may have different costs when purchased
c. the company wants to report income as high as possible
d. some items of inventory take longer to sell than other items
Check Your Answer
B. When the company buys the same item at different prices, it can not tell which price was sold when. The items all look the same in the warehouse. A method must be used to consistently determine which costs were sold.
12. Which method gives the highest net income?
a. FIFO
b. LIFO
c. Weighted average
d. it depends on if the items in inventory are incurring inflation or deflation
Check Your Answer
D. Net income is affected by cost of goods sold. Cost of goods sold is equal to the cost of the items sold. In times of inflation, the higher costs are purchased last, so higher cost of goods sold gives lower net income under LIFO (last ones are considered sold). In times of deflation, lower costs are purchased last, so lower cost of goods sold gives higher net income under FIFO.
13. Lower of cost or market is used because
a. of the historical cost concept
b. assets may not be reported at higher than future benefit of the asset
c. future cash flows are higher than cost
d. inventory that appreciates must be reported at a higher value
Check Your Answer
B. An asset is defined as probably future economic benefit. Economic benefit for inventory is the futures cash that will be received when the asset is sold. The asset inventory can not be reported at a higher amount than the company expects to receive. Asset are not reported at higher than historical cost, they are only reported lower if the value of the asset is less.
14. Write down of inventory to fair market value is called
a. loss on sale of inventory
b. impairment
c. value reduction
d. cost of goods held
Check Your Answer
B. Impairment is the technical term used to describe the write down of inventory to a fair market value lower than cost when lower of cost or market is applied. “Impairment” means an asset has lost value.
15. The periodic method of recording inventory
a. adjusts the inventory account when inventory is purchased or sold
b. adjusts the inventory account when inventory is sold only
c. adjusts the inventory account for reductions in fair market value
d. adjusts the inventory account to the cost of inventory held at the end of the period only
Check Your Answer
D. When using the periodic method, the inventory account is not used until the end of the period adjustment to get inventory equal to what is really on hand. Purchases are recorded to the “purchases” expense account. Sales are not recorded because the company does not track the cost of what is sold at the time it is sold. (c.) is done with lower of cost or market.
16. The perpetual method of recording inventory
a. adjusts the inventory account when inventory is purchased or sold
b. adjusts the inventory account when inventory is sold only
c. adjusts the inventory account for changes in fair market value
d. adjusts the inventory account to the cost of inventory held at the of the period only
Check Your Answer
A. When using the perpetual method, the inventory account is used to record all movement of inventory: purchases, returns, and sales. (d) is also done at the end of the period, but it is not the only thing recorded to the inventory account.
Remember: Periodic – don’t use the inventory account until the end
Perpetual – always use the inventory account for all transactions that impact inventory
17. Unaccounted for reductions in inventory is called
a. damaged inventory
b. lost inventory
c. shrink
d. cost of goods held
Check Your Answer
C. Shrink is the word used for reduction in inventory that the company can not identify. This is usually caused by employee error or theft.
18. When using the periodic method, the purchases account is adjusted to 0 because
a. the company did not really purchase inventory this period
b. the company transfers this account to retained earnings
c. the company transfers this account to cost of goods sold which was not recorded during the period
d. the company adds the amount in this account to cost of goods sold recorded
during the period
Check Your Answer
C. Under the periodic method, inventory is recorded to the expense account purchases. An expense does not occur when an asset is purchased. The expense occurs when the inventory is provided to the customer, which is cost of goods sold. The expense in the purchases account is moved to the cost of goods sold account. The adjustment is necessary to move purchases to cost of goods sold and then adjust cost of goods sold for changes in inventory.
19. The periodic method of inventory is used when
a. all inventory movement is tracked and recorded
b. the cost of inventory sold is not recorded when it is sold
c. the cost of purchases is recorded when it is sold
d. it is not known how much inventory items cost
Check Your Answer
B. Company’s that use the periodic method do not track the cost of inventory at the time it is sold. The cost of goods sold is determined using purchases and inventory balances (CGS calculation). Companies always know what they paid for inventory (d) (a. & c.) is the perpetual method.
20. When the value of ending inventory is incorrectly reported
a. only the balance sheet is incorrectly reported
b. cost of goods sold is correctly reported
c. net income is correctly reported
d. the balance sheet and income statement are incorrectly reported
Check Your Answer
D. Cost of goods sold is calculated using beginning and ending inventory. When inventory is incorrect, cost of goods sold is incorrect also. Inventory is reported on the balance sheet and cost of goods sold is reported on the income statements, so both statements will be incorrect when there is an error in inventory balances.
21. When ending inventory is overstated
a. cost of goods sold is understated
b. cost of goods sold is overstated
c. assets are understated
d. net income is understated
Check Your Answer
A. Beginning inventory + Purchases – Ending Inventory = Cost of goods sold. When ending inventory is too high too much is subtracted and cost of goods sold is too low. Ending inventory always has the opposite effect on cost of goods sold.
22. Which of the following formulas is the correct computation of cost of goods sold?
a. beginning inventory less purchases less ending inventory
b. ending inventory plus purchases less beginning inventory
c. gross profit plus purchases less ending inventory
d. beginning inventory plus purchases less ending inventory
Check Your Answer
D. Beginning inventory + Purchases – Ending Inventory = Cost of goods sold.