Inventory – Other Issues

Self Test

Key Things to Know

j

Practice as You Learn

Self Test

b

Easy Test

h

Medium Test

i

Hard Test

1. Lower of cost or market must be applied because

a. the lowest possible cost of inventory must be reported
b. inventory can not be valued at lower than future benefit
c. inventory can not be valued at higher than future benefit
d. market is always lower than cost and an adjustment must be made

Answer
C. Assets may not be reported on the balance sheet at higher than expected future benefit. Future benefit is often defined as future cash flows generated from the asset. Lower of cost or market is applied to determine if historical cost is higher than future benefit.  
2. When applying lower of cost or market, “market” may be

a. replacement cost
b. higher than selling cost less cost to sell
c. lower than net realizable value less a normal profit margin
d. all of the above

Answer
A. Market is defined as the middle amount of net realizable value (the highest it can be), replacement cost and net realizable value less normal profit (the lowest it can be). Inventory can not be valued at b. or c.
3. When determining lower of cost or market, cost is compared to

a. the amount determined to be market
b. appraised value
c. always replacement cost
d. all of the above

Answer
A. When applying lower of cost or market, historical cost is first compared to the amount determined to be “market” out of the three possible NRV, replacement cost, and NRV less normal profit to get LCM. LCM is then compared to cost to determine the if a write down is necessary. Appraised value is not one of the three options for “market”.  
4. When determining the inventory write-down amount

a. cost is compared to market
b. cost is compared to replacement cost
c. cost is compared to lower of cost or market
d. market is compared to lower of cost or market

Answer
C. Historical cost is compared to lower of cost or market to determine the write down.  
5. A write-down to inventory is reported on the income statement as

a. part of inventory
b. part of cost of goods sold
c. an allowance for loss of inventory value
d. all of the above

Answer
B. The loss in value of inventory is reported on the income statement as part of cost of goods sold. A separate account called “loss on market value”, “loss on inventory write down”, etc. may be used to track the amount, however, these accounts are not reported separately on the income statement. An allowance account is a contra asset account which is reported as part of inventory on the balance sheet.
6. Accountants use the gross profit method to estimate

a. the company’s gross profit for the period
b. the retail value of ending inventory
c. the cost of ending inventory
d. purchases for the period

Answer
C. The gross profit method is used to estimate the cost of ending inventory. It is used when the company does not use the perpetual method and does not do a physical count.
7. Which inventory method may require the use of the gross profit method?

a. periodic
b. perpetual
c. LIFO
d. FIFO

Answer
A. The periodic method of inventory does not record the movement of inventory in the inventory account (like the perpetual method does). The company can not determine the cost of inventory by looking at the inventory balance. LIFO and FIFO are not used when the gross profit method is used to estimate inventory value because the company does not know ending inventory quantity.  
8. When using the gross profit method, goods available for sale less cost of goods sold is equal to

a. the company’s gross profit for the period
b. the retail value of ending inventory
c. the cost of ending inventory
d. purchases for the period

Answer
C. Beginning inventory + net purchases = goods available for sale – estimated cost of goods sold = estimated cost of ending inventory.  
9. The retail inventory method is used by retail stores that

a. track the retail value of all inventory transactions only
b. track all inventory transactions at cost and at retail
c. track all purchase related items at cost only
d. know the cost of items sold as they are sold

Answer
B. In order to use the retail inventory method, the company must track costs and retail prices for all items considered to be part of goods available for sale. Purchase related items must be tracked at cost and retail (c.) 
10. When using the retail inventory method, the available row includes

a. beginning inventory only
b. beginning inventory plus all purchase related activity
c. beginning inventory plus all purchase related activity plus changes in price
d. beginning inventory plus purchase related activity less sales related items

Answer
C. The available row is goods available for sale. It includes beginning inventory plus all items related to purchases and net markups and net markdowns (changes in price). Sales are considered below the available row.  
11. Which of the following is not included in retail ending inventory?

a. purchases
b. mark-downs
c. sales
d. freight in

Answer
D. Freight in is recorded in the cost column only. All others are recorded in the retail column.
12. Ending inventory at cost is valued using a ratio computed as

a. retail ending inventory divided by cost ending inventory
b. amount available at cost divided by amount available at retail
c. ending inventory at retail divided by net sales
d. none of the above

Answer
B. The ratio used in the retail inventory method is computed using the amounts on the available row, cost divided by retail amounts.
13. Using the cost to retail percentage to value inventory is based on the assumption

a. inventory cost as a percentage of retail price is generally consistent
b. inventory cost as a percentage of retail sales is generally not consistent
c. markups materially affect the value of ending inventory at cost
d. sales are generally made at one consistent gross profit percentage

Answer
A. When using the ratio that comes from the goods available row, you are assuming that ending inventory will follow the same general cost assumption as the goods that were available.  
14. Dollar value LIFO is used

a. to minimize the documents required to value inventory
b. to maximize profits
c. to determine and report the value of inventory at last cost
d. to determine and report the value of inventory at an average LIFO value

Answer
A. Dollar value LIFO eliminates the need for the company to keep purchase records all the way back to when the company began doing business. The company values inventory at the last purchase cost (which is easy to keep record of since it is the latest invoice) and uses an inflation index to convert last cost back to a first cost (reported cost of inventory when LIFO is used since the last are sold and the first ones are left). Inflation or deflation determines if profits are higher or lower using FIFO or LIFO.
15. When using Dollar Value LIFO, the inflation rate is used to

a. convert last cost back to first cost
b. convert first cost back to last cost
c. determine the value of the latest purchases
d. all of the above

Answer
A. The inflation rate indicates how much cost has changed since the base year. The inflation rate is used to convert last cost back to first cost. First purchases are considered to be ending inventory when LIFO is used.