Financial Statements - Chapter 8 - 57Qs

Victor Chow

An analyst gathered the following information about a company ($ millions):
20x7 20x6
Sales 283.5 234.9
Yean-end inventory (under LIFO) 81.4 53.7
LIFO reserve 36.4 21.8
COGS (LIFO) 203.9 167.3

If the company used the FIFO inventory method instead of LIFO, the company's 20x7
gross profit margin would be closest to:

A 28.1%
B 29.8%
C 33.2%

C.

COGS on a FIFO basis will equal COGS LIFO - Change in the LIFO reserve.
The change in the LIFO reserve is 36.4 - 21.8 = 14.6;
FIFO COGS will be 203.9 - 14.6 = 189.3.
Gross profit will be 283.5 - 189.3 = 94.2.
The gross margin will be 94.2 / 283.5 = 33.23%.
(The gross margin for LIFO is 28.1%.)

An analyst gathered the following information about a company that uses the
LIFO method:
LIFO reserve as of Dec 31, 20x6 420,000
LIFO reserve as of Dec 31, 20x7 450,000
Marginal tax rate 30%

If the company had used the FIFO method instead of LIFO, the company's 20x7
net income would most likely have been:

A 9,000 lower
B 9,000 higher
C 21,000 higher

C.

The LIFO reserve increased by $30,000. If an increase in the LIFO reserve
occurs, LIFO cost of goods sold will be higher than FIFO by the amount of the
increase and net income would be lower than FIFO by $30,000(1 - 0.30) =
$21,000. After-tax FIFO net income would be $21,000 higher.

Is the reversal of an inventory write-down permitted under U.S. GAAP
(generally accepted accounting principles) and International Financial Reporting
Standards (IFRS)?

A No, under both
B Yes, under both
C Yes under IFRS but not under U.S. GAAP

C.

The reversal of an inventory write-down is permitted under IFRS but not under
U.S. GAAP.

A company using the LIFO inventory method reported a $20,000 decrease
in the LIFO reserve during the year that reduced the LIFO reserve to $85,000 at
year-end. If the company had used FIFO instead of LIFO in that year, the
company's financial statements would have reported:

A a higher cost of goods sold, but a lower inventory balance.
B both a lower cost of goods sold and a lower inventory balance.
C both a higher cost of goods sold and a higher inventory balance.

C.

The negative change in the LIFO reserve would increase the cost of goods sold
under FIFO compared to LIFO.
FIFO COGS = LIFO COGS - Change in LIFO reserve.
The LIFO reserve has a positive balance so that FIFO inventory would be higher
than LIFO inventory.
FIFO inventory = LIFO inventory + LIFO reserve

The year-end balances in a company's LIFO reserve were $56.8 million in
the company's financial statements for both 20x6 and 20x7. For 20x7, the
measure that will most likely be the same regardless of whether the company
used the LIFO or FIFO inventory method is the:

A inventory turnover.
B gross profit margin.
C amount of working capital.

B.

The LIFO reserve did not change from 20x6 to 20x7. Without a change in the
LIFO reserve, cost of goods sold would be the same under both methods. Sales
are always the same for both, so gross profit margin would be the same in 20x7.
The FIFO inventory would be higher because the LIFO inventory and LIFO
reserve are added to compute FIFO inventory. Because the inventory balances
would be different under FIFO, the current ratio, inventory turnover, and net
working capital would also be different under FIFO.

A company uses the LIFO inventory method, but most of the other
companies in the same industry use FIFO. Which of the following best
describes one of the adjustments that would be made to the company’s
financial statements to compare it with other companies in the industry? The
amount reported for the company’s ending inventory should be:

A increased by the ending balance in its LIFO reserve.
B decreased by the ending balance in its LIFO reserve.
C increased by the change in its LIFO reserve for that period.

A.

LIFO Reserve = FIFO Inventory – LIFO Inventory
Adding the ending balance in the LIFO reserve to the LIFO inventory would equal
the ending balance for inventory on a FIFO basis.

Compared with using the FIFO method to account for inventory, during a
period of rising prices, which of the following ratios is most likely higher for a
company using LIFO?

A Current ratio
B Gross margin
C Inventory turnover

C.

During a period of rising prices, ending inventory under LIFO will be lower than
that of FIFO and cost of goods sold higher; therefore, inventory turnover
(CGS/average inventory) will be higher.

Due to global oversupply in the microchip industry a company wrote down
its 20x6 inventory by €4.0 million from €12.0 million. The following year, due
to a change in competitive forces in the industry the market price of these chips
rose sharply to 10% above their original 20x6 value. If the company prepares its
financial statements in accordance with International Financial Reporting
Standards (IFRS), its 20x7 inventory will most likely be reported as:

A 8.0
B 12.0
C 13.2

B.

Although IFRS does require write-downs, it also allows revaluations, but not to
exceed the original value, i.e., 12. The exception to this, where gains are
allowed, is in producers of agricultural, forest and resource products. Under IFRS, if
inventory has been written down due to a decrease in net realizable value (a lower market value), and in a subsequent period
the value of the inventory increases, the write-down can be reversed. However, the amount of the reversal is limited to the amount
of the original write-down. Inventory cannot be revalued to an amount higher than the cost. In the question, the company wrote
down its inventory from €12.0 million to €8.0 million (a write-down of €4.0 million) in 20x6. In 20x7, the market price of these chips
rose sharply to 10% above their original 20x6 value. This would suggest that the inventory could be written back up to its original
value before the write-down, but not beyond. Since the original 20x6 value was €12.0 million, the highest value to which the
inventory could be written back up to in 20x7 would be the original value of €12.0 million.

During the past year, a company’s production facility was operating at 75% of
capacity. The firm’s costs were as follows:
$ millions

Fixed production overhead costs 3
Raw material costs 6
Labor costs 4
Freight-in costs for raw materials 1
Warehousing costs for finished goods 2

The firm ended the year with no remaining work-in-process inventory. The total
capitalized inventory cost for the year is closest to:

A 13.25
B 15.25
C 16.00

A
Fixed Production Costs: 75% of capacity: (75% x $3) 2.25
Raw material costs 6
Labor costs 4
Freight-in costs for raw materials 1
Total 13.25

A company which prepares its financial statements using IFRS wrote down its
inventory value by €20,000 in 20x1. In 20x2, prices increased and the same
inventory was worth €30,000 more than its value at the end of 20x1. Which of the
following statements is most accurate? In 20x2, the company’s cost of sales:

A was unaffected.
B decreased by €20,000.
C decreased by €30,000.

B.

Under IFRS, the recovery of previous write-down is limited to the amount of the original
write-down (€20,000) and is reported as a decrease in the cost of sales.

A retail company prepares its financial statements in accordance with U.S. GAAP.
Its purchases and sales of inventory for its first two years of operations are listed below.
First Year Second Year
Unit Purchased 80,000 100,000
Unit Cost $8.43 $12.25
Units Sold 73,000 78,000
Unit Selling Price $15.0 $16.0
In its second year of operation, the company’s ending inventory is $348,003. Which of
the following inventory cost flow assumptions is the company was most likely using?

A FIFO
B LIFO
C Weighted average cos

C.

The company is accounting for its inventory using the weighted average cost method.
In the 2nd year of operations, under Weighted Average Cost:
Units available for sale include ending inventory from year 1 plus purchases for year 2:
7,000 + 100,000 = 107,000
Cost of Goods Available for Sale: 7,000 x $8.43 + 100,000 x $12.25 = $1,284,000 Unit
Cost: $1,284,000/107,000 = $12.00
End Inventory = 107,000 –78,000 = 29,000 units. $12.00 x 29,000 = $348,003

A company incurs the followings costs related to its inventory during the year:
Cost $ millions
Purchase price 100,000
Trade discounts 5,000
Import duties 20,000
Shipping of raw materials to manufacturing facility 10,000
Manufacturing conversion costs 50,000
Abnormal costs as a result of waste material 8,000
Storage cost prior to shipping to customers 2,000
The amount charged to inventory cost (in millions) is closest to:

A 175,000
B 177,000
C 185,000

A.

Purchase price 100,000
Trade discounts (5,000)
Import duties 20,000
Shipping of raw materials to manufacturing facility 10,000
Manufacturing conversion costs 50,000
Total costs 175,000

A U.S. pulp brokerage firm which prepares its financial statements according to U.S. GAAP and uses a periodic inventory system had the following transactions during the year:

Date Activity Tons $

Beginning inventory 1 ton - $600 per

February Purchase 5 ton - $650 per

May Sale 2 ton - $700 per

August Purchase 3 ton - $680 per

November Sale 4 ton - $750 per

The cost of sales is closest to:
A $3,850 using FIFO
B $4,080 using LIFO
C $5,890 using weighted average

A.

Periodic
FIFO: 1 x 600 + 5 x 650 = 3,850
LIFO: 3 x 680 + 3 x 650 = 3,990
Weighted average cost = 654.44 x 6 = 3,926
Total cost = 1 x 600 + 5 x 650 + 3 x 680 = 5,890
Unit cost = 5,890 / (1+5+3) = 654.44

In a period of rising prices, when compared to a company that uses
weighted average cost for inventory, a company using FIFO will most likely
report higher values for its:

A return on sales.
B inventory turnover.
C debt-to-equity ratio

A.

In periods of rising prices FIFO results in a higher inventory value and a lower
cost of goods sold and therefore a higher net income. The higher net income
increases return on sales. The higher reported net income also increases
retained earnings, and therefore results in a lower debt-to- equity ratio not a
higher one. The combination of higher inventory and lower cost of goods sold
decreases inventory turnover (CGS/inventory)

Which of the following inventory valuation methods best matches the
actual historical cost of the inventory items to their physical flow?

A FIFO
B LIFO
C Specific identification

C.

Specific identification best matches the physical flow of the inventory items
because it tracks the actual units that are sold.

The following information is available about a manufacturing company:
Cost of ending inventory computed using FIFO 4.3
Net realizable value (NRV) 4.1
Current replacement cost 3.8
If the company is using International Financial Reporting Standards (IFRS),
instead of U.S. GAAP, its cost of goods sold ($ millions) is most likely

A the same
B 0.3 lower
C 0.3 higher

B.

COGS = Beginning Inventory + Purchases - Ending Inventory
Under IFRS, the Ending Inventory would be written down to its net realizable value ($4.1
million), whereas under U.S. GAAP, market is defined as current replacement cost ($3.8)
and hence would be written down to its current replacement cost ($3.8 million). The
smaller write down under IFRS will reduce the amount charged to the cost of goods sold,
as compared with U.S. GAAP, and result in a lower cost of goods sold of $0.3 million.

During a period of rising inventory costs, a company decides to change its
inventory method from FIFO to the weighted average cost method. Which of
the following financial ratios will most likely increase as a result of this change?

A Current
B Debt-to-equity
C Number of days in inventory

B.

All else held constant, in a period of rising costs the ending inventory would be
lower under weighted average and cost of goods sold (COGS) will be higher
(compared to FIFO) resulting in lower net income and retained earnings. There
will be no impact on the debt level, current or long-term. Therefore the debt-to-
equity ratio (Total debt ÷ Total shareholder’s equity) will increase due to the
decrease in retained earnings (and lower shareholders’ equity).

Select information from a company that uses the FIFO inventory method is provided
below:
Event                    Units $/Unit Total ($)
Opening inventory 1,000 7.5 7,500
Purchase                  250 7.6 1,900
Sales                       550 12 6,600
Purchase                 300 7.7 2,310
Sales                       600 12 7,200
If the company used a perpetual system versus a periodic inventory system, the gross
margin would most likely be:

A lower
B higher
C the same

C.

When using the FIFO inventory method the ending inventory, the cost of goods sold and
the gross margin, are the same under either the perpetual or periodic methods. The use
of a perpetual or periodic system makes a difference under weighted average, and LIFO.

Under US GAAP, which of the following is least likely a disclosure
concerning inventory?

A The carrying amounts of inventories carried at fair value less costs to sell
B The amount of the reversal of any write-down of inventories
C The amount of inventories recognized as an expense during the period

B.

US GAAP do not permit the reversal of prior-year write-downs; therefore, there
are no disclosures related to reversals.

For a company that prepares its financial statements under International
Financial Reporting Standards (IFRS), for which of the following assets is it
most likely that the company could report using the fair value model?

A Houses built by the company for sale to customers
B A building owned by the company and leased out to tenants
C A building the company owns and uses to house its administrative activities

B.

Under IFRS, a building owned for the purpose of earning rentals or capital
appreciation—in this case, the one owned by the company and leased out to
tenants—is an investment property and can be reported under either the cost
model or fair value model.

A company values its ending inventory using the prices of its most
recent purchases. The inventory valuation method that the company most likely
uses is:

A FIFO.
B Weighted average cost.
C LIFO.

A.

FIFO values ending inventory using the most recent costs of goods purchased.

The following information for a company was taken from its financial
statements and the accompanying notes:
$ thousands 20x4 20x3
Net Sales 11,159 8,895
COGS 9,898 7,901

The footnote shows that inventories are reported on a LIFO basis. The LIFO
reserve was $867 thousand and $547 thousand at the end of 20x4 and 20x3,
respectively. During 20x4, the company liquidated certain LIFO inventories
that had been carried at lower costs in prior years, and the effect of the
liquidation was to decrease COGS by $263,000. No LIFO liquidation occurred in
20x3.

After adjusting for the LIFO liquidation in 20x4, the change in gross profit
margin compared with 20x3 is most likely:

A unchanged
B higher by 2.5%
C lower by 2.3%

C.

For 20x3:
Net Sales: $8,895,000
COGS: $7,901,000
Gross Profit: $8,895,000 - $7,901,000 = $994,000

Gross Profit Margin: ($994,000 / $8,895,000) x 100 = 11.17%

For 20x4:
Adjusted COGS for 20x4: $9,898,000 + $263,000 (because COGS was
previously understated due to the LIFO liquidation) = $10,161,000

Adjusted Gross Profit for 20x4: $11,159,000 - $10,161,000 = $998,000

Adjusted Gross Profit Margin for 20x4: ($998,000 / $11,159,000) x 100 = 8.94%

The change in the gross profit margin from 20x3 to adjusted 20x4 would be:

11.17% - 8.94% = 2.23% decrease

Financial statement disclosures relating to inventory are least likely to
include which of the following? Information about the:

A amount of inventories pledged as security for liabilities
B inventory valuation method used
C types of inventory

C.

Neither IFRS nor US GAAP requires disclosure of types of inventory.

In the notes to a company's financial statements, the note dealing with
inventory indicates the following:
Inventories are stated at the lower of cost or market, with cost determined using
the last-in, first-out (LIFO) method.

20x4 20x3 20x2
LIFO Reserve 1,442 1,407 1,274
No LIFO liquidation occurred from 20x2 to 20x4.

The statement concerning LIFO liquidations most likely means that for the
stated period:

A units manufactured (or purchased) equaled or exceeded unit sales for each
year.
B no inventory write-downs occurred in any of the three years.
C costs and prices must have been rising throughout.

A.

LIFO liquidation arises when the number of units sold exceeds the number
of units purchased or manufactured, so a portion of the older inventory is
thus sold off or liquidated. Therefore, the statement means that units
manufactured (or purchased) equaled or exceeded unit sales for each year

Which of the following most likely indicates effective inventory
management?

A Finished goods growth rate exceeds growth rate of inventories other than
finished goods
B Current year's days of inventory on hand exceeds the prior year's days of
inventory on hand
C Sales growth rate exceeds finished goods inventory growth rate

C.

When the sales growth rate exceeds the finished goods inventory growth rate,
the company is managing to service its increased sales level with a relatively
lower level of inventory, indicating effective inventory management.

Inventory cost is least likely to include:

A transportation costs of shipping inventory to customers
B production-related storage costs
C costs incurred as a result of normal waste of materials

A.

Transportation costs incurred to ship inventory to customers are an expense and
may not be capitalized in inventory. (Transportation costs incurred to bring
inventory to the business location can be capitalized in inventory.) Storage costs
required as part of production, as well as costs incurred as a result of normal waste
of materials, can be capitalized in inventory. (Costs incurred as a result of
abnormal waste must be expensed.)

Mustard Seed PI.C adheres to IFRS. It recently purchased inventory for $100
million and spent $5 million for storage prior to selling the goods. The amount
it charged to inventory expense($ millions) was closest to:

A $95
B $100
C $105

B.

Inventory expense includes costs of purchase, costs of conversion, and other
costs incurred in bringing the inventories to their present location and condition. It
does not include storage costs not required as part of production.

Carrying inventory at a value above its historical cost would most likely be
permitted if:

A financial statements were prepared using U.S. GAAP
B the change resulted from a reversal of a previous write-down
C the inventory was held by a producer of agricultural products

C.

IFRS allow the inventories of producers and dealers of agricultural and forest
products, agricultural produce after harvest, and minerals and mineral products to
be carried at net realizable value even if above historical cost. (U.S. GAAP
treatment is similar.)

Eric's Used Book Store prepares its financial statements in accordance with
IFRS. Inventory was purchased for $1 million and later marked down to
$550,000. One of the books, however, was later discovered to be a rare collectible
item, and the inventory is now worth an estimated $3 million. The inventory is most
likely reported on the balance sheet at:

A $1,000,000
B $550,000
C $3,000,000

A.

Under IFRS, the reversal of write-downs is required if net realizable value
increases. The inventory will be reported on the balance sheet at $1,000,000. The
inventory is reported at the lower of cost or net realizable value. Under U.S.
GAAP, inventory is carried at the lower of cost or market value. After a write-down,
a new cost basis is determined and additional revisions may only reduce the value
further. The reversal of write-downs is not permitted.

Fernando's Pasta purchased inventory and later wrote it down. The current
net realizable value is higher than the value when written down. Fernando's
inventory balance will most likely be:

A higher if it complies with U.S. GAAP
B higher if it complies with IFRS
C the same under U.S. GAAP and IFRS

B.

IFRS require the reversal of inventory write-downs if net realizable values
increase; U.S. GAAP does not permit the reversal of write-downs.

Cinnamon Corp. started business in 20x7 and uses the weighted average
cost method. During 20x7, it purchased 45,000 units of inventory at $10 each
and sold 40,000 units for $20 each. In 20x8, it purchased another 50,000 units at
$11 each and sold 45,000 units for $22 each. Its 20x8 cost of sales($ thousands)
was closest to: (periodic inventory system)

A 490
B 495
C 491

C.

Cinnamon uses the weighted average cost method, so in 20x8, 5,000 units of
inventory were 20x7 units at $10 each and 50,000 were 2008 purchases at $11.
The weighted average cost of inventory during 2008 was thus (5,000 x 10) +
(50,000 x11) = 50,000+ 550,000 = $600,000, and the weighted average cost was
approximately $10.91 = $600,000/55,000. Cost of sales was $10.91 x 45,000,
which is approximately $490,950.

Zit AG started business in 20x7 and uses the FIFO method. During 20x7, it
purchased 45,000 units of inventory at $10 each and sold 40,000 units for $20
each. In 20x8, it purchased another 50,000 units at $11 each and sold 45,000
units for $22 each. Its 20x8 ending inventory balance($ thousands) was closest
to:

A $110
B $105
C $109

A.

Zit AG uses the FIFO method, and thus the first 5,000 units sold in 20x8 depleted
the 20x7 inventory. Of the inventory purchased in 20x8, 40,000 units were sold
and 10,000 remain, valued at $11 each, for a total of $110,000.

Zit AG uses the FIFO method, and Nutmeg Inc. uses the LIFO method.
Compared to the cost of replacing the inventory, during periods of rising
prices, the cost of sales reported by: (periodic inventory system)

A Nutmeg is too low
B Zit AG is too low
C Nutmeg is too high

B.

Zit AG uses the FIFO method, so its cost of sales represents units purchased at
a (no longer available) lower price. Nutmeg uses the LIFO method, so its cost of
sales is approximately equal to the current replacement cost of inventory.

Zit AG uses the FIFO method, and Nutmeg Inc. uses the LIFO method.
Compared to the cost of replacing the inventory, during periods of rising prices
the ending inventory balance reported by: (periodic inventory system)

A Zit AG is too high
B Nutmeg is too high
C Nutmeg is too low

C.

Nutmeg uses the LIFO method, and thus some of the inventory on the balance
sheet was purchased at a (no longer available) lower price. Zit AG uses the FIFO
method, so the carrying value on the balance sheet represents the most recently
purchased units and thus approximates the current replacement cost.

Like many technology companies, Tech Tools operates in an environment
of declining prices. Its reported profits will tend to be highest if it accounts for
inventory using the: (periodic inventory system)

A FIFO method
B weighted average cost method
C LIFO method

C.

In a declining price environment, the newest inventory is the lowest-cost inventory.
In such circumstances, using the LIFO method (selling the newer, cheaper
inventory first) will result in lower cost of sales and higher profit.

Compared to using the weighted average cost method to account for
inventory, during a period in which prices are generally rising, the current
ratio of a company using the FIFO method would most likely be: (periodic
inventory system)

A Lower
B Higher
C dependent upon the interaction with accounts payable

B.

In a rising price environment, inventory balances will be higher for the company
using the FIFO method. Accounts payable are based on amounts due to suppliers,
not the amounts accrued based on inventory accounting.

Zit AG wrote down the value of its inventory in 20x7 and reversed the write-
down in 20x8. Compared to the ratios that would have been calculated if the write-
down had never occurred, Zit's reported 20x7:

A current ratio was too high
B gross margin was too high
C inventory turnover was too high

C.

When a company writes down the value of its inventory, it recognizes a loss in the income
statement, which reduces net income for that period. The inventory value on the balance
sheet is also reduced. Here’s how such a write-down would affect the financial ratios:

Current Ratio: This ratio measures a company's ability to pay short-term obligations or
those due within one year. It is calculated by dividing current assets by current liabilities. If
Zit AG wrote down its inventory, the current assets would decrease, which would lead to a lower current ratio, not a higher one.Gross Margin:

Gross margin is calculated as sales minus the cost of goods sold (COGS)
divided by sales. A write-down increases COGS because the loss is included in the
COGS calculation. This would result in a lower gross margin, not a higher one.

Inventory Turnover: This ratio shows how many times a company's inventory is sold
and replaced over a period. It is calculated by dividing COGS by the average inventory
value. A write-down decreases the value of the ending inventory, which could lead to
an artificially higher inventory turnover if the COGS does not change significantly
because the average inventory value would be lower.

Because the write-down reduces the value of inventory, the denominator in the inventory
turnover ratio decreases, which can make the turnover appear higher than it would have
been if the write-down had not occurred.

Zit AG wrote down the value of its inventory in 20x7 and reversed the write-
down in 20x8. Compared to the results the company would have reported if the
write-down had never occurred, Zit's reported 20x8:

A profit was overstated
B cash flow from operations was overstated
C year-end inventory balance was overstated

A.

The reversal of the write-down shifted cost of sales from 20x8 to 20x7. The 20x7
cost of sales was higher because of the write-down, and the 20x8 cost of sales
was lower because of the reversal of the write-down. As a result, the reported 20x8
profits were overstated. Inventory balance in 20x8 is the same because the write-
down and reversal cancel each other out. Cash flow from operations is not affected
by the non-cash write-down, but the higher profits in 20x8 likely resulted in higher
taxes and thus lower cash flow from operations.

Compared to a company that uses the FIFO method, during periods of
rising prices a company that uses the LIFO method will most likely appear
more:

A Liquid
B Efficient
C profitable

B.

LIFO will result in lower inventory and higher cost of sales. Gross margin (a
profitability ratio) will be lower, the current ratio (a liquidity ratio) will be lower, and
inventory turnover (an efficiency ratio) will be higher.

Nutmeg, Inc. uses the LIFO method to account for inventory. During years in
which inventory unit costs are generally rising and in which the company
purchases more inventory than it sells to customers, its reported gross profit
margin will most likely be:

A higher than it would be if the company used the FIFO method
B about the same as it would be if the company used the FIFO method
C lower than it would be if the company used the FIFO method

C.

LIFO will result in lower inventory and higher cost of sales in periods of rising costs
compared to FIFO. Consequently, LIFO results in a lower gross profit margin than
FIFO.

Compared to using the FIFO method to account for inventory, during periods
of rising prices, a company using the LIFO method is most likely to report higher:

A cost of sales
B net income
C income taxes

A.

The LIFO method increases cost of sales, thus reducing profits and the taxes
thereon.

Carey Company adheres to U.S. GAAP, whereas Jonathan Company
adheres to IFRS. It is least likely that:

A Jonathan has reversed an inventory write-down
B Carey has reversed an inventory write-down
C Jonathan and Carey both use the FIFO inventory accounting method

B.

U.S. GAAP does not permit inventory write-downs to be reversed.

Which of the following is most likely included in a firm’s ending inventory?

A. Storage costs of finished goods.
B. Variable production overhead.
C. Selling and administrative costs.

B.

Variable production overhead is capitalized as a part of inventory. Storage
costs not related to the production process, and selling and administrative
costs are expensed as incurred.

Under which inventory cost flow assumption does inventory on the balance
sheet best approximate its current cost?

A. First-in, first-out.
B. Weighted average cost.
C. Last-in, first-out.

A.

Under FIFO, ending inventory is made up of the most recent purchases,
thereby providing a closer approximation of current cost.

During the year, a firm’s inventory purchases were as follows:
Quarter Units Purchased Cost per Unit Total
1 400 $3.30 $1,320
2 100 3.60 360
3 200 3.90 780
4 50 4.20 210
750 $2,670

The firm uses a periodic inventory system and calculates inventory and
COGS at the end of the year.
Beginning inventory was 200 units at $3 per unit = $600.
Sales for the year were 600 units.
Compute COGS for the year under FIFO and LIFO.

FIFO LIFO
A. $1,920 $2,175
B. $1,920 $1,850
C. $2,070 $2,175

A.

FIFO COGS
200 units from beginning inventory × $3.00 = $600
400 units from 1st quarter × $3.30 = 1,320
Total = $1,920
LIFO COGS
50 units from 4th quarter × $4.20 = $210
200 units from 3rd quarter × $3.90 = 780
100 units from 2nd quarter × $3.60 = 360
250 units from 1st quarter × $3.30 = 825
Total = $2,175
Note the shortcut. Once FIFO COGS of $1,920 is calculated, look at the LIFO
column. We know that during inflation and stable or increasing inventory
quantities, LIFO COGS is higher than FIFO. Only LIFO COGS of $2,175 meets
this condition

During May, a firm’s inventory account included the following transactions:
May 1 Inventory 25 units @ $4.00
May 12 Purchased 60 units @ $4.20
May 16 Sold 40 units @ $6.00
May 27 Purchased 30 units @ $4.25
May 29 Sold 40 units @ $6.10
Assuming periodic FIFO inventory costing, gross profit for May was:

A. $132.
B. $147.
C. $153

C.

Under FIFO, the first units purchased are the first units sold. FIFO COGS is the
same under a periodic system and a perpetual system.
Revenue $484 (40 units × $6.00) + (40 units × $6.10)
COGS $331 (25 units × $4.00) + (55 units × $4.20)
Gross profit $153

In periods of rising prices and stable inventory quantities, which of the
following best describes the effect on gross profit of using LIFO as compared to
using FIFO?

A. Lower.
B. Higher.
C. The same.

A.

Compared to FIFO, COGS calculated under LIFO will be higher because the
most recent, higher cost units are assumed to be the first units sold. Higher
COGS under LIFO will result in lower gross profit (revenue – COGS).

Kamp, Inc., sells specialized bicycle shoes. At year-end, due to a sudden
increase in manufacturing costs, the replacement cost per pair of shoes is $55.
The original cost is $43, and the current selling price is $50. The normal profit
margin is 10% of the selling price, and the selling costs are $3 per pair. Using
the lower of cost or market method under U.S. GAAP, which of the following
amounts should each pair of shoes be reported on Kamp’s year-end balance
sheet?

A. $42.
B. $43.
C. $47.

B.

Market is equal to the replacement cost as long as replacement cost is within a
specific range. The upper bound is net realizable value (NRV) which is equal to
the selling price ($50) less selling costs ($3) for a NRV of $47. The lower bound
is NRV ($47) less normal profit margin (10% of selling price = $5) for a net
amount of $42. Because replacement cost is greater than NRV ($47), market
equals NRV ($47). Additionally, we have to use the lower of cost ($43) or
market ($47) principle, so the shoes should be recorded at a cost of $43.

Which of the following inventory disclosures would least likely be found in
the footnotes of a firm following IFRS?

A. The amount of loss reversals, from previously written-down inventory,
recognized during the period.
B. The carrying value of inventories that collateralize a short-term loan.
C. The separate carrying values of raw materials, work-in-process, and
finished goods computed under the LIFO cost flow method.

C.

While the separate carrying values of raw materials, work-in-process, and
finished goods are required disclosure for some firms, LIFO is not permitted
under IFRS.

Which of the following is most likely for a firm with high inventory turnover
and lower sales growth than the industry average? The firm:

A. is managing its inventory effectively.
B. may have obsolete inventory that requires a writedown.
C. may be losing sales by not carrying enough inventory.

C.

High inventory turnover coupled with low sales growth relative to the industry
may be an indication of inadequate inventory levels. In this case, the firm may
be losing sales by not carrying enough inventory.

In an inflationary environment, a LIFO liquidation will most likely result in an
increase in:

A. inventory.
B. accounts payable.
C. operating profit margin

C.

In a LIFO liquidation, older and lower costs are included in cost of sales. Thus,
cost of sales per unit decreases and profit margins increase.

In a period of falling prices, a firm reporting under LIFO, compared to
reporting under FIFO, will have a higher:

A. cost of sales.
B. gross profit margin.
C. inventory turnover ratio.

B.

With falling prices, LIFO COGS will include the cost of lower priced inventory
and COGS will be less when compared to FIFO COGS. Because of this, the firm
would report a higher gross profit margin under LIFO than under FIFO, while
LIFO inventory will be higher and inventory turnover lower.

A firm that uses LIFO for inventory accounting reported COGS of $300,000
and ending inventory of $200,000 for the current period, and a LIFO reserve that
decreased from $40,000 to $35,000 over the period. If the firm had reported
using FIFO, its gross profit would have been:

A. the same.
B. $5,000 higher.
C. $5,000 lower.

C.

FIFO COGS = LIFO COGS – (ending LIFO reserve – beginning LIFO reserve)
Ending LIFO reserve – beginning LIFO reserve = $35,000 – $ 40,000 = –$5,000
With FIFO COGS $5,000 greater than LIFO COGS, gross profit under FIFO
would be $5,000 lower than under LIFO.

Poulter Products reports under IFRS and wrote its inventory value down
from cost of $400,000 to net realizable value of $380,000. The most likely
financial statement effect of this change is a(n):

A. increase in cost of sales.
B. decrease in depreciation charges.
C. loss reported as other comprehensive income.

A.

The write down in inventory value from cost to net realizable value is reported
on the income statement either as an addition to cost of sales or as a separate
line item, not as other comprehensive income. Depreciation will not be
affected as inventory is not depreciated.

During a period of increasing prices, compared to reporting under LIFO, a
firm that reports using average cost for inventory will have a:

A. lower gross margin.
B. higher current ratio.
C. higher asset turnover.

B.

Compared to using LIFO, using average cost would produce lower COGS, higher
gross operating income, and higher ending inventory, so current assets and the
current ratio would be higher. Consequently, gross margin would be higher and
asset turnover would be lower under the average cost inventory method.

Compared to reporting under FIFO for both tax and financial statements, a
firm that chooses to report under LIFO during a period of falling prices would be
most likely to report a lower:

A. inventory.
B. gross profit.
C. cash balance

C.

When prices are falling, LIFO would result in lower COGS (higher gross profit)
and higher ending inventory than FIFO. Higher gross profit with LIFO would
result in higher taxes payable which would reduce cash balances (as long they
pay their taxes).

Eric's Used Book Store prepares its financial statements in accordance
with U.S. GAAP. Inventory was purchased for $3 million and later
marked down to $550,000. One of the books, however, was later
discovered to be a low market value item, and the inventory is now
worth an estimated $1 million. The inventory is most likely reported on
the balance sheet at:

A $1,000,000
B $550,000
C $3,000,000

B.

Under IFRS, the reversal of write-downs is required if net
realizable value increases. The inventory will be reported on
the balance sheet at $1,000,000. The inventory is reported at
the lower of cost or net realizable value. Under U.S. GAAP,
inventory is carried at the lower of cost or market value. After
a write-down, a new cost basis is determined and additional
revisions may only reduce the value further. The reversal of
write-downs is not permitted.