Chapter 5
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Page 1
True / False
1. The three forms of inventory for a manufacturer are direct materials, direct labor, and finished goods.
a. True
b. False
2. The three distinct types of costs to a manufacturer are direct materials, direct labor, and manufacturing overhead.
a. True
b. False
3. When inventory is sold by a wholesaler or retailer, it is recorded in a different account on the income statement than a
manufacturer would use.
a. True
b. False
Chapter 5
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Page 2
4. Finished goods for a manufacturer are the equivalent of merchandise inventory for a retailer or wholesaler in that both
represent the inventory of goods held for sale.
a. True
b. False
5. The distinction between inventory and an operating asset is the intent of the owner.
a. True
b. False
6. Sales revenue is an inflow of assets.
a. True
b. False
Chapter 5
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Page 3
7. If a customer returns merchandise which has already been paid for, the retailer may give either a cash refund or a credit
on account.
a. True
b. False
8. Credit terms of n/30 mean that the net amount of the invoice, less any returns or allowances, is due within 30 days of
the date of the invoice.
a. True
b. False
9. On the income statement of a merchandising company, cost of goods sold is added to net sales to arrive at gross margin,
or gross profit.
a. True
b. False
Chapter 5
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Page 4
10. Like sales revenue, cost of goods sold represents an inflow of assets.
a. True
b. False
11. Cost of goods sold represents an outflow of an asset, inventory, from the sale of products.
a. True
b. False
12. If cost of goods sold does not equal the cost of merchandise purchased during the period, an adjustment must be made
to correct the error.
a. True
b. False
Chapter 5
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Page 5
13. Net purchases equals purchases less purchase returns, allowances, and discounts plus transportation-in.
a. True
b. False
14. Cost of goods sold is the difference between cost of goods sold available for sale and beginning inventory.
a. True
b. False
15. With the periodic inventory system, the Inventory account is updated after each sale or purchase of merchandise.
a. True
b. False
Chapter 5
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Page 6
16. Under the periodic inventory system, a physical inventory must be taken at the end of the period to determine cost of
goods sold.
a. True
b. False
17. Under the perpetual inventory system, each time goods are purchased, the Inventory account is transferred to sales
revenue.
a. True
b. False
18. A company using the periodic inventory system must total the selling prices of the units on hand at the end of the
period to value the ending inventory.
a. True
b. False
Chapter 5
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Page 7
19. Purchases is the temporary account used in a perpetual inventory system to record acquisitions of merchandise.
a. True
b. False
20. Purchase discounts decrease the total cost of merchandise acquired.
a. True
b. False
21. The buyer must include goods purchased FOB shipping point in its Inventory account if the goods are still in transit.
a. True
b. False
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Page 8
22. When merchandise is sold FOB shipping point, the buyer is responsible for the shipping costs.
a. True
b. False
23. Cost of goods available for sale is equal to beginning inventory less cost of goods sold.
a. True
b. False
24. The gross profit ratio is computed by dividing net sales by gross profit.
a. True
b. False
Chapter 5
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Page 9
25. The gross profit ratio is calculated as gross profit divided by net income.
a. True
b. False
26. It important that the proper amount be assigned to inventory because the amount assigned to inventory will affect the
amount eventually recorded as net sales.
a. True
b. False
27. The value assigned to an asset such as inventory on the balance sheet determines the amount eventually recognized as
an expense on the income statement.
a. True
b. False
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Page 10
28. Assets are unexpired costs, and expenses are expired costs.
a. True
b. False
29. One problem with the weighted average cost method is that it allows management to manipulate income.
a. True
b. False
30. The weighted average cost is calculated by adding up the units’ costs from each purchase and then dividing by the
number of purchases.
a. True
b. False
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Page 11
31. Under FIFO, the units in the ending inventory represent the oldest purchase of the period.
a. True
b. False
32. Specific identification relies on matching unit costs with the actual units sold.
a. True
b. False
33. Under LIFO, the units in the ending inventory represent the most recent purchase of the period.
a. True
b. False
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34. Changing inventory methods to take advantage of the tax breaks offered by LIFO is not a valid justification for a
change in methods.
a. True
b. False
35. A LIFO liquidation occurs when a company sells fewer units than it buys during the period.
a. True
b. False
36. According to the IRS’s LIFO conformity rule, a company that chooses LIFO to report net income to its stockholders
may not use LIFO in preparing its tax return.
a. True
b. False
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Page 13
37. A LIFO reserve represents the amount by which cost of goods sold on a FIFO basis exceeds the cost of goods sold on
a LIFO basis for the current year.
a. True
b. False
38. FIFO results in the least amount of income before taxes, assuming a period of rising prices.
a. True
b. False
39. The primary determinant in selecting an inventory costing method should be the ability of the method to accurately
reflect the cost of goods sold of the period.
a. True
b. False
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Page 14
40. The LIFO conformity rule requires that if a company uses LIFO in reporting income to stockholders, it also must use
LIFO on its tax return.
a. True
b. False
41. Many countries prohibit the use of LIFO for tax or financial reporting purposes.
a. True
b. False
42. A counterbalancing inventory error is one where the error on the balance sheet is offset by the same amount of error
on the income statement.
a. True
b. False
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Page 15
43. The effect of a misstatement of the year-end inventory is limited to the net income for that year.
a. True
b. False
44. If ending inventory is understated, then cost of goods sold is overstated.
a. True
b. False
45. If ending inventory is overstated, then net income is overstated as well.
a. True
b. False
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Page 16
46. The lower-of-cost-or-market (LCM) rule violates the historical cost principle.
a. True
b. False
47. The adjustment to write down inventory to its market value results in a loss on the income statement.
a. True
b. False
48. Both U.S. GAAP and international financial reporting standards (IFRS) require the use of the lower-of-cost-or-market
rule to value inventories.
a. True
b. False
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Page 17
49. The inventory turnover ratio is defined as cost of goods sold divided by average inventory.
a. True
b. False
50. If a company has a number of days’ sales in inventory equal to 60, that means that it takes about two months on
average to sell its inventory.
a. True
b. False
51. The lower the inventory turnover ratio, the less time inventory resides in storage.
a. True
b. False
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Page 18
52. The inventory turnover ratio is a measure of how many times during a period a company sells off its inventory.
a. True
b. False
53. If the direct method is used to prepare the Operating Activities category of the statement of cash flows, the amount of
cash paid to suppliers of inventory is shown as an addition in this section of the statement.
a. True
b. False
54. Under the indirect method of preparing the statement of cash flows, an increase in accounts payable is added to net
income to determine cash flow from operating activities.
a. True
b. False
Chapter 5
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Page 19
55. Under the indirect method of preparing the statement of cash flows, a decrease in inventory is added to net income to
determine cash flow from operating activities.
a. True
b. False
56. If a change in accounts payable was added back to net income on the statement of cash flows prepared using the
indirect method, then the amount owed to suppliers during the period had decreased.
a. True
b. False
57. Moving average is the name given to the use of an average cost method used with a periodic inventory system.
a. True
b. False
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Page 20
58. Whether LIFO costing is applied at the time each sale is made or only at the end of the period, both the periodic and
perpetual systems will yield the same ending inventory under LIFO.
a. True
b. False
59. Ending inventory valued under the FIFO method will be the same regardless of whether the periodic system or the
perpetual system is used.
a. True
b. False
60. Which one of the following types of inventory accounts would be used by a wholesaler or retailer?
a. Raw Materials Inventory
b. Work-in-Process Inventory
c. Finished Goods Inventory
d. Merchandise Inventory