Chapter 6
INVENTORIES AND COST OF SALES
1. Goods in transit are automatically included in inventory.
2. Goods on consignment are goods shipped by their owner, called the consignee, to another
party called the consignor.
3. If obsolete or damaged goods can be sold, they will be included in inventory at their net
realizable value.
4. If the seller is responsible for paying freight charges, then ownership of inventory passes
when goods arrive at their destination.
5. Net realizable value for damaged or obsolete goods is sales price plus the cost of making
the sale.
6. The cost of an inventory item includes its invoice cost minus any discount, and plus any
added or incidental costs necessary to put it in a place and condition for sale.
7. When taking a physical count of inventory, the use of pre-numbered inventory tickets is an
application of internal control.
8. Incidental costs often added to the costs of inventory include import duties, freight, storage,
and insurance.
9. The Inventory account is a controlling account for the inventory subsidiary ledger that
contains a separate record for each separate product.
10. Few companies take a physical count of inventory each year, and rely on inventory
records alone to determine the inventory value.
11. The matching principle is used by some companies to avoid allocating incidental
inventory costs to cost of goods sold.
12. The consistency concept prescribes that a company use the same accounting methods
period after period, so that financial statements are comparable across periods.
13. A company can change its inventory costing method without mentioning this change in its
financial statements because it is an internal management decision.
14. Whether purchase costs are rising or falling, FIFO always will yield the highest gross
profit and net income.
15. An advantage of the weighted average inventory method is that it tends to smooth out
erratic changes in costs.
16. In a period of rising purchase costs, FIFO usually gives a lower taxable income and
therefore, yields a tax advantage.
17. LIFO is preferred when purchase costs are rising and managers have incentives to report
higher income for reasons such as bonus plans, job security, and reputation.
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18. The LIFO method of inventory valuation can result in a company’s ending inventory being
valued at less than the inventory’s replacement cost because LIFO inventory leaves the oldest
costs in inventory.
19. The full disclosure principle requires that the notes to the financial statements report a
change in accounting method for inventory.
20. An advantage of LIFO is that it assigns the most recent costs to cost of goods sold, and
does a better job of matching current costs with revenues on the income statement.
21. Companies are allowed to use FIFO for financial reporting and LIFO for tax reporting,
according to IRS requirements.
22. An error in the period-end inventory balance will cause an error in the calculation of cost
of goods sold.
23. Errors in the period-end inventory balance only affect the current period’s records and
financial statements.
24. An inventory error is sometimes said to be self-correcting because it causes an offsetting
error in the next period.
25. An understatement of the ending inventory balance will understate cost of goods sold and
overstate net income.
26. An understatement of the beginning inventory balance will understate cost of goods sold
and overstate net income.
27. An understatement of ending inventory will cause an understatement of assets and equity
on the balance sheet.
28. An overstatement of ending inventory will cause an overstatement of assets and an
understatement of equity on the balance sheet.
29. A merchandiser’s ability to pay its short-term obligations depends on many factors
including how quickly it sells its merchandise inventory.
30. The inventory turnover ratio is computed by dividing average merchandise inventory by
cost of goods sold.
31. The days’ sales in inventory ratio is computed by dividing ending inventory by cost of
goods sold and multiplying the result by 365.
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32. There is no simple rule for inventory turnover, except that a high ratio is preferable
provided inventory is adequate to meet demand.
33. It can be expected that companies selling perishable goods have a higher inventory
turnover than companies selling nonperishable goods.
34. A company’s cost of goods sold was $15,500 and its average merchandise inventory was
$4,500. Its inventory turnover equals 3.4.
35. Tops had cost of goods sold of $8,321 million and its ending inventory was $2,027
million. Therefore its days’ sales in inventory equals 89 days.
36. One of the most important decisions in accounting for inventory is determining the unit
costs assigned to inventory items.
37. When units are purchased at different costs over time, determining the cost per unit
assigned to inventory items is simple.
38. LIFO assumes that inventory costs flow in the order incurred.
39. The assignment of costs to cost of goods sold and inventory using weighted average
usually yields different results depending on whether a perpetual or periodic system is used.
40. The FIFO inventory method assumes that costs for the earliest units purchased are the first
to be charged to the cost of goods sold.
41. The costs of goods purchased will vary under the different inventory methods of specific
identification, FIFO, LIFO, and weighted average.
42. The assignment of costs to the cost of goods sold and to ending inventory using FIFO is
the same for both the perpetual and periodic inventory systems.
43. Under LIFO, the most recent costs are assigned to ending inventory.
44. The choice of an inventory valuation method can have a major impact on gross profit and
cost of sales.
45. In applying the lower of cost or market method to inventory valuation, market is defined
as the current replacement cost.
46. In applying the lower of cost or market method to inventory valuation, market is defined
as the current selling price.
47. A company has inventory with a market value of $217,000 and a cost of $241,000.
According to the lower of cost or market, the inventory should be written down to $217,000.
48. The lower of cost or market rule for inventory valuation must be applied to each
individual unit separately, and not to major categories of inventory or to the entire inventory.
49. The conservatism constraint requires that when more than one estimate of the amounts to
be received or paid in the future exists and these estimates are about equally likely, then the
less optimistic amount is used.
50. A company’s total cost of inventory was $305,000 and its market value is $297,000.
Under the lower cost or market, the amount reported should be $305,000.
51. A company’s cost of inventory was $317,500. Due to phenomenal demand the market
value of its inventory increased to $323,000. This company should write up the value of its
inventory according to the consistency principle.
52. When LIFO is used with the periodic inventory system, cost of goods sold is assigned
costs from the most recent purchases at the point of each sale, rather than from the most
recent purchases for the period.
53. The retail inventory method estimates the cost of ending inventory by applying the gross
profit ratio to net sales.
54. The reasoning behind the retail inventory method is that if we can get a good estimate of
the cost-to-retail ratio, we can multiply ending inventory at retail by this ratio to estimate
ending inventory at cost.
55. The reliability of the gross profit method depends on a good estimate of the gross profit
ratio.
56. In the retail inventory method of inventory valuation, the retail amount of inventory refers
to its dollar amount measured using selling prices of inventory items.
57. To avoid the time-consuming process of taking an inventory each year, most companies
use the gross profit method to estimate ending inventory.
58. Using the retail inventory method, if the cost to retail ratio is 60% and ending inventory at
retail is $45,000, then estimated ending inventory at cost is $27,000.
59. Damaged and obsolete goods that can be sold:
A. Are never counted as inventory.
B. Are included in inventory at their full cost.
C. Are included in inventory at their net realizable value.
D. Should be disposed of immediately.
E. Are assigned a value of zero.
60. Merchandise inventory includes:
A. All goods owned by a company and held for sale.
B. All goods in transit.
C. All goods on consignment.
D. Only damaged goods.
E. Only non-damaged goods.
61. Goods in transit are included in a purchaser’s inventory:
A. At any time during transit.
B. When the purchaser is responsible for paying freight charges.
C. When the supplier is responsible for freight charges.
D. If the goods are shipped FOB destination.
E. After the half-way point between the buyer and seller.
62. Goods on consignment:
A. Are goods shipped by the owner to the consignee who sells the goods for the owner.
B. Are reported in the consignee’s books as inventory.
C. Are goods shipped to the consignor who sells the goods for the owner.
D. Are not reported in the consignor’s inventory since they do not have possession of the
inventory.
E. Are always paid for by the consignee when they take possession.
63. Regardless of the inventory costing system used, cost of goods available for sale must be
allocated at the end of the period between
A. beginning inventory and net purchases during the period.
B. ending inventory and beginning inventory.
C. net purchases during the period and ending inventory.
D. ending inventory and cost of goods sold.
E. beginning inventory and cost of goods sold.
64. On December 31 of the current year, Hewett Company reported an ending inventory
balance of $215,000. The following additional information is also available:
· Hewett sold goods costing $38,000 to Trump Enterprises on December 28 and shipped the
goods on that date with shipping terms of FOB shipping point. The goods were not included
in the ending inventory amount of $215,000 because they were not in Hewett’s warehouse.
· Hewett purchased goods costing $44,000 on December 29. The goods were shipped FOB
destination and were received by Hewett on January 2 of the following year. The shipment
was a rush order that was supposed to arrive by December 31. These goods were included in
the ending inventory balance of $215,000.
· Hewett’s ending inventory balance of $215,000 included $15,000 of goods being held on
consignment from Rumsfeld Company. (Hewett Company is the consignee.)
· Hewett’s ending inventory balance of $215,000 did not include goods costing $95,000 that
were shipped to Hewett on December 27 with shipping terms of FOB destination and were
still in transit at year-end.
Based on the above information, the correct balance for ending inventory on December 31 is:
A. $194,000
B. $209,000
C. $200,000
D. $171,000
E. $156,000