Accounting Chapter 9 1 For ratio analysis, a distortion in the current ratio under

Chapter 9 Inventories

True/False

[QUESTION]

1. Cost of goods available for sale is always the same regardless of the inventory cost flow

assumption in use.

2. Under a periodic inventory system, cost of goods sold automatically includes the cost of

inventory “shrinkage.”

3. All inventory items to which the firm has legal title should be included in the inventory

account although most firms record inventory only when they physically receive it.

4. Generally accepted accounting principles do not allow variable costing to be used in external

financial statements because absorption costing makes it easier for financial statement users to

interpret year-to-year changes in reported net income.

5. Absorption costing makes it difficult for financial statement users to interpret year–to-year

changes in cost of goods sold when production levels significantly change between one year and

the next.

6. GAAP requires the cost flow assumption to correspond to the actual physical flow of

inventory.

7. For ratio analysis, a distortion in the current ratio under LIFO inventory costing may be

adjusted by subtracting the LIFO reserve from current assets.

8. When a LIFO firm liquidates old LIFO layers, the net income number under LIFO can be

seriously distorted because the older costs in the LIFO layers that are liquidated are matched

against sales dollars that are stated at higher current prices.

9. U. S. tax rules specify that if LIFO is used for tax purposes, the external financial statements

must also use LIFO.

10. During periods of rising inventory costs, LIFO cost of goods sold is understated because of

the inventory holding gains that have occurred during the period.

11. When using LIFO, management occasionally deliberately stops normal purchases for the last

few weeks of the year in an attempt to boost profits.

12. In the Old-LCM approach to valuing inventory, the ceiling is the inventory’s net realizable

value.

13. For international financial reporting, the accounting standard IAS 2 permits the use of either

the FIFO or weighted average cost flow assumption, but prohibits the use of LIFO.

14.IFRS only permits the use of either the FIFO or weighted average cost flow assumption.

15. Dollar-value LIFO avoids much of the detailed recordkeeping required under standard LIFO.

Multiple Choice

[QUESTION]

16. The major issue in inventory accounting is

a. determining whether to take inventory using cycle counts instead of counting all inventory

only at the end of the year.

b. deciding whether to maintain records on a periodic or perpetual basis.

c. determining what goods to include in inventory.

d. choosing the method for allocating goods available for sale to ending inventory and cost of

goods sold.

17. Goods available for sale is determined by

a. adding the cost of any beginning inventory and the cost of purchases during the period.

b. subtracting the cost of any ending inventory from the cost of any beginning inventory.

c. subtracting the cost of any beginning inventory from the cost of any ending inventory.

d. subtracting the cost of any beginning inventory from the cost of purchases during the period.

18. In an actual business, which of the following is an inventory accounting issue that frequently

arises?

a. How should physical quantities in inventory be determined?

b. What items should be included in ending inventory?

c. What costs should be included in inventory purchases?

d. All of these answer choices are correct..

19. If an inventory error is discovered during the reporting year,

a. it should be deferred and discussed with the external auditors.

b. it should be corrected immediately.

c. a certification of inventory is required.

d. a running inventory balance should be implemented immediately.

20. A periodic system of inventory

a. reduces record keeping.

b. increases record keeping.

c. increases the cost of maintaining inventory.

d. eliminates the need for a physical count.

21. The use of perpetual inventory systems is preferred where a

a. large number of expensive inventory units exist.

b. small number of expensive inventory units exist.

c. large number of inexpensive inventory units exist.

d. small number of inexpensive inventory units exist.

22. A perpetual inventory system

a. usually maintains inventory records only in terms of physical units on hand.

b. uses a purchases account to record additions to inventory.

c. eliminates the need to periodically take a physical inventory count.

d. keeps a running record of the amount of inventory on hand.

23. Goods held on consignment are included in the inventory valuation of

a. the consignor.

b. the consignee.

c. both the consignor and the consignee.

d. neither the consignor nor the consignee.

24. Manufacturing costs not considered to be closely associated with production are called

a. period costs.

b. product costs.

c. absorption costs.

d. variable costs.

25. The carrying cost of inventory should include all the following costs except

a. purchase costs.

b. sales taxes and transportation costs paid by the purchaser.

c. general administrative costs associated with the purchase of inventory.

d. insurance and storage costs.

26. The inventory accounts of a manufacturer would include all the following accounts except

a. raw materials inventory.

b. work-in-process inventory.

c. finished goods inventory.

d. sold goods awaiting shipment inventory.

27. Which of the following statements regarding inventory accounting is false?

a. The tax advantage of LIFO is that it provides a lower net income than FIFO during periods of

rising prices and decreasing inventory quantities.

b. Managers can avoid the negative tax implications of LIFO liquidations by purchasing enough

inventory before year-end to bring inventory up to the level at the start of the year.

c. The size of the difference between cost of goods sold under FIFO and cost of goods sold under

replacement cost depends on the amount of change in input cost as well as the inventory

turnover.

d. To avoid providing an incentive for managers to engage in intentional LIFO liquidations,

bonus contracts should subtract out any profits from LIFO liquidations.

28. When a company uses absorption costing

a. only fixed costs are inventoried.

b. only variable costs are inventoried.

c. all production costs are inventoried.

d. fixed costs are expensed as incurred.

29. Analysts must be aware that with the use of absorption costing, as inventory absorbs more

fixed costs, reported net income tends to

a. increase.

b. decrease.

c. remain the same.

d. become highly volatile.

30. Examples of variable costs include all the following except

a. raw materials costs.

b. the plant manager’s salary.

c. direct labor costs.

d. electricity used in running production machinery.

31. The mechanics of absorption costing can lead to year-to-year income changes

a. whenever inventory levels remain fairly constant.

b. if the productivity of factory workers improves.

c. if production and sales levels are not the same.

d. when raw material prices are increasing.

32. Analysts must recognize that the use of the specific identification method to value inventory

has a serious deficiency because it

a. allows manipulation of net income.

b. allows manipulation of period costs.

c. allows manipulation of selling expenses.

d. allows manipulation of administrative expenses.

33. Goods available for sale needs to be allocated between

a. beginning inventory and inventory purchases.

b. beginning inventory and ending inventory.

c. ending inventory and cost of goods sold.

d. inventory purchases and cost of goods sold.

34. Financial analysts recognize that the deficiency of the FIFO cost flow assumption is the

failure to

a. match current costs with current revenues.

b. match current costs with oldest revenues.

c. match oldest costs with current revenues.

d. match oldest costs with oldest revenues.

35. The input cost changes that occur after the purchase of inventory items in a current cost

accounting system are recognized as

a. realized gains and losses.

b. unrealized holding gains and losses.

c. extraordinary gains and losses.

d. costs of goods sold.

Use the following to answer questions 36 – 39:

REFERENCE: Ref. 09_01

The following information pertains to the Fan Company’s inventory item B1008:

March 1

Inventory Balance

400 units

@ $3.10

5

Purchase

1,400 units

@ $3.20

14

Purchase

280 units

@ $3.25

31

Inventory Balance

520 units

[QUESTION]

REFER TO: Ref. 09_01

36. In a periodic inventory system, the ending LIFO inventory is

a. $1,624.

b. $1,655.

c. $1,678.

d. $1,733.

Ending LIFO inventory:

$1,240

384

$1,624

37. In a periodic inventory system, the LIFO cost of goods sold is

a. $4,952.

b. $4,967.

c. $4,993.

d. $5,006.

LIFO cost of goods sold:

$910

4,096

$5,006

38. In a periodic inventory system, the FIFO cost of goods sold is

a. $4,952.

b. $4,967.

c. $4,993.

d. $5,006.

39. In a periodic inventory system, the ending FIFO inventory is

a. $1,624.

b. $1,655.

c. $1,678.

d. $1,733.

40. The Wheat Company has used the LIFO method for inventory valuation since the start of

business 15 years ago. The current year ending inventory is $375,000. If the FIFO method of

inventory had been used, the inventory would be $450,000. If Wheat Company had used the FIFO

inventory method, pre-tax income would have been

a. $75,000 higher over the 15-year period.

b. $75,000 lower over the 15-year period.

c. $75,000 higher in the current year.

d. $75,000 lower in the current year.

41. The LIFO reserve disclosure is required because LIFO inventory costs are

a. higher than FIFO inventory costs.

b. lower than FIFO inventory costs.

c. equal to FIFO inventory costs.

d. usually of no consequence.

42. The conversion of a LIFO inventory to approximate the inventory at FIFO is accomplished

through application of which one of the following formulas?

a. FIFO inventory = LIFO inventory  LIFO reserve

b. FIFO inventory = LIFO inventory ÷ LIFO reserve

c. FIFO inventory = LIFO inventory – LIFO reserve

d. FIFO inventory = LIFO inventory + LIFO reserve

43. The formula to convert the cost of goods sold LIFO to an estimate of the cost of goods sold

FIFO is

a. cost of goods sold LIFO + increase in LIFO reserve = cost of goods sold FIFO

b. cost of goods sold LIFO – increase in LIFO reserve = cost of goods sold FIFO

c. cost of goods sold LIFO – decrease in LIFO reserve = cost of goods sold FIFO

d. cost of goods sold LIFO + beginning LIFO reserve = cost of goods sold FIFO

44. The Xano Company reported merchandise inventory at LIFO of $450,000 on the year-end

financial statements. The company also reported a LIFO reserve of $34,000. An estimate of the

inventory balance if the inventory had been reported using the FIFO assumption is

a. $382,000.

b. $416,000.

c. $461,000.

d. $484,000.

45. The Skone Corporation reported a LIFO reserve of $25,000 at the end of the year. The

beginning LIFO reserve was $20,000. The cost of goods sold was $197,500 under LIFO. The

cost of goods sold under FIFO should be

a. $192,500.

b. $197,500.

c. $202,500.

d. $222,500.

46. The Mick Company reported a LIFO cost of goods sold for the year of $100,000. The LIFO

reserve decreased by $30,000 for the year. An estimate of the cost of goods sold under FIFO is

a. $70,000.

b. $130,000.

c. $160,000.

d. $200,000.

47. The Johnson Corporation reported a LIFO reserve of $45,000 at the end of the year. The

beginning LIFO reserve was $60,000. The cost of goods sold was $260,000 under LIFO. The

cost of goods sold under FIFO should be

a. $245,000.

b. $260,000.

c. $275,000.

d. $305,000.

48. Inventory turnover distortion under LIFO inventory costing may be adjusted by

a. adding the LIFO reserve amounts to cost of goods sold and adjusting beginning and ending

inventory for pre-tax LIFO liquidation profits whenever LIFO liquidation occurs.

b. subtracting the LIFO reserve amounts from cost of goods sold and adjusting beginning and

ending inventory for pre-tax LIFO liquidation profits whenever LIFO liquidation occurs.

c. adding the LIFO reserve amounts to beginning and ending inventory and adjusting cost of

goods sold for pre-tax LIFO liquidation profits whenever LIFO liquidation occurs.

d. subtracting the LIFO reserve amounts from beginning and ending inventory and adjusting cost

of goods sold for pre-tax LIFO liquidation profits whenever LIFO liquidation occurs.

49. As a firm liquidates old LIFO layers of inventory, the lower costs of the LIFO layers are

matched against current sales dollars resulting in a profit margin that is

a. inflated.

b. deflated.

c. lower than normal.

d. always the same as under FIFO.

50. Current ratio distortion under LIFO inventory costing may be adjusted by

a. adding the LIFO reserve to current assets.

b. subtracting the LIFO reserve from current assets.

c. adding the LIFO reserve to current liabilities.

d. subtracting the LIFO reserve from current liabilities.

51. When the income effect of a LIFO liquidation is material, the SEC requires that the 10-K

report disclose

a. the dollar impact of LIFO liquidation on both a pre-tax and after-tax basis.

b. the dollar impact of LIFO liquidation on the year-end inventory balance.

c. this fact following a prescribed disclosure format.

d. the dollar impact of LIFO liquidation on net income.

52. For a firm using LIFO, the numerator of the inventory turnover ratio is predominantly current

period costs

a. and the denominator consists of old LIFO costs.

b. and it must be adjusted to conform to the old LIFO costs in the denominator.

c. and the denominator must be adjusted by adding the LIFO reserve to ending inventory.

d. and the denominator must be adjusted by subtracting the LIFO reserve from both beginning

and ending inventory.

53. The LIFO conformity rule states that

a. if LIFO is used for tax purposes, the external financial statements must also use LIFO.

b. if FIFO is used for tax purposes, the external financial statements must also use FIFO.

c. if LIFO is used for tax purposes, the external financial statements must use FIFO.

d. if FIFO is used for tax purposes, the external financial statements must use LIFO.

54. LIFO’s tax advantage is that

a. it provides a higher net income than FIFO during periods of rising prices and level inventory

quantities.

b. it provides a lower net income than FIFO during periods of rising prices and level inventory

quantities.

c. it provides a lower net income than FIFO during periods of falling prices and level inventory

quantities.

d. it provides a lower net income than FIFO during periods of rising prices and decreasing

inventory quantities.

55. Firms that use FIFO inventory cost assumptions always include some realized holding gains

in reported income in periods of

a. level prices.

b. deflation.

c. falling prices.

d. rising prices.

56. The size of the divergence between FIFO cost of goods sold and replacement cost of goods

sold depends on the rapidity of the inventory turnover and the

a. change in accounts receivable turnover.

b. divergence of total asset turnover from previous periods.

c. severity of input cost change.

d. rapidity of fixed asset turnover.

Use the following to answer questions 57 and 58:

REFERENCE: Ref. 09_02

The World Company’s financial statements for 2018 and 2017 contain the following errors:

2018

2017

Ending Inventory

$6,000 overstated

$16,000 overstated

Insurance Expense

$4,000 understated

$12,000 overstated

[QUESTION]

REFER TO: Ref. 09_02

57. If the proper correcting entries were made at the end of 2017, how much will 2018 income

before taxes be overstated or understated?

a. $2,000 understated

b. $2,000 overstated

c. $10,000 understated

d. $10,000 overstated