Chapter 5: Inventories and Cost of Goods Sold
86. A company fails to record one storeroom full of inventory in its year-end inventory records. As a result, this will
cause:
a. an overstatement of inventory on the year-end balance sheet.
b. an understatement of gross profit in the following year.
c. an overstatement of retained earnings at the end of the year.
d. an overstatement of cost of goods sold for the current year.
87. Hawk Store counted some of its inventory twice. As a result, its operating expenses will be
a. Correct only if Hawk Store calculates it cost of goods sold correctly
b. Correct since operating expenses are not affected by inventory costs
c. Overstated
d. Understated
88. If a company overstates its ending inventory for the current year, what are the effects on cost of goods sold and
net income for the current year?
Effect on Cost of Goods Sold Effect on Net Income
a. Understated Overstated
b. Overstated No effect
c. Understated Understated
d. Overstated Overstated
89. If a company understates its ending inventory balance for 2015 by $15,500, what are the effects on its net income
for 2015 and 2014?
Effect on 2015 Net Income Effect on 2014 Net Income
a. Overstated by $15,500 Understated by $15,500
b. Understated by $15,500 Overstated by $15,500
c. Understated by $15,500 No effect
d. Overstated by $15,500 No effect
Chapter 5: Inventories and Cost of Goods Sold
90. If a company overstates its ending inventory balance for 2015 by $10,000, and understates its ending inventory
balance for 2014 by $5,000 what are the effects on its net income for 2015 and 2014?
Effect on 2015 Net Income Effect on 2014 Net Income
a. Overstated by $15,000 Understated by $10,000
b. Understated by $5,000 Overstated by $10,000
c. Overstated by $15,000 Understated by $5,000
d. Overstated by $10,000 Understated by$5,000
91. If a company overstates its ending inventory balance for 2015 by $10,000, and overstates its ending inventory
balance for 2014 by $5,000 what are the effects on its net income for 2015 and 2014?
Effect on 2015 Net Income Effect on 2014 Net Income
a. Overstated by $15,000 Overstated by $10,000
b. Understated by $5,000 Overstated by $10,000
c. Overstated by $5,000 Overstated by $5,000
d. Overstated by $10,000 Overstated by $5,000
92. When the market value of inventory items has declined below its cost, which method would be the most appropriate
in complying with GAAP?
a. Gross Profit
b. LIFO
c. Lower of Cost or market
d. Retail
93. When inventories are written down due to the application of the lower of cost or market (LCM) rule, the account
that is usually increased is
a. Cost of Goods Sold
b. Inventories
c. Loss on Decline in Inventory Value
d. Accumulated Depreciation—Inventory
94. Which one of the following statements regarding the application of the lower of cost or market method is true?
a. Generally, market value is greater than replacement cost.
b. When the lower of cost or market method is used, inventories are valued at selling price.
c. The lower of cost or market method is most commonly applied on a total inventory basis because it is a more
conservative approach.
d. The lower of cost or market method is an exception to the historical cost principle.
Chapter 5: Inventories and Cost of Goods Sold
95. All of the following statements are true except:
a. Both U.S. GAAP and international financial reporting standards (IFRS) require the use of the lower-of-cost-
or–market rule to value inventories.
b. U.S. GAAP defines market value as replacement cost.
c. IFRS uses net realizable value with no upper or lower limits imposed.
d. Write-downs of inventory can be reversed in later periods under U.S. GAAP.
96. Which of these is not an acceptable inventory costing method under IFRS?
a. FIFO
b. LIFO
c. Specific Identification
d. Average cost
97. Selected data for Sorenta, Inc. and New World Corp., two companies in the same industry, are presented below:
Sorenta, Inc.
New World Corp.
Sales
$50,000
$80,000
Cost of goods sold
30,000
50,000
Average inventory balance
5,000
5,000
Based on this data, which statement below is true?
a. Sorenta, Inc. has a lower gross profit ratio than New World Corp.
b. New World Corp has a higher net income than Sorenta, Inc.
c. New World Corp sells its inventory faster than Sorenta, Inc.
d. Sorenta, Inc. has lower storage costs and a lower investment in inventory than New World Corp.
98. Caruso, Inc. has an inventory turnover rate of 8 times. If its cost of goods sold is $150,000, then
a. The company will report sales of $1,200,000.
b. The gross margin will be $1,200,000.
c. The company‘s average inventory is $18,750.
d. It sells its inventory 1,200 times per year.
Chapter 5: Inventories and Cost of Goods Sold
99. A company began the year with $150,000 in inventory and ended the year with $170,000 in inventory. Cost of goods
sold for the year amounted to $960,000. Assuming 360 days in a year, how long, on average, does it take the
company to sell its inventory (to the nearest day)?
a. 6 days
b. 60 days
c. 120 days
d. 3 days
100. The following information is reported in the operating activities section of Gateway‘s statement of cash flows for
2014:
Net income
$1,200,000
Increase in inventories
600,000
Decrease in accounts payable
400,000
Which one of the following conclusions can be assumed from the information provided?
a. Gateway used the direct method to determine cash flows from operating activities.
b. Gateway purchased more merchandise than it sold in 2014.
c. Cash payments for merchandise purchases were less than the amount of merchandise purchased on credit
during 2014.
d. Cash payments for merchandise exceeded cost of goods sold by $200,000.
101. The following information was taken from the operating activity section of the 2014 statement of cash flows for
Limited Corp:
Additions to net income: Change in accounts payable $2,000
Deductions from net income: Change in inventories 8,000
Based on the information provided, which one of the following conclusions is correct?
a. Accounts payable decreased $2,000 in 2014.
b. Inventories increased $8,000 in 2014.
c. The direct method was used to prepare the operating section of the cash flow statement.
d. Cash payments of merchandise exceeded cost of goods sold by $2,000.
102. Payment for the acquisition of inventories is shown on the statement of cash flows as
a. An operating activity
b. An investing activity
c. A financing activity
d. Either an operating activity or a financing activity
Chapter 5: Inventories and Cost of Goods Sold
103. Which of the following statements is true when using the indirect method of preparing the operating activities
section of the statement of cash flows?
a. Inventory decreases are subtracted from net income.
b. Inventory increases are subtracted from net income.
c. Inventory increases are added to net income.
d. None of the above.
104. Readers.com uses a perpetual inventory system.
Feb. 1
On hand, 30 units at $5.00 each
8
Purchased 40 units at $5.35 each
15
Sold 50 units
22
Purchased 40 units at $5.20 each
28
On hand, 60 units
If Readers.com uses the moving average method, how much is cost of goods sold for the units sold on February 15?
a. $245
b. $255
c. $260
d. $270
105. Readers.com uses a perpetual inventory system.
Feb. 1
On hand, 30 units at $5.00 each
8
Purchased 40 units at $5.35 each
15
Sold 50 units
22
Purchased 40 units at $5.20 each
28
On hand, 60 units
If Readers.com uses the moving average method, how much is ending inventory on February 28?
a. $300
b. $306
c. $312
d. $318
Chapter 5: Inventories and Cost of Goods Sold
106. Adam Inc. uses a perpetual inventory system.
Jan. 1
On hand, 10 units at $2 each
$ 20
4
Sold 8 units for $10 each
80
22
Purchased 50 units at $4 each
200
26
Sold 48 units for $10 each
480
If Adam uses the FIFO method, how much is cost of goods sold for the month of January?
a. $204
b. $208
c. $212
d. $560
107. Adam Inc. uses a perpetual inventory system.
Jan. 1
On hand, 10 units at $2 each
$ 20
4
Sold 8 units for $10 each
80
22
Purchased 50 units at $4 each
200
26
Sold 48 units for $10 each
480
If Adam uses the LIFO method, how much is cost of goods sold for the month of January?
a. $204
b. $208
c. $212
d. $560
108. Adam Inc. uses a perpetual inventory system.
Jan. 1
On hand, 10 units at $2 each
$ 20
4
Sold 8 units for $10 each
80
22
Purchased 50 units at $4 each
200
26
Sold 48 units for $10 each
480
If Adam uses the FIFO method, how much is ending inventory on January 31?
a. $ 8
b. $ 12
c. $ 16
d. $ 40
Chapter 5: Inventories and Cost of Goods Sold
109. The three forms or states in the development of inventory for a manufacturer are direct materials, direct labor, and
finished goods.
a. True
b. False
110. The three distinct types of cost to a manufacturer are direct materials, direct labor, and manufacturing
overhead.
a. True
b. False
111. Gross margin as a percentage of sales is a common analytical tool for service companies.
a. True
b. False
112. Sales revenue is an inflow of assets.
a. True
b. False
113. 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
114. Sales Returns and Allowances is a contra-asset account.
a. True
b. False
115. 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
Chapter 5: Inventories and Cost of Goods Sold
116. On the income statement of a merchandising company, cost of goods is added to net sales to arrive at gross margin
or gross profit.
a. True
b. False
117. Like sales revenue, cost of goods sold represents an inflow of assets.
a. True
b. False
118. Cost of goods sold represents an outflow of an asset, inventory, from the sale of products.
a. True
b. False
119. 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
120. Net purchases equals purchases less purchase returns, allowances, and discounts plus transportation-in.
a. True
b. False
121. Cost of goods sold is the difference between costs available for sale and beginning inventory.
a. True
b. False
122. With the periodic inventory system, the inventory account is updated after each sale or purchase.
a. True
b. False
123. 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
Chapter 5: Inventories and Cost of Goods Sold
124. Under the perpetual inventory system, each time goods are purchased, the inventory account is transferred to sales
revenue.
a. True
b. False
125. 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
126. Purchase returns and allowances is subtracted from cost of goods sold to determine net purchases.
a. True
b. False
127. Purchase discounts decrease the total cost of merchandise acquired.
a. True
b. False
128. The buyer must include goods purchased FOB shipping point in its inventory account if the goods are still in transit.
a. True
b. False
129. When merchandise is sold FOB shipping point, the buyer is responsible for the shipping costs.
a. True
b. False
130. Cost of goods available for sale is equal to beginning inventory less cost of goods sold.
a. True
b. False
131. The gross profit ratio is computed by dividing net sales by gross profit.
a. True
b. False
Chapter 5: Inventories and Cost of Goods Sold
132. The gross profit ratio is calculated as gross profit divided by net income.
a. True
b. False
133. 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
134. The inventory method that assigns the most recent costs to ending inventory is LIFO.
a. True
b. False
135. 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
136. Under FIFO, the units in the ending inventory represent the oldest purchase(s).
a. True
b. False
137. Specific identification relies on matching unit costs with the actual units sold.
a. True
b. False
138. Under LIFO, the units in the ending inventory represent the most recent purchase(s).
a. True
b. False
139. Changing inventory methods to take advantage of the tax breaks offered by LIFO is not a valid reason for a
change in methods.
a. True
b. False
Chapter 5: Inventories and Cost of Goods Sold
140. A LIFO liquidation occurs when a company sells fewer units than it buys during the period.
a. True
b. False
141. According to the IRS’s LIFO conformity rule, a company that chooses LIFO to report net income to its
shareholders may not use LIFO in preparing its income tax return.
a. True
b. False
142. 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
143. FIFO results in the least amount of income before taxes, assuming a period of rising prices.
a. True
b. False
144. 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
145. Many countries prohibit the use of LIFO for tax or financial reporting purposes.
a. True
b. False
146. 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
Chapter 5: Inventories and Cost of Goods Sold
147. If ending inventory is understated, then cost of goods sold is overstated.
a. True
b. False
148. If ending inventory is overstated, then net income is overstated as well.
a. True
b. False
149. The lower of cost or market (LCM) rule violates the historical cost principle.
a. True
b. False
150. The journal entry to write down inventory to its market value results in a loss on the income statement.
a. True
b. False
151. 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
152. The inventory turnover ratio is defined as cost of goods sold divided by average inventory.
a. True
b. False
153. The inventory turnover ratio is a measure of how many times during a period a company sells off its inventory.
a. True
b. False
154. Under the indirect method, a decrease in inventory is added to net income to determine cash flow from operating
activities.
a. True
b. False
Chapter 5: Inventories and Cost of Goods Sold
155. 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
156. Moving average is the name given to the use of an average cost method used with a periodic inventory system.
a. True
b. False
157. 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
158. 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
159. The inventory of a(n) consists of three distinct types of costs: direct materials, direct
labor, and manufacturing overhead.
160. Sales returns and allowances is a contra account.
161. A is an amount deducted by customers for payment within the discount period.
162. Cost of goods sold is equal to beginning inventory plus the net cost of purchases minus
_________________________.
163. Under the inventory system, the inventory account is updated after each purchase or
sale.
Chapter 5: Inventories and Cost of Goods Sold
164. The cost of goods purchased is equal to net purchases plus .
165. Shipping terms of mean that the buyer pays shipping costs.
166. The amount recognized on the Income Statement as the cost of inventory will be recognized as a(n)
_________________________.
167. When a company using LIFO experiences a partial or complete liquidation of its older, lower–priced inventory, its
gross margin will be (higher, lower, or unchanged) for the period.
168. The method most nearly approximates replacement cost of inventory on the balance
sheet.
169. The excess of the value of a company’s inventory stated at FIFO over the value stated at LIFO is called a(n)
_________________________.
170. The method results in the best approximation of replacement cost of goods sold on the
income statement during periods of rising prices.
171. The understatement of ending inventories in one period leads to a(n) of cost of goods
sold expense in the same period.
172. A departure from the cost basis of accounting may be necessary when the _________________________ of the
inventory is less than its cost to the company.
173. Accountants define the market value of inventory as its .
174. The ratio of a company’s cost of goods sold to its average inventory is called its
________________________________________.
Chapter 5: Inventories and Cost of Goods Sold
175. Under the method, the amount of cash paid to suppliers of inventory is shown as a
deduction in the operating activities category of the cash flow statement.
176. Under the method, an increase in inventory is shown as an adjustment to net income in
the operating activities category of the cash flow statement.
177. When a weighted average cost assumption is applied with a perpetual system, it is sometimes called a
__________________.
178. During the current period, Audix Corp. sold products to customers for a total of $76,000. Due to defective products,
customers were given $2,800 in refunds for products that were returned and another $3,500 in reductions to their
account balances. Discounts in the amount of $5,500 were given for early payment of account balances.
REQUIRED:
Prepare the Net Sales section of Audix’s income statement.
179. Based upon the following data, determine the cost of merchandise sold for April.
Merchandise Inventory April 1
$ 85,560
Merchandise Inventory April 30
96,330
Purchases
373,880
Purchases Returns & Allowances
14,760
Purchases Discounts
10,900
Freight In
4,135
Chapter 5: Inventories and Cost of Goods Sold
Net income
315
420
215
Sales
975
865
560
Operating expenses
115
125
110
Cost of merchandise sold
545
320
235
Sales
975
865
560
Less: Cost of merch. sold
545
320
235
Gross profit
430
545
325
Less: Operating expenses
115
125
110
Net income
315
420
215
180. Complete the following data taken from the condensed income statements for merchandising companies: Action,
Break, & Connors.
Action
Break
Connors
Net income
315
?
215
Sales
?
865
560
Gross profit
430
?
325
Operating expenses
?
125
?
Cost of merchandise sold
545
320
?
181. For each of the following, calculate the cost of inventory reported on the balance sheet.
(a) The total merchandise inventory counted at the end of the year was $63,000. Purchases for
$6,000 are in transit under FOB shipping point terms.
(b) The total merchandise inventory counted at the end of the year was $75,000. Purchases for $5,000
are in transit under FOB destination terms.
Chapter 5: Inventories and Cost of Goods Sold
182. Hound Dog Bisquits reported the following financial data for 2014 and 2015:
2014
2015
Sales
$700,000
$600,000
Sales returns and allowances
(10,000)
( D )
Net sales
690,000
580,000
Cost of goods sold:
Inventory, January 1
30,000
E
Net purchases
A
340,000
Goods available for sale
250,000
380,000
Inventory, December 31
(40,000)
(30,000)
Cost of goods sold
B
F
Gross profit
C
G
======
======
Provide the answer for each missing letter above.
183. Presented below is a partially completed income statement of Deep Sea, Inc. for 2015.
Net Sales
$ A
Cost of Sales:
Beginning Inventory
B
Net Purchases
138,193
Available for Sale
149,315
Less: Ending Inventory
C
Cost of Sales
136,225
Gross Profit
72,978
Selling, General and Administrative Expenses
D
Operating Income
$ 9,083
Using the partially completed income statement for Deep Sea, Inc., determine each of the following for 2015.
A) Net Sales
B) Beginning Inventory
C) Ending Inventory
D) Selling, General and Administrative Expenses