2) When using the FIFO inventory method, the ending inventory has the newer costs.
3) When using the LIFO inventory method, the ending inventory has the newer, higher costs.
4) The choice of inventory costing method does not have an effect on net income.
5) The average cost method generates gross profit, net income, and income tax amounts that fall
between the extremes of FIFO and LIFO.
6) In order to pay the least income tax possible in periods of rising inventory costs, the company
should use which of the following inventory costing methods?
A) FIFO
B) LIFO
C) Average cost
D) Specific identification
7) In order to pay the least income tax possible in periods of decreasing inventory costs, the
company should use which of the following inventory costing methods?
A) FIFO
B) LIFO
C) Average cost
D) Specific identification
8) In order to pay the least income tax possible in periods of constant costs, the company should
use which of the following inventory costing methods?
A) FIFO
B) LIFO
C) Average cost
D) Any method, as there is no effect on net income or taxes for the period if costs are constant.
9) The most popular inventory costing method is:
A) FIFO.
B) LIFO.
C) average cost.
D) specific identification.
10) ________ produces the lowest cost of goods sold and the highest gross profit when prices are
increasing.
A) FIFO
B) LIFO
C) Average cost
D) Specific identification
11) ________ produces the highest cost of goods sold and the lowest gross profit when prices are
increasing.
A) FIFO
B) LIFO
C) Average cost
D) Specific identification
12) Companies that want a “middle ground” solution to net income and the amount of income
taxes that the company will pay will value their inventory at:
A) FIFO.
B) LIFO.
C) average cost.
D) specific identification.
13) ________ helps investors compare a company’s financial statements from one period to the
next.
A) Reliability
B) Consistency
C) Objectivity
D) Entity
14) Consistency is mandated by:
A) the IRS.
B) the SEC.
C) GAAP.
D) the federal government.
15) In order to attract investors and borrow on favorable terms, a company would use ________
in times when inventory costs are rising.
A) LIFO
B) FIFO
C) average costing
D) specific-identification costing
16) A drawback to using ________ when inventory costs are rising is that the company reports
lower net income.
A) LIFO
B) FIFO
C) average costing
D) specific-identification costing
17) Which inventory costing method results in the oldest costs in ending inventory?
A) Average cost
B) Last-In, First-Out
C) First-In, First-Out
D) Average-In, First-Out
5.4 Questions
1) Under the LCM rule, a business must report inventory at the current replacement cost.
2) Under the conservatism rule, assets and income would be understated, rather than overstated.
3) Under the conservatism principle, liabilities and expenses would be overstated, rather than
understated.
4) The LCM rule compares original cost to current replacement cost to determine the amount at
which inventory should be valued.
5) A material amount of value is one large enough to cause someone to change a decision that
has been made.
6) Changing from LIFO to FIFO over two accounting periods could be viewed as a violation of
which accounting concept or principle?
A) Conservatism
B) Consistency
C) Materiality
D) Entity
7) Ignoring a write-off of inventory because it will not make a difference to financial statement
users is an example of:
A) conservatism.
B) consistency.
C) materiality.
D) entity.
8) Underestimating inventory would be an example of:
A) conservatism.
B) consistency.
C) materiality.
D) entity.
9) If the replacement cost of inventory is less than its historical cost, the company will write
down the inventory by:
A) debiting Cost of Goods Sold and crediting Inventory.
B) debiting Inventory and crediting Cost of Goods Sold.
C) making a note in the financial statements only.
D) debit Inventory for replacement cost, credit Inventory for historical cost.
10) One lot of merchandise was counted at $566.34. A second count of the same merchandise
showed $566.82. The difference could be ignored due to:
A) conservatism.
B) consistency.
C) materiality.
D) entity.
11) The LCM rule must be applied to inventory:
A) on an item-by-item basis.
B) by categories of items.
C) as a whole.
D) as a company decides, for there is no requirement to apply LCM.
12) Applying LCM to the items that make up ending inventory is an application of which of the
following concepts?
A) Materiality
B) Conservatism
C) Reliability
D) Full disclosure
13) Cypress Co. has the following LIFO perpetual inventory records:
Date
Purchases
Cost of Goods Sold
Inventory on Hand
December 1
$4,250
December 7
$1,300
$5,550
December 18
$1,100
$4,450
December 31
$1,500
$5,950
The current replacement cost of the ending inventory is $5,200. To apply the lower-of-cost-or–
market rule, the journal entry would be:
A) Debit Cost of Goods Sold $750, credit Inventory $750
B) Debit Inventory $750, credit Cost of Goods Sold $750
C) Debit Cost of Goods Sold $1,100, credit Inventory $1,100
D) Debit inventory $1,100, credit Cost of Goods Sold $1,100
14) S&C Inc. has the following LIFO perpetual inventory records:
Date
Purchases
Cost of Goods Sold
Inventory on Hand
December 1
$3,300
December 7
$1,100
$4,400
December 18
$800
$3,600
December 31
$1,400
$5,000
The current replacement cost of the ending inventory is $4,500. To apply the lower-of-cost-or–
market rule, the journal entry would be:
A) Debit Cost of Goods Sold $800, credit Inventory $800
B) debit Inventory $800, credit Cost of Goods Sold $800
C) Debit Cost of Goods Sold $500, credit Inventory $500
D) debit Inventory $500, credit Cost of Goods Sold $500
5.5 Questions
1) A company using the perpetual inventory system does not need to perform a physical count of
inventory.
2) To save time when performing physical inventory counts, outside companies are rarely used
because they are not familiar with the inventory.
3) An example of full disclosure would be a footnote to the financial statements indicating what
method was used to value inventory.
4) Knowledgeable decisions that are made by outsiders who read financial reports are a result of
the concept of conservatism.
5) Shrinkage refers to the loss of inventory due to theft, damage or other similar occurrences.
6) If shrinkage is found for $500, an adjusting entry would be made as follows:
A) debit Inventory for $500; credit Cost of Goods Sold for $500.
B) debit Inventory for $500; credit Sales Returns and Allowances for $500.
C) debit Cost of Goods Sold for $500; credit Inventory for $500.
D) debit Sales Returns and Allowances for $500; credit Inventory for $500.
7) The ending physical inventory count revised for adjustments is listed on the Balance Sheet as
a:
A) current asset before Accounts Receivable.
B) current asset after Accounts Receivable.
C) long-term asset.
D) current asset immediately after cash.
8) Which of the following is often used when taking a physical inventory?
A) Pre-numbered count sheets
B) Tags to show what inventory has been counted
C) Maps of the location of the inventory
D) All of the above
9) If the inventory shows an actual count of $350 and the perpetual inventory according to the
records shows $339, the adjusting entry for the $11 would:
A) debit Cost of Goods Sold; debit Purchase Returns and Allowances.
B) debit Cost of Goods Sold; credit Inventory.
C) debit Inventory; credit Cost of Goods Sold.
D) debit Inventory; credit Purchase Returns and Allowances.
10) Footnotes are used with what concept or principle of accounting?
A) Conservatism
B) Consistency
C) Materiality
D) Full disclosure
11) Which is usually NOT a common practice in taking a physical inventory?
A) Taking inventory during slow store hours
B) Hiring an outside firm
C) Taking inventory during the November and December holidays
D) Taking inventory in team of two persons
12) Which account would always be used for an inventory adjustment?
A) Sales
B) Purchase Returns and Allowances
C) Cost of Goods Sold
D) Cash
13) Which is NOT an assurance of footnote disclosures?
A) Conservative information
B) Reliable information
C) Comparable information
D) Relevant information
14) Which of the following would probably NOT need to be disclosed in a footnote?
A) Change of inventory methods
B) A material change in estimated shrinkage
C) A change in depreciation method
D) A 10% increase in sales
15) Which of the following would cause inventory shrinkage?
A) Employee theft
B) Spoilage of items
C) Spills of items
D) All of the above
16) Making notes in the financial statements to explain the justification of valuation changes and
other financial decisions would be an example of:
A) conservatism.
B) consistency.
C) materiality.
D) full disclosure.
5.6 Questions
1) If the ending inventory is overstated in Year 1, then the Cost of Goods Sold will be overstated
in Year 2.
2) If the ending inventory is understated in Year 1, then the Gross Profit will be understated in
Year 2.
3) The ending inventory of one year becomes the beginning inventory of the next year.
4) Counting inventory that is in transit on December 31 that was shipped from the supplier FOB
shipping point would not cause any error in the final inventory valuation.
5) An ending inventory error in one year does not have any effect on the inventory at the start of
the next year.
6) If Period 1 ending inventory is understated, then:
A) both cost of goods sold and net income are understated in Period 1.
B) cost of goods sold is overstated and net income is understated in Period 1.
C) cost of goods sold is understated and net income is overstated in Period 1.
D) both cost of goods sold and net income are overstated in Period 1.