CHAPTER 8: INVENTORIES: SPECIAL VALUATION ISSUES
1. Reporting inventory at the lower of cost or market provides a representationally faithful value of inventory; therefore,
the application of the lower of cost or market rule is consistent with the materiality principle.
a.
True
b.
False
False
1
Easy
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2. The Net Realizable Value is considered the ceiling that prevents inventory from being valued at amount higher than
what the company could reasonably sell it.
a.
True
b.
False
True
1
Easy
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3. The lower-of-cost-or-market rule must be applied to each individual inventory item but not to groups of items
a.
True
b.
False
False
1
Easy
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4. If a company recognizes a loss due to inventory write-down then the inventory value subsequently increases due to a
market reversal the following year, GAAP does not permit the loss to be recovered.
a.
True
b.
False
True
1
Easy
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Bloom’s: Remembering
5. Precious metals can be valued above costs because they are immediately marketable at a quoted market price.
a.
True
b.
False
True
1
Easy
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6. An auditor may not use the gross profit method to verify the accuracy of the reported cost of inventory.
a.
True
b.
False
False
1
Easy
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7. The gross profit method is an appropriate method for determining the cost of inventory for interim financial statements.
a.
True
b.
False
True
1
Easy
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8. An advantage of the retail inventory method over the gross profit is the retail method uses current-period estimates
whereas the gross profit used past periods.
a.
True
b.
False
True
1
Easy
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9. The gross profit method is more sensitive to price changes than the FIFO method and produces a more accurate
estimate of current period ending inventory.
a.
True
b.
False
False
1
Easy
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Chapter 8: Inventories: Special Valuation Issues
10. The purpose of dollar-value LIFO retail method is to eliminate the effects of price changes during a period.
a.
True
b.
False
True
1
Easy
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11. Under the dollar-value LIFO the cost-to-retail ratio includes net markups and net markdowns from both the current
period and beginning inventory. during the current period.
a.
True
b.
False
False
1
Easy
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12. If a purchase on credit is omitted from the purchase account in error and ending inventory is correctly determined, net
income for the period would be understated.
a.
True
b.
False
False
1
Moderate
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Chapter 8: Inventories: Special Valuation Issues
13. If ending inventory is overstated for the current period due to a costing error but purchases are correct, the balance
sheet at the end of the succeeding year would be correctly stated.
a.
True
b.
False
True
1
Moderate
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14. A company using the periodic inventory system to record the reduction of inventory to market value would record the
following journal entry to close beginning inventory using the direct method:
Allowance to Reduce Inventory to Market
x,xxx
Inventory
x,xxx
a.
True
b.
False
False
1
Easy
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15. A company using the periodic inventory system to record the reduction of inventory to market would record the
following journal entry to record inventory at market using the allowance method:
Loss due to Market Valuation
x,xxx
Allowance to Reduce Inventory to Market
x,xxx
a.
True
b.
False
True
1
Easy
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Chapter 8: Inventories: Special Valuation Issues
16. The most common approach to implementing the lower of cost or market rule for inventory valuation is to apply it to
a.
each individual item of inventory separately.
b.
each major category of inventory.
c.
the total inventory in the aggregate.
d.
inventory items that have increased in value but not to items that have decreased in value.
a
1
Easy
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17. Which application of the lower of cost or market rule will generally result in the lowest valuation for the ending
inventory?
a.
to each item of the inventory
b.
to each major category of inventory
c.
to the total inventory in the aggregate
d.
To high-cost items but not to low-cost items
a
1
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18. When applying lower of cost or market, market value
a.
is defined as the selling price.
b.
should not exceed the net realizable value.
c.
should not exceed the net realizable value less an allowance for a normal profit margin.
d.
should not exceed the net realizable value plus an allowance for a normal profit margin.
b
1
Easy
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19. When applying lower of cost or market, market value should not be less than
a.
replacement value.
b.
net realizable value.
c.
net realizable value less an allowance for a normal profit margin.
d.
replacement value less an allowance for a normal profit margin.
b
1
Easy
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Bloom’s: Remembering
Exhibit 8-1
Rival Inc. uses the lower of cost or market rule in valuing its inventory. One unit has a ceiling constraint of $45.50. The
following is other information concerning this unit:
Estimated transportation costs for delivery
$3.90
Normal profit margin
7.50
Packaging costs prior to delivery
3.40
20. Refer to Exhibit 8-1. The selling price of this unit must be
a.
$49.30
b.
$53.00
c.
$52.80
d.
c
1
Moderate
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$49.10
21. Refer to Exhibit 8-1. The floor constraint of this unit must be
a.
$41.90
b.
$38.00
c.
$41.70
d.
$38.10
b
1
Moderate
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22. When comparing the lower of cost to market
a.
the appropriate market value is determined before comparing it to the cost.
b.
the purpose of the ceiling is to ensure that the write-down is sufficient to cover all expected gains.
c.
the purpose of the floor is to prevent an excessive gain from being recognized in the future.
d.
the process is consistent with the principle of conservatism because the goal is to limit excessive swings in
gross margin.
a
1
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23. Morris Company uses the lower of cost or market rule in valuing its inventory. The floor constraint for one item in the
inventory is $68.20. The following is other information concerning this unit:
Transportation costs
$ 4.00
Normal profit margin
12.70
Packaging costs
4.20
The net realizable value for this item is
a.
$72.40
b.
$55.50
c.
$80.90
d.
$76.40
c
1
Moderate
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24. When applying the lower of cost or market rule to the valuation of inventory, the allowance method is considered
preferable to the direct method because
a.
the allowance method reports smaller losses than the direct method.
b.
the allowance method reports a higher inventory net valuation for balance sheet purposes than the direct
method.
c.
the allowance method reports the inventory loss or loss recovery in a separate income statement account.
d.
the allowance method, unlike the direct method, reduces the value of inventory reported on the balance sheet.
c
1
Easy
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25. In comparison to the allowance method of applying the lower of cost or market rule to the valuation of inventory, the
direct method has which of the following deficiencies?
a.
The direct method reports a more conservative amount for net income.
b.
For the direct method, the loss or loss recovery due to market valuation changes is included in the cost of
goods sold amount.
c.
The direct method makes changes to the historical cost of inventory reported on the balance sheet.
d.
The direct method can only be used with a perpetual inventory system.
b
1
Moderate
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26. Given the following information for the Raquel Company:
Date
Cost
Market
December 31, 2016
$500
$500
December 31, 2017
700
700
December 31, 2018
800
730
Under the periodic system, if the direct method of recording lower of cost or market is in use, which December 31,
2018 entry is correct?
a.
Inventory 70
Cost of Goods Sold 70
b.
Cost of Goods Sold 70
Inventory 70
c.
Loss Due to Market Valuation 70
Allowance to Reduce Inventory to Market 70
d.
b
1
Moderate
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Cost of Goods Sold 70
Allowance to Reduce Inventory to Market 70
27. Given the following information for the Tea Company:
Date
Cost
Market
December 31, 2016
$ 800
$ 800
December 31, 2017
1,000
1,000
December 31, 2018
1,200
1,060
Under the periodic system, if the allowance method of recording lower of cost or market is in use, which December
31, 2018entry is correct?
a.
Loss Due to Market Valuation 140
Allowance to Reduce Inventory to Market 140
b.
Allowance to Reduce Inventory to Market 140
Loss Recovery Due to Market Valuation 140
c.
Inventory 140
Cost of Goods Sold 140
d.
Cost of Goods Sold 140
Inventory 140
a
1
Moderate
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28. Zoe Company has provided the following values for its 400 units of inventory at the end of 2014:
Item
Per Unit
Historical cost
$65.00
Replacement cost
$54.20
Net realizable value
$54.50
Normal profit margin
$ 13.80
Under IFRS requirements, the per-unit reported value for Zoe’s inventory will be
a.
$65.00
b.
$54.50
c.
$54.20
d.
$40.70
b
1
Moderate
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29. The Maxa Company normally sells its inventory at a 20% profit margin on sales. In 2016, the net realizable value of
inventory purchased for $75,000 declined to $66,000. There are no costs to complete and dispose of this inventory.
What is the floor constraint on the valuation of this inventory using the lower of cost or market rule?
a.
$60,000
b.
$66,000
c.
$79,200
d.
$52,800
d
1
Moderate
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30. Which one of the following statements is true with regard to the lower of cost or market rule?
a.
If the direct method is used in applying the lower of cost or market rule, the loss or loss recovery due to
market valuation changes is included in cost of goods sold.
b.
The lower of cost or market rule must be applied on an individual item basis for financial accounting purposes.
c.
With the application of the lower of cost or market rule using the direct method, the account, Allowance to
Reduce Inventory to Market, is reported on the balance sheet as a contra asset.
d.
The lower of cost or market rule is primarily an application of the going concern assumption.
a
1
Moderate
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31. Although IFRS require the use of the lower of cost or market method to value inventory, some differences from
GAAP still exist. Which of the following is not one of the differences?
a.
IFRS eliminate the need to use a ceiling in determining market value.
b.
When write-downs occur, IFRS do not specify how the loss must be categorized in the income statement.
c.
IFRS allow the reversal of a previous write-down.
d.
IFRS define market only as replacement value.
d
1
Moderate
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32. The major criticism of the lower of cost or market rule for valuation of inventory is that.
a.
holding losses are recognized, but holding gains are not.
b.
holding gains are recognized, but holding losses are not.
c.
the total difference between selling price and cost is usually recognized in the period of the sale.
d.
the conservatism principle is violated because of the use of the floor constraint.
a
1
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33. Concerning application of the lower of cost or market method, which one of the following statements is true regarding
the constraints on market value?
a.
The upper constraint is estimated selling price less costs of completion and disposal.
b.
The lower constraint is net realizable value less costs of completion and disposal.
c.
The lower constraint is estimated selling price less a normal profit margin.
d.
The upper constraint is estimated selling price less costs of completion and disposal and a normal profit
margin.
a
1
Moderate
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34. Major Company uses the lower of cost or market rule in valuing its inventory. The floor constraint for one item in the
inventory is $58.20. The following is other information concerning this unit:
Transportation costs
$ 5.00
Normal profit margin
12.70
Packaging costs
5.20
The market value for this item is
a.
$58.20
b.
$70.90
c.
$75.90
d.
$81.10
d
1
Moderate
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35. In general, it is argued that the lower of cost or market rule is supported most closely by which of the following
theoretical assumptions?
a.
revenue recognition
b.
Representational faithfulness
c.
historical cost
d.
going concern
b
1
Moderate
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36. Assume that there is a decline in inventory value in one period, then there is a reversal of value to the original or
higher value and a later period. Which of the following statements about recognition of the loss is true?
a.
The decline in inventory value and related loss should be recognized in the first period and reversed in the
second period in all situations.
b.
The decline in inventory value and related loss should be recognized in the first period and reversed in the
second period but only if the second period is within the same fiscal year.
c.
The decline in inventory value and related loss should be recognized in the first period and reversed in the
second period but only if the second period is within a different fiscal year.
d.
The decline in inventory value and related loss should never be recognized.
b
1
Easy
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37. Which of the following is not a justification for valuing inventory above historical cost?
a.
Floor value above both market price and historical cost
b.
Interchangeability of the units of inventory
c.
each item, the total of inventory, or major categories of inventory
d.
Inability to determine appropriate prices
c
1
Easy
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38. Which one of the following inventories may not be valued for balance sheet purposes at the inventory’s selling price
less distribution costs even if it is above the cost of the inventory?
a.
grain for an agricultural company
b.
crude oil for an oil company
c.
gold for a mining corporation
d.
laptops for a computer manufacturer
d
1
Moderate
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39. Generally, valuing inventory above cost
a.
violates conservatism and is never allowed.
b.
violates the lower of cost or market rule and is never allowed.
c.
is acceptable when revenue recognition is not applicable.
d.
is acceptable only in selected industries and in certain circumstances.
d
1
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40. Which one of the following inventories may be valued for balance sheet purposes at the inventory’s selling price less
distribution costs even if it is above the cost of the inventory?
a.
automobiles for an automobile manufacturer
b.
gold for a mining corporation
c.
steel for a steel manufacturer
d.
athletic shoes for a retail store
b
1
Easy
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41. For the period from 2016 through 2016, the Charlie Company had net sales of $500,000 and a gross profit of
$200,000. During the first quarter of 2018, the company made purchases of $19,500 and recorded sales of $47,500.
The inventory value at the beginning of the year was 15,500. What is the estimated cost of Charlie’s inventory on
March 31, 2018, using the gross profit method?
a.
$22,500
b.
$15,000
c.
$6,500
d.
c
1
Moderate
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$6,000
Exhibit 8-2
The Dormer Company uses the gross profit method to estimate its inventory in interim financial statements. The markup
on cost is 50%. The following information is available:
January 1, 2016, inventory balance
$12,500
Purchases
25,000
Sales during January
24,000
42. Refer to Exhibit 8-2. The estimated inventory at January 31, 2016, is
a.
$25,500
b.
$21,500
c.
$16,000
d.
$12,000
b
1
Moderate
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43. Refer to Exhibit 8-2. The estimated cost of goods sold at January 31, 2016, is
a.
$25,500
b.
$21,500
c.
$16,000
d.
$12,000
c
1
Moderate
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44. Consider the following:
Code:
A = Gross profit to net sales ratio
B = Gross profit to cost of goods sold ratio
Which equation is correct?
a.
A = B / (1 − B)
b.
A = (1 + B) / B
c.
A = (1 − B) / B
d.
A = B / (1 + B)
d
1
Moderate
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45. Relevance of the gross profit margin depends upon
a.
the accuracy of the gross profit percentage
b.
the net sales
c.
applying the overall profit margin to each individual department
d.
averaging prior periods’ net sales and total sales to verify which is best to use
a
1
Easy
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46. Which one of the following statements is not true with regard to the gross profit method of estimating inventories?
a.
The gross profit method may be used to determine inventory for interim financial reporting purposes without
taking a physical count.
b.
The percentage used for the gross profit method is determined by using previous years’ historical data.
c.
The gross profit method is not as accurate as the retail inventory method.
d.
The gross profit method may only be used with a perpetual inventory accounting system.
d
1
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47. The Sahara Company’s inventory was partially destroyed on June 4, 2016, when its warehouse caught on fire early in
the morning. Inventory that had a cost of $8,000 was saved. The accounting records, which were located in a fireproof
vault, contained the following information:
Sales (1/1/16 through 6/3/16)
$260,000
Purchases (1/1/16 through 7/3/16)
190,000
Inventory (1/1/16)
40,000
Gross profit ratio
30% of cost
Using the gross profit method, what is the estimated cost of the inventory destroyed by the fire?
a.
$130,,000
b.
$48,000
c.
$39,000
d.
$30,000
d
1
Moderate
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48. Given the following information for Bonnie Bunny Company:
Freight-in
$ 650
Purchases
12,550
Sales returns
350
Beginning inventory
1,950
Sales
23,450
Gross profit on sales
45%
Calculate ending inventory of Bonnie Bunny using the gross profit method.
a.
$4,755
b.
$4,373
c.
$2,445
d.
$2,060
c
1
Challenging
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