Learning Objective 5-7
1) An example of a sound control for inventory is ________.
A) requiring authorization for all purchases
B) verifying that the items received are the items ordered
C) physically protecting the inventory with locked storage rooms
D) all of these
2) Which of the following would be an example of a WEAKNESS in controls over inventory?
A) having an employee identify reliable vendors from whom to buy merchandise
B) paying for inventory only after it has been checked that all items were received
C) having the employee who keeps inventory records also make payments for the goods
D) limiting access to inventory by using locked warehouses and storage rooms
3) Which statement below is TRUE about the purchase of inventory?
A) Large firms tend to have entire departments for purchasing and for accounts payable.
B) All firms, large and small, need to keep detailed records of what they are buying and paying
for.
C) The person who records inventory purchases should not have access to the inventory.
D) All of these statements are true.
4) Which statement below is STRENGTH in controls over inventory?
A) Have an employee order the merchandise and also be the one to sign for the delivery of the
merchandise ordered.
B) Have the accountant order the merchandise so that the amounts will be accurately reflected in
the accounting records.
C) Have the employee who keeps inventory records also make payments for the goods to avoid
overpayment of merchandise purchased.
D) The accountant who records inventory purchases should not have access to the inventory.
5) An example of an internal control procedure to protect inventory is to limit access to inventory
deliveries to the accountants.
6) An example of an internal control procedure to protect inventory is to prevent the person who
records inventory purchases from having access to the inventory.
7) Discuss the risks to be avoided and the control procedures associated with purchasing and
paying for inventory.
8) Jennifer works the front counter at Burger King. Often her friends drop by when she’s
working and she gives them free food (inventory) without ringing up any sales. She figures it’s
OK as long as she isn’t caught.
1. Assume that Burger King uses a perpetual inventory system. Describe how a perpetual
inventory system helps to identify inventory shrinkage.
2. Is it ethical to give your friends free food as long as you aren’t caught?
9) Match each of the following with the internal control that best minimizes the related risk.
There is only one best answer for each.
Internal Controls (I/C):
A.
Limiting access
B.
Selection of Reliable Vendors
C.
Segregation of duties
I/C
1.
Bart Simpson, the purchasing agent, always orders the
company’s inventory from Uncle Crusty.
2.
The employee at the receiving dock steals some of the
inventory without being caught because she writes down a
lower number of goods received on the receiving report.
3.
Customers steal inventory from the warehouse.
10) Match the risk with the related internal control that best minimizes the risk. There is only one
best answer for each.
Internal Controls (I/C):
A.
Segregation of duties
B.
Selection of Reliable
Vendors
C.
Limiting access
I/C
1.
The unscrupulous bookkeeper, while unloading the
delivery truck, steals inventory and then makes an
adjusting entry to remove the inventory from the
accounting records so as not to be detected.
2.
Companies use sensors on their inventory to prevent
customers from leaving the store with merchandise.
3.
The company is paying too much for its merchandise
because it is ordered from an employee’s friend who
charges more than competitors.
Learning Objective 5-8 (Appendix 5A)
1) Z Company uses a periodic inventory system. If ending inventory is overstated, net income
will be ________.
A) overstated
B) understated
C) unaffected by the inventory error
D) impossible to determine from the information given
2) Which of the following 2011 financial statement line items will be affected if the 2011 ending
inventory balance is overstated?
A) Cost of goods sold will be understated.
B) Current assets will be understated.
C) Net income will be understated.
D) Current liabilities will be overstated.
3) Which financial statement line item will be misstated if the 2011 ending inventory balance is
overstated?
A) 2011 Balance sheet only
B) 2011 and 2012 Balance sheets only
C) 2011 and 2012 Income statements and 2011 Balance sheet only
D) 2011 and 2012 Income statements only
4) Newcastle Company has the following inventory data for the current period:
Beginning inventory $ 10,000
+ Purchases 130,000
Cost of goods available for sale 140,000
– Ending inventory 20,000
Cost of goods sold $120,000
Assume that the ending inventory is understated by $5,000. What is the effect on the current
period’s net income?
A) It will be overstated by $5,000.
B) It will be understated by $5,000.
C) It will be understated by $20,000.
D) The inventory error will have no effect on net income.
5) Newcastle Company has the following inventory data for the current period:
Beginning inventory $ 10,000
+ Purchases 130,000
Cost of goods available for sale 140,000
– Ending inventory 20,000
Cost of goods sold $120,000
Assume that the ending inventory is overstated by $5,000. What is the effect on the current
period’s net income and on the following period’s net income?
A) Net Income this period will be overstated by $5,000 and next period will be understated by
$5,000.
B) Net income this period will be understated by $5,000 and next period will be understated by
$5,000.
C) Net income this period will be overstated by $5,000, but next period will be correctly stated.
D) Net income this period will be understated by $5,000 and next period will be overstated by
$5,000.
6) A company uses a periodic inventory system. If the ending inventory is understated, the error
will affect only the current accounting period.
7) If ending inventory is overstated, the error will affect two income statement periods.
8) An error in ending inventory in 2011 will cause ending inventory in 2012 to be misstated as
well.
9) Assume TFG Company uses a periodic inventory system and overstates its ending inventory
by $12,000. In other words, the company counts and states that its ending inventory is $50,000,
when in fact the correct ending inventory balance should have been $38,000. Describe how this
mistake of overstating inventory affects the income statement.
10) Determine the effect on net income of each of the following errors. Treat each part of this
question as an independent case and assume that the error given is the only error during the year.
a. Ending inventory is overstated by $5,000.
b. Beginning inventory is overstated by $7,000.
c. Ending inventory is understated by $4,000.
d. Beginning inventory is understated by $6,000.
e. Ending inventory is overstated by $2,500.
f. Beginning inventory is overstated by $9,500.
g. Ending inventory is understated by $6,200.
11) The following inventory information comes from the records of Hoboken Widget Company.
Beginning inventory
$120,000
Ending inventory
$80,000
Cost of goods sold
$540,000
A physical inventory count revealed that the inventory was actually $75,000. If this error were
not corrected, what effect would it have on the income statements for this fiscal year and the
following fiscal year?
12) The following inventory data are from the records of Hobo Widget Company:
Beginning inventory
$100,000
Ending inventory
$70,000
Cost of goods sold
$230,000
A physical inventory count revealed that the inventory was actually $75,000. If this error were
not corrected, what effect would it have on the income statements for this fiscal year and the
following fiscal year?
13) Records for the Short Company showed the following at the end of the year:
Beginning inventory
$10,000
Ending inventory
30,000
Cost of goods sold
80,000
A physical inventory was taken and showed that the ending inventory was actually $29,000.
Required: Put an X in the appropriate box to show the effect the error will have on the following
financial statement line items for the year if Short Company fails to correct it:
Overstated
Understated
Correct
1
Current assets
2
Current liabilities
3
Cost of goods sold
4
Gross profit
5
Income taxes
6
Retained earnings
Overstated
Understated
Correct
1
Current assets
2
Current liabilities
3
Cost of goods sold
4
Gross profit
5
Income taxes
6
Retained earnings
Learning Objective 5-9 (Appendix 5b)
1) The accountant for Rock Springs, Inc. needs to estimate the ending inventory balance so that
she can prepare quarterly financial statements. The accountant has gathered the following
information:
Beginning inventory
$14,000,000
Sales
$42,000,000
Purchases
$30,000,000
Gross profit percentage
40%
Use the gross profit method to estimate the cost of the ending inventory.
A) $22,300,000
B) $18,800,000
C) $15,600,000
D) $16,800,000
2) The accountant for Buy & Large, Inc. needs to estimate the ending inventory balance so that
he can prepare quarterly financial statements. The accountant has gathered the following
information:
Beginning inventory
$10,000
Sales
$100,000
Purchases
$80,000
Gross profit percentage
40%
Use the gross profit method to estimate the cost of the ending inventory.
A) $30,000
B) $40,000
C) $20,000
D) $42,000
3) Minoan Company lost its entire inventory during an earthquake. The following key inventory
information was recovered from backup data stored electronically at a remote location:
Beginning inventory
$150,000
Sales
$300,000
Purchases
$225,000
Gross profit percentage
38%
Use the gross profit method to estimate the cost of the ending inventory.
A) $189,000
B) $211,000
C) $199,000
D) $186,000
4) Santorini Company lost its entire inventory during an earthquake. The following key
inventory information was reconstructed from backup data stored electronically at a remote
location:
Beginning inventory
$750,000
Sales
$800,000
Purchases
$200,000
Gross profit percentage
40%
Use the gross profit method to estimate the cost of the ending inventory.
A) $500,000
B) $480,000
C) $470,000
D) $320,000
5) Explain what information is needed in order to estimate a company’s ending inventory cost
using the gross profit method. Why would a company need to estimate inventory?
6) The accountants for Ruiz Imports need to estimate the ending inventory balance so that they
can prepare quarterly financial statements. The accountants have gathered the following
information:
Beginning inventory
$96,950
Sales
$138,500
Purchases
$13,850
Gross profit ratio
40%
Required: Use the gross profit method to estimate the ending inventory.
7) The El Paso Chili Pepper Company lost its entire inventory during a fire that started when the
hot sauce it was making overheated. Fortunately, the company’s accounting records were not lost
in the fire. Key inventory data follow:
Beginning inventory
$1,000,000
Purchases (up to date of fire)
$850,000
Sales (up to date of fire)
$2,200,000
Gross profit ratio
30%
Required: Use the gross profit method to estimate the cost of the inventory lost in the fire.
8) The Morris Lest, Inc. lost its entire inventory during a hurricane. Fortunately, the company’s
records were not lost in the same disaster. Key inventory data follow:
Beginning inventory
$100,000
Purchases (up to date of quake)
$800,000
Net sales (up to date of quake)
$1,000,000
Gross profit ratio
30%
Use the gross profit method to estimate the cost of the inventory lost in the earthquake.
9) The accountants for Gonzalez Furniture Imports need to estimate the ending inventory balance
so that they can prepare quarterly financial statements. The accountants have gathered the
following information:
Beginning inventory
$60,000
Sales
$105,000
Purchases
$80,000
Gross profit ratio
35%
Required: Use the gross profit method to estimate the ending inventory.