FOR INSTRUCTOR USE ONLY
CHAPTER 6
REPORTING AND ANALYZING INVENTORY
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVE AND BLOOM’S TAXONOMY
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Multiple Choice Questions
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Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
6-2
Exercises
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*This topic is dealt with in an Appendix to the chapter.
SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE
Learning Objective 1
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Learning Objective 2
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Reporting and Analyzing Inventory
FOR INSTRUCTOR USE ONLY
6-3
`
Learning Objective 3
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Learning Objective 4
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Learning Objective 5
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Learning Objective 6
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Learning Objective 7
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Learning Objective 8
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Ex
Note: TF = True-False C = Completion
MC = Multiple Choice Ex = Exercise
Ma = Matching SA = Short Answer Essay
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
6-4
CHAPTER LEARNING OBJECTIVES
1. Determine how to classify Inventory and inventory quantities. Merchandisers need only
one inventory classification. merchandise inventory to describe the different items that make
up total inventory. Manufacturers, on the other hand, usually classify inventory into three
categories: finished goods work in process and raw materials. To determine inventory
quantities, manufacturers (1) take a physical inventory of goods on hand and (2) determine
the ownership of goods in transit on an consignment.
2. Explain the basis of accounting for inventories and apply the inventory cost flow
methods under a periodic inventory system. The primary basis of accounting for
inventories is cost. Cost includes all expenditures necessary to acquire goods and place
them in a condition ready for sale. Cost of goods available for sale includes (a) cost of
beginning inventory and (b) cost of goods purchased. The inventory cost flow methods are:
specific identification and three assumed cost flow methods—FIFO, LIFO, and average-cost.
3. Explain the financial statement and tax effects of each of the inventory cost flow
assumptions. The cost of goods available for sale may be allocated to cost of goods sold
and ending inventory by specific identification or by a method based on an assumed cost
flow. When prices are rising, the first-in, first-out (FIFO) method results in lower cost of goods
sold and higher net income than the average-cost and the last-in, first-out (LIFO) methods.
The reverse is true when prices are falling. In the balance sheet, FIFO results in an ending
inventory that is closest to current value, whereas the inventory under LIFO is the farthest
from current value. LIFO results in the lowest income taxes (because of lower taxable
income).
4. Explain the lower–of-cost-or-market basis of accounting for inventories. Companies use
the lower–of-cost-or-market (LCM) basis when the current replacement cost (market) is less
than cost. Under LCM, companies recognize the loss in the period in which the price decline
occurs.
5. Compute and interpret the inventory turnover. The inventory turnover is calculated as
cost of goods sold divided by average inventory. It can be converted to average days in
inventory by dividing 365 days by the inventory turnover. A higher turnover or lower average
days in inventory suggests that management is trying to keep inventory levels low relative to
its sales level.
6. Describe the LIFO reserve and explain its importance for comparing results of
different companies. The LIFO reserve represents the difference between ending inventory
using LIFO and ending inventory if FIFO were employed instead. For some companies this
difference can be significant, and ignoring it can lead to inappropriate conclusions when
using the current ratio or inventory turnover.
*7. Apply the inventory cost flow methods to perpetual inventory records. Under FIFO, the
cost of the earliest goods on hand prior to each sale is charged to cost of goods sold. Under
LIFO, the cost of the most recent purchase prior to sale is charged to cost of goods sold.
Under the average-cost method, a new average cost is computed after each purchase.
Reporting and Analyzing Inventory
FOR INSTRUCTOR USE ONLY
6-5
* 8. Indicate the effects of inventory errors on the financial statements. In the income
statement of the current year: (1) An error in beginning inventory will have a reverse effect on
net income (e.g. overstatement of inventory results in understatement of net income, and
vice versa). (2) An error in ending inventory will have a similar effect on net income (e.g.
overstatement of inventory results in overstatement of net income). If ending inventory errors
are not corrected in the following period, their effect on net income for that period is reversed,
and total net income for the two years will be correct. In the balance sheet: Ending inventory
errors will have the same effect on total assets and total stockholders’ equity and no effect on
liabilities.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
6-6
TRUE-FALSE STATEMENTS
1. Raw materials inventories are the goods that a manufacturing company has completed
and are ready to be sold to customers.
2. A manufacturer’s inventory consists of raw materials, work in process, and finished goods.
3. When the terms of sale are FOB shipping point, legal title to the goods remains with the
seller until the goods reach the buyer.
4. Goods in transit shipped FOB shipping point should be included in the buyer’s ending
inventory.
5. Goods that have been purchased FOB destination but are in transit, should be excluded
from a physical count of goods by the buyer.
6. If the ownership of merchandise passes to the buyer when the seller ships the
merchandise, the terms are stated as FOB destination.
7. Under the periodic inventory system, both the sales amount and the cost of goods sold
amount are recorded when each item of merchandise is sold.
8. Under a periodic inventory system, the merchandise on hand at the end of the period is
determined by a physical count of the inventory.
9. Consigned goods are held for sale by one party although ownership of the goods is
retained by another party.
10. Goods held on consignment should be included in the consignor’s ending inventory.
11. In accounting for inventory, the assumed flow of costs must match the physical flow of
goods.
Reporting and Analyzing Inventory
6-7
12. Inventory methods such as FIFO and LIFO deal more with flow of costs than with flow of
goods.
13. The average cost inventory method relies on a simple average calculation.
14. If prices never changed there would be no need for alternative inventory methods.
15. The specific identification method of costing inventories tracks the actual physical flow of
the goods available for sale.
16. Management may choose any inventory costing method it desires as long as the cost flow
assumption chosen is consistent with the physical movement of goods in the company.
17. The First-in, First-out (FIFO) inventory method results in an ending inventory valued at the
most recent cost.
18. The expense recognition principle requires that the cost of goods sold be matched against
the ending merchandise inventory in order to determine income.
19. The specific identification method of inventory valuation is desirable when a company
sells a large number of low-unit cost items.
20. If a company has no beginning inventory and the unit cost of inventory items does not
change during the year, the value assigned to the ending inventory will be the same under
LIFO and average cost flow assumptions.
21. If the unit price of inventory is increasing during a period, a company using the LIFO
inventory method will show less gross profit for the period, than if it had used the FIFO
inventory method.
22. If a company has no beginning inventory and the unit price of inventory is increasing
during a period, the cost of goods available for sale during the period will be the same
under the LIFO and FIFO inventory methods.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
6-8
23. A company may use more than one inventory cost flow method at the same time.
24. Use of the LIFO inventory valuation method enables a company to report paper or
phantom profits.
25. The LIFO inventory method agrees with the actual physical movement of goods in most
businesses.
26. In periods of falling prices, LIFO will result in a higher ending inventory valuation than
FIFO.
27. In periods of falling prices, FIFO will result in a larger net income than the LIFO method.
28. If a company changes its inventory valuation method, the effect of the change on net
income should be disclosed in the financial statements.
29. A major criticism of the FIFO inventory method is that it magnifies the effects of the
business cycle on business income.
30. The LIFO method is rarely used because most companies do not sell the last goods they
purchase first.
31. The LIFO inventory method tends to smooth out the peaks and valleys of a business
cycle.
32. Computers has made the periodic inventory system more popular and easier to apply.
33. When the market value of inventory is lower than its cost, the inventory is written down to
its market value.
34. The lower-of-cost–or-market rule implies that it is unrealistic to carry inventory at a cost
that is in excess of its market value.
Reporting and Analyzing Inventory
FOR INSTRUCTOR USE ONLY
6-9
35. Accountants believe that the write down from cost to market should not be made in the
period in which the price decline occurs.
36. Under the LCM basis, market is defined as selling price, not current replacement cost.
37. The inventory turnover is calculated as cost of goods sold divided by ending inventory.
38. An inventory turnover that is too high may indicate that the company is losing sales
opportunities because of inventory shortages.
39. The LIFO reserve is the difference between ending inventory using LIFO and ending
inventory if FIFO were used instead.
40. The FIFO reserve is a required disclosure for companies that use FIFO.
Reporting
*41. When the average cost method is applied in a perpetual inventory system, the sale of
goods will change the unit cost that remains in inventory.
*42. When the average cost method is applied to a perpetual inventory system, a moving
average cost per unit is computed with each purchase.
*43. An error in the ending inventory of the current period will have a similar effect on net
income of the next accounting period.
*44. An error that overstates the ending inventory will also cause net income for the period to
be overstated.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
6-10
Answers to True-False Statements
MULTIPLE CHOICE QUESTIONS
45. Manufactured inventory that has begun the production process but is not yet completed is
a. work in process.
b. raw materials.
c. merchandise inventory.
d. finished goods.
46. The factor which determines whether or not goods should be included in a physical count
of inventory is
a. physical possession.
b. legal title.
c. management’s judgment.
d. whether or not the purchase price has been paid.
47. If goods in transit are shipped FOB destination
a. the seller has legal title to the goods until they are delivered.
b. the buyer has legal title to the goods until they are delivered.
c. the transportation company has legal title to the goods while the goods are in transit.
d. no one has legal title to the goods until they are delivered.
48. Independent internal verification of the physical inventory process occurs when
a. the employee is required to count all items twice for sake of verification.
b. the items counted are compared to the inventory account balance.
c. a second employee counts the inventory and compares the result to the count made
by the first employee.
d. all prenumbered inventory tags are accounted for.
Reporting and Analyzing Inventory
6-11
49. An employee assigned to counting computer monitors in boxes should
a. estimate the number if there is a large quantity to be counted.
b. read each box and rely on the box description for the contents.
c. determine that the box contains a monitor.
d. rely on the warehouse records of the number of computer monitors.
50. After the physical inventory is completed,
a. quantities are listed on inventory summary sheets.
b. quantities are entered into various general ledger inventory accounts.
c. the accuracy of the inventory summary sheets is checked by the person listing the
quantities on the sheets.
d. unit costs are determined by dividing the quantities on the summary sheets by the
total inventory costs.
51. When is a physical inventory usually taken?
a. When goods are not being sold or received.
b. When the company has its greatest amount of inventory.
c. At the end of the company’s fiscal year.
d. When the company has its greatest amount of inventory and at the end of the
company’s fiscal year.
52. Which of the following should not be included in the physical inventory of a company?
a. Goods held on consignment from another company.
b. Goods in transit from another company shipped FOB shipping point.
c. Goods shipped on consignment to another company.
d. All of these answer choices should be included.
53. Tidwell Company’s goods in transit at December 31 include sales made
(1) FOB destination
(2) FOB shipping point
and purchases made
(3) FOB destination
(4) FOB shipping point.
Which items should be included in Tidwell’s inventory at December 31?
a. Sales made FOB shipping point and purchase made FOB destination
b. (1) and (4)
c. (1) and (3)
d. (2) and (4)
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
6-12
54. The term “FOB” denotes
a. free on board.
b. freight on board.
c. free only (to) buyer.
d. freight charge on buyer.
55. Goods held on consignment are
a. never owned by the consignee.
b. included in the consignee’s ending inventory.
c. kept for sale on the premises of the consignor.
d. included as part of no one’s ending inventory.
56. Many companies use just–in-time inventory methods. Which of the following is not an
advantage of this method?
a. It limits the risk of having obsolete items in inventory.
b. Companies may not have quantities to meet customer demand.
c. It lowers inventory levels and costs.
d. Companies can respond to individual customer requests.
57. When a perpetual inventory system is used, which of the following is a purpose of taking a
physical inventory?
a. To check the accuracy of the perpetual inventory records
b. To determine cost of goods sold for the accounting period
c. To compute inventory ratios
d. All are a purpose of taking a physical inventory when a perpetual inventory system is
used.
58. Which statement is false?
a. Taking a physical inventory involves actually counting, weighing, or measuring each
kind of inventory on hand.
b. No matter whether a periodic or perpetual inventory system is used, all companies
need to determine inventory quantities at the end of each accounting period.
c. An inventory count is generally more accurate when goods are not being sold or
received during the counting.
d. Companies that use a perpetual inventory system must take a physical inventory to
determine inventory on hand on the balance sheet date and to determine cost of
goods sold for the accounting period.
Reporting and Analyzing Inventory
6-13
59. Reeves Company is taking a physical inventory on March 31, the last day of its fiscal year.
Which of the following must be included in this inventory count?
a. Goods in transit to Reeves, FOB destination
b. Goods that Reeves is holding on consignment for Parker Company
c. Goods in transit that Reeves has sold to Smith Company, FOB shipping point
d. Goods that Reeves is holding in inventory on March 31 for which the related Accounts
Payable is 15 days past due
60. At December 31, 2014 Mohling Company’s inventory records indicated a balance of
$602,000. Upon further investigation it was determined that this amount included the
following:
• $112,000 in inventory purchases made by Mohling shipped from the seller 12/27/14
terms FOB destination, but not due to be received until January 2nd
• $74,000 in goods sold by Mohling with terms FOB destination on December 27th. The
goods are not expected to reach their destination until January 6th.
• $6,000 of goods received on consignment from Dollywood Company
What is Mohling’s correct ending inventory balance at December 31, 2014?
a. $490,000
b. $596,000
c. $410,000
d. $484,000
61. At December 31, 2014 Howell Company’s inventory records indicated a balance of
$858,000. Upon further investigation it was determined that this amount included the
following:
• $168,000 in inventory purchases made by Howell shipped from the seller 12/27/14
terms FOB destination, but not due to be received until January 2nd
• $111,000 in goods sold by Howell with terms FOB destination on December 27th. The
goods are not expected to reach their destination until January 6th.
• $9,000 of goods received on consignment from Westwood Company
What is Howell’s correct ending inventory balance at December 31, 2014?
a. $690,000
b. $849,000
c. $570,000
d. $681,000
62. Manufacturers usually classify inventory into all the following general categories except:
a. work in process
b. finished goods
c. merchandise inventory
d. raw materials
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
6-14
63. For companies that use a perpetual inventory system, all of the following are purposes for
taking a physical inventory except to:
a. check the accuracy of the records.
b. determine the amount of wasted raw materials.
c. determine losses due to employee theft.
d. determine ownership of the goods.
64. Inventory costing methods place primary reliance on assumptions about the flow of
a. goods.
b. costs.
c. resale prices.
d. values.
65. The LIFO inventory method assumes that the cost of the latest units purchased are
a. the last to be allocated to cost of goods sold.
b. the first to be allocated to ending inventory.
c. the first to be allocated to cost of goods sold.
d. not allocated to cost of goods sold or ending inventory.
66. Alpha First Company just began business and made the following four inventory
purchases in June:
June 1 150 units $ 780
June 10 200 units 1,170
June 15 200 units 1,260
June 28 150 units 990
$4,200
A physical count of merchandise inventory on June 30 reveals that there are 210 units on
hand. Using the LIFO inventory method, the value of the ending inventory on June 30 is
a. $1,092
b. $1,131
c. $1,386
d. $1,368
Reporting and Analyzing Inventory
6-15
67. Baker Bakery Company just began business and made the following four inventory
purchases in June:
June 1 150 units $ 780
June 10 200 units 1,170
June 15 200 units 1,260
June 28 150 units 990
$4,200
A physical count of merchandise inventory on June 30 reveals that there are 210 units on
hand. Using the FIFO inventory method, the amount allocated to ending inventory for
June is
a. $1,092
b. $1,131
c. $1,368
d. $1,386
68. Charlene Cosmetics Company just began business and made the following four inventory
purchases in June:
June 1 150 units $ 780
June 10 200 units 1,170
June 15 200 units 1,260
June 28 150 units 990
$4,200
A physical count of merchandise inventory on June 30 reveals that there are 210 units on
hand. Using the average cost method, the amount allocated to the ending inventory on
June 30 is
a. $1,229.
b. $1,368.
c. $1,323.
d. $1,260.
69. Echo Sound Company just began business and made the following four inventory
purchases in June:
June 1 150 units $ 780
June 10 200 units 1,170
June 15 200 units 1,260
June 28 150 units 990
$4,200
A physical count of merchandise inventory on June 30 reveals that there are 210 units on
hand. The inventory method which results in the highest gross profit for June is
a. the FIFO method.
b. the LIFO method.
c. the average cost method.
d. not determinable.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
6-16
70. Atom Company just began business and made the following four inventory purchases in
June:
June 1 150 units $ 825
June 10 200 units 1,120
June 15 200 units 1,140
June 28 150 units 885
$3,970
A physical count of merchandise inventory on June 30 reveals that there are 200 units on
hand. Using the LIFO inventory method, the value of the ending inventory on June 30 is
a. $1,105.
b. $1,100.
c. $1,170.
d. $1,180.
71. Quark Inc. just began business and made the following four inventory purchases in June:
June 1 150 units $ 825
June 10 200 units 1,120
June 15 200 units 1,140
June 28 150 units 885
$3,970
A physical count of merchandise inventory on June 30 reveals that there are 200 units on
hand. Using the FIFO inventory method, the amount allocated to ending inventory for
June is
a. $1,105.
b. $1,100.
c. $1,170.
d. $1,180.
72. A company just began business and made the following four inventory purchases in June:
June 1 150 units $ 825
June 10 200 units 1,120
June 15 200 units 1,140
June 28 150 units 885
$3,970
A physical count of merchandise inventory on June 30 reveals that there are 200 units on
hand. Using the average-cost method, the amount allocated to the ending inventory on
June 30 is
a. $1,134.
b. $1,180.
c. $1,100.
d. $1,120.
Reporting and Analyzing Inventory
6-17
73. A company purchased inventory as follows:
200 units at $5.00
300 units at $5.50
The average unit cost for inventory is
a. $5.00.
b. $5.25.
c. $5.30.
d. $5.50.
74. Noise Makers Inc has the following inventory data:
July 1 Beginning inventory 20 units at $19 $ 380
7 Purchases 70 units at $20 1,400
22 Purchases 10 units at $22 220
$2,000
A physical count of merchandise inventory on July 30 reveals that there are 32 units on
hand. Using the average cost method, the value of ending inventory is
a. $620.
b. $640.
c. $651.
d. $660.
75. Olympus Climbers Company has the following inventory data:
July 1 Beginning inventory 20 units at $19 $ 380
7 Purchases 70 units at $20 1,400
22 Purchases 10 units at $22 220
$2,000
A physical count of merchandise inventory on July 30 reveals that there are 32 units on
hand. Using the FIFO inventory method, the amount allocated to cost of goods sold for
July is
a. $620.
b. $660.
c. $1,340.
d. $1,380.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
6-18
76. Pop-up Party Favors Inc has the following inventory data:
July 1 Beginning inventory 20 units at $19 $ 380
7 Purchases 70 units at $20 1,400
22 Purchases 10 units at $22 220
$2,000
A physical count of merchandise inventory on July 30 reveals that there are 32 units on
hand. Using the FIFO inventory method, the amount allocated to ending inventory for July
is
a. $620.
b. $660.
c. $640.
d. $704.
77. Quiet Phones Company has the following inventory data:
July 1 Beginning inventory 20 units at $19 $ 380
7 Purchases 70 units at $20 1,400
22 Purchases 10 units at $22 220
$2,000
A physical count of merchandise inventory on July 30 reveals that there are 32 units on
hand. Using the LIFO inventory method, the amount allocated to cost of goods sold for
July is
a. $620.
b. $660.
c. $1,340.
d. $1,380.
78. Radical Radials Company has the following inventory data:
July 1 Beginning inventory 20 units at $19 $ 380
7 Purchases 70 units at $20 1,400
22 Purchases 10 units at $22 220
$2,000
A physical count of merchandise inventory on July 30 reveals that there are 32 units on
hand. Using the LIFO inventory method, the amount allocated to ending inventory for July
is
a. $620
b. $608
c. $640
d. $704.
Reporting and Analyzing Inventory
6-19
79. Orange-Aide Company has the following inventory data:
July 1 Beginning inventory 20 units at $20 $ 400
7 Purchases 70 units at $21 1,470
22 Purchases 10 units at $22 220
$2,090
A physical count of merchandise inventory on July 30 reveals that there are 25 units on
hand. Using the average cost method, the value of ending inventory is
a. $535
b. $523
c $525
d $550
80. Peach Pink Inc. has the following inventory data:
July 1 Beginning inventory 20 units at $20 $ 400
7 Purchases 70 units at $21 1,470
22 Purchases 10 units at $22 220
$2,090
A physical count of merchandise inventory on July 30 reveals that there are 25 units on
hand. Using the FIFO inventory method, the amount allocated to cost of goods sold for
July is
a. $1,555
b. $1,585
c. $1,505.
d. $1,540.
81. Grape Gratuities Company has the following inventory data:
July 1 Beginning inventory 20 units at $20 $ 400
7 Purchases 70 units at $21 1,470
22 Purchases 10 units at $22 220
$2,090
A physical count of merchandise inventory on July 30 reveals that there are 25 units on
hand. Using the FIFO inventory method, the amount allocated to ending inventory for July
is
a. $585.
b. $505.
c. $535.
d. $550.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
6-20
82. Apple-A-Day Company has the following inventory data:
July 1 Beginning inventory 20 units at $20 $ 400
7 Purchases 70 units at $21 1,470
22 Purchases 10 units at $22 220
$2,090
A physical count of merchandise inventory on July 30 reveals that there are 25 units on
hand. Using the LIFO inventory method, the amount allocated to cost of goods sold for
July is
a. $1,585
b. $1,540
c. $1,555.
d. $1,540.
83. Bonkers Bananas has the following inventory data:
July 1 Beginning inventory 20 units at $20 $ 400
7 Purchases 70 units at $21 1,470
22 Purchases 10 units at $22 220
$2,090
A physical count of merchandise inventory on July 30 reveals that there are 25 units on
hand. Using the LIFO inventory method, the amount allocated to ending inventory for July
is
a. $550
b. $505
c. $535
d. $500.
84. Which of the following is an inventory costing method?
a. Periodic
b. Specific identification
c. Perpetual
d. Lower of cost or market
85. Inventory costing methods place primary reliance on assumptions about the flow of
a. good.
b. costs.
c. resale prices.
d. values.