Reporting and Analyzing Inventory
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*Ex. 222
Condensed income statements for Werly Corporation are shown below for two years.
2013 2014
Sales $75,000 $90,000
Cost of Goods Sold 45,000 54,000
Gross Profit $30,000 $36,000
Operating Expense 15,000 15,000
Net Income $15,000 $21,000
Compute the corrected net income for 2013 and 2014 assuming that the inventory as of the end
of 2013 was mistakenly overstated by $5,000.
2013 $ __________ 2014 $__________
*Ex. 223
Arnold Pharmacy reported cost of goods sold as follows:
2013 2014
Beginning inventory $ 54,000 $ 64,000
Cost of goods purchased 847,000 891,000
Cost of goods available for sale 901,000 955,000
Ending inventory 64,000 55,000
Cost of goods sold $837,000 $900,000
Arnold made two errors:
(1) 2013 ending inventory was overstated by $6,000.
(2) 2014 ending inventory was understated by $11,000.
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FOR INSTRUCTOR USE ONLY
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*Ex. 223 (Cont.)
Instructions
Assuming the errors had not been corrected, indicate the dollar effect that the errors had on the
items appearing on the financial statements listed below. Also indicate if the amounts are
overstated (O) or understated (U).
2013 2014
Overstated/ Overstated/
Amount Understated Amount Understated
Total assets $_________ _______ $_________ _______
Stockholders’ equity $_________ _______ $_________ _______
Cost of goods sold $_________ _______ $_________ _______
Net income $_________ _______ $_________ _______
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COMPLETION STATEMENTS
224. In a manufacturing company, goods that are ready to be sold to customers are referred to
as ________________, whereas in a merchandising company they are generally referred
to as _______________.
225. In a manufacturing company, there are three categories of inventory: they are
_____________________, _________________, and _________________.
226. When the terms of sale are FOB ______________, ownership of the goods passes to the
buyer when the public carrier accepts the goods from the seller.
227. The two inventory costing systems used are the ______________ and ______________.
228. When a business holds goods of other parties without taking ownership, and tries to sell
them for a fee, the goods are called ____________ goods.
229. Cost of goods available for sale must be allocated between cost of goods ___________
and ______________.
230. The ______________ method tracks the actual physical flow of each unit of inventory
available for sale; however, management may be able to manipulate ______________ by
using this method.
231. If the unit cost of inventory has continuously increased, the ______________, first-out
inventory valuation method will result in a higher valued ending inventory than if the
______________, first-out method had been used.
232. Under the LCM basis, market is defined as current ______________ cost.
233. The ______________ is calculated as cost of goods sold divided by average inventory.
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234. The _____________ is a required disclosure for companies that use LIFO.
Answers to Completion Statements
MATCHING
235. Match the items below by entering the appropriate code letter in the space provided.
A. Merchandise Inventory F. First-in, first-out (FIFO) method
B. Work in process G. Last-in, first-out (LIFO) method
C. FOB shipping point H. Average cost method
D. FOB destination I. LIFO reserve
E. Specific identification method J. Inventory turnover ratio
____ 1. The difference between inventory reported using LIFO and inventory using FIFO.
____ 2. Tracks the actual physical flow for each inventory item available for sale.
____ 3. Goods that are only partially completed in a manufacturing company.
____ 4. Cost of goods sold consists of the most recent inventory purchases.
____ 5. Goods ready for sale to customers by retailers and wholesalers.
____ 6. Title to the goods transfers when the public carrier accepts the goods from the
seller.
____ 7. Ending inventory valuation consists of the most recent inventory purchases.
____ 8. The same unit cost is used to value ending inventory and cost of goods sold.
____ 9. Title to goods transfers when the goods are delivered to the buyer.
____ 10. Measures the number of times the inventory sold during the period.
Reporting and Analyzing Inventory
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Answers to Matching
SHORT-ANSWER ESSAY QUESTIONS
S-A E 236
The periodic and the perpetual inventory systems are two methods that companies use to
account for inventories. Briefly describe the major features of each system and explain why a
physical inventory is necessary under both systems.
S-A E 237
What is the primary basis of accounting for inventories? What is the major objective in accounting
for inventories?
S-A E 238
A survey of major U.S. companies revealed that 77% of those companies used either LIFO or
FIFO cost flow methods, while 19% used average cost, and only 4% used other methods.
Requirement
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
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Provide brief, yet concise responses to the following questions.
a. Why are LIFO and FIFO so popular?
b. Since computers and inventory management software are readily available, why aren’t
more companies using specific identification?
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S-A E 239
Your office is on the 68th floor of your building. The CEO’s office is on the 77th floor. The two of
you are waiting for an elevator one morning. The CEO states “Our prices are rising and I want the
lowest net income for tax purposes and the highest ending inventory for external reporting
purposes. Which inventory method should we use?
Requirement
You have three minutes to respond to the CEO. What is your response?
S-A E 240
Your former college roommate is opening a new retail store and asks you “Which inventory
costing method should I use?”
What is your response? Include a comparison of the tax effect, balance sheet effect, and income
statement effect for FIFO versus LIFO.
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Solution 240 (Cont.)
S-A E 241
FIFO and LIFO are the two most common cost flow assumptions made in costing inventories.
The amounts assigned to the same inventory items on hand may be different under each cost
flow assumption. If a company has no beginning inventory, explain the difference in ending
inventory values under the FIFO and LIFO cost bases when the price of inventory items
purchased during the period have been (1) increasing, (2) decreasing, and (3) remained constant.
S-A E 242
Glenda Carson is studying for the next accounting midterm examination. What should Glenda
know about (a) departing from the cost basis of accounting for inventories and (b) the meaning of
“market” in the lower-of-cost–or-market method?
Ans: N/A, LO: 4, Bloom: C, Difficulty: Easy, Min: 5, AACSB: Communications, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA
PC: Communications, IMA: Business Economics
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Solution 242
S-A E 243
What is the LIFO reserve? What are the consequences of ignoring a large LIFO reserve when
analyzing a company?
S-A E 244 (Ethics)
Angie and Neal Fry are department managers in the housewares and shoe departments,
respectively, for Calhouns, a large department store. Neal has observed Angie taking inventory
from her own department home, apparently without paying for it. He hesitates confronting Angie
because he is due to be promoted, and needs Angie’s recommendation. He also does not want to
notify the company management directly, because he doesn’t want an ethics investigation on his
record, believing that it will give him a “goody–goody” image. This week, Angie tried on several
pairs of expensive running shoes in his department before finding a pair that suited her. She did
not, however, buy them. That very pair was missing this morning.
Calhouns recently replaced its old periodic inventory system with a perpetual inventory system
using scanners and bar codes. In addition, the annual inventory is to be replaced by a monthly
inventory conducted by an independent firm. On hearing the news of the changes, Neal relaxes.
“The system will catch Angie now,” he says to himself.
Required:
1. Is Neal’s attitude justified? Why or why not?
2. What, if any, action should Neal take now?
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S-A E 245 (Communication)
Al Bodkin, a new employee of Crafter’s Paradise, recorded $1,000 in consigned goods received
as part of the firm’s inventory. The goods were received one day after the end of the fiscal period,
but Al reasoned that the goods should be included in inventory sooner because Crafter’s paid the
freight. The mistake was brought to his attention by the purchasing department who said the
goods should not have been recorded as Crafter’s inventory at all. Al told Sid Goza, the
purchasing supervisor, that nobody needed to worry, because the mistake would cancel itself out
the following month. In Al’s opinion, there was no reason to get everyone excited over nothing,
especially since it was monthly, and not annual, financial statements that were affected. Sid Goza
has reported the problem to the accounting department.
Required:
You are Al’s supervisor. Write a memo to Al explaining why the error should have been corrected.
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IFRS QUESTIONS
1. The requirements for accounting for and reporting of inventories under IFRS, compared to
GAAP, tend to be more
a. detailed.
b. rules-based.
c. principles-based.
d. full of disclosure requirements.
2. The major IFRS requirements related to accounting for and reporting inventories are
a. the same as GAAP.
b. the same as GAAP with a couple of exceptions.
c. completely different fom GAAP.
d. not comparable to GAAP.
3. Inventory accounting under IFRS differs from GAAP in regard to
a. neither the use of LIFO nor lower–of-cost-or-market.
b. the use of LIFO but not lower–of-cost-or-market.
c. the use of lower-of-cost-or-market but not LIFO.
d. the use of LIFO and lower-of-cost-or-market.
4. Under GAAP, companies can choose which inventory system?
LIFO FIFO
a. Yes No
b. Yes Yes
c. No Yes
d. Yes No
5. Under IFRS, companies can choose which inventory system?
LIFO FIFO
a. Yes No
b. Yes Yes
c. No Yes
d. Yes No
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6. Inventories are defined by IFRS as
a. held–for-sale in the ordinary course of business.
b. in the process of production for sale in the ordinary course of business.
c. in the form of materials or supplies to be consumed in the production process or in the
providing of services.
d. All of these answer choices are correct.
7. Specific Identification can be used for inventory valuation under
GAAP IFRS
a. Yes No
b. Yes Yes
c. No No
d. No Yes
8. Specific Identification must be used for inventory valuation where the inventory items are
not interchangeable under
GAAP IFRS
a. Yes No
b. Yes Yes
c. No No
d. No Yes
9. GAAP’s provision for ownership of goods (goods–in-transit or consigned goods), as well
as which costs to include in inventory, as compared to IFRS are:
Ownership of goods Costs to include in inventory
a. essentially similar essentially similar
b. essentially different essentially different
c. essentially similar essentially different
d. essentially different essentially similar
10. The only acceptable cost flow assumptions under IFRS are
a. FIFO and LIFO.
b. FIFO and average.
c. LIFO and average.
d. FIFO, LIFO and average.
11. LIFO can be used
a. under neither GAAP nor IFRS.
b. under IFRS but not GAAP.
c. under GAAP but not IFRS.
d. under both GAAP and IFRS.
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12. The requirement that companies use the same cost flow assumption of all goods of a
similar nature is found in
GAAP IFRS
a. Yes No
b. Yes Yes
c. No No
d. No Yes
13. IFRS defines market for lower-of-cost-or market as
a. net realizable value.
b. estimated selling price in the ordinary course of business.
c. replacement cost.
d. replacement cost less costs of disposal.
14. GAAP defines market for lower-of-cost-or market essentially as
a. net realizable value.
b. estimated selling price in the ordinary course of business.
c. replacement cost.
d. replacement cost less costs of disposal.
15. Inventory written down under lower–of-cost-or market may be written back up to original cost
in a subsequent period under
GAAP IFRS
a. Yes No
b. Yes Yes
c. No No
d. No Yes
16. The option to value inventory at fair value exists under
GAAP IFRS
a. Yes No
b. Yes Yes
c. No No
d. No Yes
17. Certain agricultural and mineral products can be reported at net realizable value under
GAAP IFRS
a. Yes No
b. Yes Yes
c. No No
d. No Yes
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18. The convergence issue that will be most difficult to resolve in the area of inventory
accounting is:
a. FIFO.
b. LIFO.
c. ownership of goods.
d. costs to include in inventory.