Test Bank For Understanding Financial Accounting Canadian Edition

Test Bank for Understanding Financial Accounting Canadian Edition
Test Bank for Understanding Financial Accounting

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CHAPTER 7
INVENTORY
SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE
AND LEVEL OF DIFFICULTY
Item LO LOD Item LO LOD Item LO LOD Item LO LOD Item LO LOD
True-False Statements
1. 1 E 6. 2 M 11. 4 E 16. 6 E 21. 8 M
2. 2 M 7. 3 E 12. 4 M 17. 7 E *22. App E
3. 2 E 8. 3 E 13. 4 H 18. 8 M *23. App M
4. 2 E 9. 3 E 14. 5 E 19. 8 H
5. 2 E 10. 3 M 15. 6 E 20. 8 M
Multiple Choice Questions
24. 1 M 35. 3 E 46. 4 H 57. 5 M 68. 8 H
25. 2 E 36. 3 E 47. 4 H 58. 5 M 69. 8 M
26. 2 E 37. 4 E 48. 4 H 59. 5 H 70. 8 M
27. 2 E 38. 4 E 49. 4 H 60. 5 H *71. App M
28. 2 M 39. 4 E 50. 4 H 61. 5 H *72. App E
29. 2 M 40. 4 M 51. 4 H 62. 6 M *73. App M
30. 3 H 41. 4 E 52. 4 H 63. 6 M *74. App E
31. 3 E 42. 4 M 53. 5 M 64. 6 M
32. 3 H 43. 4 H 54. 5 E 65. 7 M
33. 3 E 44. 4 E 55. 5 M 66. 8 H
34. 3 E 45. 4 H 56. 5 E 67. 8 H
Exercises
75. 4 M 77. 4 M 79. 8 H *81. App M
76. 4–6 H 78. 4 E *80. App M
Matching
82. 3 M 83. 4 H
Short-Answer Essay
84. 3 M 85. 4,6,8 M 86. 8 E *87. App M
Essay
88. 3 M 89. 3 M
Note: E = Easy M = Medium H = Hard
Copyright © 2015 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited
7-2 Test Bank for Understanding Financial Accounting, Canadian Edition
SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE
Item Type Item Type Item Type Item Type Item Type Item Type Item Type
Learning Objective 1
1. TF 24. MC
2. TF 4. TF 6. TF 26. MC 28. MC
3. TF 5. TF 25. MC 27. MC 29. MC
7. TF 10. TF 32. MC 35. MC 84. SAE
8. TF 30. MC 33. MC 36. MC 88. Es
9. TF 31. MC 34. MC 82. Ma 89. Es
11. TF 38. MC 42. MC 46. MC 50. MC 76. Ex 85. SAE
12. TF 39. MC 43. MC 47. MC 51. MC 77. Ex
13. TF 40. MC 44. MC 48. MC 52. MC 78. Ex
37. MC 41. MC 45. MC 49. MC 75. Ex 83. Ma
14. TF 54. MC 56. MC 58. MC 60. MC 76. Ex
53. MC 55. MC 57. MC 59. MC 61. MC
15. TF 16. TF 62. MC 63. MC 64. MC 76. Ex 85. SAE
17. TF 65. MC
18. TF 20. TF 66. MC 68. MC 70. MC 85. SAE
19. TF 21. TF 67. MC 69. MC 79. Ex 86. SAE
Appendix
*22. TF *71. MC *73. MC *80. Ex *87. SAE
*23. TF *72. MC *74. MC *81. Ex
Note: TF = True-False Ex = Exercise SAE = Short-Answer Essay

MC = Multiple Choice Ma = Matching Es = Essay
Inventory 7-3
CHAPTER LEARNING OBJECTIVES
1. Discuss the importance of inventory to a company’s overall success.

• Inventory includes any item purchased by a company for resale to customers or to be
used in the manufacture of a product that is sold to customers.
• Inventory is often a company’s most significant current asset.
• Management must source suppliers, determine order quantities (ensuring that the risks
of obsolescence and stockouts are considered), establish selling prices, and implement
safeguards to prevent damage and losses due to theft.
2. Distinguish between the different inventory classifications and determine which

goods should be included in a company’s inventory.
• Manufacturers have three classes of inventory: (1) raw materials, (2) work-in-process,
and (3) finished goods.
• All of the goods that retailers and merchandisers have available for sale are included in
a single class of inventory.
• Goods that are purchased with shipping terms FOB shipping point become part of
buyer’s inventory when they leave the seller’s premises. Goods purchased with shipping
terms FOB destination become part of inventory when they are received at the buyer’s
premises.
• Goods on consignment remain as part of the inventory of their owner (the consignor)
and are not part of the inventory of the consignee (the business where the goods are
being held for sale).
3. Explain the differences between perpetual inventory systems and periodic

inventory systems.
• Cost of goods available for sale (COGAS) is equal to opening inventory plus
purchases. It is allocated between cost of goods sold and ending inventory. This
allocation is affected by the type of inventory system in use.
• Periodic inventory systems update a company’s inventory information periodically (at
the end of each month, quarter, or year) when inventory is physically counted. Until
inventory is physically counted, a company using a periodic inventory system is unable
to assign costs to cost of goods sold or ending inventory. It is also unaware of the
number of units sold or that remain on hand.
• Perpetual inventory systems constantly update a company’s inventory information; it is
updated with every purchase or sale of inventory. Companies always know their cost of
goods sold and ending inventory amounts. Perpetual inventory systems often also track
the physical flow of goods, enabling automatic reordering to occur. Perpetual inventory
systems also enable companies to quantify shrinkage (theft) and eliminate the need for
frequent inventory counts. An inventory count is still required at least annually in order to
quantify shrinkage.
4. Explain why cost formulas are necessary and calculate the cost of goods sold
and ending inventory under the specific identification, weighted-average, and
first-in, first-out cost formulas.
• The cost of inventory includes purchase price, non-refundable taxes, shipping or

transportation costs, and import duties.
• Cost formulas are necessary because inventory purchase costs change (that is,
different units of inventory will have different costs) and companies need to determine
which unit costs will be allocated to cost of goods sold and which will be allocated to
ending inventory.
• There are three cost formulas: (1) specific identification, (2) weighted-average, and (3)
first-in, first-out.
• If a company’s goods are not interchangeable (in other words, the goods are unique
and each item can be identified), then the specific identification cost formula must be
used. If the goods are interchangeable, then the company can use either weighted-
average or first-in, first-out.
• The same cost formula must be used for all inventories of a similar nature or use, but
different cost formulas can be selected for inventories with a different nature or use.
• Specific identification assigns the specific costs of each item to either cost of goods
sold or ending inventory depending upon whether it has been sold or remains on hand.
• Under the weighted-average cost formula, a weighted-average cost per unit is
determined each time additional goods are purchased. This is used to assign costs
when goods are sold or when the value of ending inventory is determined.
• When the first-in, first-out formula is used, the costs of the first units purchased are
assigned to the first units sold. Ending inventory is valued using the costs of the most
recent purchases.
5. Explain the value at which inventory is carried on the statement of financial

position.
• Inventory is carried on the statement of financial position at the lower of cost and net
realizable value. Net realizable value is equal to selling price less the estimated costs to
make the sale.
• This ensures that inventory is being carried at a value that reflects the economic
benefits expected to flow from it.
• When the carrying amount of inventory is reduced to net realizable value, it is referred
to as an inventory writedown.
6. Explain how a company’s gross margin is determined and why it is an

important measure.
• Gross margin is equal to sales revenue less cost of goods sold. It is often expressed as
a percentage of sales revenue.
• It represents the portion of sales revenue, after product costs, available to meet
operating expenses and income taxes.
• Gross margin is commonly used to assess a company’s performance in terms of its
pricing strategies and controlling its product costs either period-to-period or relative to its
competitors.
7. Describe management’s responsibility for internal control measures related to

inventory.
• The five key elements of internal control are applied to inventory. These are:
• physical controls—use of locks, inventory behind counters, use of electronic alarm tags
Inventory 7-5
• assignment of responsibility—specific employees are responsible for different types of

inventory
• separation of duties—ordering and receiving is done by different employees
• independent verification—use of independent count teams or external auditors
• documentation—use of purchase orders, receiving reports, and so on.
8. Calculate the inventory turnover ratio and the days to sell inventory ratio and
explain how they can be interpreted by users.
• The inventory turnover ratio is determined by dividing cost of goods sold by average
inventory. It is a measure of how fast inventory is sold or how long it is held before being
sold.
• The days to sell inventory ratio is calculated by dividing 365 days by the inventory
turnover ratio. It measures the number of days, on average, that it took a company to
sell through its inventory.
TRUE-FALSE STATEMENTS
1. Companies that make products are known as retailers.
2. The Finished Goods account collects all the costs incurred as a product is being
made.
3. Raw materials are all items required to make a product.
4. Once the manufacturing process is complete, the product is transferred from the
Work-in-Process account to Raw Materials account.
5. FOB means “For only Buyers”.
6. FOB shipping means the seller owns the inventory until it reaches the buyers premise.
7. Periodic inventory systems provide more relevant and timely information to managers
for decision making purposes than perpetual inventory systems do.
8. Perpetual inventory systems are incapable of identifying inventory shrinkage.
9. Perpetual inventory systems provide more timely information than periodic systems.
10. COGS is equal to the inventory purchased for a given time period.
11. The cost formula used by a firm must match the physical flow of units through the
firm.
12. Under the FIFO inventory formula, the cost of ending inventory and cost of goods
sold will be the same under both the perpetual and periodic inventory systems.
13. If prices were rising and a Canadian company wanted to report a smaller amount of
profit for tax purposes, they should use the weighted-average cost formula.
14. The LCM rule is usually applied to groups of similar items.
Inventory 7-7
15. Gross margin is the difference between sales revenue and costs of goods available
for sale.
16. The gross margin ratio is equal to gross margin divided by sales revenue.
17. Just-in-time inventory systems are designed to reduce the cost of inventory storage
and increase the amount of cash on hand.
18. The inventory turnover ratio is calculated as cost of goods sold divided by total
inventory.
19. One way to estimate the cost of goods sold is to multiply the sales revenue for the
period by the inventory turnover ratio.
20. If a company’s inventory turnover ratio is 6.6, it takes them on average 55 days to
sell their inventory.
21. The cost to sales ratio is a method used to estimate inventory instead of performing
a physical count.
*22. When we calculate weighted-average using the periodic system, we recalculate a

new weighted-average cost per unit after every sale.
*23. The major difference between the periodic and perpetual inventory systems is that
inventory must be physically counted in the periodic system to determine ending
inventory.
ANSWERS TO TRUE-FALSE STATEMENTS

Item Ans. Item Ans. Item Ans.
1. F 9. T 17. T
2. F 10. F 18. F
3. T 11. F 19. F
4. F 12. T 20. T
5. F 13. T 21. T
6. F 14. T *22. F
7. F 15. F *23. T
8. T 16. T
Inventory 7-9
MULTIPLE CHOICE QUESTIONS
24. The longer the inventory remains unsold, the higher the risk of
a) spoilage.
b) damage.
c) obsolescence.
d) all of the above.
25. All of the following are manufacturing accounts EXCEPT for

a) Cost of goods Available for sale.
b) Raw Materials.
c) Finished Goods.
d) Work-in-Process.
26. Which of the following is the correct flow of costs in a manufacturing operation?
a) Raw materials to finished goods
b) Raw materials to finished goods to work-in-process
c) Raw materials to work-in-process to finished goods
d) Direct materials to work-in-process to finished goods.
27. Which of the following is NOT an inventory account in a manufacturing company?

a)Raw Material
b)Work-in-Process
c) Goods Available For Sale
d) Finished Goods
28. In a manufacturing process overhead costs are added to which inventory account?
a) Raw Materials
b) Finished Goods
c) Work-in-Process
d) Cost of Goods Sold
29. The buyer is responsible for paying shipping and other costs incurred while goods
are in transit from the sellers premise to buyers premises.
a) FOB shipping
b) FOB destination
c) FOB purchasing
d) FOB receiving
30. When a perpetual inventory system is used,

a) a physical inventory count must be taken to determine cost of goods sold.
b) inventory shrinkage is difficult to determine.
c) it eliminates the need for frequent inventory counts.
7 - 10 Test Bank for Understanding Financial Accounting, Canadian Edition
d) the timeliness of data is sacrificed for lower costs of operation.
31. When a periodic inventory system is used

a) inventory shrinkage is impossible to calculate.
b) timely data is of utmost importance.
c) cost of goods sold is always known.
d) every inventory transaction is reflected in the inventory account.
32. Which of the following would most likely use a perpetual inventory system?
a) hardware store
b) shoe store
c) car dealership
d) bookstore
33. Which of the following would most likely use a periodic inventory system?
a) car dealership
b) heavy metal distributor
c) computer dealership
d) local handcrafted furniture store
34. The following amounts are always known under which inventory costing system?
Current inventory Cost of goods sold Inventory shrinkage
a) Periodic Periodic Perpetual
b) Perpetual Perpetual Periodic
c) Perpetual Perpetual Perpetual
d) Periodic Periodic Periodic
35. Which of the following is true under a periodic system?

a) A COGS expense is recognized each time a sale is made.
b) The inventory account is not updated with each purchase.
c) Inventory shrinkage is easily identified.
d) This system can be costly to implement.
36. When a company is evaluating whether or not to use a perpetual vs. a periodic
inventory system the following statement is most accurate.
a) A perpetual inventory system provides far superior information and should be used at
any cost.
b) A periodic system is inferior and should never be used if possible.
c) The cost of the system used should be measured against the benefits it provides.
d) Both systems are equally good.
37. Which of the following should be included in the cost of inventory?

a) the cost of keeping the inventory records
b) depreciation on the inventory warehouse
Inventory 7 - 11
c) the salesperson’s commission.

d) receiving and inspection costs
38. Which of the following cost formulas would be most appropriate when the inventory
units are unique or costly?
a) FIFO
b) specific identification
c) just-in-time
d) weighted-average
39. Which of the following would be most likely to use the specific identification method?
a) shoe store
b) car dealership
c) grocery store
d) bookstore
40. Which cost formula will produce the same results under both the periodic and
perpetual inventory systems?
a) FIFO
b) weighted-average
c) They both produce the same results.
d) They both produce different results.
41. Which of the following cost formulas would be most appropriate for costing an
inventory of liquids stored in tanks?
a) weighted-average
b) FIFO
c) periodic
d) perpetual
42. An inventory of grocery items where the shelves are stocked from the back would be
similar to which cost formula?
a) FIFO
b) specific identification
c) weighted-average
d) none of the above
43. Which of the following statements about the FIFO cost formula is true?
a) The same costs per unit are assigned to the ending inventory and the cost of goods
sold.
b) Companies prefer to use FIFO because it lowers their tax liability.
c) In times of rising prices FIFO will produce a higher net income than weighted-average.
d) In time of rising prices FIFO produces an inventory cost per unit that is lower than the
cost per unit of cost of goods sold.
44. Use of the FIFO cost formula means that

a) the perpetual costing system is used.
b) the ending inventory contains the oldest costs.
c) the periodic costing system is used.
d) the ending inventory contains the most recent costs.
45. Which of the following statements about the weighted-average cost formula is true?
a) If prices are rising, companies prefer it because it lowers their tax liability.
b) It is the most popular method in Canada.
c) In times of rising prices, weighted-average will produce a higher net income than
FIFO.
d) In time of rising prices, weighted-average produces an inventory cost per unit that is
higher than the cost per unit of cost of goods sold.
Use the following information for questions 46–48.
Birken Bark Industries had the following activity with one of its inventory items during the
current period:
Units Unit Cost
Beginning inventory 30 $8.00
Purchase October 5 80 10.50
Sale October 11 (40)
Purchase October 17 60 12.00
Sale October 26 (70)
46. Using a perpetual inventory system and the FIFO cost formula, the ending inventory
was valued at
a) $500.
b) $625.
c) $720.
d) $825.
47. Using a perpetual inventory system and the FIFO cost formula, the cost of goods
sold was
a) $975.
b) $1,080.
c) $1,175.
d) $1,300.
48. Using a perpetual inventory system and the weighted-average cost formula, the cost
of goods sold for the October 11 sale was closest to
a) $540.
b) $420.
c) $393.
d) $370.
Inventory 7 - 13
A company had the following inventory activity during January:
Units Unit Cost Total Cost

Beginning inventory 800 $10.00 $ 8,000
Purchase: January 5 1,400 11.00 15,400
Sale: January 8 (1,500)
Purchase: January 13 900 10.50 9,450
Sales: January 24 (900)
49. If the company is using a perpetual system and the FIFO cost formula, what is the
ending inventory closest to?
a) $7,100
b) $7,350
c) $7,650
d) $7,920
50. If the company is using a perpetual system and the FIFO cost formula, what is the
cost of goods sold closest to?
a) $25,700
b) $25,500
c) $25,200
d) $25,930
51. If the company is using a perpetual system and the weighted-average cost formula,
what is the ending inventory closest to?
a) $8,470
b) $7,777
c) $7,560
d) $7,391
52. If the company is using a perpetual system and the weighted-average cost formula,
what is the cost of goods sold closest to?
a) $24,380
b) $24,840
c) $25,459
d) $25,631
53. Net realizable value is also known as the

a) replacement cost.
b) wholesale price.
c) estimated selling price.
d) liquidated price.
54. Which of the following statements best describes net realizable value when applying
the LCM rule?
a) Net realizable value is the selling price less the costs necessary to sell the item.
b) Net realizable value is the selling price plus the costs necessary to sell the item.
c) Net realizable value is the selling price plus the normal profit margin.
d) Net realizable value is the selling price less the normal profit margin.
55. Tamarack Co. prepares its estimate of LCM using the net realizable value. Inventory
item 101 cost $45 and its current replacement cost is $50. The item is currently selling in
the market for $55 and selling costs are estimated to be $6. Tamarack expects to earn a
profit of $4 on the sale of this item. In its year-end financial statements, Tamarack Co.
should value this item at
a) $50.
b) $45.
c) $49.
d) $55.
56. When using the LCM rule in Canada, the market value is most commonly
a) net present value.
b) selling price less profit margin.
c) replacement cost.
d) net realizable value.
57. The inventory writedown that results from the application of the LCM rule is often
hidden in the
a) selling expense.
b) inventory account.
c) cost of goods sold.
d) loss due to market decline of inventory.
58. The inventory writedown incurred from applying the LCM rule to inventory is
a) not reflected on the Statement of Financial Position.
b) an adjustment to cost of goods sold.
c) not reflected on the Statement of Income.
d) not considered a permanent loss.
Use the following information to answer questions 59–60.
Hannibal Inc. values its inventory on an LCM basis. The following data came from the
2017 inventory, which consisted of two items:
Item # 130 Item # 140

Original cost $12,000 $15,000
Selling price 15,000 26,000
Inventory 7 - 15
Estimated selling costs 5,000 10,000

Replacement cost 13,000 15,000
Normal profit margin 1,500 1,000
59. The appropriate carrying value for the entire inventory when applying the LCM rule
using net realizable value on an item-by-item basis would be
a) $25,000.
b) $26,000.
c) $27,000.
d) $28,000.
60. The appropriate carrying value for the entire inventory when applying the LCM rule
using net realizable value to the inventory as a whole would be
a) $25,000.
b) $26,000.
c) $27,000.
d) $28,000.
61. When applying the LCM, the following is true:

a) The inventory account remains at its original value.
b) A contra account to inventory is used.
c) COGS rises when ending inventory is reduced to market value.
d) LCM can only be applied to individual items.
A company had the following inventory activity during May:
Units Unit Cost Total Cost Unit Price

Purchase: May 3 900 $21.00 18,900
Sale: May 5 (900) $30.00
Purchase: May 15 1,000 $21.00 21,000
Sale: May 28 (900) $30.00
62. If the company uses a perpetual system and the FIFO cost formula, what is the
gross margin on the May 5 sale closest to?
a) $6,100
b) $8,100
c) $8,200
d) $8,550
63. If the company uses a perpetual system and the weighted-average cost formula,
what is the gross margin on the May 5 sale closest to?
a) $6,100
b) $8,100
c) $8,190
d) $8,550
64. If the company uses a perpetual system and the FIFO cost formula, what is the
gross margin for the month closest to?
a) $12,100
b) $16,200
c) $16,300
d) $17.100
65. Effective inventory management would have one person place the order for new
inventory, a second person check it against the purchase order when it arrives and a
third person record the receipt of inventory in the accounting records. The purpose of
this system is
a) to reduce spoilage.
b) to reduce storage costs.
c)to guard against stock-outs.
d) to guard against internal theft and collusion.
66. Cullen Company has a normal markup of 40%. Its cost-to-sales ratio is
a) 71.4%.
b) 67.5%.
c) 60%.
d) Cannot be calculated.
67. Grey Industries. had beginning inventory of $10,000 and purchased $75,000 during
2017. The company had sales of $90,000 and has traditionally had a cost-to-sales ratio
of 75%. Using the gross margin estimation method, the company estimates its ending
inventory to be
a) $67,500.
b) $65,000.
c) $17,500.
d) $22,500.
68. Best Beauties Ltd. had a fire at its warehouse and was trying to determine the cost of
the inventory lost. For the year to date, sales had been $525,000, opening inventory was
$25,000, purchases to date were $198,000, the cost-to-sales ratio is normally 60%.
Inventory not damaged in the fire was $18,000. What was the cost of the inventory
damaged in the fire?
a) $110,000
b) $124,000
c) $160,000
d) $74,000
Inventory 7 - 17
69. In 2017 Borger Inc. had beginning inventory of $106,000, purchases of $1,126,500,
ending inventory of $116,000, accounts payable of $49,605, and sales of $2,147,250.
Inventory turnover for 2017 was closest to
a) 9.625.
b) 10.06.
c) 10.15.
d) 10.53.
70. The gross margin estimation method estimates the cost of goods sold by
a) multiplying the sales revenue by cost to sales ratio.
b) multiplying the cost of goods available by the gross margin percentage.
c) multiplying the costs to sales ratio by purchases.
d) multiplying the sales revenue by the inventory turnover ratio.
Use the following information for questions *71-*74.
A company had the following inventory activity during June:

Purchases:
June 5 1,500 10.00 15,000
June 13 900 10.25 9,225
Sales:
June 8 1,100
June 24 600
*71. If the company is using a FIFO cost formula and a periodic system, what is the cost
of goods sold closest to?
a) $17,225
b) $17,000
c) $16,775
d) $16,500
*72. If the company is using a FIFO cost formula and a periodic system, what is the
ending inventory closest to?
a) $11,275
b) $11,500
c) $11,725
d) $12,000
*73. If the company is using a weighted-average cost formula and a periodic system,
what is the cost of goods sold closest to?
a) $17,085
b) $17,000
c) $16,915
d) $16,575
*74. If the company is using a weighted-average cost formula and a periodic system,
what is the ending inventory closest to?
a) $11,925
b) $11,415
c) $11,500
d) $11,585
Inventory 7 - 19
ANSWERS TO MULTIPLE CHOICE QUESTIONS

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
24. d 33. d 42. a 51. d 60. b 69. b
25. a 34. c 43. c 52. c 61. c 70. a
26. c 35. b 44. d 53. c 62. c *71. c
27. c 36. c 45. a 54. a 63. c *72. c
28. c 37. d 46. c 55. b 64. c *73. b
29. a 38. b 47. b 56. d 65. d *74. c
30. c 39. b 48. c 57. c 66. a
31. a 40. a 49. b 58. b 67. c
32. c 41. a 50. b 59. a 68. a
EXERCISES
75. Kaytana Inc. uses a perpetual inventory system and had the following activity for a
single inventory item:
May 1, inventory 140 $2.50 $350
Purchases:
May 5 200 3.50 700
May 10 140 4.50 630
May 15 160 5.50 880
Sales:
May 11 250
May 19 150
Instructions
Using the perpetual system, determine the ending inventory and cost of goods sold
under:
a) FIFO
b) Weighted-average (round unit cost to nearest cent)
Solution (10 min.)

a) FIFO:
May 11 sale = (140 × $2.50 + 110 × $3.50)
= 350 + 385 = $735
May 19 sale = (90 × $3.50 + 60 × $4.50)
= (315 + 270) = $585
Total cost of sales = $735 + $585 = $1,320
Ending inventory: 160 × $5.50 + 80 × $4.50 = $1,240

or $2,560 – $1,320 = $1,240
b) Weighted-average:
May 11 sale average cost = (140 × $2.50 + 200 × $3.50 + 140 × $4.50) ÷ 480
= $3.50 per unit
Cost of sale = 250 × $3.50 = $875
May 15 sale average cost = (230 × $3.50 + 160 × $5.50) ÷ 390
= $4.32 per unit
Cost of sale = 150 × $4.32 = $648
Total cost of goods sold = $875 + $648 = $1,523
Ending Inventory: 240 × $4.32 = $1,037

or $2,560 – $1,523 = $1,037
76. Nemi Inc. distributes electronic components and has just completed their first year of
operation. Management is looking forward to finding out what the profit for the year was
because they get paid a bonus based on net income. The accountant has provided them
with the following information concerning their inventory for the year:
Inventory 7 - 21
Sales: 8,000 units Total revenue: ................. $172,000

Purchases: 10,000 units Total cost: ....................... $190,000
Ending inventory under weighted- average:................ $ 36,667
Ending inventory under FIFO: ................................. $ 36,000
Due to over-supply in the industry at year-end, the price for the product had fallen to $20
and the company estimates that the costs to ship and sell the product are $2.50 per unit.
Instructions
a) Calculate the gross margin if Nemi decides to use the weighted-average cost
formula.
b) Calculate the gross margin if Nemi decides to use the FIFO cost formula.
c) Based on your answers to a) and b) which cost formula would management prefer?
Why?
d) Have prices for the inventory been rising or falling during the year?
e) What is the net realizable value of the inventory?
f) What value should Nemi report on its financial statements for cost of goods sold and
ending inventory? Support your answer.
Solution (15 min.)

Cost of goods sold = Purchases – ending inventory (there is no opening inventory in the
first year of operation)
a) Sales .......................................................................... $172,000

Cost of goods sold (190,000 – 36,667) ....................... 153,333
Gross margin .............................................................. $18,667
b) Sales .......................................................................... $172,000

Cost of goods sold (190,000 – 36,000) ....................... 154,000
Gross margin .............................................................. $18,000
c) Management would prefer weighted-average in order to maximize the net income

and hence their bonuses.
d) Prices have been falling. If prices were rising the ending inventory for FIFO would
be the larger than for weighted-average and the gross margin would be smaller for
weighted-average.
e) Net realizable value = $20.00 – $2.50 = $17.50
f) Average unit cost; weighted-average ending inventory: $36,667/2,000 = $18.33

Average unit cost; FIFO ending inventory: $36,000/2,000 = $18.00
Because the NRV is lower than the average costs for either FIFO or weighted-
average the ending inventory should be valued at NRV: $17.50 x 2,000 = $35,000
Costs of goods sold would be: purchases – ending inventory:

$190,000 – $35,000 = $155,000.
Note: it does not matter which cost formula is selected. Some students may use the cost
of goods sold they calculated in part (a) or (b) and then add the loss on the decline in
value of inventory to that.
Cost of goods sold (weighted-average) ...................... $153,333
Loss on inventory 2,000 x (18.33 – 17.50) .................. 1,660
Total cost of goods sold:............................................. $154,993
(the $7 difference is due to rounding)
77. Emmett Inc. uses a perpetual inventory system and had the following activity for a
January 1, inventory 500 $2.50 $1,250
Purchases:
January 5 250 3.50 875
January 10 175 4.50 787.50
January 15 100 5.50 550
Sales:
January 11 550
January 19 375
Instructions
Using the perpetual system, determine the ending inventory and cost of goods sold
under:
a) FIFO
Solution (10 min.)

a) FIFO:
January 11 sale = (500 × $2.50 + 50 × $3.50) = $1,425
January 19 sale = (200 × $3.50 + 175 × $4.50) = $1,487.50
Total cost of sales = 2,912.50
Ending inventory: 100 × $5.50 = $550

or $3,462.5 – 2,912.50 = $550
b) Weighted-average:
January 11 sale average cost = (500 × $2.50 + 250 × $3.50 + 175 × $4.50)/ 925
= $3.15 per unit
Cost of sale = 550 × $3.15 = $1,732.50
January 19 sale average cost = (375 × $3.15 + 100 × $5.50) / 475

= $3.64 per unit
Cost of sale = 375 × $3.64 = $1,366
Total cost of goods sold = $1,732.50 + $1,366 = $3,098.50
Ending Inventory: 100 × $3.64 = $364
Inventory 7 - 23
78. The following information is available for Devon Ltd.:

Sales ................................................................................. $595,000
Sales returns and allowances............................................ 20,000
Freight in ........................................................................... 5,000
Purchases ......................................................................... 462,000
Operating expenses .......................................................... 82,000
Interest expense................................................................ 20,000
Income tax expense .......................................................... 25,000
Inventory, January 1, 2016 ................................................ 40,000
Inventory, December 31, 2016 .......................................... 65,000
Instructions
Use the above information to calculate the cost of goods available for sale and cost of
goods sold for Devon Ltd.
Solution (5 min.)
Beginning Inventory........................................................... $ 40,000
+ purchases ...................................................................... 462,000
+ Freight in ........................................................................ 5,000
= Cost of Goods Available for Sale .................................... 507,000
– Ending Inventory ............................................................ (65,000)
COGS ............................................................................... $442,000
79. Brilliant Boats Ltd. uses the gross margin method to calculate the cost of its ending
inventory. In 2017, the company had beginning inventory of $475,000 and purchases of
$3,750,000. The company has traditionally marked up its inventory 45% and in 2017 had
sales of $5,250,000.
Instructions
Calculate Brilliant Boats Ltd.’s ending inventory for 2017.
Solution (5 min.)
Cost-to-sales ratio for 45% markup is 69%, i.e., an item that costs $60 will sell for $87
(60 ÷ 87 = 69%)
Sales × cost-to-sales ratio = cost of goods sold
$5,250,000 × 69% = $3,622,500
Ending inventory = Beginning inventory + Purchases – Cost of Goods Sold

= $475,000 + $3,750,000 – $3,622,500
= $602,500
*80. Matteo Co. uses a periodic inventory system and had the following activity for a
May 1, inventory 140 $2.50 $ 350

Purchases:
May 5 200 3.50 700
May 10 140 4.50 630
May 15 160 5.50 880
Sales:
May 11 250
May 19 150
Instructions
Determine the ending inventory and cost of goods sold using:
a) FIFO
b) Weighted average (round unit cost to nearest cent)
Solution (8 min.)
a) Units in ending inventory = Goods available – sales
= 640 – 400 = 240 units
Ending inventory = (160 × $5.50) + (80 × $4.50) = $1,240
C.G.S. = Cost of goods available – ending inventory
= $2,560 – $1,240 = $1,320
b) Units Unit Cost Total Cost

Beginning inventory 140 $2.50 $ 350
Purchases:
May 5 200 3.50 700
May 10 140 4.50 630
May 15 160 5.50 880
Total 640 $2,560
Cost per unit = $2,560 ÷ 640 units = $4.00
Ending inventory = 240 units × $4.00 = $960
C.G.S. = $2,560 – $960 = $1,600
*81. Jungle Jamboree Inc. uses a periodic inventory system and had the following
activity for a single inventory item:
August 1, inventory 500 $2.50 $1,250
Purchases:
August 5 250 3.50 875
August 10 175 4.50 787.50
August 15 100 5.50 550
Sales:
August 11 550
August 19 375
Instructions
Determine the ending inventory and cost of goods sold using:
a) FIFO
Inventory 7 - 25
Solution (8 min.)
a) Units in ending inventory = Goods available – sales
= 1,025 – 925 = 100 units
Ending inventory = (100 × $5.50) = $550
C.G.S. = Cost of goods available – ending inventory
= $3,462.5 – $550 = $2,912.50
b) Cost per unit = $3,462.50 / 1025 units = $3.38

Ending inventory = 100 units × $3.38 = $338
C.G.S. = $3,462.5 – $338 = $3,124.50
MATCHING
82. Listed below are characteristics relating to inventory costing systems. Place a check
mark under the appropriate column that matches the characteristic to the inventory
system.
Periodic Perpetual
Systems Systems
a) Cost of goods sold is calculated at the end of
each accounting period. ______ ______
b) Inventory shrinkage can be determined. ______ ______
c) A physical inventory count must be taken to

determine ending inventory. ______ ______
d) Provides more timely data. ______ ______
e) Involves a more costly bookkeeping system. ______ ______
f) Merchandise inventory account only reflects

the beginning inventory balance during the
accounting period. ______ ______
g) The cost of an item sold may not be known

at the time of sale. ______ ______
h) Uses the physical inventory count at year end

to verify the balance of the inventory count. ______ ______
i) Every transaction involving inventory results

in an entry to the inventory account. ______ ______
j) Does not record a reduction in inventory

every time a sale is made ______ ______
k) Can be very expensive to maintain. ______ ______
l) Continuously updated inventory units. ______ ______
Inventory 7 - 27
Solution (5 min.)
Periodic Perpetual
Systems Systems
a) X
b) X
c) X
d) X
e) X
f) X
g) X
h) X
i) X
j) X
k) X
l) X
83. Listed below are the various inventory cost formulas, followed by a series of
descriptive statements. Match the inventory cost formulas to the descriptive statements
by placing the appropriate letter in the space provided.
INVENTORY COST FORMULAS

A. Specific identification
B. Weighted-average
C. FIFO
D. None of these
STATEMENTS
____ 1. Includes the oldest costs in cost of goods sold.
____ 2. Cost of goods sold and ending inventory are based on the same unit cost.
____ 3. Cost of goods sold and ending inventory are based on the most recent
costs.
____ 4. Physical units are unique and the accounting records identify each unit and
its cost.
____ 5. Results in the highest net income in a period of rising costs.
____ 6. Unit cost is recalculated after each purchase.
____ 7. Ending inventory consists of the most recent costs.
____ 8. Calculates a new unit cost after each sale.
____ 9. Can be used to manipulate income by the choice of units sold.
Solution (5 min.)
1. C
2. B
3. D
4. A
5. C
6. B
7. C
8. D
9. A
Inventory 7 - 29
SHORT ANSWER ESSAY QUESTIONS
84. Compare and contrast a perpetual and a periodic inventory system. What factors
should a company take into consideration when deciding which system to use?
Solution (10 min.)

Perpetual Systems:
• can be either a physical or cost inventory system
• inventory units and costs are updated on a continuous basis
• information is up to date, timely and can provide a trigger for ordering
• helps to identify inventory shrinkage
• helps managers make better decisions
Periodic Systems:
• no adjustments are made to inventory when a sale is recorded, COGS are
calculated at the end of the period when inventory is counted
• it is impossible to identify shrinkage or theft – the COGS calculation assumes that all
items have been sold
• Inventory counts can be very expensive particularly when inventory levels are very
high
When choosing an inventory system a company should take into account the cost of
maintaining a system versus the benefits received from it.
85. Explain how the choice of inventory cost formula, FIFO or weighted-average, would
affect the analysis of a company’s financial statements by a potential user. Identify what
ratios are affected and how they are affected.
Solution (12 min.)

The choice of cost formula affects both the Statement of Financial Position and the
Statement of Income. The effect depends on if prices are rising or falling.
In periods of rising prices, weighted-average will have a lower net income and a lower
ending inventory figure then FIFO.
• Current ratio would be lower; company appears less liquid.
• Gross margin and profit margin are lower; company appears less profitable.
• Inventory turnover would be higher (CGS higher, inventory lower).
In periods of falling prices the opposite is true.
Note: Depending on the coverage by the instructor, other ratios, such as ROA may be
discussed and the fact that there is no effect on cash flow.
86. Prairie Fruit is a fruit distributor located in Sudbury, Ontario. The company has been
losing significant business over the past year and the manager has asked you to use the
following information to help identify any areas of concern.
Year Cost of goods sold Average inventory

2017 $6,200,000 $875,000
2016 $5,750,000 $520,000
Solution
The company’s inventory turnover has been falling:
2017: $6,200,000 ÷ $875,000 = 7.1 times or 51 days (365 days ÷ 7.1).
2016: $5,750,000 ÷ $520,000 = 11.1 times or 33 days (365 days ÷ 11.1)
Since Prairie Fruit is a fruit distributor, it would seem that the company is selling its
inventory much too slowly and it may be selling spoiled fruit to its customers (51 days is
a long time to stock fresh fruit). This may explain why the company is losing customers.
One suggestion is that the company should decrease the amount of inventory it is
carrying thereby speeding up its turnover and ensuring a fresher product for its
customers.
*87. McLaughlin Inc. began business in the current month. The bookkeeper received a
report from an outside firm specializing in physical inventory counts that the ending
inventory was $1,426.60. However, according to the bookkeeper's records, the inventory
at month end was $1,517.50. The bookkeeper has rechecked his records several times
and still comes up with the same amount. He believes that the difference between the
two amounts must be due to inventory shrinkage. The company had no inventory at the
beginning of the month and 70 units on hand per a physical inventory count at the end of
the month. The company uses the periodic method. Listed below are the company's
purchases for the month:
Purchase Units Unit Cost
1 40 $20.00
2 50 21.00
3 60 20.50
4 75 20.00
5 90 19.00
6 50 22.00
7 45 21.50
Instructions
Write an explanation for the bookkeeper on how the difference in amounts could occur.
Provide numerical support.
Solution (10 min.)

The difference is due to applying different inventory cost formulas to the 70 units in
ending inventory. The outside company used the weighted-average method and the
bookkeeper used the FIFO method.
Numerical support:
Weighted-average:
Cost per unit = $8,357.50 ÷ 410 units = $20.38/unit
Ending inventory = 70 units × $20.38 = $1,426.60
FIFO:
Inventory 7 - 31
Ending inventory = (45 × $21.50) + (25 × $22.00)

= $967.50 + $550.00 = $1,517.50
ESSAY QUESTIONS
88. A car dealership specializing in luxury vehicles most likely uses a perpetual inventory
system for inventory management.
Instructions
Why would the perpetual system be important for the manager of the car dealership?
Solution (10 min.)

A perpetual system provides more up-to-date information, which would be useful to the
manager. In a car dealership often final prices are negotiated at the time of sale. The
manager must have accurate information in order to ensure he does not sell the car
below its cost to the dealership. They must also have an up-to-date listing of what is in
inventory so they do not sell the same car twice.
89. Bertin’s Boutique Inc., a furniture store, uses a periodic inventory system. The
company president has heard that a perpetual inventory system would help him make
better decisions in the day-to-day management of his business. He has come to you, the
company accountant, for more information.
Instructions
Prepare a reply to the president that includes a brief description of the perpetual
inventory system. Identify three disadvantages and three advantages associated with
implementing such a system.
Solution (10 min.)

Perpetual inventory systems keep track of units or their associated costs, or both, on a
continual basis. This means that as soon as a unit is sold, it (or its cost) is immediately
removed from the inventory account. In this type of system, the ending inventory balance
and the cost of goods sold account are always up-to-date in terms of units or costs. The
information provided by this system is very useful in making day-to-day decisions
because the information is received on a timely basis.
Advantages:
a) Computer technology has come down in price, making the implementation of a
perpetual system a real possibility for most businesses.
b) May be able to implement an EDI system (electronic data interchange) where the
information concerning the level of inventory could be linked to suppliers such that
the system automatically reorders items when the level of inventory reaches a
predetermined level.
c) Can identify shrinkage due to theft or spoilage.
d) Main benefit is that it provides timely information. Management knows which items
are selling and how many they still have on hand. They can make informed
decisions about reordering, pricing, and other issues.
Disadvantages:
a) Costly to maintain
b) May only be useful to track units (not costs), especially if there are several identical
Inventory 7 - 33
items in inventory, which were purchased at different times and costs.

c) Must still conduct inventory counts to provide assurance that the system works
Test Bank for Understanding Financial Accounting Canadian Edition
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Note: E = Easy M = Medium H = Hard

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Note: TF = True-False Ex = Exercise SAE = Short-Answer Essay

CHAPTER LEARNING OBJECTIVES

1. Discuss the importance of inventory to a company’s overall success.

2. Distinguish between the different inventory classifications and determine which

3. Explain the differences between perpetual inventory systems and periodic

• The cost of inventory includes purchase price, non-refundable taxes, shipping or

5. Explain the value at which inventory is carried on the statement of financial

6. Explain how a company’s gross margin is determined and why it is an

7. Describe management’s responsibility for internal control measures related to

• assignment of responsibility—specific employees are responsible for different types of

1. Companies that make products are known as retailers.

3. Raw materials are all items required to make a product.

5. FOB means “For only Buyers”.

8. Perpetual inventory systems are incapable of identifying inventory shrinkage.

14. The LCM rule is usually applied to groups of similar items.

*22. When we calculate weighted-average using the periodic system, we recalculate a

ANSWERS TO TRUE-FALSE STATEMENTS

MULTIPLE CHOICE QUESTIONS

25. All of the following are manufacturing accounts EXCEPT for

27. Which of the following is NOT an inventory account in a manufacturing company?

30. When a perpetual inventory system is used,

d) the timeliness of data is sacrificed for lower costs of operation.

31. When a periodic inventory system is used

35. Which of the following is true under a periodic system?

37. Which of the following should be included in the cost of inventory?

c) the salesperson’s commission.

44. Use of the FIFO cost formula means that

Use the following information for questions 46–48.

Use the following information for questions 49–52.

A company had the following inventory activity during January:

Units Unit Cost Total Cost

53. Net realizable value is also known as the

Use the following information to answer questions 59–60.

Item # 130 Item # 140

Estimated selling costs 5,000 10,000

61. When applying the LCM, the following is true:

Use the following information for questions 62–64.

A company had the following inventory activity during May:

Units Unit Cost Total Cost Unit Price

Use the following information for questions *71-*74.

A company had the following inventory activity during June:

Units Unit Cost Total Cost

ANSWERS TO MULTIPLE CHOICE QUESTIONS

Solution (10 min.)

Ending inventory: 160 × $5.50 + 80 × $4.50 = $1,240

Ending Inventory: 240 × $4.32 = $1,037

Sales: 8,000 units Total revenue: ................. $172,000

Solution (15 min.)

a) Sales .......................................................................... $172,000

b) Sales .......................................................................... $172,000

c) Management would prefer weighted-average in order to maximize the net income

e) Net realizable value = $20.00 – $2.50 = $17.50

f) Average unit cost; weighted-average ending inventory: $36,667/2,000 = $18.33

Costs of goods sold would be: purchases – ending inventory:

Solution (10 min.)

January 19 sale = (200 × $3.50 + 175 × $4.50) = $1,487.50

Total cost of sales = 2,912.50

Use the following information for questions 71-74.

b) Inventory shrinkage can be determined.

d) Provides more timely data.

e) Involves a more costly bookkeeping system.

k) Can be very expensive to maintain.

l) Continuously updated inventory units.