Widget Inc. took a physical inventory count on December 31, Year 3.

The count
revealed an inventory amount of $435,875 before any of the following items were
recorded.

Inventory in the amount of $55,000 was purchased on December 27, Year 3. As of December 31,
Year 3, this inventory was in transit, FOB shipping point.
Inventory purchased by a customer on December 28, Year 3, was in transit as of December 31,
Year 3, FOB shipping point. The inventory had a cost to Widget of $35,000.
Inventory in the amount of $27,000 was held on consignment by another company.

What is the correct inventory amount reported on Widget Inc.'s December 31, Year 3,
balance sheet?

CalculatorTime Value Tables

A. $462,875
B. $517,875
C. $526,375
D. $553,375
Explanation

Choice "B" is correct. Given that the three listed transactions have not been included in
inventory, Widget must determine whether they should be. The inventory of $55,000
was purchased prior to the end-of-the-year FOB shipping point, and it should be added
to inventory. (The purchaser, Widget, pays the freight and so owns the inventory in
transit.) The inventory with a cost of $35,000 was sold prior to the end-of-the-year FOB
shipping point. It should not be included in Widget's inventory, but should be included by
the customer, who pays the freight. The $27,000 of inventory out on consignment
should be added to inventory. $435,875 + $55,000 + $27,000 = $517,875.

Choices "A", "C", and "D" are incorrect based on the above explanation.
A wholesaler using a perpetual inventory system sold and shipped goods FOB
Destination on December 31, costing $80,210. These goods are scheduled to reach
various retailers on January 3. At the end of the day on December 31, the merchandise
inventory account totaled $2,457,820 for the wholesaler before any adjusting entries.
This balance excludes the potential impacts of the following:

 The wholesaler is expecting a $75,330 incoming shipment that was sent on

December 30 (FOB Shipping Point) to arrive on January 2.
 Of the existing inventory, it was determined that $20,440 of the goods are
obsolete, cannot be sold, and have no scrap value.

What is the wholesaler’s true cost of inventory on December 31?

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A. $2,437,380
B. $2,512,710
C. $2,517,590
D. $2,592,920
Explanation

Choice "D" is correct. With a perpetual inventory system, the inventory record for each
item of inventory is updated for each purchase and sale as they occur. The actual cost
of goods sold is determined and recorded with each sale. Therefore, the perpetual
inventory system keeps a running total of inventory balances. Ending inventory under
the perpetual inventory system is still physically counted and costed and then compared
to the perpetual inventory balance. If the amount of ending inventory determined from
the physical count is less than the ending inventory amount shown in the ledger, the
difference is adjusted to an inventory shrinkage/spoilage account.

At the end of each accounting period, inventory should include all goods and materials
to which the company has legal title, even if the company does not have physical
possession of the goods. This may include outgoing inventory shipped to a customer
FOB destination, or incoming goods which have not yet been received but have been
shipped FOB shipping point. Additionally, goods are written down for obsolete material.

The true cost of inventory is equal to $2,592,920.

Merchandise inventory $2,457,820

Outgoing goods – FOB Destination 80,210
Incoming goods – FOB Shipping Point 75,330
Less: Obsolete inventory (20,440)
True cost of inventory $2,592,920
Nemo Diving Products, Inc. usually stores its product inventory in a special area within
its manufacturing facility. Due to a recent fire, all inventory this month was stored off site
at a cost of $3,000. Some inventory items are normally purchased from Switzerland.
This month's import duty was $2,000. This month's unreimbursable freight charges on
product sold were $4,000. Given the above three costs, what amount(s) are chargeable
to inventory verses chargeable to expense.

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Inventory Expense

A. $2,000 $7,000

B. $9,000 $0

C. $5,000 $4,000

D. $3,000 $6,000
Explanation

Choice "A" is correct. Import duty should be charged to inventory. The other two items
are expensed as incurred. The $3,000 warehousing cost is not chargeable to inventory
since it is not a "usual" cost. To be included in inventory, a cost must be usual,
necessary and make the item ready for sale. The $4,000 freight out charge is a selling
expense.

Choices "B", "C", and "D" are incorrect, per the above explanation.
During inflationary periods, compared to LIFO inventory accounting, FIFO inventory
accounting will generally show:

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A. Lower cost of goods sold and lower inventory value.
B. Lower cost of goods sold and higher inventory value.
C. Higher cost of goods sold and higher inventory value.
D. Higher cost of goods sold and lower inventory value.
Explanation

Choice "B" is correct. Under FIFO inventory accounting, the first costs inventoried are
the first costs transferred to cost of goods sold. Ending inventory includes the most
recently incurred costs; thus, the ending balance approximates replacement cost.

During inflationary periods, the FIFO method results in the highest ending inventory, the
lowest cost of goods sold, and the highest net income.

Choice "A" is incorrect. Under FIFO, ending inventory includes the most recently
incurred costs. During inflationary periods, the most recently incurred costs are higher
resulting in a higher inventory value.

Choice "C" is incorrect. Under FIFO, the first costs inventoried are the first costs
transferred to cost of goods sold. During inflationary periods, earlier costs are lower
when compared to more recent costs, which results in a lower cost of goods sold.

Choice "D" is incorrect. Under FIFO, the first costs inventoried are the first costs
transferred to cost of goods sold. During inflationary periods, earlier costs are lower
when compared to more recent costs resulting in lower cost of goods sold. In addition,
ending inventory includes the most recently incurred costs. During inflationary periods,
the most recently incurred costs are higher, resulting in a higher inventory value.
In periods of inflation, the use of the FIFO method for inventory costing instead of LIFO
will lead to:

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A. Better overall cash flow.
B. Lower current assets.
C. Higher gross profit margin.
D. Higher inventory turnover ratio.
Explanation

Choice “C” is correct. In a period of rising prices, FIFO results in the highest ending
inventory, the lowest cost of goods sold, and the highest net income (i.e., current costs
are not matched with current revenues). LIFO results in the lowest ending inventory and
the highest cost of goods sold, and the average method balances the fall between the
LIFO and FIFO balances.

In periods of inflation, FIFO results in the lowest cost of goods sold, which in turn leads
to a higher gross profit margin. (Gross profit margin is calculated as Gross profit / Net
sales. Gross profit is calculated as Net sales – Cost of goods sold. Therefore, a lower
cost of goods sold will result in a higher gross profit and a higher gross profit margin.)

Choice “A” is incorrect. Using the FIFO method will generally not result in better overall
cash flow as taxes will typically be higher.

Choice “B” is incorrect. During periods of inflation, using the FIFO method for inventory
costing results in the highest ending inventory, which is classified as a current asset.

Choice “D” is incorrect. Inventory turnover is calculated by dividing costs of goods sold
by the average inventory balance. In a period of inflation, FIFO results in the highest
ending inventory and the lowest cost of goods sold. Using FIFO will result in a lower
numerator and higher denominator, leading to a lower inventory turnover ratio.
With respect to a perpetual inventory system, which of the following is true when
inventory is sold?

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A. Inventory decreases and cost of goods sold decreases.
B. Inventory increases and cost of goods sold decreases.
C. Inventory decreases and cost of goods sold increases.
D. Inventory increases and cost of goods sold increases.
Explanation

Choice "C" is correct. The connection between the financial statements and the balance
sheet and income statement can be readily observed when inventory is sold, and the
perpetual inventory method is utilized by the organization. When acquired, inventory is
reported as an asset on the balance sheet until the inventory is later sold. Under the
perpetual inventory system cost, both the sale of inventory and any related revenue as
well as the cost of inventory items sold are accounted for at the time of the sale. The
inventory is removed from the balance sheet and the determined cost of inventory using
FIFO, LIFO, or moving average is reported as cost of goods sold on the income
statement.

When inventory is sold under the perpetual inventory system, two journal entries are
recorded to capture the sale. Cash/accounts receivable are recorded in conjunction with
the recognition of revenue as well as the cost of goods sold assigned to the inventory
sold and the reduction to the inventory balance as a result of the sale. This journal entry
removes the cost of the inventory from the balance sheet and places the cost onto the
income statement in the form of cost of goods sold. Therefore, this journal entry causes
inventory per balance sheet account to decrease and cost of goods sold per the income
statement to increase.

Choice "A" is incorrect. When inventory is sold, the inventory account decreases
because of the sale. The cost of goods sold account increases, not decreases, by the
same amount.

Choice "B" is incorrect. Sales of inventory will result in a decrease to the inventory
account, not an increase. Additionally, cost of goods sold is increased under the
perpetual method when inventory is sold to reflect the cost of inventory sold at the same
time the related revenue of the sale is recorded.

Choice "D" is incorrect. When inventory is sold, the inventory account decreases
because of the sale. The cost of goods sold reported on the income statement would
increase.
The inventory method that will produce the same ending inventory and cost of goods
sold regardless of use of perpetual inventory system or the periodic inventory system
would be:

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A. Periodic average cost
B. LIFO
C. FIFO
D. Perpetual weighted average
Explanation

Choice "C" is correct. The FIFO inventory valuation method assumes the first goods
purchased are the first goods sold. With respect to the determination of cost of goods
sold, the oldest inventory layers are always fully depleted before moving to the next
layer of inventory. Because the oldest inventory layer is always the first layer to transfer
to, and constitute, cost of goods sold, the perpetual inventory system and periodic
inventory system will always produce the same cost of goods sold and the same ending
inventory.

Choice "A" is incorrect. Periodic average cost will calculate the cost of goods sold and
ending inventory by calculating an average cost per unit: total purchases of inventory
divided by total number of units. This average is used to allocate cost between cost of
goods sold and ending inventory. This method is only used under a periodic inventory
system.

Choice "B" is incorrect. The LIFO inventory method assumes the most recently acquired
goods are the first ones sold. The periodic inventory system and the perpetual LIFO
inventory system will not produce the same cost of goods sold; the periodic inventory
system and the perpetual LIFO inventory system will not produce the same cost of
ending inventory. LIFO periodic will assume that the cost of ending inventory is from the
cost of oldest inventory layers held by the company, whereas LIFO perpetual might
result in a different cost of ending inventory.

Choice "D" is incorrect. The perpetual weighted average will calculate cost of goods
sold using a weighted average cost per unit of inventory held at the point of a sale. The
weighted average cost per unit is the inventory costs divided by units purchased. After
each purchase of inventory, a new average cost is calculated and used to allocate costs
between cost of goods sold and ending inventory for sales of goods. This method is
only used under a perpetual inventory system.
The Loyd Company had 150 units of product Omega on hand at December 1, Year 1,
costing $400 each. Purchases of product Omega during December were as follows:

Date Units Unit Cost

December 7 100 $440
December 14 200 $460
December 29 300 $500

Sales during December were 500 units. The cost of inventory at December 31, Year 1
under the FIFO method would be closest to:

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A. $100,000
B. $104,000
C. $115,000
D. $125,000
Explanation

Choice "D" is correct. Under the FIFO method, the first units purchased are the first
units sold. In this problem, there are 750 units available for sale (150 + 100 + 200 +
300) and 500 units sold, leaving 250 units of ending inventory. This ending inventory
must come from the last purchase of 300 units at $500/unit, so the cost of ending
inventory is 250 units × $500/unit = $125,000.

Choice "A" is incorrect. This answer incorrectly calculates the cost of ending inventory
using the $400/unit cost from the items in beginning inventory.

Choice "B" is incorrect. This is the cost of ending inventory using the LIFO method.
Under the LIFO method, the last units purchased are the first units sold. In this problem,
there are 750 units available for sale (150 + 100 + 200 + 300) and 500 units sold,
leaving 250 units of ending inventory. This ending inventory must come from the 150
units on hand at $400/unit plus first purchase of 100 units at $440/unit, so the cost of
ending inventory is (150 units × $400/unit) + (100 units × $440/unit) = $104,000.

Choice "C" is incorrect. This is the cost of ending inventory using the weighted average
method. Under the weighted average method, both the cost of goods sold and the cost
of ending inventory are determined using the weighted average cost per unit, calculated
as follows:

Cost of goods available for sale / Number of units available for sale = [(150 × $400) + (100
× $440) + (200 × $460) + (300 × $500)] / (150 + 100 + 200 + 300) = $346,000 / 750 = $461.33
Which one of the following statements reflects a disadvantage of the LIFO inventory
valuation method?

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A. It rarely approximates the physical flow of inventory.
B. Current costs are not matched to the current revenues.
C. It often can cause acceleration of income tax impacts.
D. It can negatively impact a company’s cash flow.
Explanation

Choice “A” is correct. Under LIFO, the last costs inventoried are the first costs
transferred to cost of goods sold. Ending inventory, therefore, includes the oldest costs.
The ending balance of inventory will

typically not approximate replacement cost.

LIFO does not generally approximate the physical flow of goods in a company because
most companies sell or use their oldest goods first to prevent holding old or obsolete
items. This is one disadvantage of using the LIFO inventory valuation method.

Choice “B” is incorrect. The use of the LIFO method generally better matches expense
against revenues because it matches current costs with current revenues.

Choice “C” is incorrect. Companies wishing to reduce taxable income may select the
LIFO method because of increased costs of goods sold recorded under this method in
periods of rising prices. In this way, income tax impacts are decelerated. This is an
advantage of the LIFO inventory valuation method.

Choice “D” is incorrect. Using LIFO results in lower taxes with rising prices. Lower taxes
result in better cash flow for the company.
Dawson Corp. uses the FIFO perpetual inventory system. During the first six months of
operations, Dawson made the following purchases and sales of inventory:

Purchases
January 1 40 units @ $110 each
February 15 60 units @ $115 each
June 4 75 units @ $125 each
Sales
February 1 25 units
March 15 40 units

What is cost of goods sold for Dawson Corp.?

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A. $7,350
B. $8,125
C. $7,275
D. $7,679
Explanation

Choice "C" is correct. Under FIFO, the first costs inventoried are the first costs
transferred to cost of goods sold. Ending inventory includes the most recently incurred
costs; therefore, the ending balance approximates replacement cost. Ending inventory
and cost of goods sold are the same regardless of the inventory system (periodic or
perpetual) used.

Dawson's sales of 65 units would be attributable to the oldest inventory layers first.

Sale
February 1 25 units × $110/unit = $2,750
Total COGS—Feb. 1 sale $2,750

March 15 15 units × $110/unit = $1,650

25 units × $115/unit = $2,875
Total COGS—March 15 sale $4,525

Total COGS for all sales $7,275

During a period of rising prices, which U.S. GAAP inventory method reports the most
current inventory costs on the income statement and on the balance sheet?

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Income Balance
Statement Sheet

A. LIFO LIFO

B. LIFO FIFO

C. FIFO LIFO

D. FIFO FIFO
Explanation

Choice "B" is correct. LIFO reports the most recent costs on the income statement, but
reports the lowest ending inventory on the balance sheet because ending inventory
includes the oldest costs. FIFO reports the most recent inventory costs in ending
inventory, but reports the oldest, lowest costs on the income statement.

Choices "A", "C", and "D" are incorrect, based on the information above.
The Loyd Company had 150 units of product Omega on hand at December 1, Year 1
costing $400 each. Purchases of product Omega during December were as follows:

Date Units Unit Cost

December 7 100 $440
December 14 200 $460
December 29 300 $500

Sales during December were 500 units. The cost of inventory at December 31, Year 1
under the weighted average method would be closest to:

CalculatorTime Value Tables

A. $100,000
B. $104,000
C. $115,000
D. $125,000
Explanation

Choice "C" is correct. Under the weighted average method, both the cost of goods sold
and the cost of ending inventory are determined using the weighted average cost per
unit, calculated as follows:

Cost of goods available for sale / Number of units available for sale = [(150 × $400) + (100 ×
$440) + (200 × $460) + (300 × $500)] / (150 + 100 + 200 + 300) = $346,000 / 750 = $461.33

In this problem, there are 750 units available for sale (150 + 100 + 200 + 300) and 500
units sold, leaving 250 units of ending inventory. Therefore, the cost of ending inventory
is $115,333 ($461.33 × 250), which is closest to $115,000.

Choice "A" is incorrect. This answer incorrectly calculates the cost of ending inventory
using the $400/unit cost from the items in beginning inventory.

Choice "B" is incorrect. This is the cost of ending inventory using the LIFO method.
Under the LIFO method, the last units purchased are the first units sold. In this problem,
there are 750 units available for sale (150 + 100 + 200 + 300) and 500 units sold,
leaving 250 units of ending inventory. This ending inventory must come from the 150
units on hand at $400/unit plus first purchase of 100 units at $440/unit, so the cost of
ending inventory is (150 units × $400/unit) + (100 units × $440/unit) = $104,000.

Choice "D" is incorrect. This is the cost of ending inventory using the FIFO method.
Under the FIFO method, the first units purchased are the first units sold. In this problem,
During a period of decreasing prices, cost of goods sold will be:

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A. Higher under LIFO than FIFO
B. Higher under average cost than FIFO
C. Lower under FIFO than LIFO
D. Lower under LIFO than average cost
Explanation

Choice "D" is correct. During a period of declining prices, the method of inventory
valuation will produce varying effects on the financial statements. When prices are
declining, the FIFO inventory method will produce the highest cost of goods sold; LIFO
will produce the lowest cost of goods sold; and average cost will remain in the middle of
the two.

Period of Falling Prices

FIFO LIFO Weighted Average
Income statement:
Highest Lowest Middle
Cost of goods sold
Income statement:
Lowest Highest Middle
Net income
Balance sheet:
Lowest Highest Middle
Inventory

Cost of goods sold will be lowest under the LIFO method of inventory when prices are
declining.

Choice "A" is incorrect. During a period of declining prices, LIFO will produce the lowest
cost of goods sold, and FIFO will produce the highest cost of goods sold.

Choice "B" is incorrect. During a period of declining prices, average cost will be lower
than FIFO but higher than LIFO.

Choice "C" is incorrect. During a period of declining prices, LIFO will produce the lowest
cost of goods sold, and FIFO will produce the highest cost of goods sold.
During inflationary periods, last in, first out inventory accounting will generally have a:

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A. Lower cost of goods sold and lower ending inventory value.
B. Lower cost of goods sold and higher ending inventory value.
C. Higher cost of goods sold and higher ending inventory value.
D. Higher cost of goods sold and lower ending inventory value.
Explanation

Choice "D" is correct. Last in, first out (LIFO) is an inventory accounting method that
records the most recently produced or most recently acquired items as being the first
items sold. Under LIFO the cost of the most recent products purchased (or produced)
are the first to be expensed as cost of goods sold (COGS), which means that during
inflationary periods the lower cost of previously produced or previously acquired
products will be reported in ending inventory.

During inflationary periods prices are rising; under LIFO the most recent items produced
and the most recently items acquired will show higher COGS and lower ending
inventory.

Choices "A", "B", and "C" are incorrect. During inflationary periods prices are rising;
LIFO will show higher COGS and lower ending inventory.
During January, Metro Co., which maintains a perpetual inventory system, recorded the
following information pertaining to its inventory:

Unit Total Units

Units Cost Cost on Hand
Balance on 1/1 1,000 $1 $1,000 1,000
Purchased on 1/7 600 3 1,800 1,600
Sold on 1/20 900 700
Purchased on 1/25 400 5 2,000 1,100

Using the LIFO method, what amount should Metro report as inventory at January 31?

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A. $1,300
B. $2,700
C. $3,900
D. $4,100
Explanation
Unit Total Inventory
Units Cost Cost Balance
Balance 1/1 1,000 $1.00 $1,000 $1,000
Purchased 1/7 600 3.00 1,800 2,800
Sold 1/20 (600) 3.00 (1,800) 1,000
Sold 1/20 (300) 1.00 (300) 700
Purchased 1/25 400 5.00 2,000 2,700

Choice "B" is correct, $2,700 LIFO inventory cost at January 31.

Dawson Corp. uses the LIFO perpetual inventory system. During the first six months of
operations, Dawson made the following purchases and sales of inventory:

Purchases
January 1 40 units @ $110 each
February 15 60 units @ $115 each
June 4 75 units @ $125 each
Sales
February 1 25 units
March 15 40 units

What is the cost of goods sold for Dawson Corp.?

CalculatorTime Value Tables

A. $7,350
B. $8,125
C. $7,275
D. $7,679
Explanation

Choice "A" is correct. Under LIFO, the most recent purchases are the first costs
transferred to cost of goods sold. Ending inventory, therefore, is comprised of the oldest
inventory costs. As a result, the ending balance of inventory on the balance sheet likely
does not approximate replacement cost.

Dawson's sales of inventory would be attributable to the most recently acquired

inventory.

Sale
February 1 25 units × $110/unit = $2,750
Total COGS—Feb. 1 sale $2,750

March 15 40 units × $115/unit = $4,600

Total COGS—March 15 sale $4,600

Total COGS for all sales $7,350

Justine Enterprises is attempting to value one of its product patents using the market
approach. The balance sheet value of this patent is $35.0 million but based on its
review of similar patent sale transactions, values of $32.5 million, $34.2 million, $36.6
million, and $39.3 million, respectively, were obtained. Assuming that the company uses
a market (median value) approach, what is the value recognized for the product patent?

CalculatorTime Value Tables

A. $32.5 million
B. $35.0 million
C. $35.4 million
D. $35.7 million
Explanation

Choice "C" is correct. Using the market approach and reviewing similar patent sales
transactions, the median market value is $35.4 million removing the $32.5-million and
$39.3-million outlier values.

Choice "A" is incorrect. This represents the lowest market value obtained for the patent
but is not consistent with the median value calculation.

Choice "B" is incorrect. This represents the historical cost basis of the patent and not
the market approach value.

Choice "D" is incorrect. This represents the mean of the patent market value
transactions and not the median.
Finer Foods Inc., a chain of supermarkets specializing in gourmet food, has
been using the average cost method to value its inventory. During the current
year, the company changed to the first-in, first-out method of inventory
valuation. The president of the company reasoned that this change was
appropriate because it would more closely match the flow of physical goods.
This change should be reported on the financial statements as a:

CalculatorTime Value Tables

A. Cumulative-effect type accounting change.
B. Retroactive-effect type accounting change.
C. Change in an accounting estimate.
D. Correction of an error.
Explanation

Choice "B" is correct. Changing the accounting treatment from a generally accepted
accounting (GAAP) method to another method that is also GAAP is a change in
accounting principle. Changes in accounting principles are treated retroactively by
adjusting the beginning balance of retained earnings. There are two exceptions to this
rule: 1) A change in depreciation method, and 2) and an inventory valuation change to
LIFO. The exceptions are treated prospectively.

This situation is a change in accounting principle (from average cost to FIFO) and
requires a retroactive adjustment to maintain consistency and comparability.

Choice "A" is incorrect. A change in accounting principle is treated retroactively. With

respect to the treatment of changes in accounting principles, there is no "cumulative-
effect type accounting change." Watch for trick choices that sound impressive but are
not actual accounting terms.

Choice "C" is incorrect. A change in accounting principle is treated retroactively. A

change in accounting estimate is when management decides to change an estimate or
component due to new facts or circumstances that did not exist when the original
estimate was made. A change from a GAAP inventory valuation method to another
(non-LIFO) GAAP inventory valuation method is a change in accounting principle.

Choice "D" is incorrect. Errors take place when management does not properly
implement generally accepted accounting principles. In this situation, management is
moving from one GAAP method to another (non-LIFO) GAAP method, which is a
change in accounting principle. Changes in accounting principle are treated
retroactively.
Simmons Inc. uses lower-of-cost-or-market to value its inventory that is accounted for
using the LIFO method. Data regarding an item in its inventory is as follows:

Cost 26
Replacement cost 20
Selling price 30
Cost of completion 2
Normal profit margin 7

What is the lower-of-cost-or-market for this item?

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A. $21
B. $20
C. $28
D. $26
Explanation

Choice "A" is correct. Under the lower of cost or market, market starts at the $20
replacement cost. It is then limited to a ceiling and a floor. The ceiling is the selling price
less cost of completion and/or selling. In this case, the selling price is $30, and the costs
of completion are $2; the ceiling is thus $28 ($30 − $2). No problem exists here because
the $20 replacement cost is already under the ceiling.

The floor is the ceiling less the normal profit margin. The ceiling is $28, and the normal
profit margin is $7; the floor is thus $21 ($28 − $7). Because the market cannot be lower
than the floor, it is $21. The lower of the cost ($26) and the market ($21) is $21.
Simmons, Inc. uses lower-of-cost-and-net-realizable-value to value its inventory that is
accounted for using FIFO. Data regarding an item in its inventory is as follows:

Cost 26
Replacement cost 20
Selling price 30
Cost of completion 2
Normal profit margin 7

What is the lower of cost or net realizable value for this item?

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A. $18
B. $26
C. $28
D. $30
Explanation

Choice "B" is correct. The cost of $26 is lower than the net realizable value (selling price
- costs to complete and sell) of $28 ($30 − $2).

Choice "A" is incorrect. Net realizable value is computed as selling price less costs to
sell and complete, not replacement cost less costs to sell and complete.

Choice "C" is incorrect. The cost of $26 is lower than the net realizable value (selling
price - costs to complete and sell) of $28 ($30 − $2).

Choice "D" is incorrect. Net realizable value is computed as selling price less costs to
sell and complete. Additionally, the cost of $26 is lower than the net realizable value
(selling price - costs to complete and sell) of $28 ($30 − $2
The original cost of an inventory item is below the net realizable value and above the
net realizable value less a normal profit margin. The inventory item's replacement cost
is below the net realizable value less a normal profit margin. Under the lower of cost or
market method, the inventory item should be valued at:

CalculatorTime Value Tables

A. Original cost.
B. Replacement cost.
C. Net realizable value.
D. Net realizable value less normal profit margin.
Explanation

Choice "D" is correct. Net realizable value less normal profit margin.

Approach:

List costs in descending sequence from highest to lowest and assign arbitrary dollar
values in descending sequence.

Then use "rule of thumb."

Lower of cost or market (take lower of two)

Rule of thumb:
Market (take middle of three)
Net realizable value (ceiling) .90
Net realizable value less normal profit margin (floor) .80
Replacement cost .70
Original cost .85
Lower of cost or market (take lower of two)
Which is net realizable value less normal profit margin .80

Choice "A" is incorrect. The inventory item would not have been valued at original cost
in this question because the calculated market value is lower.

Choice "B" is incorrect. The inventory item would not have been valued at replacement
cost in this question because the replacement cost was below the net realizable value
less a normal profit margin, which was the floor. Thus the floor would have been used
as market in the calculation.
Choice "C" is incorrect. The inventory item would not have been valued at the net
realizable value in this question. The replacement cost was below the floor, and net
realizable value was the ceiling.

Golden Corporation has collected the following information for its main product:

Cost $18.00
Replacement cost 17.00
Estimated cost to sell 5.00
Selling price 30.00

A profit margin of 25% is considered normal for the product. In determining the value of
its ending inventory, what unit value should Golden use under lower of cost and net
realizable value and lower of cost and market?

CalculatorTime Value Tables

Lower of Cost
and Net Realizable
Value Lower of Cost and Market

A. $25.00 $18.00

B. $25.00 $17.50

C. $18.00 $18.00

D. $18.00 $17.50
Explanation

Choice "D" is correct. Assuming ending inventory is valued at the lower of cost or net
realizable value:

Cost $18.00
Net realizable value $25.00 ($30.00 selling price - $5.00 cost to sell)

If ending inventory is valued at the lower of cost or market, where market value is the
middle value of replacement cost, net realizable value (marketing ceiling), and net
realizable value less normal profit margin (market floor):

Market:
Net realizable value $25.00
Based on a physical inventory taken on December 31, Chewy Co. determined its
chocolate inventory on a FIFO basis at $26,000 with a replacement cost of $20,000.
Chewy estimated that, after further processing costs of $12,000, the chocolate could be
sold as finished candy bars for $40,000. Chewy's normal profit margin is 10% of sales.
Under the lower of cost or net realizable value rule, what amount should Chewy report
as chocolate inventory in its December 31 balance sheet?

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A. $20,000
B. $24,000
C. $26,000
D. $28,000
Explanation

Choice "C" is correct. Net realizable value is computed as selling price less costs to
complete and sell:

Net realizable value = $40,000 - $12,000 = $28,000

The net realizable value of $28,000 is greater than the cost of $26,000, so the inventory
will be reported at the cost of $26,000.

Choice "A" is incorrect. Replacement cost is not used in inventory valuation under lower
of cost or net realizable value.

Choice "B" is incorrect. Net realizable value less normal profit margin is not used in
inventory valuation under lower of cost or net realizable value.

Choice "D" is incorrect. This is the net realizable value of the inventory. The net
realizable value of $28,000 is greater than the cost of $26,000, so the inventory will be
reported at the cost of $26,000.
At the end of the year, Ian Co. determined its inventory to be $258,000 on a FIFO (first-
in, first-out) basis. The current replacement cost of this inventory was $230,000. Ian
estimates that it could sell the inventory for $275,000 at a disposal cost of $14,000. If
Ian's normal profit margin for its inventory was $10,000, what would be its net carrying
value under lower of cost or net realizable value?

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A. $230,000
B. $251,000
C. $258,000
D. $261,000
Explanation

Choice "C" is correct. Net realizable value is the selling price less costs to complete and
sell:

Net realizable value = $275,000 - $14,000 = $261,000

Net realizable value is greater the inventory cost, so the inventory will be reported at the
cost of $258,000.

Choice "A" is incorrect. Current replacement cost is not used to value inventory under
lower of cost or net realizable value.

Choice "B" is incorrect. Net realizable value less normal profit margin is not used to
value inventory under lower of cost or net realizable value..

Choice "D" is incorrect. The net realizable value of $261,000 exceeds the cost of
$258,000, so the inventory will be reported at cost.
Based on a physical inventory taken on December 31, an entity determined its inventory
on a LIFO basis to be $70,000, with a replacement cost of $65,000. The entity
estimated that after further processing costs of $8,000, the completed inventory could
be sold for $75,000. The entity's normal profit margin is 30%. What amount should the
entity report as inventory in its December 31 balance sheet under the lower of cost or
market?

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A. $44,500
B. $65,000
C. $67,000
D. $70,000
Explanation

Choice "B" is correct. Under the lower of cost or market, market is the middle value of
replacement cost, the market ceiling (net realizable value), and the market floor (NRV -
normal profit):

Ceiling, net realizable value ($75,000 - 8,000) $67,000

Replacement cost 65,000
Floor, NRV less profit [$67,000 - (30% of $75,000)] 44,500

Therefore, the inventory will be reported at the market value (replacement cost) of
$65,000, which is lower than the cost of $70,000.

Choice "A" is incorrect. The inventory would not be reported at the market floor of
$44,500 because the market floor is less than replacement cost. Under lower of cost or
market method, market is the middle value of replacement cost, the market ceiling (net
realizable value), and the market floor (NRV - normal profit).

Choice "C" is incorrect. The inventory would not be reported at the market ceiling of
$67,000 because the market ceiling is greater than replacement cost. Under the lower
of cost or market, market is the middle value of replacement cost, the market ceiling
(net realizable value), and the market floor (NRV - normal profit).

Choice "D" is incorrect. The inventory would not be reported at the cost of $70,000
because cost exceeds the market value of $65,000.
Based on a physical inventory taken on December 31, an entity determined its inventory
on a FIFO basis to be $70,000, with a replacement cost of $65,000. The entity
estimated that after further processing costs of $8,000, the completed inventory could
be sold for $75,000. The entity's normal profit margin is 30%. What amount should the
entity report as inventory in its December 31 balance sheet under the lower of cost and
net realizable value?

CalculatorTime Value Tables

A. $67,000
B. $70,000
C. $75,000
D. $83,000
Explanation

Choice "A" is correct. Net realizable value is lower than cost, so the inventory will be
reported at the NRV of $67,000.

Net realizable value ($75,000 − 8,000) $67,000

Cost $70,000

Choice "B" is incorrect. The inventory would not be reported at cost because the cost of
$70,000 exceeds the net realizable value of $67,000.

Choice "C" is incorrect. Under the lower of cost and net realizable value, the inventory is
not reported at the selling price of $75,000.

Choice "D" is incorrect. Further processing costs are not added to the selling cost of
inventory to determine the reported inventory balance.
On December 31, Year 1, Johnson Corp. sold on account and shipped to Gibsen Co.
merchandise with a list price of $75,000. The terms of the sale were n/30. FOB shipping
point. The merchandise arrived at Gibsen on January 5, Year 2. Due to confusion about
the shipping terms, the sale was not recorded until January of Year 2, and the
merchandise, sold at a markup of 25 percent of cost, was included in Johnson's
inventory on December 31, Year 1. Johnson uses a perpetual inventory system. As a
result of the above, Johnson's income before income taxes for the year ended
December 31, Year 1, was:

CalculatorTime Value Tables

A. Understated by $15,000.
B. Understated by $18,750.
C. Understated by $75,000.
D. Overstated by $60,000.
Explanation

Choice “A” is correct. Issues surrounding title transfers related to sales of inventory
become important at the end of a reporting period. Inventory shipped FOB shipping
point results in the transfer of title to the customer at the time the goods are delivered to
the common carrier. When goods are shipped in this manner, the goods should be
included in the customer's inventory, not the seller's inventory, at the date of the FOB
shipment because the title has transferred on the FOB shipping date, and the
associated revenues should be recognized on the FOB shipping date.

The effect on income can be calculated by determining the cost of the goods sold and
by using the markup information provided.

Cost of goods sold times 1.25 (based on 25 percent markup) = List price of $75,000
COGS × 1.25 = $75,000
COGS = $60,000

Gross profit = List price – COGS

Gross profit = $75,000 – $60,000
Gross profit = $15,000

Johnson should have recorded $15,000 gross profit as of the FOB shipment date.

Choice “B” is incorrect. This answer incorrectly calculates the understatement of income
as 25 percent of the $75,000 list price.

Choice “C” is incorrect. This answer incorrectly uses the $75,000 list price as the
understatement of income but does not consider the $60,000 costs of goods sold. Both
the selling price and cost of goods sold are needed to determine the effect on income.
On December 31, Year 1, Acme Inc. shipped to Plaza Co. merchandise with a list price
of $90,000. The goods were sold on account with terms of net 30 days, FOB shipping
point. Due to an oversight, the sale was not recorded until January Year 2, and the
merchandise, which was sold at a 25 percent markup, was included in Acme's perpetual
inventory on December 31, Year 1. As a result, Acme's income before taxes for the year
ended December 31, Year 1, was understated by:

CalculatorTime Value Tables

A. $72,000.
B. $67,500.
C. $22,500.
D. $18,000.
Explanation

Choice “D” is correct. Issues surrounding title transfers related to sales of inventory
become important at the end of a reporting period. Inventory shipped FOB shipping
point results in the transfer of title to the customer at the time the goods are delivered to
the common carrier. When goods are shipped in this manner, the goods should be
included in the customer's inventory, not the seller's inventory, at the date of the FOB
shipment because the title has transferred on the FOB shipping date, and the
associated revenues should be recognized on the FOB shipping date.

The effect on income can be calculated by determining the cost of the goods sold and
by using the markup information provided.

Cost of goods sold times 1.25 (based on 25 percent markup) = List price of $90,000
COGS × 1.25 = $90,000
COGS = $72,000

Gross profit = List price – COGS

Gross profit = $90,000 – $72,000
Gross profit = $18,000
Acme should have recorded $18,000 gross profit as of the FOB shipment date.

Choice “A” is incorrect. This answer incorrectly uses the cost of goods sold to determine
the impact to income, but this answer does not consider the selling price of the goods.
Both the selling price and the cost of goods sold are needed to determine the impact to
income.

Choice “B” is incorrect. This answer incorrectly uses the selling price of $90,000 minus
$22,500, which is 25 percent of the $90,000 selling price.

Choice “C” is incorrect. This answer incorrectly calculates the understatement of income
by multiplying the $90,000 selling price by 25 percent.
The following inventory valuation errors have been discovered for Knox Corp.

 The Year 1 year-end inventory was overstated by $23,000.

 The Year 2 year-end inventory was understated by $61,000.
 The Year 3 year-end inventory was understated by $17,000.

The reported income before taxes for Knox was:

Year Income Before Taxes

1 $138,000
2 254,000
3 168,000

Reported income before taxes for Year 1, Year 2, and Year 3, respectively, should have
been:

CalculatorTime Value Tables

A. $115,000, $338,000, and $124,000.
B. $161,000, $338,000, and $90,000.
C. $115,000, $338,000, and $212,000.
D. $115,000, $170,000, and $124,000.
Explanation

Choice “A” is correct. Inventory errors involve the over- or understatement of ending
inventory. Typically, these errors are due to mistakes made during physical counts of
inventory and/or pricing extensions on inventory quantities. If errors are caught prior to
the end of the reporting period, a correction should be made to reflect correct current
year information. If material inventory errors are discovered in a period subsequent to
the year in which the error relates, the financial statements must be restated to reflect
appropriate amounts for cost of goods sold.

Overstatements in ending inventory result in understatement of cost of goods sold and

an overstatement of net income. In the immediately subsequent period beginning
inventory is overstated, which results in an overstatement of costs of goods sold and an
understatement of net income for that immediately subsequent period. Therefore, over a
two-year period, inventory errors correct themselves and do not require journal entries
to correct the retained earnings balance at the end of that two-year period.

Helpful hint: An error in ending inventory will have the opposite effect on cost of goods
sold; an error in beginning inventory will have the same effect on costs of goods sold.

Effects on income for each respective year can be determined as follows:

BGSE Inc. operates a large shoe-making factory. During the current year ending
finished goods inventory was overstated by $22,000. What effect will this have on the
income statement, and specifically cost of goods sold and net income during the current
year?

CalculatorTime Value Tables

Cost of Goods Sold Net Income
A. Overstated Overstated
B. Understated Overstated
C. Understated No effect
D. Overstated Understated
Explanation

Choice "B" is correct. Inventory errors include the overstatement of ending inventory or
the understatement of ending inventory due to a mistake in the physical count and/or a
mistake in pricing inventory. If management discovers the error during the year of the
error, management simply corrects inventory with the appropriate journal entry (debit or
credit inventory, and credit or debit cost of goods sold). When the inventory error is
discovered and corrected in the same reporting period, there are no financial statement
errors.

If the ending inventory for BGSE is overstated, then the cost of goods sold during the
year is understated (more cost is reflected on the balance sheet when that cost should
have been part of the cost of goods sold). If cost of goods sold is understated, the
reported income of the company is overstated.

Choice "A" is incorrect. If ending inventory is overstated, then the cost of goods sold is
understated, not overstated. Additionally, if cost of goods sold is overstated, then net
income will be understated. If cost of goods sold is understated, then net income will be
overstated. That is, when there is an inventory error, the impact on the cost of goods
sold and impact on net income always are opposite.

Choice "C" is incorrect. If ending inventory is overstated, then the cost of goods sold is
understated. However, if cost of goods sold is understated, net income is overstated.

Choice "D" is incorrect. If ending inventory is overstated, then the cost of goods sold is
understated, not overstated. If the cost of goods sold is understated, net income is
overstated, not understated.
BGSE Inc. operates a large shoe-making factory. During Year 1, the correct ending
finished goods inventory balance should be $57,000 but is incorrectly reported as
$63,000. As a result, Year 1 ending inventory is overstated by $6,000. In Year 2, ending
inventory was appropriately recorded. Which of the following is true related to Year 2?

CalculatorTime Value Tables

Year 2 Beginning Inventory Year 2 Cost of Goods Sold Year 2 Gross Profit
A
. Overstated by $6,000 Overstated by $6,000 Understated by $6,000
B
. Overstated by $6,000 Understated by $6,000 Overstated by $6,000
C
. Understated by $6,000 Understated by $6,000 No effect
D
. Understated by $6,000 Overstated by $6,000 Understated by $6,000
Explanation

Choice "A" is correct. Inventory errors include the overstatement of ending inventory or
the understatement of ending inventory due to a mistake in the physical count and/or a
mistake in pricing inventory. If management discovers the error during the year of the
error, management simply corrects inventory with the appropriate journal entry (debit or
credit inventory, and credit or debit cost of goods sold). When the inventory error is
discovered and corrected in the same reporting period, there are no financial statement
errors. If an error related to inventory goes undetected, the error will correct itself by the
end of the second year.

Beginning inventory
Ending inventory
Cost of goods sold
Gross profit
Net income
Year 1
No error
Overstated by $6,000
Understated by $6,000
Overstated by $6,000
Overstated by $6,000
Year 2
Overstated by $6,000
No error
Overstated by $6,000
Understated by $6,000
Understated by $6,000

If the ending inventory for BGSE is overstated at the end of Year 1, the cost of goods
sold on the income statement during Year 1 is understated, and gross profit and net
income are both overstated. In Year 2, the inventory error will reverse. If ending
inventory is overstated at the end of Year 1, the beginning inventory for Year 2 will be
overstated as well. If beginning inventory is overstated, cost of goods sold for that year
is overstated, and gross profit and net income would both be understated for that year.

Choice "B" is incorrect. If beginning inventory is overstated by $6,000 in Year 2, then

the cost of goods sold is overstated for that year. However, gross profit and net income
would both be understated for that year.
A material overstatement in ending inventory was discovered after the year-end
financial statements of a company were issued to the public. What effect did this error
have on the year-end financial statements?

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Current assets Gross profit

A. Understated Overstated

B. Overstated Overstated

C. Understated Understated

D. Overstated Understated
Explanation

Choice "B" is correct. Because inventory is a component of current assets, an

overstatement of ending inventory will cause current assets to be overstated

The income statement effects of an inventory overstatement or understatement can

best be seen by analyzing the cost of goods sold formula:

Beginning inventory
+ Purchases
Cost of goods available for sale
- Ending inventory
Cost of goods sold

Based on this formula, an overstatement of ending inventory will cause an

understatement of cost of goods sold, which will result in an overstatement of gross
profit (Sales - Cost of goods sold = Gross profit).

Choices "A", "C", and "D" are incorrect, per the above explanation.
Which of the following inventory accounting methods is not permitted under IFRS?

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A. FIFO.
B. LIFO.
C. Specific identification.
D. Moving average.
Explanation

Choice "B" is correct. IFRS state that the inventory accounting method used by an entity
should match the actual flow of goods. LIFO rarely reflects the actual flow of goods and
is therefore prohibited under IFRS.

Choice "A" is incorrect. FIFO is permitted under IFRS because many inventory items
are sold on a first-in, first-out basis. IFRS state that the inventory accounting method
should match the actual flow of goods.

Choice "C" is incorrect. Specific identification is the preferred method under IFRS and
should be used whenever possible.

Choice "D" is incorrect. The moving average method is permitted under IFRS.
A fundamental difference between U.S. GAAP and IFRS is that:

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A. Reversal of inventory write-downs is permitted under IFRS; however, reversal of inventory
write-downs is prohibited under U.S. GAAP.
B. Distribution costs are included in cost of sales under U.S. GAAP; however, distribution costs
are excluded from cost of sales under IFRS.
C. Inventory is generally valued at the lower of cost or market under IFRS; however, inventory is
generally valued at the lower of cost or net realizable value under U.S. GAAP.
D. Marketing costs are included in cost of sales under U.S. GAAP; however, marketing costs are
excluded from cost of sales under IFRS.
Explanation

Choice "A" is correct. While there are many similarities between the accounting
principles applied under GAAP and IFRS, there are several areas where GAAP and
IFRS differ. The best approach is to focus on the key differences that exist and to
remember which principles apply to which set of standards.

In the case of inventory write-downs, GAAP is more conservative than IFRS. IFRS
allows for inventory write-downs to be reversed, while GAAP does not allow for such a
reversal.

Choice "B" is incorrect. Distribution costs are not treated differently from a fundamental
perspective under GAAP and IFRS.

Choice "C" is incorrect. Inventory is valued at lower of cost or net realizable value (NRV)
under IFRS, not lower of cost or market.

Choice "D" is incorrect. Marketing costs are treated similarly under both GAAP and
IFRS.
The IASB has been working closely with the FASB to harmonize the international
standards with U.S. GAAP. Differences in accounting treatment exist for all of the
following except:

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A. Accounting for impairment of assets.
B. Accounting for inventory using last in, first out (LIFO).
C. Accounting for inventory using first in, first out (FIFO).
D. Accounting for development costs.
Explanation

Choice "C" is correct. Both IAS and U.S. GAAP allow accounting for inventory using
FIFO; therefore there is no difference using this method.

Choice "A" is incorrect. A difference of accounting treatment between the IASB and
FASB does exist for accounting for impairment of assets.

Choice "B" is incorrect. The IASB does not allow LIFO, but the FASB does.

Choice "D" is incorrect. A difference of accounting treatment between the IASB and
FASB does exist for accounting for development costs.