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Tb06 - test bank chapter6

Financial Accounting (University of Ottawa)

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CHAPTER 6
REPORTING AND ANALYZING INVENTORY
SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF
DIFFICULTY

Ite
SO LOD Item SO LOD Item SO LOD Item SO LOD Item SO LOD
m
True-False Statements
1. 1 E 9. 2 M 17. 2 E 25. 4 M 33. 5 E
2. 1 E 10. 2 E 18. 2 E 26. 4 E 34. 5 E
3. 1 M 11. 2 M 19. 2 M 27. 4 E 35. 5 M
4. 1 M 12. 2 E 20. 3 E 28. 5 E *36. 6 M
5. 1 E 13. 2 E 21. 3 M 29. 5 E *37. 6 E
6. 1 E 14. 2 E 22. 3 E 30. 5 E *38. 6 E
7. 1 M 15. 2 E 23. 3 M 31. 5 M
8. 2 E 16. 2 M 24. 4 M 32. 5 M
Multiple Choice Questions
39. 1 M 53. 2 M 67. 3 E 81. 3 E 95. 5 M
40. 1 M 54. 2 E 68. 3 E 82. 3 E 96. 5 H
41. 1 M 55. 2 M 69. 3 E 83. 3 M 97. 5 E
42. 1 E 56. 2 H 70. 3 M 84. 3 E 98. 5 E
43. 1 H 57. 2 M 71. 3 E 85. 3 E 99. 5 E
44. 1 H 58. 2 M 72. 3 E 86. 3 E 100. 5 E
45. 1 E 59. 2 M 73. 3 E 87. 3 M 101. 5 E
46. 2 E 60. 2 M 74. 3 E 88. 4 M 102. 5 M
47. 2 E 61. 2 H 75. 3 E 89. 4 M 103. 5 H
48. 2 M 62. 2 M 76. 3 M 90. 4 E *104. 6 E
49. 2 M 63. 2 E 77. 3 M 91. 4 E *105. 6 M
50. 2 M 64. 2 E 78. 3 E 92. 5 E *106. 6 E
51. 2 H 65. 2 E 79. 3 E 93. 5 E *107. 6 E
52. 2 M 66. 3 M 80. 3 M 94. 5 M *108. 6 M
Exercises
109. 1 H 113. 2 H 117. 4 H 121. 5 M *125. 6 M
110. 1,4 H 114. 2 H 118. 4 M 122. 5 E *126. 6 M
111. 2 H 115. 2,3 E 119. 4 M 123. 5 M *127. 6 M
112. 2 M 116. 3 M 120. 5 E *124. 6 E
Matching
128. 1,2,5 E,M
Short-Answer Essay
129. 1 M 131. 2,3 H 133. 4 M
130. 1,5 E 132. 2,3 M 134. 5 E

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Note: E = Easy M = Medium H = Hard

*This topic is dealt with in an Appendix to the chapter.

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Item Type Item Type Item Type Item Type Item Type Item Type Item Type
Study Objective 1
1. TF 4. TF 7. TF 41. MC 44. MC 110. Ex 130. SAE
2. TF 5. TF 39. MC 42. MC 45. MC 128. Ma
3. TF 6. TF 40. MC 43. MC 109. Ex 129. SAE
Study Objective 2
8. TF 14. TF 46. MC 52. MC 58. MC 64. MC 115. Ex
9. TF 15. TF 47. MC 53. MC 59. MC 65. MC 128. Ma
10. TF 16. TF 48. MC 54. MC 60. MC 111. Ex 131. SAE
11. TF 17. TF 49. MC 55. MC 61. MC 112. Ex 132. SAE
12. TF 18. TF 50. MC 56. MC 62. MC 113. Ex
13. TF 19. TF 51. MC 57. MC 63. MC 114. Ex
Study Objective 3
20. TF 67. MC 72. MC 77. MC 82. MC 87. MC
21. TF 68. MC 73. MC 78. MC 83. MC 115. Ex
22. TF 69. MC 74. MC 79. MC 84. MC 116. Ex
23. TF 70. MC 75. MC 80. MC 85. MC 131. SAE
66. MC 71. MC 76. MC 81. MC 86. MC 132. SAE
Study Objective 4
24. TF 26. TF 88. MC 90. MC 110. Ex 118. Ex 133. SAE
25. TF 27. TF 89. MC 91. MC 117. Ex 119. Ex
Study Objective 5
28. TF 32. TF 92. MC 96. MC 100. MC 120. Ex 128. Ma
29. TF 33. TF 93. MC 97. MC 101. MC 121. Ex 130. SAE
30. TF 34. TF 94. MC 98. MC 102. MC 122. Ex 134. SAE
31. TF 35. TF 95. MC 99. MC 103. MC 123. Ex
*Study Objective 6
*36. TF *38. TF *105. MC *107. MC *124. Ex *126. Ex
*37. TF *104. MC *106. MC *108. MC *125. Ex *127. Ex

Note: TF = True-False Ma = Matching

MC = Multiple Choice Ex = Exercise SAE = Short-Answer Essay

*This topic is dealt with in an Appendix to the chapter.

CHAPTER STUDY OBJECTIVES

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1. Describe the steps in determining inventory quantities. The steps are (1) taking a physical
inventory of goods on hand and (2) determining the ownership of goods in transit, on
consignment, and in similar situations.

2. Apply the methods of cost determination using specific identification, FIFO, and average
cost under a perpetual inventory system. Costs are allocated to the cost of goods sold
account each time that a sale occurs in a perpetual inventory system. The cost is determined by
specific identification, or by using the first-in, first-out (FIFO) and average cost methods.
Specific identification is used for goods that are not ordinarily interchangeable. This method
tracks the actual physical flow of goods, allocating the exact cost of each merchandise item to
cost of goods sold and ending inventory.
The FIFO cost formula assumes a first-in, first-out cost flow for sales. Cost of goods sold
consists of the cost of the earliest goods purchased. Ending inventory consists of the cost of the
most recent goods purchased.
The average cost method is used for goods that are homogenous or non-distinguishable. Under
this method, a new weighted (moving) average unit cost is calculated after each purchase or
purchase return and applied to the number of units sold (and as a result, to the number of units
remaining in ending inventory).

3. Explain the effects on the financial statements of choosing each of the inventory
cost determination methods. Specific identification results in an exact match of costs
and revenues on the income statement. When prices are rising, the average cost
formula results in a higher cost of goods sold and lower profit than FIFO. The average
cost method therefore results in a better allocation on the income statement of more
current (recent) costs with current revenues than does FIFO. In the statement of
financial position, FIFO is considered to be better because it results in an ending
inventory that is closest to current (replacement) value. All three methods result in the
same cash flow before income tax.

4. Identify the effects of inventory errors on the financial statements. Ignoring the effects of
income tax, an error made in determining the quantities and/or cost of inventory at the end of
the year will also affect cost of goods sold. If ending inventory is overstated, cost of goods sold
will be understated and this in turn will cause profit to be overstated. Therefore, an error that
overstates inventory will also overstate profit and after recording closing entries, the
overstatement in profit will be reflected as an overstatement in retained earnings. In following
period, the overstatement in inventory will flow into cost of goods sold and overstate cost of
goods sold and understate profit, thereby reversing the effect of the prior period error. As long
as the cost of inventory at the end of this subsequent period is determined properly, the reversal
of the error will mean that both inventory and retained earnings are not misstated at that time.
If an error is made by recording an inventory purchase in a period preceding the actual
purchase, both inventory and accounts payable will be overstated; if the purchase has actually
occurred but is not recorded or counted, then both inventory and accounts payable will be
understated.

5. Demonstrate the presentation and analysis of inventory. Inventory is valued at the lower of
its cost and net realizable value, which results in the recording of an increase in cost of goods
sold and a reduction in inventory when the net realizable value is less than cost.

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Ending inventory is reported as a current asset on the statement of financial position at the
lower of cost and net realizable value. Cost of goods sold is reported as an expense on the
income statement.
The inventory turnover ratio is a measure of liquidity. It is calculated by dividing the cost of
goods sold by average inventory. It can be converted to days in inventory by dividing 365 days
by the inventory turnover ratio. In general, a higher inventory turnover and lower days in
inventory ratio is desired.

*6. Apply the FIFO and average cost inventory cost determination methods under a periodic
inventory system (Appendix 6A). Under the FIFO cost formula, the cost of the most recent
goods purchased is allocated to ending inventory. Cost of goods sold is calculated by deducting
ending inventory from the cost of goods available for sale (or proven by applying the cost of the
earliest goods on hand to determine the cost of goods sold).
Under the average cost method, the total cost of goods available for sale during the period is
divided by the units available for sale during the same period to calculate a weighted average
cost per unit. This unit cost is then applied to the number of units remaining in inventory to
calculate the ending inventory. Cost of goods sold is calculated by deducting ending inventory
from the cost of goods available for sale (or proven by applying the unit cost to the units sold to
determine the cost of goods sold).
Each of these cost methods is applied in the same cost flow order as in a perpetual inventory
system. The main difference is that in a perpetual inventory system, the cost is determined at
the date of each sale, while in a periodic inventory system, the cost is determined only at the
end of the period.
TRUE-FALSE STATEMENTS

1. A system of internal control is not needed when a company regularly takes a physical
inventory.

2. An inventory count should be done by the employees who keep track of the stock.

3. Goods in transit shipped FOB shipping point should be included in the buyer’s ending
inventory.

4. Goods that have been purchased FOB destination, but are in transit, should be excluded from
the buyer’s ending inventory.

5. Consigned goods are held for sale by one party although ownership of the goods is retained
by another party.

6. Once goods leave the premises of the seller, they should never be added to the seller’s
physical inventory count.

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7. In order to remove the cost of items sold from inventory, a unit cost must be determined.

8. When using the perpetual system, the average cost method relies on a simple average
calculation.

9. If prices never changed, there would be no need for alternative inventory cost methods.

10. Inventory cost methods such as FIFO and average deal more with the flow of costs than
with the flow of goods.

11. The first-in, first-out (FIFO) inventory cost method results in an ending inventory valued at
the most recent cost.

12. The physical inventory count determines the number of units on hand.

13. The specific identification method is desirable when a company sells a large number of low-
unit-cost items.

14. If a company has no beginning inventory and the unit cost of inventory items does not
change during the year, the unit cost assigned to the cost of goods sold will be the same under
FIFO and average cost formulas.

15. A company may use more than one inventory cost determination method if it has different
types of inventory.

16. The cost formula a company chooses should correspond as closely as possible to the actual
physical flow of goods.

17. The FIFO inventory cost formula agrees closely to the actual physical movement of goods in
most businesses.

18. In periods of falling prices, FIFO will result in a higher ending inventory valuation than the
average cost formula.

19. The method of inventory cost determination that best matches cost and revenues is FIFO.

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20. In periods of falling prices, FIFO will result in a higher cost of goods sold than the average
cost formula.

21. A change in the method of cost determination for inventory must be disclosed in the financial
statements.

22. Approximating the physical flow of inventory is not important when selecting an inventory
cost formula.

23. All three methods of inventory cost determination will produce the same cumulative cost of
goods sold over the life cycle of the business.

24. An error in the ending inventory of the current period will have a similar but inverse effect on
profit of the next accounting period.

25. An error that overstates the ending inventory will cause profit for the period to be
understated.

26. An error that understates the ending inventory will cause assets to be understated.

27. An error that understates the ending inventory will cause the cost of goods sold for the
period to be understated.

28. When the value of inventory is lower than its cost, the inventory is written down to its net
realizable value.

29. If net realizable value of the inventory is lower than its cost, the total assets on the statement
of financial position and profit on the income statement will be reduced.

30. Inventory that originally cost $100 had been written down to its net realizable value (NRV) of
$75. Subsequently, the NRV of the inventory recovered to equal its cost of $100. In this
situation, the amount of the $25 ($100 – $75) prior write-down in value should be reversed.

31. An inventory write down from cost to net realizable value should not be made in the period in
which the price decline occurs.

32. The lower of cost and net realizable value should be applied to the total inventory, rather
than to individual inventory items.

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33. A low inventory turnover ratio could mean a company is at risk of experiencing inventory
shortages.

34. A high inventory turnover ratio indicates that minimal funds are tied up in inventory.

35. In the average cost method used in a periodic inventory system, the same weighted average
cost per unit is used to calculate all of the goods sold during the period.

*36. When the average cost method is applied in a periodic inventory system, the sale of goods
during the year will change the unit cost used for calculating ending inventory.

*37. When the average cost method is applied in a periodic inventory system, a moving average
cost per unit is calculated after each purchase.

*38. The results under FIFO in a perpetual inventory system are the same as in a periodic
inventory system.

ANSWERS TO TRUE-FALSE STATEMENTS

Ite Ite Ite Ans Ite

Ans. Item Ans. Ans. Item Ans. Ans.
m m m . m
1. F 8. F 15. F 22. T 29. F *36. T
2. F 9. T 16. T 23. F 30. T *37. T
3. T 10. F 17. T 24. F 31. T *38. F
4. T 11. T 18. F 25. T 32. T
5. T 12. T 19. T 26. T 33. F
6. F 13. T 20. T 27. F 34. F
7. F 14. T 21. F 28. T 35. F
MULTIPLE CHOICE QUESTIONS

39. The factor which determines whether or not goods should be included in a physical count of
inventory is
(a) physical possession.
(b) ownership.
(c) management's judgement.
(d) whether or not the purchase price has been paid.

40. If goods in transit are shipped FOB destination,

(a) the seller has legal title to the goods until they are delivered.

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(b) the buyer has legal title to the goods during transit.
(c) the transportation company has legal title to the goods while the goods are in transit.
(d) no one has legal title to the goods until they are delivered.

41. To ensure the accuracy of the inventory during a physical inventory count,
(a) the employee is required to count all items twice for the sake of verification.
(b) the items counted are compared to the inventory account balance.
(c) a second employee or auditor counts the inventory and compares the result to the count
made by the first employee.
(d) pre-numbered inventory tags need not be used.

42. To accurately determine inventory quantities, a company must

(a) use the perpetual inventory system.
(b) employ an independent company to conduct inventory counts.
(c) rely on the warehouse records.
(d) take a physical inventory.

43. Which of the following should not be included in an inventory count?

(a) goods taken home by a customer on approval
(b) purchased goods shipped FOB shipping point still in transit from a supplier
(c) consigned goods
(d) consigned goods and goods taken home by a customer on approval

44. Westcom Corporation's goods in transit at December 31 include (1) sales made FOB
destination, (2) sales made FOB shipping point, (3) purchases made FOB destination, and (4)
purchases made FOB shipping point. Which items should be included in Westcom's inventory at
December 31?
(a) (2) and (3)
(b) (1) and (4)
(c) (1) and (3)
(d) (2) and (4)

45. Goods held on consignment are

(a) never owned by the consignee.
(b) included in the consignee’s ending inventory.
(c) kept for sale on the premises of the consignor.
(d) not included in anyone’s ending inventory.

46. A company just starting in business purchased three merchandise inventory items at the
following prices. March 2, $75; March 7, $80; and March 15, $90. If the company sold two units
for $125 each on March 10 and March 20, and used the FIFO cost formula in a perpetual
inventory system, the gross profit for March would be
(a) $100.
(b) $95.

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(c) $90.
(d) $75.

47. Inventory cost methods make assumptions about the flow of

(a) costs.
(b) goods.
(c) resale prices.
(d) fair values.

48. A company just starting a business purchased three inventory items at the following prices:
March 2, $75; March 7, $80; and March 15, $90. If the company sold one unit for $115 on March
10 and one unit for $125 on March 20 and uses the average cost method in a perpetual
inventory system, what is the cost of ending inventory?
(a) $81.67
(b) $83.75
(c) $90.00
(d) $125.00

Use the following information for questions 49–52.

A company just starting business made the following four inventory purchases in June:
Date Number of Units Total Cost
June 1 150 $480
June 10 200 660
June 15 200 680
June 28 150 525

On June 25, the company made its first sale when a local customer purchased 500 units for
$3,500. The company uses a perpetual inventory system.

49. Using the FIFO cost method, the cost of the ending inventory on June 30 is
(a) $645.
(b) $695.
(c) $1,650.
(d) $1,700.

50. Using the FIFO cost method, the amount of the cost of goods sold for June is
(a) $645.
(b) $695.
(c) $1,650.
(d) $1,700.

51. Using the average cost method, the cost of the ending inventory on June 30 is
(a) $670.00.

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(b) $690.45.
(c) $1,645.55.
(d) $1,675.00.

52. The inventory cost formula that results in the highest gross profit for June is
(a) FIFO.
(b) average.
(c) Gross profit is the same under both cost formulas.
(d) not determinable.

53. Average Corp. purchased inventory as follows:

March 3 300 units at $9
March 4 200 units at $10
March 7 100 units at $11
On March 5, Average sold 400 units for $17 each. The average unit cost to be used for the cost
of goods sold on March 5, in a perpetual inventory system, is
(a) $9.40.
(b) $9.50.
(c) $9.67.
(d) $17.00.

Use the following information for the month of July for questions 54–58.

ABC Inc. uses the FIFO cost method in a perpetual inventory system.
Jul 1 Beginning inventory 20 units @ $19 per unit
Jul 7 Purchases 70 units @ $20 per unit
Jul 8 Sales 50 units
Jul 9 Sales 25 units
Jul 10 Purchases 50 units @ $22 per unit
Jul 22 Sales 40 units

54. The cost of goods sold for the July 8 sale was
(a) $950.
(b) $980.
(c) $989.
(d) $1,000.

55. The cost of goods sold for the July 9 sale was
(a) $475.
(b) $480.
(c) $495.
(d) $500.

56. Total cost of goods sold for the month of July is

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(a) $2,330.
(b) $2,530.
(c) $2,830.
(d) $2,880.

57. Ending inventory at July 31 is

(a) $2,330.
(b) $720.
(c) $680.
(d) $550.

58. If ABC Inc. used the average cost method instead of FIFO, gross profit from the July 8 sale
would be
(a) higher.
(b) lower.
(c) the same.
(d) cannot be determined.

Use the following information for the month of June for questions 59–62.

XYZ Inc. uses the average cost formula in a perpetual inventory system.
(Use unrounded numbers in your calculations but round to the nearest cent for presentation
purposes in your answer.)
Jun 1 Beginning inventory 20 units @ $19.00 per unit
Jun 5 Purchase 100 units @ $22.00 per unit
Jun 8 Sale 70 units
Jun 9 Purchase 80 units @ 22.31 per unit
Jun 10 Sale 25 units
Jun 22 Sale 40 units

59. The cost of goods sold for the June 8 sale is

(a) $1,480.00.
(b) $1,505.00.
(c) $1,527.68.
(d) $1,540.00.

60. The cost of goods sold for the June 10 sale is

(a) $545.60.
(b) $549.96.
(c) $550.00.
(d) $557.75.

61. Total cost of goods sold for the month of June is

(a) $2,914.65.

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(b) $2,934.90.
(c) $2,946.24.
(d) $2,994.80.

62. XYZ Inc. has an ending inventory on June 30 of

(a) $1,370.00
(b) $1,418.56.
(c) $1,429.90.
(d) $1,450.15.

63. Gene’s Used Cars uses the specific identification method of costing inventory. During
March, Gene purchased three cars for $5,000, $6,500, and $8,000, respectively. During March,
two cars are sold for $7,500 each. Gene determines that at March 31, the $8,000 car is still on
hand. What is Gene's cost of goods sold for March?
(a) $8,000
(b) $11,500
(c) $14,500
(d) $15,000

64. Which of the following statements regarding inventories is correct?

(a) FIFO assumes that the costs of the earliest goods acquired are the last to be sold.
(b) It is generally good business management to sell the most recently acquired goods first.
(c) Under FIFO, the ending inventory is based on the latest units purchased.
(d) FIFO seldom coincides with the actual physical flow of inventory.

65. Management may be able to manipulate profit using

(a) the FIFO cost formula.
(b) specific identification.
(c) the average cost formula.
(d) need more information to answer.

66. XYZ Inc. uses the average cost formula in a perpetual inventory system.
(Use unrounded numbers in your calculations but round to the nearest cent for presentation
purposes in your answer.)
Jun 1 Beginning inventory 20 units @ $19.00 per unit
Jun 5 Purchase 100 units @ $22.00 per unit
Jun 8 Sale 70 units
Jun 9 Purchase 80 units @ 22.31 per unit
Jun 10 Sale 25 units
Jun 22 Sale 40 units
If XYZ Inc. was using the FIFO cost formula instead of average, gross profit from the June 8
sale would be
(a) higher.
(b) lower.
(c) the same.
(d) cannot be determined.

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67. Of the following businesses, which one would not be likely to use the specific identification
method for inventory costing?
(a) piano store
(b) car dealership
(c) antique shop
(d) grocery store

68. A problem with the specific identification method is that

(a) inventories can be reported at actual costs.
(b) management can manipulate profit.
(c) matching is not achieved.
(d) lower of cost and net realizable value cannot be applied.

69. The selection of an appropriate inventory cost formula for a company is made by:
(a) external auditors.
(b) Canada Revenue Agency (CRA).
(c) industry standards.
(d) management.

70. Which of the following should a business consider when choosing between the FIFO and
average cost formulas?
(a) whether the method closely follows the physical flow of goods
(b) whether the method reports an inventory cost that approximates recent cost
(c) using the same method for inventory of similar nature and use
(d) all of the above.

71. Which of the following statements regarding inventory cost determination methods is
correct?
(a) A company may use more than one inventory cost determination method.
(b) A company should use the method that is easiest.
(c) A company must use the method that allows them to manage profit.
(d) A company may never change its inventory cost method once it has chosen it.

72. The specific identification method of inventory cost determination must be used
(a) for goods that are produced and segregated for specific projects.
(b) when goods are not ordinarily interchangeable.
(c) when high priced goods are purchased.
(d) for goods that are produced and segregated for specific projects, and/or when goods are not
ordinarily interchangeable.

73. The inventory cost determination method that results in the inventory value on the statement
of financial position that is closest to its actual cost is

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(a) FIFO.
(b) specific identification.
(c) average cost.
(d) either FIFO or average cost.

74. In a period of declining prices, which of the following inventory cost formulas generally
results in the lowest inventory figure on the statement of financial position?
(a) average cost
(b) FIFO
(c) The figure would be the same under both FIFO and average cost.
(d) Need more information to answer.

75. In a period of rising prices, which of the following inventory cost methods generally results in
the lowest profit figure?
(a) average cost
(b) FIFO
(c) The inventory cost formula only affects the statement of financial position.
(d) Need more information to answer.

76. Two companies report the same cost of goods available for sale but each employs a
different inventory cost formula. If the price of goods has increased during the period, then the
company using
(a) FIFO will report lower ending inventory.
(b) Average cost will report lower ending inventory.
(c) FIFO will report higher cost of goods sold.
(d) Average cost will report lower cost of goods sold.

77. In a period of inflation (prices are rising), which inventory cost formula will result in higher
profit?
(a) FIFO
(b) average cost
(c) Cost of goods sold for the period will be the same under both formulas.
(d) There would be no effect on profit.

78. The specific identification method of costing inventories is used when the
(a) physical flow of units cannot be determined.
(b) company sells large quantities of relatively homogeneous items.
(c) company has sophisticated technology to account for its inventory.
(d) company sells a small number of expensive, easily distinguishable items.

79. The specific identification method of inventory costing

(a) always maximizes a company's profit.
(b) always minimizes a company's profit.
(c) has no effect on a company's profit.

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(d) may enable management to manipulate profit.

80. The managers of Winning Ways Ltd. receive performance bonuses based on the company’s
profit. Which inventory cost formula are they likely to favour in periods of declining prices?
(a) FIFO
(b) average cost
(c) They would have no preference.
(d) Need more information to answer.

81. Which cost determination method smoothes the effects of price changes?
(a) specific identification
(b) FIFO
(c) average cost
(d) lower of cost and net realizable value

82. Selection of an inventory cost method by management should be influenced most by the
(a) fiscal year end.
(b) physical flow of goods.
(c) goal of reporting inventory at its lowest cost.
(d) Income tax effects.

83. Which cost method provides the better (1) income statement and (2) statement of financial
position valuations, respectively?
(a) (1) average and (2) FIFO
(b) (1) FIFO and (2) average
(c) (1) FIFO and (2) FIFO
(d) (1) average and (2) average

84. During a period of inflation, using ___ will approximate a company’s current cost of ending
inventory.
(a) the average cost method
(b) FIFO
(c) the lower of cost and net realizable value
(d) both FIFO and the average cost method

85. The consistent application of an inventory cost method is essential for

(a) neutrality.
(b) accuracy.
(c) comparability.
(d) relevance.

86. Cost of goods available for sale consists of the

(a) cost of beginning inventory plus the cost of ending inventory.

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(b) cost of ending inventory plus the cost of goods purchased during the year.
(c) cost of beginning inventory plus the cost of goods purchased during the year.
(d) difference between the cost of goods purchased and the cost of goods sold during the year.

87. The cost of goods available for sale is allocated between

(a) beginning inventory and ending inventory.
(b) beginning inventory and cost of goods on hand.
(c) beginning inventory and cost of goods purchased.
(d) ending inventory and cost of goods sold.

88. An error in the physical count of goods on hand at the end of a period resulted in a $10,000
overstatement of the ending inventory. The effect of this error in the current period is
Cost of Goods Sold Profit .
(a) Understated Understated
(b) Overstated Overstated
(c) Understated Overstated
(d) Overstated Understated

89. If beginning inventory is understated by $10,000, the effect of this error in the current period
is
Cost of Goods Sold Profit .
(a) Understated Understated
(b) Overstated Overstated
(c) Understated Overstated
(d) Overstated Understated

90. An overstatement of the beginning inventory results in

(a) an overstatement of profit.
(b) an understatement of profit.
(c) no effect on the period’s profit.
(d) a need to adjust purchases.

91. An overstatement of ending inventory in one period results in

(a) no effect on profit of the next period.
(b) an overstatement of profit of the next period.
(c) an understatement of profit of the next period.
(d) an overstatement of the ending inventory of the next period.

92. The lower of cost and net realizable value basis of valuing inventories ensures that
inventories are
(a) valued at their current cost.
(b) valued at their selling price.
(c) not under-valued.
(d) not over-valued.

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93. Under the lower of cost and net realizable value basis, the adjusting entry to record a
decline in net realizable value below cost includes a
(a) debit to the Inventory account.
(b) debit to the Cost of Goods Sold account.
(c) credit to the Cost of Goods Sold account.
(d) credit to the Sales account.

94. XYZ Inc. is a wholesaler of electronics. It purchased 1,000 units of Product X for $500 each
during 2015. The selling price during the year was $750 per unit. At year end, it had 100 units
on hand and due of changes in technology, the selling price will have to be reduced by 40% in
order to sell them. The value of each unit of Product X for the year-end inventory presentation
should be
(a) $600.
(b) $500.
(c) $400.
(d) $450.

95. Inventory that originally cost $10,000 was written down to its net realizable value of $8,500
at the end of 2014. At the end of 2015, the net realizable value is determined to be $10,500. At
what amount should the inventory be reported on the December 31, 2015 statement of financial
position?
(a) $10,500
(b) $10,000
(c) $9,500
(d) $8,500

96. For 2015, Nervous Energy Inc. reported $24,000 beginning inventory and $26,000 ending
inventory. Net sales were $160,000 and gross profit was $55,000 for the same period. Based on
these figures, inventory turnover for 2015 was
(a) 3.4 times.
(b) 4.2 times.
(c) 6.4 times.
(d) 9.2 times.

97. An aircraft manufacturer would most likely have a

(a) high inventory turnover.
(b) low profit margin.
(c) high volume.
(d) low inventory turnover.

98. The inventory turnover ratio is calculated by dividing cost of goods sold by
(a) beginning inventory.
(b) ending inventory.

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(c) average inventory.

(d) 365 days.

99. Days in inventory is calculated by dividing 365 days by

(a) average inventory.
(b) beginning inventory.
(c) ending inventory.
(d) the inventory turnover ratio.

Use the following information for questions 100–101.

The following information was available for Riley Limited at December 31, 2015:
Beginning inventory $ 120,000
Ending inventory 150,000
Cost of goods sold 810,000
Net sales 1,400,000

100. Riley’s inventory turnover was

(a) 5.0 times.
(b) 6.0 times.
(c) 7.5 times.
(d) 9.0 times.

101. Riley’s days in inventory was

(a) 40.6 days.
(b) 48.7 days.
(c) 60.8 days.
(d) 73.0 days.

102. An increase in inventory turnover means days in inventory

(a) increases.
(b) decreases.
(c) remains the same.
(d) cannot be determined.

103. NHL Canada Ltd. has a days in inventory ratio of 40 and average inventory of $254,000.
What is its cost of goods sold?
(a) Cannot be determined.
(b) $12,700,000
(c) $2,317,750
(d) $1,854,200

*104. In a periodic inventory system, the cost of goods sold is determined

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(a) at the beginning of the accounting period.

(b) after each sale.
(c) after each purchase.
(d) at the end of the accounting period.

*105. In order to determine cost of goods sold in a periodic inventory system we

(a) add purchases to beginning inventory.
(b) subtract ending inventory from beginning inventory.
(c) subtract ending inventory from cost of goods available for sale.
(d) subtract purchases from ending inventory.

Use the following information to answer questions *106–*108.

Abalone Corp. uses a periodic inventory system.

Jul 1 Beginning inventory 20 units @ $19 $ 380
7 Purchases 70 units @ $20 1,400
22 Purchases 10 units @ $22 220
$2,000
A physical count of merchandise inventory on July 31 shows that 25 units are on hand.

*106. Under the FIFO cost method, ending inventory at July 31 was
(a) $1,500.
(b) $1,480.
(c) $520.
(d) $500.

*107. Under the average cost method, cost of goods sold for July was
(a) $1,600.
(b) $1,500.
(c) $520.
(d) $500.

*108. Which cost method will provide the highest profit?

(a) average cost
(b) FIFO
(c) Profit is the same under both methods.
(d) Cannot be determined.
ANSWERS TO MULTIPLE CHOICE QUESTIONS

Ite Ans
Ans. Item Ans. Item Ans. Item Item Ans. Item Ans. Item Ans.
m .
39. b 49. b 59. b 69. d 79. d 89. c 99. d
40. a 50. c 60. b 70. d 80. b 90. b 100. b

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41. c 51. b 61. b 71. a 81. c 91. c 101. c

42. d 52. a 62. c 72. d 82. b 92. d 102. b
43. c 53. a 63. b 73. b 83. a 93. b 103. c
44. b 54. b 64. c 74. b 84. b 94. d *104. d
45. a 55. d 65. b 75. a 85. c 95. b *105. c
46. b 56. a 66. a 76. b 86. c 96. b *106. c
47. a 57. d 67. d 77. a 87. d 97. d *107. b
48. b 58. b 68. b 78. d 88. c 98. c *108. b
EXERCISES

Ex. 109
Bunkers Corporation has just completed a physical inventory count at year end, December 31,
2015. Only the items on the shelves, in storage, and in the receiving area were counted. The
inventory amounted to $77,000. Bunkers uses a perpetual inventory system. During the year-
end audit, the independent C.A. discovered the following additional information:
1. There were goods in transit on December 31, 2015, from a supplier with terms FOB destination,
costing $8,500. Because the goods had not arrived, they were excluded from the physical inventory
count.
2. On December 27, 2015, a regular customer purchased goods for cash amounting to $1,000 and left
them for pickup on January 4, 2016. Bunkers had paid $1,200 for the goods and, because they were
on hand, included them in the physical inventory count.
3. Bunkers Corporation, on the date of the inventory count, received notice from a supplier that goods
ordered earlier, at a cost of $10,000, had been delivered to the transportation company on
December 28, 2015; the terms were FOB shipping point. Because the shipment had not arrived on
December 31, 2015, it was excluded from the physical inventory.
4. On December 31, 2015, there were goods in transit to customers, with terms FOB shipping point,
amounting to $800 (expected delivery on January 8, 2016). Because the goods had been shipped,
they were excluded from the physical inventory count.
5. On December 31, 2015, Bunkers shipped $2,500 worth of goods to a customer, FOB destination.
This shipment arrived on January 5, 2016. Because the goods were not on hand, they were not
included in the physical inventory count.
6. Bunkers Corporation, as the consignee, had goods on consignment that cost $5,000. Because these
goods were on hand at December 31, 2015, they were included in the physical inventory count.

Instructions
Analyze the above information and calculate a corrected amount for the ending inventory.
Explain the rationale for your treatment of each item.

Solution 109 (20 min.)

$77,000

— (Because the goods were shipped FOB destination, the title will pass to Bunkers upon
arrival. Correctly excluded.)

– 1,200 (Goods should be excluded. The customer owns them.)

+ 10,000 (Goods belong to Bunkers. Title passed when supplier delivered the goods to the
transportation company.)

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— (Because the goods were shipped FOB shipping point, Bunkers no longer has title to
these goods. Correctly excluded.)

+ 2,500 (Goods were shipped FOB destination. Bunkers retains title until the customer
receives them.)

– 5,000 (These goods are owned by the consignor, not the consignee, and should not be
included in Bunkers' inventory.)

ry $83,300

Ex. 110
Haddock Sales Inc. has a December 31 year end. Complete the table below to show the error
(understated (U) or overstated (O)), if any, including the dollar amount. If there is no impact,
state no effect (NE).

Assets Profit Retained

December December Earnings
31, 2015 31, 2015 December
31, 2015

1. Inventory of $75,000 held on consignment is

included in inventory at December 31, 2015.

2. $25,000 of inventory purchased was included in

the inventory on December 31, 2015. It was
shipped FOB shipping point on December 28,
2015, but did not arrive until January 4, 2016.

3. Merchandise costing $3,000 was returned by a

customer on January 2, 2016. The merchandise
was in good condition and the customer was given
full credit of $5,000. $3,000 was deducted from
inventory on December 31, 2015.

4. Merchandise was returned to a supplier for credit

on December 28, 2015. Credit of $7,000 was
received on January 2, 2016. No adjustment was
made until the credit was received.

5. Merchandise shipped FOB destination was

received by Haddock on December 30, 2015. It
was recorded in inventory at $980—the invoice
cost of $1,000 less the 2% early payment
discount. The company has a policy of always
taking cash discounts.

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Solution 110 (20–25 min.)

Assets Profit Retained
December December Earnings
31, 2015 31, 2015 December
31, 2015

1. Inventory of $75,000 held on consignment is Overstated Overstated Overstated

included in inventory at December 31, 2015. $75,000 $75,000 $75,000

2. $25,000 of inventory purchased was included

in the inventory on December 31, 2015. It was
NE NE NE
shipped FOB shipping point on December 28,
2015, but did not arrive until January 4, 2016.

3. Goods on approval costing $3,000 were

returned by a customer on January 2, 2016.
The merchandise was in good condition and
Understated Understated Understated
the customer was given full credit of $5,000.
$3,000 $3,000 $3,000
$3,000 was deducted from inventory on
December 31, 2015.

4. Merchandise was returned to a supplier for

credit on December 28, 2015. Credit of
Overstated Overstated Overstated
$7,000 was received on January 2, 2016. No
$7,000 $7,000 $7,000
adjustment was made until the credit was
received.

5. Merchandise shipped FOB destination was

received by Haddock on December 30, 2015.
It was recorded in inventory at $980—the
NE NE NE
invoice cost of $1,000 less the 2% early
payment discount. The company has a policy
of always taking cash discounts.

Ex. 111
Hansen Corporation uses the perpetual inventory system and had the following information
available:
Units Unit Cost Total Cost
Jan 1 Beginning inventory 15 $4.00 $ 60
20 Purchase 60 4.40 264
21 Sale 65 - -
Jul 25 Purchase 30 4.20 126
Oct 20 Purchase 45 4.80 216
Nov 15 Sale 75 - -

Instructions
Answer the following independent questions and show calculations supporting your answers:
(a) Assume that the company uses the FIFO cost method. The cost of goods sold for the Jan 21
sale was $__________.

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(b) Assume that the company uses the average cost method. The cost of goods sold for the Jan 21
sale was $__________. (Use unrounded numbers in your calculations but round to the nearest
cent for presentation purposes in your answer.)
(c) Assume that the company uses the average cost method. The value of the inventory after the
Nov 15 sale was $__________. (Use unrounded numbers in your calculations but round to the
nearest cent for presentation purposes in your answer.)
(d) Assume that the company uses the FIFO cost method. The value of the inventory after the Oct
20 purchase is $__________.

Solution 111 (20 min.)

(a) Cost of Goods Sold (FIFO): (15 units @ $4) + (50 units @ $4.40) = $280

(b) Cost of Goods Sold (average): ($60 + $264) = $324 ÷ 75 = $4.32 per unit

Sold 65 units @ $4.32 = $280.80

(c) Inventory (average): $60 + $264 – $280.80 (see (b) above) + $126 + $216 = $385.20
$385.20 ÷ (15 + 60 – 65 + 30 + 45) = $4.53 (rounded) per unit

10 units on hand (85 – 75) @ $4.53 (rounded) = $45.32 (using unrounded numbers in
calculation)

(d) Inventory (FIFO): $386.00

After the Jan 21 sale 10 units x $4.40 = $ 44.00

Jul 25 purchase 30 units x $4.20 = 126.00
Oct 20 purchase 45 units x $4.80 = 216.00
Value of inventory = $386.00

Ex. 112
Owl Ltd. sells many products. Hoot is one of its popular items. Below is an analysis of the
inventory purchases and sales of Hoot for the month of March. Owl uses the perpetual inventory
system.
Purchases Sales
Units Unit Cost Units Selling Price/Unit
Mar 1 Beginning inventory 600 $40
3 Purchase 100 60
4 Sales 190 $80
10 Purchase 100 66
16 Sales 275 120
19 Sales 220 120
25 Sales 75 120
30 Purchase 460 75

Instructions
(a) Using the FIFO cost method, calculate the cost of goods sold for March. Show calculations.

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(b) Using the average cost method, calculate the ending inventory at March 31. Show calculations
and use unrounded numbers in your calculations but round to the nearest cent for presentation
purposes in your answer.

Solution 112 (20 min.)

(a) FIFO

Date Description Purchases COGS Ending Inventory

Mar Beginning 600 $40 $24,000
1
3 Purchase 100 $60 $ 6,000 600 40
100 60 30,000
4 Sale 190 $40 $ 7,600 410 40
100 60 22,400
10 Purchase 100 66 6,600 410 40
100 60
100 66 29,000
16 Sale 275 40 11,000 135 40
100 60
100 66 18,000
19 Sale 135 40 15 60
85 60 10,500 100 66 7,500
25 Sale 15 60
60 66 4,860 40 66 2,640
30 Purchase 460 75 34,500 40 66
460 75 37,140
30 Ending 760 $33,960 220 , $37,140

(b) Average
Date Description Purchases COGS Ending Inventory
Mar 1 Beginning 600 $42.86$24,000
3 Purchase 100 $60 $ 6,000 700 42.86 30,000
4 Sale 190 $42.86 $ 8,143 510 42.86 21,859
10 Purchase 66 6,600 610 46.65 28,459
100
16 Sale 275 46.65 12,829 335 46.65 15,628
19 Sale 220 46.65 10,263 115 46.65 5,365
25 Sale 75 46.65 3,499 40 46.65 1,866
30 Purchase 460 75 34,500 500 72.73 36,366
30 Ending 760 $34,734 500 ,$36,366

Please note that discrepancies may result in the above schedule due to rounding.

Ex. 113
Nector Ltd., which uses a perpetual inventory system, recorded the following inventory
transactions for this year:

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Purchases Sales
Units Unit Cost Units Selling Price/Unit
Apr 1 Beginning inventory 45 $8
25 Purchase 150 9
May 4 Purchase 65 10
16 Sale 120 $16
Jun 4 Purchase 50 12

Instructions
(a) Using the FIFO cost method, calculate the cost of goods sold for the quarter ended June 30.
Show calculations.
(b) Using the average cost method, calculate the ending inventory at June 30. Show calculations
and use unrounded numbers in your calculations but round to the nearest cent for presentation
purposes in your answer.

Solution 113 (30 min.)

(a) Purchases Cost of Balance
Goods Sold
Apr 1 (45 @ $8) = $360

Apr 25 (150 @ $9) = $1,350 (45 @ $8) = $360

(150 @ $9) = 1,350
$1,710

May 4 (65 @ $10) = $650 (45 @ $8) = $360

(150 @ $9) = 1,350
(65 @ $10) = $650
$2,360

May 16 (45 @ $8) = $360 (75 @ $9) = $675

(75 @ $9) = $675 (65 @ $10) = $650
$1,035 $1,325

Jun 4 (50 @ $12) = $600 (75 @ $9) = $675

(65 @ $10) = $650
(50 @ $12) = $600
$1,925

(b) Purchases Cost of Balance

Goods Sold
Apr 1 (45 @ $8) = $360.00
Apr 25 (150 @ $9) = $1,350.00 (195 @ $8.77) =
$1,710.00
May 4 (65 @ $10) = $650.00 (260 @ $9.08) = $2,360.00
May 16 (120 @ $9.08) = $1,089.23) (140 @ $9.08) =
$1,270.77
Jun 4 (50 @ $12) = $600.00 (190 @ $9.85) = $1,870.77

Please note that discrepancies may result in the above schedule due to rounding.

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Ex. 114
Churchill Corporation, which uses a perpetual inventory system, recorded the following
inventory transactions during the last two months of 2015:
Purchases Sales
Units Unit Cost Units Selling Price/Unit
Nov 1 Beginning inventory 105 $60
13 Purchase 70 58
29 Sale 96 $87
Dec 3 Purchase 50 56
16 Sale 52 84

Instructions
(a) Using the FIFO cost method, calculate the cost of goods sold for the two months of November
and December. Show calculations.
(b) Using the average cost method, calculate the ending inventory at December 31. Show
calculations and use unrounded numbers in your calculations but round to the nearest cent for
presentation purposes in your answer.

Solution 114 (30 min.)

(a) Purchases Cost of Balance
Goods Sold
Nov 1 (105 @ $60) = $6,300

Nov 13 (70 @ $58) = $4,060 (105 @ $60) = $6,300

(70 @ $58) = $4,060
$10,360

Nov 29 (96 @ $60) = $5,760

(9 @ $60) = $540
(70@$58)=$4,060
$4,600

Dec 3 (50 @ $56) = $2,800 (9 @ $60) = $540

(70 @ $58) = $4,060
(50 @ $56) = $2,800 $7,400

Dec 16 (9 @ $60) = $540 (27 @ $58) = $1,566

(43 @ $58)= $2494 (50 @ $56) = $2,800
$3,034 $4,366

(b) Purchases Cost of Balance

Goods Sold
Nov 1 (105 @ $60) = $6,300.00
Nov 13 (70 @ $58) $4,060.00 (175 @ $59.20) = $10,360.00
Nov 29 (96 @ $59.20) = $5,683.20 (79 @ $59.20) = $4,676.80
Dec 3 (50 @ $56) $2,800.00 (129 @ $57.96) = $7,476.80
Dec 16 (52 @ $57.96) = $3,013.92 (77 @ $57.96) = $4,462.88

Please note that discrepancies may result in the above schedule due to rounding.

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Ex. 115
Glamorous Gold Inc. opened for business on April 1, 2015 selling unique jewellery, which it
purchases from local artisans. During April, the company made the following purchases:
Date Inventory Tag Number Cost
April 1 001 $2,750
April 3 002 600
April 5 003 1,150
004 2,300
April 10 005 700
April 13 006 1,200
007 3,900
April 26 008 600
009 1,700
April 31 010 2,400

On April 31, only inventory items 006, 008, and 010 remained in inventory.

Instructions
(a) Calculate the cost of goods sold for April using the specific identification cost determination
method.
(b) Discuss whether or not specific identification is an appropriate cost determination method for
this company.

Solution 115 (20 min.)

(a) Inventory sold:
Inventory Tag Number Cost
001 $ 2,750
002 600
003 1,150
004 2,300
005 700
007 3,900
009 1,700
Cost of goods sold: $13,100

(b) Specific identification would be the preferred inventory method for this company because it
provides the most accurate cost of goods sold and ending inventory values. It is appropriate
because of the uniqueness of the company’s inventory items. The comparatively small volume
of inventory items purchased and sold makes this method practical for either a computerized or
manual inventory system.

Ex. 116
Houle Limited reported the following summarized annual data at the end of 2015:
Sales revenue $3,500,000
Cost of goods sold* 1,700,000
Gross profit 1,800,000
Operating expenses 1,200,000

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Profit before income tax $ 600,000

*Based on an ending inventory of $420,000, using FIFO.

The controller of the company is considering a switch from FIFO to average cost. He has
determined that on an average cost basis, the ending inventory would have been $320,000.

Instructions
(a) Restate the summary information on an average cost basis.
(b) If you were the management of this business, what would your reaction be to this proposed
change?

Solution 116 (25 min.)

(a) Restate to average cost:
Sales revenue $3,500,000
Cost of goods sold* 1,800,000
Gross profit 1,700,000
Operating expenses 1,200,000
Profit before income tax $ 500,000
*Ending inventory would be $100,000 less ($420,000 – $320,000 = $100,000) under average
cost, thereby increasing cost of goods by $100,000.

(b) The company’s management would not likely see this change as desirable, since it results in an
increase in cost of goods sold, and thus a decrease in profit before income tax. In addition, the
inventory cost determination method chosen should be the one that closely corresponds with
the physical flow of goods and the inventory’s recent cost reported on the statement of financial
position. It should be used consistently, so unless the type of inventory or its nature and usage
has changed, management should not be changing its inventory cost method.

Ex. 117
For each of the independent events listed below, analyze the impact on the indicated items at
the end of the current year by placing the appropriate code letter in the box under each item.
Code: O = item is overstated
U = item is understated
NA = item is not affected
Items _
Assets Shareholders’ Cost of Profit
Equity Goods Sold
1. The ending inventory in the previous period
was overstated.
—————————————————————————————————————————–
2. A physical count of goods on hand at the end
of the current year resulted in some goods
being counted twice.
—————————————————————————————————————————–
3. Goods purchased on account in December of
the current year and shipped FOB shipping
point were recorded as purchases, but were
not included in the count of goods on hand on

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December 31 because they had not arrived by

December 31.
—————————————————————————————————————————–
4. Goods purchased on account in December of
the current year and shipped FOB destination
were recorded as purchases, but were not
included in the count of goods on hand on
December 31 because they had not arrived by
December 31.
—————————————————————————————————————————–
5. The internal auditors discovered that the
ending inventory in the previous period was
understated $15,000 and that the ending
inventory in the current period was overstated
$25,000.

Solution 117 (20 min.)

Items
Shareholders’ Cost of
Events Assets Equity Goods Sold Profit
1. NA NA O U

2. O O U O

3. U U O U

4. NA U O U

5. O O U O

Ex. 118
Condensed income statements for Collingwood Limited are shown below for two years:
2015 2016
Sales $92,000 $106,000
Cost of goods sold 54,000 65,000
Gross profit 38,000 41,000
Operating expenses 15,000 15,000
Profit before income tax $23,000 $ 26,000

Instructions
(a) Calculate the corrected profit before income tax for 2015 and 2016, assuming that the inventory
as of the end of 2015 was mistakenly understated by $7,000.
2015 $____________ 2016 $____________
(b) Calculate the ending retained earnings at the end of 2016, assuming retained earnings at the
end of 2015 was $195,000 and at the end of 2016, $205,000.

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Solution 118 (5 min.)

(a) 2015 = $30,000 ($23,000 + $7,000)
2016 = $19,000 ($26,000 – $7,000)

(b) Retained earnings at the end of 2016 would be unchanged at $205,000 because the profit
corrects itself over the two year period.

Ex. 119
Miller’s Grocery reported the following selected information:
2015 2016
Cost of goods sold $837,000 $900,000
Ending inventory 64,000 55,000

Miller made two errors:

1. 2015 ending inventory was overstated by $5,000.
2. 2016 ending inventory was understated by $9,000.

Instructions
Assuming the errors have not been corrected, indicate the dollar effect that the errors had on
the items listed below. Also indicate if the amounts are overstated (O) or understated (U).

2015 2016
Overstated/ Overstated/
Amount Understated Amount Understated
Total assets $_________ _______ $_________ _______

Shareholders’ equity $_________ _______ $_________ _______

Cost of goods sold $_________ _______ $_________ _______

Profit before income tax $_________ _______ $_________ _______

Solution 119 (20 min.)

2015 2016
Overstated/ Overstated/
Amount Understated Amount Understated
Total assets $5,000 O $9,000 U

Shareholders’ equity $5,000 O $9,000 U

Cost of goods sold $5,000 U $14,000 O

Profit before income tax $5,000 O $14,000 U

Ex. 120

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Copper Mining Inc. has been stock-piling copper inventory in anticipation of better prices.
Unfortunately, the market has not improved and at year end, December 31, 2014, inventory with
a cost of $4.5 million would only be worth $3.5 million if it could be sold.

During the next year, the prices start to recover, but the company still has not sold the inventory.
At December 31, 2015, the market value of the same copper inventory has increased and would
be worth $4.6 million.

Instructions
(a) Prepare the adjusting entry required at December 31, 2014 to record the decline in the value of
the inventory, assuming Copper Mining uses a perpetual inventory system.
(b) Prepare the adjusting entry required at December 31, 2015, if any.

Solution 120 (10 min.)

(a) Dec 31, 2014 Cost of Goods Sold 1,000,000

Merchandise Inventory 1,000,000
($4,500,000 – $3,500,000 = $1,000,000)

(b) Dec 31, 2015 Merchandise Inventory 1,000,000

Cost of Goods Sold 1,000,000
Note that inventory cannot be written up above cost.

Ex. 121
The following information is available from recent financial statements of Competitor A and
Competitor B:
(Amounts in millions)
Competitor A Competitor B
Ending inventory $ 7,500 $ 5,210
Beginning inventory 8,100 6,059
Cost of goods sold 23,760 33,616
Sales 30,251 39,950

Instructions
(a) Calculate the inventory turnover and days in inventory for both companies.
(b) What conclusions concerning the management of inventory can be drawn from these data?

Solution 121 (20 min.)

(a) Competitor A Competitor B

$23,760 $33,616
Inventory turnover —————————— ——————————
($7,500 + $8,100) ÷ 2 ($5,210 + $6,059) ÷ 2

$23,760 $33,616
———— = 3.0 times ———––– = 6.0 times
$7800 $5,634.50

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Days in inventory 365 ÷ 3.0 = 122 days 365 ÷ 6.0 = 61 days

(b) Competitor B’s inventory turnover is approximately 100% [(6.0 – 3.0) ÷ 3.0)] higher than
Competitor A’s. In addition, Competitor B’s days in inventory is 50% [(122– 61) ÷ 122] lower than
Competitor A’s. Generally, a company prefers to maintain as high an inventory turnover as
possible. We can conclude that Competitor B manages inventory more effectively than
Competitor A.

Ex. 122
The following information is available for Omari Corporation for 2015:
Beginning inventory $ 700,000
Ending inventory 800,000
Cost of goods sold 6,000,000
Sales 8,000,000

Instructions
Calculate the inventory turnover and days in inventory for Omari Corporation.

Solution 122 (5 min.)

Inventory turnover = $6,000,000 ÷ [($700,000 + $800,000) ÷ 2]
= $6,000,000 ÷ $750,000 = 8 times

Days in inventory = 365 days ÷ 8 = 46 days

Ex. 123
Solve for the missing amounts:
A B C
Sales $100,000 $239,000 $438,000
Cost of goods sold (a) 122,000 345,000
Inventory, beginning of year 23,000 45,000 (h)
Inventory, end of year 17,000 39,000 105,000
Average inventory (b) (e) 101,500
Gross profit 46% (f) (i)
Inventory turnover (c) (g) (j)
Days in inventory (d) 126 (k)

Solution 123 (20 min.)

A B C
Sales $100,000 $239,000 $438,000
Cost of goods sold 54,000 122,000 345,000
Inventory, beginning of year 23,000 45,000 98,000
Inventory, end of year 17,000 39,000 105,000
Average inventory 20,000 42,000 101,500
Gross profit 46% 49% 21%
Inventory turnover 2.7 2.9 3.4
Days in inventory 135 126 107

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*Ex. 124
Quinoa Corp. uses the periodic inventory system, and has the following information about
purchases and sales during the year:
January 1 Beginning inventory 150 items @ $3 = $ 450
May 1 Purchases 450 items @ $5 = 2,250
Total 600 items $2,700
Total sales 300 items
December 31 Ending inventory 300

Instructions
Calculate the cost to be assigned to ending inventory for each of the cost methods below:
(a) Average $____________
(b) FIFO $____________

*Solution 124 (10 min.)

(a) $1,350 ($2,700 ÷ 600 = $4.50 × 300)

(b) $1,500 (300 × $5)

*Ex. 125
Coucous Corp. uses the periodic inventory system. Information related to Coucous’ inventory for
September is given below:
Sep 1 Beginning inventory 200 units @ $10.00 = $ 2,000
8 Purchase 600 units @ $10.40 = 6,240
16 Purchase 400 units @ $10.80 = 4,320
24 Purchase 100 units @ $11.60 = 1,160
1,300 units $13,720

Instructions
(a) Calculate the ending inventory using FIFO assuming 400 units remain on hand at September 31
(show calculations).
(b) Calculate the ending inventory using average cost assuming 400 units remain on hand at
September 31 (show calculations).

*Solution 125 (20 min.)

(a) 400 units in ending inventory
Under FIFO, the units remaining in inventory are the ones purchased most recently.
Sep 24 100 units @ $11.60 = $1,160
16 300 units @ 10.80 = 3,240
400 units $4,400

(b) 400 units in ending inventory

Under the average cost method, the weighted-average cost per unit must be calculated:
$13,720 ÷ 1,300 units = $10.55
400 units × $10.55 = $4,220

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*Ex. 126
Garmin Ltd. uses the periodic inventory system and had the following inventory information
available:
Units Unit Cost Total Cost
Jan 1 Beginning inventory 100 $4 $ 400
20 Purchase 500 $5 2,500
Jul 25 Purchase 100 $6 600
Nov 20 Purchase 300 $7 2,100
1,000 $5,600

A physical count of inventory on December 31 showed that there were 350 units on hand.

Instructions
Answer the following independent questions and show calculations supporting your answers.
(a) Assume that the company uses FIFO. The value of the ending inventory at December 31 is
$__________.
(b) Assume that the company uses average cost. The value of the ending inventory on December
31 is $__________.
(c) Determine the difference in the amount of profit that the company would have reported if it had
used FIFO instead of average cost. Would profit have been greater or less?

*Solution 126 (20 min.)

(a) FIFO: Ending inventory $2,400
300 units @ $7 = $2,100
50 units @ $6 = 300
350 units $2,400

(b) Average Cost: Ending inventory $1,960

$5,600 ÷ 1,000 = $5.60 per unit × 350 units = $1,960

(c) FIFO: Cost of goods sold $3,200

Cost of goods available – Ending Inventory = Cost of goods sold

$5,600 – $2,400 = $3,200

Proof: 100 units @ $4 = $ 400

500 units @ $5 = 2,500
50 units @ $6 = 300
650 units $3,200

Average: Cost of goods sold $3,640

Proof: Cost of goods available – Ending Inventory = Cost of goods sold

$5,600 – $1,960 = $3,640

Profit would have been $440 ($3,640 vs. $3,200) greater if the company used FIFO instead of
average.

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*Ex. 127
Harmony Corporation uses the periodic inventory system and had the following inventory
information available:
Units Unit Cost Total Cost
Jan 1 Beginning inventory 15 $4.00 $ 60
20 Purchase 60 4.40 264
Jul 25 Purchase 30 4.20 126
Oct 20 Purchase 45 4.80 216
150 $666

A physical inventory count on December 31 showed that there were 50 units on hand.

Instructions
Answer the following independent questions and show calculations supporting your answers:
(a) Assume that the company uses FIFO. The value of the ending inventory at December 31 is
$__________.
(b) Assume that the company uses average cost. The value of the ending inventory on December
31 is $__________.
(c) Assume that the company uses average cost. The value of cost of goods sold for the year
ended December 31 is $__________.
(d) Assume that the company uses FIFO. The value of the cost of goods sold for the year ended
December 31 is $__________.

*Solution 127 (20 min.)

(a) FIFO: Ending inventory $237
45 units @ $4.80 = $216
5 units @ $4.20 = 21
50 units $237

(b) Average Cost: Ending inventory $222

$666 ÷ 150 = $4.44 per unit × 50 units = $222

(c) Average Cost: Cost of Goods Sold

Cost of goods available – Ending Inventory = Cost of goods sold

$666 – $222 = $444

(d) FIFO: Cost of goods sold $429

Cost of goods available – Ending Inventory = Cost of goods sold

$666 – $237 = $429

Proof: 15 units @ $4.00 = $ 60

60 units @ $4.40 = 264
25 units @ $4.20 = 105
100 units $429

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MATCHING

128. Match the items below by entering the appropriate code letter in the space provided.

A. Merchandise inventory F. First-in, first-out (FIFO)

B. Cost G. Periodic
C. FOB shipping point H. Average cost
D. FOB destination I. Perpetual
E. Specific identification method J. Inventory turnover

1. Cost of goods sold is determined at the time of each sale in a ___ inventory system.

2. ___ consists of goods ready for sale to customers by retailers and wholesalers.

3. If goods are sold ___ and are in transit at the end of the period, they should be included in the
buyer’s inventory.

4. If goods are sold ___ and are in transit at the end of the period, they should be included in the
seller’s inventory.

5. Each of the inventory cost methods used in a perpetual inventory system may be used in a(n)
___ inventory system.

6. The ___ method tracks the actual physical flow for each inventory item available for sale.

7. Ending inventory consists of the most recent inventory purchases in the ___ cost method.

8. The same unit cost is used to determine the cost of inventory and cost of goods sold in the ___
cost method.

9. Inventory is valued on the statement of financial position at the lower of ___ and net realizable
value.

10. The ___ measures the number of times the inventory sold during the period.
ANSWERS TO MATCHING
1. I

2. A

3. C

4. D

5. G

6. E

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7. F

8. H

9. B

10. J

SHORT-ANSWER ESSAY QUESTIONS

S-A E 129
Lucia Kraus and Tren Lee are department managers in the housewares and shoe departments,
respectively, for Beatons, a large department store. Tren has observed Lucia taking inventory
from her own department home, apparently without paying for it. He hesitates confronting Lucia
because he is due to be promoted, and needs Lucia's recommendation. He also does not want
to notify the company management directly, because he doesn't want an ethics investigation on
his record, believing that it will give him a “goody-goody” image. This week, Lucia tried on
several pairs of expensive running shoes in her department before finding a pair that suited her.
She did not, however, buy them. That very pair was missing this morning.
Beatons recently replaced its old periodic inventory system with a perpetual inventory system
using scanners and bar codes. In addition, the annual physical inventory count is to be replaced
by a monthly inventory conducted by an independent firm. On hearing the news of the changes,
Tren relaxes. "The system will catch Lucia now," he says to himself.

Instructions
(a) Who are the stakeholders in this situation?
(b) Is Tren's attitude justified? Why or why not?
(c) What, if any, action should Tren take now?

Solution 129
(a) The stakeholders in this situation include
Lucia Kraus
Tren Lee
Company management
Bankers and other parties who might rely on the financial statements

(b) Tren's attitude is not justified. The system will only be able to detect that merchandise is
missing, but will not be able to determine who took it.

(c) Tren should notify his superiors at once. He has knowledge of what may be criminal acts, and
by concealing them, he is very close to becoming a party to the acts. Tren's apparent fear of not
being promoted because of a “goody-goody” image seems unjustified. It would seem more likely
that Tren's refusal to accept unethical (and illegal) acts by others would make him a more
valuable manager. He may even be jeopardizing his career with Beatons if someone else
reports Lucia's actions. The resulting investigation may implicate Tren because of his failure to
notify the proper authorities in a timely manner.

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S-A E 130
Why do you think a business will take goods on consignment, rather than purchasing them
outright?

Solution 130
Two common reasons for taking goods on consignment are to keep inventory costs down and to
avoid buying inventory that the business may not be able to sell. Consignments will also keep
the inventory turnover ratio higher. Consignments are commonly entered into by used clothing
and sporting goods stores, art galleries, and antique dealers.

S-A E 131
FIFO and average cost are the two most commonly used cost methods in Canada. The
amounts assigned to the same inventory items on hand may be different under each cost
method. Assuming a perpetual inventory system, explain the difference in the cost of the ending
inventory under FIFO and average cost when prices of inventory items purchased during the
period have (1) been increasing, (2) been decreasing, and (3) remained constant.

Solution 131
The FIFO cost formula method determines cost of goods sold using the earliest purchase cost.
The amount left in inventory represents the cost of the most recent purchase(s). The average
cost method determines the cost of goods sold using an average cost calculated at the date of
each purchase. The amount left in inventory represents the same (moving) average cost.
If the FIFO cost method is used and prices during the period are increasing, the ending
inventory value under FIFO will be greater than under average cost. Likewise, if the FIFO cost
method is used and prices during the period are decreasing, the ending inventory under FIFO
will be less than under average. If prices remain constant, then there will be no difference in the
ending inventory values.

S-A E 132
The general manager of Winnipeg Manufacturing Corp. wants to use the specific identification
method for the machinery the company manufactures (all of which have a unique serial
number), and average cost for the parts inventory. The controller, on the other hand, insists that
Winnipeg must use the same cost determination method for all the company’s inventory,
“otherwise, we won’t be following the principle of consistency.” Who do you think is right here?
Give your rationale.

Solution 132
They are both right. It is acceptable to use two different inventory cost determination methods
for different types of inventory, as long as the company is consistent. Specific identification is
normally used for items that are not interchangeable and can be easily tracked (such as the
machinery which can be identified by serial number). Since parts can be interchanged easily
and it would be prohibitively expensive to track each one separately, average cost would be an
acceptable method to use.

S-A E 133
Vu Mobutu, a new employee of Crafter's Paradise, recorded $3,000 in consigned goods
received as part of the company's January 2015 inventory. The goods were received one day

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after the end of the month, but Vu reasoned that the goods should be included in inventory
sooner because Crafter's paid the freight. The mistake was brought to his attention by the
purchasing department who said the goods should not have been recorded as Crafter’s
inventory at all. Vu told Sun Ying, the purchasing supervisor, that nobody needed to worry,
because the mistake would cancel itself out the following month. In Vu's opinion, there was no
reason to get everyone excited over nothing, especially since it was monthly, and not annual,
financial statements that were affected. Sun Ying has reported the problem to the accounting
department.

Instructions
You are Vu's supervisor. Write a memo to Vu explaining why the error should have been
corrected.

Solution 133

MEMO

TO: Vu Mobutu, Accounting Department

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FROM:Supervisor

DATE: March 12, 2015

It has come to my attention that $3,000 in consigned goods were included in the inventory reported in
our January financial statements. You were informed that this amount should be removed from
inventory, which you did not do, apparently believing that February's entries would correct the
error.

The error would have been corrected in February if it were only a matter of your recording inventory in
the wrong month. January's inventory and expenses would have been overstated, and
February's understated, but the net effect would have been zero. Since the $3,000 is a fairly
large amount, however, that still would not have been appropriate.

The error you made, however, was to enter into inventory goods that the company did not own, and will
not own. Consigned goods are owned by the consignors until purchased by customers. We only
provide our shops for the consignors to sell their goods, and we collect a fee for doing so.

Please correct the error at once. We may need to notify some of the other departments of the error as
well. Please arrange to meet with me in my office as soon as possible to discuss the matter.

(signature)

S-A E 134
Winter Wonderland Ltd. is a private company that sells winter sports equipment. Its year end is
June 30, which is the off-season for its products. Matilda Eisenberg, the company's new
controller, has decided to mark all inventory down by 20% for the current year end. Her theory is
that sales are slow at this time of year and, therefore, inventory should be less. There is no
indication based on prior years that inventory will be sold at less than cost. Matilda says the
write-down is necessary and justifies it based on the rule of reporting inventory at lower of cost
and net realizable value. She also points out that it will produce the added benefit of paying less
income tax.

Instructions
Is the controller's treatment appropriate? Why or why not?

Solution 134
The controller's treatment is not appropriate. Sales are slow because it is the off-season. It
doesn't mean there is a decline in the net realizable value or that net realizable value will fall
below cost. It is appropriate to use the lower of cost and net realizable value rule only when
there is evidence that the net realizable value has declined below cost. The facts in this case,
including information from previous years, do not support a write-down. The fact that Winter
Wonderland is a private company or that the write-down will reduce income tax is not relevant.
In any case, even if the inventory were written down and the value recovered the following year
(assuming the inventory was still on hand), the write-down would have to be reversed.

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LEGAL NOTICE

Copyright © 2014 by John Wiley & Sons Canada, Ltd. or related companies. All rights
reserved.

The data contained in these files are protected by copyright. This manual is furnished
under licence and may be used only in accordance with the terms of such licence.

The material provided herein may not be downloaded, reproduced, stored in a retrieval
system, modified, made available on a network, used to create derivative works, or
transmitted in any form or by any means, electronic, mechanical, photocopying,
recording, scanning, or otherwise without the prior written permission of John Wiley &
Sons Canada, Ltd.

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