ACTG 221 Exam 2

Under the perpetual inventory method,

• a. assets increase when inventory is purchased on account.

• b. ignoring the effects of revenue recognition, assets decrease when inventory is sold.

• c. ignoring the effects of revenue recognition, stockholders’ equity increases when inventory is sold.

• d. both a and b are correct.

Answer explanation

Under the perpetual inventory method, the inventory account is increased when inventory is purchased and decreased when inventory is sold. Thus, (a) assets increase when inventory is purchased on account and (b) ignoring the effects of revenue recognition, assets decrease when inventory is sold are both correct.

Beginning inventory 200 units @ $1.20

First purchase 400 units @ $1.30

Second purchase 250 units @ $1.40

Sales 550 units @ $2.00

Assuming a LIFO cost flow, the amount of ending inventory reported on the balance sheet would be

• $240

• $370

• $130

• $415

Answer explanation

There were 850 units available for sale (200 units in beginning inventory + first purchase 400 units + second purchase 250 units). Ending inventory consisted of 300 units (850 units available for sale – 550 units sold). LIFO ending inventory consists of the 200 units in beginning inventory at $1.20 per unit ($240) plus 100 units from the first purchase of inventory at $1.30 ($130). Ending inventory would be $240 + $130 = $370.

Beginning inventory 200 units @ $1.20

First purchase 400 units @ $1.30

Second purchase 250 units @ $1.40

Sales 550 units @ $2.00

Assuming a weighted average cost flow, the amount of ending inventory reported on the balance sheet would be closest to:

• $392

• $415

• $370

• $417

Answer explanation

Cost of goods available for sale = $1,110 [(beginning inventory 200 units x $1.20 = $240) + (first purchase 400 units x $1.30 = $520) + (second purchase 250 units x $1.40 = $350). Cost of goods available for sale $1,110 / 850 units available for sale = $1.306 (rounded) weighted-average cost per unit. $1.306 weighted-average cost per unit x 300 units in ending inventory = $391.8 which is closest to $392.

Beginning inventory 200 units @ $1.20

First purchase 400 units @ $1.30

Second purchase 250 units @ $1.40

Sales 550 units @ $2.00

Assuming a FIFO cost flow, the amount of gross margin reported on the income statement would be

• $415

• $695

• $405

• None of the above

Answer explanation

Sales revenue = $1,100 (550 units x $2.00). Cost of goods sold using FIFO = $695 [(beginning inventory 200 units sold x $1.20 = $240) + (first purchase 350 units sold x $1.30 = $455)]. Sales revenue $1,100 – cost of goods sold $695 = Gross margin $405.

Aaron Co. purchased $5,000 of inventory on account with payment terms of 2/10, n/30. The goods were delivered FOB shipping point. Aaron paid freight costs of $200 in cash. Aaron paid for the goods within the discount period. Assuming a beginning inventory balance of zero, what would be the balance in the inventory account after the purchase and payment for inventory were recorded? Aaron Co. keeps perpetual inventory records and uses the gross method of accounting for inventory purchases.

• $4,900

• $5,300

• $5,100

• $4,700

Answer explanation

The purchase of inventory increased the inventory account $5,000. The inventory account was also increased $200 for freight costs. The inventory account was decreased $100 ($5,000 x 2%) for paying within the discount period. $5,000 + $200 - $100 = $5,100.

Zhang Co. purchased $2,000 of inventory on account. This inventory was sold for $3,000 cash. The amount of gross margin reported on the income statement and the amount of net cash inflow from operating activities reported on the statement of cash flows would be 

• $1,000 / $3,000.

• $3,000 / $1,000.

• $1,000 / $-0-.

• $-0- / $1,000.

Answer explanation

Sales price of inventory $3,000 - $2,000 cost of inventory sold = gross margin $1,000. Net cash inflow from operating activities $3,000 which is the amount of cash received from sale of inventory.

The following information was taken from the records of Cindy’s Candies:

Item A: 50 units, cost per unit: $24, market value per unit: $18

Item B: 20 units, cost per unit: $40, market value per unit: $42

Item C: 10 units, cost per unit: $20, market value per unit: $10

Cindy’s reports inventory at the lower of cost or market (applied individually). The necessary adjusting entry would

• reduce assets and stockholders’ equity by $400.

• increase assets and stockholders’ equity by $2,200.

• reduce assets and stockholders’ equity by $360.

• reduce assets and increase liabilities by $400.

Answer explanation

Market value per unit is lower than cost per unit for items A and C. Item A would be valued at $900 (50 units x $18) which is $300 less than its $1,200 cost (50 units x $24). Item C would be valued at $100 (10 units x $10) which is $100 less than its $200 cost (10 units x 20). Overall, inventory would be reduced $400 (item A $300 + item C $100) and cost of goods sold would increase $400 for the inventory loss. The necessary adjusting entry would reduce assets and stockholders’ equity by $400.

Sanchez Co. sold for $12,000 inventory that had cost $8,000. Freight terms for the sale were FOB destination and payment terms were 1/10, n/30. Sanchez records sales transactions at the gross amount. Sanchez paid freight costs of $400 in cash. The receivable was collected within the discount period. Based on this information alone, the amount of gross margin would be

• $3,480

• $3,880

• $3,600

• $4,000

Answer explanation

Revenues $12,000 - sales discounts $120 = Net sales $11,880 – cost of goods sold $8,000 = gross margin $3,880.

Xu Co. purchased $5,000 of inventory on account. Assuming that Xu Co. uses the perpetual inventory method, which of the following entries would it make to record this transaction?

• Debit purchases / credit accounts payable

• Debit accounts payable / credit purchases

• Debit accounts payable / credit inventory

• Debit inventory / credit accounts payable

Answer explanation

The inventory account is increased when inventory is purchased following the perpetual inventory method. A purchase of inventory on account is recorded with a debit inventory / credit accounts payable.

Sandy Bay Merchandising Co. sold for $12,000 cash inventory that had cost $10,000. Assuming Sandy Bay uses the perpetual inventory method, the entries to record this transaction would 

• decrease stockholders’ equity by $10,000.

• increase assets by $2,000.

• increase net income by $12,000.

• increase expenses by $2,000.

Answer explanation

Assets increase $2,000 (cash increases $12,000 and inventory decreases $10,000).