FAR-Inventory Fixed Assets & Intangible Quiz

During January Year 3, Metro Co., which maintains a perpetual inventory system, recorded the following information pertaining to its inventory:

Under the LIFO method, what amount should Metro report as inventory at January 31, Year 3?

• $1,300

• $2,700

• $3,900

• $4,100

Answer explanation

Entities with inventory must adopt an inventory system (eg, perpetual, periodic) and an inventory costing method (eg, FIFO, LIFO, average cost). Under a perpetual system, the inventory is continuously updated after every applicable transaction (eg, purchase, sale, returns).

When LIFO is used, the last items purchased are assumed to be sold first. Under the perpetual system, the most recently purchased items at the time of sale are used to determine COGS. If the units sold exceeds the units from the last purchase, then the next most recent purchase is used.

Here, Metro has 2,000 units (1,000 + 600 + 400) available for sale and one sale for 900 units, resulting in an ending inventory of 1,100 units. Metro's cost of goods available for sale (COGAS) is $4,800 ($1,000 + $1,800 + $2,000). The simplest way to compute the cost of inventory is to subtract the COGS from the COGAS. The cost of ending inventory is therefore $2,700.

What is the appropriate treatment for goods held on consignment?

• a. The goods should be included in ending inventory of the consignor.

• b. The goods should be included in ending inventory of the consignee.

• The goods should be included in cost of goods sold of the consignee only when sold.

• The goods should be included in cost of goods sold of the consignor when transferred to the consignee.

Answer explanation

A retailer or dealer (ie, buyer) may not want to assume the financial risks of purchasing certain products (eg, books, works of art, expensive items) for resale (ie, inventory). As an alternative, a buyer may choose to enter a consignment arrangement with a seller (eg, wholesaler, artist).

Under such an arrangement:

• the consignee receives the goods (ie, has physical possession of them) but does not purchase them from the consignor(seller). As such, the goods are never included in the consignee's inventory or COGS (Choices B and C).

• the consignor retains legal ownership and reports the inventory on its balance sheet until sold by the consignee (Choice D).

• transportation (eg, shipping, insurance) costs incurred for delivery to the consignee are added to the consignor's total cost of inventory.

• the consignee agrees to sell the merchandise on behalf of the consignor for a commission, plus any reimbursable costs (eg, advertising, credit card processing fees). These are selling expenses to the consignor and are treated as period costs when the sales revenue is recognized.

The original cost of a LIFO inventory item is below both replacement cost and net realizable value. The net realizable value less normal profit margin is below the original cost. Under the lower of cost or market method for LIFO or retail method inventories, the inventory item should be valued at

• a. Replacement cost.

• b. Net realizable value.

• c. Net realizable value less normal profit margin.

• d. Original cost.

Answer explanation

If LIFO or the retail inventory method is used, then the lower of cost or market (LCM) is applied. For all other inventory methods, a simplified lower of cost or NRV rule applies. LCM compares the historical cost (ie, purchase price) to the current market value. Although market value is usually replacement cost, it is subject to a ceiling and floor limitation:

• The ceiling is NRV (sales price − costs required to complete the inventory and any disposal costs), which is the maximum amount that may be reported as market.

• The floor is the lowest amount that may be reported as market. It is the NRV (ceiling) less profit margin.

Here, because the floor is below cost, the market value would be either replacement cost or NRV (=ceiling). The original cost is below both replacement cost and ceiling. So, regardless of the market value, the inventory is reported at the lower value or cost.

Vane Co.'s trial balance for the year ended December 31, Year 3, included the following:

Cost of goods sold $240,000

Sales commissions $50,000

Freight-out $15,000

Inventory, Year 3

January 1, $400,000

December 31, $360,000

What are Vane's Year 3 net inventory purchases?

• a. $160,000

• b. $200,000

• c. $215,000

• d. $240,000

Answer explanation

Cost of goods sold (COGS) is an expense representing the acquisition cost of all inventory units sold during a period. COGS is calculated as the difference between goods available for sale (beginning inventory plus net inventory purchases) and ending inventory. Net purchases include all costs of acquiring inventory (eg, shipping costs [freight-in], sales taxes paid).

In this scenario, beginning inventory ($400,000 on January 1), ending inventory ($360,000 on December 31), and COGS ($240,000) are known. These data can be used to calculate net inventory purchases of $200,000.

Beginning inventory $400,000　　+ Net purchases　$200,000 (plug)　= Goods available for sale $600,000

Goods available for sale $600,000 − Ending inventory ($360,000) 　 = COGS $240,000

Williams Co. has the following inventory transactions for the month of March on picture on the left.

What amount should Williams report as cost of goods sold on the income statement for the month of March under the perpetual and periodic inventory systems?

• a

• b

• c

• d

Answer explanation

The average cost formula can be can used in a perpetual or periodic system as follows:

• In a perpetual system, the average cost method is called the moving average method since a new average unit cost must be calculated each time goods are purchased. The new unit cost is used for the COGS until the next purchase.

• In a periodic system, the average cost method is the weighted average cost method. At the end of the period, one average cost is calculated and used to value the units sold.

In this scenario, Williams Co. has one sale of 5,500 units. Under the perpetual system, the average unit cost of $2.60 is calculated at the time of the sale, resulting in a COGS of $14,300. Under the periodic system, the average unit cost of $3 is calculated at the end of the period, resulting in a COGS of $16,500.

Kauf Co. had the following amounts related to the sale of consignment inventory:

Cost of merchandise shipped to consignee $72,000

Sales value for two-thirds of inventory sold by consignee $80,000

Freight cost for merchandise shipped $7,500

Advertising paid for by consignee, to be reimbursed $4,500

10% commission due the consignee for the sale $8,000

What amount should Kauf report as net profit (loss) from this transaction for the year?

• ($12,000)

• $8,000

• $14,500

• $32,000

Answer explanation

Usual consignment agreement :

• Consignee receives (has physical possession of) but does not purchase the goods from the consignor (seller).

• Consignor retains legal ownership and reports the inventory on its balance sheet until the goods are sold by the consignee. Transportation costs incurred for delivery to the consignee are added to the cost of inventory.

• Consignee agrees to sell the merchandise on behalf of the consignor for a stated commission plus any reimbursable costs (eg, advertising, credit card processing fees). These are selling expenses to the consignor.

In this scenario, Kauf consigned inventory costing $79,500 ($72,000 + $7,500 shipping) of which two-thirds is sold. The $8,000 commission and $4,500 reimbursed advertising are selling expenses for Kauf and are treated as period costs when the sales revenue is recognized. Therefore, the gross profit from consignment sales is $14,500.

Consignment sales revenue $80,000

Less COGS (2/3 × $79,500)=($53,000)

Gross margin $27,000

Commissions ($8,000)

Advertising ($4,500)

Net profit $14,500

Which of the following inventory valuation methods produce(s) the same dollar amount result in ending inventory in both periodic and perpetual inventory systems?

• a

• b

• c

• d

Answer explanation

Since FIFO assumes that ending inventory consists of the most recent purchases, the FIFO cost flow assumption leads to the same ending inventory balance under both the perpetual and periodic systems. Under the LIFO cost flow assumption, the most recent goods purchased are assumed to be sold while older inventory is assumed to remain on hand. When using the periodic method under LIFO, it is assumed that all sales occur at the end of the period and are taken from the latest purchases. Since goods cannot be sold before they are purchased, the perpetual method will require that early sales be charged against the most recent purchases as of the date of sale and will lead to a different ending inventory balance.

Fireworks, Inc. had an explosion in its plant that destroyed most of its inventory. Its records show that beginning inventory was $40,000. Fireworks made purchases of $480,000 and had sales of $620,000 during the year. Its normal gross profit percentage is 25%. It can sell some of its damaged inventory for $5,000. The insurance company will reimburse Fireworks for 70% of its loss. What amount should Fireworks report as loss from the explosion?

• a. $15,000

• b. $18,000

• c. $35,000

• d. $50,000

Answer explanation

Fireworks' estimated ending inventory before any adjustments is $55,000, as computed in my video.

Fireworks can sell some of its damaged inventory for $5,000 (ie, salvage value) and the insurance proceeds, the net inventory loss from the explosion is $15,000.

stimated ending inventory $55,000

Less: salvage value proceeds from damaged inventory ($5,000)

Inventory loss before insurance $50,000

Less: insurance proceeds (70% × $50,000) =($35,000)

Net inventory loss $15,000

Lyon Co. estimated its ending inventory using a method based on the financial statements of prior periods in order to prepare its quarterly interim financial statements. What type of inventory system and method of estimating ending inventory is Lyon using?

• a

• b

• c

• d

Answer explanation

Companies with inventory adopt either a perpetual or periodic inventory system. Under a perpetual system, the inventory is updated continuously (ie, after every purchase, sale, and return). This allows the company to know how much inventory is on hand at any given time.

In contrast, a periodic system makes no adjustment to inventory until the end of the period, when a physical inventory count is performed. Consequently, a company must estimate its inventory during the year (for interim statements) if a periodic system is used (Choices A and B).

There are two costing methods used to estimate ending inventory: retail inventory and gross profit (Choice C).

• The retail inventory method uses the current cost of inventory and revenue (ie, sales) to estimate ending inventory.

• The gross profit method uses the company's historical gross profit percentage (derived from prior periods financial data) to determine COGS and estimate ending inventory.

If Lyon Co. used a perpetual system, it would have no need to estimate its inventory. Therefore, the company is using a periodic system. Because the method used is based on prior periods financial statements, Lyon must be using the gross profit method.

Rose Co. sells one product and uses the last-in, first-out method to determine inventory cost. Information for the month of January, Year 9, on the picture on the left.

Rose has determined that at January 31, Year 9, the replacement cost of its inventory was $8 per unit and the net realizable value was $8.80 per unit. Rose's normal profit margin is $1 per unit. Rose applies the lower of cost or market rule to total inventory and records any resulting loss. At January 31, Year 9, what should be the net carrying amount of Rose's inventory?

• a. $79,000

• b. $79,800

• c. $80,000

• d. $81,400

Answer explanation

If LIFO or the retail inventory method is used, then the lower of cost or market (LCM) rule is applied. LCM compares the historical cost (ie, purchase price) to the current market value. Although market value is usually replacement cost, it is subject to a ceiling and floor limitation.

• The ceiling or NRV (sales price − costs required to complete the inventory and any disposal costs) is the maximum amount that may be reported as market.

• The floor (NRV − profit margin) is the lowest amount that may be reported as market.

Rose must determine the cost and market values of the 10,000 [(8,000 + 12,000) − 10,000 sold) units remaining in inventory. The cost of Rose's ending inventory under LIFO is $81,400 [(2,000 × 7.90) + (8,000 × 8.20)]. The market value and carrying value of the inventory is the $80,000 replacement cost as shown in my video.