Challenge Exercises: 206-208
Matching Question: 219
IFRS Questions: 228-247
CHAPTER LEARNING OBJECTIVES
1. Describe the steps in determining inventory
... [Show More] quantities. The steps are (1) take a physical
inventory of goods on hand and (2) determine the ownership of goods in transit or on
consignment.
2. Explain the accounting for inventories and apply the inventory cost flow methods. The
primary basis of accounting for inventories is cost. Cost of goods available for sale includes
(a) cost of beginning inventory and (b) the cost of goods purchased. The inventory cost flow
methods are: specific identification and three assumed cost flow methods—FIFO, LIFO, and
average-cost.
3. Explain the financial effects of the inventory cost flow assumptions. Companies may
allocate the cost of goods available for sale to cost of goods sold and ending inventory by
specific identification or by a method based on an assumed cost flow. When prices are rising,
the first-in, first-out (FIFO) method results in lower cost of goods sold and higher net income
than the other methods. The reverse is true when prices are falling. In the balance sheet,
FIFO results in an ending inventory that is closest to current value, inventory under LIFO is
the farthest from current value. LIFO results in the lowest income taxes.
FOR INSTRUCTOR USE ONLY
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Inventories
4. Explain the lower-of-cost-or-market basis of accounting for inventories. Companies
may use the lower-of-cost-or-market (LCM) basis when the current replacement cost
(market) is less than cost. Under LCM, companies recognize the loss in the period in which
the price decline occurs.
5. Indicate the effects of inventory errors on the financial statements. In the income
statement of the current year: (a) An error in beginning inventory will have a reverse effect on
net income. (b) An error in ending inventory will have a similar effect on net income. In the
following period, its effect on net income for that period is reversed, and total net income for
the two years will be correct. In the balance sheet: Ending inventory errors will have the
same effect on total assets and total stockholders’ equity and no effect on liabilities.
6. Compute and interpret the inventory turnover ratio. The inventory turnover ratio is cost of
goods sold divided by average inventory. To convert it to average days in inventory, divide
365 days by the inventory turnover ratio.
a7. Apply the inventory cost flow methods to perpetual inventory records. Under FIFO and
a perpetual inventory system, companies charge to cost of goods sold the cost of the earliest
goods on hand prior to each sale. Under LIFO and a perpetual system, companies charge to
cost of goods sold the cost of the most recent purchase prior to sale. Under the movingaverage (average cost) method and a perpetual system, companies compute a new average
cost after each purchase.
a8. Describe the two methods of estimating inventories. The two methods of estimating
inventories are the gross profit method and the retail inventory method. Under the gross
profit method, companies apply a gross profit rate to net sales to determine estimated cost of
goods sold. They then subtract estimated cost of goods sold from cost of goods available for
sale to determine the estimated cost of the ending inventory. Under the retail inventory
method, companies compute a cost-to-retail ratio by dividing the cost of goods available for
sale by the retail value of the goods available for sale. They then apply this ratio to the
ending inventory at retail to determine the estimated cost of the ending inventory. [Show Less]