Exam 19 December 2020, questions and answers PDF

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CHAPTER 8 INVENTORY CHAPTER STUDY OBJECTIVES 1. Understand inventory from a business perspective. It is important to understand the nature of the various types of businesses that have significant inventory as well as the different types of inventory. Retailers, manufacturers, and wholesalers generally carry significant amounts of inventory. However, different companies have different business models. For example, some manufacturers follow a just-in-time strategy and carry very little inventory on hand. Only one inventory account, Merchandise Inventory, appears in the financial statements of a merchandising concern. A manufacturer normally has three inventory accounts: Raw Materials, Work in Process, and Finished Goods. There may also be an inventory account for factory or manufacturing supplies. Management must manage inventory levels in order to ensure sufficient choice and quantities to meet customer needs yet keep costs to a minimum. The financial statements need to provide information about all of this. 2. Define inventory from an accounting perspective. Differing companies have different types of inventories including securities, land for development, work in progress, grain, and other. For accounting purposes, inventory is defined as an asset that is held for sale in the ordinary course of business or for the production of such inventory (including raw materials, work in process, and supplies). Special guidance and/or industry practice exists for inventories of financial instruments, construction in progress, biological assets, agricultural products, mineral products, inventories held by producers of agricultural and forest producers, and inventories held by commodity broker-traders. 3. Identify which inventory items should be included in ending inventory. Inventory is included on the balance sheet of the entity that has substantially all of the risks and rewards of ownership, which is generally the company that has possession and legal title to the goods. Professional judgement must be used to determine whether substantially all of the risks and rewards have passed. For instance, consigned goods remain the property of the consignor. Purchase commitments are generally not recognized unless onerous. 4. Identify the effects of inventory errors on the financial statements and adjust for them. If the ending inventory is misstated, (1) the inventory, retained earnings, working capital, and current ratio in the balance sheet will be incorrect; and (2) the cost of goods sold and net income in the income statement will be incorrect. If purchases and inventory are misstated, (1) the inventory, accounts payable, and current ratio will be incorrect; and (2) purchases and ending inventory will be incorrect. 5. Determine the components of inventory cost. Inventory costs include all costs of purchase, conversion, and other costs incurred in bringing the inventories to the present location and condition necessary for sale. Such charges include freight charges on goods

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8 - 2Test Bank for Intermediate Accounting, Eleventh Canadian Edition

purchased, other direct costs of acquisition, and labour and other direct production costs incurred in processing the goods up to the time of sale. Manufacturing overhead costs are allocated to inventory based on the normal capacity of the production facilities. Interest and asset retirement costs may be included as part of the cost of inventory in some circumstances. 6. Distinguish between perpetual and periodic inventory systems and account for them. Under a perpetual inventory system, a continuous record of changes in inventory is maintained in the Inventory account. That is, all purchases into and transfers of goods out of the account are recorded directly in the Inventory account as they occur. No such record is kept under a periodic inventory system. Under the periodic system, year-end inventory is determined by a physical count, and the amount of ending inventory and cost of goods sold is based on this count. Even under the perpetual system, an annual count is needed to test the accuracy of the records. 7. Identify and apply GAAP cost formula options and indicate when each cost formula is appropriate. The specific identification method is used to assign costs for items of inventory that are not ordinarily interchangeable or that are produced for specific projects. The weightedaverage or first-in, first-out cost formula is used to assign costs to other types of inventory. All inventory items that have a similar nature and use to the entity apply the same cost formula. 8. Explain why inventory is measured at the lower of cost and market, and apply the lower of cost and net realizable value standard. Current assets should not be reported on the balance sheet at a higher amount than the net cash that is expected to be generated from their use or sale. When this amount is less than “cost,” inventory is written down and the loss in value is recognized in the same period as the decline. Net realizable value is the estimated selling price in the ordinary course of business reduced by the expected costs to complete and sell the goods. Ordinarily, each item’s cost and NRV are compared and the lower value is chosen. However, items that are related to each other and have similar purposes, that are produced and marketed in the same geographical area, and that cannot be evaluated separately from other items may be grouped and the lower of the group’s cost and net realizable value is chosen. 9. Identify inventories that are or may be valued at amounts other than the lower of cost and net realizable value. Inventories of financial instruments, biological assets related to agricultural activity, agricultural produce at the point of harvest and after harvest, inventories held by producers of agricultural and forest producers, mineral products, and inventories of commodity broker-traders all may be accounted for at other than the lower of cost and net realizable value. 10. Apply the gross profit method of estimating inventory. Ending inventory is determined by deducting an estimate of cost of goods sold from the actual cost of goods available for sale. Cost of goods sold is estimated by multiplying net sales by the percentage of cost of goods sold to sales. This percentage is derived from the gross profit percent: 100% – gross profit percentage = cost of goods sold percentage.

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11. Identify how inventory should be presented and the type of inventory disclosures required by IFRS and ASPE. ASPE requires disclosure of how cost is determined, inventory that is pledged as security, the amount charged to the income statement as expense in the period, and the inventories’ carrying value by category. Additional information is required by IFRS, including details about inventory impairment writedowns and any recoveries, the circumstances responsible for these, and the carrying amounts and reconciliations of items measured at NRV or fair value. Biological assets must be presented separately on the balance sheet under IFRS. In general, cost of sales is presented on the income statement under both IFRS and ASPE unless expenses are grouped by nature. 12. Explain how inventory analysis provides useful information and apply ratio analysis to inventory. Common ratios that are used in the management and evaluation of inventory levels are the inventory turnover and a related measure, average days to sell the inventory, often called the average age of inventory. This is useful information as excessive investment in inventory is expensive to carry, yet too little inventory results in lost sales and dissatisfied customers. 13. Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future. IFRS and ASPE are substantially harmonized. IFRS has specific guidance on the measurement of agricultural and construction inventories, the capitalization of borrowing costs on qualifying assets, and on onerous contracts. Asset retirement obligations may be treated differently under IFRS. No major changes are expected in the near future. 14. Apply the retail method of estimating inventory. The retail inventory method is based on converting the retail price of ending inventory by a cost-to-retail percentage, which is derived from information in the accounting and supplementary records. To use this method, records must be kept of the costs and retail prices for beginning inventory, net purchases, and abnormal spoilage, as well as the retail amount of net markups, net markdowns, and net sales. Which items go into the numerator and denominator of the cost-to-retail ratio depends on the type of inventory valuation estimate that is wanted. 15. Identify other primary sources of GAAP for inventory.

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8 - 4Test Bank for Intermediate Accounting, Eleventh Canadian Edition

MULTIPLE CHOICE—Conceptual Answer c a d c b d c d a b a b d b a c d c b a c a a d a a a d c b d b a c d b a d a c b b c c a d c

No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47.

Description Inventory categories of a manufacturer Inventory categories of a retailer Monitoring of inventory Calculation of cost of goods available for sale Monitoring of inventory Monitoring of inventory Monitoring of inventory Purchase commitment Loss on purchase commitment Recognition of ownership Classification of goods in transit Classification of goods in transit Classification of goods in transit Goods on consignment Effect of consignment goods on financial statements Effect of consignment goods on financial statements Accounting for potential sales returns Identify a product financing arrangement Identify ownership under product financing arrangement. Purchase commitments Definition of onerous contract Material purchase commitments Effect of understating inventory on financial statements Effect of understating purchases and ending inventory Effect of inventory errors Effect of inventory errors Effect of understating inventory on financial statements Use of Purchases Discounts account Effect on income of gross vs. net method Net method and cost/benefit constraint Vendor rebates Identification of product costs Concept of product costs Conversion costs Costs to charge to expense Interest capitalization in manufacturing inventory Classification of factory overhead costs Borrowing costs Concept of standard costs Definition of basket purchase Method to use for basket purchases Cost allocation Borrowing costs Perpetual inventory system characteristics Periodic inventory system characteristics Accounts used with a periodic system Perpetual inventory system characteristics

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a

48.

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Computation of net income

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8 - 6Test Bank for Intermediate Accounting, Eleventh Canadian Edition

MULTIPLE CHOICE—Conceptual (cont’d) Answer c b a c a b d b b c b a a b c a c c d c b a d b c b d b b c a a c d a d c b a d

No. 49. 50. 51. 52. 53. 54. 55. 56 57 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. *83. *84. *85. *86. *87. *88.

Description Perpetual system – moving-average cost Specific indentification cost formula characteristics Nature of FIFO valuation of inventory FIFO in periodic vs perpetual system Weighted average cost formula characteristics FIFO cost formula characteristics Objectives underlying inventory standards Inventory costing method Caculate ending inventory balance Departure from accounting for inventory at cost Appropriate use of net realizable value Net realizable value “Replacement cost” definition of “market” Definition of net realizable value Appropriate use of net realizable value Valuation of inventory at net realizable value Valuation of inventory Calculation of year-end adjusting entry Valuation of inventory above cost Valuation at fair value less costs to sell Accounting for bearer plants Valuation of inventory at net realizable value Appropriate use of the gross profit method Appropriate use of the gross profit method Calculation of gross profit percentage Appropriate use of the gross profit method Gross profit method Gross profit method Gross profit method Presentation and disclosure of inventory Inventory disclosure Calculation of inventory turnover ratio Calculation of inventory turnover ratio Calculation of average days to sell inventory Cost-to-retail ratio Retail inventory method Conventional retail method Markdowns and the conventional retail method Markups and the conventional retail method Use of the retail method

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

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MULTIPLE CHOICE—Computational Answer c d d c d c a d a b c d a a a d c b c b b b a a c b a c c d a c a a c b a d d d c d a c b a

No. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117. 118 119. 120. 121. 122. 123. 124. 125. 126. 127. 128. 129. *130. *131. *132. *133. *134.

Description Calculate cost of goods available for sale Calculate sales given manufacturing cost information Calculate ending inventory Calculate beginning inventory Calculate total sales from cost information Calculate accounts payable at year end Calculate accounts payable at year end Calculate accounts payable at year end Calculate cost of sales Inventory errors Inventory errors Effect of inventory and depreciation errors on income Effect of inventory and depreciation errors on retained earnings Effect of inventory errors on working capital Account for inventory errors Account for inventory errors Accounting for a purchase return (net method) Adjust account payable using the net method Calculate inventoriable cost Calculate unit cost using moving-average method Adjusting entry for inventory shortage Journal entries for periodic inventory system Journal entries for perpetual inventory system Calculate ending inventory using weighted average Calculate ending inventory using moving average Calculate ending inventory using FIFO Calculate ending inventory using average cost Journal entries for perpetual inventory system Calculate cost of goods sold using FIFO Calculate ending inventory using FIFO Adjusting entry to value inventory at NRV Adjusting entry to value inventory at NRV Recognizing a loss due to application of lower of cost and NRV Markup on cost equivalent to markup on selling price Estimate ending inventory using gross profit method Estimate ending inventory using gross profit method Estimate ending inventory using gross profit method Estimate cost of inventory destroyed by fire Estimate cost of inventory lost by theft Calculate inventory turnover ratio Calculate average inventory Basis of cost-to-retail ratio Calculate ending inventory at retail Calculate ending inventory using conventional retail method Calculate ending inventory using retail method Calculate ending inventory using retail method

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8 - 8Test Bank for Intermediate Accounting, Eleventh Canadian Edition

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

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EXERCISES Item E8-135 E8-136 E8-137 E8-138 E8-139 E8-140 E8-141 E8-142 E8-143 E8-144 E8-145 E8-146 E8-147 E8-148 E8-149 E8-150 E8-151 E8-152 E8-153 E8-154 E8-155 E8-156 E8-157 E8-158 E8-159 E8-160 E8-161 E8-162 E8-163 E8-164 E8-165 E8-166 *E8-167 *E8-168 *E8-169

Description Inventory management Definitions Inventory journal entries Inventories from an accounting perspective Accounting definition Items to be included in ending inventory Terminology Impact of accounting errors on financial statement items and ratios Purchases and inventory misstated Vendor rebates Recording purchases at net amounts Inventory cost flow assumptions Year-end entries to update inventory accounts FIFO cost formula Perpetual FIFO Periodic FIFO Journal entries for perpetual inventory system FIFO and LIFO inventory methods Inventory cost flow assumptions Adjustments to lower of cost and NRV Lower of cost and net realizable value (NRV) Lower of cost and net realizable value (NRV) Accounting for biological & agricultural assets Accounting for biological & agricultural assets Gross profit method Gross profit method Gross profit method Gross profit method Inventory presentation and disclosures under IFRS & ASPE Inventory presentation and disclosures under IFRS Inventory analysis and ratios Interpretation of inventory ratios Retail method of accounting for inventory Retail method of accounting for inventory Conventional retail inventory method

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

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Test Bank for Intermediate Accounting, Eleventh Canadian Edition 8 - 10

PROBLEMS Item P8-170 P8-171 P8-172 P8-173 P8-174 P8-175 P8-176 P8-177 *P8-178 *P8-179

Description Theory (executory vs onerous contract) Inventory cut-off Inventory errors Analysis of errors Accounting for purchase discounts Year-end entries to update inventory under periodic system Gross profit method Gross profit method Retail inventory method Conventional retail inventory method

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

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MULTIPLE CHOICE—Conceptual 1. A manufacturing company typically maintains the following inventory account(s): a) Merchandise Inventory. b) Raw Materials and Work in Process only. c) Raw Materials, Work in Process and Finished Goods. d) Work in Process and Merchandise Inventory. Answer: c Difficulty: Easy Learning Objective: Understand inventory from a business perspective. Section Reference: Understanding Inventory CPA: Financial Reporting Bloomcode: Knowledge 2. A hardware retailer typically maintains the following inventory account(s): a) Merchandise Inventory. b) Raw Materials and Work in Process only. c) Raw Materials, Work in Process and Finished Goods. d) Work in Process and Merchandise Inventory. Answer: a Difficulty: Easy Learning Objective: Understand inventory from a business perspective. Section Reference: Understanding Inventory CPA: Financial Reporting Bloomcode: Knowledge 3. Companies that carry inventories must carefully monitor inventory in order to a) have the greatest selection available so customers can always find what they want. b) minimize carrying costs and keep inventory levels high so stockouts never occur. c) keep inventory levels high to maximize profits. d) minimize carrying costs and meet customer demands. Answer: d Difficulty: Medium Learning Objective: Understand inventory from a business perspective. Section Reference: Understanding Inventory CPA: Financial Repo...