Flashcards in FAR 13 - Inventory 3 - Gross Margin/Retail Inventory/Errors/Inventory and IFRS Deck (22):
When marking up a specific line of household items for resale, a retailer computes its markup as 40% of cost. For purposes of estimating ending inventory using the gross margin method, what percentage is applied to sales when estimating cost of goods sold?
Let S be selling price and C be cost. The markup is computed on cost; therefore, C + .4C = S or 1.4C = S. Therefore, C/S = 1/1.4 = .71.
The gross margin method applies the cost to sales ratio to sales in order to derive an estimate of cost of goods sold. Subtracting the resulting estimate of cost of goods sold from the cost of goods available for sale yields an estimate of ending inventory without counting the items. This firm determines the selling price to be 140% of cost because the markup is 40% of cost. Cost plus markup yields selling price. Therefore, the cost to sales ratio is 1.00/1.40 or .71.
T/F: Beginning inventory is $40,000, net purchases are $400,000, and sales are $450,000. If the margin on cost is 30%, the ending inventory is $ 93,846.
T/F: A gross margin percentage of 55% is equivalent to a margin on cost of 122%.
T/F: A gross margin percentage of 55% implies a cost to sales ratio of 45%.
T/F: A margin on cost of 1/9 is equivalent to a gross margin percentage of 1/10.
How does the retail inventory method establish the lower-of-cost-or-market valuation for ending inventory?
A. The procedure is applied on a cost basis at the unit level.
B. By excluding net markups from the cost-to-retail ratio.
C. By excluding beginning inventory from the cost-to-retail ratio.
D. By excluding net markdowns from the cost-to-retail ratio.
D. Although the result is approximate, by excluding net markdowns from the denominator of the cost-to-retail ratio, the ratio is a smaller amount, resulting in a lower ending inventory valuation.
The retail inventory method includes which of the following in the calculation of both cost and retail amounts of goods available for sale?
A. Purchase returns.
B. Sales returns.
C. Net markups.
D. Freight in.
A. The retail method measures beginning inventory and net purchases at both cost and retail. It then applies the average relationship between cost and retail (based on beginning inventory and purchases) to ending inventory at retail to determine ending inventory at cost.
Purchase returns reduce net purchases at both cost and retail because returns represent amounts included in gross purchases that are not available for sale.
T/F: The cost to retail ratio for the average retail method is the cost of beginning inventory and purchases divided by the retail value of these two amounts plus net additional markups less net markdowns.
T/F: Freight-in increases only the numerator of the cost to retail ratio.
T/F: The FIFO retail method applies all markups and markdowns to current period purchases in computing the cost to retail ratio.
Choose the correct inclusions to the cost-to-retail ratio computation under the dollar-value LIFO retail method.
Beginning Inventory Net Markdowns
DV LIFO retail uses the FIFO (not LCM) cost-to-retail ratio. Under LIFO, a layer added during a period should reflect only the cost and retail amounts pertaining to that period. Thus, beginning inventory amounts are not used in calculating the ratio. Also, because LIFO may contain inventory layers for several preceding periods, excluding net markdowns is not an effective way to accomplish the LCM valuation objective. Thus, net markdowns are included in the cost to retail computation.
T/F: DV LIFO retail applies DV LIFO to retail dollars, and then applies the FIFO cost to retail ratio to the increase in retail inventory as measured in current period prices.
When an inventory overstatement in year one counterbalances in year two, this means:
A. There are no reporting errors, even if the overstatement is never discovered.
B. A prior period adjustment is recorded if the error is discovered in year three.
C. The year one Balance Sheet does not need to be restated if the error is discovered in year three.
D. A prior period adjustment is recorded if the error is discovered in year two.
D. Counterbalancing simply means that the effect of the inventory error in the second year is opposite that of the first year. Discovery in year two provides an opportunity for the firm to correct year two beginning retained earnings, which is overstated by the error in year one. The overstatement of inventory in year one caused cost of goods sold to be understated and income overstated in year one. The prior period adjustment, dated as of the beginning of year two, is a debit to retained earnings for the after-tax effect of the income overstatement in year one. Inventory is credited for the amount of the overstatement. This allows year two to begin with corrected balances.
A retailer failed to record a purchase of inventory on credit near the end of the current year. The goods did arrive and were included in the inventory count. The purchase will be recorded next year, when the goods are paid for. As a result,
A. Cost of goods sold is understated for the current year.
B. Net income for next year is overstated.
C. Income tax expense for the next year is overstated.
D. By the end of next year, all of the effects of the error will be automatically eliminated.
A. The error affects purchases but not ending inventory. Therefore, cost of goods sold for the current period is understated because goods available is understated. When ending inventory (which is not in error) is subtracted from goods available, cost of goods sold is understated by the amount of the understatement in purchases.
T/F: A firm overstated its ending inventory in Year 1. This mean that retained earnings at the end of year 1 is overstated.
In October of year one, a firm committed to a purchase of inventory at a total cost of $26,000. The contract is irrevocable and specifies a delivery date in March of year two. At the end of year one, the market value of the inventory under contract is worth $23,000 at current cost. Choose the correct reporting for the year one financial statements:
A. A liability of $3,000 is reported in the Balance Sheet.
B. An extraordinary loss of $3,000 is reported in the Income Statement.
C. The potential loss on contract is reported in the footnotes, but there is no recognition in the financial statements.
D. No reporting is required.
A. The firm has committed to a purchase for a total cost of $26,000, but at year-end, the value of the item to be received is $3,000 less. The firm cannot postpone the loss and liability recognition because the reduction in the firm's earnings and net assets has already occurred. The economic events causing the loss have occurred as of the Balance Sheet date.
T/F: If a contract for a purchase commitment cannot be revised based on changing market conditions, a footnoted contingent liability is appropriate, but an accrued contingent liability is not.
T/F: If a contract for a purchase commitment can be revised based on changing market conditions, a footnoted contingent liability is appropriate, but an accrued contingent liability is not.
T/F: A contract for a purchase commitment specifies a price of $10 per unit for a commodity. The price is fixed by contract. As of the balance sheet date, the contract had not been executed, and the market price of the commodity had decreased to $7. The firm should report a loss of $3 per unit in the income statement.
How is inventory under IFRS reported?
Inventory under IFRS is reported at the lower of cost or net realizable value (NRV) where NRV is the selling price less the cost to complete or dispose.
Net realizable value is defined by IAS 2 as "the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimate costs necessary to make the sale."
T/F: Under IFRS accounting for inventory, it is permitted to reverse the previous write down of inventory to net realizable value.