Question #1 (AICPA.

931104FAR-TH-FA)
The lower of cost or market rule for inventories may be applied to total inventory, to groups
of similar items, or to each item.
Which application generally results in the lowest inventory amount?
A.  All applications result in the same amount.
B.  Total inventory.
C.  Groups of similar items.
D.  Separately to each item.
When LCM is applied to each item, the lowest overall inventory amount is achieved
because in no case will market exceed cost.

However, when LCM is applied to groups or to the total inventory, the total difference
between items with cost exceeding market is partially offset by items with market
exceeding cost. Thus, the resulting inventory valuation is not the lowest possible. An
example illustrates the point:

Inventory Item Cost Market LCM-individual basis

A1 $4 $1 $1
A2 5 6 5
Total group cost $9
Total group market $7
LCM-group basis $7
LCM-individual basis $6
In this case, LCM applied separately to each item results in an inventory valuation of
$6, the sum of the separate LCM amounts. LCM applied to the group cost and group
market values yields an inventory valuation of $7, which is higher than if LCM were
applied individually. This occurs because A2's market value of $6 is higher than its cost
yet it is counted in the group market value.

Thus, a market value higher than cost is used in the inventory valuation. This excess of
market over cost partially offsets the excess of A1's cost over its market value. This
cannot occur when LCM is applied on an individual item basis because market could
never exceed cost for any of the items.
Question #2 (AICPA.110573FAR)
The replacement cost of an inventory item is below the net realizable value and above the
net realizable value less a normal profit margin. The inventory item's original cost is above
the net realizable value. Under the lower of cost or market method, the inventory item
should be valued at
A.  Original cost.
B.  Replacement cost.
The easiest way to answer a question like this is to make up simple numbers. The
following simple numbers were made up to fit the abstract information in the question.
Lower of cost or market states you record the inventory at the lower of original cost or
market value (replacement cost) within the range of a ceiling and a floor. The numbers
below show that replacement cost is lower than original cost and within the floor and
ceiling. Replacement cost is the correct answer.
Original cost $10
Net realizable value 9
Replacement cost 8
NRV less normal PM 7
 C.  Net realizable value.
D.  Net realizable value less normal profit margin.

Question #3 (AICPA.0821123FAR-II.C)

At the end of the year, Ian Co. determined its inventory to be $258,000 on a LIFO (last in,
first out) basis. The current replacement cost of this inventory was $230,000. Ian estimates
that it could sell the inventory for $275,000 at a disposal cost of $14,000. If Ian's normal
profit margin for its inventory was $10,000, what would be its net carrying value?

A.  $244,000
B.  $251,000
The "ceiling" for LCM (lower of cost or market) valuation is $261,000 net realizable
value ($275,000 selling price less $14,000 disposal cost). The "floor" is net realizable
value less normal profit margin or $251,000 ($261,000 - $10,000). Replacement cost
of $230,000 is below the floor so "market" value is the floor, or middle, of the three
amounts ($251,000). This amount is less than cost of $258,000. Therefore, the lower
of cost or market valuation is $251,000.
C.  $258,000
D.  $261,000

Question #4 (AICPA.941113FAR-FA)
Herc Co.'s inventory on December 31, 2005 was $1,500,000, based on a physical count
priced at cost, and before any necessary adjustment for the following:
 Merchandise costing $90,000, shipped FOB shipping point from a vendor on December
30, 2005, was received and recorded on January 5, 2006.
 Goods in the shipping area were excluded from inventory although shipment was not
made until January 4, 2006. The goods, billed to the customer FOB shipping point on
December 30, 2005, had a cost of $120,000.

What amount should Herc report as inventory in its December 31, 2005, balance sheet?

A.  $1,500,000
B.  $1,590,000
C.  $1,620,000
D.  $1,710,000
The correct ending inventory balance is $1,710,000 ($1,500,000 + $90,000 +
$120,000).

The $90,000 of merchandise is included because it was shipped before year-end and
the title was transferred to Herc at the shipping point (before year-end). The $120,000
also is included because the goods have not been shipped. The FOB designation is
irrelevant because the goods have not yet reached a common carrier.
Question #5 (AICPA.0821122FAR-II.C)

Which inventory costing method would a company that wishes to maximize profits in a
period of rising prices use?

A.  FIFO
FIFO assumes the sale of the earliest goods first. With rising prices, the earliest goods
reflect the lowest prices. Therefore, cost of goods sold under FIFO is the lowest of the
 cost flow assumptions. With the lowest cost of goods sold, gross margin and income
are the highest among the available cost flow assumptions (LIFO and average being
the others).
B.  Dollar-value LIFO.
C.  Weighted average.
D.  Moving average.

Question #6 (AICPA.920524FAR-TH-FA)
When the FIFO inventory method is used during periods of rising prices, a perpetual
inventory system results in an ending inventory cost that is
A.  The same as in a periodic inventory system.
FIFO produces the same results for periodic and perpetual systems. FIFO always
assumes the sale of the earliest goods acquired. Therefore, unlike LIFO periodic, goods
can never be assumed sold before they are acquired.
Cost of goods sold and ending inventory are the same under FIFO for both a periodic
and a perpetual system.
B.  Higher than in a periodic inventory system.
FIFO's results are the same for both systems. Under FIFO, a firm always assumes the
sale of the earliest purchases.
C.  Lower than in a periodic inventory system.
D.  Higher or lower than in a periodic inventory system, depending on whether physical
quantities have increased or decreased.
Question #7 (AICPA.951105FAR-FA)
Which of the following attributes would not be used to measure inventory?
A.  Historical cost.
B.  Replacement cost.
C.  Net realizable value.
D.  Present value of future cash flows.
Discounting is not allowed in the valuation of inventory. Historical cost is the primary
valuation basis used in inventory but the other two answer alternatives are also
encountered in practice.
Question #8 (AICPA.911107FAR-TH-FA)
Generally, which inventory costing method approximates most closely the current cost for
each of the following?
  Cost of goods sold     Ending inventory  
 LIFO   FIFO 

LIFO assumes the sale of the most recent purchases first and thus results in cost of
goods sold that is the most current value. FIFO assumes the sale of the earliest
purchases first (and beginning inventory before any purchases) and thus results in
ending inventory that is the most current value. FIFO is sometimes called LISH: last in
still here.
 LIFO   LIFO 

 FIFO   FIFO 

 FIFO   LIFO 

Incorrect on both counts. LIFO assumes the sale of the most recent purchases first and
thus results in a cost of goods sold that is the most current value. FIFO assumes the
sale of the earliest purchases first (and beginning inventory before any purchases) and
thus results in an ending inventory that is the most current value. FIFO is sometimes
called LISH: last in still here.
Question #9 (AICPA.101060FAR)

Garson Co. recorded goods in transit purchased FOB shipping point at year-end as
purchases. The goods were excluded from the ending inventory. What effect does the
omission have on Garson's assets and retained earnings at year end?

  Assets     Retained earnings  

 No effect   Overstated 

 No effect   Understated 

 Understated   No effect 

The effect on retained earnings in this choice is incorrect. FOB shipping point means
that the title passed to the buyer at the selling company's warehouse. Therefore,
Garson should have included this inventory in the ending inventory. This leaves
inventory (assets) understated. This error also has overstated the cost of goods sold,
which understates net income and retained earnings.
 Understated   Understated 

Both responses in this choice are correct. FOB shipping point means that the title
passed to the buyer at the selling company's warehouse. Therefore, Garson should
have included this inventory in the ending inventory. This leaves inventory (assets)
understated. This error also has overstated the cost of goods sold, which understates
net income and retained earnings.
Question #10 (AICPA051165FAR-TI)
Which of the following statements regarding inventory accounting systems is true?
A.  A disadvantage of the perpetual inventory system is that the inventory dollar amounts used
for interim reporting purposes are estimated amounts.
B.  A disadvantage of the periodic inventory system is that the cost of goods sold amount used
for financial reporting purposes includes both the cost of inventory sold and inventory shortages.
A periodic system does not record the cost of each item as it is sold; nor does it
maintain a continuously current record of the inventory balance. Rather, cost of goods
sold is the amount derived from the equation: Beginning inventory + Purchases =
Ending inventory + Cost of goods sold. A count of ending inventory establishes the
inventory remaining at the end of the period, but there is no recording of cost of goods
sold during the period. Cost of goods sold is the amount that completes the equation.
Thus, cost of goods sold is really the cost of inventory no longer with the firm at year-
end - an amount that includes shrinkage. Inventory shrinkage refers to breakage,
waste, and theft. Shrinkage cannot be identified directly with a periodic inventory
system.
C.  An advantage of the perpetual inventory system is that the record keeping required to
maintain the system is relatively simple.
D.  An advantage of the periodic inventory system is that it provides a continuous record of the
inventory balance.
Question #11 (AICPA.901117FAR-TH-FA)
The replacement cost of an inventory item is below the net realizable value and above the
net realizable value less the normal profit margin. The original cost of the inventory item is
below the net realizable value less the normal profit margin.

Under the lower of cost or market method, the inventory item should be valued at

A.  Net realizable value.

B.  Net realizable value less the normal profit margin.
 C.  Original cost.
In LCM, market value is replacement cost if replacement cost is between the ceiling
value (net realizable value) and the floor value (net realizable value less normal profit
margin).
This is the situation in this question. The original cost is below the floor value. Thus,
market exceeds cost and the item is recorded at cost (lower of cost or market).
D.  Replacement cost.

Question #12 (AICPA.901108FAR-P2-FA)
The following information was derived from the 2005 accounting records of Clem Co.:
Clem's central warehouse Clem's goods held by consignees
Beginning inventory $110,000 $12,000
Purchases 480,000 60,000
Freight-in 10,000
Transportation to consignees 5,000
Freight-out 30,000 8,000
Ending inventory 145,000 20,000

Clem's 2005 cost of sales was

A.  $455,000
B.  $485,000
C.  $507,000
D.  $512,000
The goods on consignment are included in Clem's inventory and therefore are included
in the computation of Clem's cost of goods sold.
The only costs not included in the computation are the two freight-out costs. Freight-
out is a distribution expense. This cost does not contribute to the process of placing
the goods into salable condition.
Only costs that assist in placing goods into salable condition are inventoried. Because
this cost is required to place those items on consignment, freight-in is an inventoriable
cost, as is transportation to consignees.
Beginning inventory $110,000 + $12,000 = $122,000
Plus purchases $480,000 + $60,000 = 540,000
Plus freight-in $10,000 = 10,000
Plus trans. in to consignees $5,000 = 5,000
Less ending inventory $145,000 + $20,000 = (165,000)
Equals cost of goods sold $512,000
Question #13 (INVY-0019)
The original cost of an inventory item is above the replacement cost. The replacement cost
is above the net realizable value. Under the lower of cost or market method, the inventory
item should be priced at its
A.  Replacement cost.
B.  Original cost.
C.  Net realizable value.
This answer is correct because under LCM, market is the replacement cost provided
that replacement cost is lower than net realizable value (ceiling) and higher than the
net realizable value less a normal profit margin (floor). Since the replacement cost is
above the ceiling, the ceiling represents the market value to be compared with cost.
The ceiling (market price) is less than cost so the inventory would be priced at net
realizable value.
 D.  Net realizable value less the normal profit margin.

Question #14 (INVY-0002)
Theoretically, cash discounts permitted on purchased raw materials should be
A.  Added to other income, whether taken or not.
B.  Added to other income, only if taken.
C.  Deducted from inventory, whether taken or not.
This answer is correct. There are two methods of accounting for cash discounts: the
gross method and the net method. The gross method records purchases before any
discounts, and records cash discounts only when taken. The net method records
purchases net of cash discounts whether taken or not, and any discounts foregone are
considered to be financing expenses. Theoretically, purchases and accounts payable
should be shown net of cash discounts whether taken or not because this net method
allows for a more correct reporting of the related asset and liability, and it allows for a
measure of the inefficiency of financial management if the discount is not taken.
D.  Deducted from inventory, only if taken.

Question #15 (AICPA.010502FAR-FA)
Units Unit cost Total cost Units on hand
Balance on 1/1 2,000 $1 $2,000 2,000
Purchased on 1/8 1,200 3 3,600 3,200
Sold on 1/23 1,800 1,400
Purchased on 1/28 800 5 4,000 2,200
Nest uses the LIFO method to cost inventory. What amount should Nest report as inventory
on January 31 under each of the following methods of recording inventory?
Perpetual Periodic

A. $2,600 $5,400

B. $5,400 $2,600

C. $2,600 $2,600

D. $5,400 $5,400
A.  A
B.  B
Under the LIFO (last-in, first-out) inventory method, goods sold are assumed to be
the most recently acquired goods (at their related costs). Therefore, goods
remaining (ending inventory) are assumed to be the earliest acquired goods (at
their related costs). If the perpetual LIFO inventory method is used, when goods are
sold, they are assumed to be the goods acquired just prior to the sale.
Thus, Nest's sale of 1,800 units on 1/23 would have consisted of the 1,200 units
acquired 1/8 and 600 units (of the 2,000) in beginning inventory. Ending inventory
on January 31 would be:
1,400 units of beginning inventory @ $1 each = $1,400
800 units purchased 1/28 @ $5 each = 4,000
2,200 units in ending inventory reported @ = $5,400
If the periodic LIFO inventory method is used, ending inventory (and cost of goods
sold) are determined only at the end of the period. Therefore, Nest's sale of 1,800
units on 1/23 would have consisted of (by assumption at the end of the period) 800
units acquired on 1/28 and 1,000 units (of the 1,200) acquired on 1/8. Ending
inventory on January 31 would be:
 200 units of the 1,200 purchased 1/8 @ $3 = $ 600
2,000 units (all) of beginning inventory @ $1 = 2,000
2,200 units in ending inventory reported @ = $2,600
C.  C
D.  D