1.

Why is it unrealistic to assume that inventory costs will remain constant over
time?

The market is constantly changing so prices for items will fluctuate accordingly.

2. What is a cost flow assumption?

Cost flow assumption is how a company moves products from its inventory to its
cost of goods sold.

3. Briefly explain the specific identification approach.

The specific identification approach requires a detailed physical count of inventory

so that the company knows what was bought on which date and how much of the
year-end inventory includes products bought at the same price.

4. Briefly explain the first-in, first-out cost flow assumption.

FIFO cost flow assumption requires the oldest items to be sold first. This is ensures
freshness and also is how the goods sold are reclassified to cost of goods sold.

5. Briefly explain the last-in, first-out cost flow assumption.

LIFO is the opposite of FIFO. Goods bought last are sold first in terms of how
inventory is moved to cost of goods sold.

6. Briefly explain the averaging cost flow assumption.

When there are items on hand that vary in cost, the average cost of the product is
used for the final cost flow analysis.

7. Which cost flow assumption will give a higher net income in a period of rising
prices?

FIFO
8. Why don’t all companies use specific identification?

Companies that sell identical products have no real way of maintaining specific
identification records without a ridiculously tedious and time consuming inventory
process.

9. Which cost flow assumption appears to be used by more companies than any
other?

LIFO

10. What are advantages of using LIFO?

LIFO helps reduce the amount companies pay in income taxes.

11. Why must a company keep one set of books for financial reporting purposes and
another for tax compliance purposes?

One Set of books is prepared based on tax laws and the other is prepared for
financial statements using U.S. GAAP guidelines.

12. Why do many countries not permit their companies to use LIFO?

The International Financial Reporting Standards (IFRS) rules do not recognize LIFO
as appropriate.

13. Explain LIFO liquidation.

LIFO Liquidation is when a company who uses the LIFO inventory valuation method
sells more than they buy. This allows some of the old stock to be cleared out which
causes the old costs to be matched with the current revenues. It causes an
appearance that the company made more money than they spent and can lead to
a higher tax bill.
14. How can users compare companies who use different cost flow assumptions?

Read the footnotes, pay attention to the gross profit percentage, the number of
days inventory is held, and the inventory turnover.

15. How is gross profit percentage calculated and what does it tell a user about a
company?
Calculate:
Sales – sales returns and discounts = net sales
Net sales – cost of goods sold = gross profit
Gross profit/net sales = gross profit percentage

16. How is number of days in inventory calculated and why would a user want to
know this number?
Calculate:
Cost of goods sold/365 days = cost of inventory sold per day
Average inventory/cost of inventory sold per day=number of days inventory is held

17. What is inventory turnover? What does it tell a user about a company?

Inventory turnover is the number of times during the reported period that an
amount equal to the average inventory was sold. If bigger that number is, the
faster inventory is selling. This is a good indicator of how many sales the company
is making.

True or False
1. _ F__ Using the LIFO cost assumption will always result in a lower net income
than using the FIFO cost assumption.
2. __T__ The United States is the only country that allows LIFO.
3. __F__ LIFO tends to provide a better match of costs and expenses than FIFO and
averaging.
4. __F__ Companies can use LIFO for tax purposes and FIFO for financial reporting.
5. __T__ The larger the inventory turnover, the better, in most cases.
6. __F__ It is impossible for decision makers to compare a company who uses LIFO
with one who uses FIFO.
7. __T__ A jewelry store or boat dealership would normally be able to use the
specific identification method.
8. __T__ The underlying concept of FIFO is that the earliest inventory purchased
would be sold first.
9. __F__ Gross profit percentage can help users determine how long it takes
companies to sell inventory after they purchase it.
10. __T__ LIFO liquidation may artificially inflate net income.

Multiple Choice

1. Which of the following provides the best matching of revenues and expenses?
a. Specific Identification
b. FIFO
c. LIFO
d. Averaging

2. Milby Corporation purchased three hats to sell during the year. The first,
purchased in February, cost $5. The second, purchased in April, cost $6. The third,
purchased in July, cost $8. If Milby sells two hats during the year and uses the FIFO
method, what would cost of goods sold be for the year?
a. $13
b. $19
c. $14
d. $11

3. Which is not a reason a company would choose to use LIFO for financial
reporting?
a. The company wishes to use LIFO for tax purposes.
b. The company wants net income to be as high as possible.
c. The company would like to match the most current costs with revenues.
d. LIFO best matches the physical flow of its inventory.

4. During the year, Hostel Company had net sales of $4,300,000 and cost of goods
sold of $2,800,000. Beginning inventory was $230,000 and ending inventory was
$390,000. Which of the following would be Hostel’s inventory turnover for the
year?
a. 9.03 times
b. 7.18 times
c. 4.84 times
d. 13.87 times

5. Traylor Corporation began the year with three items in beginning inventory,
each costing $4. During the year Traylor purchased five more items at a cost of $5
each and two more items at a cost of $6.50 each. Traylor sold eight items for $9
each. If Traylor uses LIFO, what would be Traylor’s gross profit for the year?
a. $42
b. $30
c. $35
d. $72

Chapter 10

Questions

1. At what value is property, plant, and equipment (PP&E) typically reported on the
balance sheet?

PP&E is reported at its initial cost and then depreciated unless it has an infinite life.

2. What is accumulated depreciation?

Accumulated depreciation is the amount of a long term asset’s cost that has been
allotted to the depreciation expense account since the asset was purchased.

3. What type of account is accumulated depreciation?

A long term asset account with a credit balance.

4. Define “book value.”

The book value is the historical cost of the asset minus the accumulated
depreciation.
5. Why is property and equipment not reported at its fair value?

Property and equipment do not use the fair value because no definitive amount
can be determined until the object is bought. Also, fair value can change day to day
making any prior assessments null and void.

6. Why is land not depreciated?

Land is not depreciated because it has an unlimited useful life.

7. Why would land be classified as an investment rather than PP&E?

Land is not classified as PP&E because it is not depreciable.

8. How does a company determine the historical cost of a property and equipment?

The company determines the historical cost by seeing what it has previously been
sold for.

9. Define “useful life.”

The useful life is the amount of time an asset can be used

10. Define “residual value.”

Residual Value is the estimated value left over at the end of an assets useful life

11. Which method of depreciation allocates an equal amount to each period the
asset is used?

The straight-line method

12. How does a company determine the gain or loss on the sale of PP&E?
compare the amount of cash received for the asset to the asset's book (carrying)
value at the time of the sale. If the cash received is greater than the asset's book
value, the difference is recorded as a gain.

13. What is the half-year convention?

The half-year convention is used to calculate depreciation for tax purposes, and
states that a fixed asset is assumed to have been in service for one-half of its
first year, irrespective of the actual purchase date. The remaining half-year of
depreciation is deducted from earnings in the final yearof depreciation.

14. What is accelerated depreciation and how is its use justified?

Accelerated depreciation is a depreciation method where an asset loses book

value at a faster rate than the usual straight-line method. This allows bigger
deductions in the earlier years of an asset and is used to reduce taxable income.

15. How does the units-of-production method differ from straight-line?

The straight-line method of depreciation is the easiest to calculate, and consists of

depreciating the value of an asset in equal installments over the cost of its useful
life. The declining balance method calculates more depreciation expense initially,
and uses a percentage of the asset's current book value, as opposed to its initial
cost. So, the amount of depreciation declines over time, and continues until the
salvage value is reached.

16. What is depletion?

Depletion is the movement of the cost of natural resources from a company's

balance sheet to its income statements.

17. What is a basket purchase?

A basket purchase is the acquisition of multiple assets as a group, in a single
transaction. They typically occur when the buyer has the opportunity to acquire
numerous assets at a price below their combined market values.

18. How are the values attributed to the different assets determined in a basket
purchase?

The firm must allocate the purchase price amongst the assets based on their
relative fair values and record the cost of each asset individually in the fixed assets
register.

19. When should a subsequent expenditure associated with currently owned

property and equipment be capitalized?

Additions, reinstallations, improvements and repairs

20. What are land improvements?

Land improvements are enhancements to a plot of land to make the land more
usable.

21. How is an impairment loss on PP&E determined?

Impairment cost = recoverable amount – carrying value

Multiple Choice

1. On January 1, the Rhode Island Redbirds organization purchased new workout

equipment for its athletes. The equipment had a cost of $15,600, transportation
costs of $450, and set up costs of $290. The Redbirds spent $350 training their
trainers and athletes on its proper use. The useful life of the equipment is five
years and has no residual value. How much depreciation expense should the
Redbirds take in the first year, if straight-line is being used?
B. $3,268
2. See the information in number 1 above. Assume the Redbirds decide to use the
double-declining balance depreciation method instead. What would Year 1
depreciation expense be?
C. $6,240

3. Kite Corporation wishes to trade equipment it owns for a vehicle owned by the
Runner Corporation. Kite’s equipment has a book value of $4,000 and a fair value
of $4,500. Runner’s vehicle has a book value and fair value of $5,100. Kite agrees
to pay Runner $600 in cash in addition to giving up the equipment. What would be
Kite’s gain or loss on this exchange?
A. $500

4. At the beginning of the year, the Kelvin Company owned equipment that
appeared on its balance sheet as such:
Equipment $7,000,000
Accumulated Depreciation ($2,000,000)
The equipment was purchased two years ago and assigned a useful life of six years
and a salvage value of $1,000,000. During the first month of the year, Kelvin made
modifications to the equipment that increased its remaining useful life from four
years to five years. Its salvage value remained unchanged. The cost of these
modifications was $50,000. What would be the balance in the accumulated
depreciation account of this equipment on 12/31 of that year?
C. $810,000

5. On January 3, 20X1, Jewels Inc. purchases a South American mine found to be

rich in amethyst for $560,000. Once all the amethyst has been removed, the land is
estimated to be worth only $100,000. Experts predict that the mine contains 4,000
pounds of amethyst. Jewels plans on completing the extraction process in four
years. No amethyst was extracted during 20X1. What would accumulated
depletion be on 12/31/X1?
D. $0
6. Maxwell Corporation wishes to sell a building it has owned for five years. It was
purchased for $430,000. Maxwell performed additional modifications to the
building, which totaled $45,000. On the proposed date of sale, the accumulated
depreciation on the building totaled $75,000. The proposed sales price of the
building is $380,000. Maxwell is trying to determine the income statement effect
of this transaction. What would be Maxwell’s gain or loss on this sale?
A. $20,000 LOSS