Chapter 7

Chapter 07 - Reporting and Interpreting Cost of Goods Sold and Inventory
Chapter 07
Reporting and Interpreting Cost of Goods Sold and Inventory
True / False Questions
1. Ownership of goods passes from the seller to the buyer after the buyer has paid for the
goods.
True False
2. If transportation costs are the responsibility of the buyer, they should be added to the cost
of inventory purchases for the period.
True False
3. The weighted average method of inventory costing results in a valuation between that
determined by the FIFO and LIFO costing methods.
True False
4. When the weighted average inventory method is used, ending inventory and cost of goods
sold are valued at a different cost per unit.
True False
5. LIFO will always result in highest income when costs are rising in comparison to specific
identification, FIFO and weighted average.
True False
6. LIFO can be used for income tax purposes and FIFO can be used for financial reporting
purposes for a company in a given year.
True False
7-1
7. A large retail department store probably would use the specific identification inventory
costing method for most of the items in its inventory.
True False
8. The lower-of-cost-or-market (LCM) rule is used because of the conservatism constraint,

which allows a departure from the historical cost principle.
True False
9. If Dell Computer has 10,000 Pentium disks in stock at a cost of $300 per chip when they
can be purchased at a replacement cost of $250 each. Dell will recognize this decline in cost
when the chips are sold as part of their computers.
True False
10. Inventory turnover is computed as cost of goods sold divided by ending inventory.
True False
11. Reducing inventory can free up cash and allow for reduced borrowing.
True False
12. If a company sells their inventory every 87 days then their inventory turnover ratio must
be 4.2 times.
True False
13. If a company has a decrease in inventory equal to $3 million and a decrease in accounts
payable of $2 million, then cash flow from operating activities will increase by $1 million.
True False
7-2
14. The LIFO Reserve is a contra-asset account for the excess of FIFO inventory costs over
the LIFO inventory costs.
True False
15. In a period of rising costs, the LIFO Reserve account would be deducted from the ending
inventory under LIFO costing to convert it to ending inventory under FIFO costing.
True False
16. The beginning inventory of one accounting period becomes the beginning inventory
amount of the next accounting period.
True False
17. An understatement error in the ending inventory causes an overstatement of both net
income and current assets in that year.
True False
18. When a company using LIFO costing reduces its inventory levels at the end of the year, it
can lead to a LIFO liquidation.
True False
19. When a perpetual inventory system is used, the purchases returns and allowances account
will not be part of the general ledger accounts.
True False
20. Under the periodic inventory system, the balance in the inventory account changes each
time a purchase or sale of inventory is recorded.
True False
7-3
Multiple Choice Questions
21. Which of the following best describes inventory?

A. They are held for resale.
B. They are tangible property.
C. They are used in the operations of the company.
D. They are held for resale and are tangible property.
22. Which of the following statements about inventory is true?

A. It is acquired for use in operating the company.
B. It is intangible property.
C. It is a current asset on the balance sheet.
D. Manufacturers have four inventory accounts.
23. Rockwell Company reported the following amounts on its 2009 income statement:
Purchases, $100,000; Beginning inventory, $20,000; and Cost of goods sold, $110,000.
Therefore, the 2009 ending inventory was
A. $10,000.
B. $25,000.
C. $15,000.
D. $27,000.
24. The 2009 records of Coleman Company showed beginning inventory, $100,000; cost of
goods sold, $450,000; and ending inventory, $80,000. The purchases for 2009 equal
A. $450,000.
B. $410,000.
C. $430,000.
D. $420,000.
7-4
25. When goods are sold on credit, revenue usually should be recognized at the date of
A. receipt of the sales order.
B. passage of title from the seller to the buyer.
C. receipt of the goods by the buyer.
D. manufacture of the goods.
26. Which of the following types of inventory usually is not held by a manufacturing
business?
A. Finished goods inventory
B. Raw material inventory
C. Merchandise inventory
D. Work in process inventory
27. Which of the following is true about a manufacturing company's inventory?

A. Components purchased from vendors will be added to a raw material inventory account.
B. Direct labor and factory overhead are added to the materials in the raw material inventory
account.
C. Cost of storing finished units in a separate warehouse will be added to the finished goods
inventory account.
D. Direct labor and factory overhead are subtracted from the materials in the raw material
inventory account.
28. Thorton Co. reported the following data at year-end. Sales, $500,000; beginning
inventory, $40,000; ending inventory, $45,000; cost of goods sold, $350,000; and gross
margin, $150,000. What was the amount of merchandise purchased during the year?
A. $370,000
B. $355,000
C. $348,000
D. $341,000
7-5
29. The following information was taken from the 2010 income statement of Cobra Company:
Pretax income, $12,000; Total operating expenses (not including income taxes), $20,000;
Sales revenue, $120,000. Compute cost of goods sold.
A. $ 88,000
B. $100,000
C. $108,000
D. $112,000
30. The following information was taken from the 2010 income statement of Milburn
Company: Pretax income, $12,000; Total operating expenses (not including income taxes),
$20,000; Sales revenue, $120,000; Beginning inventory, $8,000; and Purchases, $90,000.
Compute the amount of the ending inventory.
A. $88,000
B. $10,000
C. $ 8,000
D. $18,000
31. Which of the following is true?

A. Factory overhead consists of manufacturing costs other than direct materials and direct
labor.
B. Net realizable value is the expected sales price plus selling costs.
C. LIFO Reserve is a contra sales account for the excess of LIFO over FIFO inventory.
D. Purchases discounts increase sales revenue to arrive at net sales.
32. Sheffield Company had the following information taken from its 2009 adjusted trial
balance: Sales, $400,000; Sales Discounts, $12,000; Beginning Inventory, $20,000; and
Purchases, $200,000. Ending inventory was determined to be $25,000. Compute the gross
margin (gross profit) that would appear in the income statement.
A. $162,000.
B. $180,000.
C. $193,000.
D. $205,000.
7-6
33. On March 10, Anthony Company received merchandise for resale from its normal
supplier. The price was $3,600 with terms of 2/10, n/30 for 100 units of Part #345. The
invoice was paid on March 17. Freight costs were $120 and the company paid $108 of interest
on a loan to buy the inventory. What is the unit cost that should be recorded for each of the
100 units of Part # 345?
A. $36.48
B. $37.20
C. $36.00
D. $37.56
34. Which of the following is correct?

A. Beginning Inventory + Purchases - Cost of Goods Sold = Ending Inventory.
B. Sales + Cost of Goods Sold = Gross Margin.
C. Beginning Inventory + Ending Inventory - Purchases = Cost of Goods Sold.
D. Income Before Taxes - Operating Expenses = Cost of Goods Sold.
35. Which of the following costs while includable in inventory, is usually expensed as
incurred instead of being assigned to the inventory units?
A. Freight costs
B. Inspection and preparation costs
C. Purchases discounts
D. Purchase returns
36. Which of the following costs would not be part of product inventory costs for a
manufacturer such as Harley Davidson?
A. Costs to advertise the newest model.
B. Kickstands purchased for use in manufacturing the motorcycles
C. The factory manager's salary and benefits
D. The wages and benefits of an employee in the welding department
7-7
37. Which of the following businesses would not have cost of goods sold?
A. A jewelry store
B. A grocery store
C. A law firm
D. A manufacturer of batteries
38. Which of the following inventory costing methods is subject to manipulation with regard
to the resulting inventory cost?
A. LIFO.
B. FIFO.
C. Weighted-average cost.
D. All of the inventory methods are subject to manipulation.
39. Lauer Corporation uses the periodic inventory system and the following information about
their laptop computer is available:
During the year, 750 laptop computers were sold.

What was ending inventory and cost of goods sold on 12/31 under the FIFO cost flow
assumption?
A. $60,000 and $710,000.
B. $52,500 and $717,500.
C. $52,000 and $718,000.
D. None of the answers is correct.
7-8

What was ending inventory and cost of goods sold on 12/31 under the LIFO cost flow
assumption?
A. $56,000 and $714,000.
B. $45,000 and $725,000.
C. $40,000 and $730,000.
41. Under the FIFO cost flow assumption during a period of inflation, which of the following
is false?
A. Income tax expense will be higher than under LIFO.
B. Gross margin will be higher than under LIFO.
C. Ending inventory will be lower than under LIFO.
D. Cost of goods sold will be lower than under LIFO.
42. Under the LIFO cost flow assumption during a period of inflation, which of the following
is false?
A. Cost of goods sold will be lower than under FIFO.
B. Gross margin will be lower than under FIFO.
C. Income tax expense will be lower than under FIFO.
D. Ending inventory will be lower than under FIFO.
43. When prices are rising:

A. LIFO will result in lower net income and a higher inventory valuation than will FIFO.
B. LIFO will result in higher net income and lower inventory valuation than will FIFO.
C. FIFO will result in lower net income and a lower inventory valuation than will LIFO.
D. FIFO will result in higher net income and a higher inventory valuation than will LIFO.
7-9
44. When prices are rising, the method of inventory valuation that results in the highest
relative net cash inflow is:
A. FIFO.
B. LIFO.
C. weighted average.
D. inventory methods cannot affect cash flows.
45. Which of the following statements is correct?

A. FIFO reports lower income amounts than LIFO when prices are rising.
B. LIFO reports a higher income amount than FIFO when prices are rising.
C. LIFO reports a higher income amount than FIFO when prices are decreasing.
D. LIFO reports the same amount of income as FIFO when prices are rising.
46. Which of the following statements is true?

A. Applying the lower of cost or market (LCM) rule is optional and depends on whether a
company wants to write off inventory when it loses its value or prefers to delay the write off
until the inventory is sold.
B. The LIFO conformity rule requires use of LIFO for financial reports if it is adopted for tax
purposes.
C. LIFO liquidation occurs when a company switches from LIFO to another cost method.
D. The LIFO conformity rule requires use of LIFO for taxes if it is adopted for financial
reports.
47. The LIFO costing method is more costly and time consuming than a FIFO system. Which
of the following would be a valid justification for choosing LIFO?
A. It usually provides for more control over inventory
B. It usually provides managers with more useful information about the level of inventory by
monitoring the cost level in the inventory account
C. The tax savings from using LIFO during an inflationary period exceeds the cost of using a
LIFO costing system
D. It usually produces a higher net income when unit costs of inventory are rising
7-10
48. Moore Company purchased an item for inventory that cost $20 per unit and was marked to
sell at $30. It was determined that the replacement cost is $18 per unit. No purchases in the
near future are anticipated. Using the lower-of-cost-or- market rule, the per unit valuation for
inventory should be
A. $18.00.
B. $20.00.
C. $25.00.
D. $30.00.
49. On December 31, 2009, the end of the accounting period, Cruise Company has on hand
10,000 units of a resale item which cost $40 per unit when purchased on June 15, 2009. The
selling price is $70 per unit. On December 30, 2009, the cost had dropped to $38 per unit. In
view of the large quantity of units on hand, no purchases are anticipated in the next six to nine
months. At what inventory amount should the 10,000 units be reported?
A. $100,000.
B. $120,000.
C. $350,000.
D. $380,000.
50. Under the lower-of-cost-or-market basis for valuing inventory if replacement cost of an
item in inventory has declined during a given accounting period,
A. pretax income and the amount of ending inventory will be reduced for the period in which
the merchandise is sold.
B. pretax income and the amount of ending inventory will be reduced for the period during
which the decline in market value occurred.
C. pretax income will be reduced for the period during which the decline in market value
occurred and the amount of ending inventory will decline for the period in which the
merchandise is sold.
D. pretax income will be reduced for the period during which the merchandise is sold and the
amount of ending inventory will decline for the period in which the decline in market value
occurred
7-11
51. Which of the following is a true statement about lower of cost or market (LCM)?
A. It is optional under generally accepted accounting principles, whether you apply LCM in
the year in which net realizable value declines below cost or the company waits until the
inventory is sold.
B. LCM can be applied to all cost methods under generally accepted accounting principles
except for LIFO.
C. For tax purposes, the LIFO cost flow method cannot have LCM applied.
D. Under LCM, market equals the current selling price to the retail customer.
52. Tinker's Toys had cost of goods sold in 2009 of $7,506 million and $7,646 million in
2008. Their merchandise inventory at the end of 2009 was $1,884 million and $2,094 million
at the end of 2008. What was their inventory turnover in 2009?
A. 3.77
B. 3.89
C. 3.97
D. 3.58
2008. Their merchandise inventory in 2009 was $1,884 million and $2,094 million in 2008.
How long were their average days to sell inventory in 2009?
A. 104.52 days
B. 100.31 days
C. 96.82 days
D. 101.96 days
54. A company reports its 2010 cost of goods sold at $15.0 million. Its ending inventory for
2010 is $1.6 million and for 2009, ending inventory was $1.2 million. How much inventory
did the company purchase during 2009?
A. $14.6 million
B. $15.0 million
C. $15.4 million
D. $15.8 million
7-12
55. A company recorded net purchases on credit of $15.7 million for 2010. In 2009, ending
accounts payable was $1.4 million and in 2010, it was $1.9 million. How much cash was paid
to suppliers in 2010?
A. $14.8 million
B. $15.0 million
C. $15.2 million
D. $15.7 million
56. A company reports its cost of goods sold as $15.0 billion in 2009. It has $2.9 billion in
inventory and reports accounts payable at $1.2 billion at the end of 2009. At the end of 2008
ending inventory was reported at $3.1 billion and accounts payable was $1.4 billion. How
much cash was paid to suppliers for 2009?
A. $14.8 billion
B. $15.0 billion
C. $15.2 billion
D. $15.7 billion
57. In 2010, QV-TV, Inc. provided the following items in their footnotes. Their cost of goods
sold was $22 billion under FIFO costing and their inventory value under FIFO costing was
$2.1 billion. Their LIFO Reserve figure for year end 2009 was a $0.6 billion credit balance
and at year end 2010 it had increased to a credit balance of $0.8 billion. How much is LIFO
inventory value at year end 2010?
A. $1.9 billion
B. $2.9 billion
C. $2.3 billion
D. $1.3 billion
58. In 2010, Terry Inc. provided the following items in their footnotes. Their cost of goods
$2.1 billion. Their LIFO Reserve account balance for year end 2009 had a $0.6 billion credit
balance and then at year end 2010, it had a credit balance of $0.8 billion. How much would
they report as LIFO cost of goods sold?
A. $22.2 billion
B. $19.8 billion
C. $22.8 billion
D. $19.2 billion
7-13
59. Which of the following statements is false?

A. The LIFO Reserve is a contra-asset account for the excess of FIFO over LIFO inventory
costs.
B. When the LIFO Reserve account increases from one year to the next, then FIFO cost of
goods sold will be less than LIFO cost of goods sold.
C. The LIFO Reserve account balance at the end of the year would be deducted from ending
LIFO inventory cost to convert to FIFO ending inventory cost.
D. We want to convert LIFO cost of goods sold and LIFO inventory balances to FIFO cost of
goods sold and inventory balances to obtain a more realistic inventory turnover ratio.
60. A $25,000 overstatement of the 2010 ending inventory was discovered after the financial
statements for 2010 were prepared. The effect of the inventory error on the 2010 financial
statements was
A. current assets were overstated and net income was understated.
B. current assets were understated and net income was understated.
C. current assets were overstated and net income was overstated.
D. current assets were understated and net income was overstated.
61. Wilmington Company reported pretax income amounts of: 2010, $25,000; and 2011,
$30,000. Later it was discovered that the ending inventory for 2010 was understated by
$2,000 (and not corrected in 2011). The correct pretax income for each year was:
A.
B.
C.
D.
7-14
62. At the end of 2009, a $5,000 understatement was discovered in the amount of the 2009
ending inventory as reflected in the perpetual inventory records. What were the 2009 effects
of the $5,000 inventory error (before correction)?
A. Assets (inventory) were understated by $5,000 and pretax income was understated by
$5,000.
B. Assets (inventory) were understated by $5,000 and pretax income was overstated by
$5,000.
C. Cost of goods sold was understated by $5,000 and pretax income was understated by
$5,000.
D. Cost of goods sold was overstated by $5,000 and pretax income was overstated by $5,000.
63. An understatement of the ending inventory in Year 1, if not corrected, will cause
A. Year 1 net income to be understated and Year 2 net income to be overstated.
B. Year 1 net income to be overstated and Year 2 net income to be overstated.
C. Year 1 net income to be overstated and Year 2 net income will be correct.
D. Year 1 net income to be overstated and Year 2 net income to be understated.
64. If beginning inventory is understated by $1,300 and ending inventory is understated by

$700, pretax income for the period will be:
A. understated by $600.
B. understated by $2,000.
C. overstated by $600.
D. overstated by $2,000.
65. On December 15, 2009, Transport Company accepted delivery of merchandise which it
purchased on credit. As of December 31, 2009, the company had neither recorded the
transaction nor included the merchandise in its ending inventory amount because the seller's
invoice had not been received. The effect of this omission on its balance sheet at December
31, 2009, (end of the accounting period) was that
A. assets and stockholder's equity were overstated but liabilities were not affected.
B. stockholder's equity was the only item affected by the omission.
C. assets and liabilities were understated but stockholders' equity was not affected.
D. assets and stockholders' equity were understated but liabilities were not affected.
7-15
66. A company using the periodic inventory system correctly recorded a purchase of
merchandise, but the merchandise was not included in the physical inventory count at the end
of the accounting period. The error caused an:
A. understatement of both net income and assets.
B. overstatement of inventory, purchases, and accounts payable.
C. understatement of inventory, purchases, and accounts payable.
D. overstatement of net income and assets.
67. At the end of 2010, XYZ Company failed to include some goods in its ending inventory
and failed to record the purchase of these goods. For 2010, these two errors caused
A. goods available for sale, cost of goods sold, and income to be overstated.
B. ending inventory, cost of goods sold, and retained earnings to be understated.
C. ending inventory, goods available for sale, and retained earnings to be understated.
D. no effect on income, working capital, or retained earnings.
68. Hollander Company hired some students to help count inventory during their semester
break. Unfortunately, the students added incorrectly and ending inventory was overstated by
$5,000. What would be the effect of this error in ending inventory?
A. Income would be overstated.
B. Income would be understated.
C. Ending retained earnings would be understated.
D. Cost of goods sold would be overstated.
69. During the audit of Montane Company's 2010 financial statements, the auditors
discovered that the 2010 ending inventory had been overstated by $8,000. Before the effect of
this error, 2010 pretax income had been computed as $100,000. What should be reported as
the correct 2010 pretax income before taxes?
A. $ 92,000.
B. $100,000.
C. None of the other answers is correct.
D. $108,000.
7-16
70. Under the periodic method, cost of goods sold is computed by

A. adding the cost of purchases during the period to the cost of the inventory on hand at the
beginning of the period and adding this figure to the cost of the inventory on hand at the end
of the period.
B. adding the cost of purchases during the period to the cost of the inventory on hand at the
end of the period and subtracting the inventory on hand at the beginning of the period.
C. subtracting the cost of the inventory on hand at the ending of the period from the cost of
goods available for sale.
D. carefully matching selling and administrative expenses with the sales to which they are
related and then reporting these expenses in the same period the associated revenue is
reported.
71. Under the perpetual inventory system:

A. one entry is required to record a sales return.
B. cost of goods sold cannot be determined unless a physical inventory is taken.
C. one entry is required to record a sale.
D. a separate account for purchases is not required.
72. Under the periodic inventory system:

A. a transaction by transaction unit inventory record is maintained.
B. the cost of goods sold for each sale is recorded at the time each sale is made.
C. a separate account for purchases is used.
D. a continuous inventory record provides the amount of ending inventory and the cost of
goods sold throughout the period.
73. Which of the following may be used to calculate ending inventory (EI) under the periodic
inventory system?
A. BI + P + CGS = EI.
B. BI + P - CGS = EI.
C. BI - P + CGS = EI.
D. BI + P + GM = EI.
7-17
74. On March 15, 2009, Ryan Company purchased $10,000 of merchandise on credit subject
to terms, 2/10, n/30. Ryan Company records its purchases using the gross amount. The
periodic inventory system is used. If Ryan Company pays for these goods on March 30, the
entry made to record the payment should include
A. $200 credit to Purchase discounts.
B. debit of $9,800 to Accounts payable.
C. debit of $10,000 to Accounts payable.
D. $9,800 credit to cash.
75. Two systems are used in accounting for inventoryperpetual and periodic. Which of the
following statements is correct?
A. In a perpetual inventory system, the inventory account is not changed for each purchase
during the accounting period.
B. In a perpetual inventory system, cost of goods sold is recorded at the time of each sale
C. In a periodic inventory system, cost of goods sold is developed from a comparison of
beginning inventory and ending inventory only.
D. In a periodic inventory system, the inventory account is increased for each purchase during
the accounting period.
76. Which one of the following statements concerning the periodic and perpetual inventory
systems is true?
A. The periodic system uses a purchases account.
B. Inventory controls are only needed for the periodic inventory systems.
C. None of the accounting entries vary between the two systems.
D. Due to advances in computers, many businesses recently have begun to use the periodic
inventory system.
77. When a company uses the periodic inventory system in accounting for its merchandise
inventory, which of the following is true?
A. Purchases are recorded in the cost of goods sold account.
B. The inventory account is updated after each sale.
C. Cost of goods sold is computed at the end of the accounting periods rather than at each
sale.
D. The inventory account is updated throughout the year as purchases are made.
7-18
78. A LIFO liquidation occurs when a company

A. goes out of business.
B. converts from LIFO to FIFO.
C. converts from the periodic to the perpetual inventory system.
D. sells more units than it purchased during the year.
79. Carrie Company sold merchandise with an invoice price of $1,000 to Underwood, Inc.,
with terms of 2/10, n/30. Which of the following is the correct entry to record the payment by
Underwood Inc., within the 10 days if the company uses the periodic inventory system and
the gross method to record purchases?
A.
B.
C.
D.
80. On September 20, 2009, Precision Electric Company purchased $10,000 of stereo
equipment for resale on credit, subject to the terms 2/15, n/30. The periodic inventory system
is used. If the company paid for these goods on October 18, the entry made to record the
payment should include a/an
A. $200 debit to Purchases discounts.
B. $10,000 debit to Accounts payable.
C. $9,800 credit to Cash.
D. $10,000 debit to Purchases.
7-19
Chapter 07 Reporting and Interpreting Cost of Goods Sold and Inventory

Answer Key
True / False Questions
1. Ownership of goods passes from the seller to the buyer after the buyer has paid for the
goods.
FALSE
AACSB Tag: Reflective Thinking

Difficulty: Easy
Learning Objective: 1
2. If transportation costs are the responsibility of the buyer, they should be added to the cost
of inventory purchases for the period.
TRUE

Difficulty: Medium
3. The weighted average method of inventory costing results in a valuation between that
determined by the FIFO and LIFO costing methods.
TRUE

Difficulty: Medium
7-20
4. When the weighted average inventory method is used, ending inventory and cost of goods
sold are valued at a different cost per unit.
FALSE

Difficulty: Medium
5. LIFO will always result in highest income when costs are rising in comparison to specific
identification, FIFO and weighted average.
FALSE

Difficulty: Medium
6. LIFO can be used for income tax purposes and FIFO can be used for financial reporting
purposes for a company in a given year.
FALSE
AACSB Tag: Communications

Difficulty: Hard
7. A large retail department store probably would use the specific identification inventory
costing method for most of the items in its inventory.
FALSE

Difficulty: Easy
7-21
8. The lower-of-cost-or-market (LCM) rule is used because of the conservatism constraint,

which allows a departure from the historical cost principle.
TRUE

Difficulty: Medium
9. If Dell Computer has 10,000 Pentium disks in stock at a cost of $300 per chip when they
can be purchased at a replacement cost of $250 each. Dell will recognize this decline in cost
when the chips are sold as part of their computers.
FALSE

Difficulty: Medium
10. Inventory turnover is computed as cost of goods sold divided by ending inventory.
FALSE

Difficulty: Medium
11. Reducing inventory can free up cash and allow for reduced borrowing.
TRUE

Difficulty: Medium
7-22
12. If a company sells their inventory every 87 days then their inventory turnover ratio must
be 4.2 times.
TRUE
AACSB Tag: Analytic

Difficulty: Medium
13. If a company has a decrease in inventory equal to $3 million and a decrease in accounts
payable of $2 million, then cash flow from operating activities will increase by $1 million.
TRUE
AACSB Tag: Analytic

Difficulty: Medium
14. The LIFO Reserve is a contra-asset account for the excess of FIFO inventory costs over
the LIFO inventory costs.
TRUE

Difficulty: Medium
15. In a period of rising costs, the LIFO Reserve account would be deducted from the ending
inventory under LIFO costing to convert it to ending inventory under FIFO costing.
FALSE

Difficulty: Hard
7-23
16. The beginning inventory of one accounting period becomes the beginning inventory
amount of the next accounting period.
FALSE

Difficulty: Easy
17. An understatement error in the ending inventory causes an overstatement of both net
income and current assets in that year.
FALSE

Difficulty: Medium
18. When a company using LIFO costing reduces its inventory levels at the end of the year, it
can lead to a LIFO liquidation.
TRUE

Difficulty: Medium
Learning Objective: Sup A
19. When a perpetual inventory system is used, the purchases returns and allowances account
will not be part of the general ledger accounts.
TRUE

Difficulty: Medium
Learning Objective: Sup B
7-24
20. Under the periodic inventory system, the balance in the inventory account changes each
time a purchase or sale of inventory is recorded.
FALSE

Difficulty: Medium
Learning Objective: Sup C
Multiple Choice Questions
21. Which of the following best describes inventory?

A. They are held for resale.
B. They are tangible property.
C. They are used in the operations of the company.
D. They are held for resale and are tangible property.

Difficulty: Medium
22. Which of the following statements about inventory is true?

A. It is acquired for use in operating the company.
B. It is intangible property.
C. It is a current asset on the balance sheet.
D. Manufacturers have four inventory accounts.

Difficulty: Easy
7-25
23. Rockwell Company reported the following amounts on its 2009 income statement:
Purchases, $100,000; Beginning inventory, $20,000; and Cost of goods sold, $110,000.
Therefore, the 2009 ending inventory was
A. $10,000.
B. $25,000.
C. $15,000.
D. $27,000.
AACSB Tag: Analytic

Difficulty: Medium
24. The 2009 records of Coleman Company showed beginning inventory, $100,000; cost of
goods sold, $450,000; and ending inventory, $80,000. The purchases for 2009 equal
A. $450,000.
B. $410,000.
C. $430,000.
D. $420,000.
AACSB Tag: Analytic

Difficulty: Medium
25. When goods are sold on credit, revenue usually should be recognized at the date of
A. receipt of the sales order.
B. passage of title from the seller to the buyer.
C. receipt of the goods by the buyer.
D. manufacture of the goods.

Difficulty: Medium
7-26
26. Which of the following types of inventory usually is not held by a manufacturing
business?
A. Finished goods inventory
B. Raw material inventory
C. Merchandise inventory
D. Work in process inventory

Difficulty: Easy
27. Which of the following is true about a manufacturing company's inventory?

A. Components purchased from vendors will be added to a raw material inventory account.
B. Direct labor and factory overhead are added to the materials in the raw material inventory
account.
C. Cost of storing finished units in a separate warehouse will be added to the finished goods
inventory account.
D. Direct labor and factory overhead are subtracted from the materials in the raw material
inventory account.

Difficulty: Hard
28. Thorton Co. reported the following data at year-end. Sales, $500,000; beginning
inventory, $40,000; ending inventory, $45,000; cost of goods sold, $350,000; and gross
margin, $150,000. What was the amount of merchandise purchased during the year?
A. $370,000
B. $355,000
C. $348,000
D. $341,000
AACSB Tag: Analytic

Difficulty: Medium
7-27
29. The following information was taken from the 2010 income statement of Cobra Company:
Pretax income, $12,000; Total operating expenses (not including income taxes), $20,000;
Sales revenue, $120,000. Compute cost of goods sold.
A. $ 88,000
B. $100,000
C. $108,000
D. $112,000
AACSB Tag: Analytic

Difficulty: Medium
30. The following information was taken from the 2010 income statement of Milburn
Company: Pretax income, $12,000; Total operating expenses (not including income taxes),
$20,000; Sales revenue, $120,000; Beginning inventory, $8,000; and Purchases, $90,000.
Compute the amount of the ending inventory.
A. $88,000
B. $10,000
C. $ 8,000
D. $18,000
AACSB Tag: Analytic

Difficulty: Hard
31. Which of the following is true?

A. Factory overhead consists of manufacturing costs other than direct materials and direct
labor.
B. Net realizable value is the expected sales price plus selling costs.
C. LIFO Reserve is a contra sales account for the excess of LIFO over FIFO inventory.
D. Purchases discounts increase sales revenue to arrive at net sales.

Difficulty: Medium
7-28
32. Sheffield Company had the following information taken from its 2009 adjusted trial
balance: Sales, $400,000; Sales Discounts, $12,000; Beginning Inventory, $20,000; and
Purchases, $200,000. Ending inventory was determined to be $25,000. Compute the gross
margin (gross profit) that would appear in the income statement.
A. $162,000.
B. $180,000.
C. $193,000.
D. $205,000.
AACSB Tag: Analytic

Difficulty: Medium
33. On March 10, Anthony Company received merchandise for resale from its normal
supplier. The price was $3,600 with terms of 2/10, n/30 for 100 units of Part #345. The
invoice was paid on March 17. Freight costs were $120 and the company paid $108 of interest
on a loan to buy the inventory. What is the unit cost that should be recorded for each of the
100 units of Part # 345?
A. $36.48
B. $37.20
C. $36.00
D. $37.56
AACSB Tag: Analytic

Difficulty: Medium
34. Which of the following is correct?

A. Beginning Inventory + Purchases - Cost of Goods Sold = Ending Inventory.
B. Sales + Cost of Goods Sold = Gross Margin.
C. Beginning Inventory + Ending Inventory - Purchases = Cost of Goods Sold.
D. Income Before Taxes - Operating Expenses = Cost of Goods Sold.

Difficulty: Easy
7-29
35. Which of the following costs while includable in inventory, is usually expensed as
incurred instead of being assigned to the inventory units?
A. Freight costs
B. Inspection and preparation costs
C. Purchases discounts
D. Purchase returns

Difficulty: Medium
36. Which of the following costs would not be part of product inventory costs for a
manufacturer such as Harley Davidson?
A. Costs to advertise the newest model.
B. Kickstands purchased for use in manufacturing the motorcycles
C. The factory manager's salary and benefits
D. The wages and benefits of an employee in the welding department

Difficulty: Medium
37. Which of the following businesses would not have cost of goods sold?
A. A jewelry store
B. A grocery store
C. A law firm
D. A manufacturer of batteries

Difficulty: Easy
7-30
38. Which of the following inventory costing methods is subject to manipulation with regard
to the resulting inventory cost?
A. LIFO.
B. FIFO.
C. Weighted-average cost.
D. All of the inventory methods are subject to manipulation.

Difficulty: Hard

What was ending inventory and cost of goods sold on 12/31 under the FIFO cost flow
assumption?
A. $60,000 and $710,000.
B. $52,500 and $717,500.
C. $52,000 and $718,000.
AACSB Tag: Analytic

Difficulty: Medium
7-31

What was ending inventory and cost of goods sold on 12/31 under the LIFO cost flow
assumption?
A. $56,000 and $714,000.
B. $45,000 and $725,000.
C. $40,000 and $730,000.
AACSB Tag: Analytic

Difficulty: Medium
41. Under the FIFO cost flow assumption during a period of inflation, which of the following
is false?
A. Income tax expense will be higher than under LIFO.
B. Gross margin will be higher than under LIFO.
C. Ending inventory will be lower than under LIFO.
D. Cost of goods sold will be lower than under LIFO.

Difficulty: Hard
7-32
42. Under the LIFO cost flow assumption during a period of inflation, which of the following
is false?
A. Cost of goods sold will be lower than under FIFO.
B. Gross margin will be lower than under FIFO.
C. Income tax expense will be lower than under FIFO.
D. Ending inventory will be lower than under FIFO.

Difficulty: Hard
43. When prices are rising:

A. LIFO will result in lower net income and a higher inventory valuation than will FIFO.
B. LIFO will result in higher net income and lower inventory valuation than will FIFO.
C. FIFO will result in lower net income and a lower inventory valuation than will LIFO.
D. FIFO will result in higher net income and a higher inventory valuation than will LIFO.

Difficulty: Medium
44. When prices are rising, the method of inventory valuation that results in the highest
relative net cash inflow is:
A. FIFO.
B. LIFO.
C. weighted average.
D. inventory methods cannot affect cash flows.

Difficulty: Medium
7-33
45. Which of the following statements is correct?

A. FIFO reports lower income amounts than LIFO when prices are rising.
B. LIFO reports a higher income amount than FIFO when prices are rising.
C. LIFO reports a higher income amount than FIFO when prices are decreasing.
D. LIFO reports the same amount of income as FIFO when prices are rising.

Difficulty: Medium
46. Which of the following statements is true?

A. Applying the lower of cost or market (LCM) rule is optional and depends on whether a
company wants to write off inventory when it loses its value or prefers to delay the write off
until the inventory is sold.
B. The LIFO conformity rule requires use of LIFO for financial reports if it is adopted for tax
purposes.
C. LIFO liquidation occurs when a company switches from LIFO to another cost method.
D. The LIFO conformity rule requires use of LIFO for taxes if it is adopted for financial
reports.

Difficulty: Medium
47. The LIFO costing method is more costly and time consuming than a FIFO system. Which
of the following would be a valid justification for choosing LIFO?
A. It usually provides for more control over inventory
B. It usually provides managers with more useful information about the level of inventory by
monitoring the cost level in the inventory account
C. The tax savings from using LIFO during an inflationary period exceeds the cost of using a
LIFO costing system
D. It usually produces a higher net income when unit costs of inventory are rising

Difficulty: Hard
7-34
48. Moore Company purchased an item for inventory that cost $20 per unit and was marked to
sell at $30. It was determined that the replacement cost is $18 per unit. No purchases in the
near future are anticipated. Using the lower-of-cost-or- market rule, the per unit valuation for
inventory should be
A. $18.00.
B. $20.00.
C. $25.00.
D. $30.00.
AACSB Tag: Analytic

Difficulty: Medium
49. On December 31, 2009, the end of the accounting period, Cruise Company has on hand
10,000 units of a resale item which cost $40 per unit when purchased on June 15, 2009. The
selling price is $70 per unit. On December 30, 2009, the cost had dropped to $38 per unit. In
view of the large quantity of units on hand, no purchases are anticipated in the next six to nine
months. At what inventory amount should the 10,000 units be reported?
A. $100,000.
B. $120,000.
C. $350,000.
D. $380,000.
AACSB Tag: Analytic

Difficulty: Medium
7-35
50. Under the lower-of-cost-or-market basis for valuing inventory if replacement cost of an
item in inventory has declined during a given accounting period,
A. pretax income and the amount of ending inventory will be reduced for the period in which
the merchandise is sold.
B. pretax income and the amount of ending inventory will be reduced for the period during
which the decline in market value occurred.
C. pretax income will be reduced for the period during which the decline in market value
occurred and the amount of ending inventory will decline for the period in which the
merchandise is sold.
D. pretax income will be reduced for the period during which the merchandise is sold and the
amount of ending inventory will decline for the period in which the decline in market value
occurred

Difficulty: Medium
51. Which of the following is a true statement about lower of cost or market (LCM)?
A. It is optional under generally accepted accounting principles, whether you apply LCM in
the year in which net realizable value declines below cost or the company waits until the
inventory is sold.
B. LCM can be applied to all cost methods under generally accepted accounting principles
except for LIFO.
C. For tax purposes, the LIFO cost flow method cannot have LCM applied.
D. Under LCM, market equals the current selling price to the retail customer.

Difficulty: Hard
7-36
2008. Their merchandise inventory at the end of 2009 was $1,884 million and $2,094 million
at the end of 2008. What was their inventory turnover in 2009?
A. 3.77
B. 3.89
C. 3.97
D. 3.58
AACSB Tag: Analytic

Difficulty: Medium
2008. Their merchandise inventory in 2009 was $1,884 million and $2,094 million in 2008.
How long were their average days to sell inventory in 2009?
A. 104.52 days
B. 100.31 days
C. 96.82 days
D. 101.96 days
AACSB Tag: Analytic

Difficulty: Medium
54. A company reports its 2010 cost of goods sold at $15.0 million. Its ending inventory for
2010 is $1.6 million and for 2009, ending inventory was $1.2 million. How much inventory
did the company purchase during 2009?
A. $14.6 million
B. $15.0 million
C. $15.4 million
D. $15.8 million
AACSB Tag: Analytic

Difficulty: Medium
7-37
55. A company recorded net purchases on credit of $15.7 million for 2010. In 2009, ending
accounts payable was $1.4 million and in 2010, it was $1.9 million. How much cash was paid
to suppliers in 2010?
A. $14.8 million
B. $15.0 million
C. $15.2 million
D. $15.7 million
AACSB Tag: Analytic

Difficulty: Medium
56. A company reports its cost of goods sold as $15.0 billion in 2009. It has $2.9 billion in
inventory and reports accounts payable at $1.2 billion at the end of 2009. At the end of 2008
ending inventory was reported at $3.1 billion and accounts payable was $1.4 billion. How
much cash was paid to suppliers for 2009?
A. $14.8 billion
B. $15.0 billion
C. $15.2 billion
D. $15.7 billion
AACSB Tag: Analytic

Difficulty: Hard
57. In 2010, QV-TV, Inc. provided the following items in their footnotes. Their cost of goods
$2.1 billion. Their LIFO Reserve figure for year end 2009 was a $0.6 billion credit balance
and at year end 2010 it had increased to a credit balance of $0.8 billion. How much is LIFO
inventory value at year end 2010?
A. $1.9 billion
B. $2.9 billion
C. $2.3 billion
D. $1.3 billion
AACSB Tag: Analytic

Difficulty: Hard
7-38
58. In 2010, Terry Inc. provided the following items in their footnotes. Their cost of goods
$2.1 billion. Their LIFO Reserve account balance for year end 2009 had a $0.6 billion credit
balance and then at year end 2010, it had a credit balance of $0.8 billion. How much would
they report as LIFO cost of goods sold?
A. $22.2 billion
B. $19.8 billion
C. $22.8 billion
D. $19.2 billion
AACSB Tag: Analytic

Difficulty: Hard
59. Which of the following statements is false?

A. The LIFO Reserve is a contra-asset account for the excess of FIFO over LIFO inventory
costs.
B. When the LIFO Reserve account increases from one year to the next, then FIFO cost of
goods sold will be less than LIFO cost of goods sold.
C. The LIFO Reserve account balance at the end of the year would be deducted from ending
LIFO inventory cost to convert to FIFO ending inventory cost.
D. We want to convert LIFO cost of goods sold and LIFO inventory balances to FIFO cost of
goods sold and inventory balances to obtain a more realistic inventory turnover ratio.

Difficulty: Hard
60. A $25,000 overstatement of the 2010 ending inventory was discovered after the financial
statements for 2010 were prepared. The effect of the inventory error on the 2010 financial
statements was
A. current assets were overstated and net income was understated.
B. current assets were understated and net income was understated.
C. current assets were overstated and net income was overstated.
D. current assets were understated and net income was overstated.

Difficulty: Medium
7-39
61. Wilmington Company reported pretax income amounts of: 2010, $25,000; and 2011,
$30,000. Later it was discovered that the ending inventory for 2010 was understated by
$2,000 (and not corrected in 2011). The correct pretax income for each year was:
A.
B.
C.
D.
AACSB Tag: Analytic

Difficulty: Hard
62. At the end of 2009, a $5,000 understatement was discovered in the amount of the 2009
ending inventory as reflected in the perpetual inventory records. What were the 2009 effects
of the $5,000 inventory error (before correction)?
A. Assets (inventory) were understated by $5,000 and pretax income was understated by
$5,000.
B. Assets (inventory) were understated by $5,000 and pretax income was overstated by
$5,000.
C. Cost of goods sold was understated by $5,000 and pretax income was understated by
$5,000.
D. Cost of goods sold was overstated by $5,000 and pretax income was overstated by $5,000.
AACSB Tag: Analytic

Difficulty: Medium
63. An understatement of the ending inventory in Year 1, if not corrected, will cause
A. Year 1 net income to be understated and Year 2 net income to be overstated.
B. Year 1 net income to be overstated and Year 2 net income to be overstated.
C. Year 1 net income to be overstated and Year 2 net income will be correct.
D. Year 1 net income to be overstated and Year 2 net income to be understated.

Difficulty: Medium
7-40
64. If beginning inventory is understated by $1,300 and ending inventory is understated by

$700, pretax income for the period will be:
A. understated by $600.
B. understated by $2,000.
C. overstated by $600.
D. overstated by $2,000.
AACSB Tag: Analytic

Difficulty: Hard
65. On December 15, 2009, Transport Company accepted delivery of merchandise which it
purchased on credit. As of December 31, 2009, the company had neither recorded the
transaction nor included the merchandise in its ending inventory amount because the seller's
invoice had not been received. The effect of this omission on its balance sheet at December
31, 2009, (end of the accounting period) was that
A. assets and stockholder's equity were overstated but liabilities were not affected.
B. stockholder's equity was the only item affected by the omission.
C. assets and liabilities were understated but stockholders' equity was not affected.
D. assets and stockholders' equity were understated but liabilities were not affected.

Difficulty: Hard
66. A company using the periodic inventory system correctly recorded a purchase of
merchandise, but the merchandise was not included in the physical inventory count at the end
of the accounting period. The error caused an:
A. understatement of both net income and assets.
B. overstatement of inventory, purchases, and accounts payable.
C. understatement of inventory, purchases, and accounts payable.
D. overstatement of net income and assets.

Difficulty: Medium
7-41
67. At the end of 2010, XYZ Company failed to include some goods in its ending inventory
and failed to record the purchase of these goods. For 2010, these two errors caused
A. goods available for sale, cost of goods sold, and income to be overstated.
B. ending inventory, cost of goods sold, and retained earnings to be understated.
C. ending inventory, goods available for sale, and retained earnings to be understated.
D. no effect on income, working capital, or retained earnings.

Difficulty: Hard
68. Hollander Company hired some students to help count inventory during their semester
break. Unfortunately, the students added incorrectly and ending inventory was overstated by
$5,000. What would be the effect of this error in ending inventory?
A. Income would be overstated.
B. Income would be understated.
C. Ending retained earnings would be understated.
D. Cost of goods sold would be overstated.

Difficulty: Medium
69. During the audit of Montane Company's 2010 financial statements, the auditors
discovered that the 2010 ending inventory had been overstated by $8,000. Before the effect of
this error, 2010 pretax income had been computed as $100,000. What should be reported as
the correct 2010 pretax income before taxes?
A. $ 92,000.
B. $100,000.
C. None of the other answers is correct.
D. $108,000.
AACSB Tag: Analytic

Difficulty: Hard
7-42
70. Under the periodic method, cost of goods sold is computed by

A. adding the cost of purchases during the period to the cost of the inventory on hand at the
beginning of the period and adding this figure to the cost of the inventory on hand at the end
of the period.
B. adding the cost of purchases during the period to the cost of the inventory on hand at the
end of the period and subtracting the inventory on hand at the beginning of the period.
C. subtracting the cost of the inventory on hand at the ending of the period from the cost of
goods available for sale.
D. carefully matching selling and administrative expenses with the sales to which they are
related and then reporting these expenses in the same period the associated revenue is
reported.

Difficulty: Medium
71. Under the perpetual inventory system:

A. one entry is required to record a sales return.
B. cost of goods sold cannot be determined unless a physical inventory is taken.
C. one entry is required to record a sale.
D. a separate account for purchases is not required.

Difficulty: Medium
72. Under the periodic inventory system:

A. a transaction by transaction unit inventory record is maintained.
B. the cost of goods sold for each sale is recorded at the time each sale is made.
C. a separate account for purchases is used.
D. a continuous inventory record provides the amount of ending inventory and the cost of
goods sold throughout the period.

Difficulty: Medium
7-43
73. Which of the following may be used to calculate ending inventory (EI) under the periodic
inventory system?
A. BI + P + CGS = EI.
B. BI + P - CGS = EI.
C. BI - P + CGS = EI.
D. BI + P + GM = EI.

Difficulty: Medium
74. On March 15, 2009, Ryan Company purchased $10,000 of merchandise on credit subject
to terms, 2/10, n/30. Ryan Company records its purchases using the gross amount. The
periodic inventory system is used. If Ryan Company pays for these goods on March 30, the
entry made to record the payment should include
A. $200 credit to Purchase discounts.
B. debit of $9,800 to Accounts payable.
C. debit of $10,000 to Accounts payable.
D. $9,800 credit to cash.
AACSB Tag: Analytic

Difficulty: Medium
75. Two systems are used in accounting for inventoryperpetual and periodic. Which of the
following statements is correct?
A. In a perpetual inventory system, the inventory account is not changed for each purchase
B. In a perpetual inventory system, cost of goods sold is recorded at the time of each sale
C. In a periodic inventory system, cost of goods sold is developed from a comparison of
beginning inventory and ending inventory only.
D. In a periodic inventory system, the inventory account is increased for each purchase during
the accounting period.

Difficulty: Medium
7-44
76. Which one of the following statements concerning the periodic and perpetual inventory
systems is true?
A. The periodic system uses a purchases account.
B. Inventory controls are only needed for the periodic inventory systems.
C. None of the accounting entries vary between the two systems.
D. Due to advances in computers, many businesses recently have begun to use the periodic
inventory system.

Difficulty: Medium
77. When a company uses the periodic inventory system in accounting for its merchandise
inventory, which of the following is true?
A. Purchases are recorded in the cost of goods sold account.
B. The inventory account is updated after each sale.
C. Cost of goods sold is computed at the end of the accounting periods rather than at each
sale.
D. The inventory account is updated throughout the year as purchases are made.

Difficulty: Medium
78. A LIFO liquidation occurs when a company

A. goes out of business.
B. converts from LIFO to FIFO.
C. converts from the periodic to the perpetual inventory system.
D. sells more units than it purchased during the year.

Difficulty: Medium
Learning Objective: Sup A
7-45
79. Carrie Company sold merchandise with an invoice price of $1,000 to Underwood, Inc.,
with terms of 2/10, n/30. Which of the following is the correct entry to record the payment by
Underwood Inc., within the 10 days if the company uses the periodic inventory system and
the gross method to record purchases?
A.
B.
C.
D.
AACSB Tag: Analytic

Difficulty: Medium
Learning Objective: Sup B
80. On September 20, 2009, Precision Electric Company purchased $10,000 of stereo
equipment for resale on credit, subject to the terms 2/15, n/30. The periodic inventory system
is used. If the company paid for these goods on October 18, the entry made to record the
payment should include a/an
A. $200 debit to Purchases discounts.
B. $10,000 debit to Accounts payable.
C. $9,800 credit to Cash.
D. $10,000 debit to Purchases.
AACSB Tag: Analytic

Difficulty: Medium
Learning Objective: Sup C
7-46

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Chapter 07 - Reporting and Interpreting Cost of Goods Sold and Inventory

True / False Questions

8. The lower-of-cost-or-market (LCM) rule is used because of the conservatism constraint,

Multiple Choice Questions

21. Which of the following best describes inventory?

22. Which of the following statements about inventory is true?

27. Which of the following is true about a manufacturing company's inventory?

31. Which of the following is true?

34. Which of the following is correct?

During the year, 750 laptop computers were sold.

During the year, 750 laptop computers were sold.

43. When prices are rising:

45. Which of the following statements is correct?

46. Which of the following statements is true?

59. Which of the following statements is false?

64. If beginning inventory is understated by $1,300 and ending inventory is understated by

70. Under the periodic method, cost of goods sold is computed by

71. Under the perpetual inventory system:

72. Under the periodic inventory system:

78. A LIFO liquidation occurs when a company

Chapter 07 Reporting and Interpreting Cost of Goods Sold and Inventory

True / False Questions

AACSB Tag: Reflective Thinking

AACSB Tag: Reflective Thinking

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AACSB Tag: Communications

AACSB Tag: Reflective Thinking

8. The lower-of-cost-or-market (LCM) rule is used because of the conservatism constraint,

AACSB Tag: Reflective Thinking

AACSB Tag: Reflective Thinking

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AACSB Tag: Analytic

AACSB Tag: Analytic

AACSB Tag: Reflective Thinking

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AACSB Tag: Reflective Thinking

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AACSB Tag: Reflective Thinking

Multiple Choice Questions

21. Which of the following best describes inventory?

AACSB Tag: Reflective Thinking

22. Which of the following statements about inventory is true?

AACSB Tag: Reflective Thinking

AACSB Tag: Analytic

AACSB Tag: Analytic

AACSB Tag: Reflective Thinking

AACSB Tag: Reflective Thinking

27. Which of the following is true about a manufacturing company's inventory?

AACSB Tag: Reflective Thinking

AACSB Tag: Analytic

AACSB Tag: Analytic

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31. Which of the following is true?

AACSB Tag: Reflective Thinking

AACSB Tag: Analytic

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34. Which of the following is correct?

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