Financial Reporting and Analysis 【Reading 29】Sample company, capacity, following, 2012

kim226

Diabelli Inc. is a manufacturing company that is operating at normal capacity levels. Which of the following inventory costs is most likely to be recognized as an expense on Diabelli’s financial statements when the inventory is sold?

A) Administrative overhead.

B) Allocation of fixed production overhead.

C) Selling cost.

---

Assuming normal capacity levels, allocation of fixed production overhead is a product cost that is capitalized as part of inventory. Thus, this cost will not be recognized as an expense until the inventory is sold (it becomes part of COGS for that period). Administrative overhead and selling costs are period costs that must be expensed in the period incurred.

kim226

Goldberg Inc. produces and sells electronic equipment. Which of the following inventory costs is most likely to be recognized as an expense on Goldberg’s financial statements in the period incurred?

A) Conversion cost.

B) Selling cost.

C) Freight costs on inputs.

---

Selling costs are expensed in the period incurred since they result in no future benefit (i.e. the inventory has been sold). Conversion costs and freight costs add value in assisting in the future sale of the related inventory. Therefore, these costs are not recognized until the inventory is ultimately sold.

kim226

In an environment of increasing prices, the last-in first-out (LIFO) inventory cost method results in:

A) cost of sales near current cost and inventory below replacement cost.

B) inventory near replacement cost and cost of sales below current cost.

C) cost of sales below current cost and inventory above replacement cost.

---

LIFO assumes the most recently purchased items are the first items sold. In an increasing or decreasing price environment, LIFO results in cost of sales that are nearer to current costs compared to other inventory cost methods, and inventory values based on outdated prices (below replacement cost if prices are increasing, above replacement cost if prices are decreasing).

kim226

A U.S. company uses the LIFO method to value its inventory for their income tax return. For its financial statements prepared for shareholders, the company may:

A) use any other inventory method under generally accepted accounting principles (GAAP).

B) only use the LIFO method.

C) use the FIFO method, but must disclose a LIFO reserve.

---

The LIFO conformity rule in the U.S. requires firms to use LIFO for their financial statements if they use LIFO for income tax purposes.

kim226

JME purchased 400 units of inventory that cost $4.00 each. Later the firm purchased an additional 500 units that cost $5.00 each. JME sold 700 units of inventory for $7.00 each. If JME uses a first in, first out (FIFO) cost flow method, the amount of gross profit appearing on the income statement is:

A) $2,400.

B) $3,100.

C) $1,800.

---

(units sold × sales price) – [(inventory cost × unit cost) + (inventory cost × unit cost)] = sales – COGS = gross profit
(700 × 7.00) – [(400 × 4.00) + (300 × 5.00)] = 1,800

kim226

Given the following inventory data about a firm:

• Beginning inventory 20 units at $50/unit
• Purchased 10 units at $45/unit
• Purchased 35 units at $55/unit
• Purchased 20 units at $65/unit
• Sold 60 units at $80/unit

What is the inventory value at the end of the period using first in, first out (FIFO)?

A) $1,575.

B) $3,475.

C) $3,100.

---

Ending inventory equals 20 + 10 + 35 + 20 − 60 = 25 of last units purchased in inventory.
(20 units)($65/unit) + (5 units)($55/unit) = $1,300 + $275 = $1,575

kim226

Which inventory method will provide the largest net income during periods of falling prices?

A) Weighted average cost.

B) FIFO.

C) LIFO.

---

During periods of falling prices last in, first out (LIFO) provides a higher net income than first in, first out (FIFO) or the average cost methods because the items most recently purchased are the ones being sold first and these costs are continually falling increasing net income. Using FIFO during periods of falling prices would cause net income to be lower than LIFO or average cost methods because the first inventory purchased is the first sold but during periods of falling prices this is the most expensive inventory causing net income to be lower.

kim226

	Units	Unit Price
Beginning Inventory	709	$2.00
Purchases	556	$6.00
Sales	959	$13.00
SGA Expenses	$2,649 per annum

What is the cost of goods sold using the weighted average method?

A) $3,604.02.

B) $3,423.82.

C) $2,918.00.

---

Weighted average = cost of goods available / total units available. COGS = Units sold × weighted average = 959 × 3.7581 = $3,604.02.

---

What is the cost of goods sold using the first in, first out (FIFO) method?

A) $8,325.00.

B) $2,918.00.

C) $2,772.10.

---

COGS = (709 × 2) + (250 × 6) = $2,918.00.

---

What is the ending inventory level in dollars using the FIFO method?

A) $1,836.00.

B) $4,142.00.

C) $1,744.20.

---

Ending Inventory = 306 × 6 = $1,836.00.

kim226

Blocher Company is evaluating the following methods of accounting for depreciation of long-lived assets and inventory:

• Depreciation: straight-line; double-declining balance (DDB)
• Inventory: first in, first out (FIFO); last in, first out (LIFO)

Assuming a deflationary environment (prices are falling), which of the following combinations will result in the highest net income in year 1?

A) DDB; FIFO.

B) Straight-line; FIFO.

C) Straight-line; LIFO.

---

For year 1, straight-line depreciation will be lower than DDB. During deflationary periods, LIFO will result in lower cost of goods sold and hence higher income.

kim226

Arlington, Inc. uses the first in, first out (FIFO) inventory cost flow assumption. Beginning inventory and purchases of refrigerated containers for Arlington were as follows:

	Units	Unit Cost	Total Cost
Beginning Inventory	20	$10,000	$200,000
Purchases, April	10	12,000	120,000
Purchases, July	10	12,500	125,000
Purchases, October	20	15,000	300,000

In November, Arlington sold 35 refrigerated containers to Johnson Company. What is the cost of goods sold assigned to the 35 sold containers?

A) $485,000.

B) $434,583.

C) $382,500.

---

Under FIFO, cost of goods sold is the value of the first units purchased. The 35 units sold consist of the 20 units in beginning inventory, the 10 units purchased in April, and 5 of the units purchased in July. COGS = $200,000 + $120,000 + (5 × $12,500) = $382,500.