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# Financial Reporting and Analysis【Reading 20】Sample

A firm’s financial statements reflect the following information:
 Beginning inventory \$3,200,000 Purchase during the year \$1,700,000 Ending inventory \$2,100,000 Sales \$4,800,000 Gross profit margin ????

What was the firm’s gross profit margin?
 A) 0.58.
 B) 0.42.
 C) 2.29.

First we can determine the COGS by: COGS = beginning inventory + purchases – ending inventory = \$2,800,000.
Then, gross profit margin = (sales – COGS) / sales = 0.42.

An analyst notes the following about a company:
• Beginning inventory was reported as \$5,000.
• Costs of goods sold were reported as \$8,000.
• Ending inventory is \$7,000 (the analyst has physically verified this amount).

Which of the following statements is most accurate?
 A) If the analyst discovered that beginning inventory was overstated by \$1,000, then cost of goods sold must have been understated by \$1,000.
 B) Purchases must have been \$6,000.
 C) If the analyst discovered that beginning inventory was understated by \$2,000, then earnings before taxes must have been overstated by \$2,000.

If inventory is overstated then COGS must also be overstated or purchases were understated, since you are told that ending inventory is ok.
While attending a local university, CFA candidate Anjolie Webster accepts a temporary position with a small manufacturing firm. Currently, the firm uses LIFO to account for inventory, but the owner is “just curious” about how the financial results would look if the company used FIFO. The owner hands Webster a photocopy of the inventory data for the current period (summarized below).
• Beginning inventory of 1,000 units at \$30 cost.
• Ending inventory of 800 units.
• Sales of 1,100 units.
• Three inventory purchases (listed from earliest purchase to latest purchase): 400 units at \$27 each, 300 units at \$25 each, and an unreadable number of units at \$22 each. (Unfortunately, when the owner copied the original document, he left a yellow sticky note covering some of the inventory information.)
• Current assets (less inventory) of \$75,000.
• Current liabilities of \$65,000.

Using the information provided, determine which of the following statements is least accurate? All else equal, compared to LIFO, using FIFO would result in:
 A) a lower ending inventory balance.
 B) a current ratio of approximately 1.60.
 C) a lower gross margin.

To calculate the current ratio (which includes the ending inventory balance) using FIFO, we first need to determine how many units were purchased in the third illegible purchase order.
Ending inventory = beginning inventory + units purchased – units sold, so
units purchased = units sold + ending inventory – beginning inventory
= 1,100 + 800 – 1,000 = 900
Third purchase units = 900 – 400 – 300 = 200

• FIFO ending inventory = [(300 × 27) + (300 × 25) + (200 × 22)] = \$20,000
• FIFO current ratio (all else equal) = (75,000 + 20,000) / 65,000 = approximately 1.46

The other choices are correct. Since prices are decreasing, FIFO cost of goods sold is higher (and gross margin is lower) than LIFO. And, FIFO ending inventory is lower than LIFO ending inventory. No LIFO calculations are necessary.
A firm’s financial statements reflect the following information:
 Beginning inventory \$2,900,000 Purchase during the year \$1,600,000 Ending inventory ???? Sales \$3,900,000 Gross Margin 0.41

What was the firm’s ending inventory for this period?
 A) \$2,199,000.
 B) \$2,799,000.
 C) \$1,699,000.

First we can determine the cost of goods sold (COGS) by: COGS = sales (1 − gross margin) = \$2,301,000.
Then, the ending inventory = beginning inventory + purchases − COGS = \$2,199,000.
A firm uses the last in, first out (LIFO) accounting method and posts \$100,000 as ending inventory. Last year's financial statements show inventory at \$110,000. This period's income statement shows costs of goods sold at \$90,000 with a LIFO reserve of \$30,000. How much inventory was purchased this period, and what would the ending inventory balance be under first in, first out (FIFO)?
 Inventory purchases Ending inventory (FIFO)
A)
 \$80,000 \$130,000
B)
 \$90,000 \$130,000
C)
 \$80,000 \$70,000

EI = BI + P - COGS
100 = 110 + P - 90
P = \$80,000
In order to convert ending inventory under FIFO to LIFO you have to add the LIFO reserve to the ending inventory under LIFO.
EIFIFO = \$100,000 + \$30,000 = \$130,000
A company's beginning inventory was overstated by \$3,000, now ending inventory is understated by \$2,000. If purchases were properly reported, then earnings before taxes will be:
 A) overstated by \$1,000.
 B) overstated by \$5,000.
 C) understated by \$5,000.

The key relationship being tested is beginning inventory + purchases – COGS = ending inventory. So, beginning inventory + purchases – ending inventory = COGS. You could solve the equation as +3000 +0 - -2000 = +5000. However, it is probably easier to conceptualize by making up numbers that meet the requirements.
Actual (I made these numbers up):
20,000 + 5,000 – 15,000 = 10,000
Reported:
(20,000 + 3,000) + 5,000 – (15,000-2,000) = 15,000
COGS will be overstated by 5,000 so earnings before taxes (EBT) will be understated by 5,000.
Sweet Milk Inc uses the last in, first out (LIFO) inventory method and had 5,000 units of beginning inventory on January 1, 2002, that was valued at \$10.00 a unit. The company purchased 50,000 units at \$12 a unit and sold 52,000 units at \$15 a unit. Sweet Milk is considering an additional purchase of 10,000 units at \$13 a unit. The company will make the purchase at the end of December or in the early part of year 2003. Which statement about the effect of the purchase decision on net income is most accurate?
 A) Making the purchase in December will increase income by \$16,000 in year 2002.
 B) Income for year 2002 will not be affected no matter when the inventory is purchased.
 C) Postponing the purchase until January will increase income for 2002 by \$14,000.

By postponing the purchase until January, cost of goods sold (COGS) would be \$620,000. A purchase in December would increase COGS to \$634,000.
COGS for January purchase = (50,000 × 12) + (2,000 × 10) = 620,000
COGS for December purchase = (10,000 × 13) + (42,000 × 12) = 634,000
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) \$3,475.
 B) \$1,575.
 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
 Units Unit Price Beginning Inventory 559 \$1.00 Purchases 785 \$5.00 Sales 848 \$15.00 SGA Expenses \$3,191 per annum

What is the cost of goods sold using the weighted average cost method?
 A) \$2,004.00.
 B) \$2,829.19.
 C) \$3,988.00.

Average cost = cost of goods available / total units available. COGS = Units sold × wt. ave = 848 × 3.33631 = \$2,829.19.

What is the cost of goods sold using the first in, first out (FIFO) method?
 A) \$2,829.19.
 B) \$2,004.00.
 C) \$8,732.00.

COGS = (559 × 1) + (289 × 5) = \$2,004.00.

What is the ending inventory level in dollars using the FIFO method?
 A) \$2,480.00.
 B) \$3,988.00.
 C) \$2,356.00.

Ending inventory = 496 × 5 = \$2,480.00.
Which of the following statements about inventory accounting is least accurate?
 A) If a U.S. firm uses last in, first out (LIFO) for tax reporting it must use LIFO for financial reporting.
 B) During periods of rising prices, last in, first out (LIFO) income will be lower than under first in, first out (FIFO) but cash flows will be higher.
 C) During periods of rising prices, first in, first out (FIFO) based current ratios will be smaller than last in, first out (LIFO) based current ratios.

During periods of rising prices, FIFO based current ratios will be larger than LIFO based current ratios because the more expensive units (last purchases) are assigned to ending inventory, resulting in greater current assets.
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