Download Practice Test for Chapters 4 and 5

Solutions for
Practice Test for Chapters 4 and 5
This practice test is a sample of the types of problems and short answer questions that you will find on
the test. Your test preparation should also include reviewing the chapter objectives, end-of-chapter
questions, assigned exercises and problems, and YNI lab assignments.
1) The following events pertain to Ann's Office Supply Company for January 20X8. The company
uses the net method to account for purchases and sales. Record the following events in general
journal format:
a) Jan 3. Ann purchased $60,000 of merchandise inventory from her supplier, DD Distributors,
Inc. The terms of the sale: 2/10 n 30 and FOB shipping point.
1/3 Inventory
58,800
Accounts Payable
58,800
60,000 * 2% = 1,200 60,000 – 1,200 = 58,800
2/10 n30 means DD (the seller) will allow a 2% discount if Ann (the purchaser) pays cash
within 10 days of the date of purchase. If Ann pays later than the 10th day, the discount is lost,
and the full amount is due within 30 days.
Because Ann uses the net method, the purchase is recorded at the net price, which is the list
price (60,000) – the discount (1,200).
b) Jan 5. Paid $400 cash for freight to trucking company to have goods shipped from DD
Distributors, Inc.
1/5 Inventory
400
Cash
400
Incurring a transportation-in cost is necessary to obtain the inventory, as the terms of the sale
are FOB shipping point (buyer pays shipping). Therefore, it is a product cost and added to the
inventory.
c) Jan 7. Sold merchandise for $8,000 to a customer on account. Credit terms 1/10,n/30. The
merchandise sold cost $5,600.
1/7 Accounts Receivable
7,920
Sales
7,920
Cost of Goods Sold
5,600
Inventory
5,600
8,000 * 1% = 80
8,000 – 80 = 7,920
Ann records sales net of 1% sales discount
d) Jan. 7. Ann delivered the merchandise sold under terms FOB destination. Freight costs were
$100 paid in cash.
1/7 Delivery Expense
100
Cash
100
Delivering merchandise to the customer is a cost that is
incurred AFTER the goods are produced and sold. It is
a period cost, expensed in the period in which it is
incurred – NOT a product cost.
e) Jan 10. Returned $10,000 of defective merchandise to DD Distributors.
1/10 Accounts Payable
9,800
Inventory
9,800
10,000 * 2% = 200
10,000 – 200 = 9,800
Ann reverses $10,000 of inventory purchase on
account. Because this purchase was recorded net of
the 2% discount, the return must also be recorded
using the net method.
f) Jan. 11. Paid amount due to DD Distributors for merchandise purchased on 1/3.
1/11 Accounts Payable
49,000
Cash
49,000
$58,800 (1/3 purchase) – 9,800 (returned) = $49,000
g) Jan. 12 . Accepted a return of $1,500 from the goods sold on Jan. 7. The cost of these goods is
$1,100.
1/12 Sales Returns and Allowances (or Sales)
1,485
Accounts Receivable
1,485
Inventory
1,100
Cost of Goods Sold
1,100
1,500 * .01 = 1,485
Ann reverses $1,500 of the 1/7 sale on account. This
sale was recorded using the net method, so the return is
recorded net of the 1% sales discount as well.
h) Jan.14 Collected the amount owed to us by the customer from Jan. 7.
1/14 Cash
6,435
Accounts Receivable
7,920 (1/7 sale) – 1,485 (return) = 6,435
6,435
2) Allison Company uses the perpetual inventory method. The company's inventory account had a
$5,500 balance as of December 31, 20X7. A physical count of inventory shows only $5,300 of
merchandise in stock at December 31, 20X7. Prepare the adjusting journal entry:
Inventory Loss Expense
200
Inventory
200
Allison must make an adjusting entry to write down the Inventory account so that the amount
reported on the financial statements agrees with the amount actually on hand at the end of the
period. The write-down decreases both assets (inventory) and stockholder’s equity (retained
earnings decreased due to inventory loss expense).
3)
Which of the following items is not a product cost?
A. Transportation cost on goods delivered to customers.
B. Cost of merchandise purchased for resale.
Transportation cost on merchandise purchased from
C.
suppliers.
D. All of the above are product costs.
The correct answer is A. Delivering goods to customers is a cost incurred after the production and
sale of merchandise. Because it is not part of the costs necessary to obtain goods or ready them for
sale, it is not a product cost – and thus is expensed as it is incurred.
4) Delius Company purchased $5,000 of merchandise on account, terms n/30. Delius
sold the merchandise the following day to a customer for $7,000 cash. Calculate the
increase in gross margin and the net change in cash flow from operating activities as a
result of these transactions.
Cash Flow From
Gross Margin.............
..Operating
...................................................
Activities
A. $5,000.............................................. $7,000 outflow
B. $2,000.............................................. $7,000 inflow
C. $2,000.............................................. $2,000 outflow
D. $7,000.............................................. $5,000 inflow
The correct answer is B. $7,000 Sales - $5,000 Cost of Goods Sold = $2,000 Gross Margin. There is
a $7,000 cash inflow from the sale, but no cash outflow from this transaction (Delius has 30 days to
pay for the inventory).
5)
Consider the following data for Companies A, B, C and D:
Company........................A................B........................C.....................D
Sales.........................$40,000.........$60,000............$50,000............$90,000
Cost of Goods Sold....22,000...........36,000..............30,000..............67,500
Operating Expenses…..4,800............5,400.................5,000...............6,300
Net Income.................11,200..........18,600...............15,000.............16,200
Calculate each company’s gross margin percentage.
(gross margin %)?
A
B
Sales
40,000
60,000
CGS
(22,000)
(36,000)
Gross
18,000
24,000
Margin
Gross
18,000/40,000= 24,000/60,000=
Margin %
45%
40%
Which company has the highest markup
C
D
50,000
(30,000)
20,000
90,000
(67,500)
22,500
20,000/50,000= 22,500/90,000=
40%
25%
Company A has the highest gross margin %. For every $1 of sales, Company A has 45 cents
(45%) of gross profit remaining after it has paid for its goods.
6) Which of the following statements is true about period costs?
A. Period costs are usually recorded as assets.
B. Most period costs are expensed in the period the costs are incurred.
C. Period costs are expensed when the products associated with these costs are sold.
D. Operating expenses are not period costs.
The correct answer is B. Examples of period costs include advertising, sales commissions and freight
costs on delivering goods to the customer.
7) Which group of accounts appears on the balance sheet?
a) Sales, Sales Discounts, and Cost of Goods Sold
b) Inventory, Transportation-out, and Distributions
c) Inventory, Cash, and Contributed Capital
d) Sales, Selling Expenses, and Sales Returns and Allowances
The correct answer is C. Cash and Inventory are listed under
Assets on the balance sheet. Contributed Capital (Common Stock) appears in the Stockholders’
Equity section of the balance sheet.
Sales, Sales Discounts, Sales Returns and Allowances, Cost of Goods Sold, Selling Expenses and
Transportation-out are all temporary accounts that appear on the Income Statement.
Distributions (Dividends) appear on the Statement of Changes in Stockholder’s Equity.
8) The cost of goods sold account is classified as:
A. an expense.
B. an asset.
C. a contra asset.
D. a liability.
The correct answer is A. Product costs are recorded as assets (in the inventory account) until the
product is sold. At the point of sale, these costs are expensed as Cost of Goods Sold.
9) The credit terms, 3/15, n/30 indicate that a:
three percent discount can be deducted if the invoice is paid after the fifteenth day following
A.
the sale, but before the thirtieth day.
B.
three percent discount can be deducted if the invoice is paid before the fifteenth day
following the date of the sale.
C.
three percent discount can be deducted for a period up to thirty days following the date of
sale.
D.
fifteen percent discount can be deducted if the invoice is paid within three days following
the date of sale.
The correct answer is B. 3/15 n/30 means that the seller will allow a 3% discount if the
purchaser pays cash within 15 days of the date of purchase. If the purchaser makes payment
later than the 15th day, the discount is lost, and the full amount is due within 30 days.
10) Indicate whether each of the following statements is true or false. (Assume a perpetual inventory
system)
___F__ a. Purchase of merchandise inventory is treated as an expense.
___F__ b. Merchandise inventory is expensed in the period it is purchased.
___T__ c. Merchandise inventory is an item appearing on the balance sheet.
___T__ d. Cost of goods sold is an expense.
___F__ e. Cost of goods sold is a part of administrative and selling costs.
Merchandise inventory is recorded as an asset when purchased. It is not expensed until it is
sold to a customer. At the point of sale, Inventory is decreased (with a credit) and Cost of Goods
Sold is increased (with a debit). On the multi-step income statement, Cost of Goods Sold is
subtracted from Net Sales to arrive at Gross Margin.
11) If goods are shipped F.O.B. destination, who is responsible for the shipping costs?
The seller pays if the terms are FOB destination.
The purchaser pays if the terms are FOB shipping point.
12) In an inflationary environment, which inventory cost flow method will produce the lowest amount of
cost of goods sold?
A. FIFO
B. LIFO
C. Weighted Average.
D. All methods will produce the same amount of cost of goods sold.
In a period of rising prices, FIFO (First-In, First-Out) will produce the lowest amount of CGS,
because the bottom (or first) layer of inventory containing the lowest costs will be expensed first.
13) Bentley Company purchased two identical inventory items. The item purchased first
cost $3.00 and the item purchased second cost $4.00. Bentley sold one of the items
for $6.00. Which of the following statements is true?
Gross margin will be higher if Bentley uses LIFO than it would be if FIFO
A.
were used.
B.
Ending inventory will be lower if Bentley uses weighted average than it
would be if FIFO were used.
C. Cost of goods sold will be higher if Bentley uses FIFO than it would be if
weighted average were used.
D.
Ending inventory will be the same no matter which cost flow method is
used.
LIFO
FIFO
Weighted Avg.
Sales Revenue
6.00
6.00
6.00
Cost of Goods
Sold
(4.00) Last purchase
(3.00) 1st purchase
(3.50) Avg. of purchases
Gross Margin
2.00
3.00
2.50
Ending
Inventory
3.00 (1st purchase)
4.00 (last purchase)
3.50 (avg. of purchases)
The correct answer is B. Ending inventory will be $3.50 using WA, which is less than the ending
inventory using FIFO.
14)
Cost of
Goods
Sold...
Company X
Company Y
Company Z
$2,400,000... $5,250,000............ $3,920,000
Inventory 200,000
350,000
280,000
The average number of days in inventory for Company Y is:
A. 15.0
B. 24.3
C. 26.1
D. 30.4
The correct answer is B.
First, calculate the Inventory Turnover (CGS/Inventory)…5,250,000/350,000 = 15.0
This means that Co. Y turns its inventory over 15 times per year.
Next, to calculate the average number of days in inventory, divide into 365.
365 / 15 = 24.3 days
15) When prices are falling:
LIFO will result in higher income and a higher inventory valuation than
A.
FIFO.
B. LIFO will result in higher income and a lower inventory valuation than FIFO.
C. LIFO will result in lower income and a higher inventory valuation than FIFO.
D. LIFO will result in lower income and a lower inventory valuation than FIFO.
The correct answer is A. In a period of falling prices, LIFO will produce a lower CGS than FIFO,
and therefore a higher income than FIFO. In a deflationary environment, LIFO’s ending inventory
will also be higher than FIFO.
To illustrate –
Beg. Inv.
10 units @ $100 each = $1,000
1st purchase
5 units @ $75 each = $375
2nd purchase 5 units @ $50 each = $250
10 units were sold for $200 each.
LIFO
FIFO
Sales
2,000
2,000
Cost of Goods Sold
2nd purchase = 5 @ $50
Beg. inv. = 10 @ $100
1st purchase = 5 @ $75
CGS =
CGS =
Gross Margin
1,375
625
$1,000
$1,000
Ending Inventory
$1,000
$625
16) If prices are rising, which inventory cost flow method will produce the lowest amount of cost of
goods sold?
A. LIFO
B. NIFO
C. FIFO
D. Weighted Average.
If prices are rising, FIFO will produce the lowest CGS, since the bottom (or first) layer of inventory
containing the lowest costs will be expensed first. See #13 above for an example.
17) Which of the following accounts will always be shown on the balance sheet at market value?
A. Accounts receivable.
B. Inventory.
C. Land.
D. Trading securities.
Trading Securities are reported on the investor’s balance sheet at their market (or fair) value,
regardless whether the market value is higher or lower than cost. Land is reported at its historical
cost. Inventory is reported on the balance sheet as the lower of its cost or market value. Accounts
Receivable is reported at its Net Realizable Value (chapter 7).
18) Which inventory costing method will produce a cost of goods sold closest to
market value?
A. Weighted average.
B. Specific identification.
C. FIFO.
D. LIFO.
The correct answer is D. The most recent inventory purchase (expensed 1st using LIFO) will be
closest to market (or replacement) value.
19) Hill Company purchased investment securities at a cost of $7,000. At the end of the accounting
period the securities had a market value of $7,600. Indicate whether each of the following
statements is true or false assuming the securities are
classified as trading securities.
___T__ a. The unrealized gain would cause net income to increase.
___T_ b. The unrealized gain would cause equity to increase.
___T__ c. The securities would be carried at $7,600 on the balance sheet.
___F__ d. A $7,600 cash outflow would be shown in the investing activities section of the
statement of cash flows.
___F__ e. The unrealized gain would not be recognized in the financial statements.
At the end of the period, the trading securities would be marked up to $7,600 and Hill would
report an unrealized gain of $600. This mark-to-market adjustment would increase Assets
(Investment Securities), Net Income, Retained Earnings, and Equity.
20) Indicate whether each of the following statements is true or false.
__T__a. The FIFO cost flow method assumes that the items purchased first would be assigned to
cost of goods sold first.
__F__ b. The LIFO inventory flow method assumes that items purchased last
should stay in the ending inventory, if they have not been sold out.
__T__ c. Under the weighted average cost flow method, the average unit cost of the inventory is
determined by dividing the total inventory costs by the number of units.
__F__d. The cost flow of inventory should be consistent with the physical flow.
__T__ e. The FIFO cost flow method assumes that the items purchased last should stay in the
ending inventory, if they have not been sold out.
21) In an inflationary period, which inventory cost flow method (FIFO or LIFO) is more desirable from
a tax standpoint? Why?
In a normal, inflationary period, LIFO may be more desirable strictly from a tax standpoint,
because it will assign the larger amount of cost to Cost of Goods Sold, which results in a smaller
net income. A smaller net income translates into paying less income tax.
22) Give an example of a product where specific identification cost flow is necessary.
Specific identification is used when the items sold are unique with different unit costs.
Examples include automobiles, unique jewelry items, construction projects, etc…
23). Pro-Supply uses the perpetual inventory method. At the end of the year Pro-Supply had the
following items in inventory.
Item
S1
S2
S3
S4
Quantity
20
30
25
10
Unit Cost
$100
$80
$175
$150
Unit Market
$100
$85
$155
$160
Required:
(a.) Determine the amount of ending inventory using lower of cost or market applied to each
individual item.
Item
Quantity
S1
S2
S3
S4
Total Ending
Inventory
20
30
25
10
Lower of Unit
Cost or Market
$100
$80
$155
$150
Total Lower of
Cost or Market
$2,000
$2,400
$3,875
$1,500
$9,775
(b.) Prepare any journal entry necessary to adjust inventory.
Lower of Cost or Market Expense
Inventory
$500
$500
The inventory is currently on the books for $10,275 (20 * $100) + (30 * $80) + (25 * $175) +
(10 * $150). But GAAP requires that the inventory be reported at lower of cost or market.
Applying the LCM rule to each individual item results in an ending inventory of $9,775. ProSupply must write down its inventory by $500, and expense the loss in the current period with
an adjusting entry.
(c.) Determine the amount of ending inventory using lower of cost or market applied to total
inventory in aggregate.
Item
Units
Unit Cost
Total Cost
S1
S2
S3
S4
Total
20
30
25
10
$100
$80
$175
$150
$2,000
$2,400
$4,375
$1,500
$10,275
Unit
Market
$100
$85
$155
$160
Total
Market
$2,000
$2,550
$3,875
$1,600
$10,025
If Pro-Supply applies LCM to the entire stock of inventory in aggregate, the ending inventory
should be $10,025. ($10,025 total market is lower than $10,275 total historical cost, so the
inventory is written down to the lower total market amount).
(d.) Which method (individual items or aggregate) produces the smallest amount of total assets?
LCM applied to each individual inventory item results in an ending inventory of $9,775, which
is less than the $10,025 using total aggregate inventory.
24) Prepare the journal entries for the following events involving marketable trading securities:
a) Purchased 2000 shares of Company X stock as trading securities for $30 per share. Paid a $100
brokerage commission.
Trading Securities
$60,100
Cash
$60,100
2,000 shares * $30 = $60,000 + $100 =
$60,100
The $100 brokerage commission is a cost incurred in purchasing the securities, so it is
capitalized (or added) to the Trading Securities asset account.
b) Received a cash dividend of $1.00 per share on Company X stock.
Cash
2,000
Dividend Revenue
2,000
c) Sold 1000 shares of Company X stock for $34 per share. Broker charged $75.
Cash
33,925
Trading Securities
30,050
Gain on Sale of securities
3,875
First, compute the cost basis of the 1000 shares. It is NOT $30, because that does not factor in
the brokerage commission. Instead, it is $30.05 per share (60,100/2,000). So, $30.05 * 1,000
shares = $30,050. Reduce trading securities by $30,050 with a credit.
Next, calculate the cash received from the sale. 1,000 * $34 = $3,400 less the $75 brokerage fee
= $33,925. Debit cash.
Because the net proceeds from the sale ($33,925) are greater than the cost basis of the 1,000
shares ($30,050), there is a gain on the sale. A $3,875 credit to gain on sale of securities will
balance the entry.
Conversely, if the cost basis of the securities is greater than the net proceeds, a loss on the sale
would be reported.
d) At the end of the year, determined that Company X stock is now trading on the stock exchange
at $36 per share.
Trading Securities**
5,950
Unrealized Gain
5,950
($36 market – $30.05 cost) * 1,000 shares =
$5,950
Trading Securities are reported on the balance sheet at market (or fair) value. At the end of the
accounting period, the securities are marked to market value, which means the market value
replaces the cost on the books. This is accomplished through an adjusting entry, which is the
difference between current market value and the securities’ cost basis. An increase in the value
results in an unrealized gain (commonly known as a paper gain). In this case, the increase in the
market value of Company X trading securities results in an unrealized gain of $5,950. This
adjusting entry increases assets, net income, retained earnings and net income.
**You can also use a separate valuation allowance account instead of directly debiting or
crediting the marketable securities account. In this case, the separate account would add to the
trading securities account. On the other hand, if you had written the securities down, the
valuation allowance account would act as a contra account.
25) The market value adjustment for marketable securities (trading) differs from the lower-of-cost or
market adjustment -- in what way? Explain why we treat marketable securities differently from
inventory citing a generally accepted accounting principle.
The LCM adjustment writes inventory down if market has fallen below cost – this is considered
conservative (GAAP) because the loss is taken in the current period and the inventory is shown
at a relatively low amount on the balance sheet. Inventory is NOT written up because there’s no
objective measure for the current market value of the inventory.
The mark-to-market adjustment writes securities both up and down, so that the trading securities
appear on the balance sheet at the current market value – even if this market value is more than
historical cost. Accountants violate historical cost to write the securities up because there’s an
objective measure (GAAP) for determining their current value – an active securities market
where the last trading price can easily be determined (on the internet, calling a broker, etc…).
26). During 20X7, Jaymar Sales sold 120 units @ $800 each. Cash selling and administrative
expenses for the year were $14,000. The company’s tax rate is 30%. All transactions are cash
transactions. The following information is also available:
Beginning inventory
40 units @
$200 = $8,000
January 31 purchase
60 units @
$220 = $13,200
October 30 purchase
40 units @
$240 = $9,600
Total
140 units
$30,800
Cost of Goods Sold
FIFO
40 @ $200 = $8,000
LIFO
40 @ $240 = $9,600
Weighted Average
$30,800 / 140 units =
60 @ $220 = $13,200 60 @ $220 = $13,200 $220 unit average
Ending Inventory
20 @ $240 = $4,800
20 @ $200 = $4,000
120 units * $220 =
Total
Total
Total CGS =
$26,400
20 @ $220 = $4,400
= $26,000
20 @ $240 = $4,800
= $26,800
20 @ $200 = $4,000
Required:
(a.) Determine the amount of cost of goods sold and ending inventory using FIFO
CGS = $26,000
End. Inv. = $4,800
(b) Determine the amount of cost of goods sold and ending inventory using LIFO
CGS = $26,800
End. Inv. = $4,000
(c) Determine the amount of cost of goods sold and ending inventory using Weighted Average
CGS = $26,400
End. Inv. = $4,400
(d) Using LIFO, prepare Jaymar’s income statement for 2007.
Sales
Cost of Goods Sold
Gross Margin
Operating Expenses
Selling and Admin. Expenses
Operating Income
Income Tax Expense
Net Income
$96,000
(26,800)
$69,200
(14,000)
$55,200
(16,560)
$38,640