Exercise 4-1 Effect of inventory cost flow assumption on financial statements
For each of the following situations, fill in the blank with FIFO, LIFO, or weighted average.
a. _____ would produce the highest amount of net income in an inflationary environment.
b. _____ would produce the highest amount of assets in an inflationary environment.
c. _____ would produce the lowest amount of net income in a deflationary environment.
d. _____ would produce the same unit cost for assets and cost of goods sold in an inflationary
5. In an inflationary period, which inventory cost flow
method will produce the highest net income? Explain.
6. In an inflationary period, which inventory cost flow
method will produce the largest amount of total assets on
the balance sheet? Explain.
7. What is the difference between the flow of costs and the
physical flow of goods?
8. Does the choice of cost flow method (FIFO, LIFO, or
weighted average) affect the statement of cash flows?
9. Assume that Key Co. purchased 1,000 units of merchandise
in its first year of operations for $25 per unit. The company
sold 850 units for $40. What is the amount of cost of goods
sold using FIFO? LIFO? Weighted average?
10. Assume that Key Co. purchased 1,500 units of merchan-
dise in its second year of operation for $27 per unit. Its
beginning inventory was determined in Question 9. Assum-
ing that 1,500 units are sold, what is the amount of cost
of goods sold using FIFO? LIFO? Weighted average?
11. Refer to Questions 9 and 10. Which method might be pref-
erable for financial statements? For income tax reporting?
12. In an inflationary period, which cost flow method, FIFO
or LIFO, produces the larger cash flow? Explain.
13. Which inventory cost flow method produces the highest
net income in a deflationary period?
14. What are the policies and procedures called that are used
to provide reasonable assurance that the objectives of an
enterprise will be accomplished?
15. What is the difference between accounting controls and
16. What are several features of an effective internal control
17. What is meant by separation of duties? Give an illustration.
18. What are the attributes of a high-quality employee?
19. What is a fidelity bond? Explain its purpose.
20. Why is it important that every employee periodically take
a leave of absence or vacation?
21. What are the purpose and importance of a procedures
22. What is the difference between specific and general author-
23. Why should documents (checks, invoices, receipts) be
24. What procedures are important in the physical control of
assets and accounting records?
25. What is the purpose of independent verification of per-
26. What items are considered cash?
27. Why is cash more susceptible to theft or embezzlement
than other assets?
28. Giving written copies of receipts to customers can help
prevent what type of illegal acts?
29. What procedures can help to protect cash receipts?
30. What procedures can help protect cash disbursements?
31. What effect does a debit memo in a bank statement have
on the Cash account? What effect does a credit memo in
a bank statement have on the Cash account?
32. What information is normally included in a bank statement?
33. Why might a bank statement reflect a balance that is larger
than the balance recorded in the depositor’s books? What
could cause the bank balance to be smaller than the book
34. What is the purpose of a bank reconciliation?
35. What is an outstanding check?
36. What is a deposit in transit?
37. What is a certified check?
38. How is an NSF check accounted for in the accounting
39. What information does inventory turnover provide?
40. What is an example of a business that would have a high
inventory turnover? A low inventory turnover? Accounting for Inventories 157
Beginning inventory 70 units @ $26
Units purchased 280 units @ $30
Ending inventory consisted of 30 units. Boone sold 320 units at $40 each. All purchases and
sales were made with cash.
a. Compute the gross margin for Boone Company using the following cost flow assumptions:
(1) FIFO, (2) LIFO, and (3) weighted average.
b. What is the dollar amount of difference in net income between using FIFO versus LIFO?
(Ignore income tax considerations.)
e. _____ would produce the lowest amount of net income in an inflationary environment.
f. _____ would produce an asset value that was the same regardless of whether the environ-
ment was inflationary or deflationary.
g. _____ would produce the lowest amount of assets in an inflationary environment.
h. _____ would produce the highest amount of assets in a deflationary environment.
(Edmonds, Thomas P.. Survey of Accounting, 2nd Edition. McGraw-Hill Higher Education/CourseSmart, 02/06/2009. 156 - 157).
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