Far Eastern University

Institute of Accounts. Business and Finance

Department of Accountancy and Internal Auditing

INTERMEDIATE ACCOUNTING 1
DO-IT-YOURSELF EXERCISES

TABLE OF CONTENTS

• Exercise 2.3-1 Inventoriable Costs

A. Inventoriable Costs
B. Inventoriable Costs
C. Related Multiple-Choice Questions

• Exercise 2.3-2 Inventory Composition at Year-end

A. Computation of Correct Amount of Inventory
B. Computation of Correct Amount of Inventory
C. Related Multiple-Choice Questions

• Exercise 2.3-3 Accounting Inventory System

A. Journal Entries Using the Two Accounting Inventory Methods of Recording
B. Related Multiple-Choice Questions

• Exercise 2.3-4 Recording of Purchases - Gross Method and Net Method

A. Recording Purchases Related Transactions Using the Gross and Net Methods
B. Related Multiple-Choice Questions

• Exercise 2.3-5 Inventory Cost Flow Methods

A. Average Method
B. FIFO Method
C. Specific Identification Method
D. Related Multiple-Choice Questions

• Exercise 2.3-6 Inventory Error Adjustments

A. Inventory Purchase Error Adjustments
B. Inventoriable Costs - Error Adjustments

• Exercise 2.3-7 Lower of Costs or Net Realizavle Value

A. Determining LCNRV
B. Methods of Applying LCNRV
C. LCNRV - Two Methods of Recording
D. Related Multiple-Choice Questions

• Exercise 2.3-8 Purchase Commitments

A. Journal Entries - Purchase Commitments
B. Related Multiple-Choice Questions

• Exercise 2.3-9 Gross Profit Method

A. Computing the Estimated Inventory
B. Construction of Accounts to Compute the Estimated Inventory
C. Computation of Inventory Shortage
D. Computation of Inventory Fire Loss
E. Related Multiple-Choice Questions

• Exercise 2.3-10 Retail Inventory Method

A. Conservative Approach and Average Cost Approach
B. FIFO Retail Approach
C. Related Multiple-Choice Questions

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

EXERCISE 2.3-1
Inventoriable Costs

Exercise 2.3-1A (Inventoriable Costs)

(Adapted from Auditing Textbook)
The costs set out below are those typically incurred by manufacturing businesses. Under column (3), write YES if the
given cost is inventoriable and NO if not. If the answer is YES, write the amount of inventoriable costs under column
(4).

Inventoriable? Amount
No. Items (column 3) (column 4)
1. Supplier’s gross price for raw materials, P 150,000
2. Materials purchased from another supplier on extended credit amounting
to P 570,000. The price to be paid under normal credit term is P
550,000.
3. Invoice price of raw materials purchased amounting to P 180,000.
Quantity discounts of 10, 5 are allowed by supplier.
4. Materials purchased from a supplier amounting to P 616,000, inclusive of
12% VAT. The company is VAT registered and can claim this as an input
VAT.
5. Materials purchased from a supplier amounting to P 515,000, inclusive of
nonrecoverable purchase tax of P 15,000.
6. Cost of transporting raw materials to the business premises, P 5,000.
7. Import duties to authorities on import of raw materials to be used during
the manufacturing process, P 25,000.
8. Labor cost directly incurred in the processing of raw materials, P 420,000
9. Normal amount of wasted labor, P 57,000
10. Abnormal amount of wasted labor, P 69,000

SOLUTION:
Inventoriable? Amount
No. Items (column 3) (column 4) Explanation
1. Supplier’s gross price for raw materials, P YES 150,000 This is the invoice price.
150,000
2. Materials purchased from another supplier The amount to be recorded is
on extended credit amounting to P 570,000. based on the price under
The price to be paid under normal credit YES 550,000 normal credit term. The
term is P 550,000. difference between the two
prices is interest expense over
credit term.
3. Invoice price of raw materials purchased Invoice price means the
amounting to P 180,000. Quantity discounts YES 180,000 quantity discount or trade
of 10, 5 are allowed by supplier. discount was already
deducted.
4. Materials purchased from a supplier This is an example of
amounting to P 616,000, inclusive of 12% recoverable purchase tax since
VAT. The company is VAT registered and YES 550,000 it can be claimed as an input
can claim this as an input VAT. tax.
5. Materials purchased from a supplier Nonrecoverable purchase tax
amounting to P 515,000, inclusive of YES 515,000 is inventoriable cost.
nonrecoverable purchase tax of P 15,000.
6. Cost of transporting raw materials to the YES 5,000 This is freight-in.
business premises, P 5,000.
7. Import duties to authorities on import of Import duties are inventoriable
raw materials to be used during the YES 25,000 costs
manufacturing process, P 25,000.
8. Labor cost directly incurred in the YES 420,000 Labor cost is a production
processing of raw materials, P 420,000 cost, therefor, inventoriable
cost.
9. Normal amount of wasted labor, P 57,000 YES 57,000 Normal wasted labor cost is
capitalized as cost of the
product.
10. Abnormal amount of wasted labor, P 69,000 NO - Abnormal waste is not an
inventoriable cost but charged
to cost of sales.

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Exercise 2.3-1B (Inventoriable Costs)

(Adapted from Auditing Textbook)
The costs set out below are those typically incurred by manufacturing businesses. Under column (3), write YES is the
given cost is inventoriable and NO if not. If the answer is YES, write the amount of inventoriable costs under column
(4).

Inventoriable? Amount
No. Items (column 3) (column 4)
1. Cost of transporting goods to customers on sale, P 2,500.
2. Non-recoverable purchase taxes charged to customers on sale, P 12,000
3. Non-recoverable sales taxes, P 14,440.
4. Commission payable to salesmen on the sale of the goods, P 14,500.
5. Provision for bad and doubtful debts in relation to trade receivable, P
56,000.
6. Costs of the accounts department, P 140,000
7. Head office costs relating to the overall management of the business, P
234,000.
8. Borrowing cost incurred on inventories that takes substantial amount of
time to create, P 122,000.
9. Storage cost for a manufacturing product, P 56,000
10. Selling costs, P 45,600.
11. Non-production overhead costs of designing products for a specific
customer, P 10,000.
12. Storage cost of finished goods, P 23,000
13. Fixed administration costs/overheads (rent of office), P 450,000
14. Insurance on in-transit inventories, p 17,800
15. Freight incurred when the inventories were returned and redelivered, P
34,100
16. Foreign exchange differences arising directly on the recent acquisition of
inventories invoiced in a foreign currency. The peso equivalent when
acquired is P 567,000 and the peso equivalent of the merchandise when
paid is P 577,000.

SOLUTION:
Inventoriable Amount
No. Items ? (column 4) Explanation
(column 3)
1. Cost of transporting goods to customers on NO - This is freight-out or delivery
sale, P 2,500. expense which is a selling
expense.
2. Non-recoverable purchase taxes charged to NO - This is related to sale, not
customers on sale, P 12,000 part of inventory.
3. Non-recoverable sales taxes, P 14,440. NO - This is related to sale, not
part if inventory. An example
is a sale to non-VAT
registered buyer/customer.
4. Commission payable to salesmen on the NO - This is selling expense.
sale of the goods, P 14,500.
5. Provision for bad and doubtful debts in This can either be selling or
relation to trade receivable, P 56,000. NO - administrative expense.
6. Costs of the accounts department, P NO - This is administrative
140,000 expense.
7. Head office costs relating to the overall This is administrative
management of the business, P 234,000. NO - expense.
8. Borrowing cost incurred on inventories that
takes substantial amount of time to YES 122,000
create, P 122,000.
9. Storage cost for a manufacturing product, P YES 56,000
56,000
10. Selling costs, P 45,600. NO This is selling expense
11. Non-production overhead costs of designing
products for a specific customer, P 10,000. YES 10,000
12. Storage cost of finished goods, P 23,000. NO - This is not a cost to bring
the products to their present
location or condition. This is
not an inventoriable cost.
13. Fixed administration costs/overheads (rent NO - This is administrative cost.
of office), P 450,000
14. Insurance on in-transit inventories, p YES 17,800

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

17,800
15. Freight incurred when the inventories were Expensed outright. This is a
returned and redelivered, P 34,100 NO - result of inefficiency.
16. Foreign exchange differences arising Foreign exchange difference
directly on the recent acquisition of is not capitalized as
inventories invoiced in a foreign currency. inventory but recognized as
The peso equivalent when acquired is P NO - FOREIGN EXCHANGE LOSS.
567,000 and the peso equivalent of the The amount to be capitalized
merchandise when paid is P 577,000. as inventory cost is P
567,000.

Exercise 2.3-1C (Related Multiple-Choice Questions)

In relation to the above, answer the following multiple-choice questions. Write your answer on the space provided
before each number. Use only CAPITAL LETTERS.

A 1. What inventory account is generally applied to goods held by a trading concern?

A. Merchandise inventory
B. Raw materials inventory
C. Goods in process inventory
D. Finished goods inventory

B 2. Which is part of inventory cost?

A. Freight charge on goods sold
B. Freight charge on goods consigned
C. Excessive spoilage
D. Selling cost

D 3. Inventories are assets (choose the incorrect one)

A. Held for sale in the ordinary course of business.
B. In the process of production for sale
C. In the form of materials or supplies to be consumed in the production process or in the
rendering of services.
D. Held for use in the production or supply of goods or services.

D 4. Inventories encompasses all of the following, except:

A. Materials and supplies awaiting use in the production process
B. Work in process
C. Goods purchased with the intention to resell
D. Land and other property not held for sale

C 5. The cost of inventories shall comprise all of the following, except:

A. Cost of purchase
B. Labor cost and production overhead
C. Abnormal amount of wasted materials
D. Other cost incurred in bringing the inventories to their present location and condition

D 6. The cost of purchase price does not include

A. Handling costs directly attributable to the acquisition of goods
B. Purchase price
C. Import duties and taxes
D. Discounts to encourage customers to purchase in bulk or in volume

C 7. The cost of conversion of inventories include all of the following, except:

A. Direct labor
B. Indirect materials
C. Salaries of the president of the company
D. Indirect labor

EXERCISE 2.3-2
Inventory Composition at Year-end

Exercise 2.3-2A (Computation of Correct Amount of Inventory)

(Adapted from Intermediate Accounting Textbook)
Amiable Company provided the following data at year end:

Items counted in the bodega 4,000,000

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Items included in the count specifically segregated per sales contract 100,000
Items in receiving department, returned by customer, in good condition 50,000
Items ordered and in the receiving department, invoice not received 400,000
Items ordered, invoice received but goods not received. Freight is paid by the seller 300,000
Items shipped today, invoice mailed, FOB shipping point 250,000
Items shipped today, invoice mailed, FOB destination 150,000
Items currently being used for window display 200,000
Items on counter for sale 800,000
Items in receiving department, refused by us because of damage 180,000
Items included in count, damaged and unsalable 50,000
Items in the shipping department 250,000

Required:
Compute the correct amount of inventory.

SOLUTION:
Items Amount Included Explanation
Items counted in the bodega 4,000,000 4,000,000
Items included in the count specifically Seller. Segregated per sales
segregated per sales contract 100,000 (100,000) contract. Assumed included among
the items counted in the bodega.
Items in receiving department, returned by Seller. In good condition, already in
customer, in good condition 50,000 50,000 the receiving department (returns)
Items ordered and in the receiving department, Buyer. Already received by the
invoice not received 400,000 400,000 receiving department
Items ordered, invoice received but goods not Buyer. Term is FOB Destination;
received. Freight is paid by the seller 300,000 - still in transit (not yet received)
Items shipped today, invoice mailed, FOB Seller. Already shipped. Title to
shipping point 250,000 - goods is already with the buyer
Items shipped today, invoice mailed, FOB Seller. Title to goods is still with the
destination 150,000 150,000 seller.
Items currently being used for window display 200,000 200,000
Items on counter for sale 800,000 800,000
Items in receiving department, refused by us Buyer. Refused to accept upon
because of damage 180,000 - delivery. (returns)
Items included in count, damaged and 50,000 (50,000) Damaged and unsalable. Assumed
unsalable to be included among the items
counted in the bodega.
Items in the shipping department 250,000 250,000 It is the shipping department and
not at the shipping point of the
seaport.
Correct amount of inventory 5,700,000

Exercise 2.3-2B (Computation of Correct Amount of Inventory)

(Adapted from Intermediate Accounting Textbook)
Natal Company provided the following information:

Materials 1,400,000
Advances for materials ordered 200,000
Goods in process 650,000
Unexpired insurance on inventories 60,000
Advertising catalogs and shipping cartons 150,000
Finished goods in factory 2,000,000
Finished goods in company-owned retail store, including 50% profit on cost 750,000
Finished goods in hands of consignee including 40% profit on sales 400,000
Finished goods in transit to customers, shipped FOB destination, at cost 250,000
Finished goods out on approval, at cost 100,000
Unsalable finished goods, at cost 50,000
Office supplies 40,000
Materials in transit shipped FOB shipping point, excluding freight of P 30,000 330,000
Goods held on consignment, at sales price, cost P 150,000 200,000

Required:
Compute the correct amount of inventory.

SOLUTION:
Items Amount Included Explanation
Materials 1,400,000 1,400,000
Advances for materials ordered 200,000 - Advances to Suppliers

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Goods in process 650,000 650,000

Unexpired insurance on inventories 60,000 - Prepayments
Advertising catalogs and shipping cartons 150,000 - Supplies
Finished goods in factory 2,000,000 2,000,000
Finished goods in company-owned retail store,
including 50% profit on cost 750,000 500,000 Cost = P 750,000 / 150%
Finished goods in hands of consignee
including 40% profit on sales 400,000 240,000 Cost = P 400,000 x 60% cost rate
Finished goods in transit to customers, Seller. Still owned by seller
shipped FOB destination, at cost 250,000 250,000 because of FOB Destination term
Finished goods out on approval, at cost 100,000 100,000 Seller. Still owned by the seller.
Unsalable finished goods, at cost 50,000 - Unsalable - exclude
Office supplies 40,000 - Supplies
Materials in transit shipped FOB shipping point, Buyer. Title to materials is with
excluding freight of P 30,000 330,000 360,000 the buyer because of FOB
shipping point term. Freight is
included. (P 330,000 + P 30,000)
Goods held on consignment, at sales price,
cost P 150,000 200,000 - Consignee
Correct amount of inventory 5,500,000

Exercise 2.3-2C (Related Multiple-Choice Questions)

In relation to the above, answer the following multiple-choice questions. Write your answer on the space provided
before each number. Use only CAPITAL LETTERS.

D 1. Which of the following would not be reported as inventory?

A. Land acquired for resale by a real estate firm.
B. Shares of stocks held for resale by a brokerage firm
C. Partially completed goods held by a manufacturing company
D. Machinery acquired by a manufacturing company for use in the production process.

B 2. Which of the following describes the flow of product costs through the inventory accounts of a
manufacturer?
A. Raw materials, goods in process, factory overhead, finished goods
B. Raw materials, goods in process, finished goods
C. Raw materials, direct labor, factory overhead, finished goods
D. Raw materials, direct labor, factory overhead

A 3. Merchandise shipped FOB shipping point on the last day of the year should ordinarily be
included in the inventory balance of the
A. The buyer’s inventory balance
B. The seller’s inventory balance
C. Neither the buyer’s nor the seller’s inventory balance
D. Both the buyer’s and the seller’s inventory balance

A 4. If goods shipped FOB destination are in transit at the end of the year, they should be included in
the inventory balance of the
A. Seller
B. Common carrier
C. Buyer
D. bank

C 5. Which of the following costs of conversion cannot be included in the cost of inventory?
A. Salaries of factory supervisor
B. Depreciation of machinery sued in production
C. Salaries of sales staff in which the sales department shares the building with the production
department
D. Indirect materials

EXERCISE 2.3-3
Accounting Inventory System

Exercise 2.3-3A (Journal Entries using the Two Accounting Inventory Methods of Recording)
Rainy Days Company is a wholesaler of high-quality raincoat. At January 1 of the current year, the entity’s inventory
consisted of 900 raincoats priced at P 100 each. During the current year, the following events occurred:

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

1. Purchased 8,000 raincoats on credit from Happy Days Corporation at P 100

each.
2. Returned to suppliers 500 defective raincoats and received credit memorandum.
3. Partially paid 6,000 of the raincoats purchased.
4. Sold 7,900 raincoats on credit to various customers at P 200 each.
5. Received 200 raincoats returned by various customer and issued credit memoranda. These goods were
in excellent condition.
6. Collected cash from various customers for 6,800 of the raincoats sold.
7. At December 31, the physical count of raincoats revealed 600 units were on hand.

Required:
1. Journal entries, including adjustments to record the above transactions using the periodic and perpetual system.
2. Prepare partial statement of comprehensive income for the year ended.

SOLUTION:
Requirement 1 – Journal entries, including adjustments

PERIODIC SYSTEM PERPETUAL SYSTEM

No. Transactions Particulars Dr. Cr. Particulars Dr. Cr.

1 Purchased 8,000 Purchases 800,000 Inventory 800,000

raincoats on credit from Accounts Pay. 800,000 Accounts Pay. 800,000
Happy Days (8,000 x P 100)
Corporation at P 100
each.

2 Returned to suppliers Accounts Payable 50,000 Accounts Payable 50,000

500 defective PRA 50,000 Inventory 50,000
raincoats and received (500 x P 100)
credit memorandum.

3 Partially paid 6,000 of Accounts Payable 600,000 Accounts Payable 600,000

the raincoats Cash 600,000 Cash 600,000
purchased. (6,000 x P 100)

4 Sold 7,900 raincoats Accounts Receivable 1,580,000 Accounts Receivable 1,580,000

on credit to various Sales 1,580,000 Sales 1,580,000
customers at P 200 (7,900 x P 200)
each. Cost of Sales 790,000
Inventory 790,000
(7,900 x P 100)

5 Received 200 SRA 40,000 SRA 40,000

raincoats returned by Accounts Rec. 40,000 Accounts Rec. 40,000
various customer and (200 x P 200)
issued credit Inventory 20,000
memoranda. These Cost of Sales 20,000
goods were in (200 x P 100)
excellent condition.
6 Collected cash from Cash 1,360,000 Cash 1,360,000
various customers for Accounts Rec. 1,360,000 Accounts Rec. 1,360,000
6,800 of the raincoats (6,800 x P 200)
sold.

7 At December 31, the Inventory, ending 60,0,00 NO ENTRY

physical count of Income Summary 60,000
raincoats revealed (600 x P 100)
600 units were on
hand.

8 Inventory shortage NO ENTRY Cost of Sales 10,000

adjustment Inventory 10,000

Inventory, per book Units Peso

Beginning bal.
(900 x P 100) 900 90,000
Purchases 8,000 800,000
Purchase return (500) (50,000)
Sales (7,900) (790,000)
Sales return 200 20,000
PER BOOK-OVER 700 70,000
PER COUNT

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

(600 x P 100) 600 60,000

SHORTAGE 100 10,000

Requirement 2 – Partial Statement of Comprehensive Income

PERIODIC SYSTEM PERPETUAL SYSTEM

Revenue from Sales: Revenue from Sales:

Sales 1,580,000 Sales 1,580,000
Sales Returns (40,000) Sales Returns (40,000)
Net Sales 1,540,000 Net Sales 1,540,000

Cost of Sales: Cost of Sales (780,000)

Inventory, beginning 90,000 Gross Profit 760,000
Purchases 800,000
Purchase Returns (50,000)
GAFS 840,000
Inventory, ending (60,000) (780,000)
Gross Profit 760,000

*COS = P 790,000 – P 20,000 + P 10,000 = P 780,000

Exercise 2.3-3B (Related Multiple-Choice Questions)

In relation to the above, answer the following multiple-choice questions. Write your answer on the space provided
before each number. Use only CAPITAL LETTERS.

C 1. Which is the method of accounting for inventories in which the cost of goods sold is recorded
each time a sale is made?
A. Professional inventory system
B. Periodic inventory system
C. Perpetual inventory system
D. Planned inventory system

D 2. An entity returned merchandise purchased on account. Under the perpetual inventory system,
the account to be credited in the journal entry to record the return is
A. Purchases
B. Purchase Returns
C. Purchase allowances
D. Inventory

D 3. Which of the following is false of the perpetual inventory system?

A. Purchases are recorded as debit to the inventory account.
B. The entry to record a sale includes a debit to cost of goods sold and a credit to inventory.
C. After a physical inventory count, inventory is credited for any missing inventory.
D. Purchase returns are recorded by debiting accounts payable and crediting purchase returns
and allowances.

C 4. An entry debiting inventory and crediting cost of goods sold would be made when
A. Merchandise is sold and the periodic inventory method is sued.
B. Merchandise is sold and the perpetual inventory method is used.
C. Merchandise is returned and the perpetual inventory method is used.
D. Merchandise is returned and the periodic inventory method is used.

C 5. Which of the following accounts is not used by the perpetual inventory system?
A. Sales
B. Cost of Goods sold
C. Inventory, beginning
D. Sales Discount

EXERCISE 2.3-4
Recording of Purchases – Gross Method and Net Method

Exercise 2.3-4A (Recording Purchases Related Transactions Using the Gross Method and Net Method)
OHYES Corporation purchased P 120,000 of merchandise on August 1, 2020, subject to trade discount of 10% and
with credit terms of 3/15, n/60. It returned P 30,000 (gross price before trade or cash discount) on August 4. The
company is using periodic inventory system.

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Required:
1. Prepare journal entries to record the transactions using gross method and net method. Use the following
assumptions: (1) The invoice was paid on August 13, 2020; (2) The invoice was paid on August 20, 2020.
2. Compute cost of sales under each method. Assuming beginning inventory on August 1 is P 50,000 while ending
inventory on August 31 is 40,000 and all discounts are paid within the discount period.

Requirement 1 – Journal entries using gross method and net method (Periodic System)

GROSS METHOD NET METHOD

Dat Transactions Particulars Dr. Cr. Particulars Dr. Cr.
e
2020
8/1 Purchased P 120,000 of Purchases 108,000 Purchases 104,760
merchandise, subject Accounts Payable 108,000 Accounts Payable 104,760
to trade discount of P 120,000 x 90% P 108,000 x 97%
10% and with credit
terms of 3/15, n/60.

8/4 Returned P 30,000 Accounts Payable 27,000 Accounts Payable 26,190

worth of goods) gross Purchase Returns 27,000 Purchase Returns 26,190
price before trade and P 30,000 x 90% P 27,000 x 90% 97%
cash discount)

8/13 Full settlement of Accounts Payable 81,000 Accounts Payable 78,570

(a) account Purchase Discount 2,430 Cash 78,570
Cash 78,570 (P 104,760 – P 23,571)
P 120,000 – P 30,000) x 90% x 3%

8/20 Full settlement of Accounts Payable 81,000 Accounts Payable 78,570

(b) account Cash 81,000 Purchase Discount Lost 2,430
Cash 81,000

Requirement 2 – Cost of Sales amount using gross method and net method (Periodic System)

GROSS METHOD NET METHOD

Cost of Sales: Cost of Sales:

Inventory, August 1 50,000 Inventory, August 1 50,000
Purchases 108,000 Purchases 104,760
Purchase Returns (27,000) Purchase Returns (26,190)
Purchase Discount (2,430) 78,570 Purchase Discount - 78,750
Goods available for sale 128,750 Goods available for sale 128,750
Inventory, August 31 (40,000) Inventory, August 31 (40,000)
Cost of sales 88,750 Cost of Sales 88,750

Exercise 2.3-4B (Related Multiple-Choice Questions)

In relation to the above, answer the following multiple-choice questions. Write your answer on the space provided
before each number. Use only CAPITAL LETTERS.

D 1. The use of a discount lost account implies that cost of purchased inventory item is the
A. Invoice price of the items
B. List price of the item
C. Invoice price less the purchase discount taken on the item
D. Invoice price less the purchase discount allowance whether taken or not taken on the item

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Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

B 2. Which of the following is not recorded in the accounting books?

A. Purchase discount
B. Trade discount
C. Purchase returns
D. Purchase allowances

B 3. Which of the following is not correct about gross method of recording purchases?
A. The purchases are recorded at the gross amount of the invoice.
B. Cash discounts taken are recorded in the purchase discount account at the time of payment
beyond the discount period.
C. Cash payment within the discount period is net of cash discount.
D. The purchases are recorded at net of trade discount amount but before cash discount
amount.

C 4. Which account is not used by the gross method of recording purchases?

A. Purchases
B. Purchase Discount
C. Purchase Discount Lost
D. Purchase Returns and Allowances

A 5. Which of method of recording purchases violates technically the matching principle?

A. Gross method
B. Net method
C. Both gross method and net method
D. Neither the gross method nor the net method

A 6. Which is a more convenient method of recording purchases from a bookkeeping standpoint

A. Gross method
B. Net method
C. Both gross method and net method
D. Neither the gross method nor the net method

D 7. Which of the following is correct when using the net method of recording purchases?
A. Purchases is recorded at gross while Accounts Payable is recorded at net.
B. Purchases is recorded at net while Accounts Payable is recorded at gross.
C. Both Purchases and Accounts Payable accounts are recorded at gross.
D. Both Purchases and Accounts Payable accounts are recorded at net.

A 8. Which of the following is correct when using the gross method of recording purchases?
A. Both Purchases and Accounts Payable accounts are recorded at gross.
B. Both Purchases and Accounts Payable accounts are recorded at net.
C. Purchases is recorded at gross while Accounts Payable is recorded at net.
D. Purchases is recorded at net while Accounts Payable is recorded at gross.

B 9. The Purchase Discount Lost account is shown as

A. Other Income
B. Other expense
C. Contra liability account
D. Deduction from Retained Earnings

A 10. The cost measured under the net method of recording purchases represents
A. The cash equivalent price on the date of payment
B. The cash equivalent price on the acquisition date.
C. The net present value of goods purchased.
D. The impaired value of goods purchased.

EXERCISE 2.3-5
Inventory Cost Flow Methods

Exercise 2.3-5A (Average Method)

(Adapted from Auditing Textbook)

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Records of the Gladiator New Products Company show the following data relative to Product
143:

Date Transactions Quantity Unit Cost Total Cost

Apr. 01 Balance 20,000 P 10.00 P 200,000
Apr. 02 Purchase 30,000 P 12.00 360,000
Apr. 04 Sale 25,000
Apr. 10 Purchase 15,000 P 14.00 210,000
Apr. 15 Sale 21,000
Apr. 17 Sales return 1,000
Apr. 28 Purchase 20,000 P 16.76 335,000

Based on the above date, compute the following:

1. Using the weighted average method, how much is the cost of inventory at the end of April?

SOLUTION:
RECEIVED ISSUED
Date Transactions Quantity Unit Total Cost Quantity
Cost
Apr. 01 Balance 20,000 P 10.00 P 200,000
Apr. 02 Purchase 30,000 P 12.00 360,000
Apr. 04 Sale 25,000
Apr. 10 Purchase 15,000 P 14.00 210,000
Apr. 15 Sale 21,000
Apr. 17 Sales return (1,000)
Apr. 28 Purchase 20,000 P 16.76 335,000
TOTAL 85,000 P 1,105,000 45,000
Issued/Sold (45,000)
Inventory ending 40,000
Multiply by WA unit cost* P 13 P 13
Cost of Inventory, end P 520,000
Cost of Sales No. 1 P 585.000
No. 2

*WA unit cost = P 1,105,000 total GAFS / 85,000 units = P 13 per unit

2. Using the weighted average method, how much is the cost of goods sold in April?

3. Using the moving average method, how much is the cost of inventory at the end of April?

SOLUTION:
RECEIVED ISSUED BALANCE
Date Transactions Quantity UC TC Quantity UC TC Quantity UC TC
Apr. 01 Balance 20,000 10.0 200,00 20,000 10.00 200,000
0 0
Apr. 02 Purchase 30,000 12.0 360,00 50,000 11.00 560,000
0 0
Apr. 04 Sale 25,000 11.20 280,000 25,000 11.20 280,000
Apr. 10 Purchase 15,000 14.0 210,00 40,000 12.25 490,000
0 0
Apr. 15 Sale 21,000 12.25 257,250 19,000 12.25 232,750
Apr. 17 Sales return (1,000) 12.25 (12,250) 20,000 12.25 245,000
Apr. 28 Purchase 20,000 16.7 335,00 40,000 14.50 580,000
6 0
525,000 No. 3
No. 4

4. Using the moving average method, how much is the cost of goods sold in April?

11 | P a g e
 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Exercise 2.3-5B (FIFO Method)

(Adapted from Auditing Textbook)
Using the same information in Exercise 2.3-5A, compute the following:

1. Using the perpetual FIFO method, how much is the cost of inventory at the end of April?

SOLUTION:
RECEIVED BALANCE
Date Transactions Quantity UC TC Quantity UC TC
Apr. 28 Purchase 20,000 16.76 335,000 20,000 16.76 335,000
Apr. 10 Purchase 15,000 14.00 210,000 15,000 14.00 210,000
Apr. 02 Purchase 30,000 12.00 60,000 5,000 12.00 60,000
40,000 605,000

2. Using the perpetual FIFO method, how much is the cost of goods sold in April?

SOLUTION:
RECEIVED BALANCE
Date Transactions Quantity UC TC Quantity UC TC
Apr. 02 Purchase 30,000 12.00 60,000 25,000 12.00 300,000
Apr. 01 Balance 20,000 10.00 200,000 20,000 10.00 200,000
45,000 500,000

3. Using the periodic FIFO method, how much is the cost of inventory at the end of April?

SOLUTION:
Same as in number (1). Periodic FIFO and perpetual FIFO will give the same cost of ending inventory and
cost of sales.

Exercise 2.3-5C (Specific Identification)

(Adapted from Auditing Textbook)
Using the same information in Exercise 2.3-5A, EXCEPT that it is assumed that the units sold of April 4 came from
April 2 purchases, the units sold of April 15 came from beginning inventory and the excess from April 10 purchases,
and the return of April 17 came from April 1 beginning inventory, how much is the cost of inventory at the end of
April?

SOLUTION:
RECEIVED ISSUED BALANCE
Date Transactions Quantity UC TC Quantity UC TC Quantity UC TC
Apr. 01 Balance 20,000 10.0 200,00 20,000 10.00 200,000 0 10.00 0
0 0
(1,000) 10.00 (1,000) 1,000 10.00 10,000
)
Apr. 02 Purchase 30,000 12.0 360,00 25,000 12.00 300,000 5,000 12.00 60,000
0 0
Apr. 10 Purchase 15,000 14.0 210,00 1,000 14.00 14,000 14,000 14.00 196,000
0 0
Apr. 28 Purchase 20,000 16.7 335,00 20,000 16.76 335,200
6 0
613,000 601,200

12 | P a g e
 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Exercise 2.3-5D (Related Multiple-Choice Questions)

In relation to the above, answer the following multiple-choice questions. Write your answer on the space provided
before each number. Use only CAPITAL LETTERS.

A 1. Which cost flow assumption would consistently result in the highest income in a period of
sustained inflation?
A. FIFO
B. LIFO
C. Weighted average
D. Specific identification

A 2. In a period of falling prices, the use of which of the following inventory cost flow methods would
typically result in the highest cost of goods sold?
A. FIFO
B. LIFO
C. Weighted average
D. Specific identification

B 3. The costing of inventory must be deferred until the end of the accounting period under which of
the following method of inventory valuation?
A. Moving average
B. Weighted average
C. Specific identification
D. FIFO Method

C 4. Which method of inventory valuation is no longer acceptable in accounting?

A. FIFO
B. Weighted average
C. LIFO
D. Specific identification

B 5. Which method of inventory valuation favors the statement of financial position in that the
inventory is stated at current replacement cost?
A. Specific identification
B. FIFO
C. Weighted average
D. LIFO

D 6. Which method of inventory valuation violates the proper matching of cost against revenue?
A. LIFO
B. Weighted average
C. Specific identification
D. FIFO Method

C 7. Which methods of inventory valuation will give the same amount of inventory at the end of the
accounting period?
A. Periodic FIFO and Moving average
B. Perpetual FIFO and Weighted Average
C. Periodic FIFO and Perpetual FIFO
D. No methods of inventory valuation will result to the same amount or inventory at the end of
the accounting period.

D 8. Under the moving average method of inventory valuation, a new weighted average unit cost
must be computed
A. After every sale
B. After every purchase
C. After every sale and every purchase
D. None of the above

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

EXERCISE 2.3-6
Inventory Error Adjustments

Exercise 2.3-6A (Inventory Purchases Error Adjustments)

(Adapted from Intermediate Accounting Textbook)
Myriad Company revealed the following purchase transaction occurred during the last few days of the fiscal year,
which ends December 31, and in the first few days after that date. Prepare the adjustments on December 31. Books
are still open.

No. Transactions Account Names Debit Credit

1 An invoice for P 50,000, FOB shipping point, Inventory, 12/31 50,000
was received and recorded on December 27. Income Summary 50,000
The shipment was received in satisfactory
condition on January 2. The merchandise was
not included in the inventory.
Analysis:
Myriad Company is the buyer.
FOB Shipping point – owner is Myriad Co.
At December 31 – Purchases/AP (+) correct
At December 31 – Excluded in EI (AJE)
2 An invoice for P 75,000, FOB Destination, was Accounts Payable 75,000
received and recorded on December 28. The Purchases 75,000
shipment was received in satisfactory condition
on January 3. The merchandise was not
included in the inventory.
Analysis:
Myriad Company is the buyer.
FOB Destination – not yet owned (in transit)
At December 31 – Purchases/AP (+) (AJE)
At December 31 – Excluded in EI correct
3 An invoice for P 30,000, FOB shipping point, Purchases 30,000
was received and recorded on January 4. The Accounts Payable 30,000
invoice shows that the goods had been shipped
on December 28 and the receiving report Inventory, 12/31 30,000
indicates that the goods had been received on Income Summary 30,000
January 4. The merchandise was excluded
from inventory.
Analysis:
Myriad Company is the buyer.
FOB Shipping point – owner is Myriad Co.
At December 31 – Purchases/AP (x) (AJE)
At December 31 – Excluded in EI (x) (AJE)
4 An invoice for P 90,000, FOB shipping point, Income Summary 90,000
was received on December 15. The receiving Inventory, 12/31 90,000
report indicates that the goods were received
on December 18 but across the face of the
report is the notation “merchandise not of the
same quality as ordered – returned for credit,
December 19”. The merchandise was included
in the inventory.
Analysis:
Myriad Company is the buyer.
Received on December 18, marked for return
At December 31 – Purchases/AP (+) (AJE)
At December 31 – Included in EI (AJE)
5 An invoice for P 140,000, FOB Destination, was Purchases 140,000
received and recorded on January 4. The Accounts Payable 140,000
receiving report indicates that the goods were
received on December 29. The merchandise
was included in inventory.
Analysis:
Myriad Company is the buyer.
Received on December 29, marked for return
FOB Destination – owner is Myriad Co.
At December 31 – Purchases/AP (x) (AJE)
At December 31 – Included in EI (correct)

14 | P a g e
 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Exercise 2.3-6B (Inventoriable Costs - Error Adjustments)

(Adapted from Intermediate Accounting Textbook)
Werth Company asks you to review its December 31, 2020 inventory values and prepare the necessary adjustments
to the books. The following information is given to you.

1. Werth uses the periodic inventory method of recording inventory. A physical count reveals P 234,890 of inventory
on hand at December 31, 2020.
2. Not included in the physical count of inventory is P 10,420 of merchandise purchased on December 15 from
Browser. This merchandise was shipped FOB shipping point on December 29 and arrived in January. The
invoice arrived and was recorded on December 31.
3. Included in inventory is merchandise sold to Bubbery on December 30, FOB destination. This merchandise was
shipped after it was counted. The invoice was prepared and recorded as a sale on account for P 12,800 on
December 31. The merchandise cost P 7,350 and Bubbery received it on January 3.
4. Included in the inventory was merchandise received from Dudley on December 31 with an invoice price of P
15,630. The merchandise was shipped FOB Destination. The invoice, which has not yet arrived, has not been
recorded.
5. Not included in inventory is P 8,540 of merchandise purchased from Minsky Industries. This merchandise was
received on December 31 after the inventory had been counted. The invoice was received and recorded in
December 30.
6. Included in inventory was P 10,438 of inventory held by Werth on consignment from Jackel Industries.
7. Included in inventory is merchandise sold to Sims FOB shipping point. This merchandise was shipped after it
was counted. The invoice was prepared and recorded as a sale for P 18,900 on December 31. The cost of this
merchandise was P 11,520, and Sims received the merchandise on January 5.
8. Excluded from inventory was a carton labeled “Please accept for credit.” This carton contains merchandise
costing P 1,500 which had been sold to a customer for P 2,600. No entry had been made to the books to reflect
the return, but none of the returned merchandise seemed damaged.

Required:
1. Determine the proper inventory balance for Werth Company at December 31, 2020.
2. Prepare any correcting entries to adjust inventory and related accounts to their proper amounts at December 31,
2020. Assume the books have not been closed.

SOLUTION:
Inventory
No. Transactions Account Names Debit Credit 12/31/2020
1 Werth uses the periodic inventory Inventory, December 31, 2020 234,890 234,890
method of recording inventory. A Income Summary 234,890
physical count reveals P 234,890
of inventory on hand at December
31, 2020
2 Not included in the physical count Inventory, December 31, 2020 10,420 10,420
of inventory is P 10,420 of Income Summary 10,420
merchandise purchased on
December 15 from Browser. This
merchandise was shipped FOB
shipping point on December 29
and arrived in January. The
invoice arrived and was recorded
on December 31.

3 Included in inventory is Sales 12,800

merchandise sold to Bubbery on Accounts Receivable 12,800
December 30, FOB destination.
This merchandise was shipped
after it was counted. The invoice
was prepared and recorded as a
sale on account for P 12,800 on
December 31. The merchandise
cost P 7,350 and Bubbery
received it on January 3.
4 Included in the inventory was NO ENTRY
merchandise received from The title passed to the buyer.
Dudley on December 31 with an
invoice price of P 15,630. The Purchases 15,630
merchandise was shipped FOB Accounts Payable 15,630
Destination. The invoice, which
has not yet arrived, has not been
recorded.

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Not included in Inventory, December 31, 2020 8,540 8,540

5 inventory is P 8,540 of Income Summary 8,540
merchandise purchased from
Minsky Industries. This
merchandise was received on
December 31 after the inventory
had been counted. The invoice
was received and recorded in
December 30.
6 Included in inventory was P Income Summary 10,438
10,438 of inventory held by Werth Inventory, 12/31/2020 10,438 (10,438)
on consignment from Jackel
Industries.
7 Included in inventory is Income Summary 11,520 (11,520)
merchandise sold to Sims FOB Inventory, 12/31/2020 11,520
shipping point. This merchandise
was shipped after it was counted.
The invoice was prepared and
recorded as a sale for P 18,900
on December 31. The cost of this
merchandise was P 11,520, and
Sims received the merchandise
on January 5.
8 Excluded from inventory was a Inventory, December 31, 2020 1,500 1,500
carton labeled “Please accept for Income Summary 1,500
credit.” This carton contains
merchandise costing P 1,500 Sales Returns 2,600
which had been sold to a Accounts Receivable 2,600
customer for P 2,600. No entry
had been made to the books to
reflect the return, but none of the
returned merchandise seemed
damaged.
Adjusted balance, 12/31/2020 233,392

16 | P a g e
 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

EXERCISE 2.3-7
Lower of Cost or Net Realizable Value

Exercise 2.3-7A (Determining LCNRV)

(Adapted from Intermediate Accounting Textbook)
Prime Company manufactures and sells four products. The inventories of which are priced at cost or net realizable
value whichever is lower. A normal profit of 30% is usually maintained on each product.

Original Cost to Estimated Normal

Product Cost Dispose Selling Price Selling Price
1 700 150 800 700
2 475 205 950 950
3 255 50 300 350
4 450 260 1,000 900

Required:
Determine the unit value for each product applying the LCNRV in measuring inventory.

SOLUTION:
Original Cost to Estimated NRV
Product Cost Dispose Selling Price (ESP-CTD) LCNRV
1 700 150 800 650 650
2 475 205 950 745 475
3 255 50 300 250 250
4 450 260 1,000 740 450
Inventory cost at LCNRV 1,825

Exercise 2.3-7B (Methods of Applying LCNRV)

(Adapted from Intermediate Accounting Textbook)
Fruity Veggie Company carried five items in inventory. The following per unit data relate to these items at the end of
first year of operations.

Cost LCNRV
Frozen
Pomelo 40,000 60,000
Pineapple 50,000 55,000
Mango 25,000 20,000

Canned
Mixed Fruits 45,000 36,000
Mixed Vegetables 47,500 46,000

Required: Calculate the value of the inventory under the following approaches:
A. The LCNRV is applied to the individual inventory item.
B. The LCNRV is applied to the inventory major groups.
C. The LCNRV is applied to the total inventory.

SOLUTION:
Lower of Cost or Net Realizable Value
Cost LCNRV Individual Major Total
Items Groups Inventory
Frozen
Pomelo 40,000 60,000 40,000
Pineapple 50,000 55,000 50,000
Mango 25,000 20,000 20,000
Total frozen 115,000 135,000 115,000

Canned
Mixed Fruits 45,000 36,000 36,000
Mixed Vegetables 47,500 46,000 46,000
Total canned goods 92,500 82,000 82,000

Total 207,500 217,000 192,000 197,000 207,500

17 | P a g e
 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Exercise 2.3-7C (LCNRV – Two Methods of Recording)

(Adapted from Intermediate Accounting Textbook)
Malone Company determined its ending inventory at cost and at LCNRV at December 31, 2018, December 31, 2019
and December 31, 2020, as shown below:

Cost NRV
December 31, 2018 650,000 650,000
December 31, 2019 780,000 712,000
December 31, 2020 905,000 830,000
December 31, 2021 995,000 950,000

Instructions:
1. Prepare the journal entries required at December 31, 2019 and December 31, 2020 using the Direct method and
Allowance Method of adjusting to LCNRV, assuming that a periodic inventory system is used.
2. Prepare the journal entries required at December 31, 2019 and December 31, 2020 using Direct method and
Allowance Method of adjusting to LCNRV, assuming that a perpetual inventory system is used.

SOLUTION:
Requirement 1 – Direct Method and Allowance Method under Periodic System

ALLOWANCE METHOD
Date Transactions DIRECT METHOD (Loss Method)
Particulars Dr. Cr. Particulars Dr. Cr.
2019
12/31 Cost – P 780,000 Inventory, 12/31/2019 712,000 Inventory, 12/31/2019 780,000
NRV – P 712,000 Income Summary 712,000 Income Summary 780,000

Loss on Inventory WD 68,000

Allowance for 68,000
Inventory WD
(780,000 – 712,000)

2020
12/31 Cost – P 905,000 Inventory, 12/31/2020 830,000 Inventory, 12/31/2020 905,000
NRV – P 830,000 Income Summary 830,000 Income Summary 905,000

Loss in Inventory WD 7,000

Allowance for 7,000
Inventory WD
(905,000 – 830,000) – P 68,000

2021
12/31 Cost – P 995,000 Inventory, 12/31/2021 950,000 Allowance for Inv. WD 30,000
NRV – P 950,000 Income Summary 950,000 Recovery in NRV of 30,000
Inventory
75,000 – (995,000 – 950,000)

Requirement 2 – Direct Method and Allowance Method under Perpetual System

DIRECT METHOD ALLOWANCE METHOD

Date Transactions (Cost of Goods Sold Method) (Loss Method)
Particulars Dr. Cr. Particulars Dr. Cr.
2019
12/31 Cost – P 780,000 Cost of Goods Sold 68,000 Loss on Inventory WD 68,000
NRV – P 712,000 Inventory 68,000 Allowance for
Inventory WD 68,000
(780,000 – 712,000)

2020
12/31 Cost – P 905,000 Cost of Goods Sold 75,000 Loss on Inventory WD 7,000
NRV – P 830,000 Inventory 75,000 Allowance for
(905,000 - 830,000) Inventory WD 7,000
(905,000- 830,000) – 68,000

2021
12/31 Cost – P 995,000 Cost of Goods Sold 45,000 Allowance for Inv. WD 30,000
NRV – P 950,000 Inventory 45,000 Recovery in NRV of 30,000
(995,000 – 950,000) Inventory

18 | P a g e
 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Exercise 2.3-7D (Related Multiple-Choice Questions)

In relation to the above, answer the following multiple-choice questions. Write your answer on the space provided
before each number. Use only CAPITAL LETTERS.

A 1. LCNRV of inventory
A. is always either the net realizable value or its cost.
B. should always be equal to net realizable value.
C. may sometimes be less than net realizable value.
D. should always be equal to net realizable value less costs to complete.

C 2. Lower-of-cost-or-net realizable value

A. gives the lowest valuation if applied to the total inventory.
B. gives the lowest valuation if applied to major groups of inventory.
C. gives the lowest valuation if applied to individual items of inventory.
D. must be applied to major groups for taxes.

A 3. Lower-of-cost-or-net realizable value as it applies to inventory is best described as the

A. reporting of a loss when there is a decrease in the future utility below the original cost.
B. method of determining cost of goods sold.
C. assumption to determine inventory flow.
D. change in inventory value to net realizable value.

A 4. Which of the following is not an acceptable method of applying the lower-of-cost-or-net

realizable value method to inventory?
A. Inventory location.
B. Groups of inventory items.
C. Individual item.
D. Total of the inventory.

D 5. Which method(s) may be used to record a loss due to a price decline in the value of inventory?
A. Loss method.
B. Sales method.
C. Cost-of-goods-sold method.
D. Both a and c.

D 6. When the cost-of-goods-sold method is used to record inventory at net realizable value
A. there is a direct reduction in the selling price of the product that results in a loss being
recorded on the income statement prior to the sale.
B. a loss is recorded directly in the inventory account by crediting inventory and debiting loss
on inventory decline.
C. only the portion of the loss attributable to inventory sold during the period is recorded in the
financial statements.
D. the net realizable value figure for ending inventory is substituted for cost and the loss is
buried in cost of goods sold.

D 7. Net realizable value is

A. fair value plus estimated costs to complete and make a sale.
B. selling price.
C. selling price plus estimated costs to complete and make a sale.
D. selling price less estimated costs to complete and make a sale.

B 8. Which of the following statements is incorrect regarding the lower-of-cost-or-net realizable value
(LCNRV)?
A. Net realizable value (NRV) is the selling price less estimated costs to complete and
estimated costs to make a sale.
B. In most situations, companies price inventory on a total-inventory basis.
C. One of two methods may be used to record the income effect of valuing inventory at net
realizable value.
D. Companies use an allowance account, the “Allowance to Reduce Inventory to Net
Realizable Value.”

19 | P a g e
 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

EXERCISE 2.3-8
Purchase Commitments

Exercise 2.3-8A (Journal Entries – Purchase Commitments)

(Adapted from Intermediate Accounting Textbook)
On December 31, 2019, Naysaver Company has outstanding purchase commitments for 10,000 gallons at P 200 per
gallon of raw material to be used in the manufacturing process.

Required:
Prepare journal entry under each of the following assumptions:
A. The market price on December 31, 2019 is P 210.
B. It is expected that the market price will decline to P 170 in early January 2020.
C. The market price on December 31, 2019 is P 170.
D. The market price on December 31, 2019 is P 170. On January 31, 2020 when 10,000 gallons shipment is
received, the market price is P 150.
E. The market price on December 31, 2019 is P 170. On January 31, 2020 when the 10,000 gallons shipment is
received, the market price is P 210.

SOLUTION:
No. Transactions Account Names Debit Credit
A. The market price on December 31, NO ENTRY
2019 is P 210. Increase in market price is not
recognized. This is gain.

B. It is expected that the market price NO ENTRY

will decline to P 170 in early January The decline in market price is
2020. only an expectation

C. The market price on December 31, Loss on Purchase Commitment 300,000

2019 is P 170. Estimated liability for PC 300,000
(P 200 – P 170) x 10,000 gal.

D. The market price on December 31, Loss on Purchase Commitment 300,000

2019 is P 170. On January 31, 2020 Estimated liability for PC 300,000
when 10,000 gallons shipment is
received, the market price is P 150. Loss on Purchase Commitment* 200,000
Estimated Liability for PC 300,000
Purchases (10,000 gal x P 150 MP) 1,500,000
Accounts Payable** 2,000,000

*(P 170 – P 150) x 10,000 gal.

**10,000 gal. x P 200
E. The market price on December 31, Loss on Purchase Commitment 300,000
2019 is P 170. On January 31, 2020 Estimated liability for PC 300,000
when the 10,000 gallons shipment is
received, the market price is P 210. Estimated liability for PC 300,000
Purchases (10,000 gal. x P 200 cost) 2,000,000
Accounts Payable** 2,000,000
Gain on Purchase Commitment* 300,000

*(P 210 – P 170) x 10,000 gal. (GAIN)

But RECOVERY is the to extent only of P 300,000 loss
**10,000 gal. x P 200

20 | P a g e
 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Exercise 2.3-8B (Related Multiple-Choice Questions)

In relation to the above, answer the following multiple-choice questions. Write your answer on the space provided
before each number. Use only CAPITAL LETTERS.

A 1. The credit balance that arises when a net loss on a purchase commitment is recognized should
be
A. presented as a current liability.
B. subtracted from ending inventory.
C. presented as an appropriation of retained earnings.
D. presented in the income statement.

A 2. If a material amount of inventory has been ordered through a formal purchase contract at the
statement of financial position date for future delivery at firm prices,
A. this fact must be disclosed.
B. disclosure is required only if prices have declined since the date of the order.
C. disclosure is required only if prices have since risen substantially.
D. an appropriation of retained earnings is necessary.

A 3. The Loss on Purchase Commitment account is classified as

A. Other expense
B. Adjunct account to Purchases account
C. Contra Retained Earnings
D. Other revenue

C 4. The estimated liability for purchase commitment account is classified as

A. Contra Inventory account
B. Contra Purchases account
C. Current Liability
D. Long-term liability

C 5. Purchase commitments are obligations of the entity to acquire certain goods sometime in the
future as at
A. Fixed price but not fixed in quantity
B. Fixed in quantity but not fixed in price
C. Fixed in quantity and in price
D. Not fixed both in quantity and in price

C 6. Loss on purchase commitment can be recognized only if the purchase commitment is

A. Valid
B. Cancellable
C. Non-cancellable
D. Valid but cancellable

D 7. When a loss and a related liability should be recognized in a purchase commitment?

A. The purchase contract is non-cancellable
B. The loss is probable and material
C. The loss can be reasonably estimated
D. All of the above

B 8. The account “Recovery of Loss on Purchase Commitments” is reported on the

A. Statement of financial position as contra-inventory account
B. Statement of Comprehensive Income as Other operating Income
C. Statement of Changes in Equity as a reduction in Retained Earnings balance.
D. Statement of Comprehensive Income as part of the Cost of Sales

21 | P a g e
 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

EXERCISE 2.3-9
Gross Profit Method

Exercise 2.3-9A (Computing the Estimated Inventory)

(Adapted from Intermediate Accounting Textbook)
Fiesta Company uses the gross profit method to estimate inventory for monthly reporting purposes. Presented below
is information for the month of May.

Inventory, May 1 320,000

Purchases (gross) 1,280,000
Freight-in 60,000
Sales 2,000,000
Sales Returns 140,000
Purchase Discounts 24,000

Instructions:
1. Compute the estimated inventory at May 31, assuming that the gross profit rate is 25% of sales.
2. Compute the estimated inventory at May 31, assuming that the gross profit rate is 25% of cost.

SOLUTION:
1. Computation of the estimated inventory at May 31, assuming that the gross profit rate is 25% of sales.

SOLUTION:
Inventory, May 1 320,000
Purchases (gross) 1,280,000
Purchase Discounts (24,000)
Freight-in 60,000
Goods available for sale 1,636,000
Cost of Sales
Sales 2,000,000
Sales Returns (140,000)
Net Sales 1,860,000
Multiply by cost rate (100% - 25%) 75% (1,395,000)
Estimated inventory at May 31 241,000

2. Computation of the estimated inventory at May 31, assuming that the gross profit rate is 25% of cost.

SOLUTION:
Inventory, May 1 320,000
Purchases (gross) 1,280,000
Purchase Discounts (24,000)
Freight-in 60,000
Goods available for sale 1,636,000
Cost of Sales
Sales 2,000,000
Sales Returns (140,000)
Net Sales 1,860,000
Divide by cost rate 125% 125% (1,488,000)
Estimated inventory at May 31 148,000

22 | P a g e
 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Exercise 2.3-9B (Construction of Accounts to Compute the Estimated Inventory)

(Adapted from Reviewer in Auditing Practice)
Aloha Company prepares monthly income statements. A physical inventory is taken only at year end; hence, month-
end inventories must be estimated. All sales are made on account. The rate of mark-up on cost is 50%. The
following information relates to the month of June 2020:

Accounts receivable, June 1, 2020 100,000

Accounts receivable, June 30, 2020 150,000
Collection of accounts receivable during June 2020 250,000
Inventory, June 1, 2020 180,000
Purchases of inventory during June 2020 160,000

Required:
Compute the estimated cost of the June 30, 2020 inventory.

SOLUTION:
Given Accounts Receivable
Dr. Cr.
Accounts receivable, June 1, 2020 100,000 100,000
Credit sales during June 2020 (squeeze amount) ? 300,000
Collection of accounts receivable during June 2020 250,000 250,000
Accounts receivable, June 30, 2020 150,000 150,000

Inventory, June 1, 2020 180,000

Purchases of inventory during June 2020 160,000
Cost of goods available for sale 340,000
Less: Cost of sales
Sales during June 2020 (all credit sales) 300,000
Divide by sales rate (GPR based on cost) 150% 200,000
Cost of Inventory, June 30, 2020 140,000
(Letter B)

Exercise 2.3-9C (Computation of Inventory Shortage)

(Adapted from Intermediate Accounting Textbook)
Karen Company reported the following information for the current year:

Beginning inventory 5,000,000

Purchases 26,000,000
Freight-in 2,000,000
Purchase returns and allowances 3,500,000
Purchase discounts 1,500,000
Sales 40,000,000
Sales returns 3,000,000
Sales allowances 500,000
Sales discounts 1,000,000

A physical inventory taken at year-end resulted in an ending inventory costing P 4,000,000.

At year-end, unsold goods out on consignment with selling price of P 1,000,000 are in the hands of a consignment.

The gross profit was 40% on sales.

QUESTIONS:
1. What is the cost of goods available for sale?

SOLUTION:
Beginning inventory 5,000,000
Purchases 26,000,000
Freight-in 2,000,000
Purchase returns and allowances (3,500,000)
Purchase discounts (1,500,000)
Cost of Goods Available for Sale 28,000,000
(Letter A)

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

2. What is the cost of goods sold?

SOLUTION:
Sales 40,000,000
Sales returns (3,000,000)
Net Sales 37,000,000
Multiply by cost rate (based on sales) 60%
Cost of goods sold 22,200,000

Notes:
Sales returns and allowances and sales discounts are not included in the computation of estimated inventory, ending
because these accounts do not involve physical transfer of inventory items but only reduction in amounts of balances.

3. What is the estimated cost of inventory shortage?

SOLUTION:
Cost of goods available for sale (No. 1) 28,000,000
Cost of goods sold (No. 2) (22,200,000)
Estimated Inventory, end, unadjusted 5,800,000
Goods out on consignment
(P 1,000,000 x 60%) (600,000)
Estimated Inventory, end, adjusted 5,200,000
Inventory ending per count (4,000,000)
Inventory Shortage 1,200,000

Exercise 2.3-9D (Computation of Inventory Fire Loss)

(Adapted from Intermediate Accounting Textbook)
On the night of September 30, 2020, a fire destroyed most of the merchandise inventory of Paragon Company. ll
goods were completely destroyed except for partially damaged goods that normally sell for P 100,000 and that had
an estimated net realizable value of P 25,000 and undamaged goods that normally sell for P 60,000.

Inventory, January 1, 2020 660,000

Net purchases, January 1 through September 30, 2020 4,240,000
Net sales, January 1 through September 30, 2020 5,600,000

2019 20118 20117

Net Sales 5,000,000 3,000,000 1,000,000
Cost of goods sold 3,840,000 2,200,000 710,000

Instructions:
Compute the amount of fire loss to be recognized on September 30, 2020

SOLUTION:
Step 1 – Compute first the cost rate based on previous accounting records
2018 2017 2016 Total
Net Sales (NS) 5,000,000 3,000,000 1,000,000 9,000,000
Cost of goods sold (COGS) 3,840,000 2,200,000 710,000 6,750,000

Cost rate = COGS / NS = P 6,750,000/P 9,000,000 = 75%

Step 2 – Compute the fire loss, 9/30/2019

Inventory, January 1, 2019 660,000

Net purchases, January 1 through September 30, 2019 4,240,000
Cost of goods available for sale, 1/1 to 9/30/2019 4,900,000
Less: Cost of sales
Net sales, January 1 through September 30, 2019 5,600,000
Multiply by cost rate (based on sales) 75% 4,200,000
Estimated inventory on date fire, 9/30/2019 700,000
Less: Undamaged goods (not counted as fire loss)
P 60,000 normal selling price x 75% cost rate 45,000
Partially damaged goods (not counted as loss) at NRV 25,000 70,000
Fire loss at 9/30/2019, date of fire 630,000

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Exercise 2.3-PE (Related Multiple-Choice Questions)

In relation to the above, answer the following multiple-choice questions. Write your answer on the space provided
before each number. Use only CAPITAL LETTERS.

A 1. How is the gross profit method used as it relates to inventory valuation?

A. Verify the accuracy of the perpetual inventory records.
B. Verity the accuracy of the physical inventory.
C. To estimate cost of goods sold.
D. To provide an inventory value of LIFO inventories.

D 2. Which of the following is not a basic assumption of the gross profit method?
A. The beginning inventory plus the purchases equal total goods to be accounted for.
B. Goods not sold must be on hand.
C. If the sales, reduced to the cost basis, are deducted from the sum of the opening inventory
plus purchases, the result is the amount of inventory on hand.
D. The total amount of purchases and the total amount of sales remain relatively unchanged
from the comparable previous period.

D 3. The gross profit method of inventory valuation is invalid when

A. a portion of the inventory is destroyed.
B. there is a substantial increase in inventory during the year.
C. there is no beginning inventory because it is the first year of operation.
D. none of these.

B 4. Which statement is not true about the gross profit method of inventory valuation?
A. It may be used to estimate inventories for interim statements.
B. It may be used to estimate inventories for annual statements.
C. It may be used by auditors.
D. None of these.

B 5. The gross margin method of estimating ending inventory may be used for all of the following,
except
A. Internal as well as external interim reports
B. Internal as well as external year-end reports
C. Estimate of inventory destroyed by fire or other casualty
D. Rough test of the validity of an inventory cost determined under either periodic or perpetual
system.

D 6. The use of the gross profit method assumes

A. The amount of gross profit is the same as in prior years.
B. Sales and cost of goods sold have not changed from previous years
C. Inventory values have not increased from previous years.
D. The relationship between selling price and cost of goods sold is similar to prior years.

C 7. The gross profit method of estimating inventory would not be useful

A. A system is in use and inventories are required for interim financial statements.
B. Inventories have been destroyed or lost by fire, theft or other casualty, and the specific data
required for inventory valuation are not available.
C. There is a significant change in the mix of products being sold.
D. The relationship between gross profit and sales remains stable over time.

B 8. A mark-up of 25% on cost is equivalent to what mark-up on selling price?

A. 15%
B. 20%
C. 25%
D. 33%

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

EXERCISE 2.3-10
Retail Inventory Method

Exercise 2.3-10A (Conservative Approach and Average Cost Approach)

(Adapted from Intermediate Accounting Textbook)
Empress Company used the retail inventory method to approximate the ending inventory.

The following information is available for the current year:

Cost Retail
Beginning Inventory 650,000 1,200,000
Purchases 9,000,000 14,700,000
Freight-in 200,000
Purchase returns 300,000 500,000
Purchase Allowances 150,000
Departmental transfer-in 200,000 300,000
Net markup 300,000
Net markdown 1,000,000
Sales 9,500,000
Sales Discounts 100,000
Employee Discounts 500,000
Estimated normal shoplifting losses 600,000
Estimated normal shrinkage 400,000

Instructions:
1. Compute the estimated cost of ending inventory using the conservative approach
2. Compute the estimated cost of ending inventory using the average cost approach

SOLUTION:
Conservative
Approach Average Cost Approach
Cost Retail Cost Retail
Beginning inventory 650,000 1,200,000 650,000 1,200,000

Purchases 9,000,000 14,700,000 9,000,000 14,700,000

Freight-in 200,000 200,000
Purchase Returns (300,000) (500,000) (300,000) (500,000)
Purchase Allowances (150,000) (150,000)
Departmental transfer-in 200,000 300,000 200,000 300,000
Net markup 300,000 300,000
Cost of goods available for sale 9,600,000 16,000,000
COST RATE – Conservative
P 9,600,000/P 16,000,000 = 60%
(1,000,000)
Net markdown (1,000,0000)
Cost of goods available for sale 9,600,000 15,000,000 9,600,000 15,000,000
COST RATE – Average
P 9,600,000/P 15,000,000 = 64%

Less: Sales 9,500,000 9,500,000

Employee Discount 500,000 500,000
Estimated normal shiplifting losses 600,000 600,000
Estimated normal shrinkage 400,000 11,000,000 400,000 11,000,000
Ending inventory, at retail price 4,000,000 4,000,000

ENDING INVENTORY AT COST:

Conservative (P 4,000,000 x 60%) 2,400,000 (Letter A)
Average (P 4,000,000 x 64%) 2,560,000 (Letter A)

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

Exercise 2.3-10B (FIFO Retail Approach)

(Adapted from Intermediate Accounting Textbook)
Flame Company adopted the FIFO approach of inventory pricing in connection with the use of the retail inventory
method. The retail records showed the following:

Cost Retail
Year 2020:
Beginning inventory 556,800 928,000
Purchases 4,576,000 7,028,000
Net markup 42,000
Net markdown 30,000
Sales 6,840,000

Year 2021:
Purchases 4,760,000 6,812,000
Net markup 56,000
Net markdown 68,000
Sales 6,928,000

Required:
Determine the estimated cost of inventory on December 31, 2019 and 2020 applying the FIFO retail approach.

SOLUTION:
FIFO Approach
Cost Retail
YEAR 2019:
Inventory, January 1, beginning 556,800 928,000

Purchases 4,576,00 7,028,000

0
Net markup 42,000
Net markdown (30,000)
Net Purchases 4,576,00 7,040,000
0

Cost of goods available for sale 5,132,80 7,968,000

0
COST RATE – FIFO
P 4,576,000/P 7,040,000 = 65%

Less: Sales 6,840,000

Ending inventory, at retail price 1,128,000

ENDING INVENTORY AT COST:

FIFO (P 1,128,000 x 65%) 733,200

YEAR 2020:
Inventory, January 1, beginning 733,200 1,128,000

Purchases 4,760,00 6,812,000

0
Net markup 56,000
Net markdown (68,000)
Net Purchases 4,760,00 6,800,000
0

Cost of goods available for sale 5,493,20 7,928,000

0
COST RATE – FIFO
P 4,760,000/P 6,800,000 = 70%

Less: Sales 6,928,000

Ending inventory, at retail price 1,000,000

ENDING INVENTORY AT COST:

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 Far Eastern University
Institute of Accounts. Business and Finance
Department of Accountancy and Internal Auditing

FIFO (P 1,000,000 x 700,000

70%)

Exercise 2.3-10C (Related Multiple-Choice Questions)

In relation to the above, answer the following multiple-choice questions. Write your answer on the space provided
before each number. Use only CAPITAL LETTERS.

D 1. A major advantage of the retail inventory method is that it

A. provides reliable results in cases where the distribution of items in the inventory is different
from that of items sold during the period.
B. hides costs from competitors and customers.
C. gives a more accurate statement of inventory costs than other methods.
D. provides a method for inventory control and facilitates determination of the periodic
inventory for certain types of companies.

C 2. An inventory method which is designed to approximate inventory valuation at the lower of cost or
net realizable value is
A. last-in, first-out.
B. first-in, first-out.
C. conventional retail method.
D. specific identification.

A 3. The retail inventory method is based on the assumption that the

A. final inventory and the total of goods available for sale contain the same proportion of high-
cost and low-cost ratio goods.
B. ratio of gross margin to sales is approximately the same each period.
C. ratio of cost to retail changes at a constant rate.
D. proportions of markups and markdowns to selling price are the same.

D 4. Which statement is true about the retail inventory method?

A. It may not be used to estimate inventories for interim statements.
B. It may not be used to estimate inventories for annual statements.
C. It may not be used by auditors.
D. None of these.

B 5. When the conventional retail inventory method is used, markdowns are commonly ignored in the
computation of the cost to retail ratio because
A. there may be no markdowns in a given year.
B. this tends to give a better approximation of the lower of cost or net realizable value.
C. markups are also ignored.
D. this tends to result in the showing of a normal profit margin in a period when no markdown
goods have been sold.

A 6. To produce an inventory valuation which approximates the lower-of-cost-or-net realizable value

using the conventional retail inventory method, the computation of the ratio of cost to retail
should
A. include markups but not markdowns.
B. include markups and markdowns.
C. ignore both markups and markdowns.
D. include markdowns but not markups.

A 7. Which of the following is not required when using the retail inventory method?
A. All inventory items must be categorized according to the retail markup percentage which
reflects the item's selling price.
B. A record of the total cost and retail value of goods purchased.
C. A record of the total cost and retail value of the goods available for sale.
D. Total sales for the period.

A 8. What condition is not necessary in order to use the retail method to provide inventory results?
A. Retailer keeps a record of the total costs of products sold for the period.
B. Retailer keeps a record of the total costs and retail value of goods purchased.
C. Retailer keeps a record of the total costs and retail value of goods available for sale.
D. Retailer keeps a record of sales for the period.

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