Secondary 4 Principles of Accounts Inventory Costing Quiz

Secondary 4 Principles of Accounts Quiz - Inventory Costing — Answer Key and Marking Scheme

Total Marks: 50

Section A: Short Answer (10 marks)

1. State the accounting principle that requires inventory to be valued at the lower of cost and net realisable value.

Answer: The prudence (or conservatism) concept.

Marking: 2 marks for correct identification of the principle. Accept "prudence concept" or "conservatism concept". Award 1 mark if only "prudence" is stated without "concept".

2. Define "net realisable value" (NRV) in the context of inventory valuation.

Answer: Net realisable value is the estimated selling price of inventory in the ordinary course of business, less any estimated costs to complete and sell the goods.

Marking: 2 marks for a complete definition including both elements (estimated selling price AND deduction of costs to complete/sell). Award 1 mark if only one element is correctly stated.

3. A business discovered that its closing inventory was understated by $4,200. State the effect of this error on the gross profit for the year.

Answer: Gross profit is understated by $4,200.

Marking: 2 marks for correct direction and amount. Award 1 mark if direction is correct but amount is missing, or if amount is correct but direction is wrong. Accept: "Gross profit is lower by $4,200" or "Gross profit decreased by$4,200".

4. List TWO costs that may be included in the "cost" of inventory under the lower of cost and NRV principle.

Answer: Any TWO of the following:

• Purchase price
• Import duties/taxes (non-refundable)
• Freight/carriage inwards
• Handling costs directly attributable to acquisition
• Other directly attributable costs of bringing inventory to its present location and condition

Marking: 1 mark for each valid cost (maximum 2 marks). Do not accept selling costs, storage costs, or administrative overheads.

5. Explain why a business using FIFO during a period of rising prices will report a higher closing inventory value than a business using the weighted average cost method.

Answer: Under FIFO, the earliest (oldest and cheaper) inventory is charged to cost of goods sold first, leaving the most recent (more expensive) purchases in closing inventory. Under the weighted average cost method, all units are valued at an average cost that blends both older cheaper and newer more expensive prices. Therefore, in a period of rising prices, FIFO closing inventory consists of the higher-priced recent purchases, resulting in a higher valuation than the average cost method.

Marking: 2 marks for a clear explanation linking FIFO's use of older costs in COGS and newer costs in closing inventory to the higher valuation. Award 1 mark for a partial explanation (e.g., stating FIFO leaves recent purchases in inventory without explaining the price effect).

Section B: Calculations (24 marks)

6. Cost of goods sold calculation.

Workings:

• Net purchases = Purchases − Purchases returns = $142,000 −$3,600 = $138,400
• Cost of goods sold = Opening inventory + Net purchases + Carriage inwards − Closing inventory
• COGS = $18,500 +$138,400 + $2,800 −$22,100 = $137,600

Answer: $137,600

Marking: 4 marks total.

• 1 mark for correct calculation of net purchases
• 1 mark for correct inclusion of carriage inwards
• 1 mark for correct formula application
• 1 mark for correct final answer
• Award method marks if final answer is incorrect but workings show correct approach.

7. Inventory turnover rate calculation.

Workings:

• Average inventory = (Opening inventory + Closing inventory) ÷ 2
• Average inventory = ($28,000 +$32,000) ÷ 2 = $30,000
• Inventory turnover rate = Cost of goods sold ÷ Average inventory
• Turnover rate = $210,000 ÷$30,000 = 7.0 times

Answer: 7.0 times

Marking: 3 marks total.

• 1 mark for correct calculation of average inventory
• 1 mark for correct formula application
• 1 mark for correct final answer (rounded to one decimal place)
• Deduct 0.5 marks if rounding is incorrect.

8. FIFO method calculation.

Workings:

Sales on 15 March (250 units):

• 200 units from opening inventory @ $15 =$3,000
• 50 units from 8 March purchases @ $18 =$900
• COGS for 15 March sale = $3,000 +$900 = $3,900

Remaining inventory after 15 March sale:

• 250 units from 8 March purchases @ $18 =$4,500

Sales on 28 March (350 units):

• 250 units remaining from 8 March purchases @ $18 =$4,500
• 100 units from 22 March purchases @ $20 =$2,000
• COGS for 28 March sale = $4,500 +$2,000 = $6,500

Total COGS = $3,900 +$6,500 = $10,400

Closing inventory (after both sales):

• 300 units from 22 March purchases @ $20 =$6,000

(a) Cost of goods sold: $10,400 **(b) Closing inventory:**$6,000

Marking: 6 marks total.

• 2 marks for correct COGS calculation for 15 March sale
• 2 marks for correct COGS calculation for 28 March sale
• 1 mark for correct total COGS
• 1 mark for correct closing inventory
• Award method marks for correct FIFO sequencing even if arithmetic is incorrect.

9. Weighted average cost (AVCO) method calculation.

Workings:

After purchase on 8 March (before 15 March sale):

• Total units = 200 + 300 = 500 units
• Total cost = (200 × $15) + (300 ×$18) = $3,000 +$5,400 = $8,400
• Weighted average cost per unit = $8,400 ÷ 500 =$16.80

After sale on 15 March (250 units):

• Remaining units = 500 − 250 = 250 units
• Remaining value = 250 × $16.80 =$4,200

After purchase on 22 March:

• Total units = 250 + 400 = 650 units
• Total cost = $4,200 + (400 ×$20) = $4,200 +$8,000 = $12,200
• Weighted average cost per unit = $12,200 ÷ 650 =$18.77 (rounded to 2 d.p.)

After sale on 28 March (350 units):

• Remaining units = 650 − 350 = 300 units
• Closing inventory value = 300 × $18.77 =$5,631.00

(a) Weighted average cost per unit (after 8 Mar): $16.80 **(b) Closing inventory value:**$5,631.00 (accept $5,631 or$5,630.77 depending on rounding)

Marking: 6 marks total.

• 2 marks for correct weighted average after 8 March purchase
• 2 marks for correct recalculation of weighted average after 22 March purchase
• 1 mark for correct units remaining
• 1 mark for correct closing inventory value
• Accept minor rounding differences. Award method marks for correct AVCO approach.

10. Gross profit and gross profit margin calculation.

Workings:

• Cost of goods sold = Opening inventory + Purchases − Closing inventory
• COGS = $35,000 +$290,000 − $41,000 =$284,000
• Gross profit = Revenue − COGS = $480,000 −$284,000 = $196,000
• Gross profit margin = (Gross profit ÷ Revenue) × 100%
• Gross profit margin = ($196,000 ÷$480,000) × 100% = 40.8% (to 1 d.p.)

(a) Gross profit: $196,000 (b) Gross profit margin: 40.8%

Marking: 5 marks total.

• 2 marks for correct COGS calculation
• 1 mark for correct gross profit
• 1 mark for correct formula for gross profit margin
• 1 mark for correct percentage (rounded to one decimal place)
• Award method marks if final answer is incorrect but workings show correct approach.

Section C: Analysis and Application (16 marks)

11. Inventory turnover comparison and commentary.

Answer: Epsilon Trading has an inventory turnover rate of 12 times per year, which is significantly higher than Zeta Trading's rate of 5 times. This means Epsilon sells and replaces its inventory much more frequently.

A higher inventory turnover rate generally indicates more efficient inventory management. Epsilon holds inventory for a shorter period (approximately 30 days compared to Zeta's 73 days), which reduces storage costs, lowers the risk of inventory obsolescence, and improves cash flow as money is not tied up in unsold stock. Zeta's lower turnover may indicate overstocking, slow-moving inventory, or weaker sales performance.

Possible reason for the difference: Epsilon may have a more effective sales and marketing strategy, leading to faster sales, or Zeta may be holding excessive inventory levels relative to its sales volume.

Marking: 4 marks total.

• 1 mark for identifying Epsilon as more efficient
• 1 mark for explaining the implications of higher turnover (e.g., lower holding costs, less obsolescence risk, better cash flow)
• 1 mark for commenting on Zeta's lower turnover (e.g., overstocking, slow-moving inventory)
• 1 mark for a valid reason for the difference

12. Advantage and disadvantage of weighted average cost method.

Answer:

Advantage: The weighted average cost method smooths out price fluctuations over the accounting period, providing a more stable and moderate inventory valuation and cost of goods sold figure. This reduces the impact of extreme price changes on reported profits.

Disadvantage: The weighted average cost method may not reflect the actual physical flow of goods, especially for businesses where older inventory is sold first. It can also be more complex to calculate if there are frequent purchases at varying prices, as a new average must be computed after each purchase.

Marking: 4 marks total.

• 2 marks for a valid advantage with explanation
• 2 marks for a valid disadvantage with explanation
• Award 1 mark each if advantage/disadvantage is stated without adequate explanation.

13. Inventory valuation using lower of cost and NRV.

Workings:

Item A:

• NRV = $9,500 −$500 = $9,000
• Cost = $8,000
• Lower of cost and NRV = $8,000

Item B:

• NRV = $10,000 −$800 = $9,200
• Cost = $12,000
• Lower of cost and NRV = $9,200

Item C:

• NRV = $7,200 −$300 = $6,900
• Cost = $6,000
• Lower of cost and NRV = $6,000

Total adjusted closing inventory = $8,000 +$9,200 + $6,000 =$23,200

(a) NRV: Item A: $9,000 Item B:$9,200 Item C: $6,900

(b) Inventory value: Item A: $8,000 Item B:$9,200 Item C: $6,000

(c) Total adjusted closing inventory: $23,200

Marking: 6 marks total.

• 1 mark for each correct NRV calculation (3 marks total)
• 1 mark for each correct inventory value (3 marks total)
• Award method marks if approach is correct but arithmetic is wrong.

14. Corrected gross profit calculation.

Workings:

• Overstated closing inventory means COGS was understated, so gross profit was overstated. Correction: Gross profit decreases by $3,500.
• Omitted purchase means purchases were understated, so COGS was understated, and gross profit was overstated. Correction: Gross profit decreases by $2,800.
• Total decrease in gross profit = $3,500 +$2,800 = $6,300
• Corrected gross profit = $95,000 −$6,300 = $88,700

Corrected gross profit: $88,700

Marking: 2 marks total.

• 1 mark for identifying the direction of each error's impact on gross profit
• 1 mark for correct final answer
• Award 1 mark if final answer is incorrect but workings show correct adjustments.

15. Impact of overstated closing inventory.

Answer: On the income statement, an overstated closing inventory reduces the cost of goods sold (COGS = Opening inventory + Purchases − Closing inventory), which leads to an overstated gross profit and overstated net profit.

On the statement of financial position, closing inventory is a current asset. An overstated closing inventory results in overstated current assets and overstated total assets. Consequently, the owner's equity is also overstated due to the higher profit reported.

Marking: 2 marks total.

• 1 mark for correct impact on income statement (overstated profit)
• 1 mark for correct impact on statement of financial position (overstated assets/equity)

16. Journal entry for inventory adjustment.

Answer:

(To adjust inventory from $48,000 to$45,000 per physical count)

Marking: 2 marks total.

• 1 mark for correct debit entry (expense or COGS)
• 1 mark for correct credit entry (inventory) and correct amount ($3,000)
• Accept alternative account names that are appropriate (e.g., Inventory Loss, Inventory Write-down).

17. Interpretation of inventory turnover rate.

Answer: Sigma Stores' inventory turnover rate of 8 times is below the industry average of 12 times. This indicates that Sigma is selling and replacing its inventory less frequently than its competitors.

Potential concern: Sigma may be holding excessive inventory levels relative to its sales, which could lead to higher storage costs, increased risk of inventory obsolescence or spoilage, and cash being tied up in unsold stock. It may also suggest weaker demand for Sigma's products compared to the industry.

Marking: 2 marks total.

• 1 mark for interpreting the lower turnover relative to industry average
• 1 mark for a valid concern (e.g., overstocking, obsolescence risk, poor cash flow)

18. FOB shipping point and inventory inclusion.

Answer: Yes, the goods should be included in the ending inventory of the buyer as at 30 June 2026.

Explanation: Under FOB shipping point terms, ownership of the goods transfers to the buyer at the point of shipment. Since the goods were shipped on 28 June 2026 (before the financial year-end of 30 June 2026), the buyer legally owns the goods during transit and should include them in its ending inventory, even though physical possession occurs after the year-end.

Marking: 2 marks total.

• 1 mark for correct answer (Yes)
• 1 mark for correct explanation (ownership transfers at shipping point)

19. FIFO during deflation.

Answer: During a period of deflation (falling prices), the cost of goods sold under FIFO will be higher compared to the weighted average cost method.

Explanation: Under FIFO, the earliest (oldest and more expensive) inventory is charged to cost of goods sold first. In a period of falling prices, these older units have a higher cost than the more recent, cheaper purchases. The weighted average cost method blends the older higher costs with the newer lower costs, resulting in a lower average cost per unit and therefore a lower cost of goods sold compared to FIFO.

Marking: 2 marks total.

• 1 mark for correct answer (higher)
• 1 mark for correct explanation linking FIFO's use of older, more expensive inventory to COGS during deflation

20. Cost of goods sold from gross profit margin.

Workings:

• Gross profit = Gross profit margin × Revenue = 25% × $500,000 =$125,000
• Cost of goods sold = Revenue − Gross profit = $500,000 −$125,000 = $375,000

Answer: $375,000

Marking: 2 marks total.

• 1 mark for correct calculation of gross profit
• 1 mark for correct calculation of COGS
• Award method marks if final answer is incorrect but workings show correct approach.

END OF ANSWER KEY