 In this presentation we will take a look at multiple choice questions related to inventory and cost flow. First question. When cost to purchase inventory decline, which method will result in the lowest gross profit? A. Specific identification B. Average cost method C. First and first out, FIFO method D. Weighted average method or E. Last and first out, LIFO method. Once again we'll read through the question, see if we can eliminate some of the options. When cost to purchase inventory decline, which method will result in the lowest gross profit? So we're looking for the lowest gross profit and we're looking for when the costs are declining, which is kind of the unusual, the opposite than usual nature, they usually go up. So let's go through these here and first we're looking for something that's kind of extreme again, the lowest. So if we go through a specific identification method, we don't really know if that one's going to result in the lowest gross profit because that's not really a cost flow assumption that's going to be specifically identifying the inventory that was sold. So it really depends on the customer which inventory they sell to, specific identification typically being used when we have larger types of inventory. So I don't think that's going to be, it's not really a cost flow assumption here. B, average cost method. So the average is not usually an extreme. So we're looking at the lowest gross profit, meaning we're looking for the method that's going to be somewhere on the extreme and you would think the average would be somewhere in the middle. So it's probably not going to be B. First in, first out could be one of the one of the extremer methods, meaning it's not going to be the average of the two. The average typically is the average between FIFO and LIFO. And then D, weighted average method. Weighted average method seems similar to average and once again it is an average. So for both those reasons, one we can't have two of the same type of answer and two it's an average which we would think wouldn't be an extreme. I'm going to eliminate D. And then E says last and first out or FIFO. Typically when you see these problems, when it says lowest or highest, we're usually going down to is it FIFO or LIFO? Average is usually in the middle. So which one is it LIFO or FIFO? And the default method to think about this is I would first, and there's a lot of questions that can be asked that are similar to this. They can ask about the gross profit, the cost of goods sold, the net income, the inventory. They can ask whether it is declining or increasing. I would think first the default. The default is when prices go up due to if nothing else inflation. And if prices are going up, then the default would be first and first out will make you look better. And last and first out will typically make you look worse under normal conditions, which is not what we have here under rising prices. Then we can reverse that when we think about the declining prices. So under normal conditions and rising prices, whatever they ask you for, it should look the first and first out will make you look better. So if they ask you about the assets or inventory, first and first out will have higher assets and inventory because that would make you look better. If they ask you about, in this case, gross profit, if we were talking about rising prices, then you would think that first and first out would result in gross profit that would be higher because that would make you look better. If we were talking, they can ask the same about cost of goods sold. Cost of goods sold, we would usually want to be lower because that would result in a higher gross profit and higher net income. And so you would think cost of goods sold would be lower under normal conditions under FIFO and then finally net income. If we had normal conditions of rising prices, we would think FIFO would make you look better higher net income. And then we could reverse all that if we're talking about the opposite, the lower net income. So if we have lower net, if it's a decline in prices, another way I should say a decline in prices, then first and first out will make you look worse. So we can just flip everything and say, well, which one's going to make you look worse? This one's going to make you look worse. So we're looking for the lowest gross profit and that will make you look worse, right? So that you would think then would be the first and first out method because that would make us look the worst, the lowest method here. Now again, you could go through all the cost flows to kind of figure that out. But kind of a shortcut minimizing technique like that may make it faster when you're doing a test taking kind of under pressure situation. So once again, when costs to purchase inventory decline, which method will result in the lowest gross profit? C, first and first out. Next question. Conservatism applies to accounting means, A, when multiple estimates are present, the least optimistic one should be used. B, a company must be consistent with accounting methods. C, revenues are recorded when earned. D, expenses are matched to revenue. And E, all inventory items are reported at full cost. So once again, we'll read this off and see if we can eliminate some of the options. Conservatism applied to accounting means. Now, so you might want to obviously just try to define this first before you go through the options and see if you can get an idea of what we're talking about. And then go through and eliminate it. Conservatism isn't a political type of thing when we're talking about here. We're just talking about the idea of erring on pretty much making us look worse, basically. If we make an estimate, we don't want to overstate ourselves or present ourselves in a higher position than would be accurate. In other words, if there's two positions we would want to and they could equally be the case, we typically want to lean towards the lower position and the justification for that would be that we don't want to purposely overstate information so that people can remain trustworthy financial statements that we have, which will build trust hopefully over time. So A, when multiple estimates are present, the least optimistic one should be used. And that sounds pretty good. Let's see what B, so I'm keeping that for now, B, a company must be consistent with accounting methods. And you might think that's kind of good too. I'm going to keep that for now. C says revenues are recorded when earned. And that is something, that's a method, but that's the revenue recognition principle. So that's not conservatism under this, under accounting. So it's not that one. D says expenses are matched to revenue. And that's kind of another principle, that's the matching principle. So those are a cruel concept principles, but they're not the conservatism accounting principle. E says all inventory items are reported at full cost. And that may be true, but again, it probably doesn't apply to the conservatism principle. So we're left with A and B. Once again, the question of conservatism applied to accounting means A, when multiple estimates are present, the least optimistic one should be used. Or B, a company must be consistent with accounting methods. Now the consistent thing deals with actually the consistency principle. So it's actually going to be A, these are different principles as well. A is the multiple estimates are present, the least optimistic one should be used. And again, that's going to be an estimating principle. And really the idea there is that we don't want people to be so aggressive with the financial statements that they're really overstating their position. And that will reduce the trust in the numbers, that's going to be the idea. So once again the answer, conservatism applied to accounting means A, when multiple estimates are present, the least optimistic one should be used. Next question, inventories should be reported at A, market value, B, cost, C, replacement cost, D, retail value, or E, lower of cost or market. Once again, we'll read this all, see if we can eliminate some of the options. There should be reported at A, market value, you might think that might be something, B, cost, when we buy the inventory we typically do report it at cost, C says, I'll keep those two for an hour, C says replacement cost, and you could say under certain circumstances that might be the case, I'll keep all of those for now. B says retail cost, retail cost is really what you sell it for, that's not what we're going to record the inventory for, that's our sales price typically, so I'm thinking it's not D. E says the lower of cost or market, and that kind of sounds like a term that seems applicable here. So if we read through it here again, I'm going to keep all those, inventory should be reported at A, market value, B, cost, C, replacement cost, or E, the lower of cost or market, and the rule is going to be this lower of cost or market. So although we do buy it at cost, if the cost were to go below that, the market value, the replacement cost, then we'd have to do the lower, and if the replacement cost, we might record it at replacement cost, but only if it's lower than what we actually bought it for, the default is we put it on there at cost, if the replacement cost goes below that, then we convert to replacement cost. And then A, market value is kind of, I was thinking that's similar to the market replacement cost, so that's not going to be it unless it goes below the original cost. So once again, answer, inventory should be reported at E, lower of cost or market.