PRC-1 · Chapter 7

IAS 2: Inventories MCQs with Answers

100 multiple-choice questions on IAS 2: Inventories for PRC-1 Fundamentals of Accounting. Try each one before revealing the answer and explanation.

1. Question 1

   Which of the following costs is NOT included in the cost of inventory according to IAS 2?

   • A) Purchase price
   • B) Non-refundable import duties
   • C) Selling costs
   • D) Fixed production overheads
   Show answer & explanation

   Answer: C) Selling costs

   Selling costs do not contribute to bringing the inventory to its present location and condition, so they are explicitly excluded from the cost of inventory and recognized as expenses when incurred.

2. Question 2

   When calculating the Net Realizable Value (NRV) of an inventory item, which of the following is correct?

   • A) Import duties must be excluded from the estimated selling price.
   • B) Estimated costs of completion and estimated costs necessary to make the sale are deducted from the estimated selling price.
   • C) Carriage inward is deducted from the estimated selling price.
   • D) The historical cost is deducted from the estimated selling price.
   Show answer & explanation

   Answer: B) Estimated costs of completion and estimated costs necessary to make the sale are deducted from the estimated selling price.

   NRV is defined as the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

3. Question 3

   When inventory is sold, how is its carrying amount treated in the financial statements?

   • A) It remains as an asset until cash is received.
   • B) It is recognized as a liability.
   • C) It is recognized as an expense (Cost of Sales) in the period in which the related revenue is recognized.
   • D) It is deducted directly from equity.
   Show answer & explanation

   Answer: C) It is recognized as an expense (Cost of Sales) in the period in which the related revenue is recognized.

   Under the matching principle, when goods are sold, their carrying amount is removed from the balance sheet and recognized as an expense (Cost of Sales) to match the revenue generated.

4. Question 4

   Which of the following statements correctly distinguishes between the periodic and perpetual inventory systems?

   • A) Both inventory systems are identical in their accounting treatment.
   • B) Under the periodic system, the inventory account is updated after every individual sale.
   • C) Under the perpetual system, purchases are debited directly to the Inventory account rather than a Purchases account.
   • D) The periodic system requires a continuous tracking of stock cards.
   Show answer & explanation

   Answer: C) Under the perpetual system, purchases are debited directly to the Inventory account rather than a Purchases account.

   In a perpetual system, the Inventory account is continuously updated for additions (purchases) and reductions (sales). In a periodic system, purchases are recorded in a separate Purchases account and inventory is only updated at period-end after a physical count.

5. Question 5

   An entity suffered a loss of stock worth Rs. 80,000. It recovered 70% of the value in cash from its insurance company. Under a perpetual inventory system, what is the correct double entry?

   • A) Debit Abnormal Loss Rs. 24,000; Credit Inventory Rs. 24,000
   • B) Debit Cash Rs. 56,000; Debit Abnormal Loss Rs. 24,000; Credit Inventory Rs. 80,000
   • C) Debit Abnormal Loss Rs. 24,000; Credit Purchases Rs. 24,000
   • D) Debit Cash Rs. 56,000; Debit Abnormal Loss Rs. 24,000; Credit Purchases Rs. 80,000
   Show answer & explanation

   Answer: B) Debit Cash Rs. 56,000; Debit Abnormal Loss Rs. 24,000; Credit Inventory Rs. 80,000

   The total inventory lost (Rs. 80,000) must be credited to the Inventory account (under a perpetual system). The cash received is Rs. 56,000 (70%), so Cash is debited. The unrecovered portion is a loss of Rs. 24,000, which is debited to Abnormal Loss.

6. Question 6

   Which of the following cost measurement formulas is explicitly NOT permitted under IAS 2?

   • A) First in, First out (FIFO)
   • B) Last in, First out (LIFO)
   • C) Weighted Average Cost (AVCO)
   • D) Specific Identification
   Show answer & explanation

   Answer: B) Last in, First out (LIFO)

   IAS 2 prohibits the use of the LIFO method because it often matches current revenues against outdated inventory costs, failing to accurately represent the physical flow of goods and current asset values.

7. Question 7

   An inventory item was purchased for Rs. 7,000 per unit. Its estimated sales price is Rs. 10,000, but a selling cost of Rs. 3,200 will be incurred to make the sale. The current replacement cost is Rs. 7,500. At what value should the inventory item be recorded?

   • A) Rs. 10,000
   • B) Rs. 7,500
   • C) Rs. 7,000
   • D) Rs. 6,800
   Show answer & explanation

   Answer: D) Rs. 6,800

   Inventory must be measured at the lower of Cost and NRV. Cost = Rs. 7,000. NRV = Selling Price (10,000) - Selling Cost (3,200) = Rs. 6,800. Therefore, it is valued at Rs. 6,800. Replacement cost is irrelevant under IAS 2.

8. Question 8

   The following data relates to ABC Enterprises: Opening Stock Rs. 25,000; Purchases Rs. 500,000; Sales Rs. 525,000. The business consistently earns a 25% gross margin on sales. What is the estimated value of closing inventory?

   • A) Rs. 105,000
   • B) Rs. 131,250
   • C) Rs. 50,000
   • D) Zero
   Show answer & explanation

   Answer: B) Rs. 131,250

   Cost of Sales = Sales (525,000) x 75% = 393,750. Goods available for sale = Opening Stock (25,000) + Purchases (500,000) = 525,000. Closing Stock = Goods available (525,000) - Cost of Sales (393,750) = Rs. 131,250.

9. Question 9

   A company has the following production data: Variable production overheads Rs. 350,000; Fixed production overheads Rs. 525,000; Normal production capacity 17,500 units; Actual production 12,500 units. What is the conversion cost per unit?

   • A) Rs. 70
   • B) Rs. 62
   • C) Rs. 58
   • D) Rs. 50
   Show answer & explanation

   Answer: C) Rs. 58

   Variable overheads are allocated based on actual production: 350,000 / 12,500 = Rs. 28/unit. Fixed overheads are allocated based on normal capacity: 525,000 / 17,500 = Rs. 30/unit. Total conversion cost per unit = 28 + 30 = Rs. 58.

10. Question 10

    During a period of rising prices (inflation), how will the valuation of closing inventory using the Weighted Average Cost (AVCO) method compare to the FIFO method?

    • A) AVCO will result in a lower closing inventory value than FIFO.
    • B) AVCO will result in a higher closing inventory value than FIFO.
    • C) AVCO and FIFO will result in the exact same closing inventory value.
    • D) AVCO will result in higher profits than FIFO.
    Show answer & explanation

    Answer: A) AVCO will result in a lower closing inventory value than FIFO.

    Under FIFO, the newest (and highest) costs remain in closing inventory. Under AVCO, costs are averaged, blending older (lower) costs with newer (higher) costs. Thus, AVCO closing inventory is lower than FIFO.

11. Question 11

    Which of the following is the correct journal entry to record a normal loss of inventory under a periodic inventory system?

    • A) Debit Normal Loss; Credit Inventory
    • B) Debit Normal Loss; Credit Cost of Sales
    • C) Debit Cost of Sales; Credit Inventory
    • D) No journal entry is required.
    Show answer & explanation

    Answer: D) No journal entry is required.

    Under a periodic system, normal losses are not recorded via a separate journal entry. The cost is automatically absorbed into Cost of Sales because the missing units simply do not appear in the physical closing stock count, thereby increasing the Cost of Sales figure.

12. Question 12

    What is the correct journal entry for stock distributed as free charity under a perpetual inventory system?

    • A) Debit Charity Expense; Credit Purchases
    • B) Debit Charity Expense; Credit Inventory
    • C) Debit Cost of Sales; Credit Inventory
    • D) Debit Charity Expense; Credit Supplier
    Show answer & explanation

    Answer: B) Debit Charity Expense; Credit Inventory

    Under a perpetual system, the physical removal of goods for any reason directly reduces the Inventory account. The value of the goods given away is recognized as a Charity Expense.

13. Question 13

    What is the correct journal entry for stock distributed as free charity under a periodic inventory system?

    • A) Debit Charity Expense; Credit Purchases
    • B) Debit Charity Expense; Credit Inventory
    • C) Debit Cost of Sales; Credit Inventory
    • D) Debit Charity Expense; Credit Purchases Return
    Show answer & explanation

    Answer: A) Debit Charity Expense; Credit Purchases

    In a periodic system, inventory accounts are not continuously updated. Goods taken out for non-sale purposes (like charity or drawings) are credited to the Purchases account to remove their cost from the calculation of Cost of Sales.

14. Question 14

    Which of the following correctly describes 'over-absorption' of production overheads?

    • A) Actual overheads > Absorbed overheads
    • B) Absorbed overheads > Actual overheads
    • C) Budgeted overheads > Actual overheads
    • D) Actual overheads > Budgeted overheads
    Show answer & explanation

    Answer: B) Absorbed overheads > Actual overheads

    Over-absorption occurs when the overheads applied (absorbed) to inventory units based on the predetermined rate exceed the overheads actually incurred during the period.

15. Question 15

    A business calculates the value of its closing stock on an item-by-item basis: Item A: Cost 95,000; NRV 93,000. Item B: Cost 100,000; NRV 102,000. Item C: Cost 85,000; NRV 79,000. Item D: Cost 78,000; NRV 85,000. Item E: Cost 44,000; NRV 41,000. What is the total value of the closing stock?

    • A) Rs. 402,000
    • B) Rs. 391,000
    • C) Rs. 400,000
    • D) Rs. 401,000
    Show answer & explanation

    Answer: B) Rs. 391,000

    Applying the lower of Cost and NRV rule for each item: A=93,000; B=100,000; C=79,000; D=78,000; E=41,000. Total = 93k + 100k + 79k + 78k + 41k = Rs. 391,000.

16. Question 16

    Which of the following expenditures should be included in the capitalized cost of inventory?

    • A) Abnormal amounts of wasted materials.
    • B) Storage costs of finished goods.
    • C) Non-refundable import duties and taxes.
    • D) Administrative overheads that do not contribute to bringing inventories to their present location.
    Show answer & explanation

    Answer: C) Non-refundable import duties and taxes.

    IAS 2 states that the cost of purchase includes the purchase price, import duties, and other non-refundable taxes, as well as transport and handling costs. Abnormal waste, storage of finished goods, and admin overheads must be expensed.

17. Question 17

    Which of the following scenarios describes a situation where a perpetual inventory system would be MOST suitable?

    • A) A business selling high volumes of low-value items, like a stationary shop.
    • B) A business selling low volumes of high-value items, like a luxury car dealership.
    • C) A business that never conducts physical stock counts.
    • D) A business that only reports financial results every three years.
    Show answer & explanation

    Answer: B) A business selling low volumes of high-value items, like a luxury car dealership.

    A perpetual system involves continuous tracking of every inventory movement. It is highly suitable (and cost-effective) for businesses dealing with high-value items where tight control and real-time data are essential.

18. Question 18

    An entity uses a perpetual inventory system. Which TWO journal entries are simultaneously required to record a sale of goods on credit?

    • A) Debit Cash, Credit Sales AND Debit Cost of Sales, Credit Purchases
    • B) Debit Receivables, Credit Sales AND Debit Cost of Sales, Credit Inventory
    • C) Debit Receivables, Credit Inventory AND Debit Cost of Sales, Credit Sales
    • D) Debit Receivables, Credit Sales only
    Show answer & explanation

    Answer: B) Debit Receivables, Credit Sales AND Debit Cost of Sales, Credit Inventory

    In a perpetual system, every sale requires recognizing the revenue (Debit Receivables, Credit Sales) and immediately updating the inventory records by removing the goods sold (Debit Cost of Sales, Credit Inventory).

19. Question 19

    According to IAS 2, how should unallocated fixed production overheads be treated when actual production is abnormally low?

    • A) They should be fully allocated to the few units produced, increasing their cost per unit.
    • B) They should be capitalized as intangible assets.
    • C) They should be recognized as an expense in the period in which they are incurred.
    • D) They should be carried forward as a deferred expense to the next year.
    Show answer & explanation

    Answer: C) They should be recognized as an expense in the period in which they are incurred.

    To prevent inventory from being overvalued when production is abnormally low, fixed overheads must be allocated based on normal capacity. The unallocated portion resulting from low production must be expensed immediately.

20. Question 20

    Which of the following items is EXCLUDED from the scope of IAS 2 Inventories?

    • A) Goods purchased for resale by a retailer.
    • B) Work-in-progress being produced for sale.
    • C) Financial instruments and biological assets related to agricultural activity.
    • D) Raw materials to be consumed in the production process.
    Show answer & explanation

    Answer: C) Financial instruments and biological assets related to agricultural activity.

    IAS 2 specifically excludes financial instruments (covered by IFRS 9) and biological assets related to agricultural activity and agricultural produce at the point of harvest (covered by IAS 41) from its scope.

21. Question 21

    A business bought 30 cars. Under which of the following circumstances would these cars be classified as 'Inventory'?

    • A) The business is a car dealership buying them for resale.
    • B) The business buys the cars for its sales team to visit clients.
    • C) The business buys the cars to lease them out under operating leases.
    • D) The business buys the cars for the CEO's personal use.
    Show answer & explanation

    Answer: A) The business is a car dealership buying them for resale.

    Inventories are assets held for sale in the ordinary course of business. If the business is a dealership, cars are its inventory. If used for operations (like sales team vehicles), they are Property, Plant and Equipment (IAS 16).

22. Question 22

    Which of the following definitions correctly describes 'Prime Cost'?

    • A) The sum of direct material, direct labor, and manufacturing overheads.
    • B) The sum of direct material and direct labor costs.
    • C) The sum of variable and fixed production overheads.
    • D) The total cost of raw materials purchased during the period.
    Show answer & explanation

    Answer: B) The sum of direct material and direct labor costs.

    Prime cost refers specifically to the direct, traceable costs of manufacturing a product, which consists of direct material costs and direct labor costs.

23. Question 23

    When a business records a write-down of inventory to Net Realizable Value, where is this expense initially recognized?

    • A) As a direct deduction from Retained Earnings.
    • B) As an expense in the Statement of Profit or Loss.
    • C) As a non-current liability.
    • D) As an impairment of Property, Plant, and Equipment.
    Show answer & explanation

    Answer: B) As an expense in the Statement of Profit or Loss.

    IAS 2 requires that any write-down of inventory to NRV, and all losses of inventory, be recognized as an expense in the period the write-down or loss occurs.

24. Question 24

    If an entity accidentally overstates its closing inventory value, what is the direct impact on the financial statements for that year?

    • A) Cost of Sales will be overstated, and Net Profit will be overstated.
    • B) Cost of Sales will be understated, and Net Profit will be overstated.
    • C) Cost of Sales will be overstated, and Net Profit will be understated.
    • D) Both Cost of Sales and Net Profit will be understated.
    Show answer & explanation

    Answer: B) Cost of Sales will be understated, and Net Profit will be overstated.

    Cost of Sales = Opening Stock + Purchases - Closing Stock. If closing stock is too high, the subtracted amount is too large, making Cost of Sales too low. Lower expenses lead to an artificially high (overstated) Net Profit.

25. Question 25

    Which of the following situations dictates that raw materials should NOT be written down below their cost?

    • A) When the replacement cost of the raw materials has fallen.
    • B) When the finished products in which they will be incorporated are expected to be sold at or above their cost.
    • C) When the raw materials have physically deteriorated.
    • D) When the business decides to switch to a different product line.
    Show answer & explanation

    Answer: B) When the finished products in which they will be incorporated are expected to be sold at or above their cost.

    Under IAS 2, materials held for use in production are not written down below cost if the finished products they will be used to produce are expected to be sold at or above cost.

26. Question 26

    How are trade discounts treated when determining the cost of inventory?

    • A) They are added to the purchase price.
    • B) They are ignored completely.
    • C) They are deducted from the purchase price.
    • D) They are recorded separately as Other Income.
    Show answer & explanation

    Answer: C) They are deducted from the purchase price.

    IAS 2 specifies that trade discounts, rebates, and other similar items are deducted in determining the costs of purchase.

27. Question 27

    How should refundable sales taxes (e.g., input VAT) paid on the purchase of raw materials be treated?

    • A) Added to the cost of the raw materials.
    • B) Ignored in the accounting records.
    • C) Excluded from the cost of raw materials and recorded as a receivable.
    • D) Treated as a manufacturing overhead.
    Show answer & explanation

    Answer: C) Excluded from the cost of raw materials and recorded as a receivable.

    Because the tax is refundable from the tax authorities, it does not represent a net cost to the business. It is excluded from inventory cost and recorded as a current asset (receivable).

28. Question 28

    A business has 200 units of stock. The units cost Rs. 22 each. What is the value of the closing stock?

    • A) Rs. 4,000
    • B) Rs. 4,200
    • C) Rs. 4,400
    • D) Rs. 4,600
    Show answer & explanation

    Answer: C) Rs. 4,400

    200 units x Rs. 22 per unit = Rs. 4,400.

29. Question 29

    In a manufacturing entity, which of the following items is considered 'Work in Progress' (WIP)?

    • A) Goods fully completed and waiting in the warehouse to be sold.
    • B) Raw materials that have not yet been placed into the production line.
    • C) Partially completed goods that are currently on the production line.
    • D) Machinery used to produce goods.
    Show answer & explanation

    Answer: C) Partially completed goods that are currently on the production line.

    Work-in-progress represents inventory that is in the process of production for sale, having moved past the raw material stage but not yet reached the finished goods stage.

30. Question 30

    Which inventory valuation method assumes that the items of inventory that were purchased or produced first are sold first?

    • A) LIFO
    • B) AVCO
    • C) Specific Identification
    • D) FIFO
    Show answer & explanation

    Answer: D) FIFO

    FIFO stands for First-In, First-Out, meaning the oldest costs are assigned to Cost of Sales first, leaving the most recent costs in ending inventory.

31. Question 31

    Which of the following is NOT a disclosure requirement specified in IAS 2?

    • A) The accounting policies adopted in measuring inventories.
    • B) The amount of any reversal of any write-down that is recognized as a reduction in the amount of inventories recognized as an expense.
    • C) The total carrying amount of inventories and the carrying amount in classifications appropriate to the entity.
    • D) The exact physical location of every warehouse where inventory is stored.
    Show answer & explanation

    Answer: D) The exact physical location of every warehouse where inventory is stored.

    IAS 2 requires disclosure of accounting policies, carrying amounts by classification, write-downs, and reversals, but does not require disclosing the physical geographic location of the inventory.

32. Question 32

    Under a periodic inventory system, how is the 'Cost of Sales' figure derived at the end of the accounting period?

    • A) It is tracked continuously after every sale.
    • B) By adding Opening Inventory and Purchases, then subtracting Closing Inventory.
    • C) By subtracting Gross Profit from total Sales.
    • D) By taking a physical count of the goods that were sold.
    Show answer & explanation

    Answer: B) By adding Opening Inventory and Purchases, then subtracting Closing Inventory.

    In a periodic system, Cost of Sales is a derived calculation: Opening Stock + Purchases (plus carriage inwards, less returns) - Closing Stock (determined by a physical count).

33. Question 33

    Which of the following scenarios REQUIRES the use of the 'Specific Identification' cost formula under IAS 2?

    • A) When the business sells vast quantities of homogeneous, interchangeable items like nails.
    • B) When inventory items are not ordinarily interchangeable and are segregated for specific projects.
    • C) When the business experiences high inflation.
    • D) When the business operates in the retail sector.
    Show answer & explanation

    Answer: B) When inventory items are not ordinarily interchangeable and are segregated for specific projects.

    IAS 2 mandates that the cost of inventories of items that are not ordinarily interchangeable, and goods or services produced and segregated for specific projects, shall be assigned by using specific identification of their individual costs.

34. Question 34

    If the circumstances that previously caused inventory to be written down below cost no longer exist, and the NRV has increased, what is the correct accounting treatment?

    • A) The inventory must remain at its lowered value due to the prudence concept.
    • B) The inventory is revalued to market price, recognizing a gain in equity.
    • C) The amount of the write-down is reversed so that the new carrying amount is the lower of the cost and the revised NRV.
    • D) The inventory is immediately sold.
    Show answer & explanation

    Answer: C) The amount of the write-down is reversed so that the new carrying amount is the lower of the cost and the revised NRV.

    IAS 2 requires a new assessment of NRV in each subsequent period. If circumstances change, the write-down is reversed (limited to the amount of the original write-down) so the asset reflects the lower of original cost and revised NRV.

35. Question 35

    How is 'Carriage Outwards' (freight out) treated in the financial statements?

    • A) It is added to the cost of purchases.
    • B) It is added to the cost of ending inventory.
    • C) It is treated as a selling and distribution expense and excluded from inventory cost.
    • D) It is deducted from gross sales revenue.
    Show answer & explanation

    Answer: C) It is treated as a selling and distribution expense and excluded from inventory cost.

    Carriage outwards is the cost of delivering goods to customers. It is a selling expense, not a cost incurred in bringing the inventory to its present location and condition.

36. Question 36

    A company values its inventory on a FIFO basis and adopts a perpetual system. On Jan 1: 500 units @ Rs. 60. Jan 11: Purchased 100 units @ Rs. 70. Jan 12: Sold 300 units. What is the value of the Cost of Sales for the Jan 12 transaction?

    • A) Rs. 21,000
    • B) Rs. 18,000
    • C) Rs. 19,500
    • D) Rs. 20,000
    Show answer & explanation

    Answer: B) Rs. 18,000

    Under FIFO, the first units purchased are the first ones sold. The 300 units sold on Jan 12 are taken from the Jan 1 opening stock (which cost Rs. 60 each). Cost of Sales = 300 x 60 = Rs. 18,000.

37. Question 37

    Which of the following costs are considered 'Conversion Costs'?

    • A) The cost of raw materials and carriage inwards.
    • B) Direct labor and systematic allocation of fixed and variable production overheads.
    • C) Selling, distribution, and general administrative costs.
    • D) Import duties and non-refundable taxes.
    Show answer & explanation

    Answer: B) Direct labor and systematic allocation of fixed and variable production overheads.

    Costs of conversion include costs directly related to the units of production (like direct labor) and a systematic allocation of fixed and variable production overheads incurred in converting materials into finished goods.

38. Question 38

    During a period of rising prices, which statement accurately reflects the impact of using FIFO instead of AVCO?

    • A) FIFO will result in lower Net Profit.
    • B) FIFO will result in higher Cost of Sales.
    • C) FIFO will result in higher Net Profit and higher closing inventory value.
    • D) FIFO will result in lower closing inventory value.
    Show answer & explanation

    Answer: C) FIFO will result in higher Net Profit and higher closing inventory value.

    Under FIFO, older, cheaper costs are expensed to Cost of Sales, meaning Cost of Sales is lower and Profit is higher. The newer, more expensive costs remain in closing stock, making its value higher.

39. Question 39

    A business sends goods to an agent on a 'sale or return' (consignment) basis. While the goods remain unsold by the agent, how should they be treated in the accounts of the business (the consignor)?

    • A) They should be recorded as a sale immediately.
    • B) They should be excluded from the business's inventory.
    • C) They must remain included in the business's inventory until sold to a third party.
    • D) They are recorded as an expense.
    Show answer & explanation

    Answer: C) They must remain included in the business's inventory until sold to a third party.

    Because the risks and rewards of ownership have not yet transferred (the agent can return them), the consignor still owns the goods and must include them in their closing inventory.

40. Question 40

    An entity uses the AVCO method. Opening stock: 100 units @ Rs. 10. Purchase: 100 units @ Rs. 12. Sale: 50 units. What is the AVCO per unit at the time of the sale?

    • A) Rs. 10
    • B) Rs. 11
    • C) Rs. 12
    • D) Rs. 10.5
    Show answer & explanation

    Answer: B) Rs. 11

    Total value = (100 x 10) + (100 x 12) = 1,000 + 1,200 = 2,200. Total units = 200. Average cost per unit = 2,200 / 200 = Rs. 11.

41. Question 41

    If an entity mistakenly understates its opening inventory value, what is the direct impact on the current year's financial statements?

    • A) Cost of Sales will be understated, and Net Profit will be overstated.
    • B) Cost of Sales will be overstated, and Net Profit will be understated.
    • C) Cost of Sales will be understated, and Net Profit will be understated.
    • D) There will be no impact on Net Profit.
    Show answer & explanation

    Answer: A) Cost of Sales will be understated, and Net Profit will be overstated.

    Cost of Sales = Opening Stock + Purchases - Closing Stock. If opening stock is too low, the total Cost of Sales will be artificially low. Lower expenses lead to an overstated Net Profit for the year.

42. Question 42

    Which of the following best explains why closing inventory is deducted in the Cost of Sales calculation?

    • A) Because the prudence concept states assets must be minimized.
    • B) Because the matching concept requires that the cost of unsold goods is removed from expenses and deferred to the next period.
    • C) Because the business has lost that inventory.
    • D) Because inventory is a liability.
    Show answer & explanation

    Answer: B) Because the matching concept requires that the cost of unsold goods is removed from expenses and deferred to the next period.

    Purchases account for everything bought. To find the cost of only what was *sold*, we must subtract the cost of what remains *unsold* (closing inventory). This perfectly aligns with the matching concept.

43. Question 43

    A business bought 100 units at Rs. 50 each. It paid Rs. 500 for delivery of the batch. Two units were found to be completely destroyed upon arrival (abnormal loss) and cannot be sold. What is the total cost assigned to the remaining 98 units?

    • A) Rs. 5,000
    • B) Rs. 5,390
    • C) Rs. 5,500
    • D) Rs. 5,400
    Show answer & explanation

    Answer: B) Rs. 5,390

    Total cost of 100 units = (100 x 50) + 500 = 5,500. Cost per unit = 55. The abnormal loss of 2 units must be expensed (2 x 55 = 110). The remaining 98 units are valued at 98 x 55 = Rs. 5,390.

44. Question 44

    What is the primary reason IAS 2 requires inventory to be written down to Net Realizable Value when it falls below cost?

    • A) The historical cost concept
    • B) The going concern concept
    • C) The prudence concept
    • D) The accruals concept
    Show answer & explanation

    Answer: C) The prudence concept

    The prudence concept requires that assets are not overstated and expected losses are recognized immediately. If NRV is below cost, an expected loss exists, and the asset must be written down.

45. Question 45

    Are borrowing costs (such as interest on a short-term bank loan used to buy raw materials) included in the cost of inventory?

    • A) Yes, always.
    • B) No, they are usually recognized as an interest expense in the period they are incurred.
    • C) Yes, but only if the loan is fully paid off within the year.
    • D) Yes, if the goods are imported.
    Show answer & explanation

    Answer: B) No, they are usually recognized as an interest expense in the period they are incurred.

    Under standard circumstances for routine inventories, borrowing costs are not capitalized. They are only capitalized if the inventory is a 'qualifying asset' taking a substantial period to get ready (per IAS 23), which is rare for standard raw materials.

46. Question 46

    A merchant bought 100 bags of cement at a retail price of Rs. 200 subject to a 5% trade discount. What is the gross purchase value recorded in the books before accounting for payments?

    • A) Rs. 20,000
    • B) Rs. 19,000
    • C) Rs. 21,000
    • D) Rs. 18,050
    Show answer & explanation

    Answer: B) Rs. 19,000

    Trade discounts are deducted immediately before recording the transaction. Gross list price = 100 x 200 = 20,000. Trade discount = 5% x 20,000 = 1,000. Recorded purchase value = 19,000.

47. Question 47

    Which of the following best describes the 'Retail Method' of estimating inventory?

    • A) Counting every item physically on the shop floor.
    • B) Deducing cost by reducing the sales value of the inventory by the appropriate percentage gross margin.
    • C) Assuming the oldest items are sold first.
    • D) Revaluing inventory to current retail market prices.
    Show answer & explanation

    Answer: B) Deducing cost by reducing the sales value of the inventory by the appropriate percentage gross margin.

    The retail method is often used in the retail industry for measuring large numbers of rapidly changing items with similar margins. The cost is determined by reducing the sales value by the gross margin percentage.

48. Question 48

    When raw materials are incorporated into a finished product, and the finished product is expected to be sold at a loss, how should the raw materials be valued?

    • A) They should be valued at their original historical cost.
    • B) They should be written down to their replacement cost or net realizable value.
    • C) They must be immediately destroyed.
    • D) They are valued at the selling price of the finished product.
    Show answer & explanation

    Answer: B) They should be written down to their replacement cost or net realizable value.

    While raw materials are normally not written down if the finished good is profitable, if the finished product will be sold at a loss, the materials must be written down to their NRV (often indicated by replacement cost).

49. Question 49

    An entity has an opening stock of Rs. 120,000, purchases of Rs. 253,000, and purchase returns of Rs. 8,000. Total sales were Rs. 285,250 (which includes Rs. 35,250 of goods sold at a discount). The normal margin is 20% on sales. Goods lost by fire (abnormal loss) cost Rs. 8,000. What is the value of closing inventory? (Assuming normal sales COGS = 200,000 and discounted sales COGS = 30,000)

    • A) Rs. 135,000
    • B) Rs. 129,800
    • C) Rs. 127,000
    • D) Rs. 131,000
    Show answer & explanation

    Answer: C) Rs. 127,000

    Goods Available = 120,000 (Open) + 253,000 (Pur) - 8,000 (Ret) = 365,000. Less Abnormal Loss (8,000) = 357,000. Less Total COGS (200,000 + 30,000 = 230,000). Closing Stock = 357,000 - 230,000 = Rs. 127,000.

50. Question 50

    A business owner takes goods costing Rs. 5,000 from the business for personal use. The goods have a retail price of Rs. 7,000. Under a periodic system, what is the double entry?

    • A) Debit Drawings Rs. 7,000; Credit Sales Rs. 7,000
    • B) Debit Drawings Rs. 5,000; Credit Purchases Rs. 5,000
    • C) Debit Drawings Rs. 5,000; Credit Inventory Rs. 5,000
    • D) Debit Purchases Rs. 5,000; Credit Drawings Rs. 5,000
    Show answer & explanation

    Answer: B) Debit Drawings Rs. 5,000; Credit Purchases Rs. 5,000

    Drawings of goods for personal use are recorded at cost, not retail price. In a periodic system, the cost of goods drawn is removed from the Purchases account to prevent it from inflating the Cost of Sales.

51. Question 51

    According to IAS 2, how is 'Net Realizable Value' (NRV) defined?

    • A) The historical cost of the inventory.
    • B) The current replacement cost of the inventory.
    • C) The estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
    • D) The estimated selling price minus the original purchase price.
    Show answer & explanation

    Answer: C) The estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

    NRV is formally defined by IAS 2 as the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale.

52. Question 52

    Which of the following cost measurement formulas is explicitly NOT permitted under IAS 2 for valuing inventory?

    • A) First in, First out (FIFO)
    • B) Last in, First out (LIFO)
    • C) Weighted Average Cost (AVCO)
    • D) Actual specific identification cost
    Show answer & explanation

    Answer: B) Last in, First out (LIFO)

    IAS 2 explicitly prohibits the use of the LIFO formula because it generally matches current revenues with outdated, historical inventory costs, leading to distorted inventory valuations on the balance sheet.

53. Question 53

    What is the underlying assumption of the First in, First out (FIFO) cost formula?

    • A) The inventory items which are sold or consumed are those acquired most recently.
    • B) The inventory items are sold simultaneously.
    • C) The inventory items which are sold or consumed are those acquired longest ago.
    • D) The cost of ending inventory is based on the average price of all units.
    Show answer & explanation

    Answer: C) The inventory items which are sold or consumed are those acquired longest ago.

    FIFO assumes that the first goods purchased or manufactured are the first ones to be sold or consumed, meaning the closing inventory consists of the most recently acquired items.

54. Question 54

    How should fixed production overheads be allocated to inventory if the actual production level is abnormally low during a period?

    • A) Based on the abnormally low actual production level.
    • B) Based on the normal capacity of the production facilities.
    • C) They should not be allocated to inventory at all.
    • D) They should be deferred to the next accounting period.
    Show answer & explanation

    Answer: B) Based on the normal capacity of the production facilities.

    IAS 2 requires fixed production overheads to be allocated based on normal capacity. In periods of abnormally low production, unallocated overheads are recognized as an immediate expense so that inventory is not overvalued.

55. Question 55

    How must the cost of abnormal wastage of materials and labor be treated under IAS 2?

    • A) Added to the capitalized cost of inventory.
    • B) Recognized as an expense in the period in which it is incurred.
    • C) Deducted directly from equity.
    • D) Apportioned equally between cost of sales and ending inventory.
    Show answer & explanation

    Answer: B) Recognized as an expense in the period in which it is incurred.

    Abnormal amounts of wasted materials, labor, or other production costs are expressly excluded from the cost of inventories and must be charged as an expense in the Profit or Loss account immediately.

56. Question 56

    On 31 December 2015, a company has partly-completed inventory with a cost to date of Rs. 26,300. It is expected that further costs of Rs. 8,900 will be incurred to complete it. It will then be sold for Rs. 47,500 with selling costs of Rs. 2,000. What is the Net Realizable Value (NRV)?

    • A) Rs. 36,600
    • B) Rs. 38,600
    • C) Rs. 45,500
    • D) Rs. 47,500
    Show answer & explanation

    Answer: A) Rs. 36,600

    NRV = Estimated Selling Price (47,500) - Estimated costs of completion (8,900) - Estimated selling costs (2,000) = Rs. 36,600.

57. Question 57

    Using the data from the previous question (Cost = Rs. 26,300, NRV = Rs. 36,600), at what value should this inventory be reported in the financial statements?

    • A) Rs. 36,600
    • B) Rs. 26,300
    • C) Rs. 47,500
    • D) Rs. 35,200
    Show answer & explanation

    Answer: B) Rs. 26,300

    Inventory must be measured at the lower of cost and net realizable value (NRV). Since the cost (26,300) is lower than the NRV (36,600), it remains valued at its cost.

58. Question 58

    Which of the following is NOT a required disclosure for inventories under IAS 2?

    • A) The accounting policies adopted in measuring inventories, including the cost formula used.
    • B) The location of each place where the entity keeps its physical inventory.
    • C) The total carrying amount of inventories and carrying amounts in classifications appropriate to the entity.
    • D) The amount of any write-down of inventories recognized as an expense.
    Show answer & explanation

    Answer: B) The location of each place where the entity keeps its physical inventory.

    IAS 2 mandates disclosures about policies, carrying amounts, write-downs, and inventory pledged as security, but it does not require an entity to disclose the physical geographic locations of its warehouses.

59. Question 59

    During a period of rising prices (inflation), which inventory valuation method generally results in a higher closing inventory value and a higher reported net profit?

    • A) Last in, First out (LIFO)
    • B) Weighted Average Cost (AVCO)
    • C) First in, First out (FIFO)
    • D) Replacement Cost Method
    Show answer & explanation

    Answer: C) First in, First out (FIFO)

    Under FIFO, the older (cheaper) costs are assigned to Cost of Sales, resulting in lower expenses and higher net profit. The newer (more expensive) costs remain in closing inventory, increasing its asset value.

60. Question 60

    A company uses a perpetual inventory system. Which TWO journal entries are simultaneously required to record a credit sales transaction?

    • A) Debit Cost of Sales & Credit Purchases; Debit Receivables & Credit Sales
    • B) Debit Receivables & Credit Sales; Debit Cost of Sales & Credit Inventory
    • C) Debit Cash & Credit Sales; Debit Inventory & Credit Cost of Sales
    • D) Debit Receivables & Credit Sales only
    Show answer & explanation

    Answer: B) Debit Receivables & Credit Sales; Debit Cost of Sales & Credit Inventory

    A perpetual system requires continuous updates to the inventory account. Therefore, alongside recording the revenue (Debit Receivables, Credit Sales), the removal of the goods is recorded immediately (Debit Cost of Sales, Credit Inventory).

61. Question 61

    A company uses a periodic inventory system. Which of the following is correct for recording a credit sales transaction?

    • A) Debit Receivables & Credit Sales AND Debit Cost of sales & Credit Inventory
    • B) Debit Cost of sales & Credit Purchases
    • C) Debit Receivables & Credit Sales only
    • D) Debit Inventory & Credit Cost of sales
    Show answer & explanation

    Answer: C) Debit Receivables & Credit Sales only

    Under a periodic inventory system, the inventory account is not updated continuously. Therefore, only the revenue side (Debit Receivables, Credit Sales) is recorded at the time of the sale.

62. Question 62

    The owner of a business takes goods costing Rs. 5,000 for personal use. If the business uses a periodic inventory system, what is the correct journal entry?

    • A) Debit Drawings Rs. 5,000; Credit Inventory Rs. 5,000
    • B) Debit Drawings Rs. 5,000; Credit Purchases Rs. 5,000
    • C) Debit Purchases Rs. 5,000; Credit Drawings Rs. 5,000
    • D) Debit Drawings Rs. 5,000; Credit Sales Rs. 5,000
    Show answer & explanation

    Answer: B) Debit Drawings Rs. 5,000; Credit Purchases Rs. 5,000

    Under a periodic system, the 'Purchases' account holds all acquisitions during the year. When goods are taken for personal use, their cost must be removed from Purchases so they are not included in the Cost of Sales calculation.

63. Question 63

    Yousuf flour mills gave 1,600 bags of flour to a poor community as a donation. What is the correct journal entry to record this transaction under a perpetual inventory method?

    • A) Debit Drawings & Credit Purchases
    • B) Debit Donation Expense & Credit Purchases
    • C) Debit Cost of Sales & Credit Inventory
    • D) Debit Donation Expense & Credit Inventory
    Show answer & explanation

    Answer: D) Debit Donation Expense & Credit Inventory

    In a perpetual system, the physical removal of goods for any reason (including charity/donation) directly reduces the Inventory account, and the cost is recognized as the relevant expense.

64. Question 64

    Which of the following costs must be EXCLUDED from the capitalized cost of inventories?

    • A) Variable production overheads.
    • B) Storage costs of finished goods, unless those costs are necessary in the production process before a further production stage.
    • C) Non-refundable import duties paid on raw materials.
    • D) Direct labor costs.
    Show answer & explanation

    Answer: B) Storage costs of finished goods, unless those costs are necessary in the production process before a further production stage.

    Storage costs for finished goods do not bring the inventory to its present condition and location for sale. They are treated as an expense in the period they are incurred.

65. Question 65

    What does the term 'Prime Cost' represent in a manufacturing environment?

    • A) The sum of indirect material and indirect labor costs.
    • B) The sum of direct material and direct labor costs.
    • C) The total cost of goods manufactured.
    • D) The sum of direct material and selling costs.
    Show answer & explanation

    Answer: B) The sum of direct material and direct labor costs.

    Prime cost is the direct, traceable cost of production, defined strictly as the sum of direct materials and direct labor consumed.

66. Question 66

    Which of the following equations correctly calculates the Cost of Goods Manufactured?

    • A) Prime Cost + Opening inventory (WIP) - Closing inventory (WIP)
    • B) Factory Cost + Opening inventory (raw material) - Closing inventory (raw material)
    • C) Prime Cost + Factory Overheads + Opening inventory (WIP) - Closing inventory (WIP)
    • D) Prime Cost + Opening inventory (finished goods) - Closing inventory (finished goods)
    Show answer & explanation

    Answer: C) Prime Cost + Factory Overheads + Opening inventory (WIP) - Closing inventory (WIP)

    Cost of goods manufactured equals Prime Cost plus Factory Overheads (yielding total factory cost), adjusted by adding opening Work in Progress and deducting closing Work in Progress.

67. Question 67

    Which of the following situations describes 'over-absorbed' overheads?

    • A) Actual overheads > Absorbed overheads
    • B) Absorbed overheads > Actual overheads
    • C) Budgeted overheads > Actual overheads
    • D) Actual overheads > Budgeted overheads
    Show answer & explanation

    Answer: B) Absorbed overheads > Actual overheads

    Over-absorption occurs when the overheads applied to inventory units (based on a predetermined rate) turn out to be greater than the overheads actually incurred during the period.

68. Question 68

    What is the correct journal entry to adjust for 'over-absorbed' production overheads at the end of the period?

    • A) Debit Production Overheads & Credit Cost of Sales (P&L)
    • B) Debit Cost of Sales (P&L) & Credit Production Overheads
    • C) Debit Inventory (WIP) & Credit Production Overheads
    • D) Debit Production Overheads & Credit Cash / Accrual
    Show answer & explanation

    Answer: A) Debit Production Overheads & Credit Cost of Sales (P&L)

    Because too much overhead was absorbed (expense was too high), the correction requires reducing the expense by crediting Cost of Sales (or P&L) and debiting the over-absorbed balance out of the Production Overheads control account.

69. Question 69

    When using the continuous Weighted Average Cost (AVCO) formula under a perpetual inventory system, when must a new average unit cost be calculated?

    • A) Only at the end of the accounting year.
    • B) After every sale transaction.
    • C) After every new purchase or receipt of inventory.
    • D) At the beginning of each month.
    Show answer & explanation

    Answer: C) After every new purchase or receipt of inventory.

    In a continuous weighted average (perpetual) system, the average cost per unit must be recalculated every time a new delivery of goods arrives at a different price.

70. Question 70

    If an entity discovers that its Opening Inventory was understated by Rs. 17,800 due to a carry-forward error, what is the direct impact on the current year's net profit?

    • A) Net profit is overstated by Rs. 17,800.
    • B) Net profit is understated by Rs. 17,800.
    • C) Net profit is unaffected.
    • D) Gross profit is unaffected.
    Show answer & explanation

    Answer: A) Net profit is overstated by Rs. 17,800.

    Cost of Sales = Opening Stock + Purchases - Closing Stock. If Opening Stock is understated, Cost of Sales is mathematically understated (too low). If expenses are too low, the reported Net Profit is overstated.

71. Question 71

    If an entity accidentally overstates its Closing Inventory value at the end of the period, how will this affect the financial statements?

    • A) Cost of Sales will be overstated, and Net Profit will be overstated.
    • B) Cost of Sales will be understated, and Net Profit will be overstated.
    • C) Cost of Sales will be overstated, and Net Profit will be understated.
    • D) Both Cost of Sales and Net Profit will be understated.
    Show answer & explanation

    Answer: B) Cost of Sales will be understated, and Net Profit will be overstated.

    Because Closing Inventory is subtracted in the Cost of Sales calculation, overstating it results in an artificially low Cost of Sales. This artificially inflates (overstates) Gross and Net Profit.

72. Question 72

    Jaffer Associates sold a generator for Rs. 1,440,000 net of discounts. The business normally sells items at a 25% mark-up on cost and uses a perpetual inventory system. What is the correct entry to update the inventory account?

    • A) Debit Cost of Sales Rs. 1,152,000 & Credit Inventory Rs. 1,152,000
    • B) Debit Cost of Sales Rs. 1,200,000 & Credit Inventory Rs. 1,200,000
    • C) Debit Inventory Rs. 1,440,000 & Credit Cost of Sales Rs. 1,440,000
    • D) Debit Cost of Sales Rs. 1,104,000 & Credit Inventory Rs. 1,104,000
    Show answer & explanation

    Answer: A) Debit Cost of Sales Rs. 1,152,000 & Credit Inventory Rs. 1,152,000

    Sales = Cost + Mark-up. 1,440,000 = Cost * 1.25. Therefore, Cost = 1,440,000 / 1.25 = Rs. 1,152,000. The perpetual entry removes this cost from inventory: Debit Cost of Sales 1,152,000, Credit Inventory 1,152,000.

73. Question 73

    How does IAS 2 require trade discounts, rebates, and similar items to be treated when determining the cost of purchase for inventory?

    • A) They should be added to the purchase price.
    • B) They should be ignored entirely.
    • C) They should be recorded as a separate 'Other Income' line item.
    • D) They are deducted in determining the costs of purchase.
    Show answer & explanation

    Answer: D) They are deducted in determining the costs of purchase.

    IAS 2 explicitly states that trade discounts, rebates, and other similar items are deducted in determining the costs of purchase, meaning the inventory is capitalized at the net amount.

74. Question 74

    A business imports raw materials and pays non-refundable import duties to the authorities. How are these duties treated in the financial statements?

    • A) Expensed immediately as an administrative cost.
    • B) Deducted from the costs of purchase.
    • C) Included in the capitalized cost of the raw materials.
    • D) Recorded as a current asset receivable.
    Show answer & explanation

    Answer: C) Included in the capitalized cost of the raw materials.

    Non-refundable import duties and taxes are a necessary cost of acquiring the inventory and bringing it to its location, and therefore must be included in the cost of the inventories.

75. Question 75

    In which of the following scenarios does IAS 2 require the use of the 'Specific Identification' method for assigning costs to inventory?

    • A) When dealing with large volumes of interchangeable, low-value items.
    • B) When inventory items are not ordinarily interchangeable and goods or services are produced and segregated for specific projects.
    • C) When a company wants to minimize its tax liability during inflation.
    • D) When the retail method becomes too complex to apply.
    Show answer & explanation

    Answer: B) When inventory items are not ordinarily interchangeable and goods or services are produced and segregated for specific projects.

    IAS 2 mandates specific identification of costs for items that are not ordinarily interchangeable and for goods or services produced and segregated for specific projects.

76. Question 76

    If circumstances that previously caused inventory to be written down below cost no longer exist, resulting in an increase in NRV, what is the accounting treatment?

    • A) The inventory remains at the lowered value permanently due to the prudence concept.
    • B) The inventory is revalued to its new selling price, and a gain is recognized in equity.
    • C) The amount of the write-down is reversed so that the new carrying amount is the lower of the original cost and the revised NRV.
    • D) The write-down reversal is deferred until the inventory is sold.
    Show answer & explanation

    Answer: C) The amount of the write-down is reversed so that the new carrying amount is the lower of the original cost and the revised NRV.

    IAS 2 states that when circumstances change and NRV increases, the previous write-down must be reversed (up to the amount of the original write-down) in the Statement of Profit or Loss.

77. Question 77

    Which of the following costs is treated as a period expense rather than being capitalized into the cost of ending inventory?

    • A) Carriage inwards
    • B) Carriage outwards
    • C) Variable production overheads
    • D) Non-refundable import duties
    Show answer & explanation

    Answer: B) Carriage outwards

    Carriage outwards (freight out) is a selling and distribution cost incurred to deliver goods to a customer. It is a period expense and is excluded from the cost of inventory.

78. Question 78

    Under a perpetual inventory system, what is the correct double entry for recording a purchase return of goods previously bought on credit?

    • A) Debit Accounts Payable, Credit Purchase Returns
    • B) Debit Accounts Payable, Credit Inventory
    • C) Debit Purchase Returns, Credit Accounts Payable
    • D) Debit Inventory, Credit Accounts Payable
    Show answer & explanation

    Answer: B) Debit Accounts Payable, Credit Inventory

    In a perpetual system, the Inventory account holds all acquisitions and must be directly reduced when goods are returned. Therefore, the supplier's liability is reduced (Debit Accounts Payable) and Inventory is reduced (Credit Inventory).

79. Question 79

    Which of the following best describes the 'Retail Method' of estimating inventory cost?

    • A) Physically counting every item on the retail shop floor at year-end.
    • B) Valuing inventory at the current retail market prices without adjustments.
    • C) Deducing cost by reducing the sales value of the inventory by the appropriate percentage gross margin.
    • D) Using specific identification for every item sold in a retail environment.
    Show answer & explanation

    Answer: C) Deducing cost by reducing the sales value of the inventory by the appropriate percentage gross margin.

    The retail method is often used in the retail industry for rapidly changing items with similar margins. The cost is approximated by taking the total retail value of inventory and reducing it by the expected gross margin.

80. Question 80

    Under normal circumstances, raw materials are not written down below cost if the finished products they make will be sold at a profit. However, if the finished products are expected to be sold at a loss, how should the raw materials be valued?

    • A) They should be valued at their original historical cost regardless.
    • B) They should be written down to their net realizable value (often indicated by replacement cost).
    • C) They must be immediately destroyed.
    • D) They are revalued to the expected selling price of the finished product.
    Show answer & explanation

    Answer: B) They should be written down to their net realizable value (often indicated by replacement cost).

    IAS 2 specifies that if a decline in the price of materials indicates that the cost of the finished products will exceed NRV, the materials are written down to NRV, and the replacement cost of the materials may be the best available measure of their NRV.

81. Question 81

    An entity had opening inventory of 36,000 units @ Rs. 3.9 per unit. During the month, it purchased 41,000 units @ Rs. 4.5 per unit. Sales were 60,000 units. Using the continuous weighted average method, what is the value of the cost of goods sold?

    • A) Rs. 254,900
    • B) Rs. 253,200
    • C) Rs. 253,500
    • D) Rs. 254,500
    Show answer & explanation

    Answer: B) Rs. 253,200

    Total units = 36,000 + 41,000 = 77,000. Total cost = (36,000 x 3.9) + (41,000 x 4.5) = 140,400 + 184,500 = 324,900. Average cost per unit = 324,900 / 77,000 = Rs. 4.21948. Cost of goods sold = 60,000 x 4.21948 = 253,168.8 (rounded in typical exams to 253,200).

82. Question 82

    A business using a periodic inventory system suffered a loss of stock worth Rs. 100,000 due to fire. The insurance company agreed to reimburse 60% of the loss in cash. What is the correct double entry?

    • A) Debit Cash 60k; Debit Abnormal Loss 40k; Credit Inventory 100k
    • B) Debit Cash 60k; Debit Abnormal Loss 40k; Credit Purchases 100k
    • C) Debit Abnormal Loss 100k; Credit Purchases 100k
    • D) Debit Purchases 100k; Credit Abnormal Loss 100k
    Show answer & explanation

    Answer: B) Debit Cash 60k; Debit Abnormal Loss 40k; Credit Purchases 100k

    Under a periodic system, the cost of lost goods is removed from the 'Purchases' account. Cash is debited for the 60k recovery, Abnormal Loss (P&L expense) is debited for the unrecovered 40k, and Purchases is credited for the full 100k.

83. Question 83

    Which of the following items is explicitly EXCLUDED from the scope of IAS 2 Inventories?

    • A) Goods purchased by a retailer for resale.
    • B) Work-in-progress being produced for sale.
    • C) Raw materials to be consumed in the production process.
    • D) Financial instruments and biological assets related to agricultural activity.
    Show answer & explanation

    Answer: D) Financial instruments and biological assets related to agricultural activity.

    IAS 2 excludes financial instruments (which fall under IFRS 9) and biological assets related to agricultural activity and agricultural produce at the point of harvest (which fall under IAS 41) from its scope.

84. Question 84

    How is 'Carriage Inwards' (freight-in) properly treated in the financial statements?

    • A) It is treated as a selling and distribution expense.
    • B) It is added to the cost of purchases in determining the cost of inventory.
    • C) It is deducted from gross sales revenue.
    • D) It is capitalized as Property, Plant, and Equipment.
    Show answer & explanation

    Answer: B) It is added to the cost of purchases in determining the cost of inventory.

    Carriage inwards represents transport costs necessary to bring the inventory to its present location. Under IAS 2, this is a direct cost of purchase and must be capitalized into the inventory value.

85. Question 85

    In a manufacturing entity, the valuation of Work-in-Progress (WIP) inventory shall include which of the following components?

    • A) Direct materials and direct labor only.
    • B) Direct materials, direct labor, and a systematic allocation of fixed and variable production overheads.
    • C) Prime cost plus selling and distribution expenses.
    • D) Factory cost plus abnormal wastage costs.
    Show answer & explanation

    Answer: B) Direct materials, direct labor, and a systematic allocation of fixed and variable production overheads.

    According to IAS 2, the cost of conversion (which applies to WIP and finished goods) includes direct costs (labor, materials) and a systematic allocation of fixed and variable production overheads.

86. Question 86

    An entity evaluates its closing inventory on an item-by-item basis. Item X: Cost 50, NRV 45. Item Y: Cost 30, NRV 35. Item Z: Cost 20, NRV 18. What is the total correct valuation of the closing inventory?

    • A) Rs. 100
    • B) Rs. 93
    • C) Rs. 98
    • D) Rs. 95
    Show answer & explanation

    Answer: B) Rs. 93

    Applying the lower of Cost and NRV rule for each item individually: Item X = 45. Item Y = 30. Item Z = 18. Total = 45 + 30 + 18 = 93.

87. Question 87

    Which of the following correctly defines 'under-absorbed' overheads in a manufacturing environment?

    • A) Absorbed overheads > Actual overheads
    • B) Budgeted overheads > Actual overheads
    • C) Actual overheads > Absorbed overheads
    • D) Actual overheads > Budgeted overheads
    Show answer & explanation

    Answer: C) Actual overheads > Absorbed overheads

    Under-absorption means that the total overheads absorbed into inventory costs (using predetermined rates based on normal capacity) were less than the actual overhead costs incurred during the period.

88. Question 88

    What is the required journal entry to adjust for 'under-absorbed' production overheads at the end of the accounting period?

    • A) Debit Production Overheads, Credit Cost of Sales
    • B) Debit Cost of Sales (P&L), Credit Production Overheads
    • C) Debit Inventory (WIP), Credit Production Overheads
    • D) Debit Production Overheads, Credit Cash / Accrual
    Show answer & explanation

    Answer: B) Debit Cost of Sales (P&L), Credit Production Overheads

    Under-absorbed overheads indicate that unallocated actual expenses remain in the overhead control account. These must be written off to the income statement (Debit Cost of Sales) and cleared from the overhead account (Credit Production Overheads).

89. Question 89

    Which of the following best describes a 'period cost' in accounting?

    • A) A cost that is identified with a unit produced and included in the value of inventory.
    • B) A cost that relates to a time period, is not included in inventory valuation, and is expensed immediately.
    • C) A direct material cost.
    • D) The systematic allocation of factory depreciation to manufactured units.
    Show answer & explanation

    Answer: B) A cost that relates to a time period, is not included in inventory valuation, and is expensed immediately.

    Period costs are those not directly tied to bringing inventory to its present location/condition (e.g., admin salaries, selling expenses). They are expensed in the income statement in the period they occur.

90. Question 90

    An entity purchases 100 units of raw materials. 5 units are completely destroyed during transit and are unsalvageable (abnormal loss). How is the cost of the 5 destroyed units accounted for?

    • A) It is added to the cost of the remaining 95 units.
    • B) It is excluded from inventory cost and charged immediately as an expense to Profit or Loss.
    • C) It is capitalized as a separate intangible asset.
    • D) It is deducted from gross sales revenue.
    Show answer & explanation

    Answer: B) It is excluded from inventory cost and charged immediately as an expense to Profit or Loss.

    IAS 2 states that abnormal amounts of wasted materials must not be included in the cost of inventory, but rather recognized as an expense in the period in which they are incurred.

91. Question 91

    During a month, a manufacturing business issued Rs. 20.2 million of direct materials to the factory. What is the correct double entry for this issue?

    • A) Dr. Production Overheads Rs. 20.2m, Cr. Materials Control Rs. 20.2m
    • B) Dr. Work In Progress (WIP) Rs. 20.2m, Cr. Materials Control Rs. 20.2m
    • C) Dr. Cost of Sales Rs. 20.2m, Cr. Purchases Rs. 20.2m
    • D) Dr. Materials Control Rs. 20.2m, Cr. Work In Progress (WIP) Rs. 20.2m
    Show answer & explanation

    Answer: B) Dr. Work In Progress (WIP) Rs. 20.2m, Cr. Materials Control Rs. 20.2m

    Direct materials issued to production are transferred from the raw materials store (crediting Materials Control) directly into the manufacturing process (debiting Work In Progress).

92. Question 92

    During a month, a manufacturing business issued Rs. 4.9 million of indirect materials (like factory cleaning supplies) to the factory. What is the correct double entry for this issue?

    • A) Dr. Work In Progress (WIP) Rs. 4.9m, Cr. Materials Control Rs. 4.9m
    • B) Dr. Production Overheads Rs. 4.9m, Cr. Materials Control Rs. 4.9m
    • C) Dr. Administrative Expenses Rs. 4.9m, Cr. Materials Control Rs. 4.9m
    • D) Dr. Materials Control Rs. 4.9m, Cr. Production Overheads Rs. 4.9m
    Show answer & explanation

    Answer: B) Dr. Production Overheads Rs. 4.9m, Cr. Materials Control Rs. 4.9m

    Indirect materials cannot be directly traced to specific units, so they are transferred from stores (crediting Materials Control) into the factory overhead pool (debiting Production Overheads).

93. Question 93

    According to the matching principle applied by IAS 2, when is the carrying amount of inventory formally recognized as an expense?

    • A) When the inventory is purchased and paid for.
    • B) When the inventory physically arrives at the warehouse.
    • C) In the period in which the related revenue is recognized (i.e., when sold).
    • D) At the end of the financial year, regardless of sales.
    Show answer & explanation

    Answer: C) In the period in which the related revenue is recognized (i.e., when sold).

    The matching concept requires expenses to be matched against the revenues they help generate. Therefore, inventory remains an asset until it is sold, at which point its cost becomes the Cost of Sales expense.

94. Question 94

    A retailer imports goods. The invoice price is Rs. 500,000. A trade discount of 10% is applied. Import duties are Rs. 15,000. Refundable sales tax is Rs. 8,000. What is the correct capitalized cost of this inventory?

    • A) Rs. 515,000
    • B) Rs. 465,000
    • C) Rs. 450,000
    • D) Rs. 473,000
    Show answer & explanation

    Answer: B) Rs. 465,000

    Cost = List price (500k) - Trade discount (50k) + Non-refundable import duties (15k) = 465,000. Refundable taxes (8k) are excluded from the cost.

95. Question 95

    Which of the following operational scenarios provides the strongest justification for an entity to use the Weighted Average Cost (AVCO) formula?

    • A) The inventory consists of a small number of high-value, bespoke items.
    • B) The inventory consists of a large number of homogeneous items (like liquid fuel or grains) that are mixed together and cannot be separately identified.
    • C) The entity wants to strictly ensure the oldest costs are expensed first.
    • D) The entity wants to minimize its taxes during periods of deflation.
    Show answer & explanation

    Answer: B) The inventory consists of a large number of homogeneous items (like liquid fuel or grains) that are mixed together and cannot be separately identified.

    AVCO is highly appropriate when items are physically indistinguishable and mixed together, making it impossible (or impractical) to identify the specific cost of individual units sold.

96. Question 96

    According to IAS 2, how should variable production overheads (like electricity used by manufacturing machinery) be allocated to inventory units?

    • A) Based on the normal capacity of the production facilities.
    • B) Based on the actual use of the production facilities (actual production).
    • C) They should not be allocated to inventory.
    • D) They are allocated equally across all periods regardless of production volume.
    Show answer & explanation

    Answer: B) Based on the actual use of the production facilities (actual production).

    Unlike fixed overheads (which are allocated based on normal capacity), variable production overheads vary directly with the volume of production and are allocated to each unit based on the actual use of the production facilities.

97. Question 97

    When calculating Net Realizable Value (NRV), an item has an estimated selling price of Rs. 1,000. It requires Rs. 150 of repairs before it can be sold. A 5% sales commission must be paid on the final selling price. What is the NRV?

    • A) Rs. 1,000
    • B) Rs. 850
    • C) Rs. 800
    • D) Rs. 950
    Show answer & explanation

    Answer: C) Rs. 800

    NRV = Estimated Selling Price (1,000) - Estimated costs of completion/repair (150) - Estimated costs to sell [5% of 1,000 = 50] = 1000 - 150 - 50 = Rs. 800.

98. Question 98

    Which fundamental accounting concept primarily drives the IAS 2 requirement to write down inventory to Net Realizable Value when it falls below cost?

    • A) The Historical Cost concept.
    • B) The Prudence concept.
    • C) The Going Concern concept.
    • D) The Business Entity concept.
    Show answer & explanation

    Answer: B) The Prudence concept.

    The prudence concept dictates that assets should not be overstated and that foreseeable losses should be recognized immediately. Writing down inventory to NRV ensures the asset is not carried at more than it will realize.

99. Question 99

    A business sends goods to a retail agent on a 'sale or return' basis. At the financial year-end, the agent has not yet sold these goods to end customers. How should these goods be treated?

    • A) They must be recorded as a final sale in the business's accounts.
    • B) They must be included in the business's closing inventory at cost or NRV.
    • C) They should be expensed as marketing costs.
    • D) They are completely excluded from the business's balance sheet.
    Show answer & explanation

    Answer: B) They must be included in the business's closing inventory at cost or NRV.

    Because the goods are on 'sale or return', the risks and rewards of ownership have not fully transferred to the agent. The principal (the business) still owns them and must include them in its closing inventory.

100. Question 100

     Which of the following items is explicitly prohibited by IAS 2 from being included in the cost of inventories?

     • A) Direct labor costs.
     • B) The cost of abnormal wastage of materials and labor.
     • C) Non-refundable import duties.
     • D) Variable production overheads.
     Show answer & explanation

     Answer: B) The cost of abnormal wastage of materials and labor.

     IAS 2 explicitly states that abnormal amounts of wasted materials, labor, or other production costs cannot be capitalized as inventory cost and must be recognized as expenses in the period they occur.