What are the two reasons that inventory must be estimated? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer. Any boxes left with a question mark will be automatically graded as incorrect.)
O A company uses the perpetual inventory system.
O A company experiences a casualty.
O Yearly financial statements are prepared.
O Interim financial statements are prepared.
The correct answer and explanation is:
Correct Answers:
✅ A company experiences a casualty.
✅ Interim financial statements are prepared.
Explanation:
Inventory estimation is necessary for businesses due to specific circumstances where a physical count of inventory is either impractical or impossible. Two main reasons for estimating inventory include:
- A Company Experiences a Casualty:
When unforeseen disasters such as fire, theft, flood, or other catastrophic events occur, a company may lose access to accurate inventory records. In such cases, businesses must estimate the inventory lost or remaining to file insurance claims, assess financial losses, or continue operations. Without an estimate, determining the cost of goods sold (COGS) and other financial impacts would be challenging. - Interim Financial Statements Are Prepared:
Companies often need to generate financial reports for stakeholders, such as investors and creditors, at intervals shorter than a full fiscal year. Since performing a physical inventory count every quarter or month can be time-consuming and costly, businesses use estimation methods (like the gross profit method or retail inventory method) to determine inventory levels and report financial results accurately. Estimating inventory allows companies to comply with reporting requirements and maintain transparency in their financial statements.
Incorrect Answers:
❌ A Company Uses the Perpetual Inventory System:
A perpetual inventory system continuously updates inventory records with each purchase and sale. Since it maintains real-time data, there is generally no need to estimate inventory unless discrepancies arise.
❌ Yearly Financial Statements Are Prepared:
For annual financial statements, companies typically conduct a physical inventory count rather than estimating. This ensures the most accurate reporting at the end of the fiscal year.