Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
5-1
5-2
Inventories and
Cost of Goods Sold
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Learning Outcomes
Exercises
Estimated
Time in
Minutes
Level
1
2
10
10
Easy
Mod
3
4
20*
21*
25
10
25
15
Mod
Easy
Mod
Mod
5
6
7
8
9
20*
21*
15
20
25
20
15
25
15
Easy
Mod
Mod
Mod
Mod
Mod
Mod
10
23*
15
20
Mod
Mod
11
22*
20
25
Easy
Mod
12
22*
24*
15
25
40
Mod
Mod
Mod
13
14
25
20
Mod
Mod
23*
20
Mod
15
20
Mod
Exercises
Estimated
Time in
Minutes
5-3
Level
16
20
Mod
17
18
19
10
15
15
Easy
Mod
Mod
24*
40
Mod
5-4
Learning Outcomes
Problems
and
Alternates
Estimated
Time in
Minutes
Level
1
15*
25
20
Mod
Mod
8*
9*
10*
45
40
40
Mod
Mod
Mod
8*
9*
10*
45
40
40
Mod
Mod
Mod
2
9*
25
40
Mod
Mod
11*
12*
13*
14*
45
60
30
30
Mod
Diff
Mod
Mod
11*
13*
14*
45
30
30
Mod
Mod
Mod
3
11*
12*
13*
14*
15*
16*
20
45
60
30
30
20
20
Mod
Mod
Diff
Mod
Mod
Mod
Mod
45
Diff
15*
16*
20
20
Mod
Mod
20
Mod
30
Mod
7
8*
25
45
Mod
Mod
12*
60
Diff
Learning Outcomes
Cases
Estimated
Time in
Minutes
5-5
Level
1*
3*
30
25
Mod
Mod
4*
5*
9
20
20
30
Mod
Mod
Mod
30
4*
Mod
20
20
25
Mod
Mod
4*
5*
20
20
Mod
Mod
3*
7*
25
40
Mod
Mod
2
7*
10
25
40
30
Mod
Mod
Mod
30
Mod
3*
11
25
30
Mod
Mod
5-6
QUESTIONS
1. The three distinct types of costs incurred by a manufacturer are direct materials,
direct labor, and manufacturing overhead. Direct, or raw, materials are the
ingredients used in making a product. Direct labor consists of the amounts paid to
factory workers to manufacture the product. Manufacturing overhead includes all the
other costs that are related to the manufacturing process but cannot be directly
matched to specific units of output.
2. The use of a contra-revenue account to record cash refunds and other types of
allowances allows a company to monitor the size and frequency of these
occurrences. For example, a relatively large amount of returns in any one period
may be an indication that the quality of the product has slipped. The information
provided by the use of these contra-revenue accounts would be lost if all returns and
allowances were recorded as reductions of the Sales Revenue account. Also, if this
practice were followed, the actual amount of sales would be understated for the
period to the extent of any returns and allowances.
3. Terms of 3/20, n/60 mean that the customer may deduct 3% from the selling price if
the bill is paid within 20 days. Otherwise, the full amount is due within 60 days of the
date of the invoice. Assuming a sale for $1,000, a 3% discount would save the
customer $30, resulting in a net amount due of $970. The amount saved is the result
of paying 40 days earlier than is required by the 60-day term. Assuming 360 days in
a year, there are 360/40, or 9 periods of 40 days each, in a year. Thus, a savings of
$30 for 40 days is equivalent to a savings of $30 9, or $270 for the year. This is
equivalent to an annual return of $270/$970, or 27.8%.
4. The two inventory systems differ with respect to how often the inventory account is
updated. Under the perpetual system, the account is updated each time a sale or
purchase is made. With the periodic system, the inventory account is updated only
at the end of the period. A temporary account, called Purchases, is used to keep
track of the acquisitions of inventory during the period. The periodic method relies on
a count of the inventory on hand at the end of the period to determine the amount to
assign to ending inventory on the balance sheet and to cost of goods sold expense
on the income statement.
5. A point-of-sale terminal gives the merchandiser the ability to update the inventory
records each time a sale is made. As an item is run over the sensing glass, a bar
code on the product is read by the computer. In this way, the unit can be removed
from the inventory at the point of sale. In some instances, however, merchandisers
use the terminals only to update the quantity of units on hand, not necessarily the
dollar amount.
6. The Purchases account is neither an asset nor an expense account. It is simply a
temporary holding account for the purchases of merchandise, which is closed at the
end of the period. The effect of purchases made during the period is to increase the
cost of goods sold expense.
5-7
7. For inventory in transit at the end of the year, the terms of shipment dictate whether
the buyer should record the purchase of the inventory. FOB shipping point means
that the goods belong to the buyer as soon as they are shipped, and the purchases
should be recorded at this point in time. Alternatively, FOB destination point means
that the goods do not belong to the buyer until they are received and therefore
should not be recorded if they are in transit at year-end.
8. Transportation-in represents the freight costs incurred on purchases of merchandise
and is therefore added to the purchases of the period in determining cost of goods
sold expense. Alternatively, transportation-out indicates the freight costs incurred in
selling merchandise and is therefore reported as a selling expense on the income
statement in the period of sale.
9. Gross profit is computed by deducting cost of goods sold from net sales. The gross
profit ratio indicates how well the company controlled its product costs during the
year. For example, a 30% gross profit ratio indicates that for every dollar of sales the
company has a gross profit of 30 cents. That is, after deducting 70 cents on every
dollar for the cost of the inventory that is sold, the company has 30 cents to cover its
operating costs and earn a profit.
10. According to the cost of goods sold model, beginning inventory plus purchases
minus ending inventory equals cost of goods sold. Therefore, the amount assigned
to inventory on the balance sheet has a direct effect on the measurement of cost of
goods sold on the income statement. Any errors in valuing inventory will flow through
to cost of goods sold and thus have an impact on the measurement of net income.
11. The justification for treating freight costs on incoming inventory as a cost incurred in
acquiring the asset, rather than as an expense of the period, is the matching
principle. Freight costs are necessary to put the inventory into a position to be sold
and should therefore be included in the cost of the asset. This is a significant
decision, since the cost will become an expense only at the time the inventory is
sold. If freight costs are not included in the cost of the inventory, they are expensed
immediately as they are incurred. Thus, if the inventory is not sold at the end of the
period, the decision to treat freight costs as a cost of the inventory will result in
higher net income than if the costs had been included as an expense of the period.
12. The specific identification method is appropriate only for certain types of inventory. It
is normally used for situations in which the inventory is relatively high-priced and
subject to a low amount of turnover. Although it is not a necessary condition, each
unit of inventory is often unique. For example, an automobile dealer uses the
specific identification method, as would a jewelry company.
5-8
13. When used on an inventory of identical units, the specific identification can lead to
the manipulation of income. Because all units are identical, management can select
which units to sell based on the relative high or low cost of the units on hand. For
example, in a bad year a company might be tempted to select for sale all units that
had a relatively low unit cost, regardless of when they were acquired. The use of a
cost flow assumption, such as weighted average, FIFO, or LIFO, eliminates the
ability of management to select units for sale based solely on the effect this decision
will have on the income of the period.
14. The weighted average cost method does not rely on a simple arithmetic average of
the unit cost for the various purchases of the period. Instead, more weight is
assigned to unit costs for which more units were purchased. For example, assume
that beginning inventory consists of 100 units with a unit cost of $10 per unit.
Assume that during the period, 100 units were purchased at $15 per unit, and 200
units were purchased at $20 per unit. The arithmetic average unit cost for the period
would be ($10 + $15 + $20)/3 = $15. However, the weighted average unit cost would
be [100($10) + 100($15) + 200($20)]/400 units, or $16.25. The acquisition of twice
as many units at $20 as opposed to those purchased at $10 and $15 drives the
weighted average up to $16.25.
15. The FIFO method more nearly approximates the physical flow of products in most
businesses. This is particularly true for perishable products, such as fresh fruits and
vegetables. Most businesses prefer as a matter of good customer relations to sell
their goods on a first-in, first-out basis. This minimizes the likelihood that units of
inventory will become obsolete and spoiled.
16. The use of LIFO will have the effect of maximizing net income if a company is
experiencing a decline in the unit cost of inventory. Last-in, first-out charges the most
recent purchases to cost of goods sold. If prices are declining, the amounts charged
to cost of goods sold will be less than if either the weighted average method or FIFO
was used. Because less is charged to cost of goods sold, net income will be higher.
17. In a period of rising prices, the use of LIFO will result in a lower tax bill. Because the
most recent purchases are charged to cost of goods sold under LIFO, in a period of
rising prices, these units will be higher-priced, and thus the result will be lower gross
margin as well as lower net income before tax. Lower net income will result in a
lower amount of tax to pay. If prices are declining during the period, FIFO will result
in a lower tax bill.
18. No, the president should not be enthralled with the new controller. The controller is
suggesting something that is not allowed under the tax law. The Internal Revenue
Services LIFO conformity rule requires that a company that wants to use LIFO for
tax purposes must also use it in preparing its income statement.
5-9
19. A LIFO liquidation occurs when a company using the LIFO inventory method sells
more units during the period than it purchases. A liquidation of some or all of the
older, relatively lower-priced units (assuming rising prices) will result in a low cost of
goods sold amount and a correspondingly higher gross margin. This may present a
dilemma to a company. If the company sells the lower-priced units, its net income
will improve, but higher taxes will have to be paid. To avoid facing this situation, a
company might buy inventory at the end of the year to avoid these consequences of
a liquidation. Unfortunately, the somewhat forced purchase of inventory to avoid the
liquidation may not be in the best interests of the company.
20. In a period of rising prices, FIFO can result in significant inventory profits. In
comparison with LIFO, the use of FIFO charges less to cost of goods sold because it
is the older, lower-priced units that are assumed to be sold. However, in a period of
significant inflation, there may be a large difference between the gross margin that
results from using FIFO and the much smaller amount that would result from using
the current cost of the inventory (replacement cost). This difference, called inventory
profit, is simply the result of holding the units during a period of inflation.
21. No, it is not acceptable for a company to indicate to its stockholders that it is
switching to LIFO to save on taxes. While the ability to save taxes may be an
important result of the change, the company must be able to demonstrate that LIFO
does a better job of matching costs with revenues. This is normally the justification
offered in the annual report for a companys change to LIFO.
22. Because a certain section of the warehouse is double-counted, ending inventory will
be overstated. According to the cost of goods sold model, ending inventory is
subtracted from cost of goods available to sell to arrive at cost of goods sold
expense. Therefore, an overstatement of ending inventory will lead to an
understatement of cost of goods sold expense. An understatement of an expense
results in an overstatement of net income for the period.
23. The lower-of-cost-or-market rule is invoked when the utility of inventory is less than
its cost to the company. It is a departure from the historical cost principle and is
justified on the basis of conservatism. The rule is a reaction to uncertainty by
anticipating a decline in the value of inventory and writing down the asset currently
before it is sold.
24. Application of the lower-of-cost-or-market rule on a total basis, compared with an
item-by-item basis, will usually yield a different result. The reason is that with the
total approach, increases in market value above cost are allowed to offset decreases
in value. Alternatively, when the item-by-item approach is used, any increases in
value are essentially ignored, and it is the declines in value for each item that are
recognized.
25. A company using the periodic inventory system could undoubtedly save money by
estimating its year-end inventory and thus avoiding the expense of counting it.
However, the inventory must be based on actual cost, not an estimate, for purposes
of the annual report.
5-10
26. A retailer can save time and money at the end of the year by simply counting the
number of units of each item of inventory and multiplying each of these counts by
the price marked on the units (that is, the retail price). This process gives the
company an amount that represents the value of the inventory at retail. The retail
method is then used to convert this amount to cost. It would be prohibitive for many
retailers, particularly mass merchandisers, to trace the unit cost of each item of
inventory to purchase invoices.
27. Inventory turnover equals cost of goods sold (cost of sales) divided by average
inventory. If the cost of sales remains constant while the denominator (average
inventory) increases, inventory turnover will decrease. This indicates that inventory
is staying on the shelf for a longer time. The company should probably evaluate the
salability of its inventory.
28. When a perpetual inventory system is used, the dollar amount of inventory is
calculated after each sale. Thus, when it is used in conjunction with the weighted
average costing method, a new average cost is calculated after each sale. The
weighted average changes each time a sale is made, and therefore the unit cost is
called a moving average.
EXERCISES
LO 1
Inventory Item
Fabric
Lumber
Unvarnished tables
Chairs on the showroom floor
Cushions
Decorative knobs
Drawers
Sofa frames
Chairs in the plant warehouse
Chairs in the retail storeroom
Raw
Material
X
X
Classification
Work in
Finished Merchandise
Process
Goods
Inventory
X
X
X
X
X*
X
X
X
X
*Cushions produced by the company would be work in process, but if purchased from a
supplier, they would be raw materials.
LO 1
5-11
$20,000
(2,000)
56
32
$18,088
Under the cost principle, all of these costs are necessary to put the inventory into a
position where it can be sold.
Other classifications:
The phone charges and purchasing department salary would both be difficult to
match directly with the sale of any particular product and therefore should be treated as
operating expenses of the period. The labeling supplies are immaterial in amount and
should also be reported as operating expenses. The interest paid to suppliers is a
financing cost and would be reported as interest expense on the income statement.
LO 2
1. Company A is using a perpetual inventory system because it has the account Cost of
Goods Sold. Company B is using the periodic inventory system because it uses the
accounts Purchases, Purchase Discounts, and Purchases Returns and Allowances.
2. Company As end of the year inventory is the balance in its merchandise inventory
account, $12,000. Its cost of goods sold is $38,000, the balance in that account.
3. Cost of goods sold in a periodic system is computed as: Beginning inventory + net
purchases ending inventory. Company Bs merchandise inventory account
represents beginning inventory. Ending inventory is obtained by conducting a
physical count. Because you are not given the ending inventory figure, you cannot
compute cost of goods sold.
5-12
LO 2
PerpetualAppliance store
PerpetualCar dealership
PeriodicDrugstore
PerpetualFurniture store
PeriodicGrocery store
PeriodicHardware store
PerpetualJewelry store
Changes in technology may lessen the costs of maintaining perpetual inventory
systems. Merchandisers will convert to perpetual inventory systems when the benefits
of maintaining such systems exceed the costs.
LO 3
Case 1:
(a) Beginning inventory: cost of goods available for sale cost of goods purchased =
$7,110 ($6,230 $470 $200 + $150) = $7,110 $5,710 = $1,400
(b) Ending inventory: cost of goods available for sale cost of goods sold = $7,110
$5,220 = $1,890
Case 2: (must first solve d, then c)
(d) Cost of goods available for sale: cost of goods sold + ending inventory = $5,570 +
$1,750 = $7,320
(c) Purchase discounts:
1. Cost of goods available for sale beginning inventory = cost of goods purchased
= $7,320 $2,350 = $4,970
2. Gross purchases purchase returns and allowances purchase discounts +
transportation-in = cost of goods purchased; $5,720 $800 purchase discounts
+ $500 = $4,970; purchase discounts = $5,420 $4,970 = $450
5-13
Case 3:
(e) Gross purchases:
1. Cost of goods purchased = cost of goods available for sale beginning inventory
= $8,790 $1,890 = $6,900
2. Gross purchases purchase returns and allowances purchase discounts +
transportation-in = cost of goods purchased; gross purchases $550 $310 +
$420 = $6,900; gross purchases = $6,900 + $550 + $310 $420 = $7,340
(f) Cost of goods sold = cost of goods available for sale ending inventory = $8,790
$1,200 = $7,590
LO 3
BALANCE SHEET
Assets
7/3
Liabilities
INCOME
Accounts
Payable
3,500
Accounts
Payable
7,000
7/12 Cash
(3,465)
(0.99 3,500)
Accounts
Payable
(3,500)
8/5 Cash
Accounts
Payable
(7,000)
7/6
(7,000)
STATEMENT
(3,500)
Purchases
(7,000)
Purchase
Discounts
35
5-14
LO 3
BALANCE SHEET
Assets
3/3
3/3 Cash
Liabilities
Accounts
Payable
INCOME
+
2,500
(250)
3/7
1,400
3/12 Cash
(2,450)
(0.98 2,500)
Accounts
Payable
(2,500)
3/15
Accounts
Payable
(500)
Accounts
Payable
3/22
4/6 Cash
4/18 Cash
Accounts
Payable
(900)
(1,200)
Purchases
Transportation-in
Accounts
Payable
3/18
STATEMENT
Accounts
Payable
(1,400 500)
Accounts
Payable
Purchases
Purchase
Discounts
Purchase Returns
and Allowances
Purchases
(2,500)
(250)
(1,400)
50
500
(1,600)
1,600
(400)
(900)
(1,200)
(1,600 400)
Purchase Returns
and Allowances
400
LO 3
5-15
1. The seller pays shipping costs when merchandise is shipped FOB destination point.
Miller Wholesalers pays the freight bill and is responsible for the merchandise until it
gets to Michaels warehouse.
2. The inventory should not be included as an asset on Michaels December 31, 2007,
balance sheet because the terms of shipment indicate that the merchandise does
not legally belong to Michael until it arrives, and this is after the end of the year.
Likewise, Miller should not include the sale on its 2007 income statement, since the
goods are not considered sold until they reach the buyers business.
3. If the terms of shipment were FOB shipping point, the answers to both questions in
part (2) would change. Under these terms, the inventory belongs to Michael as soon
as it is shipped, and because this is on December 23, 2007, the asset should be
recognized on the year-end balance sheet. Similarly, Miller would record a sale in
2007.
LO 3
LO 5
By ignoring the large order at year-end, and thus including the inventory in the year-end
count, the company will overstate ending inventory. This in turn will lead to an
understatement of cost of goods sold and an overstatement of net income. The effects
on next years income are the opposite. Because beginning inventory will be overstated,
cost of goods sold will also be overstated, and net income understated. The accountant
has an obligation to the financial statement users to convince the president to make the
necessary adjustments to reduce the inventory balance.
5-16
LO 6
1. Ending inventory:
(65 55)
(50 35)
(60 45)
(45 5)
80 units
$20
$22
$23
$24
= $ 200
=
330
=
345
=
960
$1,835
= $1,100
=
770
= 1,035
=
120
$3,025
= $1,080
=
805
$1,885
= $1,300
=
330
$1,630
5-17
1. a
5. b
2. d
6. a
3. c
7. b
4. c
8. c
LO 8
1.
2.
3.
LO 8
Balance Sheet
Retained
Inventory
Earnings
U
U
O
O
U
U
Income Statement
Cost of
Net
Goods Sold
Income
O
U
U
O
O
U
1. Michelson should include the costs in its inventory, since the merchandise had not
arrived at its destination, PJs, by the end of the year.
2. Filbrandt should include the costs of the merchandise in its inventory, since it has
received the shipment by the end of the year.
3. Randall would include the merchandise in its inventory, since the shipment left
James Bros. before the end of the year.
4. Barner should include the merchandise in its inventory. It is both shipped by Hinz
and received by Barner before the end of the year.
5-18
LO 10
(1)
Net sales
Estimated gross profit ratio
Estimated gross profit
Net sales
Estimated gross profit
Estimated cost of goods sold
Beginning inventory
Add: Purchases
Cost of goods available for sale
Estimated cost of goods sold
Estimate of inventory destroyed
(2)
(3)
$105,300
0.25
$ 26,325
$105,300
26,325
$ 78,975
$ 15,400
84,230
$ 99,630
78,975
$ 20,655
BALANCE SHEET
Assets
Cash*
Inventory
Liabilities
INCOME
STATEMENT
10,000
(20,655)
Loss on
Insurance
Settlement
(10,655)
*Or, if cash has not been received, Receivable from Insurance Company.
LO 11
LO 12
5-19
LO 12
LO 12
180,400
X
(1,200,000)
$ 241,200
85,400
1,260,800
(X)
$
78,400
$ xx,xxx
$(60,800)
(7,000)
(67,800)
$ xx,xxx
5-20
M U LTI - C O N C E P T E X E R C I S E S
LO 2,3
LO 2,3
5-21
LAPINE COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2007
Sales
Less: Sales returns and allowances
Sales discounts
Net sales
Less cost of goods sold:
Beginning inventory
Purchases
Less: Purchase returns and allowances
Purchase discounts
Net purchases
Add: Transportation-in
Cost of goods purchased
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
Gross margin
$80,000
$
500
1,200
$ 4,000
$30,000
400
800
$28,800
1,000
29,800
$33,800
3,800
LO 6,7
$10
$11
$12
$13
$15
=
=
=
=
=
$ 2,000
3,300
4,800
3,250
2,250
$15,600
1,300
1,000
300
1,700
$78,300
30,000
$48,300
5-22
b. FIFO method:
Ending inventory cost:
150 $15 = $2,250
150 $13 = 1,950
300
$4,200
Cost of goods sold:
200 $10 = $ 2,000
300 $11 = 3,300
400 $12 = 4,800
100 $13 = 1,300
1,000
$11,400
(OR: $15,600 $4,200 = $11,400)
c. LIFO method:
Ending inventory cost:
200 $10 = $2,000
100 $11 = 1,100
300
$3,100
Cost of goods sold:
150 $15 = $ 2,250
250 $13 = 3,250
400 $12 = 4,800
200 $11 = 2,200
1,000
$12,500
(OR: $15,600 $3,100 = $12,500)
2. LIFO cost of goods sold
FIFO cost of goods sold
Difference in expenses
Tax rate
Difference in taxes
$12,500
11,400
$ 1,100
0.30
$ 330
Conclusion: Because FIFO results in less cost of goods sold, a higher income and
thus more taxes, $330, will be reported with this method than if LIFO were used.
5-23
LO 5,9
Conservatism is the rationale for carrying inventory on the balance sheet at an amount
less than its cost. It is a departure from the historical cost principle and is used when the
utility of the inventory, as measured by the cost to replace it, is less than original cost.
Two accounts are affected by the application of the lower-of-cost-or-market rule. An
income statement account, such as Loss on Decline in Value of Inventory, is debited,
and the Inventory account on the balance sheet is credited or reduced.
The effect of writing down inventory is to reduce the income of the current year by
the amount debited to the loss account. In future years, however, income will be higher
because of the write-down. This occurs because cost of goods sold will be lower in the
future when the inventory that was written down to a lower amount is eventually sold.
LO 7,13
1. a. Moving average:
Date
1/1
2/12
3/5
4/30
6/12
7/7
8/23
9/6
10/2
12/3
Purchases
Unit Total
Units Cost Cost
Units
Sales
Unit
Cost
150 $10
300
400
Total
Cost
$ 1,500
$11 $3,300
12
200
10.857
2,171
200
11.689
2,338
300
12.235
3,670
150
13.158
1,974
4,800
250
13
3,250
150
15
2,250
Cost of goods sold
$11,653
2.
50
300
350
$10
11
150
400
$10.857 = $1,629
550
= $ 500
= 3,300
$3,800;
12
$3,800/350 = $10.857
4,800
$6,429;
$6,429/550 = $11.689
Units
200
50
350
150
550
350
600
300
450
300
Balance
Unit
Cost Balance
$10
$2,000
10
500
10.8571
3,800
10.857
1,629
11.6892
6,429
11.689
4,091
3
12.235
7,341
12.235
3,671
13.1584
5,921
13.158
$3,947
Ending inventory
5-24
350
250
$11.689 = $4,091
13
3,250
600
4.
300
150
450
$7,341;
$7,341/600 = $12.235
$12.235 = $3,671
15
= 2,250
$5,921;
$5,921/450 = $13.158
1. b. FIFO:
Date
1/1
2/12
3/5
Purchases
Unit Total
Units Cost Cost
300
400
12
250
13
12/3
150
$10
$ 1,500
50
150
10
11
500
1,650
150
50
11
12
1,650
600
300
12
3,600
3,250
9/6
10/2
150
4,800
7/7
8/23
Total
Cost
$11 $3,300
4/30
6/12
Units
Sales
Unit
Cost
15
2,250
50
100
Cost of goods sold
12
13
600
1,300
$11,400
Units
200
50
50
300
Balance
Unit
Cost Balance
$10
$2,000
10
500
10
11
3,800
150
150
400
11
11
12
1,650
350
350
250
50
250
50
250
150
150
150
12
12
13
12
13
12
13
15
13
15
4,200
6,450
7,450
3,850
6,100
$4,200
Ending inventory
5-25
1. c. LIFO:
Date
1/1
2/12
3/5
Purchases
Unit Total
Units Cost Cost
300
400
12
250
13
150
$10
$ 1,500
200
11
2,200
200
12
2,400
250
50
13
12
3,250
600
150
15
2,250
3,250
9/6
10/2
150
4,800
7/7
8/23
Total
Cost
$11 $3,300
4/30
6/12
Units
Sales
Unit
Cost
15
12/3
2,250
2.
Average cost
FIFO
LIFO
EXERCISE 5-22:
E/I
C/G/S
$3,600
$12,000
4,200
11,400
3,100
12,500
$12,200
Units
$200
50
50
300
50
100
50
100
400
50
100
200
50
100
200
250
50
100
150
50
100
150
150
50
100
150
Balance
Unit
Cost Balance
$10
$2,000
10
500
10
11
3,800
10
11
1,600
10
11
12
6,400
10
11
12
4,000
10
11
12
13
7,250
10
11
12
3,400
10
11
12
15
5,650
10
11
12
$3,400
Ending inventory
EXERCISE 5-24:
E/I
C/G/S
$3,947
$11,653 Different
4,200
11,400 Same
3,400
12,200 Different
5-26
$12,200
11,400
$ 800
0.30
$ 240
Conclusion: LIFO results in a higher cost of goods sold and therefore a lower
taxable income and lower income tax by $240.
PROBLEMS
LO 1
Accounting Treatment
Expense of
Inventory
Other
Business
Types of Costs
the Period
Cost
Treatment
Retail shoe store Shoes for sale
X
Shoe boxes
X
Advertising signs
X
Grocery store
Canned goods on the shelves
X
Produce
X
Cleaning supplies
X*
Cash registers
X**
Frame shop
Wooden frame supplies
X
Nails
X
Glass
X
Walk-in print shop Paper
X
Copy machines
X**
Toner cartridges
X*
Restaurant
Frozen food
X
China and silverware
X**
Prepared food
X
Spices
X
*Record as an asset and charge to expense as used.
**Record as an asset and depreciate over estimated useful life.
LO 4
5-27
2. In terms of the gross profit ratio, Target appears to be performing better, given a
significantly higher ratio in each year. The mix of products sold by the two
companies and the normal markups on the various products could certainly affect
the ratios. A comparison with prior years and industry averages would also be
important to consider.
LO 7
1. Company B will have the newest costs in inventory because it uses first-in, first-out.
Because costs are rising, it will have the lowest costs of goods sold and thus the
highest net income.
2. Company C will have the oldest costs in inventory because it uses last-in, first-out.
Because costs are rising, it will have the highest cost of goods sold and thus the
lowest income before taxes. Company C will pay the least in taxes.
3. This question does not lend itself to an easy answer. LIFO matches the most recent
costs with the most recent revenue and thus may be a better indicator of future
potential to investors. Inventory profits are not a major concern with LIFO as they are
with FIFO, because the newer (most recent) costs are assigned to cost of sales.
4. Company C would have the oldest costs in inventory because it uses LIFO. Because
costs are falling, it will have the lowest cost of goods sold and the highest net
income.
Company B will have the newest costs in inventory because it uses FIFO.
Because costs are falling, it will have the highest cost of goods sold and the lowest
income before taxes. Company B will pay the least in taxes.
The answer to part (3) is still not easy. There are advantages and disadvantages
in all methods. The important point is to choose one method and stay with it for
consistency.
5-28
LO 8
2007
$20,000
13,600
$ 6,400
3,000
$ 3,400
2006
$15,000
9,400
$ 5,600
2,000
$ 3,600
*Because ending inventory in 2006 was understated, cost of goods sold was
overstated. Because beginning inventory in 2007 was understated, cost of goods
sold was understated.
Revised balance sheets:
Cash
Inventory
Other current assets
Long-term assets
Total assets
Liabilities
Capital stock
Retained earnings
Total liabilities and stockholders equity
12/31/07
$ 1,700
4,200
2,500
15,000
$23,400
$ 8,500
5,000
9,900
$23,400
12/31/06
$ 1,500
4,100
2,000
14,000
$21,600
$ 7,000
5,000
9,600
$21,600
2. Net income for two years, before revision: $3,000 + $4,000 = $7,000
Net income for two years, after revision: $3,600 + $3,400 = $7,000
Thus, there is no net over- or understatement.
Retained earnings at December 31, 2007, before the revision: $9,900
Retained earnings at December 31, 2007, after the revision: $9,900
Thus, there is no over- or understatement.
3. Even though the error counterbalances over the two-year period, it is still important
to restate the statements for the two years. It is important for comparative purposes
that the correct amount of net income be known for each of the two years. The
company needs to restate the income statements for each of the two years and
restate the balance sheets at the end of each year.
LO 10
$113,500
0.40
$ 45,400
$113,500
45,400
$ 68,100
$ 3,200
164,000
$167,200
68,100
$ 99,100
4,500
$ 94,600
=
65,000
(94,600)
Liabilities
INCOME
STATEMENT
(29,600)
*Or, if cash has not yet been received, Receivable from Insurance Company.
5-29
5-30
LO 11
Dell Computer
(in millions)
2005
2004
$ 49,205
$ 41,444
40,190
33,892
$ 9,015
$ 7,552
49,205
41,444
18.3%
18.2%
LO 12
5-31
$(33,200)
22,200
30,200
$ 19,200
46,100
$ 65,300
FROM:
Students name
DATE:
5-32
M U LTI - C O N C E P T P R O B L E M S
LO 2,3,12
4/1
Liabilities
Accounts
Payable
4/10 Cash
(485) Accounts
(500 15)
Payable
4/15 Cash
STATEMENT
(500)
500
(500)
200
4/18
4/25 Cash
INCOME
Purchase Discounts
(500 .03)
Sales Revenue
Accounts
Payable
200
Purchases
(900)
900
600
4/28 Cash
(873) Accounts
(900 27)
Payable
15
Sales Revenue
(900)
600
Purchase Discounts
(900 .03)
27
$ 800
$
$1,400
42
1,358
$1,358
967
391
$ 409
$ 100
50
150
$ 259
$ 800
$1,358
100
50
1,508
$ (708)
5-33
OR:
Net income
Deduct: Increase in inventory balance
Net cash flow from operating activities
$ 259
(967)
$ (708)
4. Net income is $259. Net cash flow from operating activities is a negative $708. The
difference of $967 is attributable to inventory that has not been sold. That is, the
company has paid for $1,358 of inventory (a cash outlay) but has only recognized
cost of goods sold expense of $391. The difference is $967.
LO 2,3,4
PROBLEM 5-9 GAP INC.S SALES, COST OF GOODS SOLD, AND GROSS
PROFIT
1. Apparently, Gap Inc. does not sell its merchandise on account. If customers want to
pay on credit for their purchases, they would use one of the various credit cards that
Gap accepts.
2. Effect of sales on the accounting equation:
BALANCE SHEET
Assets
Cash 16,267,000,000
Liabilities
INCOME
STATEMENT
3. Gap Inc. would deduct sales returns and allowances from sales to arrive at the
amount of net sales reported on its income statement. Since Gap Inc. does not have
any accounts receivable on its balance sheet, it is unlikely that it offers sales
discounts to its customers. Either because they do not feel the amounts are material
enough or they would rather not divulge information about returns and allowances to
competitors, some companies choose not to separately report them.
4. Cost of goods sold section of 2004 income statement (millions of dollars):
Merchandise inventory, 1/31/04
Cost of goods purchased*
Cost of goods available for sale
Less merchandise inventory, 1/29/05
Cost of goods sold**
*Including occupancy expenses.
**Described as cost of goods sold and occupancy expenses.
(1) $9,886 + $1,814 = $11,700.
(2) $11,700 $1,704 = $9,996.
$ 1,704
9,996 (2)
$11,700 (1)
(1,814)
$ 9,886
5-34
2004
$ 16,267
9,886
$ 6,381
$16,267
39.2%
2003
$ 15,854
9,885
$ 5,969
$15,854
37.6%
Gap Inc.s gross profit ratio increased by 1.6% from 2003 to 2004. Factors affect
ing Gap Inc.s gross profit ratio might include changes in the selling prices of
merchandise, changes in the cost of goods purchased, and/or changes in the mix of
merchandise sold (that is, a slight shift between selling products that have higher
gross profit ratios and selling those with lower gross profit ratios).
LO 2,3
$ 6,400
$40,200
800
$39,400
375
39,775
$46,175
7,500
$38,675
$84,364
780
$83,584
38,675
$44,909
$25,600
4,510
3,600
2,300
36,010
$ 8,899
3,200
$ 5,699
5-35
3.
MAPLE INC.
BALANCE SHEET
AT DECEMBER 31, 2007
Assets
Current assets:
Cash
Accounts receivable
Inventory
Interest receivable
Total current assets
Property, plant, and equipment:
Land
Building and equipment, net
Total property, plant, and equipment
Total assets
590
2,359
7,500
100
$10,549
$20,000
55,550
75,550
$86,099
Liabilities
Current liabilities:
Salaries payable
Income tax payable
Total liabilities
Stockholders Equity
Capital stock
Retained earnings
Total liabilities and stockholders equity
$50,000
32,249*
650
3,200
$ 3,850
82,249
$86,099
5-36
LO 5,6,7
1.
Cost of
Goods Sold
$11,084
10,776
11,452
a. Weighted average
b. FIFO
c. LIFO
Calculations:
a. Beginning inventory
Oct. 8
Oct. 18
Oct. 29
600
800
700
800
2,900
$5.00 = $ 3,000
5.40 =
4,320
5.76 =
4,032
5.90 =
4,720
$16,072
Ending
Inventory
$4,988
5,296
4,620
Total
$16,072
16,072
16,072
5-37
5-38
2. The Total column represents the pool of costs (beginning inventory plus purchases)
to be distributed between an asset, ending inventory on the balance sheet, and an
expense, cost of goods sold on the income statement. In accounting, this pool of
costs is called cost of goods available for sale.
3. Income statements for the month of October:
Sales*
Cost of goods sold
Gross margin
Operating expenses
Income before taxes
Income tax expense (30%)
Net income
Weighted
Average
$20,800
11,084
$ 9,716
3,000
$ 6,716
2,015
$ 4,701
FIFO
$20,800
10,776
$10,024
3,000
$ 7,024
2,107
$ 4,917
LIFO
$20,800
11,452
$ 9,348
3,000
$ 6,348
1,904
$ 4,444
LO 5,7,13
$2,107
1,904
$ 203
1.
a. Moving average
b. FIFO
c. LIFO
Cost of
Goods Sold
$10,785
10,776
10,852
Ending
Inventory
$5,287
5,296
5,220
Total
$16,072
16,072
16,072
5-39
a. Moving average:
Date
10/1
10/4
10/8
10/9
10/18
10/20
10/29
Purchases
Unit Total
Units Cost Cost
Units
500
800 $5.40
Sales
Unit
Total
Cost
Cost
$5
700
5.76
4,032
800
5.90
4,720
700
5.356
3,749
800
5.67
4,536
2.
3.
$ 2,500
$4,320
100
800
900
$5.00
5.40
= $ 500
= 4,320
$4,820;
200
700
900
$5.356 = $1,071
5.76 =
4,032
$5,103;
100
800
900
$5.67
5.90
$10,785
Units
600
100
900
200
900
100
900
Balance
Unit
Cost Balance
$5
$3,000
5
500
5.3561
4,820
5.356
1,071
2
5.67
5,103
5.67
567
5.8743 $5,287
Ending inventory
$4,820/900 = $5.356
$5,103/900 = $5.67
= $ 567
= 4,720
$5,287;
$5,287/900 = $5.874
b. FIFO:
Date
10/1
10/4
10/8
Purchases
Unit Total
Units Cost Cost
Units
500
800 $5.40
700
5.76
800
5.90
$ 2,500
100
600
5
5.40
500
3,240
200
600
5.40
5.76
1,080
3,456
4,032
10/20
10/29
$5
$4,320
10/9
10/18
Sales
Unit
Total
Cost
Cost
4,720
Cost of goods sold
$10,776
Units
600
100
100
800
Balance
Unit
Cost Balance
$5
$3,000
5
500
5
5.40
4,820
200
200
700
5.40
5.40
5.76
1,080
100
100
800
5.76
5.76
5.90
576
5,112
$5,296
Ending inventory
5-40
c.
Date
10/1
10/4
10/8
LIFO:
Purchases
Unit Total
Units Cost Cost
Units
500
800 $5.40
700
5.76
800
5.90
$2,500
700
5.40
3,780
700
100
5.76
5.40
4,032
540
4,032
10/20
10/29
$5
Total
Cost
$4,320
10/9
10/18
Sales
Unit
Cost
4,720
Cost of goods sold
$10,852
Units
600
100
100
800
100
100
100
100
700
100
100
800
Balance
Unit
Cost Balance
$5
$3,000
5
500
5
5.40
4,820
5
5.40
1,040
5
5.40
5.76
5,072
5
5
5.90
500
$5,220
Ending inventory
2. The Total column represents the pool of costs (beginning inventory plus purchases)
to be distributed between an asset, ending inventory on the balance sheet, and an
expense, cost of goods sold, on the income statement. In accounting, this pool of
costs is called cost of goods available for sale.
3. Income statements for the month of October:
Sales*
Cost of goods sold
Gross margin
Operating expenses
Income before taxes
Income tax expense (30%)
Net income
Moving
Average
$20,800
10,785
$10,015
3,000
$ 7,015
2,105
$ 4,910
$2,107
2,084
$ 23
FIFO
$20,800
10,776
$10,024
3,000
$ 7,024
2,107
$ 4,917
LIFO
$20,800
10,852
$ 9,948
3,000
$ 6,948
2,084
$ 4,864
LO 5,6,7
5-41
a. FIFO
b. LIFO
c. Weighted average
Ending
Inventory
$4,410
4,155
4,301
Calculations:
a. Ending inventoryFIFO:
200 $19.20 = $3,840
30 19.00 =
570
230
$4,410
Cost of goods soldFIFO:
200 $18.00 = $ 3,600
250 18.50 =
4,625
220 18.90 =
4,158
120 19.00 =
2,280
790
$14,663
b. Ending inventoryLIFO:
200 $18.00 = $3,600
30 18.50 =
555
230
$4,155
Cost of goods soldLIFO:
220 $18.50 = $ 4,070
220 18.90 =
4,158
150 19.00 =
2,850
200 19.20 =
3,840
790
$14,918
200 $18.00 = $ 3,600
250 18.50 =
4,625
220 18.90 =
4,158
150 19.00 =
2,850
200 19.20 =
3,840
1,020
$19,073
Weighted average cost = $19,073/1,020 = $18.699
Ending inventory = 230 $18.699 = $4,301
c. Beginning inventory
Nov. 4
Nov. 13
Nov. 18
Nov. 24
200
820
1,020
790
230
Cost of
Goods Sold
$14,663
14,918
14,772
Total
$19,073
19,073
19,073
5-42
5-43
2.
Sales*
Cost of goods sold
Gross profit
Operating expenses:
Selling and administrative
expenses
Depreciation
Income before taxes
Income tax expense (35%)
Net income
FIFO
$33,480
14,663
$18,817
LIFO
$33,480
14,918
$18,562
Weighted
Average
$33,480
14,772
$18,708
10,800
4,000
$ 4,017
1,406
$ 2,611
10,800
4,000
$ 3,762
1,317
$ 2,445
10,800
4,000
$ 3,908
1,368
$ 2,540
LO 5,6,7
1. a. Weighted average:
Beginning inventory
Feb. 4
April 12
Sept. 10
Dec. 5
5,000
3,000
4,000
2,000
1,000
15,000
$10 =
9 =
8 =
7 =
6 =
$ 50,000
27,000
32,000
14,000
6,000
$129,000
15,000
12,500
2,500 $8.60 =
$21,500
12,500 $8.60 =
$107,500
b. FIFO:
Ending inventory
1,000 $ 6 =
1,500
7 =
2,500
500
4,000
3,000
5,000
$7 =
8 =
9 =
10 =
6,000
10,500
$ 16,500
3,500
32,000
27,000
50,000
5-44
12,500
$112,500
5-45
c. LIFO:
Ending inventory
Cost of goods sold
2,500 $10 =
$ 25,000
$10 =
9 =
8 =
7 =
6 =
$ 25,000
27,000
32,000
14,000
6,000
$104,000
2,500
3,000
4,000
2,000
1,000
12,500
Sales*
150,000
Cost of goods sold
Gross margin
Operating expenses
Income before taxes
Income tax expense (30%)
Net income
Weighted
Average
$150,000
FIFO
$150,000
107,500
$ 42,500
20,000
$ 22,500
6,750
$ 15,750
112,500
$ 37,500
20,000
$ 17,500
5,250
$ 12,250
104,000
$ 46,000
20,000
$ 26,000
7,800
$ 18,200
LIFO
5-46
costs with the revenues generated. Apparently, LIFO provides the most accurate
matching of costs with revenue for Tribune Companys newsprint.
LO 7,9
5-47
1. No, the use of the last-in, first-out method for its domestic merchandise inventories
does not mean that Sears always sells its newest merchandise first in the United
States. Actually, the physical flow of merchandise in most stores like Sears is
normally on a first-in, first-out basis. However, the use of a cost flow assumption
such as LIFO or FIFO for accounting purposes is independent of the actual physical
flow of products.
2. No, Sears uses the retail method to account for inventories in its stores. This is a
method that allows the company to convert its inventory from a retail value to a cost
basis for financial statement purposes.
A L T E R N AT E P R O B L E M S
LO 1
PROBLEM 5-2A CALCULATION OF GROSS PROFIT FOR BEST BUY AND CIRCUIT
CITY
5-48
LO 7
1. No, the three companies will not be equally pleased with the decline in prices. If the
decline continues, Company Y (FIFO) will begin to show lower gross profit than
Company Z (LIFO). Because gross profit will be lower, Company Y will report lower
income before tax and thus have less tax to pay.
2. It should be noted that it is not acceptable for a company to change inventory
valuation methods to save taxes. An acceptable explanation of the justification for
the change is this:
During the year recently completed, the company changed its method of valuing
inventory on the balance sheet and recognizing cost of sales on the income
statement. The company changed from the LIFO to FIFO method because it
believes that the latter results in a better matching of cost of sales with the
revenues of the period.
LO 8
2007
$35,982
12,094
$23,888
13,488
$10,400
2006
$26,890
10,412
$16,478
10,578
$ 5,900
*Because ending inventory in 2006 was overstated, cost of goods sold was
understated. Because beginning inventory in 2007 was overstated, cost of goods
sold was overstated.
Revised balance sheets:
Cash
Inventory
Other current assets
Long-term assets, net
Total assets
Current liabilities
Capital stock
Retained earnings
Total liabilities and stockholders equity
12/31/07
$ 9,400
4,500
1,600
24,500
$40,000
$ 9,380
18,000
12,620
$40,000
12/31/06
$ 4,100
4,900
1,250
24,600
$34,850
$10,600
18,000
6,250
$34,850
5-49
2. Current ratio:
Before revision:
After revision:
If the lender required a current ratio of at least 1 to 1, Planter would not be eligible
for the loan. However, the bank might not consider a current ratio of 0.97 to 1 to be
materially different from a current ratio of 1 to 1 and might be willing to grant the
loan.
3. Net income for two years, before revision: $6,400 + $9,900 = $16,300.
Net income for two years, after revision: $5,900 + $10,400 = $16,300.
Thus, there is no net over- or understatement of net income for the two-year period.
Retained earnings at December 31, 2007, before the revision: $12,620.
Retained earnings at December 31, 2007, after the revision: $12,620.
Thus, there is no over- or understatement of retained earnings at December 31,
2007.
4. Even though the error counterbalances over the two-year period, it is still important
to restate the statements for the two years. It is important for comparative purposes
that the correct amount of net income be known for each of the two years. The
company needs to restate the income statements for each of the two years and
restate the balance sheets at the end of each year.
5-50
LO 10
$93,500
0.70
$65,450
$93,500
65,450
$28,050
$14,200
77,000
$91,200
28,050
$63,150
4,500
$58,650
Cash*
Inventory
=
50,000
(58,650)
Liabilities
INCOME
STATEMENT
(8,650)
*Receivable from Insurance Company is increased instead of Cash if cash has not yet
been received.
LO 11
5-51
5-52
LO 12
$ 78,500
$(20,600)
(69,800)
(90,400)
$(11,900)
26,300
$ 14,400
FROM:
Students name
DATE:
SUBJECT:
Cash Flows
You recently expressed concern about the decrease in the companys cash
balance in spite of the profitable year that was reported on this years income
statement. My thoughts and a copy of the companys 2007 statement of cash flows
follow.
Although net income on an accrual basis was $78,500, the companys cash
balance declined by $11,900 during the year for two reasons. Most importantly, the
amount owed to the companys suppliers decreased by $69,800 during the year
from $93,700 to $23,900; this decrease in accounts payable drained our cash
balance. In addition, the amount of inventory on hand increased by $20,600 during
the year from $84,900 to $105,500; this increase in inventory required an additional
outflow of cash.
We can better manage our cash flow by carefully timing the payment of bills to
coincide with the due dates on invoices. In addition, we can improve cash flow by
closely monitoring our inventory levels and only adding to inventory levels when
increases in sales warrant an addition.
5-53
A L T E R N AT E M U L T I - C O N C E P T P R O B L E M S
LO 2,3,12
10/1
Liabilities
INCOME
Accounts
Payable
STATEMENT
(249)
249
=
(244)
Liabilities
Accounts
Payable
INCOME
STATEMENT
(249)
Liabilities
INCOME
STATEMENT
200
Sales Revenue
200
10/18
Liabilities
INCOME
Accounts
Payable
STATEMENT
(800)
800
Liabilities
INCOME
600
STATEMENT
600
Liabilities
(800) Accounts
Payable
INCOME
+
(800)
STATEMENT
5-54
5-55
3 units
(1)
10
(3)
9 units
$2,000
(244)
200
600
(800)
$1,756
The cash balance decreased during the month even though the company reported a
profit because cash outflows exceeded expenses. This was the case because the
entire inventory purchased (and paid for) was not yet sold (expensed).
LO 2,3,4
1. The effect of sales and the collection of accounts receivable during 2004 on the
accounting equation for Walgreen Co. is (in millions):
BALANCE SHEET
Assets
Liabilities
INCOME
STATEMENT
Cash
37,356.9*
Accounts Receivable (37,356.9)
5-56
$ 4,202.7
27,846.3 (2)
$32,049.0 (1)
(4,738.6)
$27,310.4
2004
$ 37,508.2
27,310.4
$ 10,197.8
37,508.2
27.2%
2003
$ 32,505.4
23,706.2
$ 8,799.2
32,505.4
27.1%
Walgreens gross profit ratio was virtually unchanged from 2003 to 2004. Factors
affecting Walgreens gross profit ratio include changes in the selling prices of
merchandise, changes in the cost of goods purchased, and/or changes in the mix of
merchandise sold (that is, a slight shift from selling products that have higher gross
profit ratios to selling those with lower gross profit ratios).
LO 2,3
$ 6,400
$ 62,845
1,237
$ 61,608
375
61,983
$ 68,383
5,900
$ 62,483
$112,768
1,008
$111,760
62,483
$ 49,277
$ 23,000
12,900
1,800
37,700
$ 11,577
1,450
$ 10,127
LLOYD INC.
BALANCE SHEET
AT DECEMBER 31, 2007
Assets
Cash
Accounts receivable
Inventory
Total assets
Liabilities
Salaries payable
Wages payable
Income tax payable
Total liabilities
Stockholders Equity
Capital stock
Retained earnings
Total stockholders equity
Total liabilities and stockholders equity
$ 22,340
56,359
5,900
$ 84,599
$
650
120
1,450
$ 2,220
$ 50,000
32,379*
82,379
$ 84,599
5-57
5-58
LO 5,6,7
1.
a. Weighted average
b. FIFO
c. LIFO
Calculations:
a. Beginning inventory
Nov. 8
Nov. 18
Nov. 29
Cost of
Goods Sold
$5,120
4,875
5,375
300
500
700
600
2,100
$4.00 = $1,200
4.50 = 2,250
4.75 = 3,325
5.00 = 3,000
$9,775
Ending
Inventory
$4,655
4,900
4,400
Total
$9,775
9,775
9,775
1,100
$5,375
5-59
5-60
2. The Total column represents the pool of costs (beginning inventory plus purchases)
to be distributed between an asset, ending inventory on the balance sheet, and an
expense, cost of goods sold on the income statement. In accounting, the pool of
costs is called cost of goods available for sale.
Sales*
Cost of goods sold
Gross margin
Operating expenses
Income before taxes
Income tax expense (25%)
Net income
Weighted
Average
$10,100
5,120
$ 4,980
2,000
$ 2,980
745
$ 2,235
FIFO
$10,100
4,875
$ 5,225
2,000
$ 3,225
806
$ 2,419
LIFO
$10,100
5,375
$ 4,725
2,000
$ 2,725
681
$ 2,044
LO 5,7,13
$806
681
$125
1.
a. Moving average
b. FIFO
c. LIFO
Cost of
Goods Sold
$4,892
4,875
4,950
Ending
Inventory
$4,883
4,900
4,825
Total
$9,775
9,775
9,775
5-61
a. Moving average:
Date
11/1
11/4
11/8
11/9
11/18
11/20
11/29
Purchases
Unit Total
Units Cost Cost
Units
200
500 $4.50
Sales
Unit
Cost
$4
Total
Cost
$ 800
$2,250
700
4.75
3,325
600
5.00
3,000
500
4.417
2,209
400
4.708
1,883
$4,892
Units
300
100
600
100
800
400
1,000
Balance
Unit
Cost Balance
$4
$1,200
4
400
4.4171
2,650
4.417
441
2
4.708
3,766
4.708
1,883
4.8833 $4,883
Ending inventory
100
500
600
$4.00
4.50
= $ 400
= 2,250
$2,650;
$2,650/600 = $4.417
100
700
800
$4.417 = $ 441
4.75 = 3,325
$3,766;
$3,766/800 = $4.708
400
600
1,000
$4.708 = $1,883
5.00 = 3,000
$4,883;
$4,883/1,000 = $4.883
2.
3.
b. FIFO:
Date
11/1
11/4
11/8
Purchases
Unit Total
Units Cost Cost
Units
200
500 $4.50
100
400
700
4.75
100
300
600
5.00
$ 800
4
4.50
400
1,800
3,325
11/20
11/29
$4
Total
Cost
$2,250
11/9
11/18
Sales
Unit
Cost
4.50
4.75
450
1,425
3,000
Cost of goods sold
$4,875
Units
300
100
100
500
Balance
Unit
Cost Balance
$4
$1,200
4
400
4
4.50
2,650
100
100
700
4.50
4.50
4.75
400
400
600
4.75
4.75
5.00
450
3,775
1,900
$4,900
Ending inventory
5-62
c. LIFO:
Date
11/1
11/4
11/8
11/9
11/18
Purchases
Unit Total
Units Cost Cost
Units
200
500 $4.50
700
4.75
600
5.00
$4
Total
Cost
$ 800
$2,250
500
4.50
2,250
400
4.75
1,900
3,325
11/20
11/29
Sales
Unit
Cost
3,000
$4,950
Units
300
100
100
500
100
100
700
100
300
100
300
600
Balance
Unit
Cost Balance
$4
$1,200
4
400
4
4.50
2,650
4
400
4
4.75
3,725
4
4.75
1,825
4
4.75
5
$4,825
Ending inventory
2. The Total column represents the pool of costs (beginning inventory plus purchases)
to be distributed between an asset, ending inventory on the balance sheet, and an
expense, cost of goods sold on the income statement. In accounting, this pool of
costs is called cost of goods available for sale.
3. Income statements for the month of November:
Sales*
Cost of goods sold
Gross margin
Operating expenses
Income before taxes
Income tax expense (25%)
Net income
Moving
Average
$10,100
4,892
$ 5,208
2,000
$ 3,208
802
$ 2,406
$806
788
$ 18
FIFO
$10,100
4,875
$ 5,225
2,000
$ 3,225
806
$ 2,419
LIFO
$10,100
4,950
$ 5,150
2,000
$ 3,150
788
$ 2,362
LO 5,6,7
5-63
a. FIFO
b. LIFO
c. Weighted average
Calculations:
a. Ending inventoryFIFO:
300 $25.00 = $7,500
45 25.40 =
1,143
345
$8,643
Cost of goods soldFIFO:
300 $27.00 = $ 8,100
375 26.50 =
9,938
330 26.00 =
8,580
180 25.40 =
4,572
1,185
$31,190
b. Ending inventoryLIFO:
300 $27.00 = $8,100
45 26.50 =
1,193
345
$9,293
Cost of goods soldLIFO:
300 $25.00 = $ 7,500
225 25.40 =
5,715
330 26.00 =
8,580
330 26.50 =
8,745
1,185
$30,540
Ending
Inventory
$8,643
9,293
8,982
300
1,230
1,530
1,185
345
Cost of
Goods Sold
$31,190
30,540
30,851
Total
$39,833
39,833
39,833
5-64
c. Beginning inventory
Nov. 4
Nov. 13
Nov. 18
Nov. 24
300
375
330
225
300
1,530
$27.00 = $ 8,100
26.50 =
9,938
26.00 =
8,580
25.40 =
5,715
25.00 =
7,500
$39,833
FIFO
$75,330
31,190
$44,140
LIFO
$75,330
30,540
$44,790
Weighted
Average
$75,330
30,851
$44,479
16,200
6,000
$21,940
7,679
$14,261
16,200
6,000
$22,590
7,907
$14,683
16,200
6,000
$22,279
7,798
$14,481
1. a. Weighted average:
Beginning inventory
Feb. 4
Apr. 12
Sept. 10
Dec. 5
4,000
2,000
3,000
1,000
2,500
12,500
$20 =
18 =
16 =
14 =
12 =
$ 80,000
36,000
48,000
14,000
30,000
$208,000
12,500
11,000
1,500 $16.64 =
$ 24,960
11,000 $16.64 =
$183,040
5-65
5-66
b. FIFO:
Ending inventory
Cost of goods sold
c. LIFO:
Ending inventory
Cost of goods sold
$20 = $ 80,000
18 =
36,000
16 =
48,000
14 =
14,000
12 =
12,000
$190,000
$12 = $ 30,000
14 =
14,000
16 =
48,000
18 =
36,000
20 =
50,000
$178,000
Sales*
Cost of goods sold
Gross profit
Operating expenses
Income before taxes
Income tax expense (30%)
Net income
Weighted
Average
$330,000
183,040
$146,960
60,000
$ 86,960
26,088
$ 60,872
FIFO
$330,000
190,000
$140,000
60,000
$ 80,000
24,000
$ 56,000
LIFO
$330,000
178,000
$152,000
60,000
$ 92,000
27,600
$ 64,400
LO 1,7,9
5-67
1. The company carries two types of inventory: newsprint and other. These costs are
comparable to raw materials in a manufacturing company. A newspaper company,
however, does not keep an inventory of finished goods. Its newspapers either are
sold within hours after being printed or become worthless if not sold.
2. Some companies use different methods to value different types of inventory. The
methods should be chosen because they provide the most accurate matching of
costs with the revenues generated. Apparently, LIFO provides the most accurate
matching of costs with revenue for the companys newsprint.
LO 7,9
1. No, the use of the first-in, first-out inventory method does not mean that a company
always sells its oldest merchandise first. Although the physical flow in many
businesses is on a first-in first-out basis, the use of a cost flow assumption such as
FIFO for accounting purposes is independent of the actual physical flow of products.
In fact, some businesses do use a LIFO (last-in, first-out) assumption even though
the physical flow is on a first-in, first-out basis.
2. No, Home Depot states in its note that it uses the retail inventory method to account
for inventories in its stores. This is a method that allows a company to convert its
inventory from a retail value to a cost basis for financial statement purposes.
D E C IS ION C AS E S
READING AND INTERPRETING FINANCIAL STATEMENTS
LO 1,3
5-68
3. According to Note 1, Finish Line uses the weighted average cost method to value
inventories. The company indicates that this approximates the first-in, first-out
method. The weighted average method is relatively easy to use.
4. According to Note 1, Foot Locker uses LIFO for domestic inventories and FIFO for
international inventories. The inventories of the companys Direct-to-Customers
business are valued using the weighted average method, which approximates
FIFO. It is not unusual for companies in the same industry to use different methods,
and it is helpful in trying to compare the companies to be aware of this fact.
5. Because companies usually do not disclose in their annual report which inventory
system they use, it is not possible to know for certain whether they use periodic or
perpetual. The ability of merchandisers to use the perpetual system has certainly
improved with advances in technology, such as the advent of point-of-sale
terminals.
LO 7
1. J.C.Penney uses LIFO. A business should employ the method that most accurately
matches inventory costs with the revenues of the period. J.C.Penney may use LIFO
because prices change frequently, and it wants to match the most recent costs with
revenues generated in the current period.
2. The LIFO reserve is $25 million at year-end 2004 and $43 million at year-end 2003.
3. The LIFO reserve decreased during 2004, from $43 million to $25 million, or $18
million. The reserve decreases because inventory costs are decreasing and cost of
goods sold on a LIFO basis is less than cost of goods sold on a FIFO basis. Thus, a
decrease in the reserve during a period indicates that prices are falling.
LO 1,6,9
1. Circuit City uses the average cost method. Given the large volume of consumer
electronics products sold by Circuit City, the average cost method seems
appropriate.
2. The company defines market as estimated realizable value. In estimating market
value, the company considers such factors as forecasted consumer demand, market
conditions, and obsolescence.
5-69
3. The company includes the statement about the possibility of being exposed to
losses in excess of amounts recorded as a way to alert the statement reader that if
various factors result in a decline in the value of its inventory the company would
need to write it down and recognize a loss.
MAKING FINANCIAL DECISIONS
LO 2,3,4
1. According to the income statement prepared by the controller, Emblems gross profit
ratio is $6,750/$15,000, or 45%.
2. Emblems should not lower its selling price. On the surface, it appears that it should,
given that the industry standard for gross margin is 40%. Emblems real gross profit,
however, is not 45%. The reason is that the controller failed to include two important
product costs in cost of sales: shipping and labeling. In error, the controller is
expensing all shipping and labeling costs as incurred, rather than treating them as
product costs. The correct gross profit is as follows:
Selling price
Costs per unit:
Purchase price
Tax (10%)
Shipping
Labeling
Total cost per unit
Gross profit per unit
Number of units sold
Gross profit
$10.00
1.00
0.50
0.75
12.25
7.75
750
$5,812.50
Thus, the correct gross profit ratio is $5,812.50/$15,000, or 38.75%. On the basis of
this new ratio, Emblems is slightly under the industry standard of 40%, and it should
not lower its selling price.
LO 2,3,4
$5.00
0.25
$5.25
0.11
$5.14
0.05
0.70
$5.89
5-70
LO 3
1. Memo to Darrell:
The purpose of this memo is to clarify for you the costs and benefits of a perpetual
inventory system. The purpose of a perpetual system is to provide a continuously
updated record of the number of units and cost of all inventory items. A perpetual
system is more costly to maintain because of the need to update the records each
time purchases and sales are made. It is likely that you will want to consider a
computerized inventory system. Numerous software packages are available, and
one should be chosen that is particularly suitable to your business.
As mentioned earlier, a perpetual inventory system is considerably more costly to
implement and maintain than a periodic system. A perpetual system would involve
an investment in a scanning device and the other necessary hardware and software.
The next step would be to explore the options available to us and the cost of each.
Please call me at your convenience to set up an appointment to discuss these
matters further.
2. The suitability of a perpetual inventory system is certainly dependent on the type of
products a company sells. The system is ideally suited to a product such as
automobiles, since there is a relatively low volume of sales. On the other hand, it
might not be well suited to the needs of a landscaper selling trees, shrubs, and
plants. The turnover of products is very high, and it may not be practical to update
the records each time a sale takes place.
LO 6,7
5-71
1. Georgetown must use the periodic inventory system at least for the first year
because it did not keep a record of the cost of the units sold as each sale was made.
2. Units on hand at the end of the year:
January
March
October
Available
Sold
On hand
1,000
1,200
1,500
3,700
3,000
700
3. Unless a company specifically identifies the cost of each unit sold, it must adopt an
assumption about which particular units were sold. Each of the inventory costing
methods takes the pool of costs (cost of goods available for sale) and makes an
assumption about which units were sold and which units remain on hand.
Because inventory costs have increased during the first year, the company could
minimize taxes paid by adopting LIFO. A comparison of partial income statements
with the use of FIFO and LIFO highlights the taxes that could be saved in the first
year:
FIFO
$45,000
24,800
$20,200
Sales revenue*
Cost of goods sold**
Gross profit
LIFO
$45,000
25,500
$19,500
**
$8 = $ 8,000
8 =
9,600
9 = 13,500
$31,100
Ending inventory:
FIFO 700 $9 = $6,300
LIFO 700 $8 = $5,600
Cost of goods sold:
FIFO
$31,100 $6,300 = $24,800
LIFO
$31,100 $5,600 = $25,500
Conclusion: All expenses other than cost of goods sold are not affected by the use
of one inventory method rather than another. Thus, the lower gross profit with the
use of the LIFO method will result in income before taxes that is $20,200
$19,500, or $700 less than if FIFO was used. Because the expected tax rate is
35%, the company will save $700 0.35, or $245, by using LIFO.
5-72
LO 8
The first error resulted in an overstatement of the ending inventory in 2005 by $45,600.
Thus, cost of goods sold in 2005 was understated, and gross profit was overstated by
the same amount. The effect on net income would be less than the amount of
overstatement of gross profit because of the effect of taxes.
The second error was the result of not applying the lower-of-cost-or-market rule to
the inventory at the end of 2006. If the cost of certain inventory was $6,000 higher than
its replacement cost, the inventory should have been written down and a loss
recognized.
The error that was made in the second quarter of the current year can be corrected
before the release of the 2007 financial statements. The company should explain the
nature of the error in the annual report: that an understatement of inventory at the end
of the second quarter led to an understatement of the income reported in that quarter.
The first two errors, if material in amount, require a restatement of the financial
statements of the years involved.
ETHICAL DECISION MAKING
LO 2
LO 7
5-73
1. The CEO is primarily concerned with reporting the highest amount of income
possible. Thus, the CEO will be satisfied if the company uses the FIFO method. This
method recognizes as cost of goods sold the oldest costs, and because prices are
rising, the costs charged to cost of goods sold will be less than if LIFO is used.
2. It would be difficult to state definitively which method is truly in the best interests of
the stockholders. The LIFO method minimizes the amount of income taxes paid in
the first year, since this method would report the highest cost of goods sold and thus
the lowest income before taxes. From a cash flow perspective, LIFO is the most
advantageous method in a period of rising prices.
3. Memo to the CEO:
TO:
CEO
FROM:
Students name
DATE:
12/31/XX
LO 9
1. The write-off of the inventory that has become obsolete would reduce the current
years income. The amount of the reduction depends on the extent of the write-off. If
the inventory is written off completely, the reduction in income will be equal to the
book value of the inventory. If the inventory is written down to a lower amount, net
income will be reduced by the amount of the write-down. This analysis ignores the
effect of taxes.
5-74
2. If the inventory is not adjusted, total assets on the year-end balance sheet will be
overstated.
3. The materiality of the obsolete inventory should be a major factor in a decision to
persist in the argument that the inventory be written down. If the inventory in
question is not material relative to the total assets of the company, the write-down
may be unnecessary. The materiality of the loss that would be recognized from the
write-down, relative to the income of the period, should also be considered.
4. If the inventory is not written down, readers do not have reliable information. Under
the lower-of-cost-or-market rule, readers assume that if inventory is worth less than
its cost, the inventory has in fact been written down to this lower amount.