Tutorial 2

A. INVENTORIES

Chapter 13

DQ13.1
What costs should be included in the cost of an item of inventory?

Manufacturing, product and period.

Manufacturing can be either variable costs or fully allocated cost.

DQ13.4

Critically examine the following statement: ‘During times of high inflation, the
LIFO cost assumption should be permitted in financial statements because it
allows the entity to show a more up-to-date profit figure.’

During times of inflation, use of LIFO cost assumption tend to cause cost
of sales to reflect the most recent purchase price. The cost of sales
calculation will thus be a close approximation of the current cost of goods
at the time of the sale by which produces a more recent gross profit figure
when minus from current sales for the period. However, this only applies if
the inventory is not run down and is maintained at a constant level or
increased during the year. However if the inventory is run down or very
old, this statement cannot be applied.
EQ 13.5 (did in class)
Inventory cost methods — perpetual inventory system

Non-GST version

The following information relates to the inventory of Gadgets Ltd during May.

Gadgets Ltd uses a perpetual inventory system. Ignore GST.

Required
Determine the cost of the ending inventory (assuming there have been no
stock losses) and the cost of sales, using the following three methods:
(a) the moving average; round unit cost to the nearest cent.
(b) specific identification; assume that the ending inventory on 31 May
consisted of 13 units from the beginning inventory, 24 units from the 3 May
purchase, and the remainder from the 10 May purchase.
(c) FIFO.
(d) LIFO.
PQ 13.16

Inventory cost flow methods — periodic inventory system

Non-GST version

The following information relates to the inventory of Margaret’s Megamart Ltd

during December. Ignore GST.

Margaret’s Megamart Ltd uses the periodic inventory system. During the
month, 1300 units were sold for $5525. A physical count on 31 December
verified that 700 units were on hand.

Required
(a) Prepare an income statement down to gross profit for December, using
each of the following costing methods:
i. specific identification, assuming that 400 units were sold from the
beginning inventory, 400 units were sold from the first purchase, 200
units were sold from the 15 December purchase, and the remainder
from the 23 December purchase.
ii. FIFO
iii. LIFO
iv. weighted average.
(b) Which cost flow method(s) resulted in the highest gross profit on sales?
the highest ending inventory? Explain your results.
(c) Prepare an income statement down to gross profit for December, using the
FIFO and LIFO costing methods and assuming that the 23 December
purchase had been delayed until January.
(d) The management of Margaret’s Megamart Ltd expects the unit cost to
increase to $3.90 excluding GST early in the next period. In anticipation of
the price increase, a purchase of 600 additional units was made on 29
December at a unit cost of $3.65 excluding GST. Prepare an income
statement down to gross profit for December, using the FIFO and LIFO
costing methods.
(e) Compare your results obtained in requirements A, C and D. Explain why
your results are or are not the same.
(ai) Specific identification
Cost of sales
400 units @ $3.00 $1,200
400 units @ $3.15 $1,260
200 units @ $3.30 $ 660
300 units @ $3.50 $1050
1300 units $4,170

Ending inventory
300 units @ $3.00 $900
100 units @ $3.15 $315
100 units @ $3.30 $330
200 units @ $3.50 $700
700 units $2,245

(aii)
units

Goods available (per question) 2000 $6,415

Ending inventory (700 units):
500 units @ $3.50 (500) (1,750)
200 units @ $3.30 (200) (660)
Cost of sales 1300 $4,005

(aiii)
LIFO Units
Goods available 2000 $6,415
Ending inventory (700 units)
700 units @ $3.00 (700) (2100)
Cost of sales 1300 $4,315

(aiv)
Weighted average Units Units cost Amount
Beginning inventory 700 $3.00 $2,100
10/12 purchase 500 $3.15 $1,575
15/12 purchase 300 $3.30 $990
23/12 purchase 500 $3.50 $1750
Goods available 2000 $6,415
$6,415/2000 = $3.12 per unit (rounded)

Goods available 2000 $3.21 $6,415

Ending inventory (700) $3.21 (2,247)
Cost of sales (rounded) 1,300 $4,168
 Income statement
Spec. ident FIFO LIFO W’ted AV.
Sales $5,525 $5,250 $5,525 $5,525
Beginning inventory 2100 2100 2100 2100
Purchase 4315 4315 4315 4315
Goods available for sales 6,415 6,415 6,415 6,415
Ending inventory 2,245 2,410 2100 2,247
Cost of sales 4,170 4,005 4,315 4,168
Gross profit 1,355 1,520 1,210 1,357

b) the highest gross profit was reported using FIFO, FIFO also reported the highest
ending inventory balance as it has the most recent higher price. This is cause by the
direction relation between inventory value and profits. The higher the value placed
on ending inventory, the higher the reported gross profit.

c) income statement
FIFO LIFO
Sales $5,525 $5,525
Beginning inventory 2100 2100
Purchases 2565 2565
Goods available for sale 4665 4665
Ending inventory (200 units) 660 660
Cost of sales 4,005 4,065
Gross profit $1,520 $1,460

d) Income Statement
FIFO LIFO
Sales $5,525 $5,525
Beginning inventory 2100 2100
Purchases 6,505 6,505
Goods available for sale 8,605 8,605
Ending inventory (1300 units) *4600 *4005
Cost of sales 4005 4600
Gross profit $1,520 $925

*FIFO *LIFO
200 @ 3.30 = 660 700 @ 3.00 = 2,100
500 @ 3.50 = 1750 500 @ 3.15 = 1575
600 @ 3.65 = 2190 100 @ 3.30 = 330
$4,600 $4,005
e) FIFO reported the same cost of sale and gross profit in all cases because the
increase and decrease in ending inventory were offset by the same increase and
decrease in purchases. LIFO reported 3 different cost of sale and gross profit results.
This shows that ending inventory and cost of sales value can be change by recent
purchases and non-purchases using LIFO assumptions.
PQ 13.20

Lower of cost and net realisable value

Non-GST version

The following information applies to the inventory of Carson’s Camera Store

as at 30 June 2019.

Required
(a) Calculate the ending inventory value as at 30 June 2019, applying the lower
of cost and net realisable value rule to:
i. individual inventory items
ii. major categories of cameras and video equipment
iii. total inventory.
(b) What effect does application of the lower of cost and net realisable rule
have on the financial statements of the business?
(c) Assume that at the end of the next financial year, 12 units of model A-4 are
still on hand and the net realisable value is $80 per unit. How would this
increase in net realisable value affect the inventory value of the 12 units.
(d) How would the increase in net realisable value in requirement C be treated
in the accounting records?

a)
Items Quantity Cost NRV Cost NRV LC&NRV (by item)
Cameras
Model A-4 18 $95 $75 $1710 $1350 $1350
Model C-7 12 100 120 1200 1440 1200
Model G-1 20 65 60 1300 1200 1200
Model Z-8 6 50 55 300 330 300
Total – Cameras 4510 4320 4050
Video equipment
Model BD-5 18 $95 $75 $1710 $1350 $1350
Model FY-9 10 240 220 2400 2200 2200
Total – Video 5100 5050 4900
Total 9610 9370 8950
(ai) Applying the lower cost and net realisable value rule to each item of the
inventory results in ending inventory of $8950.
(aii) Applying the lower of cost and net realisable value rule to each major category
of the inventory results in an ending inventory amount of $9370
Cameras $4320
Video equipment $5050
$9370
(aiii) Applying the lower of cost and net realisable value rule to total inventory results
in an ending inventory of $9370.
b) The LC & NRV procedure that results in the lowest ending inventory will also
result in the lowest profit for the year. Applying the lower of cost and net realisable
value rule to each item of the inventory will result in the lowest profit for the year.

c) If the 12 unit of Camera A04 are still on hand at the end of the financial year at a
NRV of $80 per unit, there will be a change in inventory valuation. The inventory will
then be valued at $80 per unit being an adjustment back to inventory at the end of
the year for 12 x $5.00 = $60 increase in ending inventory.

d) the increase in the NRV will be recorded by debiting inventory for $60 and
crediting gain on adjustment of inventory for $60.
B) Non- current assets

Chapter 14
DQ14.4
During your lunchtime, which you usually spend at the university canteen in the
presence of other students, one particular accounting student who was having difficulty
with the textbook complained that he did not understand which costs were to be
regarded as part of the acquisition cost of land, which costs were to be attributed to
buildings under construction, and which were to be treated as an expense. Explain the
basic principles to be followed. Are there any difficulties in applying these principles?
Explain by providing examples.

The main principle that are to be applied in determining the cost of property, plant and
equipment is to treat, as part of the cost, the purchase price plus directly attributable cost
necessarily incurred in getting the asset to a position and condition where it is ready to be put
into production. Another principle is that the only ‘reasonable and necessary’ cost are to be
included.
There are several difficulties in applying these principles such as how-to asses which cost are
‘necessary’ how to determine whether the cost incurred has added to the expected economic
benefits to be derived from asset. Does the entity allocate any indirect costs to the asset?
Another problem is determining whether a particular cost attaches to a particular asset?

DQ14.5

Z Ltd depreciates its equipment using the straight-line method of depreciation. Y

Ltd, which owns the same equipment, and has purchased the item on the same day
from the same supplier as Z Ltd, uses the diminishing balance method. Are the
depreciation charges of these two companies non-comparable? Explain.

This requires the discussion of the nature and purpose of depreciation. Assuming that
depreciation in an allocation of cost over useful life. It is important to consider how to
select an allocation method. The total cost of an asset over its useful life and disposal is
the same under all method. It is not necessarily inconsistent that both Z and Y Ltd adopt
different depreciation allocation patterns for the same asset, as they may have used the
assets differently. The important criteria to take into consideration is selecting a
depreciation method is the expected pattern of usage of the economic benefits to be
derived from the assets.
EQ14.2
Cost and annual depreciation
Non-GST version
On 2 January 2019, Johnston Ltd purchased a machine with a list price of $234 300 and
credit terms of 2/10, n/30. Payment was made within the discount period. Freight costs
of $5400 and installation costs of $5280 were also paid. The machine has a useful life of
4 years and a residual value at the end of its useful life of $24 000. Ignore GST.

Required
(a) Determine the amount that should be debited to the machinery account and prepare
a general journal entry to record the purchase, assuming a financial year ending 31
December.
(b) Determine the amount of depreciation expense for each of the 4 years ending 31
December assuming use of:
i. the straight-line depreciation method
ii. the diminishing balance method of depreciation.
(c) Prepare a journal entry to record depreciation expense for the year ending 31
December 2019 under the diminishing balance method.
(LO2 and LO5)

(a) Cost of machines = $243,300 + $5,400 + $5280 = $244,980

Note payment to supplier within the discount period will not affect the cost price of
the machine, but it will affect the amount of cash paid to supplier.

Machinery $244,980
Accounts payable $244,980

To record purchase of machine, plus freight, installation cost and GST.

Year ended 31 December

Depreciation method 2019 2020 2021 2020 Total
Straight line 55,245 55,245 55,245 55,245 220,980
Diminishing balance 10,7791 60,363 33,803 19,023 220,980

(bi) ($244,980 - $24,000) / 4 = $55,245 p.a

(bii) Depreciation rate = 1 – 00.5595 = 0.4405 or 44%

$244,980 x 0.44 = $107,791.20
$137 189 x 0.44 = $60 363.16
$78,826 x 0.44 = $33,803.44
$43,023 x 0.44 = $19,023
c) Depreciation expense – machinery 107,791
accumulated depreciation – machinery 107,791
Record depreciation expense for year ended 31 December 2019
EQ 14.4 (did in class)
Non-GST version

Nevertire Ltd purchased a delivery van costing $52 000. It is expected to have a residual
value of $12 000 at the end of its useful life of 4 years or 200 000 kilometres. Ignore
GST.

Required
Assume the van was purchased on 1 Oct 2019 and that the accounting period ends on 30
June. Calculate the depreciation expense for the year ending 30 June 2020 and 30 June
2021, using each of the following depreciation methods:
i. straight-line
ii. diminishing balance
iii. Sum-of-year-digits
iv. units of production (assume the van was driven 38 000 kilometres during the
year ending 30 June 2020 and 54,000 kilometres for the year ending 30 June
2021).

i) Straight-line:
Depreciation per year
= (cost-residual value)/useful life
= (52,000) – (12,000)/4
= 10,000

Depreciation for the year ending 30 June 2020 is 9 months

= depreciation =1000 x 9/12 = 7500

Depreciation for the year ending 30 June 2021 is one complete year
= depreciation for 2020 = 7500
Depreciation in 20121 = 7500+10,000 = 17,500

Carrying amount (brand new in 2019) = $52,000

Carrying amount (2020) = 52,000-7500 = 44,500
Carrying amount (2021) = 52,000 – 17,500

ii) Diminishing balance

Depreciation rate = 1 – r/c squareroot N

N= useful life
R = residual value
C= cost

Depreciation rate = 1 – 12,000/52,000 square root 4

= 1 – 0.6931 or 31 %
Depreciation for the year ending 30 June 2020 = $52,000 x 0.31 x 9/12 = 12,090

Depreciation for the year ending 30 June 2021 = (52,000 -12,090) = 12,372
 iii) Sum of year digits = 4+3+2+1= 10
Depreciation for the year ending 30 June 2020 = 52,000 x 4/10 x 9/12 = 15,600
Depreciation for the year ending 30 June 2021 = 52,000 x 3/10 =15,600

iv) Units of production:

Expense per kilometre = (52,000 -12,000) /200,000 = $0.2
Depreciation for the year ending 30 June 2020 = 0.2 x 38,000 = 7600
Depreciation for the year ending 30 June 2021 = 0.2 x 54,000 = 10,800

EQ 14.10

Depreciation and overhauls

Non-GST version

Prestige Printing Ltd commenced business on 1 July 2019. On 5 July 2019, a printing
machine was purchased for $35 000, payable in two equal instalments due on 1 August
and 1 October 2019. Transport costs of $1200 were paid in cash to deliver the machine
to Prestige Printing Ltd’s premises. The machine was expected to have a useful life of 5
years and a residual value of $3000.

On 22 September 2019, the business purchased a second-hand truck for $26 000. Stamp
duty amounted to $700. The truck dealer also fitted four new tyres at a cost of $1200
and spray-painted the business logo on the truck doors at a cost of $500. All amounts
were paid in cash. The truck was expected to have a useful life of 3 years and a residual
value of $5000.

On 1 March 2020, extensive repairs were carried out on the printing machine at a cost
of $18 230, paid in cash. The company expects these repairs to extend the machine’s
useful life by 2 years. The residual value was revised to $4000. The carrying amount of
the parts replaced in the machine was considered to be equal to $14 000.

The company uses the straight-line depreciation method, recording depreciation to the
nearest month. The end of its reporting period is 30 June.
(d)
Required

(a) Prepare general journal entries (narrations are not required, but show all workings) to record
the transactions and to record depreciation adjustments necessary for the year ended 30 June
2020.

(b) Justify the value you recognised as the cost of the second-hand truck purchased on 22
September 2019 by reference to the requirements of IAS 16/AASB 116.
PQ 14.12

Depreciation methods and partial years

Non-GST version

Brunswick Ltd operates four types of equipment. Because of their varied functions,
management has decided that four different depreciation methods will be used to
determine depreciation charges. Information on the equipment is summarised as
follows (ignore GST).

u
Use of equipment type 4 was 200 hours in the year ended 30 June 2020; 3200 hours in
2021; 2600 hours in 2022 and 2850 in 2023.

Required

(a) Assuming the financial year ends on 30 June and that depreciation is recorded to the
nearest month, calculate the depreciation charges for 2016, 2017, 2018 and 2019 by
preparing a schedule with the following headings:
(LO5)