Chap 008

Question 8-1

Question 8-2

Question 8-3 Perpetual System Periodic System

(1) purchase of merchandise debit inventory debit purchases

(2) sale of merchandise debit cost of goods sold;credit inventory no entry

(3) return of merchandise credit inventory credit purchase returns

Question 8-4

Inventory shipped f.o.b. shipping point is included in the inventory of the purchaser when the merchandise reaches the common carrier. Laetner Corporation records the purchase in 2011 and includes the shipment in its ending inventory. Bockner Company records the sale in 2011. Inventory shipped f.o.b. destination is included in the inventory of the seller until it reaches the purchaser’s location. Bockner would include the merchandise in its 2011 ending inventory and the sale/purchase would be recorded in 2012.

Chapter 8 Inventories: Measurement

QUESTIONS FOR REVIEW OF KEY TOPICS

Inventory for a manufacturing company consists of (1) raw materials, (2) work in process, and (3) finished goods. Raw materials represent the cost, primarily purchase price plus freight charges, of goods purchased from other manufacturers that will become part of the finished product. Work-in-process inventory represents the products that are not yet complete. The cost of work in process includes the cost of raw materials used in production, the cost of labor that can be directly traced to the goods in process, and an allocated portion of other manufacturing costs, called manufacturing overhead. When the manufacturing process is completed, these costs that have been accumulated in work in process are transferred to finished goods.

Beginning inventory plus net purchases for the period equals cost of goods available for sale. The main difference between a perpetual and a periodic system is that the periodic system allocates cost of goods available for sale to ending inventory and cost of goods sold only at the end of the period. The perpetual system accomplishes this allocation by decreasing inventory and increasing cost of goods sold each time goods are sold.

(4) payment of freight debit inventory debit freight-in

8-1

Chapter 08 - Inventories: Measurement

Answers to Questions (continued)

Question 8-5

Question 8-6

Question 8-7

Question 8-8

Question 8-9 When costs are declining, LIFO will result in a lower cost of goods sold and higher income

than FIFO. This is because LIFO will include in cost of goods sold the most recently purchased lower cost merchandise. LIFO also will provide a higher ending inventory in the balance sheet.

A consignment is an arrangement under which goods are physically transferred to another company (the consignee), but the transferor (consignor) retains legal title. If the consignee can’t find a buyer, the goods are returned to the consignor. Goods held on consignment are included in the inventory of the consignor until sold by the consignee.

By the gross method purchase discounts not taken are viewed as part of inventory cost. By the net method purchase discounts not taken are considered interest expense, because they are viewed as compensation to the seller for providing financing to the buyer.

1. Beginning inventory — increase2. Purchases — increase3. Ending inventory — decrease4. Purchase returns — decrease5. Freight-in — increase

Four methods of assigning cost to ending inventory and cost of goods sold are (1) specific identification, (2) first-in, first-out (FIFO), (3) last-in, first-out (LIFO), and (4) average cost. The specific identification method requires each unit sold during the period or each unit on hand at the end of the period to be traced through the system and matched with its actual cost. First-in, first-out (FIFO) assumes that units sold are the first units acquired. The last-in, first-out (LIFO) method assumes that the units sold are the most recent units purchased. The average cost method assumes that cost of goods sold and ending inventory consist of a mixture of all the goods available for sale. The average unit cost applied to goods sold or ending inventory is an average unit cost weighted by the number of units acquired at the various unit prices.

8-2


Answers to Questions (continued)

Question 8-10

Question 8-11

Question 8-12

Question 8-13

Question 8-14 The dollar-value LIFO method has important advantages. First, it simplifies the recordkeeping

procedures compared to unit LIFO because no information is needed about unit flows. Second, it minimizes the probability of the liquidation of LIFO inventory layers, even more so than the use of pools alone, through the aggregation of many types of inventory into larger pools. In addition, firms that do not replace units sold with new units of the same kind can use the method.

Proponents of LIFO argue that it provides a better match of revenues and expenses because cost of goods sold includes the costs of the most recent purchases. These are matched with sales that reflect a current selling price. On the other hand, inventory costs in the balance sheet generally are out of date because they are derived from old purchase transactions. It is conceivable that a company’s LIFO inventory balance could be based on unit costs actually incurred several years earlier. When inventory quantity declines during a period, then these out-of-date inventory layers will be liquidated and cost of goods sold will match noncurrent costs with current selling prices.

Many companies choose the LIFO inventory method to reduce income taxes in periods when prices are rising. In periods of rising prices, LIFO results in a higher cost of goods sold and therefore a lower net income than the other methods. The companies’ income tax returns will report lower taxable incomes using LIFO and lower taxes will be paid currently. If a company uses LIFO to measure its taxable income, IRS regulations require that LIFO also be used to measure income reported to investors and creditors.

The gross profit, inventory turnover, and average days in inventory ratios are designed to monitor inventories. The gross profit ratio is calculated by dividing gross profit (net sales minus cost of goods sold) by net sales. Inventory turnover is calculated by dividing cost of goods sold by average inventory, and we compute average days in inventory by dividing the number of days in the period by the inventory turnover ratio.

A LIFO inventory pool groups inventory units into pools based on physical similarities of the individual units. The average cost for all of a pool’s beginning inventory and for all of a pool’s purchases during the period is used instead of individual unit costs. If the quantity of ending inventory for the pool increases, then ending inventory will consist of the beginning inventory plus a layer added during the period at the average acquisition cost for the pool.

8-3


Answers to Questions (concluded)

Question 8-15

Question 8-16 between U.S. GAAP and IFRS in the methods allowed to value

inventory is that IFRS does not allow the use of the LIFO method.

After determining ending inventory at year-end cost, the following steps remain:

1. Convert ending inventory valued at year-end cost to base year cost.2. Identify the layers in ending inventory with the years they were created.3. Convert each layer’s base year cost measurement to layer year cost measurement using the

layer year’s cost index and then sum the layers.

The primary difference

8-4


Beginning inventory $186,000Plus: Purchases 945,000Less: Cost of goods sold (982,000) Ending inventory $149,000

To record the purchase of inventory on account.

Inventory....................................................................... 845,000Accounts payable...................................................... 845,000

To record sales on account and cost of goods sold.

Accounts receivable......................................................1,420,000Sales revenue............................................................. 1,420,000

Cost of goods sold......................................................... 902,000Inventory................................................................... 902,000

BRIEF EXERCISES

Brief Exercise 8-1

Brief Exercise 8-2

8-5


Both shipments should be included in inventory. The goods shipped to a customer f.o.b. destination did not arrive at the customer’s location until after the fiscal year-end. They belong to Kelly until they arrive at the customer’s location. Title to the goods shipped from a supplier to Kelly on December 30, f.o.b. shipping point, changed hands on December 30.

Purchase price = 10 units x $25,000 = $250,000

December 28, 2011Inventory....................................................................... 250,000

Accounts payable...................................................... 250,000

January 6, 2012Accounts payable.......................................................... 250,000

Cash (99% x $250,000)................................................. 247,500Inventory (1% x $250,000)........................................... 2,500

Brief Exercise 8-3

Brief Exercise 8-4

Brief Exercise 8-5

8-6


December 28, 2011Inventory (99% x $250,000).............................................. 247,500

Accounts payable ..................................................... 247,500

January 6, 2012Accounts payable.......................................................... 247,500

Cash.......................................................................... 247,500

Cost of goods available for sale:

Beginning inventory (200 x $25) $5,000Purchases:

100 x $28 $2,800200 x $30 6,000 8,800

Cost of goods available (500 units) $13,800

First-in, first-out (FIFO)

Cost of goods available for sale (500 units) $13,800Less: Ending inventory (determined below) (8,100) Cost of goods sold $5,700

Cost of ending inventory:

Date of purchase Units Unit cost Total costJanuary 8 75 $28 $2,100January 19 200 30 6,000 Total $8,100

Average cost

Cost of goods available for sale (500 units) $13,800Less: Ending inventory (determined below) (7,590) Cost of goods sold $6,210 *

Brief Exercise 8-6

8-7


Cost of ending inventory: $13,800

Weighted-average unit cost = = $27.60 500 units

275 units x $27.60 = $7,590

* Alternatively, could be determined by multiplying the units sold by the average cost: 225 units x $27.60 = $6,210


Cost of goods sold:

Date of Cost of sale Units sold Units Sold Total Cost

January 10 125 (from Beg. Inv.) $25 $3,125January 25 75 (from Beg. Inv.) 25 1,875 25 (from 1/8 purchase) 28 700 Total 225 $5,700

Ending inventory: Date of purchase Units Unit cost Total costJanuary 8 75 $28 $2,100January 19 200 30 6,000 Total $8,100

Brief Exercise 8-7

8-8


Brief Exercise 8-7 (concluded)

Average costDate Purchased Sold Balance

Beginning inventory

200 @ $25 = $5,000 200 @ $25 $5,000

January 8

Available

100 @ $28 = $2,800

$7,800

= $26/unit 300 units

January 10 125 @ $26 = $3,250 175 @ $26 $4,550

January 19

Available

200 @ $30 = $6,000

$10,550

= $28.133/unit 375 units

January 25 100 @ $28.133 = $2,813 275 @ $28.133 $7,737Ending

inventoryTotal cost of goods sold = $6,063

8-9


Cost of goods available for sale:Beginning inventory (20,000 x $25) $ 500,000Purchases:

80,000 x $30 2,400,000Cost of goods available (100,000 units) 2,900,000Less: Ending inventory (15,000 units) 375,000* Cost of goods sold $2,525,000

15,000 units x $25 each = $375,000

64,000 units were sold.

Cost of goods sold without year-end purchase:Units purchased during the year: 60,000 x $18 $1,080,000Plus units from beginning inventory: 4,000 x $15 60,000 Cost of goods sold 1,140,000

Cost of goods sold with year-end purchase:64,000 units x $18 1,152,000 Difference $ 12,000

Cost of goods sold would be $12,000 higher and income before income taxes $12,000 lower if the year-end purchase is made.

If FIFO were used instead of LIFO, the year-end purchase would have no effect on income before income taxes. FIFO cost of goods sold with or without the purchase would consist of the 10,000 units from beginning inventory and 54,000 units purchased during the year at $18:

10,000 units x $15 $ 150,000Plus: 54,000 units x $18 972,000 Cost of goods sold $1,122,000

Brief Exercise 8-8

Brief Exercise 8-9

Brief Exercise 8-10

8-10


Units liquidated 5,000Difference in cost ($30 – 25) x $5 Before tax LIFO liquidation profit $25,000Tax effect ($25,000 x 40%) (10,000) LIFO liquidation profit $15,000

Cost of goods sold for the fiscal year ended February 28, 2009 would have been $78 million lower had SuperValue used FIFO for its LIFO inventory. While beginning inventory would have been $180 million higher, ending inventory also would have been higher by $258 million. An increase in beginning inventory causes an increase in cost of goods sold, but an increase in ending inventory causes a decrease in cost of goods sold. Purchases for the year are the same regardless of the inventory valuation method used.

Cost of goods sold as reported $34,451 millionDecrease if FIFO (78) million Cost of goods sold, FIFO instead of LIFO $34,373 million

Average inventory = ($60,000 + 48,000) 2 = $54,000

Cost of goods sold Average inventory = Inventory turnover

Brief Exercise 8-11

Brief Exercise 8-12

8-11


Cost of goods sold $54,000 = 5Cost of goods sold = $54,000 x 5Cost of goods sold = $270,000

Gross profit ratio = 40%, therefore cost percentage = 60%

Sales x .60 = $270,000Sales = $270,000 .60 = $450,000

Ending Inventory Inventory Layers Inventory Layers Inventory Date at Base Year Cost at Base Year Cost Converted to Cost DVL Cost

1/1/11 $1,400,000

= $1,400,000 $1,400,000 (base) $1,400,000 x 1.00 =$1,400,000 $1,400,000 1.00

12/31/11 $1,664,000

= $1,600,000 $1,400,000 (base) $1,400,000 x 1.00 = $1,400,000 1.04 200,000 (2011) 200,000 x 1.04 = 208,000 $1,608,000

Brief Exercise 8-13

8-12


1. To record the purchase of inventory on account and the payment of freight charges.

Inventory....................................................................... 5,000Accounts payable...................................................... 5,000

Inventory....................................................................... 300Cash.......................................................................... 300

2. To record purchase returns.

Accounts payable.......................................................... 600Inventory................................................................... 600

3. To record cash sales and cost of goods sold.

Cash.............................................................................. 5,200Sales revenue............................................................. 5,200


EXERCISES

Exercise 8-1

8-13


Exercise 8-21. To record the purchase of inventory on account and the payment of freight

charges.

Purchases...................................................................... 5,000Accounts payable...................................................... 5,000

Freight-in...................................................................... 300Cash.......................................................................... 300

2. To record purchase returns.

Accounts payable.......................................................... 600Purchase returns........................................................ 600

3. To record cash sales.

Cash.............................................................................. 5,200Sales revenue............................................................. 5,200

NO ENTRY IS MADE FOR THE COST OF GOODS SOLD.

8-14


Exercise 8-3

Requirement 1Beginning inventory $ 32,000Plus net purchases:

Purchases $240,000Less: Purchase discounts (6,000)Less: Purchases returns (10,000)Plus: Freight-in 17,000 241,000

Cost of goods available for sale 273,000Less: Ending inventory (40,000)Cost of goods sold $233,000

Requirement 2

Cost of goods sold (above)............................................. 233,000Inventory (ending).......................................................... 40,000Purchase discounts........................................................ 6,000Purchase returns............................................................ 10,000

Inventory (beginning).................................................. 32,000Purchases.................................................................. 240,000Freight-in................................................................... 17,000

8-15


Exercise 8-4

PERPETUAL SYSTEM PERIODIC SYSTEM($ in 000s)

PurchasesInventory 155 Purchases 155

Accounts payable 155 Accounts payable 155

FreightInventory 10 Freight-in 10

Cash 10 Cash 10

ReturnsAccounts payable 12 Accounts payable 12

Inventory 12 Purchase returns 12

SalesAccounts receivable 250 Accounts receivable 250

Sales revenue 250 Sales revenue 250

Cost of goods sold 148 No entryInventory 148

End of periodNo entry Cost of goods sold (below) 148

Inventory (ending) 30Purchase returns 12

Inventory (beginning) 25Purchases 155Freight-in 10

Cost of goods sold:Beginning inventory $25Purchases $155Less: Returns (12)Plus: Freight-in 10Net purchases 153Cost of goods available 178Less: Ending inventory (30)Cost of goods sold $148

8-16


Exercise 8-52011 2012 2013

Beginning inventory 275 (1) 249 (3) 225Cost of goods sold 627 621 584 (6)Ending inventory 249 (2) 225 216Cost of goods available for sale 876 846 (4) 800Purchases (gross) 630 610 (5) 585Purchase discounts 18 15 12 (7)Purchase returns 24 30 14Freight-in 13 32 16

Net purchases = Purchases(gross) - Purchase returns - Purchase discounts + Freight-inBeginning inventory + Net purchases = Cost of goods available for saleCost of goods available for sale - Ending inventory = Cost of goods sold

2011:(1) Cost of goods available for sale - Net purchases = Beginning inventory 876 - (630 - 18 - 24 + 13) = 275 = Beginning inventory

(2) Cost of goods available for sale - Cost of goods sold = Ending inventory 876 - 627 = 249 = Ending inventory

2012:(3) 2012 beginning inventory = 2011 ending inventory = 249

(4) Cost of goods sold + Ending inventory = Cost of goods available for sale 621 + 225 = 846 = Cost of goods available for sale

(5) Cost of goods available for sale - Beginning inventory = Net purchases 846 - 249 = 597 = Net purchases

Net purchases + Purchases discounts + Purchase returns - Freight-in = Purchases(gross) 597 + 15 + 30 - 32 = 610 = Purchases (gross)

2013:(6) Cost of goods available for sale - Ending inventory = Cost of goods sold 800 - 216 = 584 = Cost of goods sold

8-17


Exercise 8-5 (concluded)

(7) Cost of goods available for sale - Beginning inventory = Net purchases 800 - 225 = 575 = Net purchases Purchases(gross) - Purchase returns + Freight-in - Net purchases = Purchase discounts 585 - 14 + 16 - 575 = 12 = Purchase discounts

Inventory balance before additional transactions$165,000

Add: Goods shipped to Kwok f.o.b. shipping point on Dec. 28 17,000 Goods shipped to customer f.o.b. destination on December 27 22,000 Correct inventory balance $204,000

Inventory balance before additional transactions$210,000

Add: Merchandise on consignment with Joclyn Corp. 15,000Deduct: Merchandise shipped to Raymond f.o.b. destination on December 26 (30,000) Merchandise held on consignment from the Harrison Company (14,000) Correct inventory balance $181,000

1. Excluded

2. Included3. Included4. Excluded5. Included6. Excluded7. Included8. Included

Exercise 8-6

Exercise 8-7

Exercise 8-8

8-18


Exercise 8-9

Requirement 1

Purchase price = 1,000 units x $50 = $50,000

July 15, 2011Purchases...................................................................... 50,000


July 23, 2011Accounts payable.......................................................... 50,000

Cash (98% x $50,000)................................................... 49,000Purchase discounts (2% x $50,000).............................. 1,000

Requirement 2

August 15, 2011Accounts payable.......................................................... 50,000

Cash.......................................................................... 50,000

Requirement 3The July 15 entry would include a debit to the inventory account instead of to

purchases, and the July 23 entry would include a credit to the inventory account instead of to purchase discounts.

8-19


Exercise 8-10

Requirement 1

July 15, 2011Purchases (98% x $50,000)............................................... 49,000


July 23, 2011Accounts payable.......................................................... 49,000

Cash.......................................................................... 49,000

Requirement 2

August 15, 2011Accounts payable.......................................................... 49,000Interest expense............................................................. 1,000

Cash.......................................................................... 50,000

Requirement 3The July 15 entry would include a debit to the inventory account instead of to

purchases.

8-20


Exercise 8-11

Requirement 1Purchases: $500 x 70% = $350 per unit. 100 units x $350 = $35,000

November 17, 2011Purchases...................................................................... 35,000


November 26, 2011Accounts payable ......................................................... 35,000

Purchase discounts (2% x $35,000).............................. 700Cash (98% x $35,000)................................................... 34,300

Requirement 2

December 15, 2011Accounts payable.......................................................... 35,000

Cash.......................................................................... 35,000

8-21



Requirement 3

Requirement 1:

November 17, 2011Purchases (98% x $35,000)............................................... 34,300


November 26, 2011Accounts payable.......................................................... 34,300

Cash.......................................................................... 34,300

Requirement 2:

December 15, 2011Accounts payable.......................................................... 34,300Interest expense (2% x $35,000)....................................... 700

Cash.......................................................................... 35,000

8-22


Exercise 8-12

The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is:

1. Define the meaning of cost as it applies to the initial measurement of inventory.

FASB ASC 330–10–30–1: “Inventory–Overall–Initial Measurement.”

The primary basis of accounting for inventories is cost, which has been defined generally as the price paid or consideration given to acquire an asset. As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location. It is understood to mean acquisition and production cost, and its determination involves many considerations.

2. Indicate the circumstances when it is appropriate to initially measure agricultural inventory at fair value.

FASB ASC 905–330–30–1: “Agriculture–Inventory–Initial Measurement.”

Exceptional cases exist in which it is not practicable to determine an appropriate cost basis for products. A market basis is acceptable if the products meet all of the following criteria:

a. They have immediate marketability at quoted market prices that cannot be influenced by the producer.

b. They have characteristics of unit interchangeability.

c. They have relatively insignificant costs of disposal.

The accounting basis of those kinds of inventories shall be their realizable value, calculated on the basis of quoted market prices less estimated direct costs of disposal. An example is freshly dressed meats produced in meat packing operations.

8-23



3. What is a major objective of accounting for inventory?

FASB ASC 330–10–10–1: “Inventory–Overall–Objectives.”

A major objective of accounting for inventories is the proper determination of income through the process of matching appropriate costs against revenues.

4. Are abnormal freight charges included in the cost of inventory?

FASB ASC 330–10–30–7: “Inventory–Overall–Initial Measurement.”

Unallocated overheads shall be recognized as an expense in the period in which they are incurred. Other items such as abnormal freight, handling costs, and amounts of wasted materials (spoilage) require treatment as current period charges rather than as a portion of the inventory cost.

8-24


Exercise 8-13Cost of goods available for sale:Beginning inventory (2,000 x $6.10) $12,200Purchases:

10,000 x $5.50 $55,000 6,000 x $5.00 30,000 85,000

Cost of goods available (18,000 units) $97,200


Cost of goods available for sale (18,000 units) $97,200Less: Ending inventory (determined below) (15,000) Cost of goods sold $82,200


Date of purchase Units Unit cost Total costAugust 18 3,000 $5.00 $15,000

Last-in, first-out (LIFO)

Cost of goods available for sale (18,000 units) $97,200Less: Ending inventory (determined below) (17,700) Cost of goods sold $79,500


Date of purchase Units Unit cost Total costBeg. Inv. 2,000 $6.10 $12,200August 8 1,000 5.50 5,500

Total $17,700

8-25



Average cost

Cost of goods available for sale (18,000 units) $97,200Less: Ending inventory (determined below) (16,200) Cost of goods sold $81,000 *


Weighted-average unit cost = = $5.40 18,000 units

3,000 units x $5.40 = $16,200

* Alternatively, could be determined by multiplying the units sold by the average cost: 15,000 units x $5.40 = $81,000

8-26


Exercise 8-14First-in, first-out (FIFO)

Cost of goods sold:

Date of Cost of sale Units sold Units Sold Total Cost

Aug. 14 2,000 (from Beg. Inv.) $6.10 $12,200 6,000 (from 8/8 purchase) 5.50 33,000Aug. 25 4,000 (from 8/8 purchase) 5.50 22,000 3,000 (from 8/18 purchase) 5.00 15,000 Total 15,000 $82,200

Ending inventory = 3,000 units x $5.00 = $15,000

Last-in, first-out (LIFO)Date Purchased Sold Balance

Beginning inventory

2,000 @ $6.10 = $12,200 2,000 @ $6.10 $12,200

August 8 10,000 @ $5.50 = $55,000 2,000 @ $6.1010,000 @ $5.50 $67,200

August 14 8,000 @ $ 5.50 = $44,000 2,000 @ $6.10 2,000 @ $5.50 $23,200

August 18 6,000 @ $5.00 = $30,000 2,000 @ $6.10 2,000 @ $5.50 $53,200 6,000 @ $5.00

August 25 6,000 @ $5.00 = $30,0001,000 @ $5.50 = $ 5,500

2,000 @ $6.10 1,000 @ $5.50 $17,700

Ending inventory

Total cost of goods sold = $79,500

8-27



(Note: the perpetual inventory LIFO results in this exercise are the same as periodic LIFO results, due to the timing of sales and purchases. The same LIFO layers are on hand at the end of the period under each method. This is unusual. LIFO perpetual and LIFO periodic normally produce different results for ending inventory and cost of goods sold.)

Average costDate Purchased Sold Balance

Beginning inventory

2,000 @ $6.10 = $12,200 2,000 @ $6.10 $12,200

August 8

Available

10,000 @ $5.50 = $55,000

$67,200

= $5.60/unit12,000 units

August 14 8,000 @ $5.60 = $44,800 4,000 @ $5.60 $22,400

August 18

Available

6,000 @ $5.00 = $30,000

$52,400

= $5.24/unit10,000 units

August 25 7,000 @ $5.24 = $36,680 3,000 @ $5.24 $15,720Ending


8-28


Exercise 8-15Requirement 1

LIFO will result in the highest cost of goods sold figure because both the cost of merchandise and the quantity of merchandise rose during the period. FIFO will result in the highest ending inventory balance for the same reasons.

Requirement 2Cost of goods available for sale:Beginning inventory (600 x $80) $ 48,000Purchases:

1,000 x $ 95 $95,000 800 x $100 80,000 175,000



Cost of goods available for sale (2,400 units) $223,000Less: Ending inventory (below) (80,000) Cost of goods sold $143,000


Date of purchase Units Unit cost Total costJanuary 21 800 $100 $80,000

Last-in, first-out (LIFO)

Cost of goods available for sale (2,400 units) $223,000Less: Ending inventory (below) (67,000) Cost of goods sold $156,000


Date of purchase Units Unit cost Total costBeg. Inv. 600 $80 $48,000January 15 200 95 19,000

Total $67,000

8-29


Requirement 1

Cost of goods available for sale:Beginning inventory (5,000 x $10.00) $ 50,000Purchases:

3,000 x $10.40 $31,2008,000 x $10.75 86,000 117,200


Cost of goods available for sale (16,000 units) $167,200Less: Ending inventory (below) (73,150) Cost of goods sold $ 94,050*


$167,200Weighted-average unit cost = = $10.45

16,000 units

7,000 units x $10.45 = $73,150

* Alternatively, could be determined by multiplying the units sold by the average cost: 9,000 units x $10.45 = $94,050

Exercise 8-16

8-30



Requirement 2

Date Purchased Sold Balance

Beginning inventory

5,000 @ $10.00 = $50,000 5,000 @ $10.00 $50,000

September 7

Available

3,000 @ $10.40 = $31,200

$81,200

= $10.15/unit8,000 units

September 10 4,000 @ $10.15 = $40,600 4,000 @ $10.15 $40,600

September 25

Available

8,000 @ $10.75 = $86,000

$126,600

= $10.55/unit12,000 units

September 29 5,000 @ $10.55 = $52,750 7,000 @ $10.55 $73,850Ending


8-31


Exercise 8-17

Requirement 1FIFO cost of goods sold:

10,000 units @ $5.00 = $50,000+ 10,000 units @ $6.00 (determined below) = 60,000

$110,000

Requirement 2LIFO cost of goods sold:

20,000 units @ $6.00 (determined below) = $120,000

Calculations to determine cost per unit of year 2011 purchases:

Cost of goods sold = Weighted-average cost per unitNumber of units sold

$115,000 = $5.75 per unit20,000 units

$5.75 x 40,000 units = $230,000 = Cost of goods available for sale

$230,000 - $50,000 (beginning inventory) = $180,000 = Cost of purchases

$180,000 = $6 = Cost per unit of year 2011 purchases30,000 units purchased

Cost of goods available for sale:

Beginning inventory (10,000 x $5.00) $ 50,000Purchases (30,000 x $6.00) 180,000Cost of goods available (40,000 units) $230,000

8-32


Exercise 8-18

Requirement 1

February 27, 2009 ($ in millions)LIFO reserve ($29.6-27.2)............................................... 2.4

Cost of goods sold..................................................... 2.4

Requirement 2

Requirement 1Cost of goods sold:50,000 units x $8.50 = $425,000 4,000 units x $7.00 = 28,000

$453,000

Requirement 2When inventory quantity declines during a reporting period, liquidation of LIFO

inventory layers carried at different costs prevailing in prior years results in noncurrent costs being matched with current selling prices. If the resulting effect on income is material, it must be disclosed. In this case, the effect of the LIFO layer liquidation is to increase income (ignoring taxes) by $6,000 [4,000 units liquidated x $1.50 ($8.50 current year cost per unit - $7 LIFO layer cost per unit)].

Requirement 2

The specific citation that describes the disclosure requirements that must be made by publicly traded companies for a LIFO liquidation is FASB ASC 330–10–S99–3: “Inventory–Overall–SEC Materials–LIFO Liquidations.”

Requirement 3When a company using LIFO liquidates a substantial portion of its LIFO

inventory and as a result includes a material amount of income in its income statement

$2,236.7 + 2.4 = $2,239.1 million

Exercise 8-19

Exercise 8-20

8-33


that otherwise would not have been recorded must disclose the amount of income realized as a result of the inventory liquidation.

Such disclosure would be required in order to make the financial statements not misleading. Disclosure may be made either in a footnote or parenthetically on the face of the income statement.

8-34


Exercise 8-21

($ in millions)

HOME DEPOT LOWE’S

Gross profit ratio = 23,990 = 33.7% 16,501 = 34.2% 71,288 48,230

Inventory turnover = 47,298 = 4.22 31,729 = 4.01 11,202 7,910

Average days = 365 = 86 days 365 = 91 days in inventory 4.22 4.01

The gross profit ratios for the two companies are almost identical and similar to the industry average (33%). On average, Home Depot turns over its inventory five days faster than both Lowe’s and the industry average.

Ending


1/1/11 $660,000

= $660,000 $660,000 (base) $660,000 x 1.00 = $660,000 $660,000 1.00

12/31/11 $690,000

= $663,462 $660,000 (base) $660,000 x 1.00 = $660,000 1.04 3,462 (2011) 3,462 x 1.04 = 3,600 663,600

12/31/12 $760,000

= $703,704 $660,000 (base) $660,000 x 1.00 = $660,000 1.08 3,462 (2011) 3,462 x 1.04 = 3,600

40,242 (2012) 40,242 x 1.08 = 43,461 707,061

Exercise 8-22

8-35


Exercise 8-23Ending


12/31/11 $200,000

= $200,000 $200,000 (base) $200,000 x 1.00 = $200,000 $200,000 1.00

12/31/12 $231,000

= $220,000 Index = 1.05 Index

$200,000 (base) $200,000 x 1.00 = $200,000 20,000 (2012) 20,000 x 1.05 = 21,000 221,000

12/31/13 $299,000

= $260,000 Index = 1.15 Index

$200,000 (base) $200,000 x 1.00 = $200,000 20,000 (2012) 20,000 x 1.05 = 21,000 40,000 (2013) 40,000 x 1.15 = 46,000 267,000

12/31/14 $300,000

= $250,000 Index = 1.20 Index

$200,000 (base) $200,000 x 1.00 = $200,000 20,000 (2012) 20,000 x 1.05 = 21,000 30,000 (2013) 30,000 x 1.15 = 34,500 255,500

8-36


Exercise 8-24

List A List B

i 1. Perpetual inventory a. Legal title passes when goods are system delivered to common carrier.

l 2. Periodic inventory system b. Goods are transferred to another company but title remains with transferor.

a 3. F.o.b. shipping point c. Purchase discounts not taken are included in inventory cost.

c 4. Gross method d. If LIFO is used for taxes, it must be used for financial reporting.

g 5. Net method e. Items sold are those acquired first. h 6. Cost index f. Items sold are those acquired last. k 7. F.o.b. destination g. Purchase discounts not taken are

considered interest expense. e 8. FIFO h. Used to convert ending inventory at year-

end cost to base year cost. f 9. LIFO i. Continuously records changes in

inventory. b 10. Consignment j. Items sold come from a mixture of goods

acquired during the period. j 11. Average cost k. Legal title passes when goods arrive at

location. d 12. IRS conformity rule l. Adjusts inventory at the end of the period.

8-37


CPA Exam Questions

1. d.

2. c. Under the net method, purchases are recorded net of the discount: $3,600 x 98% = $3,528

3. b. Average Cost = $4,950 / 140 units = $35.36 per unit

Ending Inventory = $35.36 x 5 = $176.79

4. a. 5 units x $30 = $150

5. c. 5 units x $50 = $250

6. b. If the inventory balance was lower using FIFO than LIFO, then prices during the period were moving downward. By using FIFO during such a period, the higher priced items are sold first with lower-priced goods remaining in the ending inventory.

7. b.

Inventory Layer Layer at base at base Cost at current Ending

Date year cost year cost Index year cost Inventory 1/1/11 $100,000 1.00 $100,000 12/31/11 120,000 $20,000 1.05 $21,000 121,000 12/31/12 128,000 8,000 1.10 8,800 129,800

CPA / CMA REVIEW QUESTIONS

8-38


8-39


CMA Exam Questions

1. c. The company began March with 3,200 units in inventory at $64.30 each. The March 4 purchase added 3,400 additional units at $64.75 each. Under FIFO, the 3,600 units sold on March 14 were the oldest units. That sale eliminated all of the 3,200 units priced at $64.30 and 400 of the units priced at $64.75, leaving an inventory of 3,000 units at $64.75 prior to the March 25 purchase. On March 25, 3,500 units were acquired at $66. The 3,450 units sold on March 28 were the 3,000 remaining units priced at $64.75 and 450 units priced at $66. The ending inventory consists of 3,050 units at $66 each, or $201,300. The answer would have been the same under the periodic FIFO method.

2. a. The ending inventory consists of 3,050 units (beginning inventory plus purchases, minus sales). Under the periodic LIFO method, those units are valued at the oldest prices for the period, which is $64.30 of the beginning inventory. Multiplying $64.30 times 3,050 units produces a total inventory value of $196,115.

3. a. Under the perpetual LIFO method, the company begins with 3,200 units at $64.30. Added to this is the March 4 purchase of 3,400 units at $64.75. The March 14 sale uses all of the March 4 purchase and 200 of the original inventory units. Thus, the firm is left with 3,000 units at $64.30. The March 25 purchase of 3,500 at $66 is added to the previous 3,000 units. The March 28 sale of 3,450 units comes entirely from the March 25 purchase, leaving just 50 of those units at $66 each. Thus, at the end of the month, the inventory consists of two layers: 3,000 units at $64.30 ($192,200), and 50 units at $66 ($3,300). Adding the two together produces a total ending inventory of $196,200.

8-40


Requirement 1

a. To record the purchase of inventory on account and the payment of freight charges.

October 12, 2011Purchases (98% x $22,000)............................................... 21,560


Freight-in...................................................................... 500Cash.......................................................................... 500

b. To record purchase returns.

October 18, 2011Accounts payable.......................................................... 3,000

Purchase returns........................................................ 3,000

c. To record payment of accounts payable.

October 31, 2011Accounts payable.......................................................... 21,560Interest expense............................................................. 440

Cash.......................................................................... 22,000

PROBLEMS

Problem 8-1

8-41


Problem 8-1 (continued)

d. To record sales on account.

October, 2011Accounts receivable...................................................... 28,000

Sales revenue............................................................. 28,000 No entry is made for the cost of goods sold.

Cost of goods sold:

Beginning inventory $15,000Plus net purchases:

Purchases $21,560Less: Purchases returns (3,000)Plus: Freight-in 500 19,060Cost of goods available for sale 34,060

Less: Ending inventory (16,060)Cost of goods sold $18,000

Adjusting entry:

October 31, 2011Cost of goods sold (above).............................................. 18,000Inventory (ending)........................................................... 16,060Purchase returns............................................................ 3,000

Inventory (beginning).................................................. 15,000Purchases.................................................................. 21,560Freight-in................................................................... 500

8-42


Problem 8-1 (concluded)Requirement 2

a. To record the purchase of inventory on account and the payment of freight charges.

October 12, 2011Inventory (98% x $22,000)............................................... 21,560


Inventory....................................................................... 500Cash.......................................................................... 500

b. To record purchase returns.

October 18, 2011Accounts payable.......................................................... 3,000

Inventory................................................................... 3,000

c. To record payment of accounts payable.

October 31, 2011Accounts payable.......................................................... 21,560Interest expense............................................................. 440

Cash.......................................................................... 22,000

d. To record sales on account.

October, 2011Accounts receivable...................................................... 28,000

Sales revenue............................................................. 28,000


8-43


Problem 8-21. The transaction is not correctly accounted for. Inventory held on consignment by

another company should be included in the inventory of the consignor. Rasul should include this merchandise in its 2011 ending inventory.

2. The transaction is not correctly accounted for. Legal title to merchandise shipped f.o.b. shipping point changes hands when the goods are shipped. Rasul should record the purchase and corresponding account payable in 2011 and include the merchandise in its 2011 ending inventory.

3. The transaction is not correctly accounted for. Since the merchandise was shipped f.o.b. destination and did not arrive at the customer's location until 2012, it should be included in Rasul’s 2011 ending inventory. The sale should be recorded in 2012.

4. The transaction is correctly accounted for. Merchandise held on consignment from another company belongs to the consignor and should be excluded from the inventory of the consignee.

5. The transaction is correctly accounted for. Since the merchandise was shipped f.o.b. destination and did not arrive at Rasul’s location until 2012, it should not be included in Rasul’s 2011 ending inventory. The purchase is correctly recorded in 2012.

Accounts

Inventory Payable SalesInitial amounts $1,250,000 $1,000,000 $9,000,000Adjustments - increase (decrease): 1. (155,000) (155,000) NONE 2. (22,000) NONE NONE 3. NONE NONE 40,000 4. 210,000 NONE NONE 5. 25,000 25,000 NONE 6. 2,000 2,000 NONE 7. (5,300) (5,300) NONETotal adjustments 54,700 (133,300) 40,000Adjusted amounts $1,304,700 $ 866,700 $9,040,000

Problem 8-3

8-44


Problem 8-4

Requirement 1Beginning inventory (10,000 x $8.00) $ 80,000Net purchases:

Purchases (50,000* units x $10.00) $500,000Less: Returns (1,000 units x $10.50) (10,500)Less: Purchase discounts ($490,000 x 2%) (9,800)Plus: Freight-in (50,000 units x $.50) 25,000 504,700

Cost of goods available (59,000 units) 584,700Less: Ending inventory (below) ( 121,200 )Cost of goods sold $463,500

* The 5,000 units purchased on December 28 are not included. The merchandise was shipped f.o.b. destination and did not arrive at Johnson’s warehouse until 2012.


Date of purchase Units Unit cost Total costBeg. Inv. 10,000 $ 8.00 $ 80,0002011 4,000 10.30** 41,200

Total 14,000 $121,200

**$10 x 98% = $9.80 + .50 in freight charges = $10.30

Requirement 2Sales (45,000 units x $18.00) $810,000Less: Cost of goods sold (above) $463,500 Other operating expenses 150,000 (613,500)Income before income taxes $196,500

8-45


Problem 8-5Cost of goods available for sale for periodic system:

Beginning inventory (6,000 x $8.00) $ 48,000Purchases:

5,000 x $ 9.00 $45,000 6,000 x $10.00 60,000 105,000


1. FIFO, periodic system

Cost of goods available for sale (17,000 units) $153,000Less: Ending inventory (determined below) (78,000) Cost of goods sold $ 75,000


Date of purchase Units Unit cost Total costJan. 10 2,000 $ 9.00 $18,000Jan. 18 6,000 10.00 60,000

Totals 8,000 $78,000

Alternatively, cost of goods sold can be determined by adding the cost of the 6,000 units in beginning inventory ($48,000) and the 3,000 units from the January 10 purchase ($27,000) = $75,000.

8-46


Problem 8-5 (continued)

2. LIFO, periodic system



Date of purchase Units Unit cost Total costBeg. Inv. 6,000 $8.00 $48,000Jan. 10 2,000 9.00 18,000

Totals 8,000 $66,000

Alternatively, cost of goods sold can be determined by adding the cost of the 6,000 units from the January 18 purchase ($60,000) and the 3,000 units from the January 10 purchase ($27,000) = $87,000.

8-47


Problem 8-5 (continued)3. LIFO, perpetual system

Date Purchased Sold Balance

Beginning inventory

6,000 @ $8.00 = $48,000 6,000 @ $8.00 $48,000

January 5 3,000 @ $8.00 = $24,000 3,000 @ $8.00 $24,000

January 10 5,000 @ $9.00 = $45,000 3,000 @ $8.005,000 @ $9.00 $69,000

January 12 2,000 @ $9.00 = $18,000 3,000 @ $8.003,000 @ $9.00 $51,000

January 18 6,000 @ $10.00 = $60,000 3,000 @ $8.003,000 @ $9.00 $111,0006,000 @ $10.00

January 20 4,000 @ $10.00 = $40,000 3,000 @ $8.003,000 @ $9.002,000 @ $10.00 $71,000

Ending inventory


4. Average cost, periodic system

Cost of goods available for sale (17,000 units) $153,000Less: Ending inventory (below) (72,000) Cost of goods sold $ 81,000



8,000 units x $9.00 = $72,000

Alternatively, cost of goods sold could be determined by multiplying the units sold by the average cost: 9,000 units x $9.00 = $81,000.

8-48


Problem 8-5 (concluded)

5. Average cost, perpetual systemDate Purchased Sold Balance

Beginning inventory

6,000 @ $8.00 = $48,000 6,000 @ $8.00 $48,000

January 5 3,000 @ $8.00 = $24,000 3,000 @ $8.00 $24,000

January 10

Available

5,000 @ $9.00 = $45,000

$69,000

= $8.625/unit8,000 units

January 12 2,000 @ $8.625 = $17,250 6,000 @ $8.625 $51,750

January 18

Available

6,000 @ $10.00 = $60,000

$111,750

= $9.3125/unit12,000 units

January 20 4,000 @ $9.3125 = $37,250 8,000 @ $9.3125 $74,500Ending

inventory


8-49


Problem 8-6

Requirement 1Cost of goods available for sale for periodic system:

Purchases: 5,000 x $4.00 $20,000 12,000 x $4.50 54,000 17,000 x $5.00 85,000


a. FIFO



Date of purchase Units Unit cost Total costMarch 22 14,000 5.00 70,000

b. LIFO



Date of purchase Units Unit cost Total costJan. 7 5,000 $4.00 $20,000Feb. 16 9,000 4.50 40,500

Totals 14,000 $60,500

8-50



c. Average cost

Cost of goods available for sale (34,000 units) $159,000Less: Ending inventory (below) (65,471) Cost of goods sold $ 93,529*



14,000 units x $4.6765 = $65,471

* Alternatively, could be determined by multiplying the units sold by the average cost: 20,000 units x $4.6765 = $93,530 (rounding)

Gross Profit ratio:

FIFO: $51,000* ÷ $140,000** = 36%

LIFO: $41,500* ÷ $140,000** = 30%

Average: $46,471* ÷ $140,000** = 33%

*Sales less cost of goods sold**20,000 units x $7 sales price = sales

Requirement 2In situations when costs are rising, LIFO results in a higher cost of goods sold

and, therefore, a lower gross profit ratio than FIFO.

8-51


Problem 8-7

Requirement 1Beginning inventory ($60,000 + 60,000 + 63,000) $183,000Purchases:

211 $63,000212 63,000213 64,500214 66,000215 69,000216 70,500217 72,000218 72,300219 75,000 615,300

Cost of goods available 798,300

Ending inventory:213 $64,500216 70,500219 75,000 (210,000)

Cost of goods sold $588,300

Requirement 2

Cost of goods available for sale $798,300Less: Ending inventory (below) (219,300) Cost of goods sold $579,000

Cost of ending inventory (3 autos):

Car ID Cost219 $ 75,000218 72,300217 72,000 Total $219,300

8-52



Requirement 3

Cost of goods available for sale $798,300Less: Ending inventory (below) (183,000) Cost of goods sold $615,300

Cost of ending inventory (3 autos):

Car ID Cost203 $ 60,000207 60,000210 63,000 Total $183,000

Requirement 4

Cost of goods available for sale (12 units) $798,300Less: Ending inventory (below) (199,575) Cost of goods sold $598,725*


Weighted-average unit cost = = $66,525 12 units

3 units x $66,525 = $199,575

* Alternatively, could be determined by multiplying the units sold by the average cost: 9 units x $66,525 = $598,725

8-53


Problem 8-8

Requirement 1The note indicates that if the company had used FIFO, inventory would have

been higher by $3,183 million and $2,617 million at the end of 2008 and 2007, respectively. Therefore, 2008 cost of goods sold would have been lower (and income before tax higher) by $566 million ($3,183 - 2,617).

The information provided also states that net income for 2008 would have been higher by $447 million if FIFO had been used. This means that the tax effect of the difference between LIFO and FIFO was $119 million ($566 - 447). The effective tax rate is therefore approximately 21% ($119 ÷ $566).

Requirement 2The information might be useful to a financial analyst interested in comparing

Caterpillar’s performance with another company using the FIFO inventory method exclusively.

Requirement 3Retained earnings would have been higher by approximately $2,515 million

[$3,183 million x (1 - .21)].

8-54


Problem 8-9

Requirement 1Beginning inventory $ 450,000Purchases:

30,000 units @ $25 750,000Cost of goods available for sale 1,200,000Less: Ending inventory (below) (250,000)Cost of goods sold $ 950,000


Date of purchase Units Unit cost Total costBeg. Inv. 10,000 $15 $150,000Beg. Inv. 5,000 20 100,000 Totals 15,000 $250,000

Requirement 2Cost of goods sold assuming all units purchased at the year 2011 price:40,000 units x $25.00 = $1,000,000 Less: LIFO cost of goods sold (950,000)LIFO liquidation profit before tax 50,000Multiplied by 1 - .40 x .60 LIFO liquidation profit $ 30,000

Requirement 3$50,000 x 40% = $20,000

8-55


Problem 8-10

Requirement 1

Cost of goods sold:2011: 1,000 x $16 = $ 16,000

10,000 x $18 = 180,00011,000 $196,000

2012: 1,500 x $16 = $ 24,00013,000 x $18 = 234,00014,500 $258,000

2013: 1,000 x $12 = $ 12,00012,000 x $18 = 216,00013,000 $228,000

Requirement 2

LIFO liquidation before-tax profit or loss:2011: 1,000 units x $2 ($18 – 16) = $2,000 profit2012: 1,500 units x $2 ($18 – 16) = $3,000 profit2013: 1,000 units x $6 ($18 – 12) = $6,000 profit

Requirement 3

Disclosure note:

During fiscal 2013, 2012, and 2011, inventory quantities in certain LIFO layers were reduced. These reductions resulted in a liquidation of LIFO inventory quantities carried at lower costs prevailing in prior years as compared with the cost of fiscal 2013, 2012, and 2011 purchases. As a result, cost of goods sold decreased by $6,000, $3,000, and $2,000 in fiscal 2013, 2012, and 2011, respectively, and net income increased by approximately $3,600, $1,800, and $1,200, respectively.

8-56


Problem 8-11

Requirement 1Sales (27,000 units x $2,000) $54,000,000Less: Cost of goods sold (27,000 units x $1,000) (27,000,000) Gross profit $27,000,000

Gross profit ratio = $27,000,000 $54,000,000 = 50%

Requirement 2

Sales (27,000 units x $2,000) $54,000,000Less: Cost of goods sold* (25,000,000) Gross profit $29,000,000

Gross profit ratio = $29,000,000 $54,000,000 = 53.7%

*Cost of goods sold: 15,000 units x $1,000 = $15,000,000 6,000 units x $ 900 = 5,400,000 4,000 units x $ 800 = 3,200,000 2,000 units x $ 700 = 1,400,000 27,000 units $25,000,000

8-57



Requirement 3The gross profit and gross profit ratio are higher applying the requirement 2

assumption of 15,000 units purchased because of the LIFO liquidation profit that results. When inventory quantity declines during a reporting period, LIFO inventory layers carried at costs prevailing in prior years are “liquidated” or assumed sold in the cost of goods sold calculation. This results in noncurrent costs being matched with current selling prices. If the company had purchased at least 27,000 units during 2007, there would be no LIFO liquidation.

The profit difference ($2,000,000 in this case), if material, must be disclosed in a note. The difference can be arrived at by comparing the current replacement cost of $1,000 with each inventory layer from prior years that were included in this year’s cost of goods sold, as follows:

6,000 units x $100 ($1,000 – 900) $ 600,0004,000 units x $200 ($1,000 – 800) 800,0002,000 units x $300 ($1,000 – 700) 600,000 Total LIFO liquidation profit $2,000,000

Requirement 4Sales (27,000 units x $2,000) $54,000,000Cost of goods sold:

5,000 units x $700 $ 3,500,000 4,000 units x $800 3,200,000 6,000 units x $900 5,400,00012,000 units x $1,000 12,000,000 24,100,000

27,000 units Gross profit = $29,900,000

Gross profit ratio = $29,900,000 $54,000,000 = 55.4%

If only 15,000 units are purchased, cost of goods sold, gross profit, and the gross profit ratio would be exactly the same as when 28,000 units are purchased.

Requirement 5The number of units purchased has no effect on FIFO cost of goods sold. When

applying the first-in, first-out approach, beginning inventory costs are included in cost of goods sold first, regardless of the quantities of inventory purchased in the new reporting period.

8-58


Requirement 1

Allowance for uncollectible accounts

Balance, beginning of year $7Add: Bad debt expense for 2011 8Less: End-of-year balance (10) Accounts receivable written off $ 5

Requirement 2Accounts receivable analysis:

Balance, beginning of year ($583 + 7) $ 590Add: Credit sales 6,255Less: write-offs (from Requirement 1) (5)Less: Balance end of year ($703 + 10) (713) Cash collections $6,127

Requirement 3Cost of goods sold for 2011 would have been $130 million lower had Inverness

used the average cost method for its entire inventory. While beginning inventory would have been $350 million higher, ending inventory also would have been higher by $480 million. An increase in beginning inventory causes an increase in cost of goods sold, but an increase in ending inventory causes a decrease in cost of goods sold. Purchases for the year are the same regardless of the inventory valuation method used. Therefore, cost of goods sold would have been $5,060 ($5,190 – 130).

Requirement 4

a. Receivables turnover ratio = $6,255 = 9.73($703 + 583)/2

b. Inventory turnover ratio = $5,190 = 6.15 ($880 + 808)/2

c. Gross profit ratio = ($6,255- 5,190) = 17% $6,255

Problem 8-12

8-59



Requirement 5If inventory costs are increasing, when inventory quantity declines during a

period, liquidation of LIFO inventory layers carried at lower costs prevailing in prior years results in noncurrent costs being matched with current selling prices. The “income” generated by this liquidation is known as LIFO liquidation profit.

The liquidation caused 2011 cost of goods sold to be lower by $9.23 million [$6 million (1 - .35)]

8-60


Problem 8-13Ending


1/1/11 $400,000

= $400,000 $400,000 (base) $400,000 x 1.00 = $400,000 $400,000 1.00

12/31/11 $441,000

= $420,000 $400,000 (base) $400,000 x 1.00 = $400,000 1.05 20,000 (2011) 20,000 x 1.05 = 21,000 421,000

12/31/12 $487,200

= $435,000 $400,000 (base) $400,000 x 1.00 = $400,000 1.12 20,000 (2011) 20,000 x 1.05 = 21,000

15,000 (2012) 15,000 x 1.12 = 16,800 437,800

12/31/13 $510,000

= $425,000 $400,000 (base) $400,000 x 1.00 = $400,000 1.20 20,000 (2011) 20,000 x 1.05 = 21,000

5,000 (2012) 5,000 x 1.12 = 5,600 426,600

Ending


1/1/11 $150,000

= $150,000 $150,000 (base) $150,000 x 1.00 = $150,000 $150,000 1.00

12/31/11 $200,000

= $185,185 $150,000 (base) $150,000 x 1.00 = $150,000 1.08 35,185 (2011) 35,185 x 1.08 = 38,000 188,000

12/31/12 $245,700

= $210,000 $150,000 (base) $150,000 x 1.00 = $150,000 1.17 35,185 (2011) 35,185 x 1.08 = 38,000

24,815 (2012) 24,815 x 1.17 = 29,034 217,034

12/31/13 $235,980

= $207,000 $150,000 (base) $150,000 x 1.00 = $150,000 1.14 35,185 (2011) 35,185 x 1.08 = 38,000

21,815 (2012) 21,815 x 1.17 = 25,524 213,524

12/31/14 $228,800

= $208,000 $150,000 (base) $150,000 x 1.00 = $150,000 1.10 35,185 (2011) 35,185 x 1.08 = 38,000

21,815 (2012) 21,815 x 1.17 = 25,524 1,000 (2014) 1,000 x 1.10 = 1,100 214,624

Problem 8-14

8-61


Problem 8-15Ending


1/1/11 $260,000

= $260,000 $260,000 (base) $260,000 x 1.00 = $260,000 $260,000 1.00

12/31/11 $340,000

= $333,333 $260,000 (base) $260,000 x 1.00 = $260,000 1.02 73,333 (2011) 73,333 x 1.02 = 74,800 334,800

12/31/12 $350,000

= $330,189 $260,000 (base) $260,000 x 1.00 = $260,000 1.06 70,189 (2011) 70,189 x 1.02 = 71,593 331,593

12/31/13 $400,000

= $373,832 $260,000 (base) $260,000 x 1.00 = $260,000 1.07 70,189 (2011) 70,189 x 1.02 = 71,593

43,643 (2013) 43,643 x 1.07 = 46,698 378,291

12/31/14 $430,000

= $390,909 $260,000 (base) $260,000 x 1.00 = $260,000 1.10 70,189 (2011) 70,189 x 1.02 = 71,593

43,643 (2013) 43,643 x 1.07 = 46,698 17,077 (2014) 17,077 x 1.10 = 18,785 397,076

8-62


Ending


1/1/11 $84,000

= $84,000 $84,000 (base) $84,000 x 1.00 = $84,000 $84,000 1.00

12/31/11 $100,800

= $96,000 $84,000 (base) $84,000 x 1.00 = $84,000 1.05 12,000 (2011) 12,000 x 1.05 = 12,600 96,600

12/31/12 $136,800

= $120,000 $84,000 (base) $84,000 x 1.00 = 84,000 1.14 12,000 (2011) 12,000 x 1.05 = 12,600 24,000 (2012) 24,000 x 1.14 = 27,360 123,960

12/31/13 $150,000

= $125,000 $84,000 (base) $84,000 x 1.00 = $84,000 1.20 (1) 12,000 (2011) 12,000 x 1.05 = 12,600

24,000 (2012) 24,000 x 1.14 = 27,3605,000 (2013) 5,000 x 1.20 = 6,000 129,960

12/31/14 $160,000(5)

= $128,000(4) $84,000 (base) $84,000 x 1.00 = 84,000 1.25 12,000 (2011) 12,000 x 1.05 = 12,600

24,000 (2012) 24,000 x 1.14 = 27,360 5,000 (2013) 5,000 x 1.20 = 6,000

3,000 (2014) 3,000(3) x 1.25 = 3,750(2) 133,710

(1) $150,000 $125,000 = 1.20 (2013 cost index)(2) $133,710 – 129,960 = $3,750(3) $3,750 1.25 = $3,000(4) $125,000 + 3,000 = $128,000 (2014 inventory at base-year cost)(5) $128,000 x 1.25 = $160,000(2014 inventory at year-end costs)

Problem 8-16

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Advance warning of the company's impending bankruptcy existed at the date of the financial statements. As a rule, inventories should rise in tandem with sales. If

inventories rise faster, it may be because the goods simply aren't selling. This is particularly true of companies in faddish or seasonal businesses — Merry-Go-Round's world.

The company's report showed that inventories on January 30 were $82.2 million, up 37 percent from $60 million a year earlier. That's well above the 15 percent sales growth in the same period, to $877.5 million from $761.2 million. This alone should have been a major cause for concern. It indicated the company's goods simply weren't selling as rapidly as it expected, causing its inventories to bulge. The increase in receivables from $6,195 to over $6 million should also have been cause for concern.

CASES

Judgment Case 8-1

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Real World Case 8-2

Requirement 1Identifying items that should be included in inventory is difficult due to goods in

transit, goods on consignment, and sales returns.Goods in transit. Inventory shipped f.o.b. shipping point is included in the

purchaser’s inventory as soon as the merchandise is shipped. On the other hand, inventory shipped f.o.b. destination is included in the purchaser’s inventory only after it reaches the purchaser’s location.

Goods on consignment. Goods held on consignment are included in the inventory of the consignor until sold by the consignee.

Sales returns. When the right of return exists, a seller must be able to estimate those returns. As a result, a company includes in inventory the cost of merchandise it anticipates will be returned.

Requirement 2In addition to the direct acquisition costs such as the price paid and transportation

costs to obtain inventory, the costs of unloading, unpacking, and preparing inventory for sale or raw materials for use, if material in amount, also should be included in the cost of inventory.

Requirement 3Sport Chalet considers cost to include the direct cost of merchandise and inbound

freight, plus internal costs associated with merchandise procurement, storage and handling.

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Judgment Case 8-31. a. The specific identification method requires each unit to be clearly

distinguished from similar units either by description, identification number, location, or other characteristic. Costs are accumulated for specific units and expensed as the units are sold. Thus, the specific identification method results in recognized cost flows being identical to actual physical flows. Ideally, each unit is relatively expensive and the number of units relatively few so that recording costs is not burdensome. Under the specific identification method, if similar items have different costs, cost of goods sold is influenced by the specific units sold.

b. It is appropriate for Happlia to use the specific identification method because each appliance is expensive, and easily identified by number and description. The specific identification method is feasible because Happlia already maintains records of its units held by individual retailers. Management’s ability to manipulate cost of goods sold is minimized because once the inventory is in the retailer’s hands, Happlia’s management cannot influence the units selected for sale.

2. a. Happlia should include in inventory carrying amounts all necessary and reasonable costs to get an appliance into a useful condition and place for sale. Common (or joint) costs should be allocated to individual units. Such costs exclude the excess costs incurred in transporting refrigerators to Minneapolis and their reshipment to Kansas City. These unit costs should only include normal freight costs from Des Moines to Kansas City. In addition, costs incurred to provide time utility to the goods, i.e. ensuring that they are available when required, will also be included in inventory carrying amounts.

b. Examples of inventoriable costs include the unit invoice price, plus an allocated proportion of the port handling fees, import duties, freight costs to Des Moines and to retailers, insurance costs, repackaging, and warehousing costs.

3. The 2011 income statement should report in cost of goods sold all inventory costs related to units sold in 2011, regardless of when cash is received from retailers. Excess freight costs incurred for shipping the refrigerators from Minneapolis to Kansas City should be included in determining operating income.

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Communication Case 8-4Suggested Grading Concepts and Grading Scheme:

Content (70%)________ 20 Describes the differential effect on ending inventory

and cost of goods sold of using FIFO versus LIFOwhen_______ Prices are increasing._______ Prices are decreasing.

________ 25 Discusses the various motivating factors that might influence the choice of inventory method.

_______ The actual physical flow of product._______ The better match of expenses with revenues

provided by LIFO._______ The effect on the balance sheet._______ The effect on reported income and income

taxes._______ The cost of implementation of LIFO.

________ 10 Discusses briefly the methods available tosimplify LIFO.

________ 15 Discusses the IRS conformity rule with respect to LIFO and the relaxation of the rule that allows aa company using LIFO to present supplemental non-LIFO disclosures.

_______________ 70 points

Writing (30%)________ 6 Terminology and tone appropriate to the audience of

a company president.

________ 12 Organization permits ease of understanding._______ Introduction that states purpose._______ Paragraphs that separate main points.

________ 12 English_______ Sentences grammatically clear and well organized, concise.

_______ Word selection._______ Spelling._______ Grammar and punctuation.

_______________ 30 points

LIFO produces a higher cost of goods sold, lower taxable income and therefore lower income taxes currently payable than FIFO only in periods

Communication Case 8-5

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when the costs of the company’s products are rising. When costs are decreasing, LIFO results in lower cost of goods sold, higher taxable income, and a higher current tax liability than FIFO. In the case of the electronics client, you would explain this to the intern concluding that the costs of the client's products must be decreasing, as frequently occurs in this industry.

At the end of a reporting period it is important to ensure that a proper inventory cutoff is made. A proper cutoff involves the determination of the ownership of goods

that are in transit between the company and its customers as well as the company and its suppliers. If the shipment is made f.o.b. shipping point, then ownership is transferred to the buyer when the goods reach the common carrier. If the shipment is made f.o.b. destination, then ownership is transferred to the buyer when the goods arrive at the buyer’s location.

In this case, John is incorrect if the goods were shipped f.o.b. destination. If so, even though the company is not in physical possession of the goods, they should be included in ending inventory because the shipment had not reached the buyer's location by the end of the reporting period.

Judgment Case 8-6

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Ethics Case 8-7

Requirement 1Without purchase of the additional units:Sales (35,000 @ $60) $2,100,000Cost of goods sold (35,000 x $30) (1,050,000)Gross profit $1,050,000

Due Jim Lester ($1,050,000 x 20%) = $210,000

With purchase of the additional units:Sales $2,100,000Cost of goods sold: 20,000 x $40 $800,000 15,000 x $30 450,000 (1,250,000)Gross profit $ 850,000

Due Jim Lester ($850,000 x 20%) = $170,000

Requirement 2Discussion should include these elements.

Facts:If Moncrief purchases the additional units at year end under a periodic LIFO

inventory system, the transaction results in a reduced payment to Jim Lester, reduced profits to shareholders, and reduced income tax payments to government entities. By purchasing the additional units of Zelenex, Moncrief reduces Jim Lester's payment by $40,000 ($210,000 - $170,000) and decreases gross profit by $200,000 ($1,050,000 - $850,000). The net effect on before-tax income is a decrease of $160,000 ($200,000 - $40,000). Since Moncrief does not intend to sell the units until 2012, the only logical reason for purchasing more costly inventory at year-end is profit manipulation.

Ethical Dilemma:Should Moncrief exercise its right to purchase inventory at will, resulting in a

reduction in net income, or recognize the rights of Jim Lester to receive profit for the sale of his product, shareholders' rights to have their investment appreciate through positive earnings, and government entities' rights to collect tax on economic net income?

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Real World Case 8-8

Requirement 1In 1981, the LIFO conformity rule was liberalized to permit LIFO users to

present designated supplemental disclosures. These disclosures allow a company using LIFO to report, in a note, the difference between inventories valued using LIFO and inventory valued as if another method had been used. Kroger's note provides this supplemental information.

Requirement 2 1/31/09

Ending BeginningInventory Inventory

($ in millions)Inventory as stated $4,859 $4,849Add: Increase in LIFO inventory 800 604FIFO inventory balances $5,659 $5,453

Requirement 3Cost of goods sold for the fiscal year ended January 31, 2009 would have been

$196 million lower had Kroger used FIFO for its entire inventory. While beginning inventory would have been $604 million higher, ending inventory also would have been higher by $800 million. An increase in beginning inventory causes an increase in cost of goods sold, but an increase in ending inventory causes a decrease in cost of goods sold. Purchases for the year are the same regardless of the inventory valuation method used.

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Real World Case 8-9

Requirement 3The following is based on Whole Food's 2009 financial statements. Answers

will vary depending on the financial statement dates chosen.a. Whole Foods uses the last-in, first-out (LIFO) method for approximately 93.6%

of its inventories at the end of 2009 and 94% of its inventories at the end of 2008 and FIFO for the remainder.

b. Assuming that current cost approximates FIFO cost, the inventory disclosure note indicates that, if FIFO had been used to value LIFO inventories, inventories would have been higher than reported by $27.1 million at the end of 2009 and $32.7 million at the end of 2008. Cost of goods sold for 2009 would have been $5.6 million higher ($32.7 – 27.1) had Whole Foods used FIFO. Beginning inventory would have been $32.7 million higher and ending inventory also would have been higher by $27.1 million. An increase in beginning inventory causes an increase in cost of goods sold, while an increase in ending inventory causes a decrease in cost of goods sold. Purchases for 2009 are the same regardless of the inventory valuation method used.

c. Inventory turnover = cost of goods sold divided by average inventory

($ rounded to millions) Inventory turnover = $5,277 = 16.54

$319 *

*($311 + 327) ÷ 2

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Communication Case 8-10The dollar-value LIFO inventory estimation technique begins with the

determination of the current year’s ending inventory valued in terms of year-end costs. It is not necessary for a company using DVL to track the cost of purchases during the year. All that is needed is to take the physical quantities of goods on hand at the end of the year and apply year-end costs.

The next step is to convert the ending inventory from year-end costs to base year costs. This usually is accomplished by dividing the ending inventory at year-end costs by the year’s cost index. The cost index reflects the change in cost from a base year to the current year. The ending inventory has been deflated for cost changes from the base year to the end of the current year.

The next step in the procedure is to identify the layers in ending inventory with the years they were created by comparing ending inventory at base year cost to the beginning inventory at base year cost. Applying the LIFO concept, if inventory has increased, ending inventory at base year cost consists of the beginning inventory layer plus a current year layer.

The final step converts the layers identified to cost by multiplying the layers at base year cost by the layer’s cost index. The costs are totaled to obtain ending inventory at DVL cost.

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Research Case 8-11

Requirement 1The FASB’s codification citation that provides guidance for determining whether

an arrangement involving the sale of inventory is in substance a financing arrangement is FASB ASC 470–40–05–2: Debt–Product Financing Arrangements–Overview and Background.

Requirement 2The FASB’s codification citation that addresses the recognition of a product

financing arrangement is FASB ASC 470–40–25–1: Debt–Product Financing Arrangements–Recognition

Requirement 3The appropriate accounting treatment for this type of arrangement is for the

sponsor to record a liability at the time the proceeds are received from the other entity. The sponsor does not record the transaction as a sale and does not remove the product from its inventory. The cost of the repurchase amount in excess of the originally recorded liability represents financing and holding costs. These costs are accounted for in accordance with the sponsor’s accounting policies applicable to other financing and holding costs. Notice that this is an example of “substance (a loan) over form (a sale).”

Requirement 4

Journal entry to record the “sale” (cash receipt):

Cash.............................................................................. 160,000Liability – product financing arrangement................. 160,000

Journal entry to record the repurchase:

Liability – product financing arrangement .................... 160,000Holding and financing costs* ....................................... 4,000

Cash.......................................................................... 164,000

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Research Case 8-11 (concluded)

*The treatment of these costs depends on the accounting policies of the sponsor. For example, if these costs normally are expensed as period costs, then the debit in this case would be to an expense account (or accounts).

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Analysis Case 8-12

Requirement 1

($ in millions)SAKS DILLARDS

Gross profit ratio = 968 = 32% 2,003 = 29%

3,030 6,831

Inventory turnover = 2,062 = 2.6 4,828 = 3.06 793 1,576.5

Average days = 365 = 140 days 365 = 119 days in inventory 2.6 3.06

The gross profit ratios for the two companies are similar, and both are higher than the industry average. The inventory turnover ratios for the two companies reveal that, on average, it takes Saks 21 more days to sell its inventory than Dillards. This could be a reflection of more “higher end” merchandise sold at Saks which would also explain the slightly higher gross profit ratio of 32% compared to 29% for Dillards. Saks turns its inventory over 6 days slower than the industry average, Dillards 15 days faster.

Requirement 2The objective of this requirement is to motivate students to obtain hands-on

familiarity with actual annual reports and to apply the techniques learned in the chapter. You may wish to provide students with multiple copies of the same annual reports and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective.

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British Airways Case Per note 2, BA uses the average cost method to value its inventory. Under IFRS,

the FIFO (first-in, first-out) method also can be used. However, the LIFO (last-in, first-out) method, which can be used under U.S. GAAP in addition to the average cost method and the FIFO method, is prohibited under IFRS.

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Documents

Chap 008