Warren SM Ch.07 Final

CHAPTER 7INVENTORIES

EYE OPENERS

1. The receiving report should be reconciled to the initial purchase order and the vendor’s invoice before recording or paying for inven-tory purchases. This procedure will verify that the inventory received matches the type and quantity of inventory ordered. It also verifies that the vendor’s invoice is charging the company for the actual quantity of inven-tory received at the agreed-upon price.

2. To protect inventory from customer theft, re-tailers use two-way mirrors, cameras, secu-rity guards, locked display cabinets, and in-ventory tags that set off an alarm if the in-ventory is removed from the store.

3. Perpetual. The perpetual inventory system provides the more effective means of con-trolling inventories, since the inventory ac-count is updated for each purchase and sale. This also assists managers in deter-mining when to reorder inventory items.

4. A physical inventory should be taken period-ically to test the accuracy of the perpetual records. In addition, a physical inventory will identify inventory shortages or shrinkage.

5. No, they are not techniques for determining physical quantities. The terms refer to cost flow assumptions, which affect the determi-nation of the cost prices assigned to items in the inventory.

6. No, the term refers to the flow of costs rather than the items remaining in the inven-tory. The inventory cost is composed of the earliest acquisitions costs rather than the most recent acquisitions costs.

7. a. LIFO c. LIFO

b. FIFO d. FIFO

8. FIFO

9. LIFO. In periods of rising prices, the use of LIFO will result in the lowest net income and thus the lowest income tax expense.

10. Yes. The inventory method may be changed for a valid reason. The effect of any change in method and the reason for the change should be fully disclosed in the financial statements for the period in which the change occurred.

11. Net realizable value (estimated selling price less any direct cost of disposition, such as sales commissions).

12. By a notation next to “Merchandise inven-tory” on the balance sheet or in a note to the financial statements.

13. a. Gross profit for the year was under-stated by $12,750.

b. Merchandise inventory and owner’s eq-uity were understated by $12,750.

14. Jaffe Company. Since the merchandise was shipped FOB shipping point, title passed to Jaffe Company when it was shipped and should be reported in Jaffe Company’s fi-nancial statements at December 31, the end of the fiscal year.

15. Manufacturer’s; The manufacturer retains ti-tle until the goods are sold. Thus, any un-sold merchandise at the end of the year is part of the manufacturer’s (consignor’s) in-ventory, even though the merchandise is in the hands of the retailer (consignee).

457457

PRACTICE EXERCISES

PE 7–1A

Gross Profit Ending Inventory

a. First-in, first-out (FIFO) $23 ($53 – $30) $78 ($36 + $42)

b. Last-in, first-out (LIFO) $11 ($53 – $42) $66 ($30 + $36)

c. Average cost $17 ($53 – $36) $72 ($36 × 2)

PE 7–1B

Gross Profit Ending Inventory

a. First-in, first-out (FIFO) $45 ($125 – $80) $172 ($84 + $88)

b. Last-in, first-out (LIFO) $37 ($125 – $88) $164 ($80 + $84)

c. Average cost $41 ($125 – $84) $168 ($84 × 2)

PE 7–2A

a. Cost of merchandise sold (July 25):

10 units @ $8 $ 8050 units @ $12 60060 $680

b. Inventory, July 31:

$900 = 75 units × $12

PE 7–2B

a. Cost of merchandise sold (April 24):

12 units @ $70 $ 840 3 units @ $72 216 15 $1,056

b. Inventory, April 30:

$1,584 = 22 units × $72

PE 7–3A

a. Cost of merchandise sold (July 25):

$720 = (60 units × $12)

b. Inventory, July 31:

10 units @ $8 $ 8065 units @ $12 78075 $860

PE 7–3B

a. Cost of merchandise sold (April 24):

$1,080 = (15 units × $72)

b. Inventory, April 30:

12 units @ $70 $ 84010 units @ $72 720 22 $1,560

PE 7–4A

a. First-in, first-out (FIFO) method: $2,786 = (10 units × $119) + (14 units × $114)

b. Last-in, first-out (LIFO) method: $2,766 = (5 units × $120) + (19 units × $114)

c. Average cost method: $2,760 (24 units × $115), where average cost = $115 = $9,200/80 units

PE 7–4B

a. First-in, first-out (FIFO) method: $2,592 = 48 units × $54

b. Last-in, first-out (LIFO) method: $2,160 = 48 units × $45

c. Average cost method: $2,400 (48 units × $50), where average cost = $50 = $11,250/225 units

PE 7–5A

A B C D E F G1 Unit Unit Total2 Inventory Cost Market Lower3 Commodity Quantity Price Price Cost Market of C or M4 Alpha 400 $ 6 $ 5 $2,400 $2,000 $2,0005 Beta 350 12 14 4,200 4,900 4,2006 Total $6,600 $6,900 $6,200

PE 7–5B

A B C D E F G1 Unit Unit Total2 Inventory Cost Market Lower3 Commodity Quantity Price Price Cost Market of C or M4 Widget 100 $30 $27 $3,000 $2,700 $2,7005 Gidget 75 24 25 1,800 1,875 1,800 6 Total $4,800 $4,575 $4,500

PE 7–6A

Amount of MisstatementOverstatement (Understatement)

Balance Sheet:Merchandise inventory overstated............... $16,000Current assets overstated............................. 16,000Total assets overstated................................. 16,000Owner’s equity overstated............................ 16,000

Income Statement:Cost of merchandise sold understated........ $(16,000)Gross profit overstated................................. 16,000Net income overstated................................... 16,000

PE 7–6B

Amount of MisstatementOverstatement (Understatement)

Balance Sheet:Merchandise inventory understated............ $(30,000)Current assets understated.......................... (30,000)Total assets understated............................... (30,000)Owner’s equity understated.......................... (30,000)

Income Statement:Cost of merchandise sold overstated.......... $ 30,000Gross profit understated............................... (30,000)Net income understated................................ (30,000)

EXERCISES

Ex. 7–1

Switching to a perpetual inventory system will strengthen Hammer & Nails Hard-ware’s internal controls over inventory, since the store managers will be able to keep track of how much of each item is on hand. This should minimize shortages of good-selling items and excess inventories of poor-selling items.

On the other hand, switching to a perpetual inventory system will not eliminate the need to take a physical inventory count. A physical inventory must be taken to verify the accuracy of the inventory records in a perpetual inventory system. In addition, a physical inventory count is needed to detect shortages of inven-tory due to damage or theft.

Ex. 7–2

a. Inappropriate. Good controls include a receiving report, prepared after all in-ventory items received have been counted and inspected. Inventory pur-chased should only be recorded and paid for after reconciling the receiving report, the initial purchase order, and the vendor’s invoice.

b. Appropriate. The inventory tags will protect the inventory from customer theft.

c. Inappropriate. The control of using security measures to protect the inven-tory is violated if the stockroom is not locked.

Ex. 7–3

Portable Video CD PlayersPurchases Cost of Merchandise Sold Inventory

Date QuantityUnitCost

TotalCost Quantity

UnitCost

TotalCost Quantity

UnitCost

TotalCost

Apr. 1 50 35 1,7505 40 35 1,400 10 35 350

14 60 36 2,160 1060

3536

3502,160

21 1025

3536

350900

35 36 1,260

23 10 36 360 25 36 90030 75 38 2,850 25

753638

9002,850

30 Balances 3,010 3,750

Ex. 7–4

Portable Video CD PlayersPurchases Cost of Merchandise Sold Inventory


TotalCost Quantity

UnitCost

TotalCost Quantity

UnitCost

TotalCost

Apr. 1 50 35 1,7505 40 35 1,400 10 35 350

14 60 36 2,160 1060

3536

3502,160

21 35 36 1,260 1025

3536

350900

23 10 36 360 1015

3536

350540

30 75 38 2,850 1015

75

3536

38

350540

2,85030 Balances 3,020 3,740

Ex. 7–5

Cell PhonesPurchases Cost of Merchandise Sold Inventory


TotalCost Quantity

UnitCost

TotalCost Quantity

UnitCost

TotalCost

Mar. 1 1,000 40 40,0005 500 42 21,000 1,000

5004042

40,00021,000

8 500200

4240

21,0008,000

800 40 32,000

14 600 40 24,000 200 40 8,00020 450 44 19,800 200

4504044

8,00019,800

31 300 44 13,200 200150

4044

8,0006,600

31 Balances 66,200 14,600

Ex. 7–6

Cell PhonesPurchases Cost of Merchandise Sold Inventory


TotalCost Quantity

UnitCost

TotalCost Quantity

UnitCost

TotalCost

Mar. 1 1,000 40 40,0005 500 42 21,000 1,000

5004042

40,00021,000

8 700 40 28,000 300500

4042

12,00021,000

14 300300

4042

12,00012,600 200 42 8,400

20 450 44 19,800 200450

4244

8,40019,800

31 200100

4244

8,4004,400 350 44 15,400

31 Balances 65,400 15,400

Ex. 7–7

a. $19,200 ($80 × 240 units)

b. $18,650 [($75 × 30 units) + ($78 × 200 units) + ($80 × 10 units)] = $2,250 + $15,600 + $800

Ex. 7–8

a. $8,124 (36 units at $165 plus 14 units at $156) = $5,940 + $2,184

b. $6,414 (27 units at $120 plus 23 units at $138) = $3,240 + $3,174

c. $7,350 (50 units at $147; $26,460/180 units = $147)

Cost of merchandise available for sale:27 units at $120......................................................... $ 3,24054 units at $138......................................................... 7,45263 units at $156......................................................... 9,828

36 units at $165......................................................... 5,940 180 units (at average cost of $147)........................... $26,460

Ex. 7–9

Cost Merchandise Merchandise

Inventory Method Inventory Sold

a. FIFO...................... $2,508 $7,242

b. LIFO...................... 2,160 7,590

c. Average cost........ 2,340 7,410

Cost of merchandise available for sale:42 units at $60........................................................... $2,52058 units at $65........................................................... 3,77020 units at $68........................................................... 1,360

30 units at $70........................................................... 2,100 150 units (at average cost of $65)............................. $9,750

a. First-in, first-out:

Merchandise inventory:30 units at $70........................................................... $2,100 6 units at $68........................................................... 408 36 units...................................................................... $2,508

Merchandise sold:$9,750 – $2,508.......................................................... $7,242

b. Last-in, first-out:

Merchandise inventory:36 units at $60........................................................... $2,160


c. Average cost:

Merchandise inventory:36 units at $65 ($9,750/150 units)............................ $2,340


Ex. 7–10

1. a. FIFO inventory > (greater than) LIFO inventory

b. FIFO cost of goods sold < (less than) LIFO cost of goods sold

c. FIFO net income > (greater than) LIFO net income

d. FIFO income tax > (greater than) LIFO income tax

2. In periods of rising prices, the income shown on the company's tax return would be lower than if FIFO were used; thus, there is a tax advantage of us-ing LIFO.

Note to Instructors: The federal tax laws require that if LIFO is used for tax pur-poses, LIFO must also be used for financial reporting purposes. This is known as the LIFO conformity rule. Thus, selecting LIFO for tax purposes means that the company's reported income will also be lower than if FIFO had been used. Companies using LIFO believe the tax advantages from using LIFO outweigh any negative impact of reporting a lower income to shareholders.

Ex. 7–11

A B C D E F G1 Unit Unit Total2 Inventory Cost Market Lower3 Commodity Quantity Price Price Cost Market of C or M4 Aquarius 20 $ 80 $ 92 $ 1,600 $ 1,840 $ 1,6005 Capricorn 50 70 65 3,500 3,250 3,2506 Leo 8 300 280 2,400 2,240 2,2407 Scorpio 30 40 30 1,200 900 9008 Taurus 100 90 94 9,000 9,400 9,000 9 Total $ 17,700 $ 17,630 $ 16,990

Ex. 7–12

The merchandise inventory would appear in the Current Assets section, as fol-lows:

Merchandise inventory—at lower of cost (FIFO) or market......... $16,990

Alternatively, the details of the method of determining cost and the method of valuation could be presented in a note.

Ex. 7–13

a. Balance Sheet

Merchandise inventory $9,400 ($325,000 – $315,600) understated

Current assets $9,400 ($325,000 – $315,600) understated

Total assets $9,400 ($325,000 – $315,600) understated

Owner’s equity $9,400 ($325,000 – $315,600) understated

b. Income Statement

Cost of merchandise sold $9,400 ($325,000 – $315,600) overstated

Gross profit $9,400 ($325,000 – $315,600) understated

Net income $9,400 ($325,000 – $315,600) understated

Ex. 7–14

a. Balance Sheet

Merchandise inventory $7,550 ($195,750 – $188,200) overstated

Current assets $7,550 ($195,750 – $188,200) overstated

Total assets $7,550 ($195,750 – $188,200) overstated

Owner’s equity $7,550 ($195,750 – $188,200) overstated

b. Income Statement

Cost of merchandise sold $7,550 ($195,750 – $188,200) understated

Gross profit $7,550 ($195,750 – $188,200) overstated

Net income $7,550 ($195,750 – $188,200) overstated

Ex. 7–15

When an error is discovered affecting the prior period, it should be corrected. In this case, the merchandise inventory account should be debited and the owner’s capital account credited for $11,900.

Failure to correct the error for 2009 and purposely misstating the inventory and the cost of merchandise sold in 2010 would cause the income statements for the two years to not be comparable. The balance sheet at the end of 2010 would be correct, however, since the 2009 inventory error reverses itself in 2010.

Appendix Ex. 7–16

$627,000 ($950,000 × 66%)

Appendix Ex. 7–17

$572,000 ($880,000 × 65%)

Appendix Ex. 7–18

$225,000 ($375,000 × 60%)

Appendix Ex. 7–19

A B C1 Cost Retail2 Merchandise inventory, April 1 $ 180,000 $ 300,0003 Purchases in April (net) 1,200,000 2,000,000 4 Merchandise available for sale $ 1,380,000 $ 2,300,000

5 Ratio of cost to retail price:

6 Sales for April (net) 2,025,000 7 Merchandise inventory, April 30, at retail price $ 275,000

8Merchandise inventory, April 30, at estimated cost ($275,000 × 60%)

$ 165,000

Appendix Ex. 7–20

a.

A B C1 Cost Retail2 Merchandise inventory, January 1 $ 260,0003 Purchases (net), January 1–October 11 1,900,000 4 Merchandise available for sale $ 2,160,0005 Sales (net), January 1–October 11 $3,200,0006 Less estimated gross profit ($3,200,000 × 40%) 1,280,000 7 Estimated cost of merchandise sold 1,920,000 8 Estimated merchandise inventory, October 11 $ 240,000

b. The gross profit method is useful for estimating inventories for monthly or quarterly financial statements. It is also useful in estimating the cost of mer-chandise destroyed by fire or other disasters.

Appendix Ex. 7–21

Merchandise available for sale........................................................... $3,150,000Less cost of merchandise sold [$4,800,000 × (100% – 40%)].......... 2,880,000 Estimated ending merchandise inventory........................................ $ 270,000

Appendix Ex. 7–22

Merchandise available for sale........................................................... $1,028,000Less cost of merchandise sold [$1,500,000 × (100% – 38%)].......... 930,000 Estimated ending merchandise inventory........................................ $ 98,000

Ex. 7–23

a. Apple: 63.1 {$13,717,000,000/[($270,000,000 + $165,000,000)/2]}

American Greetings: 4.0 {$826,791,000/[($187,817,000 + $230,308,000)/2]}

b. Lower. Although American Greetings’ business is seasonal in nature, with most of its revenue generated during the major holidays, much of its nonholi-day inventory may turn over very slowly. Apple, on the other hand, turns its inventory over very fast because it maintains a low inventory, which allows it to respond quickly to customer needs. Additionally, Apple’s computer prod-ucts can quickly become obsolete, so it cannot risk building large invento-ries.

Ex. 7–24

a. Number of Days’ Sales in Inventory =

Kroger, 33 days

Safeway, 34 days

Winn-Dixie, 45 days

Inventory Turnover =

Kroger, 11.0

Safeway, 10.6

Winn-Dixie, 8.1

b. The number of days’ sales in inventory and inventory turnover ratios are rela-tively consistent. Kroger has slightly better inventory ratios than does Safe-way or Winn-Dixie.

Ex. 7–24 Concluded

c. If Safeway matched Kroger’s days’ sales in inventory, then its hypothetical ending inventory would be determined as follows,

Number of Days’ Sales in Inventory =

33 days =

X = 33 × ($28,604/365) = 33 × $78.4 per day

X = $2,587

Thus, the additional cash flow that would have been generated is the differ-ence between the actual average inventory and the hypothetical average in-ventory, as follows:

Actual average inventory......................... $ 2,705 millionHypothetical average inventory.............. 2,587 Positive cash flow potential..................... $ 118 million

That is, a lower average inventory amount would have required less cash than actually was required.

PROBLEMS

Prob. 7–1A

1.

Purchases Cost of Merchandise Sold Inventory


TotalCost Quantity

UnitCost

TotalCost Quantity

UnitCost

TotalCost

Mar. 3 60 1,500 90,0008 120 1,800 216,000 60

1201,5001,800

90,000216,000

11 6020

1,500 1,800

90,000 36,000

100 1,800 180,000

30 50 1,800 90,000 50 1,800 90,000Apr. 8 100 2,000 200,000 50

1001,8002,000

90,000200,000

10 5010

1,800 2,000

90,000 20,000

90 2,000 180,000

19 30 2,000 60,000 60 2,000 120,00028 100 2,200 220,000 60

1002,0002,200

120,000220,000

Continued

Prob. 7–1A Concluded



TotalCost Quantity

UnitCost

TotalCost Quantity

UnitCost

TotalCost

May 5 60 2,000 120,000100 2,200 220,000

16 80 2,200 176,000 20 2,200 44,00021 180 2,400 432,000 20

1802,2002,400

44,000432,000

28 2070

2,2002,400

44,000168,000 110 2,400 264,000

31 Balances 894,000 264,000

2. Accounts Receivable....................................................... 2,307,500Sales............................................................................ 2,307,500

Cost of Merchandise Sold............................................... 894,000Merchandise Inventory.............................................. 894,000

3. $1,413,500 ($2,307,500 – $894,000)

4. $264,000 (110 units × $2,400)

Prob. 7–2A

1.



TotalCost Quantity

UnitCost

TotalCost Quantity

UnitCost

TotalCost

Mar. 3 60 1,500 90,0008 120 1,800 216,000 60

1201,5001,800

90,000216,000

11 80 1,800 144,000 6040

1,5001,800

90,00072,000

30 4010

1,8001,500

72,00015,000

50 1,500 75,000

Apr. 8 100 2,000 200,000 50100

1,5002,000

75,000200,000

10 60 2,000 120,000 5040

1,5002,000

75,00080,000

19 30 2,000 60,000 5010

1,5002,000

75,00020,000

28 100 2,200 220,000 5010

100

1,5002,0002,200

75,00020,000

220,000Continued




TotalCost Quantity

UnitCost

TotalCost Quantity

UnitCost

TotalCost

May 5 60 2,200 132,000 50 10

40

1,500 2,000

2,200

75,00020,000

88,00016 40

1030

2,200 2,000

1,500

88,000 20,000

45,000

20 1,500 30,000

21 180 2,400 432,000 20180

1,5002,400

30,000432,000

28 90 2,400 216,000 2090

1,5002,400

30,000216,000

31 Balances 912,000 246,000

2. Total sales........................................................................ $2,307,500Total cost of merchandise sold ..................................... 912,000 Gross profit ..................................................................... $1,395,500

3. $246,000 = [(20 units × $1,500) + (90 units × $2,400)] = $30,000 + $216,000

Prob. 7–3A

1. First-In, First-Out Method

Model Quantity Unit Cost Total Cost

BB900 18 $225 $ 4,05012 222 2,664

C911 2 70 1402 65 130

L100 4 317 1,268N201 2 535 1,070

2 530 1,060Q73 6 542 3,252

1 549 549Z120 2 232 464ZZRF 12 78 936

Total.................................................................. $ 15,583

2. Last-In, First-Out Method


BB900 27 $213 $ 5,7513 215 645

C911 4 60 240L100 4 305 1,220N201 2 520 1,040

2 527 1,054Q73 6 520 3,120

1 531 531Z120 2 222 444ZZRF 8 70 560

4 72 288 Total.................................................................. $ 14,893


3. Average Cost Method

Model Quantity Unit Cost* Total Cost

BB900 30 $218 $ 6,540C911 4 63 252L100 4 311 1,244N201 4 528 2,112Q73 7 534 3,738Z120 2 227 454ZZRF 12 74 888

Total.................................................................. $ 15,228

*Computations of unit costs:

BB900: $218 = [(27 × $213) + (21 × $215) + (18 × $222) + (18 × $225)] ÷

(27 + 21 + 18 + 18)

C911: $63 = [(10 × $60) + (6 × $65) + (2 × $65) + (2 × $70)] ÷ (10 + 6 + 2 + 2)

L100: $311 = [(6 × $305) + (3 × $310) + (3 × $316) + (4 × $317)] ÷ (6 + 3 + 3 + 4)

N201: $528 = [(2 × $520) + (2 × $527) + (2 × $530) + (2 × $535)] ÷ (2 + 2 + 2 + 2)

Q73: $534 = [(6 × $520) + (8 × $531) + (4 × $549) + (6 × $542)] ÷ (6 + 8 + 4 + 6)

Z120: $227 = [(4 × $222) + (4 × $232)] ÷ (4 + 4)

ZZRF: $74 = [(8 × $70) + (12 × $72) + (16 × $74) + (14 × $78)] ÷ (8 + 12 + 16 + 14)

4. a. During periods of rising prices, the LIFO method will result in a lesser amount of inventory, a greater amount of the cost of merchandise sold, and a lesser amount of net income than the other two methods. For Artic Appliances, the LIFO method would be preferred for the current year, since it would result in a lesser amount of income tax.

b. During periods of declining prices, the FIFO method will result in a lesser amount of net income and would be preferred for income tax pur-poses.

Prob. 7–4A

A B C D E F G

1Inventory Sheet

December 31, 20102 Unit Unit Total3 Inventory Cost Market Lower4 Description Quantity Price Price Cost Market of C or M5 Alpha 10 38 30 $ 60 $ 57 $ 1,800 $ 1,7106 8 59 472 456 7 2,272 2,166 $ 2,1668 Beta 30 18 170 180 3,060 3,240 3,0609 Charlie 4 30 20 132 120 2,640 2,400

10 10 131 1,310 1,200 11 3,950 3,600 3,60012 Echo 9 125 25 26 3,125 3,250 3,12513 Frank 6 18 6 550 550 3,300 3,30014 12 540 6,480 6,600 15 9,780 9,900 9,78016 George 15 60 16 15 960 900 90017 Killo 6 5 400 390 2,000 1,950 1,95018 Quebec 12 375 6 6 2,250 2,250 2,25019 Romeo 7 90 75 25 18 1,875 1,35020 15 26 390 270 21 2,265 1,620 1,62022 Sierra 3 6 5 250 235 1,250 1,17523 1 260 260 235 24 1,510 1,410 1,41025 Washburn 2 140 100 15 20 1,500 2,00026 40 14 560 800 27 2,060 2,800 2,06028 X-Ray 4 15 10 750 745 7,500 7,45029 5 740 3,700 3,725 30 11,200 11,175 11,175 31 Total $ 44,432 $ 44,261 $ 43,096

Prob. 7–5A Appendix

1.

A B C

1 CLAIREMONT CO.2 Cost Retail

3 Merchandise inventory, July 1 $ 300,000 $ 400,0004 Net purchases 3,400,000 4,600,000 5 Merchandise available for sale $ 3,700,000 $ 5,000,000


7 Sales $ 4,715,0008 Less sales returns and allowances 190,000 9 Net sales 4,525,000

10 Merchandise inventory, July 31, at retail $ 475,000

11Merchandise inventory, at estimated cost

($475,000 × 74%) $ 351,500

2.

A B C

1 MALIBU CO.2 a. Cost Retail

3 Merchandise inventory, February 1 $ 225,0004 Net purchases 3,200,000 5 Merchandise available for sale $ 3,425,0006 Sales $ 5,200,0007 Less sales returns and allowances 95,000 8 Net sales $ 5,105,0009 Less estimated gross profit ($5,105,000 × 38%) 1,939,900

10 Estimated cost of merchandise sold 3,165,100 11 Estimated merchandise inventory, March 31 $ 259,900 12

13 b.14 Estimated merchandise inventory, March 31 $ 259,90015 Physical inventory count, March 31 243,250

16Estimated loss due to theft or damage, February 1–March 31 $ 16,650

Prob. 7–1B

1.



TotalCost Quantity

UnitCost

TotalCost Quantity

UnitCost

TotalCost

Jan. 1 75 20 1,50010 200 21 4,200 75

2002021

1,5004,200

28 7525

2021

1,500525 175 21 3,675

30 110 21 2,310 65 21 1,365Feb. 5 20 21 420 45 21 945

10 120 22 2,640 45120

2122

9452,640

16 4545

2122

945990 75 22 1,650

28 50 22 1,100 25 22 550Mar. 5 175 24 4,200 25

1752224

5504,200

14 2595

2224

5502,280 80 24 1,920

25 150 25 3,750 80150

2425

1,9203,750

30 80 20

24 25

1,920500 130 25 3,250

31 Balances 13,040 3,250

Prob. 7–1B Concluded

2. Accounts Receivable................................. 26,310Sales....................................................... 26,310

Cost of Merchandise Sold......................... 13,040Merchandise Inventory......................... 13,040

3. $13,270 ($26,310 – $13,040)

4. $3,250 (130 units × $25)

Prob. 7–2B

1.



TotalCost Quantity

UnitCost

TotalCost Quantity

UnitCost

TotalCost

Jan. 1 75 20 1,50010 200 21 4,200 75

2002021

1,5004,200

28 100 21 2,100 75100

2021

1,5002,100

30 100 10

21 20

2,100 200

65 20 1,300

Feb. 5 20 20 400 45 20 90010 120 22 2,640 45

1202022

9002,640

16 90 22 1,980 4530

2022

900660

28 3020

2220

660400

25 20 500

Mar. 5 175 24 4,200 25175

2024

5004,200

14 120 24 2,880 2555

2024

5001,320

25 150 25 3,750 2555

150

202425

5001,3203,750

30 100 25 2,500 255550

202425

5001,3201,250

31 Balances 13,220 3,070


2. Total sales........................................................................ $26,310Total cost of merchandise sold...................................... 13,220 Gross profit...................................................................... $ 13,090

3. $3,070 = [(25 units × $20) + (55 units × $24) + (50 units × $25)] = $500 + $1,320 + $1,250

Prob. 7–3B

1. First-In, First-Out Method


ALN3 12 $ 92 $1,1044 85 340

UGA1 3 70 2101 68 68

SL89 9 259 2,331F69 6 90 540H60W 3 130 390

2 128 256J600T 7 180 1,260

1 175 175ZZH0 7 101 707

2 100 200 Total............................................................... $7,581

2. Last-In, First-Out Method


ALN3 16 $ 88 $1,408UGA1 1 75 75

1 65 652 68 136

SL89 7 242 1,6942 250 500

F69 6 80 480H60W 2 108 216

2 110 2201 128 128

J600T 5 160 8003 170 510

ZZH0 7 75 5252 100 200

Total............................................................... $6,957


3. Average Cost Method

Model Quantity Unit Cost* Total Cost

ALN3 16 $ 87 $1,392UGA1 4 69 276SL89 9 253 2,277F69 6 86 516H60W 5 121 605J600T 8 172 1,376ZZH0 9 92 828

Total............................................................... $7,270

*Computations of unit costs:

ALN3: $87 = [(16 × $88) + (8 × $79) + (6 × $85) + (12 × $92)] ÷ (16 + 8 + 6 + 12)

UGA1: $69 = [(1 × $75) + (1 × $65) + (5 × $68) + (3 × $70)] ÷ (1 + 1 + 5 + 3)

SL89: $253 = [(7 × $242) + (6 × $250) + (5 × $260) + (10 × $259)] ÷ (7 + 6 + 5 + 10)

F69: $86 = [(6 × $80) + (5 × $82) + (8 × $89) + (8 × $90)] ÷ (6 + 5 + 8 + 8)

H60W: $121 = [(2 × $108) + (2 × $110) + (3 × $128) + (3 × $130)] ÷ (2 + 2 + 3 + 3)

J600T: $172 = [(5 × $160) + (4 × $170) + (4 × $175) + (7 × $180)] ÷ (5 + 4 + 4 + 7)

ZZH0: $92 = [(7 × $75) + (7 × $100) + (7 × $101)] ÷ (7 + 7 + 7)

4. a. During periods of rising prices, the LIFO method will result in a lesser amount of inventory, a greater amount of cost of merchandise sold, and a lesser amount of net income than the other two methods. For Bulldog Appliances, the LIFO method would be preferred for the current year, since it would result in a lesser amount of income tax.

b. During periods of declining prices, the FIFO method will result in a lesser amount of net income and would be preferred for income tax pur-poses.

Prob. 7–4B

A B C D E F G

1Inventory Sheet

December 31, 20102 Unit Unit Total3 Inventory Cost Market Lower4 Description Quantity Price Price Cost Market of C or M5 Alpha 10 38 30 $ 60 $ 57 $ 1,800 $ 1,7106 8 59 472 456 7 2,272 2,166 $ 2,1668 Beta 30 18 175 180 3,150 3,240 3,1509 Charlie 4 30 20 130 120 2,600 2,400

10 10 129 1,290 1,200 11 3,890 3,600 3,60012 Echo 9 125 26 26 3,250 3,250 3,25013 Frank 6 18 10 565 550 5,650 5,50014 8 560 4,480 4,400 15 10,130 9,900 9,90016 George 15 60 15 15 900 900 90017 Killo 6 5 385 390 1,925 1,950 1,92518 Quebec 12 375 7 6 2,625 2,250 2,25019 Romeo 7 90 80 22 18 1,760 1,44020 10 21 210 180 21 1,970 1,620 1,62022 Sierra 3 6 5 250 235 1,250 1,17523 1 260 260 235 24 1,510 1,410 1,41025 Washburn 2 140 90 24 20 2,160 1,80026 50 22 1,100 1,000 27 3,260 2,800 2,80028 X-Ray 4 15 10 750 745 7,500 7,45029 5 745 3,725 3,725 30 11,225 11,175 11,175 31 Total $ 46,107 $ 44,261 $ 44,146

Prob. 7–5B Appendix

1.

A B C

1 GAINESVILLE CO.2 Cost Retail

3 Merchandise inventory, April 1 $ 200,000 $ 300,0004 Net purchases 2,520,000 3,700,000 5 Merchandise available for sale $ 2,720,000 $ 4,000,000


7 Sales $ 3,550,0008 Less sales returns and allowances 50,000 9 Net sales 3,500,000

10 Merchandise inventory, April 30, at retail $ 500,000

11Merchandise inventory, at estimated cost

($500,000 × 68%) $ 340,000

2.

A B C

1 TALLAHASSEE CO.2 a. Cost Retail

3 Merchandise inventory, October 1 $ 300,0004 Net purchases 1,800,000 5 Merchandise available for sale $ 2,100,0006 Sales $ 2,796,0007 Less sales returns and allowances 96,000 8 Net sales $ 2,700,0009 Less estimated gross profit ($2,700,000 × 36%) 972,000

10 Estimated cost of merchandise sold 1,728,000 11 Estimated merchandise inventory, December 31 $ 372,000 12

13 b.14 Estimated merchandise inventory, December 31 $ 372,00015 Physical inventory count, December 31 358,500

16Estimated loss due to theft or damage, October 1–December 31 $ 13,500

SPECIAL ACTIVITIES

Activity 7–1

Since the title to merchandise shipped FOB shipping point passes to the buyer when the merchandise is shipped, the shipments made before midnight, Decem-ber 31, 2010, should properly be recorded as sales for the fiscal year ending De-cember 31, 2010. Hence, Cody Bryant is behaving in a professional manner. How-ever, Cody should realize that recording these sales in 2010 precludes them from being recognized as sales in 2011. Thus, accelerating the shipment of orders to increase sales of one period will have the effect of decreasing sales of the next period.

Activity 7–2

In developing a response to Chad’s concerns, you should probably first empha-size the practical need for an assumption concerning the flow of cost of goods purchased and sold. That is, when identical goods are frequently purchased, it may not be practical to specifically identify each item of inventory. If all the iden-tical goods were purchased at the same price, it wouldn’t make any difference for financial reporting purposes which goods we assumed were sold first, second, etc. However, in most cases, goods are purchased over time at different prices, and, hence, a need arises to determine which goods are sold so that the price (cost) of those goods can be matched against the revenues to determine operat-ing income.

Next, you should emphasize that accounting principles allow for the fact that the physical flow of the goods may differ from the flow of costs. Specifically, ac-counting principles allow for three cost flow assumptions: first-in, first-out; last-in, first-out; and average. Each of these methods has advantages and disadvan-tages. One primary advantage of the last-in, first-out method is that it better matches current costs (the cost of goods purchased last) with current revenues. Therefore, the reported operating income is more reflective of current operations and what might be expected in the future. Another reason that the last-in, first-out method is often used is that it tends to minimize taxes during periods of price increases. Since for most businesses prices tend to increase, the LIFO method will generate lower taxes than will the alternative cost flow methods.

The preceding explanation should help Chad better understand LIFO and its im-pact on the financial statements and taxes.

Activity 7–3

1. a. First-in, first-out method:

4,000 units at $16.00.............................................. $ 64,0004,000 units at $14.95.............................................. 59,8006,400 units at $14.50.............................................. 92,800

1,600 units at $14.25.............................................. 22,800 16,000 units.............................................................. $ 239,400

b. Last-in, first-out method:

15,500 units at $12.20.............................................. $189,100 500 units at $13.00.............................................. 6,500 16,000 units.............................................................. $ 195,600

c. Average cost method:

16,000 units at $13.58*............................................ $ 217,280

*($1,358,000/100,000) = $13.58

2. Average FIFO LIFO Cost

Sales..................................................... $1,300,000 $1,300,000 $1,300,000Cost of merchandise sold*................. 1,118,600 1,162,400 1,140,720 Gross profit.......................................... $ 181,400 $ 137,600 $ 159,280

*Cost of merchandise availablefor sale.............................................. $1,358,000 $1,358,000 $1,358,000

Less ending inventory....................... 239,400 195,600 217,280 Cost of merchandise sold................. $1,118,600 $1,162,400 $1,140,720

3. a. The LIFO method is often viewed as the best basis for reflecting income from operations. This is because the LIFO method matches the most current cost of merchandise purchases against current sales. The matching of current costs with current sales results in a gross profit amount that many consider to best reflect the results of current opera-tions. For Mimotopes Company, the gross profit of $137,600 reflects the matching of the most current costs of the product of $1,162,400 against the current period sales of $1,300,000. This matching of current costs with current sales also tends to minimize the effects of price trends on the results of operations.

Activity 7–3 Continued

The LIFO method will not match current sales and the current cost of merchandise sold if the current-period quantity of sales exceeds the current-period quantity of purchases. In this case, the cost of merchan-dise sold will include a portion of the cost of the beginning inventory, which may have a unit cost from purchases made several years prior to the current period. The results of operations may then be distorted in the sense of the current matching concept. This situation occurs rarely in most businesses because of consistently increasing quantities of year-end inventory from year to year.

While the LIFO method is often viewed as the best method for matching revenues and expenses, the FIFO method is often consistent with the physical movement of merchandise in a business, since most busi-nesses tend to dispose of commodities in the order of their acquisition. To the extent that this is the case, the FIFO method approximates the re-sults that will be attained by a specific identification of costs.

The average cost method is, in a sense, a compromise between LIFO and FIFO. The effect of price trends is averaged, both in determining net income and in determining inventory cost.

Which inventory costing method best reflects the results of operations for Mimotopes Company depends upon whether one emphasizes the im-portance of matching revenues and expenses (the LIFO method) or whether one emphasizes the physical flow of merchandise (the FIFO method). The average cost method might be considered best if one em-phasizes the matching and physical flow of goods concepts equally.

b. The FIFO method provides the best reflection of the replacement cost of the ending inventory for the balance sheet. This is because the amount reported on the balance sheet for merchandise inventory will be as-signed costs from the most recent purchases. For most businesses, these costs will reflect purchases made near the end of the period. For example, Mimotopes Company’s ending inventory on December 31, 2009, is assigned costs totaling $239,400 under the FIFO method. These costs represent purchases made during the period of August through December. This FIFO inventory amount ($239,400) more closely approxi-mates the replacement cost of the ending inventory than either the LIFO ($195,600) or the average cost ($217,280) figures.

Activity 7–3 Continued

c. During periods of rising prices, such as shown for Mimotopes Company, the LIFO method will result in a lesser amount of net income than the other two methods. Hence, for Mimotopes Company, the LIFO method would be preferred for the current year, since it would result in a lesser amount of income tax.

During periods of declining prices, the FIFO method will result in a lesser amount of net income and would be preferred for income tax pur-poses.

d. The advantages of the perpetual inventory system include the following:

(1) A perpetual inventory system provides an effective means of control over inventory. A comparison of the amount of inventory on hand with the balance of the subsidiary account can be used to determine the existence and seriousness of any inventory shortages.

(2) A perpetual inventory system provides an accurate method for deter-mining inventories used in the preparation of interim statements.

(3) A perpetual inventory system provides an aid for maintaining inven-tories at optimum levels. Frequent review of the perpetual inventory records helps management in the timely reordering of merchandise, so that loss of sales and excessive accumulation of inventory are avoided. An analysis of Mimotopes Company’s purchases and sales, as shown below, indicates that the company may have accumulated excess inventory from May through August because the amount of month-end inventory increased materially, while sales remained rela-tively constant for the period.

Increase Next(Decrease) in Inventory at Month’s

Month Purchases Sales Inventory End of Month Sales

April 15,500 units 8,000 units 7,500 units 7,500 units 8,000 unitsMay 16,500 8,000 8,500 16,000 10,000June 20,000 10,000 10,000 26,000 12,000July 20,000 12,000 8,000 34,000 14,000August 13,600 14,000 (400) 33,600 14,000September — 14,000 (14,000) 19,600 9,000October 6,400 9,000 (2,600) 17,000 5,000November 4,000 5,000 (1,000) 16,000 4,000December 4,000 4,000 0 16,000 —

Activity 7–3 Concluded

It appears that during April through July, the company ordered inven-tory without regard to the accumulation of excess inventory. A per-petual inventory system might have prevented this excess accumula-tion from occurring.

The primary disadvantage of the perpetual inventory system is the cost of maintaining the necessary inventory records. However, com-puters may be used to reduce this cost.

Activity 7–4

a. Inventory Turnover =


Dell

Inventory Turnover: 88.8

Days’ Sales in Inventory: 4.1 days

Hewlett-Packard

Inventory Turnover: 9.5

Days’ Sales in Inventory: 38.6 days


b. Dell builds its computers primarily to a customer order, called a build-to-or-der strategy. That is, Dell doesn’t make a computer until it has an order from a customer. Customers place their orders on the Internet. Dell then builds and delivers the computer, usually in a matter of days. HP, in contrast, builds computers before actual orders are received. This is called a build-to-stock strategy. HP must forecast the type of computers customers want before it receives the orders. This strategy results in greater inventory for HP, since the computers are built before there is a sale. HP has significant finished goods inventory, while Dell has little finished goods. This difference in strat-egy is why you see HP computers at a retail store, but not a Dell computer. It also explains the difference in their inventory efficiency ratios.

Activity 7–5

a.

Inventory Turnover

Number of Days’ Sales

in Inventory

Tiffany 1.03 354.08

Amazon.com 11.44 31.90

Calculations:

Tiffany


Inventory Turnover = , or 1.03


Number of Days’ Sales in Inventory = ,

or 354.08 days


Amazon.com


Inventory Turnover = , or 11.44


Number of Days’ Sales in Inventory = ,

or 31.90 days

b. Amazon.com has a smaller investment in inventory for its volume than does Tiffany. Amazon.com’s inventory turnover is faster (larger), and the number of days’ sales in inventory is shorter (smaller). This is due to the fact that Amazon.com uses a different business model than Tiffany. That is, Amazon.com sells through the Internet, while Tiffany uses the traditional re-tail store model which requires Tiffany to stock more inventory.

Activity 7–6

a. Costco Wal-Mart JCPenney

a. Cost of merchandise sold.................... $52,746 $264,152 $12,078

Merchandise inventory, beginning..... $ 4,015 $ 32,191 $ 3,210Merchandise inventory, ending........... 4,569 33,685 3,400

Total.................................................. $ 8,584 $ 65,876 $ 6,610

b. Average merchandise inventory(Total/2).................................................. $ 4,292 $ 32,938 $ 3,305 Inventory turnover (a/b)....................... 12.3 8.0 3.7

b. Costco Wal-Mart JCPenney

a. Average merchandise inventory[from part (a)]........................................ $ 4,292 $ 32,938 $ 3,305

Cost of merchandise sold.................... $52,746 $264,152 $12,078

b. Average daily cost of merchandisesold (COMS/365)................................... $ 144.5 $ 723.7 $ 33.1 Number of day’s sales in inventory(a/b)........................................................ 29.7 45.5 99.8

c. Both the inventory turnover ratio and the number of day’s sales in inventory reflect the merchandising approaches of the three companies. Costco is a club warehouse. Its approach is to hold only mass appeal items that are sold quickly off the shelf. Most items are sold in bulk quantities at very attractive prices. Costco couples thin margins with very fast inventory turnover. Wal-Mart has a traditional discounter approach. It has attractive pricing, but the inventory moves slower than would be the case at a club warehouse. For example, many purchases made at Wal-Mart would not be packaged in the same bulk as would be the case at Costco. JCPenney is a traditional depart -ment store with a wider assortment of goods that will not necessarily appeal to the mass market. That is, some of the merchandise items will be more specialized and unique. As such, its inventory moves slower, but at a higher price (and margin).

Documents

Warren SM Ch.07 Final