Demonstrati ion Prob bl lem
2. Inventory at Dec. 31 (at average cost)
Units remaining after sale of Nov. 21 (1 unit @ $3,120) . . . $ 3,120 Units purchased on Dec. 1 (4 units @ $3,250) . . . 13,000 Total cost of 5 units in inventory . . . $16,120 Average unit cost at Dec. 31 ($16,120 5 units) . . . $ 3,224 Inventory at Dec. 31 (5 units $3,224 per unit) . . . $16,120 b. 1. Cost of goods sold (FIFO basis):
(2 units @ $3,000 2 units @ $3,200) . . . $12,400 2. Inventory at Dec. 31 (4 units @ $3,250 1 unit @ $3,200) . . . . $16,200 c. 1. Cost of goods sold (LIFO basis):
(3 units @ $3,200 1 unit @ $3,000) . . . $12,600 2. Inventory at Dec. 31 (4 units @ $3,250 1 unit @ $3,000) . . . . $16,000
The answers to these questions appear on page 380.
1. The primary purpose for using an inventory cost flow assumption is to:
a. Parallel the physical flow of units of merchandise.
b. Offset against revenue an appropriate cost of goods sold.
c. Minimize income taxes.
d. Maximize the reported amount of net income.
2. Ace Auto Supply uses a perpetual inventory system. On March 10, the company sells two Shelby four-barrel carburetors.
Immediately prior to this sale, the perpetual inventory records indicate three of these carburetors on hand, as follows:
With respect to the sale on March 10: (More than one of the following answers may be correct.)
a. If the average-cost method is used, the cost of goods sold is $460.
b. If these carburetors have identification numbers, Ace must use the specific identification method to deter- mine the cost of goods sold.
c. If the company uses LIFO, the cost of goods sold will be $15 higher than if it were using FIFO.
d. If the company uses LIFO, the carburetor remaining in inventory after the sales will be assumed to have cost
$220.
3. T-Shirt City uses a periodic inventory system. During the first year of operations, the company made four purchases of a particular product. Each purchase was for 500 units and the prices paid were $9 per unit in the first purchase, $10 per unit in the second purchase, $12 per unit in the third pur- chase, and $13 per unit in the fourth purchase. At year-end, Quantity Unit Units Total
Date Purchased Cost on Hand Cost
Feb. 4 1 $220 1 $220
Mar. 2 2 235 3 690
Self-Test Questions Self-T est Questions
Confirming Pages
Discussion Questions 363
650 of these units remained unsold. Compute the cost of goods sold under the FIFO method and LIFO method, respectively.
a. $13,700 (FIFO) and $16,000 (LIFO).
b. $8,300 (FIFO) and $6,000 (LIFO).
c. $16,000 (FIFO) and $13,700 (LIFO).
d. $6,000 (FIFO) and $8,300 (LIFO).
4. Trent Department Store uses a perpetual inventory sys- tem but adjusts its inventory records at year-end to reflect the results of a complete physical inventory. In the physi- cal inventory taken at the ends of 2010 and 2011, Trent’s employees failed to count the merchandise in the store’s window displays. The cost of this merchandise amounted to
$13,000 at the end of 2010 and $19,000 at the end of 2011.
As a result of these errors, the cost of goods sold for 2011 will be:
a. Understated by $19,000.
b. Overstated by $6,000.
c. Understated by $6,000.
d. None of the above.
5. In July 2011, the accountant for LBJ Imports is in the process of preparing financial statements for the quarter ended June 30, 2011. The physical inventory, however, was last taken on June 5, and the accountant must estab- lish the approximate cost at June 30 from the following data:
Physical inventory, June 5, 2011 . . . $900,000 Transactions for the period June 5–June 30:
Sales . . . 700,000 Purchases . . . 400,000 The gross profit on sales has consistently averaged 40 per-
cent of sales. Using the gross profit method, compute the approximate inventory cost at June 30, 2011.
a. $420,000.
b. $880,000.
c. $480,000.
d. $1,360,000.
6. Allied Products maintains a large inventory. The company has used the LIFO inventory method for many years, dur- ing which the purchase costs of its products have risen sub- stantially. (More than one of the following answers may be correct.)
a. Allied would have reported a higher net income in past years if it had been using the average-cost method.
b. Allied’s financial statements imply a lower inventory turnover rate than they would if the company were using FIFO.
c. If Allied were to let its inventory fall far below normal levels, the company’s gross profit rate would decline . d. Allied would have paid more income taxes in past years
if it had been using the FIFO method.
1. Briefly describe the advantages of using a cost flow assump- tion, rather than the specific identification method, to value an inventory.
2. Under what circumstances do generally accepted accounting principles permit the use of an inventory cost flow assump- tion? Must a cost flow assumption closely parallel the physi- cal movement of the company’s merchandise?
3. A large art gallery has in inventory more than 100 paint- ings. No two are alike. The least expensive is priced at more than $1,000 and the higher-priced items carry prices of $100,000 and more. Which of the four methods of inven- tory valuation discussed in this chapter would you consider to be most appropriate for this business? Give reasons for your answer.
4. During a period of steadily increasing purchase costs, which inventory flow assumption results in the highest reported profits? The lowest taxable income? The valuation of inven- tory that is closest to current replacement cost? Briefly explain your answers.
5. What are the characteristics of a just-in-time inventory sys- tem? Briefly explain some advantages and risks of this type of system.
ASSIGNMENT MATERIAL Discussion Questions
1
Discussion Questions
ASSIGNMENT MATERIAL
6. Why do companies that use perpetual inventory systems also take an annual physical inventory? When is this physical inventory usually taken? Why?
7. Under what circumstances might a company write down its inventory to carrying value below cost?
8. What is meant by the year-end cutoff of transactions? If mer- chandise in transit at year-end is material in dollar amount, what determines whether these goods should be included in the inventory of the buyer or the seller? Explain.
9. Explain why errors in the valuation of inventory at the end of the year are sometimes called “counterbalancing” or
“self-correcting.”
10. Briefly explain the gross profit method of estimating inven- tories. In what types of situations is this technique likely to be useful?
11. A store using the retail inventory method takes its physical inventory by applying current retail prices as marked on the merchandise to the quantities counted. Does this procedure mean that the inventory will appear in the financial state- ments at retail selling price? Explain.
12. How is the inventory turnover computed? Why is this measurement of interest to short-term creditors?
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Brief Exercises
Smalley, Inc., purchased items of inventory as follows:
Jan. 4 100 units @ $2.00 Jan. 23 120 units @ $2.25
Smalley sold 50 units on January 28. Compute the cost of goods sold for the month under the FIFO inventory method.
Wasson Company purchased items of inventory as follows:
Dec. 2 50 units @ $20 Dec. 12 12 units @ $21
Wasson sold 15 units on December 20. Determine the cost of goods sold for the month under the LIFO inventory method.
Fox Company purchased items of inventory as follows:
May 3 100 units @ $3.05 May 10 150 units @ $3.10 May 15 120 units @ $3.15
By the end of the month of May, Fox had sold 125 units. If the company uses the average-cost method of accounting for inventory, what is the amount of the ending inventory?
Murray, Inc., purchased a new inventory item two times during the month of April, as follows:
Apr. 5 100 units @ $5.00 Apr. 15 100 units @ $5.05
a. What is the amount of the ending inventory of this item on April 30 if the company has sold 75 units and uses the LIFO inventory method?
b. How would this amount differ if the company used the FIFO inventory method?
United Co. had 10 units of an inventory item on hand at the beginning of the current year, each of which had a per-unit cost of $10. During the year, 20 additional units were purchased at $11, and 25 units were sold. What is the amount of the ending inventory under the LIFO and the average- cost methods of accounting for inventory?
Brief Exercises accounting
BRIEF
EXERCISE 8.1 FIFO Inventory B
E LO1
F E LO4 F
BRIEF
EXERCISE 8.2 LIFO Inventory B
E LO1
L E LO4 L
BRIEF
EXERCISE 8.3 Average-Cost Inventory B E A LO4
BRIEF
EXERCISE 8.4 FIFO and LIFO Inventory B E F LO4
BRIEF
EXERCISE 8.5 FIFO and Average-Cost Inventory
B E LO4
13. Baxter Corporation has been using FIFO during a period of rising costs. Explain whether you would expect each of the following measurements to be higher or lower if the com- pany had been using LIFO.
a. Net income.
b. Inventory turnover rate.
c. Income taxes expense.
14. In anticipation of declining inventory replacement costs, the management of Computer Products Co. elects to use the FIFO inventory method rather than LIFO. Explain how this decision should affect the company’s future:
a. Rate of gross profit.
b. Net cash flow from operating activities.
15. Notes to the financial statements of two clothing manufac- turers follow:
Inventories: The inventories are stated at the lower of cost, determined principally by the LIFO method, or market.
Inventories: Inventories are stated at the lower of cost (first- in, first-out method) or market value, assuming a period of rising prices.
a. Which company is using the more conservative method of pricing its inventories? Explain.
b. On the basis of the inventory methods in use in their financial statements, which company is in the better position to minimize the amount of income taxes that it must pay? Explain.
c. Could either company increase its cash collections from customers or reduce its cash payments to suppli- ers of merchandise by switching from FIFO to LIFO, or from LIFO to FIFO? Explain.
Confirming Pages
Exercises 365
Wexler Company’s inventory is subject to shrinkage via evaporation. At the end of the current financial reporting period, the company’s inventory had a cost of $100,000. Management estimates that evaporation has resulted in a 5 percent inventory loss. Assuming that loss is recorded in a separate inventory loss account, prepare the general journal entry to record the inventory shrinkage for the year.
Black and Blue, Inc., overlooked $100,000 of inventory at the end of the current year because it was stored temporarily in a warehouse owned by another company. Before discovering this error, the company’s income statement showed the following:
Sales . . . $990,000 Cost of goods sold . . . (560,000) Gross profit . . . $430,000
Restate these figures to reflect the inclusion of the overlooked inventory.
Due to ineffective controls while counting its inventory, Walker & Comer, Inc., double-counted
$50,000 of inventory at the end of the current year. Before discovering this error, the company’s ending inventory was $670,000. How will correction of this error affect the company’s inventory and cost of goods sold figures?
Miller & Miller Company recorded sales, cost of goods sold, and ending inventory for the cur- rent year in the following amounts: $650,000, $500,000, and $128,000, respectively. Calculate the amount of the company’s inventory turnover for the year. What is the company’s average number of days to sell inventory?
Rouse Incorporated reported sales, cost of sales, and inventory figures for 2010 and 2011 as fol- lows (all dollars in thousands):
BRIEF
EXERCISE 8.6 Inventory Shrinkage B
E LO3
BRIEF
EXERCISE 8.7 Inventory Error B
E LO5
BRIEF
EXERCISE 8.8 Inventory Error B
E I LO5
BRIEF
EXERCISE 8.9 Inventory Turnover B
E LO7
BRIEF
EXERCISE 8.10 Inventory Turnover B
E I LO7
Sales Cost of Goods Sold Inventory 2010 . . . $100 $85 $27 2011 . . . 110 90 35
Exercises
Listed below are eight technical accounting terms introduced in this chapter.
Retail method FIFO method Lower-of-cost-or-market Gross profit method LIFO method Specific identification Flow assumption Average-cost method
Each of the following statements may (or may not) describe one of these technical terms. For each statement, indicate the term described, or answer “None” if the statement does not correctly describe any of the terms.
a. A pattern of transferring unit costs from the Inventory account to the Cost of Goods Sold that may (or may not) parallel the physical flow of merchandise.
Exercises accounting
EXERCISE 8.1 Accounting Terminology
throughg Te LO7
E Ac
through Te LO1
What is the amount of inventory turnover for each year, and in which year did Rouse manage its inventory most efficiently?
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b. The only flow assumption in which all units of merchandise are assigned the same per-unit cost.
c. The method used to record the cost of goods sold when each unit in the inventory is unique.
d. The most conservative of the flow assumptions during a period of sustained inflation.
e. The flow assumption that provides the most current valuation of inventory in the balance sheet.
f. A technique for estimating the cost of goods sold and the ending inventory that is based on the relationship between cost and sales price during the current accounting period.
On May 10, Hudson Computing sold 90 Millennium laptop computers to Apex Publishers. At the date of this sale, Hudson’s perpetual inventory records included the following cost layers for the Millennium laptops:
EXERCISE 8.2 Cost Flow Assumptions E
C A LO1
Purchase Date Quantity Unit Cost Total Cost Apr. 9 . . . 70 $1,500 $105,000 May 1 . . . 30 $1,600 48,000 Total on hand . . . 100 $153,000
Prepare journal entries to record the cost of the 90 Millennium laptops sold on May 10, assuming that Hudson Computing uses the:
a. Specific identification method (62 of the units sold were purchased on April 9, and the remain- ing units were purchased on May 1).
b. Average-cost method.
c. FIFO method.
d. LIFO method.
e. Discuss briefly the financial reporting differences that may arise from choosing the FIFO method over the LIFO method.
The Warm-Up Shop sells heating oil, coal, and kerosene fuel to residential customers. Heating oil is kept in large storage tanks that supply the company’s fleet of delivery trucks. Coal is kept in huge bins that are loaded and emptied from the top by giant scooping machines. Kerosene is sold
“off the shelf” in five-gallon containers at the company’s retail outlet. Separate inventory records are maintained for each fuel type.
a. Which of the cost flow assumptions (average-cost, FIFO, or LIFO) best describes the physical flow of:
1. The heating oil inventory? Explain.