Chapter 6: Reporting and Analysing Inventory
Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
CHAPTER 6
Reporting and Analysing InventoryASSIGNMENT CLASSIFICATION TABLE
Study ObjectivesQuestionsBriefExercisesExercisesAProblemsBProblems
1.Describe the steps in determining inventory quantities.1, 2, 311, 21A, 7A
1B, 7B
2.Explain the basis of accounting for inventories and apply the inventory cost flow assumptions under a periodic inventory system.4, 5, 6, 723, 4, 5, 12*, 13*2A, 3A, 4A, 8A* 2B, 3B, 4B, *8B
3.Explain the financial statement effects of each of the inventory cost flow assumptions.8, 9, 10352A, 3A, 7A, 9A*, 10A*2B, 3B, 7B, 9B*, 10B*
4.Indicate the effects of inventory errors on the financial statements.11, 124, 56, 75A, 6A5B, 6B
5.Explain the lower of
cost and market basis of accounting for inventories.13, 14684A4B
6.Calculate and interpret inventory turnover.15, 16, 177, 89, 104A, 5A, 7A4B, 7B
7.*Apply the inventory cost flow assumptions under a perpetual inventory system (Appendix A).18*, 19*, 20*9*, 10*, 11*11*, 12*, 13*8A*, 9A*, 10A*8B*, 9B*, 10B*
*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendices to each chapter.
ASSIGNMENT CHARACTERISTICS TABLE
ProblemNumberDescriptionDifficultyLevelTimeAllotted (min.)
1AIdentify items in inventory.Simple30-40
2AApply cost flow assumptions in periodic inventory system, and assess financial statement effects.Moderate30-40
3AApply cost flow assumptions in periodic inventory system, prepare statements of earnings, and answer questions.Moderate30-40
4APrepare journal entries for purchaser and seller using FIFO periodic; apply lower of cost and market. Moderate30-40
5ADetermine effects of inventory errors.Moderate15-20
6ADetermine effects of inventory errors.Moderate15-20
7ACalculate ratios; comment on liquidity and effect of cost flow assumptions on ratios.Moderate20-30
*8AApply average cost flow assumption in periodic and perpetual inventory system.Moderate40-50
*9AApply cost flow assumptions in perpetual inventory systems, and assess financial statement effects. Moderate40-50
*10APrepare journal entries under perpetual inventory system. Assess financial statement effects.Moderate30-40
1BIdentify items in inventory.Simple30-40
2BApply cost flow assumptions in periodic inventory system and assess financial statement effects.Moderate30-40
3BApply cost flow assumptions in periodic inventory system, prepare statement of earnings, and answer questions.Moderate30-40
4BPrepare journal entries for purchaser and seller using average periodic; apply lower of cost and market.Moderate30-40
5BDetermine effects of inventory errors.Moderate15-20
6BDetermine effects of inventory errors.Moderate15-20
7BCalculate ratios; comment on liquidity and effect of cost flow assumptions on ratios.Moderate20-30
*8BApply FIFO cost flow assumption in periodic and perpetual inventory system.Moderate40-50
*9BApply cost flow assumptions in perpetual inventory systems, and assess financial statement effects. Moderate40-50
*10BPrepare journal entries under perpetual system. Assess financial statement effects.Moderate30-40
ANSWERS TO QUESTIONS
1.Inventoriable costs are $3,010 (invoice cost $3,000 + freight charges $70 ( purchase discounts $60). The amount paid to negotiate the purchase is a buying cost that normally is not included in the cost of inventory because of the difficulty of allocating these costs. Buying costs are expensed in the year incurred.
2.Taking a physical inventory involves actually counting, weighing or measuring each kind of inventory on hand. Retailers, such as hardware stores, generally have thousands of different items to count. This is normally done when the store is closed. Tom will probably count items and mark the quantity, description, and inventory number on prenumbered inventory tags.
Purchased inventory in transit shipped FOB shipping point will have to be included in inventory. Inventory that has been shipped to customers FOB destination and not received by the customer before year-end will also have to be included in the count. Finally, any inventory held by other retailers on consignment will have to be included in the count as well.
3.(a)(1)The goods will be included in Janine Ltd.s inventory if the terms of sale
are FOB destination.
(2)They will be included in Fastrak Corporations inventory if the terms of sale are FOB shipping point.
(b)Janine Ltd. should include goods shipped to a consignee in its inventory. Goods held by Janine Ltd. on consignment should not be included in inventory
4.Actual physical flow may be impractical because many items are indistinguishable from one another. Actual physical flow may also be inappropriate because management may be able to manipulate net income through specific identification of items sold.
5Because the specific identification method requires that records be kept of the original cost of each individual inventory item it is possible to manipulate the cost of goods sold by deliberately selecting to sell inventory items with higher or lower costs.
LIFO values the cost of goods sold at the most recent purchase price, therefore a company could decide to buy or delay buying inventory at year-end to manipulate the cost of goods sold.
6.
(a) Average cost
(b) LIFO
(c)
FIFO
Questions (Continued)
7.(1)No effect cash is not affected by inventory cost flow assumptions
(2) In a period of declining prices FIFO will produce a lower ending inventory as inventory is valued using the most recent (lower) prices; LIFO will produce a higher ending inventory as ending inventory is valued at the higher older prices.
(3) The cost of goods sold effect is opposite to that of ending inventory. Hence, cost of goods sold will be higher under FIFO and lower under LIFO.
(4) Because of the effect on the cost of goods sold, net earnings will be lower under FIFO and higher under LIFO.
8.Plato Ltd. is using the FIFO cost flow assumption of inventory costing, and York Ltd. is using the LIFO cost flow assumption. Under FIFO, the latest goods purchased remain in inventory. Thus, the inventory on the balance sheet should be close to current costs. The reverse is true of the LIFO cost flow assumption. Plato Ltd. will have the higher gross profit because cost of goods sold will include a higher proportion of goods purchased at earlier (lower) costs.
9.Swift Corporation may experience severe cash shortages if this policy continues. All of its net earnings is being paid out as dividends, yet some of the earnings must be reinvested in inventory to maintain inventory levels. Some earnings must be reinvested because net earnings is calculated with cost of goods sold based on older, lower costs while the inventory must be replaced at current, higher costs. Because of this factor, net earnings under FIFO are sometimes referred to as phantom profits.
10.No. Selection of an inventory cost flow assumption is a management decision made to best match costs to revenues. However, once an assumption has been chosen, it should be consistently applied.
11.(a) Mila Ltd.s 2004 net earnings will be understated $5,000; (b) 2005 net earnings will be overstated $5,000; and (c) the 2005 retained earnings will be correct.
12.Assets will be understated because the items will not be included in inventory. If the items are not in inventory, management will assume they have been sold or lost through spoilage or theft. If the items are not in the inventory they will be expensed and therefore the shareholders equity will also be understated. Liabilities will not be affected.
13.Lucy should know the following:
(a)A departure from the cost basis of accounting for inventories is justified when the value of the goods is no longer as great as its cost. The write down to market should be recognized in the period in which the price decline occurs.
(b)Market means current replacement cost or net realizable value. For a merchandising company, current replacement cost is the cost at the present time from the usual suppliers in the usual quantities. Other companies use net realizable value, which is the selling price less the purchase cost and any disposal costs.
Questions (Continued)14.Rock Music Centre should report the CD players at $320 each for a total of $1,600. $320 is the net realizable value under the lower of cost and market basis of accounting for inventories. A decline in replacement cost recognizes losses as soon as they are evident so as not to impact decision making unfavourably. Valuation at LCM is conservative.
15.Agree. Effective inventory management is frequently the key to successful business operations. Management attempts to maintain sufficient quantities and types of goods to meet expected customer demand. It also seeks to avoid the cost of carrying inventories that are clearly in excess of anticipated sales.
16.An inventory turnover ratio that is too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory outages may also cause customer ill will and result in lost future sales.
17.An increase in the days in inventory ratio from one year to the next would be seen as deterioration in the companys efficiency in managing inventory. It means that more inventory is being held relative to sales.
18.Periodic and perpetual inventory systems differ in the accounting treatment for inventories. Under a perpetual inventory system inventory records are updated for every purchase and sale transaction. The cost of goods sold is recorded each time a sale is made. Under a periodic system, the inventory is only updated at the end of the period when a physical inventory count is performed. Inventory purchases throughout the year are debited to a purchases account. When a sale is recorded, no entry is made to record the cost of the sale. Cost of goods sold is calculated separately after the physical inventory count is performed.
*19.Disagree. The results under the FIFO cost flow assumption are the same but the results under the LIFO cost flow assumption are different. The reason is that the pool of inventoriable costs (costs of goods available for sale) is not the same. Under a periodic system, the pool of costs is the goods available for sale for the entire period, whereas under a perpetual system, the pool is the goods available for sale up to the date of sale.
*20.In a periodic system, the average is a weighted average based on total goods available for sale for the period. In a perpetual system, the average is a moving average of goods available for sale after each purchase.
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 6-1
(a)Ownership of the goods belongs to the consignor (Helgeson). Thus, these goods should be included in Helgesons inventory.
(b)Goods held on consignment belong to the other company and should not be included in Helgesons inventory.
(c)The goods being held belong to the customer. They should not be included in Helgesons inventory.
(d)The goods in transit should not be included in the inventory count because ownership by Helgeson does not occur until the goods reach the buyer.
(e)The goods in transit belong to the customer because ownership transferred at the point of shipping. They should not be included in Helgesons inventory.
BRIEF EXERCISE 6-2
UnitsDollars
Beginning inventory0$ 0
Purchases (300@$6 + 400@$7 +300@$8)1,000 7,000
Goods available for sale1,000$7,000
Goods sold (600)
Ending inventory 400(a)FIFO
Cost of Goods Sold: (300 x $6) + (300 x $7) = $3,900
Ending Inventory: (300 x $8) + (100 x $7)= 3,100
Total$7,000(b)Weighted Average
Weighted Average Cost = $7,000 1,000 = $7
Cost of Goods Sold: 600 x $7 = $4,200
Ending Inventory: 400 x $7 = 2,800
Total $7,000(c)
LIFO
Cost of Goods Sold: (300 x $8) + (300 x $7) = $4,500
Ending Inventory: (300 x $6) + (100 x $7) = 2,500
Total $7,000BRIEF EXERCISE 6-3
(a) LIFO. The ending inventory is valued at the earlier, higher costs.
(b)FIFO.The cost of goods is valued using the earlier, higher costs.
(c)Cash flow is not affected by the inventory cost flow assumptions, therefore the pretax income will be the same under all assumptions.
(d)The factor that management should consider when choosing an inventory cost flow assumptions is which assumption results in the fairest matching of costs to revenues.
BRIEF EXERCISE 6-4
The overstatement of ending inventory caused cost of goods sold to be understated $7,000 and net earnings to be overstated $7,000. The correct net earnings for 2004 is $83,000 ($90,000 - $7,000).
Total assets in the balance sheet will be overstated by the amount that ending inventory is overstated, $7,000.BRIEF EXERCISE 6-5
2004
2005
Assets
Understated
No effect
Liabilities
No effect
No effect
Shareholders Equity
Understated
No effectBRIEF EXERCISE 6-6
Inventory Categories
Cost
MarketCameras$12,000$10,200
Camcorders.9,0009,500
VCRs 14,000 12,800Total valuation$35,000$32,500The lower of cost and market is $32,500.
BRIEF EXERCISE 6-7
Inventory Turnover Ratio:
Days in Inventory:
BRIEF EXERCISE 6-8
(a) Increase
(b) Decrease
(c) No effect
*BRIEF EXERCISE 6-9
(1) FIFO
DatePurchasesCost of Goods SoldBalance
May 750 @ $10 = $50050 @ $10 = $500
June 130 @ $10 = $30020 @ $10 = 200
July 2830 @ $15 = 45020 @ $10
30 @ $15 = 650
August 2720 @ $10
13 @ $15 = 39517 @ $15 = 255
TotalGAS $950CGS $695EI $255
(2) Average Cost
DatePurchasesCost of Goods SoldBalance
May 750 @ $10 = $50050 @ $10 = $500
June 130 @ $10 = $30020 @ $10 = 200
July 2830 @ $15 = 45050 @ $13 = 650
August 2733 @ $13 = 42917 @ $13 = 221
TotalGAS $950CGS $729EI $221
*BRIEF EXERCISE 6-10
UnitsDollars
Beginning inventory0$ 0
Purchases (300 @ $6 + 400 @ $7 + 300 @ $8)1,000 7,000
Goods available for sale1,000$7,000
Goods sold (600)
Ending inventory 400(a)FIFOCost of Goods Sold: (200 x $6) + [(100 x $6) + (300 x $7)] = $3,900
Ending Inventory: (100 x $7) + (300 x $8) = 3,100
Total $7,000(b)Moving AverageCost of Goods Sold: (200 x $6) + (400 x $6.801) = $3,920
Ending Inventory: 400 x $7.702 = 3,080
Total $7,0001 (100 x $6) + (400 x $7) = $3,400; $3,400 500 = $6.80 2 (100 x $6.80) + (300 x $8) = $3,080; $3,080 400 = $7.70
(c)LIFOCost of Goods Sold: (400 x $7) + (200 x $6)= $4,000
Ending Inventory: (300 x $8) + (100 x $6) = 3,000
Total $7,000*BRIEF EXERCISE 6-11
(a) FIFO Periodic
Date
Account Titles and Explanation
DebitCreditJan.1No entry required
3Accounts Receivable
2,500
Sales
2,500
9Purchases
4,000
Accounts Payable
4,000
15Cash
6,400
Sales
6,400
(b)FIFO Perpetual
Date
Account Titles and Explanation
DebitCreditJan.1No entry required
3Accounts Receivable
2,500
Sales
2,500
Cost of Goods Sold
1,500
Merchandise Inventory
1,500
9Merchandise Inventory
4,000
Accounts Payable
4,000
15Cash
6,400
Sales
6,400
Cost of Goods Sold (200 @ $3 + 600 @ $4)
3,000
Merchandise Inventory
3,000
SOLUTIONS TO EXERCISES
EXERCISE 6-1
(a)Do not include Shippers does not own items held on consignment
(b)Include in inventory Shippers still owns the items as they were only shipped on consignment.
(c)Include in inventory Shipping terms FOB destination means that Shippers owns the items until they reach the customer.
(d)Do not include in inventory - Because the shipping terms are FOB shipping point, ownership has transferred to the customer. Shippers Ltd should record this amount as a sale on the statement of earnings.
(e)Do not include in inventory Because the shipping terms are FOB destination, Shippers does not own the supplies until they arrive at Shippers premises.
(f) Include in inventory Shipping terms FOB shipping point means that ownership transferred at the time of shipping and therefore, Shippers Ltd. owns the goods in transit.
(g) Record as supplies inventory on the balance sheet.
EXERCISE 6-2
Ending inventory(Physical count.$295,000
1.No effect(Title passes to purchaser upon shipment when terms are FOB shipping point..0
2.No effect(Title does not transfer to Novotna untilgoods are received0
3.Add to inventory: Title passed to Novotna when
goods were shipped.25,000
4.Add to inventory: Title remains with Novotna until purchaser receives goods 40,000Correct inventory..,$360,000EXERCISE 6-3
(a)FIFO Cost of Goods Sold
(#1012) $500 + (#1045) $450 = $950
(b)It could choose to sell specific units purchased at specific costs if it wished to impact earnings selectively. If it wished to minimize earnings it would choose to sell the units purchased at higher costsin which case the Cost of Goods Sold would be $950. If it wished to maximize earnings it would choose to sell the units purchased at lower costsin which case the cost of goods sold would be $850.
(c)I recommend they use the FIFO cost flow assumption because it provides a more appropriate balance sheet valuation and reduces the opportunity to manipulate earnings.
(The answer may vary depending on the assumption the student chooses.)
EXERCISE 6-4
(a)
FIFO
Beginning inventory (30 X $8)
$240
Purchases
May 15 (25 X $10)
$250
May 24 (35 X $12)
420 670Cost of goods available for sale (90 units)
910
Less: Ending inventory [(90 - 70) X $12]
240Cost of goods sold
$670(b)
Weighted Average
Beginning inventory (30 X $8)
$240
Purchases
May 15 (25 X $10)
$250
May 24 (35 X $12)
420 670Cost of goods available for sale (90 units)
910
Less: Ending inventory [(90 - 70) X $10.11*]
202Cost of goods sold
$708*$910.00 90 units = $10.11/unit
(c)
LIFO
Beginning inventory (30 X $8)
$240
Purchases
May 15 (25 X $10)
$250
May 24 (35 X $12)
420 670Cost of goods available for sale (90 units)
910
Less: Ending inventory [(90 - 70) X $8]
160Cost of goods sold
$750EXERCISE 6-5
(a)
(1) FIFOBeginning inventory (200 X $5)
$1,000
Purchases
June 12 (300 X $6)
$1,800
June 23 (500 X $7)
3,500 5,300Cost of goods available for sale
6,300
Less: Ending inventory (160 X $7)
1,120Cost of goods sold
$5,180(2) Average Cost
Cost of Goods
Total Units
Weighted Average
Available for Sale
(
Available for Sale
=
Unit Cost
$6,300
1,000
$6.30
Ending inventory
160 X $6.30 = $1,008
Cost of goods sold
840 X $6.30 = $5,292 or
$6,300 $1,008 = $5,292
(3) LIFO
Cost of goods available for sale
$6,300
Less: Ending inventory (160 X $5)
800
Cost of goods sold
$5,500(b)The FIFO cost flow assumption will produce the highest ending inventory because costs have been rising. Under this assumption, the earliest costs are assigned to cost of goods sold, and the latest costs remain in ending inventory.
(c)The LIFO cost flow assumption will produce the highest cost of goods sold for Lakshmi Ltd. Under LIFO the most recent costs are charged to cost of goods sold and the earliest costs are included in the ending inventory.
(d) The selection of a cost flow assumption does not affect cash flow. Cash flow is determined by purchases and payments not the allocation of costs between cost of goods sold and ending inventory.
EXERCISE 6-6(a)
2004
2005
Beginning inventory
$ 20,000$ 26,000
Cost of goods purchased
160,000 175,000Cost of goods available for sale
180,000 201,000
Corrected ending inventory
26,000a 38,000bCost of goods sold
$154,000$163,000a $30,000 - $4,000 = $26,000
b $35,000 + $3,000 = $38,000
(b)
Inventory error for 2004 will cause 2004 cost of goods sold to be understated by $4,000, which will cause the 2004 net earnings and retained earnings to be overstated by the same amount. When the error reverses in 2005, cost of goods sold will be overstated and 2005 net earnings will be understated. Over the two years the error will reverse and therefore the 2005 retained earnings balance will be correct.
The $3,000 understatement of inventory in 2005 will cause the 2005 cost of goods sold to be overstated and the 2005 net earnings and retained earnings to be understated by $3,000.
EXERCISE 6-7(a)
20042005
Sales
$210,000$250,000
Cost of goods sold
Beginning inventory
32,00036,000
Cost of goods purchased
173,000 202,000
Cost of goods available for sale
205,000238,000
Ending inventory ($40,000 - $4,000)
36,000 52,000
Cost of goods sold
169,000 186,000
Gross profit
$ 41,000$ 64,000(b)The cumulative effect on total gross profit for the two years is zero as shown below:
Incorrect gross profits:$45,000 + $60,000 = $105,000
Correct gross profits:$41,000 + $64,000 = 105,000
Difference
$ 0EXERCISE 6-7 (Continued)
(c)
Gross Profit Margin
2004
2005
Before correction
$45,000 $210,000
$60,000 $250,000
= 21.4%
= 24.0%
After correction
$41,000 $210,000
$64,000 $250,000
=19.5%= 25.6%
(d)Dear Mr./Ms. President:
Because your ending inventory of December 31, 2004 was overstated by $4,000, your net earnings for 2004 were overstated and net earnings for 2005 were understated by $4,000.
In a periodic system, the cost of goods sold is calculated by deducting the cost of ending inventory from the total cost of goods you have available for sale in the period. Therefore, if this ending inventory figure is overstated, as it was in December 2004, the cost of goods sold is understated and therefore net earnings will be overstated by that amount. Consequently, this overstated ending inventory figure goes on to become the next periods beginning inventory amount and is a part of the total cost of goods available for sale. Therefore, the mistake repeats itself in the reverse.
The effect on the gross profit margin is significant. Before correction the margin was 21.4% in 2004 and increased 2.6% to 24.0% in 2005. After the error is corrected the margin for 2004 is19.5% and the increase is 6.1% to 25.6% in 2005.
Thank you for allowing me to bring this to your attention. If you have any questions, please contact me at your convenience.
Sincerely,
EXERCISE 6-8
UnitsCost/UnitTotal Cost
(a)Market Value/UnitTotal Market
Value (b)
Cameras:
Minolta5$175$ 875$160$ 800
Canon7 1501,050 1521,064
Light Meters:
Vivitar12 1251,500 1191,428
Kodak10 1151,150 1351,350
Total$4,575$4,642
(c)
Cody Camera Shop should report its inventory at the lower of cost or market. In this case, the total cost of $4,575 is lower than the market of $4,642 and therefore the inventory should be reported on Codys financial statements at $4,575.
EXERCISE 6-9
Inventory Turnover
2002
=
2001
=
Days in Inventory
2002
=
2001
=
EXERCISE 6-9 (Continued)
Gross Profit Margin
2002
=
2001
=
The inventory turnover ratio decreased by approximately 10% [(7.4-8.2) 8.2] from 2002 to 2001. The days in inventory increased by approximately the same amount over the same time period. Both of these changes would be considered negative since it appears it is taking the company longer to turn over its inventory.
Best Buys gross profit margin increased slightly from 21.1% to 24.2%. This means that Best Buys selling prices increased faster than their cost of sales.
EXERCISE 6-10
(a)There was probably an insignificant difference between the two cost flow assumptions on the total inventory because overall, prices may not have changed significantly. Inventory cost flow assumptions assume that prices are rising or falling, with such a variety of inventory items, price increases on some items may be offset by decreases on other items causing the inventory changes between the two assumptions to be minimal.
(b)Inventory Turnover
FIFO: $191,808 $23,902
=
8.03
LIFO:
$191,838 $23,752
= 8.08
(c)
LIFO gives the higher inventory turnover
(d)The choice of inventory cost flow assumption is a way of matching the cost of inventory to revenue. The actual physical movement of inventory will be the same regardless of which cost flow assumption is adopted. Therefore, Wal-Marts inventory will turn over at the same rate regardless which cost flow assumption is used by the company.
*EXERCISE 6-11
(a) (1) FIFO
DatePurchasesCost of Goods SoldBalance
June 1BI 200 @ $5 = $1,000200 @ $5 = $1,000
June 12P 300 @ $6 = $1,800200 @ $5
300 @ $6 =$2,800
June 15200 @ $5
200 @ $6 = $2,200100 @ $6 =
$600
June 23P 500 @ $7 = $3,500100 @ $6
500 @ $7 = $4,100
June 27100 @ $6
340 @ $7 = $2,980160 @ $7 = $1,120
TotalGAS $6,300CGS $5,180EI $1,120
(a) (2) Average Cost
DatePurchasesCost of Goods SoldBalance
June 1BI 200 @ $5 = $1,000200 @ $5 = $1,000
June 12P 300 @ $6 = $1,800500 @ $5.60 = $2,800
June 15400 @ $5.60 = $2,240100 @ $5.60 = $560
June 23P 500 @ $7
= $3,500600 @ $6.77*=
$4,060
June 27440 @ $6.77 = $2,978160 @ $6.77 =
$1,082
TotalGAS $6,300CGS $5,218EI $1,082
* $6.766666 rounded to $6.77
(a) (3) LIFO
DatePurchasesCost of Goods SoldBalance
June 1BI 200 @ $5 = $1,000200 @ $5 = $1,000
June 12P 300 @ $6 = $1,800200 @ $5
300 @ $6 = $2,800
June 15300 @ $6
100 @ $5 = $2,300100 @ $5 = $500
June 23P 500 @ $7
= $3,500100 @ $5
500 @ $7 = $4,000
June 27440 @ $7 = $3,080100 @ $5
60 @ $7 = $920
TotalGAS $6,300CGS $5,380EI
$920
*EXERCISE 6-11 (Continued)
(b)
Cost of Goods SoldEnding Inventory
FIFOPeriodic$5,180$1,120
FIFOPerpetual05,18001,120
Weighted AveragePeriodic05,29201,008
Moving AveragePerpetual05,21801,082
LIFOPeriodic05,500800
LIFOPerpetual 05,3800920
FIFO: The results do not change.
Average cost: Cost of goods sold is $74 lower and ending inventory $74 higher using a perpetual system.
LIFO: Cost of goods sold is $120 lower and ending inventory $120 higher using a perpetual system.
(c)The average cost is not the simple average or a weighted average because average cost under the perpetual inventory system is referred to as a moving weighted average, which means that the inventory cost is recalculated each time inventory is purchased.*EXERCISE 6-12 (a)
FIFO
DatePurchasesSalesBalanceSept. 1(26 @ $97)
$2,522
Sept. 5
(12 @ $97)=$1,164(14 @ $97) = $1,358
Sept. 12(45 @ $102) = $4,590
(14 @ $97) +
(45 @ $102) =$5,948
Sept. 16
(14 @ $97) +
(36 @ $102)=$5,030(9 @ $102) = $918
Sept. 19(28 @ $104) = $2,912
(9 @ $102) +
(28 @ $104) =$3,830
Cost of Goods Sold: $1,164 + $5,030 = $6,194
Ending Inventory: $3,830
AVERAGE COST
DatePurchasesSalesBalanceSept. 1(26 @ $97)
$2,522
Sept. 5
(12 @ $97) = $1,164(14 @ $97)=$1,358
Sept. 12(45 @ $102) = $4,590
(59@$100.81) a = $5,948
Sept. 16
(50 @ $100.81) =$5,041*(9@ $100.81) = $907
Sept. 19(28 @ $104) $2,912
(37@$103.22) b=$3,819
*Rounded
a $5,948 59 = $100.81
b $3,819 37 = $103.22
Cost of Goods Sold: $1,164 + $5,041 = $6,205
Ending Inventory: $3,819
*EXERCISE 6-12 (Continued)
(a) (Continued)
LIFO
DatePurchasesSalesBalanceSept. 1(26 @ $97)
$2,522
Sept. 5
(12 @ $97)=$1,164(14 @ $97) = $1,358
Sept. 12(45 @ $102) =$4,590
(14 @ $97) +
(45 @ $102) = $5,948
Sept. 16
(5 @ $97) +
(45 @ $102) =$5,075(9 @ $97) = $873
Sept. 19(28 @ $104) = $2,912
(9@ $97)+
(28 @ $104) =$3,785
Cost of Goods Sold: $1,164 + $5,075 = $6,239
Ending Inventory: $3,785
(b)
FIFO
Beginning inventory (26 X $97)
$2,522
Purchases
Sept. 12 (45 X $102)
$4,590
Sept. 19 (28 X $104)
2,912
7,502Cost of goods available for sale
10,024
Less: Ending inventory (9 @$102) + (28 @ $104)
3,830Cost of goods sold
$6,194AVERAGE COST
Cost of goods available for sale
$10,024
Less: Ending inventory (37 X $101.251) 3,746Cost of goods sold
$ 6,2781$10,024 99 = $101.25
LIFO
Cost of goods available for sale
$10,024
Less: Ending inventory (26 @ $97) + (11@ $102) 3,644Cost of goods sold
$ 6,380*EXERCISE 6-12 (Continued)
(b) (Continued)
PeriodicPerpetual
Ending
InventoryCost of Goods SoldEnding
InventoryCost of Goods Sold
FIFO$3,830$6,194$3,830$6,194
Average cost$3,746$6,278$3,819$6,205
LIFO$3,644$6,380$3,785$6,239
*EXERCISE 6-13
(a)
FIFOMoving AverageLIFO
Dr.Cr.Dr.Cr.Dr.Cr.
Sept. 5Cash
Sales02,38802,38802,38802,38802,38802,388
5Cost of Goods Sold
Inventory01,16401,16401,16401,16401,16401,164
12Inventory
Accounts Payable04,59004,59004,59004,59004,59004,590
16Cash
Sales09,95009,95009,95009,95009,95009,950
16Cost of Goods Sold
Inventory05,03005,03005,04105,04105,07505,075
19Inventory
Accounts Payable02,91202,91202,91202,91202,91202,912
(b)
FIFOWeighted AverageLIFO
Dr.Cr.Dr.Cr.Dr.Cr.
Sept. 5Cash
Sales02,38802,38802,38802,38802,38802,388
12Purchases
Accounts Payable04,59004,59004,59004,59004,59004,590
16Cash
Sales09,95009,9509,95009,95009,95009,950
19Purchases
Accounts Payable02,91202,91202,9122,9122,91202,912
SOLUTIONS TO PROBLEMS
(a)The goods should not be included in inventory as they were shipped FOB shipping point and shipped February 26. Title to the goods transfers to the customer February 26. Banff should have recorded the transaction in the Sales and Accounts Receivable accounts.
(b)The amount should not be included in inventory as they were shipped FOB destination and not received until March 1. The seller still owns the inventory. No entry is recorded.
(c)Include $500 in inventory.
(d)Include $400 in inventory.
(e)$750 should be included in inventory as the goods were shipped FOB shipping point. (They were received March 1assume they were shipped at least one day prior.)
(f)The sale will be recorded on March 2. The goods should be included in inventory at the end of February at their cost of $320.
(g)The damaged goods should not be included in inventory. They should be recorded in a cost of goods sold (loss) account since they are not able to be sold.
(a)COST OF GOODS AVAILABLE FOR SALE
Date Explanation
UnitsUnit Cost
Total Cost
Feb. 1Beginning inventory400$8$ 3,200
Feb.20Purchase
70096,300
May5Purchase
500105,000
Aug.12Purchase
300113,300
Dec.8Purchase
10012 1,200
Total
2,000$19,000(b)FIFO
Step 1: Cost of Goods Sold Step 2: Ending Inventory
UnitTotal
UnitsCostCostDate
UnitsUnit CostTotal Cost
400$ 8$ 3,200Aug. 12300
$11$3,300
70096,300Dec. 8100
12 1,200
500
10 5,000
400
$4,500
1,600
$14,500
Average Cost
Step1:Cost of Goods SoldStep 2:Ending Inventory
Weighted Average Total
Weighted Average
Total
UnitsUnit CostCostUnitsUnit CostCost
1,600$9.50*= $15,200400$9.50 =$3,800*$19,000 ( 2,000 = $9.50
PROBLEM 6-2A (Continued)
(b) Continued
LIFO
Step 1: Cost of Goods Sold Step 2: Ending Inventory
UnitTotal
UnitsCostCostDate
UnitsUnit CostTotal Cost
100$ 12$ 1,200Beg.400
$ 8$3,200
300113,300
500
10 5,000
700
9 6,300
1,600
$15,800
(c)LIFO results in the lowest inventory amount for the balance sheet, $3,200.
FIFO results in the lowest cost of goods sold for the statement of earnings, $14,500.
Cash flow is not affected by the inventory cost flow assumption; therefore cash flow will be the same under all three assumptions.
(a)
COST OF GOODS AVAILABLE FOR SALE
Quarter Explanation
UnitsUnit CostTotal Cost
Beg. Inventory
15,000$2.25$ 33,750
1
Purchase
60,0002.30138,000
2
Purchase
50,0002.50125,000
3
Purchase
50,0002.60130,000
4
Purchase
70,0002.65 185,500
Total
245,000$612,250
FIFO: Cost of Goods Sold:
UnitTotal
UnitsCostCost
15,000$ 2.25$ 33,750
60,0002.30138,000
50,0002.50125,000
50,000
2.60 130,000
50,000
2.65 132,500
225,000
$559,250
Average Cost: Cost of Goods Sold
Weighted Average Total
UnitsUnit CostCost
225,000$2.50*=$562,500
*$612,250 ( 245,000 = $2.50 (rounded)
LIFO: Cost of Goods Sold
UnitTotal
UnitsCostCost
70,000$ 2.65$185,500
50,0002.60130,000
50,000
2.50 125,000
55,000 2.30 126,500
225,000
$567,000
PROBLEM 6-3A (Continued)
(b)
REAL NOVELTY INC.
Condensed Statements of Earnings
Year Ended December 31, 2004
FIFOAVERAGE
LIFO
Sales
$900,000$900,000$900,000Cost of goods sold
Beginning inventory
33,75033,75033,750
Cost of goods purchased
578,500 578,500 578,50
Cost of goods available for sale
612,250612,250612,250
Ending inventory
53,000a 49,750b 45,250c
Cost of goods sold
559,250 562,500 567,000
Gross profit
340,750337,500333,000
Operating expenses
147,000 147,000 147,000
Earnings before income taxes
193,750190,500186,000
Income tax expense
60,000 60,000 60,000Net earnings
$133,750$130,500$126,000a20,000 x $2.65 = $53,000
b 20,000 x $2.50 = $49,750 (adjusted for rounding errors)
c(15,000 x $2.25) + (5,000 x $2.30) = $45,250
PROBLEM 6-3A (Continued)
(c)Dear Real Novelty Inc.
After preparing the comparative condensed statement of earnings for the year ended December 31, 2004 under the FIFO, average cost, and LIFO cost flow assumptions, we have found the following:
1. The FIFO cost flow assumption produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchases. This assumption is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence.
2. The LIFO cost flow assumption produces the most meaningful net earnings because the costs of the most recent purchases are matched against sales.
3. The LIFO cost flow assumption produces the most meaningful gross profit figure because it values the cost of goods sold at the most current prices.
4. The FIFO cost flow assumption is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence.
5. None of the cost flow assumptions have an impact on cash flow. Therefore cash available to management should be the same under all assumptions.
Sincerely,
Purchaser Schwinghamer Inc.General Journal
Date
Account Titles and ExplanationDebitCreditOct.1No entry required
9Purchases
1,680
Accounts Payable
1,680
11Accounts Receivable
5,250
Sales
5,250
13Sales Returns and Allowances
875
Accounts Receivable
875
17Purchases
910
Accounts Payable
910
22Accounts Payable
65
Purchase Returns and Allowances
65
29Accounts Receivable
2,250
Sales
2,250
(b)
Seller Pataki Inc.General Journal
Date
Account Titles and ExplanationDebitCreditOct.9Accounts Receivable
1,680
Sales
1,680
17Accounts Receivable
910
Sales
910
22Sales Returns and Allowances
65
Accounts receivable
65
PROBLEM 6-4A (Continued)
(c)
Ending Inventory
Unit Total
DateUnitsCost Cost
Oct. 17
45*$13 $585
*60 + 120 150 + 25 + 70 5 75 = 45
(d) The inventory should be valued at $540, 45 units @ $12. This is the lower of cost and market.
(e)Inventory turnover is calculated by dividing cost of goods sold by average inventory. Reducing the value of the inventory will increase the inventory turnover ratio.
(a)(INCORRECT)
PELLETIER INC.
Statement of Earnings
Year Ended July 31
20042005Sales $300,000$320,000Cost of goods sold
Beginning inventory30,00022,000
Purchases 200,000 240,000
Cost of goods available for sale230,000262,000
Ending inventory 22,000 31,000
Cost of goods sold 208,000 231,000
Gross profit92,000 89,000
Operating expenses 60,000 64,000Earnings before taxes 32,00025,000
Income tax expense 12,000 0
Net earnings$ 20,000$ 25,000(CORRECT)PELLETIER INC.
Statement of Earnings
For the Year Ended July 31
20042005Sales $300,000$320,000Cost of goods sold
Beginning inventory30,00025,000
Purchases 200,000 265,000
Cost of goods available for sale230,000290,000
Ending inventory 25,000 31,000
Cost of goods sold 205,000 259,000
Gross profit95,000 61,000
Operating expenses 60,000 64,000Earnings (loss) before taxes35,000(3,000)
Income tax expense 12,000 0
Net earnings (loss)$ 23,000$ (3,000)
PROBLEM 6-5A
(Continued)
(b)Inventory turnover
(INCORRECT)
2004:
2005:
(CORRECT)
2004:
2005:
(a)
Cost of Goods Sold(b)
Net
Earnings(c)
Retained Earnings(d)
Ending
Inventory(e)
Inventory Turnover
2004UnderstatedOverstatedOverstatedOverstatedUnderstated
2005OverstatedUnderstatedNo effectNo effectUnderstated
(a)
Inventory TurnoverDays In InventoryCurrent Ratio
2002
2001
PepsiCos liquidity appears to be low. Its current ratio is just over 1:1. This means that its current assets are just sufficient to cover its current liabilities. It has 42 days sales in inventory, which seems reasonable and is likely normal for the industry. The problem may be in its immediate liquidity, or its receivables.
(b)
Raw Materials as % of Total InventoryWork in Progress as % of Total InventoryFinished Goods as % of Total Inventory
2002$525 $1,342
= 39%$214 $1,342
= 16%$603 $1,342
= 45%
2001$535 $1,310
= 40.8%$205 $1,310
= 15.6%$570 $1,310
= 43.6%
2000$503 $1,192
= 42.2%$160 $1,192
= 13.4%$529 $1,192
= 44.4%
Pepsi Cos total inventory has increased over the past three years. However, the company seems to be carrying a higher level of work in progress and finished goods and fewer raw materials. It would seem that the company is taking steps to minimize the amount of resources tied up in raw materials while having more finished goods on hand.
(c)Slightly higher inventories would result in a small decrease in then inventory turnover ratio. In this case however, the inventory turnover ratio increased slightly meaning that cost of goods sold increased at a greater percentage than the inventory.
SALES
Units
Unit CostTotal CostOct. 11150$35
$5,250
29 80$40
3,200Total
230
$8,450
COST OF GOODS AVAILABLE FOR SALE
Date Explanation
00UnitsUnit CostTotal CostOct. 1Beginning inventory60$25$1,500
9Purchase
120263,120
22Purchase
7027 1,890
Total
250
$6,510(a) 1. Average Cost Periodic
Ending Inventory
Cost of Goods Sold
UnitTotalCost of goods
DateUnitsCostCost available $6,510
Oct.3120$26.04*$521Less: Ending inventory 521
Cost of goods sold $5,989
* $6,510 ( 250 = $26.04
Sales$8,450
Less: Cost of goods sold 5,989
Gross profit$ 2,461*PROBLEM 6-8A (Continued)
(a) (Continued)
2. Average Cost - Perpetual
UnitTotalAverageCost of
Date
UnitsCostCost CostGoods Sold
Oct. 160$25.00$1,500$25.00
9 12026.003,120
180
4,62025.67
11(150)25.67 (3,851)
$3,851
30
769
22 7027.001,890
100
2,65926.59
29 (80)26.59 (2,127)
2,127
20
$ 532
$5,978
Sales$8,450
Less: Cost of goods sold 5,978
Gross profit$ 2,472 (b)
Average Cost
PeriodicPerpetual
Gross profit$2,461$2,472
Ending inventory$ 521$ 532
The results for the average cost flow assumption differ depending on whether a perpetual or periodic system is used. This is because using a perpetual system the average cost is recalculated after each purchase.
(a)(1)FIFO:
DateDescriptionPurchasesCGSEnding Inventory
May 1Purchase
05$90$450 5 $90 0$$450
6Sale
03$90 $270 02 900180
11Purchase
040$99 396 2
0490
99 0576
14Sale2
0390
99 477 01 99 099
21Purchase
030103 309 1
0399
103 0$408
27Sale1
199
1032022103206
29Purchase21062122
02103
106 418
30Balance
14$1,367 10$949 44,$418
*PROBLEM 6-9A (Continued)
(a) (Continued)
(2)Average
DateDescriptionPurchasesCGSEnding Inventory
May 1Purchase
05$90$450 5 $90 0$$$450
6Sale
03$90 $270 02 900180
11Purchase
040$99 396 06 96* 0576
14Sale0596 480 01 96 096
21Purchase
030103 309 04 101.25** 0$405
27Sale2101.25202.502101.25202.50
29Purchase210621204 103.63*** 414.50
30Balance
14$1,367 10$952.50 40,$414.50
* $576 ( 6 = $96
** $405 ( 4 = $101.25
***$414.50 ( 4 = $103.63
*PROBLEM 6-9A (Continued)
(a) (Continued)
(3) LIFO
DateDescriptionPurchasesCGSEnding Inventory
May 1Purchase
05$90$450 5 $90 0$$$450
6Sale
03$90 $270 02 900180
11Purchase
040$99 396 2
0490
99 0576
14Sale1
0490
99 48601 90090
21Purchase
030103 309 1
0390
103 0$399
27Sale21032061
0190
103 193
29Purchase21062121
01
290
103
106405
30Balance
14$1,367 10$96240,$405
*PROBLEM 6-9A (Continued)(b)Because prices are rising, FIFO will produce the highest gross profit and net earnings.
(c)Because the ending inventory is valued using the most recent prices, the FIFO cost flow assumption produces the highest ending inventory.
(a)
Moving
FIFO Average Cost
Jan. 1No entry required
(150 @ $17 = $2,550)
2Inventory
2,100
2,100
00000
Cash
2,100
2,100
00
(100 @ $21 = $2,100)
6Cash
7,000
7,000
Sales
7,000
7,000
00
(175 @ $40 = $7,000)
Cost of Goods Sold
3,075
3,255
Inventory
3,075
3,255
00
9Inventory
1,200
1,200
Cash
1,200
1,200
00
(50 @ $24 = $1,200)
*PROBLEM 6-10A (Continued)(a) (Continued)
Jan.15Cash
3,375
3,375
Sales
3,375
3,375
(75 @ $45 = $3,375)
Cost of Goods Sold
1,575
1,557
Inventory
1,575
1,557
23
Inventory
2,800
2,800
Cash
2,800
2,800
0
(100 @ $28 = $2,800)
(b)FIFO produces the higher ending inventory balance because inventory is valued at the most recent costs.
Net cash flow will be the same under either assumption, as cash flow is not affected by the inventory cost flow assumption used.
Gross profit will be higher under the FIFO assumption as it produces a lower cost of goods sold because CGS is valued at the oldest (lowest) prices.
(a)Title to the goods does not transfer to the customer until March 2. Include the $800 in ending inventory.
(b)Kananaskis owns the goods once they are shipped on February 26. Include inventory of $375.
(c)Include $500 in inventory.
(d)Exclude the items from Kananaskis inventory. Craft Producers Ltd. still owns the inventory.
(e)Title of the goods does not transfer to Kananaskis until March 2. Exclude this amount from the February 28 inventory.
(f)The sale will be recorded on February 26. The goods (cost, $280) should be excluded from Kananaskis inventory at the end of February.
(a) COST OF GOODS AVAILABLE FOR SALE
Date Explanation
UnitsUnit Cost
Total Cost
Jan. 1Beginning inventory100$20$ 2,000
Mar.15Purchase
300247,200
July20Purchase
200255,000
Sept.4Purchase
300288,400
Dec.2Purchase
10030 3,000
Total
1,000$25,600(b)FIFO
Step 1: Cost of Goods Sold Step 2: Ending Inventory
UnitTotal
UnitsCostCostDate
UnitsUnit CostTotal Cost
100$ 20$ 2,000Sept. 4100
$28$2,800
300247,200Dec. 2100
30 3,000
200
25 5,000
200
$5,800
200
28 5,600
800
$19,800
AVERAGE COST
Step1:Cost of Goods SoldStep 2:Ending Inventory
Weighted Average Total
Weighted Average
Total
UnitsUnit CostCostUnitsUnit CostCost
800
$25.60* = $20,480200
$25.60 =$5,120
*$25,600 ( 1,000 = $25.60
PROBLEM 6-2B (Continued)
(b) (Continued)
LIFO
Step 1: Cost of Goods Sold Step 2: Ending Inventory
UnitTotal
UnitsCostCostDate
UnitsUnit CostTotal Cost
100$ 30$ 3,000Beg.100
$20$ 2,000
300288,400Mar.15100
24 2,400
200
25 5,000
200
$ 4,400
200
24 4,800
800
$21,200
(c)FIFO results in the highest inventory amount for the balance sheet, $5,800.
LIFO results in the highest cost of goods sold for the statement of earnings, $21,200.
Cash flow is not affected by the inventory cost flow assumption; therefore cash flow will be the same under all assumptions.
(a)
COST OF GOODS AVAILABLE FOR SALE
Date Explanation
UnitsUnit CostTotal Cost
Beg. Inventory
10,000$3.50$ 35,000
May 10
Purchase40,0004.00160,000
Aug. 15
Purchase50,0004.25212,500
Nov. 20
Purchase 20,0004.50 90,000
Total
120,000$497,500
FIFO: Cost of Goods Sold:
UnitTotal
UnitsCostCost
10,000$3.50$ 35,000
40,0004.00160,000
45,0004.25 191,250
95,000
$386,250
Average Cost: Cost of Goods Sold
Weighted Average Total
UnitsUnit CostCost
95,000
$4.15*=$393,854
*$497,500 ( 120,000 = $4.15 (rounded)
LIFO: Cost of Goods Sold
UnitTotal
UnitsCostCost
20,000$4.50$ 90,000
50,0004.25212,500
25,000
4.00 100,000
95,000
$402,500PROBLEM 6-3B (Continued)
(b)
TUMATOE INC.
Condensed Statement of Earnings
Year Ended December 31, 2004
FIFOAVERAGELIFO
Sales
$665,000$665,000$665,000Cost of goods sold
Beginning inventory
35,00035,00035,000
Cost of goods purchased
462,500 462,500 462,500
Cost of goods available for sale
497,500497,500497,500
Ending inventory
111,250a 103,646b
95,000c
Cost of goods sold
386,250 393,854 402,500Gross profit
278,750271,146262,500
Operating expenses
120,000 120,000 120,000Income before income taxes
158,750151,146142,500
Income tax expense
50,000 50,000 50,000Net earnings
$108,750$101,146$ 92,500a (20,000 @ $4.50) + (5,000 @ $4.25) = $111,250
b (25,000 @ $497,500 ( 120,000) = $103,646c (10,000 @ $3.50) + (15,000 @ $4.00) = $95,000
PROBLEM 6-3B (Continued)
(c)Dear Tumatoe Inc.
After preparing the comparative condensed statement of earnings for the year ended December 31, 2004 under the FIFO, average cost, and LIFO cost flow assumptions, we have found the following:
1. The FIFO cost flow assumption produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchases.
2. The LIFO cost flow assumption produces the most meaningful net earnings because the costs of the most recent purchases are matched against sales.
3. The FIFO cost flow assumption is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence.
4. None of the cost flow assumptions have an impact on cash flow.
5. The factors that management should consider when choosing an inventory cost flow assumption is which assumption results in the fairest matching of costs to revenues.
You should choose the cost flow assumption that best fits the nature of your inventory items and your pattern of selling.
Sincerely,
(a) Purchaser
AMELIA INC.
General Journal
Date
Account Titles and ExplanationDebitCredit
July5Purchases
540
Cash
540
8Cash
715
Sales
715
15Sales Returns and Allowances
110
Cash
110
25Purchases
200
Cash
200
26Cash
40
Purchase Returns and Allowances
40
(b) Seller
KARINA INC.
General Journal
Date
Account Titles and ExplanationDebitCreditJuly5Cash
540
Sales
540
July25Cash
200
Sales
200
July26Sales Returns and Allowances
40
Cash
40
PROBLEM 6-4B (Continued)
(c)Average Cost = $950 ( 105 = $9.05
Ending Inventory = 501 @ $9.05 = $452.50
1 25 + 60 65 + 10 + 25 - 5 = 50
(d)Ending inventory should be valued at $350 (50 units @ $7.00) which is the lower of cost or market.
(e)The decline in the inventory would cause the inventory turnover ratio to increase and therefore cause the days in inventory ratio to decrease.
(a)(INCORRECT)
ALYSSA INC.
Statement of Earnings
Year Ended July 31
20042005Sales
$300,000$320,000
Cost of goods sold
Beginning inventory
30,00022,000
Purchases
200,000 240,000
Cost of goods available for sale
230,000262,000
Ending inventory
22,000 31,000
Cost of goods sold
208,000 231,000
Gross profit
92,000 89,000
Operating expenses
60,000 64,000
Earnings before taxes
32,00025,000
Income tax expense
12,000 10,000Net earnings
$ 20,000$ 15,000
(CORRECT)
ALYSSA INC.
Statement of Earnings
Year Ended July 31
20042005Sales
$300,000$320,000
Cost of goods sold
Beginning inventory
30,00027,000
Purchases
200,000 240,000
Cost of goods available for sale
230,000267,000
Ending inventory
27,000 31,000
Cost of goods sold
203,000 236,000
Gross profit
97,000 84,000
Operating expenses
60,000 64,000
Earnings before taxes
37,00020,000
Income tax expense
12,000 10,000Net earnings
$ 25,000$ 10,000
PROBLEM 6-5B (Continued)
(b) The impact of this error on retained earnings at July 31, 2005 is zero. The error in the 2004 ending inventory is offset by the error in the 2005 beginning inventory. The total earnings for the two years is $35,000 in both the incorrect and correct Statement of Earnings.
(a)
Cost of Goods Sold(b)
Net
Earnings(c)
Retained Earnings(d)
Ending
Inventory(e)
Days in
Inventory
2004OverstatedUnderstatedUnderstatedUnderstatedOverstated
2005UnderstatedOverstatedNo effectNo effectOverstated
(a)
Inventory TurnoverDays In InventoryCurrent Ratio
2002
2001
CoolBrands current ratio declined slightly in 2002 but is still above the industry average of 1.42:1. This indicates that CoolBrands appears to have sufficient current assets to cover its current liabilities. However, this may not be the case because there is a very slow moving inventory included in this figure. In 2002 Cool Brands inventory turnover declined to levels below that experienced by the rest of the industry. This may indicate that the company is having trouble selling its inventory, which could have an impact on future liquidity.
(b)If CoolBrands were to switch to LIFO and prices are rising it would be expected that inventory levels would be lower since inventory would now be carried at the earlier lower costs versus the most recent costs (as is the case under FIFO). The inventory turnover ratio should increase since the denominator (average inventory) would be lower and the days in inventory should decrease. The current ratio would also decrease because current assets would be lower.
(a) (1) Perpetual Inventory System
DateDescriptionPurchasesSalesCGSEnding Inventory
June1Beginning
inventory 025 $60.00 $1,500
4Purchase
085$64$5,440 25
8560.00
64.00 06,940
10Sale
090$90 $8,100 25
065$60.00
64.00 $5,660 020 64.00 01,280
18Purchase
035068 2,380 20
03564.00
68.00 03,660
25Sale0500$95 4,750 20
03064.00
68.00 3,320 05 68 0340
28Purchase
020072 1,440 5
02068.00
72.00 01,780
30Balance
140$9,260 140$12,850 140$8,980 25,$1,780
Cost of Goods Sold:
$8,980
Ending Inventory:
$1,780
*PROBLEM 6-8B (Continued)
(a) (Continued)
(2)Periodic Inventory System
COST OF GOODS AVAILABLE FOR SALE
Date Explanation
UnitsUnit Cost
Total Cost
June 1Beginning inventory25$60$ 1,500
June 4Purchase
85645,440
June 18Purchase
35682,380
June 28Purchase
2072 1,440
Total
165$10,760
FIFO
Units Sold = 90+50 = 140
Units in Ending inventory = 165 140 = 25
Step 1: Cost of Goods Sold Step 2: Ending Inventory
UnitTotal
UnitsCostCostUnitsUnit Cost Total Cost
25$ 60$1,500
5$68
$ 340
85645,440
2072
1,440
30
68 2,04025
$1,780
140$8,980(b)The results under FIFO in a perpetual system as the same as in a periodic system. Under both inventory systems, the first costs in inventory are the ones assigned to the cost of goods sold.
(a)(1)FIFO
DateDescriptionPurchasesCGSEnding Inventory
July 1Purchase
06$90$540 6 $90 0$$$540
6Sale
03$90 $270 03 900270
11Purchase
040$99 396 3
0490
99 0666
14Sale3
02 90
99 468 02 99 0198
21Purchase
050106 530 2
0599
106 0$728
30Balance
15$1,466 8$738 7,$728
PROBLEM 6-9B (Continued)
(a) (Continued)
(2)Average
DateDescriptionPurchasesCGSEnding Inventory
July 1Purchase
06$90$540 6 $90 0$$$540
6Sale
03$90.00$270 03 900270
11Purchase
040$99 396 07 95.14 0666
14Sale0595.14 47602 95.140190
21Purchase
050106 530 07102.860$720
30Balance
15$1,466 8$7467,$720
PROBLEM 6-9B (Continued)
(a) (Continued)
(3) LIFO
DateDescriptionPurchasesCGSEnding Inventory
July 1Purchase
06$90$540 6 $90 0$$$540
6Sale
03$90 $270 03 900270
11Purchase
040$99 396 3
0490
99 0666
14Sale4
0199
90 48602 900180
21Purchase
050106 530 2
0590
106 0$710
30Balance
15$1,466 8$7567,$710
(b) FIFO produces the highest gross profit and net earnings, because it has the lowest cost of goods sold.
(c)FIFO produces the highest ending inventory valuation.
(a)
Moving
FIFO Average Cost
Jan. 1No entry required
(50 @ $12= $600)
5Inventory
1,400
1,400
00000
Accounts Payable
1,400
1,400
00
(100 @ $14= $1,400)
7Accounts Receivable
2,750
2,750
Sales
2,750
2,750
00
(110 @ $25 = $7,000)
Cost of Goods Sold
1,440
1,466
Inventory
1,440
1,466
00
14
Inventory
480
480
Accounts Payable
480
480
00
(30 @ $16 = $480)
*PROBLEM 6-10B (Continued)(a) (Continued)
Jan. 20Accounts Receivable
1,500
1,500
Sales
1,500
1,500
(60 @ $25 = $1,500)
Cost of Goods Sold
880
869
Inventory
880
869
25
Inventory
360
360
Accounts Payable
360
360
0
(20 @ $18 = $360)
(b)
1.Net cash flow will be the same under either assumption, as cash flow is not affected by the inventory cost assumption used.
2.Gross profit will be higher under the FIFO cost flow assumption as it produces a lower cost of goods sold because cost of goods sold is valued at the oldest (lowest) prices.
3.FIFO produces the higher ending inventory balance because inventory is valued at the most recent costs.
(Note: All dollar amounts are in millions)
(a) Inventories were $1,702 in 2002 and $1,512 in 2001.
(b) Inventories increased $190 in 2002. Using 2001 as the base year, the increase was approximately 12.6% ($190 ( $1,512). In 2002, inventories were 48.3% of current assets ($1,702 ( $3,526). In 2001 they were 49% ($1,512 ( $3,086).
(c)Cost of sales is not reported separately in Loblaws statement of earnings. Cost of sales are reported with selling and administrative expenses. Loblaw may not report it separately because it feels it would provide competitors with valuable information.
(a)
Loblaw
Sobeys
1.Inventory turnover
2002= 12.6 times2003= 22.4 times
2001= 13.3 times2002
= 23.7 times
2. Days in inventory
2002= 29 days
2003= 16.3 days
2001= 27.4 days
2002= 15.4 days
(b)Generally, companies that are able to keep their inventory at lower levels and higher turnovers and still satisfy customer needs are the most successful. Both companies inventory ratios have deteriorated in the most recent year. Sobeys inventory ratios are better than Loblaws.
(a) If the inventory is no longer needed then its market value will decline. If the companies have entered into long-term supply contracts they may be forced to purchase the inventory at the higher contract price and then immediately write it down because of the decline in the market price due to excess supply.
(b) Nortels inventory write-off in 2001 was $1.1 billion.
(c) Nortels inventory turnover in 2001 was 11.1 and 7.3 in 2000. The turnover ratio increased in 2001 because the large inventory write down decreased the carrying value of the inventory on the balance sheet. This caused the denominator of the inventory turnover ratio to be less, leading to a higher inventory turnover ratio.
(d)A danger sign to watch for concerning the carrying values of inventory is when the inventory value is growing faster than the value of sales.
(a) By not valuating its inventory in excess of market Cooper is using the lower of cost or market to value its inventory.
(b)The company may be taking steps to better manage its inventories and reduce the amount of working capital tied up in inventory by introducing inventory management techniques such as reducing the need for raw materials though improving supplier relationships or by reducing finished goods inventory by implementing better customer ordering systems.
(c)The company probably uses FIFO to value its nondomestic inventories due to the fact that many countries do not permit the use of LIFO as a means of inventory valuation. Therefore for foreign reporting it is easier to value the nondomestic inventories initially using FIFO rather then having to convert LIFO based numbers to FIFO after the fact.
(d)
Inventory TurnoverDays In Inventory
2002
2001
The companys inventory turnover improved slightly in 2002. This companys inventory is also turning over faster than the industry average of 6.8 times per year. This may indicate that the company is better managing its inventory costs when compared to other companies in the industry.
(e) If the company had used FIFO the 2002 ending inventory would have been ($280,641+ $52,336 = $332,977). This would be an immaterial difference from the perspective of the analyst as it causes very little change in the companys inventory turnover ratios.
FIFO is a better measure of ending inventory as it values ending inventory at the most recent purchase costs.
(a) One reason Fuji makes adjustments is that by reporting using U.S. accounting standards it makes it easier for U.S. investors to evaluate the company. This increases the chances that it will attract U.S. investors. The U.S. financial markets are the largest in the world, and thus represent a huge source of potential capital. The second reason it might adjust its figures to comply with U.S. standards is that the United States represents a huge market for its product. In recent years Fuji has taken a large share of the U.S. film market away from Kodak. If it attracts U.S. citizens to invest in its shares, these people are also more likely to buy its products.
(b) Fuji uses the perpetual inventory system to account for most of its inventory. The note on Inventories state that it uses moving average cost flow assumption, which is consistent with a perpetual inventory system.
(c) They may use different cost flow assumptions because the cost of using moving average for some inventories may be greater than the benefit it provides.
BYP 6-5 (Continued)
(d) FujiKodak
(millions of dollars)(millions of dollars)
Inventory turnover
FIFO/Average
LIFO
Average days in inventory
FIFO/Average
LIFO
The comparison with both inventories at FIFO/Average is the more relevant for decision-making purposes. This comparison is more relevant because it uses the same measurement.
BYP 6-5 (Continued)
(e) FujiKodak
000(millions of dollars) 00%(millions of dollars) %
Finished goods$1,673.162.1%$ 85153.8%
Work in progress494.118.3 31820.1
Raw materials 528.3 19.6 412 26.1Total$2,695.5100.0%$1,581100.0% Fuji is holding a higher percentage of finished goods, while Kodak is holding a higher percentage of work-in-process and raw materials. This difference could be explained by a difference in their respective forecasts of the future. For example, maybe Fuji predicted an upturn in demand before Kodak did. Or, it could be a reflection of their different manufacturing practices. Perhaps Kodak holds items in finished goods for a shorter period of time. The difference also might be due to differences in the amount of work that they outsource. That is, it may be that one buys some of its product at least partially manufactured.
Due to the frequency of change with regard to information available on the world wide web, the Accounting on the Web cases are updated as required. Their suggested solutions are also updated whenever necessary, and can be found online in the Instructor Resources section of our home page .
(a) 1.Items were shipped FOB destination title had not transferred at year-end so exclude from the inventory of office supplies.
2. Goods were shipped FOB shipping ownership passed to JIT Auto Parts on July 31 and should therefore be included in the ending inventory. Increase inventory.
3. Items were shipped FOB Shipping before year-end items should not be included in ending inventory.
4. This transaction involves the purchase of property, plant and equipment and therefore does not affect inventory.
5. Goods were shipped FOB shipping ownership passed to JIT Auto Parts on July 30 and should therefore be included in the ending inventory. Increase inventory.
6. This is not an inventory transaction.
7. This purchase represents a cost of the building not inventory.
8. Items were shipped FOB destination title had not transferred at year-end so include in JIT Auto Parts inventory. Increase inventory.
(b)1.Office Max till owns the office supplies, as the shipping terms were FOB Destination.
4.Nadeau Furniture still owns the office furniture, as the shipping terms were FOB Destination.
6.JIT Auto Parts does not own the cars at year-end, as the shipping terms were FOB Destination.
7.The steel was shipped FOB shipping point and is therefore owned by JIT Auto Parts at year-end. It should be reported as a cost of the building.
MEMO
To:
Joy Small, President
From:
Student
Date:Today
Subject:
2003 Ending Inventory Error
The combined gross profit and net earnings for 2003 and 2004 are correct. However, the gross profit and net earnings for each year are incorrect.
As you know, 2003 ending inventory was overstated by $1 million. This error will cause 2003 net earnings to be incorrect because the ending inventory is used to calculate 2003 cost of goods sold. Since the ending inventory is subtracted in the calculation of cost of goods sold, an overstatement of ending inventory results in an understatement of cost of goods sold and therefore and overstatement of net earnings.
Unless corrected, this error will also affect 2004 net earnings. The 2003 ending inventory is also the 2004 beginning inventory. Therefore, 2004 beginning inventory is also overstated, which causes an overstatement of cost of goods sold and an understatement of 2004 net earnings.
If the error is not corrected the gross profit and net earnings for 2003 and 2004 will be incorrect. Because the error one year reverses in the next year the trend will be misleading.
(a)
Specific Identification Maximize 00Minimize
Gross Profit
Gross Profit
Sales
$433,000$433,000
Cost of goods sold
238,750 240,250
Gross profit $194,250$192,750
Goods Available for Sale
Date
Units
0Cost Total
Mar.1150
$300$ 45,000
320035070,000
10350
0375 131,250
$246,250
Specific IdentificationMaximize gross profit (minimize cost of sales by deciding to sell the diamonds purchased at the lowest cost)
Cost of Goods Sold
Ending Inventory
Date
Units
0Cost Total Date
0Units
Cost 0
Total
Mar. 5 1500$300$ 45,000Mar. 25 20 $375$7,500
30 ,,,,35010,500
2517035059,500
330375 123,750
$238,750
Specific IdentificationMinimize gross profit (maximize cost of sales by selling the diamonds purchased at the highest cost)
Cost of Goods Sold
Ending Inventory
Date
Units
0Cost Total Date
0Units 00Cost 0Total
Mar. 5 180,,$350$ 63,000Mar. 25 20 $300$6,000
Mar.25350375131,250
203507,000
130300 39,000
$240,250BYP 6-9 (Continued)
(b)FIFO
Sales
$433,000
Cost of goods sold
238,750
Gross profit $194,250
Goods Available for Sale
Date
Units
0Cost Total
Mar.1150$300$ 45,000
320035070,000
10350375 131,250
$246,250
Cost of Goods Sold
Ending Inventory
Date
Units
0Cost Total Date
0Units 0Cost 00Total
Mar. 5 150$300 $ 45,000Mar. 25 20 $375$7,500
30
35010,500
25170
35059,500
330
375 123,750
$238,750
(c)The stakeholders are the shareholders, customers, and staff of Discount Diamonds. The practice is unethical if management selects which diamonds to sell based solely on a desire to manipulate profits.
(d)Discount Diamonds should select FIFO. This cost flow assumption provides the best balance sheet valuation and is not subject to manipulation.
Legal Notice
Copyright
Copyright 2004 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.
The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence.
The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.
PROBLEM 6-1B
PROBLEM 6-2A
EMBED Equation.3
EMBED Equation.3
BYP 6-1 FINANCIAL REPORTING PROBLEM
PROBLEM 6-7A
PROBLEM 6-6A
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
PROBLEM 6-5A
PROBLEM 6-1A
PROBLEM 6-3A
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
*PROBLEM 6-10B
*PROBLEM 6-9B
EMBED Equation.3
PROBLEM 6-4A
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
BYP 6-9 ETHICS CASE
PROBLEM 6-3B
PROBLEM 6-5B
PROBLEM 6-6B
EMBED Equation.3
BYP 6-8COMMUNICATION ACTIVITY
BYP 6-7 COLLABORATIVE LEARNING ACTIVITY
EMBED Equation.3
PROBLEM 6-2B
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
EMBED Equation.3
PROBLEM 6-7B
PROBLEM 6-4B
*PROBLEM 6-8B
FIFO:(75 @ $21) = $1,575; Balance 50 @ $24 = $1200
Average Cost: ($1,395 + $1,200) ( (75 +50) = $20.76
75 @ $20.76 = $1,557; Balance 50 @ $20.76 = $1,038
FIFO: (150 @ $17) +(25 @ $21)= $3,075; Balance 75 @ $21 = $1,575
Average Cost: ($2,550 + $2,100) / (150 + 100) = $18.60
175 @ $18.60 = $3,255; Balance 75 @ $18.60 = $1,395
*PROBLEM 6-10A
*PROBLEM 6-9A
*PROBLEM 6-8A
BYP 6-6FINANCIAL ANALYSIS ON THE WEB
EMBED Equation.3
BYP 6-4INTERPRETING FINANCIAL STATEMENTS
BYP 6-3 RESEARCH CASE
BYP 6-2 COMPARATIVE ANALYSIS PROBLEM
FIFO:(40 @ $14) + (20 @ $16) = $880; Balance 10 @ $16 = $160
Average Cost: ($534 + $480) ( (40 +30) = $14.49
60 @ $14.49 = $869; Balance 10 @ $14.49 = $145
BYP 6-5A GLOBAL FOCUS
FIFO: (50 @ $12) + (60 @ $14)= $1,440; Balance 40 @ $14 = $560
Average Cost: ($600 + $1,400) (50 + 100) = $13.33
110 @ $13.33 = $1,466; Balance 40 @ $13.33 = $534
Solutions Manual6-1Chapter 6Copyright 2004 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited
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