Chapter 08 - Inventories: Measurement
Chapter 8Question 8-1
Inventories: Measurement FOR REVIEW OF KEY QUESTIONS
Inventory for a manufacturing company consists of (1) raw
materials, (2) work in process, and (3) finished goods. Raw
materials represent the cost, primarily purchase price plus freight
charges, of goods purchased from other manufacturers that will
become part of the finished product. Workin-process inventory
represents the products that are not yet complete. The cost of work
in process includes the cost of raw materials used in production,
the cost of labor that can be directly traced to the goods in
process, and an allocated portion of other manufacturing costs,
called manufacturing overhead. When the manufacturing process is
completed, these costs that have been accumulated in work in
process are transferred to finished goods.
Question 8-2Beginning inventory plus net purchases for the
period equals cost of goods available for sale. The main difference
between a perpetual and a periodic system is that the periodic
system allocates cost of goods available for sale to ending
inventory and cost of goods sold only at the end of the period. The
perpetual system accomplishes this allocation by decreasing
inventory and increasing cost of goods sold each time goods are
sold.
Question 8-3Perpetual System (1) purchase of merchandise (2)
sale of merchandise (3) return of merchandise (4) payment of
freight debit inventory debit cost of goods sold; credit inventory
credit inventory debit inventory Periodic System debit purchases no
entry credit purchase returns debit freight-in
Question
8-4Inventory shipped f.o.b. shipping point is included in the
inventory of the purchaser when the merchandise reaches the common
carrier. Laetner Corporation records the purchase in 2011 and
includes the shipment in its ending inventory. Bockner Company
records the sale in 2011. Inventory shipped f.o.b. destination is
included in the inventory of the seller until it reaches the
purchasers location. Bockner would include the merchandise in its
2011 ending inventory and the sale/purchase would be recorded in
2012.
8-1
Chapter 08 - Inventories: Measurement
Answers to Questions (continued) Question 8-5A consignment is an
arrangement under which goods are physically transferred to another
company (the consignee), but the transferor (consignor) retains
legal title. If the consignee cant find a buyer, the goods are
returned to the consignor. Goods held on consignment are included
in the inventory of the consignor until sold by the consignee.
Question 8-6By the gross method purchase discounts not taken are
viewed as part of inventory cost. By the net method purchase
discounts not taken are considered interest expense, because they
are viewed as compensation to the seller for providing financing to
the buyer.
Question 8-71. Beginning inventory increase 2. Purchases
increase Question 8-8 3. methods of assigning cost to ending
inventory and cost of goods sold are (1) specific decrease
FourEnding inventory 4. Purchase returnsfirst-out (FIFO),decrease
identification, (2) first-in, (3) last-in, first-out (LIFO), and
(4) average cost. 5. Freight-in increase The specific
identification method requires each unit sold during the period or
each unit on hand at the end of the period to be traced through the
system and matched with its actual cost. First-in, first-out (FIFO)
assumes that units sold are the first units acquired. The last-in,
firstout (LIFO) method assumes that the units sold are the most
recent units purchased. The average cost method assumes that cost
of goods sold and ending inventory consist of a mixture of all the
goods available for sale. The average unit cost applied to goods
sold or ending inventory is an average unit cost weighted by the
number of units acquired at the various unit prices.
Question 8-9When costs are declining, LIFO will result in a
lower cost of goods sold and higher income than FIFO. This is
because LIFO will include in cost of goods sold the most recently
purchased lower cost merchandise. LIFO also will provide a higher
ending inventory in the balance sheet.
8-2
Chapter 08 - Inventories: Measurement
Answers to Questions (continued) Question 8-10Proponents of LIFO
argue that it provides a better match of revenues and expenses
because cost of goods sold includes the costs of the most recent
purchases. These are matched with sales that reflect a current
selling price. On the other hand, inventory costs in the balance
sheet generally are out of date because they are derived from old
purchase transactions. It is conceivable that a companys LIFO
inventory balance could be based on unit costs actually incurred
several years earlier. When inventory quantity declines during a
period, then these outof-date inventory layers will be liquidated
and cost of goods sold will match noncurrent costs with current
selling prices.
Question 8-11Many companies choose the LIFO inventory method to
reduce income taxes in periods when prices are rising. In periods
of rising prices, LIFO results in a higher cost of goods sold and
therefore a lower net income than the other methods. The companies
income tax returns will report lower taxable incomes using LIFO and
lower taxes will be paid currently. If a company uses LIFO to
measure its taxable income, IRS regulations require that LIFO also
be used to measure income reported to investors and creditors.
Question 8-12The gross profit, inventory turnover, and average
days in inventory ratios are designed to monitor inventories. The
gross profit ratio is calculated by dividing gross profit (net
sales minus cost of goods sold) by net sales. Inventory turnover is
calculated by dividing cost of goods sold by average inventory, and
we compute average days in inventory by dividing the number of days
in the period by the inventory turnover ratio.
Question 8-13A LIFO inventory pool groups inventory units into
pools based on physical similarities of the individual units. The
average cost for all of a pools beginning inventory and for all of
a pools purchases during the period is used instead of individual
unit costs. If the quantity of ending inventory for the pool
increases, then ending inventory will consist of the beginning
inventory plus a layer added during the period at the average
acquisition cost for the pool.
Question 8-14The dollar-value LIFO method has important
advantages. First, it simplifies the recordkeeping procedures
compared to unit LIFO because no information is needed about unit
flows. Second, it minimizes the probability of the liquidation of
LIFO inventory layers, even more so than the use of pools alone,
through the aggregation of many types of inventory into larger
pools. In addition, firms that do not replace units sold with new
units of the same kind can use the method.
8-3
Chapter 08 - Inventories: Measurement
Answers to Questions (concluded) Question 8-15After determining
ending inventory at year-end cost, the following steps remain: 1.
Convert ending inventory valued at year-end cost to base year cost.
2. Identify the layers in ending inventory with the years they were
created. 3. Convert each layers base year cost measurement to layer
year cost measurement using the layer years cost index and then sum
the layers.
Question 8-16The primary difference between U.S. GAAP and IFRS
in the methods allowed to value inventory is that IFRS does not
allow the use of the LIFO method.
8-4
Chapter 08 - Inventories: Measurement
BRIEF EXERCISESBrief Exercise 8-1Beginning inventory$186,000
Plus: Purchases 945,000 Less: Cost of goods sold (982,000) Ending
inventory $149,000
Brief Exercise 8-2
To record the purchase of inventory on account.
Inventory.....................................................................
845,000
........................................................Accounts
payable
.......................................................................845,000
To record sales on account and cost of goods sold. Accounts
receivable....................................................1,420,000
..............................................................Sales
revenue
....................................................................1,420,000
Cost of goods
sold...................................................... 902,000
.....................................................................Inventory
.......................................................................902,000
8-5
Chapter 08 - Inventories: Measurement
Brief Exercise 8-3
Both shipments should be included in inventory. The goods
shipped to a customer f.o.b. destination did not arrive at the
customers location until after the fiscal year-end. They belong to
Kelly until they arrive at the customers location. Title to the
goods shipped from a supplier to Kelly on December 30, f.o.b.
shipping point, changed hands on December 30.
Brief Exercise 8-4
Purchase price = 10 units x $25,000 = $250,000
December 28, 2011
Inventory.....................................................................
250,000
........................................................Accounts
payable
.......................................................................250,000
January 6, 2012 Accounts
payable........................................................
250,000
......................................................................Cash
(99% x $250,000)
....................................................................................
247,500
.................................................................Inventory
(1% x $250,000)
....................................................................................
2,500
8-6
Chapter 08 - Inventories: Measurement
Brief Exercise 8-5December 28, 2011 Inventory (99% x
$250,000)............................................... 247,500
Accounts payable
....................................................... 247,500
January 6, 2012 Accounts
payable........................................................
247,500
............................................................................Cash
.......................................................................247,500
Cost of goods available for sale: Brief Exercise 8-6 Beginning
inventory (200 x $25) $5,000 Purchases: 100 x $28 $2,800 200 x $30
6,000 8,800 Cost of goods available (500 units) $13,800 First-in,
first-out (FIFO) Cost of goods available for sale (500 units) Less:
Ending inventory (determined below) Cost of goods sold Cost of
ending inventory: Date of purchase January 8 January 19 Total
Average cost Cost of goods available for sale (500 units) Less:
Ending inventory (determined below)8-7
$13,800 (8,100) $5,700
Units 75 200
Unit cost $28 30
Total cost $2,100 6,000 $8,100
$13,800 (7,590)
Chapter 08 - Inventories: Measurement
Cost of goods sold Cost of ending inventory: $13,800
Weighted-average unit cost = 500 units 275 units x $27.60 = $7,590
= $27.60
$6,210 *
* Alternatively, could be determined by multiplying the units
sold by the average cost: 225 units x $27.60 = $6,210
Brief Exercise 8-7First-in, first-out (FIFO)Cost of goods sold:
Date of sale January 10 January 25 Total Units sold 125 (from Beg.
Inv.) 75 (from Beg. Inv.) 25 (from 1/8 purchase) 225 Cost of Units
Sold $25 25 28 Total Cost $3,125 1,875 700 $5,700
Ending inventory: Date of purchase Units January 8 75 January 19
200 Total
Unit cost $28 30
Total cost $2,100 6,000 $8,100
8-8
Chapter 08 - Inventories: Measurement
Brief Exercise 8-7 (concluded) Average costDate Beginning
inventory January 8 Available Purchased200 @ $25 = $5,000
Sold
Balance200 @ $25 $5,000
100 @ $28 $7,800 300 units
=
$2,800
= $26/unit
January 10 January 19 Available200 @ $30 = $10,550 $28.133/unit
375 units = $6,000
125 @ $26 = $3,250 175 @ $26
$4,550
January 25Total cost of goods sold
100 @ $28.133 = $2,813 275 @ $28.133 = $6,063
$7,737 Ending inventory
8-9
Chapter 08 - Inventories: Measurement
Brief Exercise 8-8
Cost of goods available for sale: Beginning inventory (20,000 x
$25) $ 2,400,000 2,900,000 375,000* $2,525,000
500,000 Purchases: 80,000 x $30 Cost of goods available (100,000
units) Less: Ending inventory (15,000 units) Cost of goods sold
15,000 units x $25 each = $375,000
Brief Exercise 8-9
64,000 units were sold.
Cost of goods sold without year-end purchase: Units purchased
during the year: 60,000 x $18 $1,080,000 Plus units from beginning
inventory: 4,000 x $15 60,000 Cost of goods sold 1,140,000 Cost of
goods sold with year-end purchase: 64,000 units x $18 Difference
1,152,000 $ 12,000
Cost of goods sold would be $12,000 higher and income before
income taxes $12,000 lower if the year-end purchase is made. If
FIFO were used instead of LIFO, the year-end purchase would have no
effect on income before income taxes. FIFO cost of goods sold with
or without the purchase would consist of the 10,000 units from
beginning inventory and 54,000 units purchased during the year at
$18: 10,000 units x $15 Plus: 54,000 units x $18 Cost of goods sold
$ 150,000 972,000 $1,122,000
8-10
Chapter 08 - Inventories: Measurement
Brief Exercise 8-10
Units liquidated 5,000 Difference in cost ($30 25) Before tax
LIFO liquidation profit $25,000 Tax effect ($25,000 x 40%) (10,000)
LIFO liquidation profit $15,000
x $5
Brief Exercise 8-11
Cost of goods sold for the fiscal year ended February 28, 2009
would have been $78 million lower had SuperValue used FIFO for its
LIFO inventory. While beginning inventory would have been $180
million higher, ending inventory also would have been higher by
$258 million. An increase in beginning inventory causes an increase
in cost of goods sold, but an increase in ending inventory causes a
decrease in cost of goods sold. Purchases for the year are the same
regardless of the inventory valuation method used. Cost of goods
sold as reported Decrease if FIFO Cost of goods sold, FIFO instead
of LIFO $34,451 million (78) million $34,373 million
8-11
Chapter 08 - Inventories: Measurement
Brief Exercise 8-12
Average inventory = ($60,000 + 48,000) 2 = $54,000
Cost of goods sold Average inventory = Inventory turnover Cost
of goods sold $54,000 = 5 Cost of goods sold = $54,000 x 5 Cost of
goods sold = $270,000 Gross profit ratio = 40%, therefore cost
percentage = 60% Sales x .60 = $270,000 Sales = $270,000 .60 =
$450,000
Ending Inventory Brief Exercise 8-13Layers Date at Base Year
Cost $1,400,000 1.00 12/31/11 $1,664,000 1.04 = $1,400,000
$1,400,000 (base) 1/1/11
at Base Year Cost
Inventory Layers Inventory Converted to Cost $1,400,000 x 1.00
=$1,400,000
Inventory DVL Cost $1,400,000
= $1,600,000 $1,400,000 (base) 200,000 (2011)
$1,400,000 x 1.00 = $1,400,000 200,000 x 1.04 = 208,000
$1,608,000
8-12
Chapter 08 - Inventories: Measurement
EXERCISESExercise1. To record the purchase of inventory on
account and the payment 8-1of freight charges. 5,000
Inventory.....................................................................
........................................................Accounts
payable
...........................................................................5,000
Inventory.....................................................................
............................................................................Cash
..............................................................................300
300
2.
To record purchase returns. Accounts
payable........................................................
.....................................................................Inventory
..............................................................................600
600
3.
To record cash sales and cost of goods sold.
Cash............................................................................
..............................................................Sales
revenue
...........................................................................5,200
Cost of goods
sold......................................................
.....................................................................Inventory
...........................................................................2,800
5,200
2,800
Exercise
1. To record the purchase of inventory on account and the
payment 8-2of freight charges.
8-13
Chapter 08 - Inventories: Measurement
Purchases....................................................................
........................................................Accounts
payable
...........................................................................5,000
Freight-in.....................................................................
............................................................................Cash
..............................................................................300
5,000
300
2.
To record purchase returns. Accounts
payable........................................................
..........................................................Purchase
returns
..............................................................................600
600
3.
To record cash sales.
Cash............................................................................
..............................................................Sales
revenue
...........................................................................5,200
5,200
NO ENTRY IS MADE FOR THE COST OF GOODS SOLD.
Exercise 8-3Requirement 1Plus net purchases: Purchases Less:
Purchase discounts Less: Purchases returns Plus: Freight-in Cost of
goods available for sale Less: Ending inventory Cost of goods
sold
Beginning inventory $ 32,000 $240,000 (6,000) (10,000)
17,000
241,000 273,000 (40,000) $233,000
8-14
Chapter 08 - Inventories: Measurement
Requirement 2 Cost of goods sold
(above).......................................... 233,000 Inventory
(ending).......................................................
40,000 Purchase
discounts......................................................
6,000 Purchase
returns..........................................................
10,000 ...................................................Inventory
(beginning)
.........................................................................32,000
....................................................................Purchases
.......................................................................240,000
.....................................................................Freight-in
.........................................................................17,000
Exercise 8-4
8-15
Chapter 08 - Inventories: Measurement
PERPETUAL SYSTEM($ in 000s) Purchases Inventory Accounts payable
Freight Inventory Cash Returns Accounts payable Inventory Sales
Accounts receivable Sales revenue Cost of goods sold Inventory End
of period No entry 155 155 10 10 12 12 250 250 148 148
PERIODIC SYSTEMPurchases Accounts payable Freight-in Cash
Accounts payable Purchase returns Accounts receivable Sales revenue
No entry 155 155 10 10 12 12 250 250
Cost of goods sold (below) Inventory (ending) Purchase returns
Inventory (beginning) Purchases Freight-in Cost of goods sold:
Beginning inventory Purchases Less: Returns Plus: Freight-in Net
purchases Cost of goods available Less: Ending inventory Cost of
goods sold
148 30 12 25 155 10 $25 $155 (12) 10 153 178 (30) $148
Exercise 8-5
249 (3) Cost of goods sold Ending inventory Cost of goods
available for sale Purchases (gross)
2011 2012 Beginning inventory 225 627 621 249 (2) 225 876 846
(4) 630 610 (5)8-16
2013 275 (1) 584 (6) 216 800 585
Chapter 08 - Inventories: Measurement
Purchase discounts Purchase returns Freight-in
18 24 13
15 30 32
12 (7) 14 16
Net purchases = Purchases(gross) - Purchase returns - Purchase
discounts + Freight-in Beginning inventory + Net purchases = Cost
of goods available for sale Cost of goods available for sale -
Ending inventory = Cost of goods sold 2011: (1) Cost of goods
available for sale - Net purchases = Beginning inventory 876 - (630
- 18 - 24 + 13) = 275 = Beginning inventory (2) Cost of goods
available for sale - Cost of goods sold = Ending inventory 876 -
627 = 249 = Ending inventory 2012: (3) 2012 beginning inventory =
2011 ending inventory = 249 (4) Cost of goods sold + Ending
inventory = Cost of goods available for sale 621 + 225 = 846 = Cost
of goods available for sale (5) Cost of goods available for sale -
Beginning inventory = Net purchases 846 - 249 = 597 = Net purchases
Net purchases + Purchases discounts + Purchase returns - Freight-in
= Purchases(gross) 597 + 15 + 30 - 32 = 610 = Purchases (gross)
2013: (6) Cost of goods available for sale - Ending inventory =
Cost of goods sold 800 - 216 = 584 = Cost of goods sold
8-17
Chapter 08 - Inventories: Measurement
Exercise 8-5 (concluded)(7) Cost of goods available for sale -
Beginning inventory = Net purchases 800 - 225 = 575 = Net purchases
Purchases(gross) - Purchase returns + Freight-in - Net purchases =
Purchase discounts 585 - 14 + 16 - 575 = 12 = Purchase
discounts
Inventory balance before additional transactions Exercise 8-6
$165,000 Add: Goods shipped to Kwok f.o.b. shipping point on Dec.
28 17,000 Goods shipped to customer f.o.b. destination on December
27 22,000 Correct inventory balance $204,000 Inventory balance
before additional transactions Exercise 8-7 $210,000 Add:
Merchandise on consignment with Joclyn Corp. 15,000 Deduct:
Merchandise shipped to Raymond f.o.b. destination on December 26
(30,000) Merchandise held on consignment from the Harrison Company
(14,000) Correct inventory balance $181,000
Exercise 8-84. 5. 6. 7. 8. Excluded Included Excluded Included
Included
1. Excluded 2. Included 3. Included
Exercise 8-9Requirement 1Purchase price = 1,000 units x $50 =
$50,000
8-18
Chapter 08 - Inventories: Measurement
July 15, 2011
Purchases....................................................................
........................................................Accounts
payable
.........................................................................50,000
50,000
July 23, 2011 Accounts
payable........................................................
50,000
......................................................................Cash
(98% x $50,000)
....................................................................................
49,000 ..................................................Purchase
discounts (2% x $50,000)
....................................................................................
1,000
Requirement 2 August 15, 2011 Accounts
payable........................................................
............................................................................Cash
.........................................................................50,000
50,000
Requirement 3 The July 15 entry would include a debit to the
inventory account instead of to purchases, and the July 23 entry
would include a credit to the inventory account instead of to
purchase discounts.
Exercise 8-10Requirement 1July 15, 2011 Purchases (98% x
$50,000)................................................ Accounts
payable .......................................................
49,000 49,000
8-19
Chapter 08 - Inventories: Measurement
July 23, 2011 Accounts
payable........................................................
............................................................................Cash
.........................................................................49,000
49,000
Requirement 2 August 15, 2011 Accounts
payable........................................................
Interest
expense..........................................................
............................................................................Cash
.........................................................................50,000
49,000 1,000
Requirement 3 The July 15 entry would include a debit to the
inventory account instead of to purchases.
Exercise 8-11Requirement 1
Purchases: $500 x 70% = $350 per unit. 100 units x $350 =
$35,000
November 17, 2011
Purchases....................................................................
........................................................Accounts
payable
.........................................................................35,000
35,000
November 26, 2011 Accounts payable
.......................................................
35,000
8-20
Chapter 08 - Inventories: Measurement
..................................................Purchase
discounts (2% x $35,000)
....................................................................................
700
......................................................................Cash
(98% x $35,000)
....................................................................................
34,300
Requirement 2 December 15, 2011 Accounts
payable........................................................
............................................................................Cash
.........................................................................35,000
35,000
8-21
Chapter 08 - Inventories: Measurement
Exercise 8-11 (concluded) Requirement 3 Requirement 1: November
17, 2011 Purchases (98% x
$35,000)............................................
........................................................Accounts
payable
.........................................................................34,300
34,300
November 26, 2011 Accounts
payable........................................................
............................................................................Cash
.........................................................................34,300
34,300
Requirement 2: December 15, 2011 Accounts
payable........................................................
Interest expense (2% x $35,000)....................................
............................................................................Cash
.........................................................................35,000
34,300 700
Exercise 8-12
The FASB Accounting Standards Codification represents the single
source of authoritative U.S. generally accepted accounting
principles. The specific citation for each of the following items
is: 1. Define the meaning of cost as it applies to the initial
measurement of inventory. FASB ASC 33010301:
InventoryOverallInitial Measurement.8-22
Chapter 08 - Inventories: Measurement
The primary basis of accounting for inventories is cost, which
has been defined generally as the price paid or consideration given
to acquire an asset. As applied to inventories, cost means in
principle the sum of the applicable expenditures and charges
directly or indirectly incurred in bringing an article to its
existing condition and location. It is understood to mean
acquisition and production cost, and its determination involves
many considerations. 2. Indicate the circumstances when it is
appropriate to initially measure agricultural inventory at fair
value. FASB ASC 905330301: AgricultureInventoryInitial Measurement.
Exceptional cases exist in which it is not practicable to determine
an appropriate cost basis for products. A market basis is
acceptable if the products meet all of the following criteria:
a. They have immediate marketability at quoted market prices
that cannot be influenced by the producer. b. They have
characteristics of unit interchangeability. c. They have relatively
insignificant costs of disposal.
The accounting basis of those kinds of inventories shall be
their realizable value, calculated on the basis of quoted market
prices less estimated direct costs of disposal. An example is
freshly dressed meats produced in meat packing operations.
8-23
Chapter 08 - Inventories: Measurement
Exercise 8-12 (concluded) 3. What is a major objective of
accounting for inventory? FASB ASC 33010101:
InventoryOverallObjectives. A major objective of accounting for
inventories is the proper determination of income through the
process of matching appropriate costs against revenues. 4. Are
abnormal freight charges included in the cost of inventory? FASB
ASC 33010307: InventoryOverallInitial Measurement. Unallocated
overheads shall be recognized as an expense in the period in which
they are incurred. Other items such as abnormal freight, handling
costs, and amounts of wasted materials (spoilage) require treatment
as current period charges rather than as a portion of the inventory
cost. Cost of goods available for sale: Exercise 8-13 Beginning
inventory (2,000 x $6.10) $12,200 Purchases: 10,000 x $5.50 $55,000
6,000 x $5.00 30,000 85,000 Cost of goods available (18,000 units)
$97,200 First-in, first-out (FIFO) Cost of goods available for sale
(18,000 units) Less: Ending inventory (determined below) Cost of
goods sold Cost of ending inventory: Date of purchase August 18
Units 3,000 Unit cost $5.00 Total cost $15,000 $97,200 (15,000)
$82,200
Last-in, first-out (LIFO)8-24
Chapter 08 - Inventories: Measurement
Cost of goods available for sale (18,000 units) Less: Ending
inventory (determined below) Cost of goods sold Cost of ending
inventory: Date of purchase Beg. Inv. August 8 Units 2,000 1,000
Total Unit cost $6.10 5.50 Total cost $12,200 5,500 $17,700
$97,200 (17,700) $79,500
8-25
Chapter 08 - Inventories: Measurement
Exercise 8-13 (concluded) Average cost Cost of goods available
for sale (18,000 units) Less: Ending inventory (determined below)
Cost of goods sold Cost of ending inventory: $97,200
Weighted-average unit cost = 18,000 units 3,000 units x $5.40 =
$16,200 * Alternatively, could be determined by multiplying the
units sold by the average cost: 15,000 units x $5.40 = $81,000
First-in, first-out (FIFO) Cost of goods sold: Cost of Units Sold
$6.10 5.50 5.50 5.00 Total Cost $12,200 33,000 22,000 15,000
$82,200 = $5.40 $97,200 (16,200) $81,000 *
Exercise 8-14Date of sale Aug. 14 Aug. 25 Total
Units sold 2,000 (from Beg. Inv.) 6,000 (from 8/8 purchase)
4,000 (from 8/8 purchase) 3,000 (from 8/18 purchase) 15,000
Ending inventory = 3,000 units x $5.00 = $15,000
Last-in, first-out (LIFO)Date Beginning inventory Purchased2,000
@ $6.10 = $12,200
Sold
Balance2,000 @ $6.10 $12,200
8-26
Chapter 08 - Inventories: Measurement 10,000 @ $5.50 = $55,000
8,000 @ $ 5.50 = 6,000 @ $5.00 = $30,000 $44,000 2,000 @ $6.10
10,000 @ $5.50 2,000 @ $6.10 2,000 @ $5.50 2,000 @ $6.10 2,000 @
$5.50 6,000 @ $5.00 6,000 @ $5.00 = 1,000 @ $5.50 = Total cost of
goods sold = $30,000 $ 5,500 $79,500 2,000 @ $6.10 1,000 @
$5.50
August 8 August 14 August 18
$67,200 $23,200 $53,200
August 25
$17,700 Ending inventory
8-27
Chapter 08 - Inventories: Measurement
Exercise 8-14 (concluded) (Note: the perpetual inventory LIFO
results in this exercise are the same as periodic LIFO results, due
to the timing of sales and purchases. The same LIFO layers are on
hand at the end of the period under each method. This is unusual.
LIFO perpetual and LIFO periodic normally produce different results
for ending inventory and cost of goods sold.) Average costDate
Beginning inventory August 8 Available Purchased2,000 @ $6.10 =
$12,200
Sold
Balance2,000 @ $6.10 $12,200
10,000 @ $5.50 = $67,200 12,000 units
$55,000
= $5.60/unit
August 14 August 18 Available August 25Total cost of goods sold
6,000 @ $5.00 = $52,400 10,000 units = $5.24/unit $30,000
8,000 @ $5.60 =
$44,800 4,000 @ $5.60
$22,400
7,000 @ $5.24 = =
$36,680 3,000 @ $5.24 $81,480
$15,720 Ending inventory
Requirement 1 LIFO will result in the highest cost of goods sold
figure because both the cost of merchandise and the quantity of
merchandise rose during the period. FIFO will result in the highest
ending inventory balance for the same reasons.
Exercise 8-15
Requirement 2 Cost of goods available for sale: Beginning
inventory (600 x $80) Purchases:8-28
$ 48,000
Chapter 08 - Inventories: Measurement
1,000 x $ 95 $95,000 800 x $100 80,000 Cost of goods available
(2,400 units) First-in, first-out (FIFO) Cost of goods available
for sale (2,400 units) Less: Ending inventory (below) Cost of goods
sold Cost of ending inventory: Date of purchase January 21 Units
800 Unit cost $100 Total cost $80,000
175,000 $223,000
$223,000 (80,000) $143,000
Last-in, first-out (LIFO) Cost of goods available for sale
(2,400 units) Less: Ending inventory (below) Cost of goods sold
Cost of ending inventory: Date of purchase Beg. Inv. January 15
Total Units 600 200 Unit cost $80 95 Total cost $48,000 19,000
$67,000 $223,000 (67,000) $156,000
8-29
Chapter 08 - Inventories: Measurement
Exercise 8-16Requirement 1
Cost of goods available for sale: Beginning inventory (5,000 x
$10.00) Purchases: 3,000 x $10.40 $31,200 8,000 x $10.75 86,000
Cost of goods available (16,000 units)
$ 50,000 117,200 $167,200 $167,200 (73,150) $ 94,050*
Cost of goods available for sale (16,000 units) Less: Ending
inventory (below) Cost of goods sold Cost of ending inventory:
$167,200 Weighted-average unit cost = 16,000 units 7,000 units x
$10.45 = $73,150
= $10.45
* Alternatively, could be determined by multiplying the units
sold by the average cost: 9,000 units x $10.45 = $94,050
8-30
Chapter 08 - Inventories: Measurement
Exercise 8-16 (concluded) Requirement 2DateBeginning inventory
September 7 Available
Purchased5,000 @ $10.00 = $50,000
Sold
Balance5,000 @ $10.00 $50,000
3,000 @ $10.40 = $81,200 8,000 units
$31,200
= $10.15/unit
September 10 September 25 Available8,000 @ $10.75 = $126,600
12,000 units $86,000
4,000 @ $10.15 =
$40,600 4,000 @ $10.15
$40,600
= $10.55/unit
September 29Total cost of goods sold
5,000 @ $10.55 = =
$52,750 7,000 @ $10.55 $93,350
$73,850 Ending inventory
Exercise 8-17Requirement 1
FIFO cost of goods sold: = $50,000 = 60,000 $110,000
10,000 units @ $5.00 + 10,000 units @ $6.00 (determined below)
Requirement 2 LIFO cost of goods sold: 20,000 units @ $6.00
(determined below)
= $120,000
Calculations to determine cost per unit of year 2011
purchases:8-31
Chapter 08 - Inventories: Measurement
Cost of goods sold = Weighted-average cost per unit Number of
units sold $115,000 = $5.75 per unit 20,000 units $5.75 x 40,000
units = $230,000 = Cost of goods available for sale $230,000 -
$50,000 (beginning inventory) = $180,000 = Cost of purchases
$180,000 = $6 = Cost per unit of year 2011 purchases 30,000 units
purchased Cost of goods available for sale: Beginning inventory
(10,000 x $5.00) Purchases (30,000 x $6.00) Cost of goods available
(40,000 units) $ 50,000 180,000 $230,000
Exercise 8-18Requirement 1February 27, 2009millions) ($ in
LIFO reserve
($29.6-27.2).............................................
......................................................Cost of goods
sold
..................................................................................2.4
2.4
Requirement 2 $2,236.7 + 2.4 = $2,239.1 millionRequirement 1
Cost of goods sold: Exercise 8-19 50,000 units x $8.50 = 4,000
units x $7.00 = $453,000
$425,000 28,000
8-32
Chapter 08 - Inventories: Measurement
Requirement 2 When inventory quantity declines during a
reporting period, liquidation of LIFO inventory layers carried at
different costs prevailing in prior years results in noncurrent
costs being matched with current selling prices. If the resulting
effect on income is material, it must be disclosed. In this case,
the effect of the LIFO layer liquidation is to increase income
(ignoring taxes) by $6,000 [4,000 units liquidated x $1.50 ($8.50
current year cost per unit - $7 LIFO layer cost per unit)].
Exercise 8-20Requirement 2
The specific citation that describes the disclosure requirements
that must be made by publicly traded companies for a LIFO
liquidation is FASB ASC 33010S993: InventoryOverallSEC
MaterialsLIFO Liquidations. Requirement 3 When a company using LIFO
liquidates a substantial portion of its LIFO inventory and as a
result includes a material amount of income in its income statement
that otherwise would not have been recorded must disclose the
amount of income realized as a result of the inventory liquidation.
Such disclosure would be required in order to make the financial
statements not misleading. Disclosure may be made either in a
footnote or parenthetically on the face of the income
statement.
Exercise 8-21Gross profit ratio
($ in millions)
HOME DEPOT
LOWES 16,501 48,230 31,729 7,910 365 4.01 = 34.2% = 4.01 = 91
days
= 23,990 = 33.7% 71,288 = 47,298 = 4.22 11,202 = 365 4.22 = 86
days
Inventory turnover Average days in inventory
The gross profit ratios for the two companies are almost
identical and similar to the industry average (33%). On average,
Home Depot turns over its inventory five days faster than both
Lowes and the industry average.Ending
Exercise 8-228-33
Chapter 08 - Inventories: Measurement Ending Inventory at Base
Year Cost $660,000 = $660,000 1.00 $690,000 = $663,462 1.04
$760,000 = $703,704 1.08 Inventory Layers at Base Year Cost
$660,000 (base) Inventory Layers Converted to Cost $660,000 x 1.00
= $660,000 Inventory DVL Cost $660,000
Date 1/1/11
12/31/11
$660,000 (base) 3,462 (2011)
$660,000 x 1.00 = $660,000 3,462 x 1.04 = 3,600
663,600
12/31/12
$660,000 (base) 3,462 (2011) 40,242 (2012) Ending Inventory
Inventory at Base Year Cost $200,000 (base)
$660,000 x 1.00 = $660,000 3,462 x 1.04 = 3,600 40,242 x 1.08 =
43,461 Inventory Layers Converted to Cost $200,000 x 1.00 =
$200,000
Exercise 8-23LayersDate at Base Year Cost 12/31/11 $200,000 =
$200,000 1.00 $231,000 Index
707,061 Ending Inventory DVL Cost $200,000
12/31/12
= $220,000
Index = 1.05 $200,000 (base) 20,000 (2012) $200,000 x 1.00 =
$200,000 20,000 x 1.05 = 21,000 221,000
12/31/13
$299,000 Index
= $260,000
Index = 1.15 $200,000 (base) 20,000 (2012) 40,000 (2013)
$200,000 x 1.00 = $200,000 20,000 x 1.05 = 21,000 40,000 x 1.15 =
46,000
267,000
12/31/14
$300,000 Index = $250,000 Index = 1.20 $200,000 (base) 20,000
(2012) 30,000 (2013) $200,000 x 1.00 = $200,000 20,000 x 1.05 =
21,000 30,000 x 1.15 = 34,500
255,500
Exercise 8-24
8-34
Chapter 08 - Inventories: Measurement
List A i l a c g h k e f 1. Perpetual inventory system 2.
Periodic inventory system 3. F.o.b. shipping point 4. Gross method
5. Net method 6. Cost index 7. F.o.b. destination 8. FIFO 9.
LIFO
List B a. Legal title passes when goods are delivered to common
carrier. b. Goods are transferred to another company but title
remains with transferor. c. Purchase discounts not taken are
included in inventory cost. d. If LIFO is used for taxes, it must
be used for financial reporting. e. Items sold are those acquired
first. f. Items sold are those acquired last. g. Purchase discounts
not taken are considered interest expense. h. Used to convert
ending inventory at yearend cost to base year cost. i. Continuously
records changes in inventory. j. Items sold come from a mixture of
goods acquired during the period. k. Legal title passes when goods
arrive at location. l. Adjusts inventory at the end of the
period.
b 10. Consignment j 11. Average cost d 12. IRS conformity
rule
8-35
Chapter 08 - Inventories: Measurement
CPA / CMA REVIEW QUESTIONSCPA Exam Questions1.
d.
2.
c. Under the net method, purchases are recorded net of the
discount: $3,600 x 98% = $3,528 3. b. Average Cost = $4,950 / 140
units = $35.36 per unit Ending Inventory = $35.36 x 5 = $176.79 4.
a. 5 units x $30 = $150 5. c. 5 units x $50 = $250 6. b. If the
inventory balance was lower using FIFO than LIFO, then prices
during the period were moving downward. By using FIFO during such a
period, the higher priced items are sold first with lower-priced
goods remaining in the ending inventory.7. b. Inventory at base
year cost $100,000 120,000 128,000 Layer at base Cost year cost
Index 1.00 $20,000 1.05 8,000 1.10 Layer at current year cost
$21,000 8,800 Ending Inventory $100,000 121,000 129,800
Date 1/1/11 12/31/11 12/31/12
8-36
Chapter 08 - Inventories: Measurement
CMA Exam Questions1. c. The company began March with 3,200 units
in inventory at $64.30 each. The March 4 purchase added 3,400
additional units at $64.75 each. Under FIFO, the 3,600 units sold
on March 14 were the oldest units. That sale eliminated all of the
3,200 units priced at $64.30 and 400 of the units priced at $64.75,
leaving an inventory of 3,000 units at $64.75 prior to the March 25
purchase. On March 25, 3,500 units were acquired at $66. The 3,450
units sold on March 28 were the 3,000 remaining units priced at
$64.75 and 450 units priced at $66. The ending inventory consists
of 3,050 units at $66 each, or $201,300. The answer would have been
the same under the periodic FIFO method. 2. a. The ending inventory
consists of 3,050 units (beginning inventory plus purchases, minus
sales). Under the periodic LIFO method, those units are valued at
the oldest prices for the period, which is $64.30 of the beginning
inventory. Multiplying $64.30 times 3,050 units produces a total
inventory value of $196,115.3. a.
Under the perpetual LIFO method, the company begins with 3,200
units at $64.30. Added to this is the March 4 purchase of 3,400
units at $64.75. The March 14 sale uses all of the March 4 purchase
and 200 of the original inventory units. Thus, the firm is left
with 3,000 units at $64.30. The March 25 purchase of 3,500 at $66
is added to the previous 3,000 units. The March 28 sale of 3,450
units comes entirely from the March 25 purchase, leaving just 50 of
those units at $66 each. Thus, at the end of the month, the
inventory consists of two layers: 3,000 units at $64.30 ($192,200),
and 50 units at $66 ($3,300). Adding the two together produces a
total ending inventory of $196,200.
8-37
Chapter 08 - Inventories: Measurement
PROBLEMSProblem 8-1Requirement 1of freight charges. October 12,
2011 Purchases (98% x
$22,000)............................................
.......................................................Accounts
payable
.........................................................................21,560
Freight-in.....................................................................
............................................................................Cash
..............................................................................500
a. To record the purchase of inventory on account and the
payment
21,560
500
b.
To record purchase returns. October 18, 2011 Accounts
payable........................................................
..........................................................Purchase
returns
...........................................................................3,000
3,000
c.
To record payment of accounts payable. October 31, 2011 Accounts
payable........................................................
Interest
expense..........................................................
............................................................................Cash
.........................................................................22,000
21,560 440
8-38
Chapter 08 - Inventories: Measurement
Problem 8-1 (continued) d. To record sales on account. October,
2011 Accounts
receivable....................................................
..............................................................Sales
revenue
.........................................................................28,000
No entry is made for the cost of goods sold.
28,000
Cost of goods sold: Beginning inventory Plus net purchases:
Purchases $21,560 Less: Purchases returns (3,000) Plus: Freight-in
500 Cost of goods available for sale Less: Ending inventory Cost of
goods sold Adjusting entry: October 31, 2011 Cost of goods sold
(above)........................................... Inventory
(ending)........................................................
Purchase
returns..........................................................
....................................................Inventory
(beginning)
.........................................................................15,000
....................................................................Purchases
.........................................................................21,560
.....................................................................Freight-in
..............................................................................500
18,000 16,060 3,000 $15,000
19,060 34,060 (16,060) $18,000
8-39
Chapter 08 - Inventories: Measurement
Problem 8-1 (concluded) Requirement 2 a. To record the purchase
of inventory on account and the payment of freight charges. October
12, 2011 Inventory (98% x
$22,000).............................................
.......................................................Accounts
payable
.........................................................................21,560
Inventory.....................................................................
............................................................................Cash
..............................................................................500
21,560
500
b.
To record purchase returns. October 18, 2011 Accounts
payable........................................................
.....................................................................Inventory
...........................................................................3,000
3,000
c.
To record payment of accounts payable. October 31, 2011 Accounts
payable........................................................
Interest
expense..........................................................
............................................................................Cash
.........................................................................22,000
21,560 440
d.
To record sales on account. October, 2011
8-40
Chapter 08 - Inventories: Measurement
Accounts
receivable....................................................
..............................................................Sales
revenue
.........................................................................28,000
Cost of goods
sold......................................................
.....................................................................Inventory
.........................................................................18,000
28,000
18,000
1. The transaction is not correctly accounted for. Inventory
held on Problem 8-2 consignment by another company should be
included in the inventory of the consignor. Rasul should include
this merchandise in its 2011 ending inventory. 2. The transaction
is not correctly accounted for. Legal title to merchandise shipped
f.o.b. shipping point changes hands when the goods are shipped.
Rasul should record the purchase and corresponding account payable
in 2011 and include the merchandise in its 2011 ending inventory.
3. The transaction is not correctly accounted for. Since the
merchandise was shipped f.o.b. destination and did not arrive at
the customer's location until 2012, it should be included in Rasuls
2011 ending inventory. The sale should be recorded in 2012. 4. The
transaction is correctly accounted for. Merchandise held on
consignment from another company belongs to the consignor and
should be excluded from the inventory of the consignee. 5. The
transaction is correctly accounted for. Since the merchandise was
shipped f.o.b. destination and did not arrive at Rasuls location
until 2012, it should not be included in Rasuls 2011 ending
inventory. The purchase is correctly recorded in 2012. Accounts
Problem 8-3 Inventory Payable Sales Initial amounts $1,250,000
$1,000,000 $9,000,000 Adjustments - increase (decrease): 1.
(155,000) (155,000) NONE 2. (22,000) NONE NONE 3. NONE NONE 40,000
4. 210,000 NONE NONE 5. 25,000 25,000 NONE 6. 2,000 2,000 NONE 7.
(5,300) (5,300) NONE Total adjustments 54,700 (133,300)
40,0008-41
Chapter 08 - Inventories: Measurement
Adjusted amounts
$1,304,700
$ 866,700
$9,040,000
Problem 8-4Requirement 1$ 80,000 Net purchases: Purchases
(50,000* units x $10.00) Less: Returns (1,000 units x $10.50) Less:
Purchase discounts($500,000 x 2%) Plus: Freight-in (50,000 units x
$.50) Cost of goods available (59,000 units) Less: Ending inventory
(below)
Beginning inventory (10,000 x $8.00) $500,000 (10,500) (10,000)
25,000 504,500 584,500 (121,200) $463,300
Cost of goods sold
* The 5,000 units purchased on December 28 are not included. The
merchandise was shipped f.o.b. destination and did not arrive at
Johnsons warehouse until 2012. Cost of ending inventory: Date of
purchase Beg. Inv. 2011 Total Units 10,000 4,000 14,000 Unit cost
Total cost $ 8.00 $ 80,000 10.30** 41,200 $121,200
**$10 x 98% = $9.80 + .50 in freight charges = $10.30
Requirement 2 Sales (45,000 units x $18.00) $810,000 Less: Cost of
goods sold (above) $463,300 Other operating expenses 150,000
(613,300) Income before income taxes $196,700 Cost of goods
available for sale for periodic system:
Problem 8-5
Beginning inventory (6,000 x $8.00)
$
48,000 Purchases: 5,000 x $ 9.00 $45,000 6,000 x $10.00 60,000
Cost of goods available (17,000 units)
105,000 $153,000
8-42
Chapter 08 - Inventories: Measurement
1. FIFO, periodic system Cost of goods available for sale
(17,000 units) Less: Ending inventory (determined below) Cost of
goods sold Cost of ending inventory: Date of purchase Jan. 10 Jan.
18 Totals Units 2,000 6,000 8,000 Unit cost $ 9.00 10.00 Total cost
$18,000 60,000 $78,000 $153,000 (78,000) $ 75,000
Alternatively, cost of goods sold can be determined by adding
the cost of the 6,000 units in beginning inventory ($48,000) and
the 3,000 units from the January 10 purchase ($27,000) =
$75,000.
8-43
Chapter 08 - Inventories: Measurement
Problem 8-5 (continued) 2. LIFO, periodic system Cost of goods
available for sale (17,000 units) Less: Ending inventory
(determined below) Cost of goods sold Cost of ending inventory:
Date of purchase Beg. Inv. Jan. 10 Totals Units 6,000 2,000 8,000
Unit cost $8.00 9.00 Total cost $48,000 18,000 $66,000 $153,000
(66,000) $ 87,000
Alternatively, cost of goods sold can be determined by adding
the cost of the 6,000 units from the January 18 purchase ($60,000)
and the 3,000 units from the January 10 purchase ($27,000) =
$87,000.
8-44
Chapter 08 - Inventories: Measurement
Problem 8-5 (continued) 3. LIFO, perpetual systemDate Beginning
inventory January 5 January 10 January 12 January 186,000 @ $10.00
= $60,000 5,000 @ $9.00 = $45,000 2,000 @ $9.00 =
Purchased6,000 @ $8.00 = $48,000
Sold
Balance6,000 @ $8.00 $48,000
3,000 @ $8.00 =
$24,000 3,000 @ $8.00 3,000 @ $8.00 5,000 @ $9.00 $18,000 3,000
@ $8.00 3,000 @ $9.00 3,000 @ $8.00 3,000 @ $9.00 6,000 @
$10.00
$24,000
$69,000 $51,000 $111,000
January 20
4,000 @ $10.00 =
$40,000 3,000 @ $8.00 3,000 @ $9.00 2,000 @ $10.00 $82,000
$71,000 Ending inventory
Total cost of goods sold
=
4. Average cost, periodic system Cost of goods available for
sale (17,000 units) Less: Ending inventory (below) Cost of goods
sold Cost of ending inventory: Weighted-average unit cost = 8,000
units x $9.00 = $72,000 Alternatively, cost of goods sold could be
determined by multiplying the units sold by the average cost: 9,000
units x $9.00 = $81,000. $153,000 = $9.00 17,000 units $153,000
(72,000) $ 81,000
8-45
Chapter 08 - Inventories: Measurement
Problem 8-5 (concluded) 5. Average cost, perpetual systemDate
Beginning inventory January 5 January 10 Available5,000 @ $9.00 =
$69,000 8,000 units $45,000
Purchased6,000 @ $8.00 = $48,000
Sold
Balance6,000 @ $8.00 $48,000
3,000 @ $8.00 =
$24,000 3,000 @ $8.00
$24,000
= $8.625/unit
January 12 January 18 Available6,000 @ $10.00 = $111,750 12,000
units $60,000
2,000 @ $8.625 =
$17,250 6,000 @ $8.625
$51,750
= $9.3125/unit
January 20
4,000 @ $9.3125 = $37,250 8,000 @ $9.3125
$74,500 Ending inventory
Total cost of goods sold
= $78,500
Problem 8-6Requirement 1
Cost of goods available for sale for periodic system: $20,000
54,000 85,000 $159,000
Purchases: 5,000 x $4.00 12,000 x $4.50 17,000 x $5.00 Cost of
goods available (34,000 units) a. FIFO
Cost of goods available for sale (34,000 units)8-46
$159,000
Chapter 08 - Inventories: Measurement
Less: Ending inventory (determined below) Cost of goods sold
Cost of ending inventory: Date of purchase March 22 Units 14,000
Unit cost 5.00 Total cost 70,000
(70,000) $ 89,000
b. LIFO Cost of goods available for sale (34,000 units) Less:
Ending inventory (determined below) Cost of goods sold Cost of
ending inventory: Date of purchase Jan. 7 Feb. 16 Totals Units
5,000 9,000 14,000 Unit cost $4.00 4.50 Total cost $20,000 40,500
$60,500 $159,000 (60,500) $ 98,500
8-47
Chapter 08 - Inventories: Measurement
Problem 8-6 (concluded) c. Average cost Cost of goods available
for sale (34,000 units) Less: Ending inventory (below) Cost of
goods sold Cost of ending inventory: Weighted-average unit cost =
$159,000 = $4.6765 34,000 units $159,000 (65,471) $ 93,529*
14,000 units x $4.6765 = $65,471 * Alternatively, could be
determined by multiplying the units sold by the average cost:
20,000 units x $4.6765 = $93,530 (rounding) Gross Profit ratio:
FIFO: LIFO: Average: $51,000* $140,000** = 36% $41,500* $140,000**
= 30% $46,471* $140,000** = 33%
*Sales less cost of goods sold **20,000 units x $7 sales price =
sales Requirement 2 In situations when costs are rising, LIFO
results in a higher cost of goods sold and, therefore, a lower
gross profit ratio than FIFO.
Problem 8-7Requirement 1$183,000 Purchases: 211 212 213 214 215
216 $63,000 63,000 64,500 66,000 69,000 70,500
Beginning inventory ($60,000 + 60,000 + 63,000)
8-48
Chapter 08 - Inventories: Measurement
217 72,000 218 72,300 219 75,000 Cost of goods available Ending
inventory: 213 $64,500 216 70,500 219 75,000 Cost of goods sold
Requirement 2 Cost of goods available for sale Less: Ending
inventory (below) Cost of goods sold Cost of ending inventory (3
autos): Car ID 219 218 217 Total Cost $ 75,000 72,300 72,000
$219,300
615,300 798,300
(210,000) $588,300
$798,300 (219,300) $579,000
8-49
Chapter 08 - Inventories: Measurement
Problem 8-7 (concluded) Requirement 3 Cost of goods available
for sale Less: Ending inventory (below) Cost of goods sold Cost of
ending inventory (3 autos): Car ID 203 207 210 Total Requirement 4
Cost of goods available for sale (12 units) Less: Ending inventory
(below) Cost of goods sold Cost of ending inventory: $798,300
Weighted-average unit cost = 12 units 3 units x $66,525 = $199,575
* Alternatively, could be determined by multiplying the units sold
by the average cost: 9 units x $66,525 = $598,725 = $66,525
$798,300 (199,575) $598,725* Cost $ 60,000 60,000 63,000 $183,000
$798,300 (183,000) $615,300
Problem 8-8Requirement 1
The note indicates that if the company had used FIFO, inventory
would have been higher by $3,183 million and $2,617 million at the
end of
8-50
Chapter 08 - Inventories: Measurement
2008 and 2007, respectively. Therefore, 2008 cost of goods sold
would have been lower (and income before tax higher) by $566
million ($3,183 - 2,617). The information provided also states that
net income for 2008 would have been higher by $447 million if FIFO
had been used. This means that the tax effect of the difference
between LIFO and FIFO was $119 million ($566 - 447). The effective
tax rate is therefore approximately 21% ($119 $566). Requirement 2
The information might be useful to a financial analyst interested
in comparing Caterpillars performance with another company using
the FIFO inventory method exclusively. Requirement 3 Retained
earnings would have been higher by approximately $2,515 million
[$3,183 million x (1 - .21)].
Problem 8-9Requirement 1Purchases: 30,000 units @ $25 Cost of
goods available for sale Less: Ending inventory (below) Cost of
goods sold Cost of ending inventory: Date of purchase Units Beg.
Inv. 10,000 Beg. Inv. 5,000 Totals 15,000
Beginning inventory 750,000 1,200,000 (250,000) $ 950,000
$ 450,000
Unit cost $15 20
Total cost $150,000 100,000 $250,000
Requirement 2 Cost of goods sold assuming all units purchased at
the year 2011 price: 40,000 units x $25.00 = $1,000,000 Less: LIFO
cost of goods sold (950,000) LIFO liquidation profit before tax
50,000 Multiplied by 1 - .40 x .60 LIFO liquidation profit $ 30,000
Requirement 3 $50,000 x 40% = $20,000
8-51
Chapter 08 - Inventories: Measurement
Problem 8-102011:
Requirement 1
Cost of goods sold: 1,000 x $16 = $ 16,000 10,000 x $18 =
180,000 11,000 $196,000 1,500 x $16 = $ 24,000 13,000 x $18 =
234,000 14,500 $258,000 1,000 x $12 = $ 12,000 12,000 x $18 =
216,000 13,000 $228,000
2012:
2013:
Requirement 2 LIFO liquidation before-tax profit or loss: 2011:
1,000 units x $2 ($18 16) = 2012: 1,500 units x $2 ($18 16) = 2013:
1,000 units x $6 ($18 12) = Requirement 3 Disclosure note: During
fiscal 2013, 2012, and 2011, inventory quantities in certain LIFO
layers were reduced. These reductions resulted in a liquidation of
LIFO inventory quantities carried at lower costs prevailing in
prior years as compared with the cost of fiscal 2013, 2012, and
2011 purchases. As a result, cost of goods sold decreased by
$6,000, $3,000, and $2,000 in fiscal 2013, 2012, and 2011,
respectively, and net income increased by approximately $3,600,
$1,800, and $1,200, respectively. $2,000 profit $3,000 profit
$6,000 profit
Problem 8-11Requirement 1
Sales (27,000 units x $2,000) Less: Cost of goods sold (27,000
units x $1,000) Gross profit
$54,000,000 (27,000,000) $27,000,000
Gross profit ratio = $27,000,000 $54,000,000 = 50%
8-52
Chapter 08 - Inventories: Measurement
Requirement 2 Sales (27,000 units x $2,000) Less: Cost of goods
sold* Gross profit $54,000,000 (25,000,000) $29,000,000
Gross profit ratio = $29,000,000 $54,000,000 = 53.7% *Cost of
goods sold: 15,000 units x $1,000 6,000 units x $ 900 4,000 units x
$ 800 2,000 units x $ 700 27,000 units
= = = =
$15,000,000 5,400,000 3,200,000 1,400,000 $25,000,000
8-53
Chapter 08 - Inventories: Measurement
Problem 8-11 (concluded) Requirement 3 The gross profit and
gross profit ratio are higher applying the requirement 2 assumption
of 15,000 units purchased because of the LIFO liquidation profit
that results. When inventory quantity declines during a reporting
period, LIFO inventory layers carried at costs prevailing in prior
years are liquidated or assumed sold in the cost of goods sold
calculation. This results in noncurrent costs being matched with
current selling prices. If the company had purchased at least
27,000 units during 2007, there would be no LIFO liquidation. The
profit difference ($2,000,000 in this case), if material, must be
disclosed in a note. The difference can be arrived at by comparing
the current replacement cost of $1,000 with each inventory layer
from prior years that were included in this years cost of goods
sold, as follows: 6,000 units x $100 ($1,000 900) 4,000 units x
$200 ($1,000 800) 2,000 units x $300 ($1,000 700) Total LIFO
liquidation profit Requirement 4 Sales (27,000 units x $2,000) Cost
of goods sold: 5,000 units x $700 4,000 units x $800 6,000 units x
$900 12,000 units x $1,000 27,000 units $ 600,000 800,000 600,000
$2,000,000 $54,000,000 $ 3,500,000 3,200,000 5,400,000 12,000,000
Gross profit =
24,100,000 $29,900,000
Gross profit ratio = $29,900,000 $54,000,000 = 55.4% If only
15,000 units are purchased, cost of goods sold, gross profit, and
the gross profit ratio would be exactly the same as when 28,000
units are purchased. Requirement 5 The number of units purchased
has no effect on FIFO cost of goods sold. When applying the
first-in, first-out approach, beginning inventory costs are
included in cost of goods sold first, regardless of the quantities
of inventory purchased in the new reporting period.
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Problem 8-12Requirement 1Allowance for uncollectible accounts
Balance, beginning of year Add: Bad debt expense for 2011 Less:
End-of-year balance Accounts receivable written off Requirement 2
Accounts receivable analysis: Balance, beginning of year ($583 + 7)
Add: Credit sales Less: write-offs (from Requirement 1) Less:
Balance end of year ($703 + 10) Cash collections $ 590 6,255 (5)
(713) $6,127 $7 8 (10) $5
Requirement 3 Cost of goods sold for 2011 would have been $130
million lower had Inverness used the average cost method for its
entire inventory. While beginning inventory would have been $350
million higher, ending inventory also would have been higher by
$480 million. An increase in beginning inventory causes an increase
in cost of goods sold, but an increase in ending inventory causes a
decrease in cost of goods sold. Purchases for the year are the same
regardless of the inventory valuation method used. Therefore, cost
of goods sold would have been $5,060 ($5,190 130). Requirement 4 a.
Receivables turnover ratio b. Inventory turnover ratio c. Gross
profit ratio = = $6,255 ($703 + 583)/2 $5,190 ($880 + 808)/2 = = =
9.73 6.15 17%
= ($6,255- 5,190) $6,255
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Chapter 08 - Inventories: Measurement
Problem 8-12 (concluded) Requirement 5 If inventory costs are
increasing, when inventory quantity declines during a period,
liquidation of LIFO inventory layers carried at lower costs
prevailing in prior years results in noncurrent costs being matched
with current selling prices. The income generated by this
liquidation is known as LIFO liquidation profit. The liquidation
caused 2011 cost of goods sold to be lower by $9.23 million [$6
million (1 - .35)]
Problem 8-13LayersDate 1/1/11 at Base Year Cost $400,000 1.00
12/31/11 $441,000 1.05 12/31/12 $487,200 1.12 12/31/13 $510,000
1.20 = $425,000 = $435,000 = $420,000 = $400,000
Ending Inventory Inventory at Base Year Cost $400,000 (base)
Inventory Layers Converted to Cost $400,000 x 1.00 =
$400,000
Ending Inventory DVL Cost $400,000
$400,000 (base) 20,000 (2011) $400,000 (base) 20,000 (2011)
15,000 (2012) $400,000 (base) 20,000 (2011) 5,000 (2012) Ending
Inventory at Base Year Cost $150,000 (base)
$400,000 x 1.00 = 20,000 x 1.05 = $400,000 x 1.00 = 20,000 x
1.05 = 15,000 x 1.12 = $400,000 x 1.00 = 20,000 x 1.05 = 5,000 x
1.12 = Inventory Layers
$400,000 21,000 $400,000 21,000 16,800 $400,000 21,000 5,600
421,000
437,800
426,600 Ending Inventory DVL Cost $150,000
Problem 8-14Layers Date 1/1/11 Inventory at Base Year Cost
$150,000 1.00 12/31/11 $200,000 1.08 12/31/12 $245,700 1.17
12/31/13 $235,980 1.14 = $210,000 = $185,185 = $150,000
Converted to Cost $150,000 x 1.00 = $150,000
$150,000 (base) 35,185 (2011) $150,000 (base) 35,185 (2011)
24,815 (2012) $150,000 (base) 35,185 (2011) 21,815 (2012)
$150,000 x 1.00 = 35,185 x 1.08 = $150,000 x 1.00 = 35,185 x
1.08 = 24,815 x 1.17 = $150,000 x 1.00 = 35,185 x 1.08 = 21,815 x
1.17 =
$150,000 38,000 $150,000 38,000 29,034 $150,000 38,000
25,524
188,000
217,034
= $207,000
213,524
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12/31/14
$228,800 1.10
= $208,000
$150,000 (base) 35,185 (2011) 21,815 (2012) 1,000 (2014)
$150,000 35,185 21,815 1,000
x 1.00 x 1.08 x 1.17 x 1.10
= = = =
$150,000 38,000 25,524 1,100
214,624
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Chapter 08 - Inventories: Measurement
Problem 8-15Layers Date 1/1/11 Inventory at Base Year Cost
$260,000 1.00 12/31/11 $340,000 1.02 12/31/12 $350,000 1.06
12/31/13 $400,000 1.07 12/31/14 $430,000 1.10 = $373,832 = $330,189
= $333,333 = $260,000
Ending Inventory at Base Year Cost $260,000 (base)
Inventory Layers Converted to Cost $260,000 x 1.00 =
$260,000
Ending Inventory DVL Cost $260,000
$260,000 (base) 73,333 (2011) $260,000 (base) 70,189 (2011)
$260,000 (base) 70,189 (2011) 43,643 (2013) $260,000 (base) 70,189
(2011) 43,643 (2013) 17,077 (2014)
$260,000 x 1.00 = 73,333 x 1.02 = $260,000 x 1.00 = 70,189 x
1.02 = $260,000 x 1.00 = 70,189 x 1.02 = 43,643 x 1.07 = $260,000
70,189 43,643 17,077 x 1.00 x 1.02 x 1.07 x 1.10 = = = =
$260,000 74,800 $260,000 71,593 $260,000 71,593 46,698 $260,000
71,593 46,698 18,785
334,800
331,593
378,291
= $390,909
397,076
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Chapter 08 - Inventories: Measurement
Problem 8-16Layers Date 1/1/11 Inventory at Base Year Cost
$84,000 1.00 12/31/11 $100,800 1.05 12/31/12 $136,800 1.14 12/31/13
$150,000 = $120,000 = $96,000 = $84,000
Ending Inventory at Base Year Cost $84,000 (base)
Inventory Layers Converted to Cost $84,000 x 1.00 = $84,000
Ending Inventory DVL Cost $84,000
$84,000 (base) 12,000 (2011) $84,000 (base) 12,000 (2011) 24,000
(2012) $84,000 (base) 12,000 (2011) 24,000 (2012) 5,000 (2013)
$84,000 (base) 12,000 (2011) 24,000 (2012) 5,000 (2013) 3,000
(2014)
$84,000 12,000 $84,000 12,000 24,000 $84,000 12,000 24,000 5,000
$84,000 12,000 24,000 5,000 3,000(3)
x 1.00 = x 1.05 = x 1.00 = x 1.05 = x 1.14 = x 1.00 x 1.05 x
1.14 x 1.20 x 1.00 x 1.05 x 1.14 x 1.20 x 1.25 = = = = = = = =
=
$84,000 12,600 84,000 12,600 27,360 $84,000 12,600 27,360 6,000
84,000 12,600 27,360 6,000 3,750(2)
96,600
123,960
= $125,000 1.20 (1)
129,960
12/31/14
$160,000(5) = $128,000(4) 1.25
133,710
(1) (2) (3) (4) (5)
$150,000 $125,000 = 1.20 (2013 cost index) $133,710 129,960 =
$3,750 $3,750 1.25 = $3,000 $125,000 + 3,000 = $128,000 (2014
inventory at base-year cost) $128,000 x 1.25 = $160,000(2014
inventory at year-end costs)
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Chapter 08 - Inventories: Measurement
CASESAdvance warning of the company's impending Judgment Case
8-1bankruptcy existed at the date of the financial statements. As a
rule, inventories should rise in tandem with sales. If inventories
rise faster, it may be because the goods simply aren't selling.
This is particularly true of companies in faddish or seasonal
businesses Merry-Go-Round's world. The company's report showed that
inventories on January 30 were $82.2 million, up 37 percent from
$60 million a year earlier. That's well above the 15 percent sales
growth in the same period, to $877.5 million from $761.2 million.
This alone should have been a major cause for concern. It indicated
the company's goods simply weren't selling as rapidly as it
expected, causing its inventories to bulge. The increase in
receivables from $6,195 to over $6 million should also have been
cause for concern.
Real World Case 8-2Requirement 1
Identifying items that should be included in inventory is
difficult due to goods in transit, goods on consignment, and sales
returns. Goods in transit. Inventory shipped f.o.b. shipping point
is included in the purchasers inventory as soon as the merchandise
is shipped. On the other hand, inventory shipped f.o.b. destination
is included in the purchasers inventory only after it reaches the
purchasers location. Goods on consignment. Goods held on
consignment are included in the inventory of the consignor until
sold by the consignee. Sales returns. When the right of return
exists, a seller must be able to estimate those returns. As a
result, a company includes in inventory the cost of merchandise it
anticipates will be returned. Requirement 2 In addition to the
direct acquisition costs such as the price paid and transportation
costs to obtain inventory, the costs of unloading, unpacking, and
preparing inventory for sale or raw materials for use, if material
in amount, also should be included in the cost of inventory.
Requirement 3 Sport Chalet considers cost to include the direct
cost of merchandise and inbound freight, plus internal costs
associated with merchandise procurement, storage and handling.
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1. a. The specific identification method requires each Judgment
Case 8-3unit to be clearly distinguished from similar units either
by description, identification number, location, or other
characteristic. Costs are accumulated for specific units and
expensed as the units are sold. Thus, the specific identification
method results in recognized cost flows being identical to actual
physical flows. Ideally, each unit is relatively expensive and the
number of units relatively few so that recording costs is not
burdensome. Under the specific identification method, if similar
items have different costs, cost of goods sold is influenced by the
specific units sold. b. It is appropriate for Happlia to use the
specific identification method because each appliance is expensive,
and easily identified by number and description. The specific
identification method is feasible because Happlia already maintains
records of its units held by individual retailers. Managements
ability to manipulate cost of goods sold is minimized because once
the inventory is in the retailers hands, Happlias management cannot
influence the units selected for sale. 2. a. Happlia should include
in inventory carrying amounts all necessary and reasonable costs to
get an appliance into a useful condition and place for sale. Common
(or joint) costs should be allocated to individual units. Such
costs exclude the excess costs incurred in transporting
refrigerators to Minneapolis and their reshipment to Kansas City.
These unit costs should only include normal freight costs from Des
Moines to Kansas City. In addition, costs incurred to provide time
utility to the goods, i.e. ensuring that they are available when
required, will also be included in inventory carrying amounts. b.
Examples of inventoriable costs include the unit invoice price,
plus an allocated proportion of the port handling fees, import
duties, freight costs to Des Moines and to retailers, insurance
costs, repackaging, and warehousing costs. 3. The 2011 income
statement should report in cost of goods sold all inventory costs
related to units sold in 2011, regardless of when cash is received
from retailers. Excess freight costs incurred for shipping the
refrigerators from Minneapolis to Kansas City should be included in
determining operating income.
Communication Case 8-4ending inventory
Suggested Grading Concepts and Grading Scheme: Content (70%) 20
Describes the differential effect on
________
and cost of goods sold of using FIFO versus LIFO when _______
Prices are increasing. _______ Prices are decreasing. 25 Discusses
the various motivating factors that might influence the choice of
inventory method. _______ The actual physical flow of product.
_______ The better match of expenses with revenues provided by
LIFO.8-61
Chapter 08 - Inventories: Measurement
_______ The effect on the balance sheet. _______ The effect on
reported income and income taxes. _______ The cost of
implementation of LIFO. ________ 10 Discusses briefly the methods
available to simplify LIFO. ________ 15 Discusses the IRS
conformity rule with respect to LIFO and the relaxation of the rule
that allows a a company using LIFO to present supplemental non-LIFO
disclosures. _______ ________ 70 points Writing (30%) ________ 6
Terminology and tone appropriate to the audience of a company
president. ________ ________ 12 12 Organization permits ease of
understanding. _______ Introduction that states purpose. _______
Paragraphs that separate main points. English _______ Sentences
grammatically clear and well organized, concise. _______ Word
selection. _______ Spelling. _______ Grammar and punctuation.
_______ ________ 30 points
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Chapter 08 - Inventories: Measurement
LIFO produces a higher cost of goods sold, Communication Case
8-5lower taxable income and therefore lower income taxes currently
payable than FIFO only in periods when the costs of the companys
products are rising. When costs are decreasing, LIFO results in
lower cost of goods sold, higher taxable income, and a higher
current tax liability than FIFO. In the case of the electronics
client, you would explain this to the intern concluding that the
costs of the client's products must be decreasing, as frequently
occurs in this industry. At the end of a reporting period it is
important to ensure Judgment Case 8-6that a proper inventory cutoff
is made. A proper cutoff involves the determination of the
ownership of goods that are in transit between the company and its
customers as well as the company and its suppliers. If the shipment
is made f.o.b. shipping point, then ownership is transferred to the
buyer when the goods reach the common carrier. If the shipment is
made f.o.b. destination, then ownership is transferred to the buyer
when the goods arrive at the buyers location. In this case, John is
incorrect if the goods were shipped f.o.b. destination. If so, even
though the company is not in physical possession of the goods, they
should be included in ending inventory because the shipment had not
reached the buyer's location by the end of the reporting
period.
Ethics Case 8-7Requirement 1
Without purchase of the additional units: Sales (35,000 @ $60)
$2,100,000 Cost of goods sold (35,000 x $30) (1,050,000) Gross
profit $1,050,000 Due Jim Lester ($1,050,000 x 20%) = $210,000 With
purchase of the additional units: Sales Cost of goods sold: 20,000
x $40 $800,000 15,000 x $30 450,000 Gross profit Due Jim Lester
($850,000 x 20%) = $170,000 $2,100,000 (1,250,000) $ 850,000
Requirement 2 Discussion should include these elements.
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Facts: If Moncrief purchases the additional units at year end
under a periodic LIFO inventory system, the transaction results in
a reduced payment to Jim Lester, reduced profits to shareholders,
and reduced income tax payments to government entities. By
purchasing the additional units of Zelenex, Moncrief reduces Jim
Lester's payment by $40,000 ($210,000 - $170,000) and decreases
gross profit by $200,000 ($1,050,000 $850,000). The net effect on
before-tax income is a decrease of $160,000 ($200,000 $40,000).
Since Moncrief does not intend to sell the units until 2012, the
only logical reason for purchasing more costly inventory at
year-end is profit manipulation. Ethical Dilemma: Should Moncrief
exercise its right to purchase inventory at will, resulting in a
reduction in net income, or recognize the rights of Jim Lester to
receive profit for the sale of his product, shareholders' rights to
have their investment appreciate through positive earnings, and
government entities' rights to collect tax on economic net
income?
Real World Case 8-8Requirement 1
In 1981, the LIFO conformity rule was liberalized to permit LIFO
users to present designated supplemental disclosures. These
disclosures allow a company using LIFO to report, in a note, the
difference between inventories valued using LIFO and inventory
valued as if another method had been used. Kroger's note provides
this supplemental information. Requirement 2 1/31/09 Ending
Beginning Inventory Inventory($ in millions)
Inventory as stated Add: Increase in LIFO inventory FIFO
inventory balances
$4,859 800 $5,659
$4,849 604 $5,453
Requirement 3 Cost of goods sold for the fiscal year ended
January 31, 2009 would have been $196 million lower had Kroger used
FIFO for its entire inventory. While beginning inventory would have
been $604 million higher, ending inventory also would have been
higher by $800 million. An increase in beginning inventory causes
an increase in cost of goods sold, but an increase in ending
inventory causes a decrease in cost of goods sold. Purchases for
the year are the same regardless of the inventory valuation method
used.8-64
Chapter 08 - Inventories: Measurement
Requirement 3 Real World Case 8-9 The following is based on
Whole Food's 2009 financial statements. Answers will vary depending
on the financial statement dates chosen. a.Whole Foods uses the
last-in, first-out (LIFO) method for approximately 93.6% of its
inventories at the end of 2009 and 94% of its inventories at the
end of 2008 and FIFO for the remainder. b. Assuming that current
cost approximates FIFO cost, the inventory disclosure note
indicates that, if FIFO had been used to value LIFO inventories,
inventories would have been higher than reported by $27.1 million
at the end of 2009 and $32.7 million at the end of 2008. Cost of
goods sold for 2009 would have been $5.6 million higher ($32.7
27.1) had Whole Foods used FIFO. Beginning inventory would have
been $32.7 million higher and ending inventory also would have been
higher by $27.1 million. An increase in beginning inventory causes
an increase in cost of goods sold, while an increase in ending
inventory causes a decrease in cost of goods sold. Purchases for
2009 are the same regardless of the inventory valuation method
used. c.Inventory turnover = cost of goods sold divided by average
inventory($ rounded to millions)
Inventory turnover = *($311 + 327) 2
$5,277 = 16.54 $319 *
The dollar-value LIFO inventory estimation Communication Case
8-10technique begins with the determination of the current years
ending inventory valued in terms of year-end costs. It is not
necessary for a company using DVL to track the cost of purchases
during the year. All that is needed is to take the physical
quantities of goods on hand at the end of the year and apply
year-end costs. The next step is to convert the ending inventory
from year-end costs to base year costs. This usually is
accomplished by dividing the ending inventory at year-end costs by
the years cost index. The cost index reflects the change in cost
from a base year to the current year. The ending inventory has been
deflated for cost changes from the base year to the end of the
current year. The next step in the procedure is to identify the
layers in ending inventory with the years they were created by
comparing ending inventory at base year cost to the beginning
inventory at base year cost. Applying the LIFO concept, if
inventory has increased, ending inventory at base year cost
consists of the beginning inventory layer plus a current year
layer.
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Chapter 08 - Inventories: Measurement
The final step converts the layers identified to cost by
multiplying the layers at base year cost by the layers cost index.
The costs are totaled to obtain ending inventory at DVL cost.
Research Case 8-11Requirement 1
The FASBs codification citation that provides guidance for
determining whether an arrangement involving the sale of inventory
is in substance a financing arrangement is FASB ASC 47040052:
DebtProduct Financing ArrangementsOverview and Background.
Requirement 2 The FASBs codification citation that addresses the
recognition of a product financing arrangement is FASB ASC
47040251: DebtProduct Financing ArrangementsRecognition Requirement
3 The appropriate accounting treatment for this type of arrangement
is for the sponsor to record a liability at the time the proceeds
are received from the other entity. The sponsor does not record the
transaction as a sale and does not remove the product from its
inventory. The cost of the repurchase amount in excess of the
originally recorded liability represents financing and holding
costs. These costs are accounted for in accordance with the
sponsors accounting policies applicable to other financing and
holding costs. Notice that this is an example of substance (a loan)
over form (a sale). Requirement 4 Journal entry to record the sale
(cash receipt):
Cash............................................................................
160,000 ..................Liability product financing arrangement
.......................................................................160,000
Journal entry to record the repurchase: Liability product
financing arrangement ................. 160,000 Holding and
financing costs* ..................................... 4,000
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Chapter 08 - Inventories: Measurement
............................................................................Cash
.......................................................................164,000
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Chapter 08 - Inventories: Measurement
Research Case 8-11 (concluded) *The treatment of these costs
depends on the accounting policies of the sponsor. For example, if
these costs normally are expensed as period costs, then the debit
in this case would be to an expense account (or accounts).
Analysis Case 8-12Requirement 1($ in millions)
SAKS Gross profit ratio Inventory turnover Average days in
inventory = = = 968 3,030 2,062 793 365 2.6 = 32% = 2.6 = 140
days
DILLARDS 2,003 6,831 4,828 1,576.5 365 3.06 = 29% = 3.06 = 119
days
The gross profit ratios for the two companies are similar, and
both are higher than the industry average. The inventory turnover
ratios for the two companies reveal that, on average, it takes Saks
21 more days to sell its inventory than Dillards. This could be a
reflection of more higher end merchandise sold at Saks which would
also explain the slightly higher gross profit ratio of 32% compared
to 29% for Dillards. Saks turns its inventory over 6 days slower
than the industry average, Dillards 15 days faster. Requirement 2
The objective of this requirement is to motivate students to obtain
hands-on familiarity with actual annual reports and to apply the
techniques learned in the chapter. You may wish to provide students
with multiple copies of the same annual reports and compare
responses. Another approach is to divide the class into teams who
evaluate reports from a group perspective. Per note 2, BA uses the
average cost method to British Airways Case value its inventory.
Under IFRS, the FIFO (first-in, firstout) method also can be used.
However, the LIFO (last-in, first-out) method, which can be used
under U.S. GAAP in addition to the average cost method and the FIFO
method, is prohibited under IFRS.
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