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Chapter 5: Inventories and Cost of Goods Sold

5-80Financial Accounting Solutions Manualchapter 5 inventories and cost of goods sold5-79CHAPTER 5Inventories andCost of Goods SoldOVERVIEW OF EXERCISES, PROBLEMS, AND CASESEstimatedTime inLearning OutcomesExercisesMinutesLevel

1.Identify the forms of inventory held by different types of 110Easybusinesses and the types of costs incurred.210Mod

2.Show that you understand how wholesalers and retailers 325Modaccount for sales of merchandise.410Easy21*25Mod22*15Mod

3.Show that you understand how wholesalers and retailers 515Easyaccount for cost of goods sold.620Mod725Mod820Mod915Mod1520Mod21*25Mod22*15Mod23*10Mod27*10Mod

4.Use the gross profit ratio to analyze a companys ability 1010Modto cover its operating expenses and earn a profit.24*10Mod

5.Explain the relationship between the valuation of inventory1115Modand the measurement of income.26*20Mod

6.Apply the inventory costing methods of specific identification,1220Easyweighted average, FIFO, and LIFO by using a periodic system.23*10Mod24*10Mod25*25Mod

7.Analyze the effects of the different costing methods on 1315Modinventory, net income, income taxes, and cash flow.25*25Mod28*40Mod

8.Analyze the effects of an inventory error on various financial1425Modstatement items.

9.Apply the lower-of-cost-or-market rule to the valuation of 26*20Modinventory.

EstimatedTime inLearning Outcomes (Continued)ExercisesMinutesLevel

10.Analyze the management of inventory.1620Mod1710Diff

11.Explain the effects that inventory transactions have on the1810Easystatement of cash flows.1915Mod2015Mod27*10Mod

12.Explain the differences in the accounting for periodic and 28*40Mod perpetual inventory systems and apply the inventory costing methods using a perpetual system (Appendix).

*Exercise, problem, or case covers two or more learning outcomesLevel = Difficulty levels: Easy, Moderate (Mod), Difficult (Diff)

ProblemsEstimatedandTime inLearning OutcomesAlternatesMinutesLevel

1.Identify the forms of inventory held by different types of 125Modbusinesses and the types of costs incurred.14*20Mod

2.Show that you understand how wholesalers and retailers 7*45Modaccount for sales of merchandise.8*40Mod9*40Mod

3.Show that you understand how wholesalers and retailers 7*45Modaccount for cost of goods sold.8*40Mod9*40Mod

4.Use the gross profit ratio to analyze a companys ability 225Modto cover its operating expenses and earn a profit.8*40Mod

5.Explain the relationship between the valuation of inventory10*45Modand the measurement of income.11*60Diff12*30Mod13*30Mod

6.Apply the inventory costing methods of specific identification,10*45Modweighted average, FIFO, and LIFO by using a periodic system.12*30Mod13*30Mod

7.Analyze the effects of the different costing methods on 320Modinventory, net income, income taxes, and cash flow.10*45Mod11*60Diff12*30Mod13*30Mod14*20Mod

8.Analyze the effects of an inventory error on various financial445Diffstatement items.14**20Mod

9.Apply the lower-of-cost-or-market rule to the valuation of 14*#20Modinventory.

10.Analyze the management of inventory.530Mod

11.Explain the effects that inventory transactions have on the 625Modstatement of cash flows.7*45Mod

12.Explain the differences in the accounting for periodic and 11*60Diffperpetual inventory systems and apply the inventory costing methods using a perpetual system (Appendix).

*Exercise, problem, or case covers two or more learning outcomes**Alternate problem only#Original problem onlyLevel = Difficulty levels: Easy, Moderate (Mod), Difficult (Diff)

EstimatedTime inLearning OutcomesCasesMinutesLevel

1.Identify the forms of inventory held by different types of 1*25Modbusinesses and the types of costs incurred.

2.Show that you understand how wholesalers and retailers 4*20Modaccount for sales of merchandise.5*20Mod930Mod

3.Show that you understand how wholesalers and retailers 1*25Modaccount for cost of goods sold.4*20Mod5*20Mod625Mod

4.Use the gross profit ratio to analyze a companys ability 4*20Modto cover its operating expenses and earn a profit.5*20Mod

5.Explain the relationship between the valuation of inventoryand the measurement of income.

6.Apply the inventory costing methods of specific identification,2*25Modweighted average, FIFO, and LIFO by using a periodic system.3*25Mod7*40Mod

7.Analyze the effects of the different costing methods on 225Modinventory, net income, income taxes, and cash flow.7*40Mod1030Mod

8.Analyze the effects of an inventory error on various financial830Modstatement items.

9.Apply the lower-of-cost-or-market rule to the valuation of 3*25Modinventory.1130Mod

10.Analyze the management of inventory.

11.Explain the effects that inventory transactions have on the statement of cash flows.

12.Explain the differences in the accounting for periodic and perpetual inventory systems and apply the inventory costing methods using a perpetual system (Appendix).

*Exercise, problem, or case covers two or more learning outcomesLevel = Difficulty levels: Easy, Moderate (Mod), Difficult (Diff)

questions

1.The three distinct types of costs incurred by a manufacturer are direct materials, direct labor, and manufacturing overhead. Direct, or raw, materials are the ingredients used in making a product. Direct labor consists of the amounts paid to factory workers to manufacture the product. Manufacturing overhead includes all the other costs that are related to the manufacturing process but cannot be directly matched to specific units of output.2.The use of a contra-revenue account to record cash refunds and other types of allowances allows a company to monitor the size and frequency of these occurrences. For example, a relatively large amount of returns in any one period may be an indication that the quality of the product has slipped. The information provided by the use of these contra-revenue accounts would be lost if all returns and allowances were recorded as reductions of the Sales Revenue account. Also, if this practice were followed, the actual amount of sales would be understated for the period to the extent of any returns and allowances.3.Terms of 3/20, n/60 mean that the customer may deduct 3% from the selling price if the bill is paid within 20 days. Otherwise, the full amount is due within 60 days of the date of the invoice. Assuming a sale for $1,000, a 3% discount would save the customer $30, resulting in a net amount due of $970. The amount saved is the result of paying 40 days earlier than is required by the 60-day term. Assuming 360 days in a year, there are 360/40, or 9 periods of 40 days each, in a year. Thus, a savings of $30 for 40 days is equivalent to a savings of $30 9, or $270 for the year. This is equivalent to an annual return of $270/$970, or 27.8%. Conclusion: The customer should pay in the first 20 days unless another investment can be found offering a return in excess of 27.8%.4.The two inventory systems differ with respect to how often the Inventory account is updated. Under the perpetual system, the Merchandise Inventory account is updated each time a sale or purchase is made. Therefore, the perpetual system continuously shows the inventory on hand and cost of goods sold. With the periodic system, the Inventory account is updated only at the end of the period. A temporary account, called Purchases, is used to keep track of the acquisitions of inventory during the period. The periodic method relies on a count of the inventory on hand at the end of the period to determine the amount to assign to ending inventory on the balance sheet and to cost of goods sold expense on the income statement.5.A point-of-sale terminal gives the merchandiser the ability to update the inventory records each time a sale is made. As an item is slid over the sensing glass, a bar code on the product is read by the computer. In this way, the unit can be removed from the inventory at the point of sale. In some instances, however, merchandisers use the terminals only to update the quantity of units on hand, not necessarily the dollar amount.6.The Purchases account is neither an asset nor an expense account. It is simply a temporary holding account for the purchases of merchandise, which is closed at the end of the period. The effect of purchases made during the period is to increase the cost of goods sold expense. It is included in the income statement as an integral part of the calculation of cost of goods sold and is therefore shown as a reduction of stockholders equity in the accounting equation.7.For inventory in transit at the end of the year, the terms of shipment dictate whether the buyer should record the purchase of the inventory. FOB shipping point means that the goods belong to the buyer as soon as they are shipped, and the purchases should be recorded at this point in time. Alternatively, FOB destination point means that the goods do not belong to the buyer until they are received and therefore should not be recorded if they are in transit at year-end.8.Transportation-in represents the freight costs incurred on purchases of merchandise and is therefore added to the purchases of the period in determining cost of goods sold expense. Alternatively, transportation-out indicates the freight costs incurred in selling merchandise and is therefore reported as a selling expense on the income statement in the period of sale.9.Gross profit is computed by deducting cost of goods sold from net sales. The gross profit ratio indicates how well the company controlled its product costs during the year. For example, a 30% gross profit ratio indicates that for every dollar of net sales, the company has a gross profit of 30 cents. That is, after deducting 70 cents on every dollar for the cost of the inventory that is sold, the company has 30 cents to cover its operating costs and earn a profit.10.According to the cost of goods sold model, beginning inventory plus purchases minus ending inventory equals cost of goods sold. Therefore, the amount assigned to inventory on the balance sheet has a direct effect on the measurement of cost of goods sold on the income statement. Any errors in valuing inventory will flow through to cost of goods sold and thus have an impact on the measurement of net income.11.The justification for treating freight costs on incoming inventory as a cost incurred in acquiring the asset, rather than as an expense of the period, is the matching principle. Freight costs are necessary to put the inventory into a position to be sold and should therefore be included in the cost of the asset. This is a significant decision, since the cost will become an expense only at the time the inventory is sold. If freight costs are not included in the cost of the inventory, they are expensed immediately as they are incurred. Thus, if the inventory is not sold at the end of the period, the decision to treat freight costs as a cost of the inventory will result in higher net income than if the costs had been included as an expense of the period.12.The specific identification method is appropriate only for certain types of inventory. It is normally used for situations in which the inventory is relatively high-priced and subject to a low amount of turnover. Although it is not a necessary condition, each unit of inventory is often unique. For example, an automobile dealer uses the specific identification method, as would a jewelry company.

13.When used on an inventory of identical units, the specific identification can lead to the manipulation of income. Because all units are identical, management can select which units to sell based on the relative high or low cost of the units on hand. For example, in a bad year, a company might be tempted to select for sale all units that had a relatively low unit cost, regardless of when they were acquired. The use of a cost flow assumption, such as weighted average, FIFO, or LIFO, eliminates the ability of management to select units for sale based solely on the effect this decision will have on the income of the period.14.The weighted average cost method does not rely on a simple arithmetic average of the unit cost for the various purchases of the period. Instead, more weight is assigned to unit costs at which more units were purchased. For example, assume that beginning inventory consists of 100 units with a unit cost of $10 per unit. Assume that during the period, 100 units were purchased at $15 per unit and 200 units were purchased at $20 per unit. The arithmetic average unit cost for the period would be ($10 + $15 + $20)/3 = $15. However, the weighted average unit cost would be [100($10) + 100($15) + 200($20)]/400 units, or $16.25. The acquisition of twice as many units at $20 as opposed to those purchased at $10 and $15 drives the weighted average up to $16.25.15.The FIFO method more nearly approximates the physical flow of products in most businesses. This is particularly true for perishable products such as fresh fruits and vegetables. Most businesses prefer as a matter of good customer relations to sell their goods on a first-in, first-out basis. This minimizes the likelihood that units of inventory will become obsolete and spoiled.16.The use of LIFO will have the effect of maximizing net income if a company is experiencing a decline in the unit cost of inventory. Last-in, first-out charges the most recent purchases to cost of goods sold. If prices are declining, the amounts charged to cost of goods sold will be less than if either the weighted average method or FIFO is used. Because less is charged to cost of goods sold, net income will be higher.17.In a period of rising prices, the use of LIFO will result in a lower tax bill. Because the most recent purchases are charged to cost of goods sold under LIFO, in a period of rising prices, these units will be higher-priced. Thus, the result will be lower gross margin as well as lower net income before tax. Lower net income will result in a lower amount of tax to pay. If prices are declining during the period, FIFO will result in a lower tax bill.18.No, the president should not be enthralled with the new controller. The controller is suggesting something that is not allowed under the tax law. The Internal Revenue Services LIFO conformity rule requires that a company that wants to use LIFO for tax purposes must also use it in preparing its income statement. Note that this rule applies only to the use of LIFO on the tax return. A company is free to use different methods in preparing its tax return and its income statement as long as the method used for the tax return is not LIFO.

19.A LIFO liquidation occurs when a company using the LIFO inventory method sells more units during the period than it purchases. A liquidation of some or all of the older, relatively lower-priced units (assuming rising prices) will result in a low cost of goods sold amount and a correspondingly higher gross margin. This may present a dilemma to a company. If the company sells the lower-priced units, its net income will improve, but higher taxes will have to be paid. To avoid facing this situation, a company might buy inventory at the end of the year to avoid these consequences of a liquidation. Unfortunately, the somewhat forced purchase of inventory to avoid the liquidation may not be in the best interests of the company.20.FIFO, LIFO, and weighted average are all cost-based methods to value inventory. These three methods assign historical costs to inventory. Many accountants argue that the use of historical cost in valuing inventory leads to what is called inventory profit, particularly when FIFO is used in a period of rising prices. In a period of rising prices, FIFO can result in significant inventory profits. In comparison with LIFO, the use of FIFO in a period of rising prices charges less to cost of goods sold because it is the older, lower-priced units that are assumed to be sold. However, in a period of significant inflation, there may be a large difference between the gross margin that results from using FIFO and the much smaller amount that would result from using the current cost of the inventory (replacement cost). This difference, called inventory profit, is simply the result of holding the units during a period of inflation. However, a replacement cost approach is not acceptable under the professions current standards, although many believe it provides more relevant information to users.21.No, it is not acceptable for a company to indicate to its stockholders that it is switching to LIFO to save on taxes. While the ability to save taxes may be an important result of the change, the company must be able to demonstrate that LIFO does a better job of matching costs with revenues. This is normally the justification offered in the annual report for a companys change to LIFO.22.Because a certain section of the warehouse is double-counted, ending inventory will be overstated. According to the cost of goods sold model, ending inventory is subtracted from cost of goods available to sell to arrive at cost of goods sold expense. Therefore, an overstatement of ending inventory will lead to an understatement of cost of goods sold expense. An understatement of an expense results in an overstatement of net income for the period.23.The lower-of-cost-or-market rule is invoked when the utility of inventory is less than its cost to the company. It is a departure from the historical cost principle and is justified on the basis of conservatism. The rule is a reaction to uncertainty by anticipating a decline in the value of inventory and writing down the asset before it is sold.

24.Application of the lower-of-cost-or-market rule on a total basis, compared with an item-by-item basis, will usually yield a different result. The reason is that with the total approach, increases in market value above cost are allowed to offset decreases in value. Alternatively, when the item-by-item approach is used, any increases in value are essentially ignored and it is the declines in value for each item that are recognized.25.Inventory turnover equals cost of goods sold (cost of sales) divided by average inventory. If the cost of sales remains constant while the denominator (average inventory) increases, inventory turnover will decrease. This indicates that inventory is staying on the shelf for a longer time. The company should probably evaluate the salability of its inventory.26.When a perpetual inventory system is used, the dollar amount of inventory is calculated after each sale. Thus, when it is used in conjunction with the weighted average cost method, a new average cost is calculated after each sale. The weighted average changes each time a sale is made; therefore, the unit cost is called a moving average.

BRIEF exercises

LO 1BRIEF EXERCISE 5-1 TYPES AND FORMS OF INVENTORY COSTS FOR A MANUFACTURER

The three types of cost incurred by a manufacturer are direct or raw materials, direct labor, and manufacturing overhead. The three forms that inventory can take for a manufacturer are direct or raw materials, work in process or work in progress, and finished goods.

LO 2BRIEF EXERCISE 5-2 NET SALES

Sales revenue$85,000Less:Sales returns and allowances6,500Sales discounts6,500Net sales$72,000

LO 3BRIEF EXERCISE 5-3 COST OF GOODS SOLD

Purchases: IBeginning inventory: IPurchase discounts: DTransportation-in: IEnding inventory: DPurchase returns and allowances: D

LO 4BRIEF EXERCISE 5-4 GROSS PROFIT RATIO

Gross profit ratio: ($50,000 $30,000)/$50,000 = 40%

LO 5BRIEF EXERCISE 5-5 VALUATION OF INVENTORY AND MEASUREMENT OF INCOME

Examples of costs that should be added to the purchase price of inventory are freight costs on purchases, insurance during the time inventory is in transit, storage costs before inventory is ready to be sold, and various taxes such as excise and sales taxes.

LO 6BRIEF EXERCISE 5-6 INVENTORY COSTING METHODS

Ending Inventory:FIFO: 500 $6 = $3,000LIFO: 500 $5 = $2,500

LO 7BRIEF EXERCISE 5-7 SELECTING AN INVENTORY COSTING METHOD

Cost of goods sold: LGross profit: HIncome before taxes: HIncome taxes: HCash outflow: H

LO 8BRIEF EXERCISE 5-8 INVENTORY ERROR

If ending inventory is overstated by $50,000, then cost of goods sold will be understated by $50,000 and gross profit will overstated by $50,000. Net income will be overstated, but the effect of the overstatement will not be for the same amount because of the effect of taxes. Retained earnings will also be overstated.

Hint: To summarize, if ending inventory is overstated, then cost of goods sold will be understated and both net income and retained earnings will be overstated. On the other hand, if ending inventory is understated, then cost of goods sold is overstated and both net income and retained earnings will be understated.

LO 9BRIEF EXERCISE 5-9 LOWER-OF-COST-OR-MARKET RULE

JournalDec. 31Loss on Decline in Value of Inventory20,000

EntryInventory20,000

AnalysisTo record decline in value of inventory.

Balance SheetIncome Statement

Assets=Liabilities+StockholdersEquityRevenuesExpenses=NetIncome

Inventory(20,000)(20,000)

Loss on Decline in Value of Inventory20,000(20,000)

LO 10BRIEF EXERCISE 5-10 INVENTORY TURNOVER

Company As inventory turnover is $10,000,000/$100,000, or 100 times. Company Bs turnover is $10,000,000/$1,000,000, or 10 times. Company A with the much higher turnover is the wholesaler of fresh fruits and vegetables. Company B is the car dealer because its inventory would not turn over nearly as often given the nature of its products.

LO 11BRIEF EXERCISE 5-11 CASH FLOW EFFECTS

The increase in inventory would be deducted from net income on the statement of cash flows prepared using the indirect method since the buildup of inventory required cash outflow. The increase in accounts payable would be added to net income since this indicates a net cash inflow.

LO 12BRIEF EXERCISE 5-12 INVENTORY METHODS USING A PERPETUAL SYSTEM

Yes, the dollar amount assigned to ending inventory will differ when a company uses the average cost method, depending on whether a periodic or perpetual system is used. This is because when the average method is applied in a perpetual system a new average has to be computed each time a purchase is made, resulting in a moving average.

exercises

LO 1EXERCISE 5-1 CLASSIFICATION OF INVENTORY COSTS

ClassificationRawWork inFinishedMerchandiseInventory ItemMaterialProcessGoodsInventory

FabricXLumberXUnvarnished tablesXChairs on the showroom floorXCushionsXX*Decorative knobsXDrawersXSofa framesXChairs in the plant warehouseXChairs in the retail storeroomX

*Cushions produced by the company would be work in process, but if purchased from a supplier, they would be raw materials.

LO 1EXERCISE 5-2 INVENTORIABLE COSTS

List price: $100 200 units$20,000Less: 10% volume discount(2,000)Freight costs56Insurance for goods in transit32Total cost$18,088

Under the cost principle, all of these costs are necessary to put the inventory into a position where it can be sold.

Other classifications:

The phone charges and purchasing department salary would both be difficult to match directly with the sale of any particular product and therefore should be treated as operating expenses of the period. The labeling supplies are immaterial in amount and should also be reported as operating expenses. The interest paid to suppliers is a financing cost and would be reported as interest expense on the income statement.

LO 2EXERCISE 5-3 PERPETUAL AND PERIODIC INVENTORY SYSTEMS

1.Company A is using a perpetual inventory system because it has the account Cost of Goods Sold. Company B is using the periodic inventory system because it uses the accounts Purchases, Purchase Discounts, and Purchase Returns and Allowances.2.Assuming no losses due to theft, breakage or shrinkage, Company As end-of-year inventory is the balance in its Merchandise Inventory account, $12,000. Its cost of goods sold is $38,000, the balance in that account.3.Cost of goods sold in a periodic system is computed as: Beginning inventory + net purchases ending inventory. Company Bs Merchandise Inventory account represents beginning inventory. Ending inventory is obtained by conducting a physical count. Because you are not given the ending inventory figure, you cannot compute cost of goods sold.

LO 2EXERCISE 5-4 PERPETUAL AND PERIODIC INVENTORY SYSTEMS

PerpetualAppliance storePerpetualCar dealershipPeriodicDrugstorePerpetualFurniture storePeriodicGrocery storePeriodicHardware storePerpetualJewelry store

Changes in technology may lessen the costs of maintaining perpetual inventory systems. Merchandisers will convert to perpetual inventory systems when the benefits of maintaining such systems exceed the costs.

LO 3EXERCISE 5-5 MISSING AMOUNTS IN COST OF GOODS SOLD MODEL

Case 1:(a)Beginning inventory: cost of goods available for sale cost of goods purchased = $7,110 ($6,230 $470 $200 + $150) = $7,110 $5,710 = $1,400(b)Ending inventory: cost of goods available for sale cost of goods sold = $7,110 $5,220 = $1,890Case 2: (must first solve d, then c)(d)Cost of goods available for sale: cost of goods sold + ending inventory = $5,570 + $1,750 = $7,320(c)Purchase discounts:1.Cost of goods available for sale beginning inventory = cost of goods purchased = $7,320 $2,350 = $4,9702.Gross purchases purchase returns and allowances purchase discounts + transportation-in = cost of goods purchased; $5,720 $800 purchase discounts + $500 = $4,970; purchase discounts = $5,420 $4,970 = $450Case 3:(e)Gross purchases:1.Cost of goods purchased = cost of goods available for sale beginning inventory = $8,790 $1,890 = $6,9002.Gross purchases purchase returns and allowances purchase discounts + transportation-in = cost of goods purchased; gross purchases $550 $310 + $420 = $6,900; gross purchases = $6,900 + $550 + $310 $420 = $7,340(f)Cost of goods sold = cost of goods available for sale ending inventory = $8,790 $1,200 = $7,590

LO 3EXERCISE 5-6 PURCHASE DISCOUNTS

JournalJuly 3Purchases3,500

EntryAccounts Payable3,500

AnalysisTo record purchases of merchandise on credit.



Accounts Payable3,500(3,500)Purchases3,500(3,500)

JournalJuly 6Purchases7,000


AnalysisTo record the purchase of merchandise on credit.




JournalJuly 12Accounts Payable3,500

EntryCash3,465

AnalysisPurchase Discounts35

To record payment on account:

$3,500 0.01($3,500) = $3,465.



Cash(3,465)

Accounts Payable(3,500)35

Purchase Discounts*(35)35

*The Purchase Discounts account has increased. It is shown as a decrease because it is a contra-purchases account and causes expenses to decrease.

JournalAug. 5Accounts Payable7,000

EntryCash7,000

AnalysisTo record payment on account.



Cash(7,000)AccountsPayable(7,000)

LO 3EXERCISE 5-7 PURCHASESPERIODIC SYSTEM

JournalMar. 3Purchases2,500


AnalysisTo record purchases on credit.




JournalMar. 3Transportation-In250

EntryCash250

AnalysisTo record payment of freight costs.



Cash(250)(250)Transportation-In250(250)







JournalMar. 12Accounts Payable2,500

EntryCash2,450


To record payment for purchases on credit:

$2,500 0.02($2,500) = $2,450.



Cash(2,450)AccountsPayable(2,500)50



EXERCISE 5-7 (Continued)

JournalMar. 15Accounts Payable500

EntryPurchase Returns and Allowances500

AnalysisTo record credit on defective merchandise.



Accounts Payable(500)

500

Purchase Returns andAllowances*(500)500

*The Purchase Returns and Allowances account has increased. It is shown as a decrease because it is a contra-purchases account and causes expenses to decrease.







JournalMar. 22Accounts Payable400

EntryPurchase Returns and Allowances400

AnalysisTo record credit on returned merchandise.



Accounts Payable(400)

400

Purchase Returns andAllowances*(400)400

*The Purchase Returns and Allowances account has increased. It is shown as a decrease because it is a contra-purchases account and causes expenses to decrease.

JournalApr. 6Accounts Payable900

EntryCash900

AnalysisTo record payment for purchases on credit:

$1,400 $500.



Cash(900)Accounts Payable(900)

EXERCISE 5-7 (Concluded)

JournalApr. 18Accounts Payable1,200

EntryCash1,200

AnalysisTo record payment for purchases on credit:

$1,600 $400.



Cash(1,200)Accounts Payable(1,200)

LO 3EXERCISE 5-8 SHIPPING TERMS AND TRANSFER OF TITLE

1.The seller pays shipping costs when merchandise is shipped FOB destination point. Miller Wholesalers pays the freight bill and is responsible for the merchandise until it gets to Michaels warehouse.2.The inventory should not be included as an asset on Michaels December 31, 2012, balance sheet because the terms of shipment indicate that the merchandise does not legally belong to Michael until it arrives, and this is after the end of the year. Likewise, Miller should not include the sale on its 2012 income statement, since the goods are not considered sold until they reach the buyers business.3.If the terms of shipment were FOB shipping point, the answers to both questions in part (2) above would change. Under these terms, the inventory belongs to Michael as soon as it is shipped, and because this is on December 23, 2012, the asset should be recognized on the year-end balance sheet. Similarly, Miller would record a sale in 2012.

LO 3EXERCISE 5-9 TRANSFER OF TITLE TO INVENTORY

Purchases of merchandise that are in transit from vendors to Cameron Companies on December 31, 2012:

D:Shipped FOB shipping pointJ:Shipped FOB destination point

Sales of merchandise that are in transit to customers of Cameron Companies on December 31, 2012:

D:Shipped FOB shipping pointJ:Shipped FOB destination point

LO 4EXERCISE 5-10 WORKING BACKWARD: GROSS PROFIT RATIO

The prior years gross profit ratio was ($120,000 $90,000)/$120,000 = 25%. The ratio increased this year by 20%, which means it must be 1.2 25% = 30%. Cost of goods sold in the current year is $140,000, which means sales must be $140,000/(1 0.30) 200,000.

LO 5EXERCISE 5-11 INVENTORY AND INCOME MANIPULATION

By ignoring the large order at year-end, and thus including the inventory in the year-end count, the company will overstate ending inventory. This in turn will lead to an under-statement of cost of goods sold and an overstatement of net income. The effects on next years income are the opposite. Because beginning inventory will be overstated, cost of goods sold will also be overstated and net income understated. The accountant has an obligation to the financial statement users to convince the president to make the necessary adjustments to reduce the inventory balance regardless of whether the company follows IFRS or U.S. GAAP.

LO 6EXERCISE 5-12 INVENTORY COSTING METHODS

1.Ending inventory:(65 55)$20=$200(50 35)$22=330(60 45)$23=345(45 5)$24=96080units$1,835

Cost of goods sold:55$20=$1,10035$22=77045$23=1,0355$24=120140units$3,025

2.Ending inventory:45$24=$1,08035$23=80580units$1,885

Cost of goods sold:65$20=$1,30050$22=1,10025$23=575140units$2,975

EXERCISE 5-12 (Concluded)3.Ending inventory:65$20=$1,30015$22=33080units$1,630

Cost of goods sold: 45$24=$1,08060$23=1,38035$22=770140units$3,230

4.Cost of goods available for sale and units available:65$20=$1,30050$22=1,10060$23=1,38045$24=1,080220units$4,860

Weighted average cost = $4,860/220 = $22.09/unit

Ending inventory: 80 $22.09 = $1,767.20

Cost of goods sold: 140 $22.09 = $3,092.60

Note: Ending inventory and cost of goods sold do not total $4,860 because of rounding of average cost. Regardless of the inventory method used, the total amount allocated between cost of goods sold and ending inventory should be the same:Specific identification= $1,835 + $3,025 = $4,860FIFO= $1,885 + $2,975 = $4,860LIFO= $1,630 + $3,230 = $4,860Weighted average= $1,767 + $3,093 = $4,860

LO 7EXERCISE 5-13 EVALUATION OF INVENTORY COSTING METHODS

1.a4.c7.b2.d5.b8.c3.c6.a9.d

LO 8EXERCISE 5-14 INVENTORY ERRORS

Balance SheetIncome StatementRetainedCost of NetInventoryEarningsGoods SoldIncome1.UUOU2.OOUO3.UUOU

Hint: To summarize, if ending inventory is understated, then cost of goods sold is overstated, but both net income and retained earnings will be understated. On the other hand, if ending inventory is overstated, then cost of goods sold will be understated, but both net income and retained earnings will be overstated.

LO 3EXERCISE 5-15 TRANSFER OF TITLE TO INVENTORY

1.Michelson should include the costs in its inventory since the merchandise had not arrived at its destination, PJs, by the end of the year and it belongs to Michelson until arrival.2.Filbrandt should include the costs of the merchandise in its inventory since it has received the shipment by the end of the year.3.Randall should include the merchandise in its inventory since the shipment left James Bros. before the end of the year and it belongs to Randall upon shipment.4.Barner should include the merchandise in its inventory. It is both shipped by Hinz and received by Barner before the end of the year.

LO 10EXERCISE 5-16 INVENTORY TURNOVER FOR NORDSTROM

1.Inventory turnover for 2010 = Cost of goods sold/Average inventory = $5,897/[($977 + $898)/2] = $5,897/$937.5 = 6.29 times2.The average length of time it takes to sell an item of inventory can be estimated by dividing the number of times inventory turns over in a year into the number of days in a year:(assuming 360 days in a year): 360/6.29 times = 57.2, or approximately 57 days

EXERCISE 5-16 (Concluded)3.It is difficult to determine from the information given whether 57 days is reasonable as the average length of time it takes to sell inventory. Other information needed to make this determination includes:The historical average number of days.The industry norms for large, national retailers.Any recent changes in types of inventory, customer base, markets for the products, and other relevant factors.

LO 10EXERCISE 5-17 WORKING BACKWARD: INVENTORY TURNOVER

If it takes the company 90 days to sells its inventory, the inventory turnover ratio is 360/90 = 4 times per year. The inventory turnover ratio is:

Cost of goods sold/Average inventory = 4 times$60,000/Average inventory = 4 timesAverage inventory = $60,000/4 = $15,000If the beginning inventory is $17,000, the ending inventory must be $13,000 to result in an average of $15,000.

LO 11EXERCISE 5-18 IMPACT OF TRANSACTIONS INVOLVING INVENTORIES ON STATEMENT OF CASH FLOWS

Increase in accounts payable: ADecrease in accounts payable: DIncrease in inventories: DDecrease in inventories: A

LO 11EXERCISE 5-19 EFFECTS OF TRANSACTIONS INVOLVING INVENTORIES ON THE STATEMENT OF CASH FLOWSDIRECT METHOD

Cash payments for inventory to be reported in the operating activities of Mastheads 2012 statement of cash flows (direct method):

Inventory, December 31, 2011$180,400Plus: Purchases during 2012XLess: Cost of goods sold during 2012(1,200,000)Inventory, December 31, 2012$241,200$180,400 + X $1,200,000 = $241,200X = $1,260,800*

Accounts payable, December 31, 2011$85,400Plus: Purchases during 2012 (from above)1,260,800*Less: Cash payments during 2012(X)Accounts payable, December 31, 2012$78,400$85,400 + $1,260,800 X = $78,400X = $1,267,800

LO 11EXERCISE 5-20 EFFECTS OF TRANSACTIONS INVOLVING INVENTORIES ON THE STATEMENT OF CASH FLOWSINDIRECT METHOD

Cash flows from operating activities:Net income$xx,xxxAdjustments to reconcile net income to net cash provided by operating activities:Increase in inventory ($241,200 $180,400)$(60,800)Decrease in accounts payable ($78,400 $85,400)(7,000)(67,800)Cash flows from operating activities$xx,xxx

MULTI-CONCEPT EXERCISES

LO 2,3EXERCISE 5-21 INCOME STATEMENT FOR A MERCHANDISER

a.Sales Net sales = Sales returns and allowances$125,600 $122,040 = $3,560

b.Do (c) first. Net purchases + Purchase discounts = Purchases$74,600 + $1,300 = $75,900

c.Cost of goods purchased Transportation-in = Net purchases$81,150 $6,550 = $74,600

d.Net sales Gross profit = Cost of goods sold$122,040 $38,600 = $83,440

e.Cost of goods available for sale Cost of goods sold = Ending inventory$104,550 $83,440 = $21,110

f.Gross profit Income before tax = Operating expenses$38,600 $26,300 = $12,300

g.Income before tax Income tax expense = Net income$26,300 $10,300 = $16,000

LO 2,3EXERCISE 5-22 PARTIAL INCOME STATEMENTPERIODIC SYSTEM

LAPINE COMPANYINCOME STATEMENTFOR THE YEAR ENDED DECEMBER 31, 2012

Sales$80,000Less:Sales returns and allowances$500Sales discounts1,2001,700Net sales$78,300Less cost of goods sold:Beginning inventory$4,000Purchases$30,000Less:Purchase returns and allowances400Purchase discounts800Net purchases$28,800Add: Transportation-in1,000Cost of goods purchased29,800Cost of goods available for sale$33,800Less: Ending inventory3,800Cost of goods sold30,000Gross profit$48,300

The gross profit ratio is ($48,300/$78,300) 61.7%.

LO 3,6EXERCISE 5-23 COST OF GOODS SOLD, FIFO, AND LIFO

Cost of goods available for sale:

200 units $5 =$1,000500 units $6 =3,000300 units $7 =2,100Cost of goods available for sale$6,100

If the cost of goods sold expense using FIFO amounted to $4,000, the company must have sold the 700 units from the first two layers of inventory because the cost of these two is $1,000 + $3,000 = $4,000. Under LIFO, cost of goods sold for 700 units sold would be computed as:

300 units $7 =$2,100400 units $6 =2,400Cost of goods sold, LIFO$4,500

LO 4,6EXERCISE 5-24 WEIGHTED AVERAGE COST METHOD AND GROSS PROFIT RATIO

1.Beginning inventory2,000 units $6 =$12,000Purchases:5,000 units $8 =40,0008,000 units $10 =80,000Cost of goods available for sale$132,000Units available for sale15,000Weighted average cost$8.80per unit

Cost of goods sold expense = $8.80 9,000 units sold = $79,200

2.Sales = $15 9,000 units = $135,000Cost of goods sold expense (from above)79,200Gross profit$55,800

Gross profit ratio: $55,800/$135,000 = 41.3%

LO 6,7EXERCISE 5-25 INVENTORY COSTING METHODSPERIODIC SYSTEM

1.a.Weighted average method:

Cost of goods available for sale and units available:

200$10=$2,000300$11=3,300400$12=4,800250$13=3,250150$15=2,2501,300$15,600

Weighted average cost = $15,600/1,300 = $12 per unit

Units available1,300Units sold1,000Units in ending inventory300

Cost of ending inventory = 300($12) = $3,600Cost of goods sold = 1,000($12) = $12,000

EXERCISE 5-25 (Continued)b.FIFO method:

Ending inventory cost:150$15=$2,250150$13=1,950300$4,200

Cost of goods sold: 200$10=$2,000300$11=3,300400$12=4,800100$13=1,3001,000$11,400

(OR: $15,600 $4,200 = $11,400)

c.LIFO method:

Ending inventory cost:200$10=$2,000100$11=1,100300$3,100

Cost of goods sold:150$15=$2,250250$13=3,250400$12=4,800200$11=2,2001,000$12,500

(OR: $15,600 $3,100 = $12,500)

2.LIFO cost of goods sold$12,500FIFO cost of goods sold11,400Difference in expenses$1,100 Tax rate0.30Difference in taxes$330

Conclusion: Because FIFO results in less cost of goods sold, higher income will be reported, and thus, higher taxes, $330, will be due using FIFO rather than LIFO.

Note: Regardless of the inventory method used, the total amount allocated between cost of goods sold and ending inventory should be the same:Weighted average= $3,600 + $12,000 = $15,600FIFO= $4,200 + $11,400 = $15,600LIFO= $3,100 + $12,500 = $15,600

EXERCISE 5-25 (Concluded)3.If Carter Inc. prepares its financial statements in accordance with IFRS, it is not allowed to use LIFO. Under IFRS, LIFO cannot be used; so the weighted average method will result in the largest cost of goods sold, the lowest income, and consequently the lowest income tax for Carter.

LO 5,9EXERCISE 5-26 LOWER-OF-COST-OR-MARKET RULE

Conservatism is the rationale for carrying inventory on the balance sheet at an amount less than its cost. It is a departure from the historical cost principle and is used when the utility of the inventory, as measured by the cost to replace it, is less than the original cost.Two accounts are affected by the application of the lower-of-cost-or-market rule. An income statement account, such as Loss on Decline in Value of Inventory, is debited, and the Inventory account on the balance sheet is credited or reduced.The effect of writing down inventory is the reduction of the income of the current year by the amount debited to the loss account. In future years, however, income will be higher because of the write-down. This occurs because cost of goods sold will be lower in the future when the inventory that was written down to a lower amount is eventually sold.

LO 3,11EXERCISE 5-27 WORKING BACKWARD: COST OF GOODS SOLD AND THE STATEMENT OF CASH FLOWS

Because the change in the Inventory account during the period of $6,000 was added on the statement of cash flows, the inventory decreased during the period by this amount. Cost of goods sold was $50,000. Therefore, the company purchased $6,000 less than what it sold, or $50,000 $6,000 = $44,000.

LO 7,12EXERCISE 5-28 INVENTORY COSTING METHODSPERPETUAL SYSTEM (Appendix)

1.a.Moving average:PurchasesSalesBalanceUnitTotalUnitTotalUnitDateUnitsCostCostUnitsCostCostUnitsCostBalance1/1200$10$2,0002/12150$10$1,50050105003/5300$11$3,30035010.85713,8004/3020010.8572,17115010.8571,6296/12400124,80055011.68926,4297/720011.6892,33835011.6894,0918/23250133,25060012.23537,3419/630012.2353,67030012.2353,67110/2150152,25045013.15845,92112/315013.1581,97430013.158$3,947

Cost of goods sold$11,653Ending inventory

All amounts rounded to agree with total cost.

150$10=$50030011=3,300350$3,800;$3,800/350 = $10.857

2150$10.857=$1,62940012=4,800550$6,429;$6,429/550 = $11.689

3350$11.689=$4,09125013=3,250600$7,341;$7,341/600 = $12.235

4300$12.235=$3,67115015=2,250450$5,921;$5,921/450 = $13.158

EXERCISE 5-28 (Continued)

1.b.FIFO:PurchasesSalesBalanceUnitTotalUnitTotalUnitDateUnitsCostCostUnitsCostCostUnitsCostBalance1/1200$10$2,0002/12150$10$1,50050105003/5300$11$3,3005010300113,8004/305010500150111,650150111,6506/12400124,80015011400126,4507/7150111,6505012600350124,2008/23250133,25035012250137,4509/6300123,6005012250133,85010/2150152,250501225013150156,10012/3501260015013100131,30015015$4,200


EXERCISE 5-28 (Continued)1.c.LIFO:PurchasesSalesBalanceUnitTotalUnitTotalUnitDateUnitsCostCostUnitsCostCostUnitsCostBalance1/1$200$10$2,0002/12150$10$1,50050105003/5300$11$3,3005010300113,8004/30200112,2005010100111,6006/12400124,800501010011400126,4007/7200122,400501010011200124,0008/23250133,25050101001120012250137,2509/6250133,2505010501260010011150123,40010/2150152,25050101001115012150155,65012/3150152,25050101001115012$3,400


2.EXERCISE 5-25:EXERCISE 5-28:E/ICGSE/ICGSAverage cost$3,600$12,000$3,947$11,653DifferentFIFO4,20011,4004,20011,400SameLIFO3,10012,5003,40012,200Different

EXERCISE 5-28 (Concluded)3.Cost of goods sold:LIFO$12,200FIFO11,400Difference in expense$800 Tax rate0.30Difference in taxes$240

Conclusion: LIFO results in a higher cost of goods sold and therefore a lower taxable income and lower income tax by $240.

problems

LO 1PROBLEM 5-1 INVENTORY COSTS IN VARIOUS BUSINESSES

Accounting TreatmentExpense ofInventoryOtherBusinessTypes of Coststhe PeriodCostTreatment

Retail shoe storeShoes for saleXShoe boxesXAdvertising signsXGrocery storeCanned goods on the shelvesXProduceXCleaning suppliesX*Cash registersX**Frame shopWooden frame suppliesXNailsXGlassXWalk-in print shopPaperXCopy machinesX**Toner cartridgesX*RestaurantFrozen foodXChina and silverwareX**Prepared foodXSpicesX

*Record as an asset and charge to expense as used.**Record as an asset and depreciate over estimated useful life (long-term tangible asset).

LO 4PROBLEM 5-2 CALCULATION OF GROSS PROFIT RATIO FOR WAL-MART AND TARGET

1.Gross profit ratios (dollar amounts in millions):

Wal-Mart:2010*: ($418,952 $315,287)/$418,952 = $103,665/$418,952 = 24.7%2009*: ($405,132 $304,444)/$405,132 = $100,688/$405,132 = 24.9%

*Wal-Mart labels these as the 2011 and 2010 fiscal years.

Target:2010: ($65,786 $45,725)/$65,786 = $20,061/$65,786 = 30.5%2009: ($63,435 $44,062)/$63,435 = $19,373/$63,435 = 30.5%

2.In terms of the gross profit ratio, Target appears to be performing better, given a significantly higher ratio in each year. The mix of products sold by the two companies and the normal markups on the various products could certainly affect the ratios. A comparison with prior years and industry averages would also be important to consider.

LO 7PROBLEM 5-3 EVALUATION OF INVENTORY COSTING METHODS

1.Company B will have the newest costs in inventory because it uses first-in, first-out. Because costs are rising, it will have the lowest costs of goods sold and thus the highest net income.2.Company C will have the oldest costs in inventory because it uses last-in, first-out. Because costs are rising, it will have the highest cost of goods sold and thus the lowest income before taxes. Company C will pay the least in taxes.3.This question does not lend itself to an easy answer. LIFO matches the most recent costs with the most recent revenue and thus may be a better indicator of future potential to investors. Inventory profits are not a major concern with LIFO as they are with FIFO, because the newer (most recent) costs are assigned to cost of sales.4.Company C would have the oldest costs in inventory because it uses LIFO. Because costs are falling, it will have the lowest cost of goods sold and the highest net income.Company B will have the newest costs in inventory because it uses FIFO. Because costs are falling, it will have the highest cost of goods sold and the lowest income before taxes. Company B will pay the least in taxes.The answer to part (3) is still not easy. There are advantages and disadvantages in all methods. The important point is to choose one method and stay with it for consistency.

LO 8PROBLEM 5-4 INVENTORY ERROR

1.Revised income statements:20122011Revenues$20,000$15,000Cost of goods sold13,600**9,400*Gross profit$6,400$5,600Operating expenses3,0002,000Net income$3,400$3,600

*Because ending inventory in 2011 was understated, cost of goods sold was overstated. Correct amount is $10,000 $600 = $9,400.**Because beginning inventory in 2012 was understated, cost of goods sold was understated. Correct amount is $13,000 + $600 = $13,600.

Revised balance sheets:12/31/1212/31/11Cash$1,700$1,500Inventory4,2004,100*Other current assets2,5002,000Long-term assets15,00014,000Total assets$23,400$21,600Liabilities$8,500$7,000Capital stock5,0005,000Retained earnings9,9009,600Total liabilities and stockholders equity$23,400$21,600

*$3,500 + $600 understatement = $4,100*

2.Net income for two years, before revision: $3,000 + $4,000 = $7,000Net income for two years, after revision: $3,600 + $3,400 = $7,000Thus, there is no net over- or understatement.

Retained earnings at December 31, 2012, before the revision: $9,900Retained earnings at December 31, 2012, after the revision: $9,900Thus, there is no over- or understatement. This illustrates the nature of a counter-balancing error.

3.Even though the error counterbalances over the two-year period, it is still important to restate the statements for the two years. It is important for comparative purposes that the correct amount of net income be known for each of the two years. The company needs to restate the income statements for each of the two years and restate the balance sheets at the end of each year.

LO 10PROBLEM 5-5 INVENTORY TURNOVER FOR APPLE COMPUTER AND HEWLETT-PACKARD

1.Gross profit ratios:

Apple ComputerHewlett-Packard(in millions)(in millions)2010200920102009Net sales/revenue$65,225$42,905$84,799$74,051Less: Cost of sales/product39,54125,68365,06456,503Gross profit$25,684$17,222$19,735$17,548Divided by sales65,22542,90584,79974,051Gross profit ratio39.4%40.1%23.3%23.7%

2.Inventory turnover ratios for 2010:

Apple Computer:$39,541/[($1,051 + $455)/2] = $39,541/$753 = 52.51 times

Hewlett-Packard:$65,064/[($6,466 + $6,128)/2] = $65,064/$6,297 = 10.33 times

3.Both Apples and Hewlett-Packards gross profit ratios remained about the same for both years. Apples turnover is much higher than Hewlett-Packards. Another measure to consider is the number of days sales in inventory.

Apple Computer:360/52.51 = 6.86 days

Hewlett-Packard:360/10.33 = 34.85 days

It takes Apple an average of less than seven days to sell an item of inventory, whereas Hewlett-Packard requires nearly 35 days.On the basis of the gross profit ratio, Apple Computer appears to be performing better. The higher inventory turnover ratio for Apple may be largely due to the nature of some of the products that Apple sells, such as its iPods, which would be expected to turn over more quickly than computers.It would be helpful to measure all of these statisticsgross profit ratio, inventory turnover, and days sales in inventorywith the same measures for prior years. It would also be helpful to compare these measures with the industry averages.

LO 11PROBLEM 5-6 EFFECTS OF CHANGES IN INVENTORY AND ACCOUNTS PAYABLE BALANCES ON STATEMENT OF CASH FLOWS

1.Statement of cash flows:COPELAND ANTIQUESSTATEMENT OF CASH FLOWSFOR THE YEAR ENDED DECEMBER 31, 2012

Net loss$(33,200)Adjustments to reconcile net loss to net cash provided by operating activities:Decrease in inventory ($192,600 $214,800)22,200Increase in accounts payable ($123,900 $93,700)30,200Cash flows from operating activities$19,200Cash, December 31, 201146,100Cash, December 31, 2012$65,300

2.Memo to the president:TO:President of Copeland AntiquesFROM:Students nameDATE:January 20, 2013SUBJECT:Cash FlowsYou recently questioned the increase in the companys cash balance in light of this years net loss. My thoughts and a copy of the companys 2012 statement of cash flows follow.Copeland Antiques was able to generate a significant amount of cash from operations even though the company incurred an accrual basis net loss of $33,200 during 2012. First, the amount of inventory on hand decreased by $22,200 during the year from $214,800 to $192,600; this reduction in inventory generated cash for the company. Second, the amount owed to the companys suppliers increased by $30,200 during the year from $93,700 to $123,900; the related bills have not yet been paid.Operating expenses need to be decreased relative to gross profit if we are to improve the companys bottom line. I look forward to discussing our plans to turn things around.

MULTI-CONCEPT problems

LO 2,3,11PROBLEM 5-7 PURCHASES AND SALES OF MERCHANDISE, CASH FLOWS

1.Journal entries:

JournalApr. 1Purchases500

EntryAccounts Payable500

AnalysisTo record purchase of merchandise on account.



Accounts Payable500(500)Purchases500(500)


EntryCash485



$500 (1 0.03) = $485.




15



JournalApr. 15Cash200

EntrySales Revenue200

AnalysisTo record cash sale.



Cash200200

Sales Rev-enue200200

PROBLEM 5-7 (Continued)

JournalApr. 18Purchases900


AnalysisTo record purchase of merchandise on account.




JournalApr. 25Cash600


AnalysisTo record cash sales: 3 $200.



Cash600600



EntryCash873

AnalysisPurchase Discounts ($900 3%)27


$900 (1 0.03) = $873.




27



PROBLEM 5-7 (Concluded)2.Net income for April:Sales revenue ($200 + $600)$800Cost of goods sold:Beginning inventory$0Purchases ($500 + $900)$1,400Less: Purchase discounts ($15 + $27)42Net purchases1,358Cost of goods available for sale$1,358Less: Ending inventory967Cost of goods sold391Gross profit$409Operating expenses:Rent expense$100Miscellaneous expense50Total operating expenses150Net income$259

3.Net cash flow from operating activities for April:Cash collected from sales ($200 + $600)$800Cash paid for:Inventory ($485 + $873)$1,358Rent100Miscellaneous 50(1,508)Net cash flow from operating activities$(708)

OR:Net income$259Deduct: Increase in inventory balance(967)Net cash flow from operating activities$(708)

4.Net income is $259. Net cash flow from operating activities is a negative $708. The difference of $967 is attributable to inventory that has not been sold. That is, the company has paid for $1,358 of inventory (a cash outlay) but has only recognized cost of goods sold expense of $391. The difference is $967.

LO 2,3,4PROBLEM 5-8 GAP INC.S SALES, COST OF GOODS SOLD, AND GROSS PROFIT

1.Apparently, Gap Inc. does not sell its merchandise on account. If customers want to pay on credit for their purchases, they would use one of the various credit cards that Gap accepts.2.Summary journal entry for sales during the year ended January 29, 2011 (millions of dollars):

JournalCash14,664

EntrySales14,664

AnalysisTo record sales.



Cash14,66414,664Sales14,66414,664

3.Gap Inc. would deduct sales returns and allowances from sales to arrive at the amount of net sales reported on its income statement. Since Gap Inc. does not have any accounts receivable on its balance sheet, it is unlikely that it offers sales discounts to its customers. Either because they do not feel the amounts are material enough or they would rather not divulge information about returns and allowances to competitors, some companies choose not to separately report them.4.Cost of Goods Sold section of 2010 income statement (millions of dollars):Merchandise inventory, 1/30/10$1,477Cost of goods purchased18,9184Cost of goods available for sale$10,3953Less: Merchandise inventory, 1/29/11(1,620)Cost of goods sold2$8,775

1Including occupancy expenses.2Described as cost of goods sold and occupancy expenses.3$8,775 + $1,620 = $10,3954$10,395 $1,477 = $8,918

PROBLEM 5-8 (Concluded)5.Gross profit ratios:

(millions of dollars)20102009Sales$14,664$14,197Less: Cost of sales8,7758,473Gross profit$5,889$5,724Divided by sales14,66414,197Gross profit ratio40.2%40.3%

Gap Inc.s gross profit ratio was virtually unchanged from 2009 to 2010. If the gross profit does change from one year to the next, any number of factors can be responsible. These include changes in the selling prices of merchandise, changes in the costs of goods purchased, and/or changes in the mix of merchandise sold (that is, a slight shift between selling products that have lower gross profit ratios and selling those with higher gross profit ratios).

LO 2,3PROBLEM 5-9 FINANCIAL STATEMENTS

1.Cost of goods sold for 2012:Beginning inventory$6,400Purchases$40,200Less:Purchase discounts800Net purchases$39,400Add:Transportation-in375Cost of goods purchased39,775Cost of goods available for sale$46,175Less:Ending inventory7,500Cost of goods sold$38,675

2.Net income for 2012:Sales$84,364Less:Sales returns780Net sales$83,584Cost of goods sold [from part (1)]38,675Gross profit$44,909Operating expenses:Salaries$25,600Advertising4,510Utilities3,600Depreciation2,300Total operating expenses36,010Income before tax$8,899Income tax expense3,200Net income$5,699

PROBLEM 5-9 (Concluded)3.MAPLE INC.BALANCE SHEETAT DECEMBER 31, 2012

AssetsCurrent assets:Cash$590Accounts receivable2,359Inventory7,500Interest receivable 100Total current assets$10,549Property, plant, and equipment:Land$20,000Buildings and equipment, net55,550Total property, plant, and equipment75,550Total assets$86,099

LiabilitiesCurrent liabilities:Salaries payable$650Income tax payable3,200Total liabilities$3,850

Stockholders EquityCapital stock$50,000Retained earnings32,249*82,249Total liabilities and stockholders equity$86,099

*Beginning retained earnings+Net incomeDividends$32,550+$5,699$6,000

LO 5,6,7PROBLEM 5-10 COMPARISON OF INVENTORY COSTING METHODSPERIODIC SYSTEM

1.Cost ofEndingGoods SoldInventoryTotala.Weighted average$11,084$4,988$16,072b.FIFO10,7765,29616,072c.LIFO11,4524,62016,072

a.Beginning inventory600$5.00=$3,000Oct.88005.40=4,320Oct.187005.76=4,032Oct.298005.90=4,7202,900$16,072

Weighted average cost = $16,072/2,900 = $5.542

Units sold: 500 + 700 + 800 = 2,000 units

Units Available Units Sold = Ending Inventory

2,900 2,000 = 900 units

Ending inventory = 900 $5.542 = $4,988

Cost of goods sold = 2,000 $5.542 = $11,084

b.Ending inventory:800$5.90=$4,7201005.76=576900$5,296

Cost of goods sold:600$5.76=$3,4568005.40=4,3206005.00=3,0002,000$10,776

c.Ending inventory: 600$5.00=$3,0003005.40=1,620900$4,620


PROBLEM 5-10 (Concluded)2.The Total column represents the pool of costs (beginning inventory plus purchases) to be distributed between an asset, ending inventory on the balance sheet, and an expense, cost of goods sold on the income statement. In accounting, this pool of costs is called cost of goods available for sale, which, regardless of the inventory method used, should always be the same. For this problem, the cost of goods available for sale is $16,072.*Weighted average= $4,988 + $11,084 = $16,072*FIFO= $5,296 + $10,776 = $16,072*LIFO= $4,620 + $11,452 = $16,072*

3.Income statements for the month of October:WeightedAverageFIFOLIFOSales*$20,800$20,800$20,800Cost of goods sold11,08410,77611,452Gross profit$9,716$10,024$9,348Operating expenses3,0003,0003,000Income before taxes$6,716$7,024$6,348Income tax expense (30%)2,0152,1071,904Net income$4,701$4,917$4,444

*Sales = 500($10) + 700($10) + 800($11) = $20,800

4.The company will pay $203 more in taxes if it uses FIFO:

FIFO tax$2,107LIFO tax1,904Difference$203

LO 5,7,12PROBLEM 5-11 COMPARISON OF INVENTORY COSTING METHODSPERPETUAL SYSTEM (Appendix)

1.Cost ofEndingGoods SoldInventoryTotala.Moving average$10,785$5,287$16,072b.FIFO10,7765,29616,072c.LIFO10,8525,22016,072

PROBLEM 5-11 (Continued)a.Moving average:PurchasesSalesBalanceUnitTotalUnitTotalUnitDateUnitsCostCostUnitsCostCostUnitsCostBalance10/1600$5.00$3,00010/4500$5.00$2,5001005.0050010/8800$5.40$4,3209005.35614,82010/97005.3563,7492005.3561,07110/187005.764,0329005.6725,10310/208005.674,5361005.6756710/298005.904,7209005.8743$5,287


1100$5.00=$5008005.40=4,320900$4,820;$4,820/900 = $5.356

2200$5.356=$1,0717005.76=4,032900$5,103;$5,103/900 = $5.67

3100$5.67=$5678005.90=4,720900$5,287;$5,287/900 = $5.874

b.FIFO:PurchasesSalesBalanceUnitTotalUnitTotalUnitDateUnitsCostCostUnitsCostCostUnitsCostBalance10/1600$5.00$3,00010/4500$5.00$2,5001005.0050010/8800$5.40$4,3201005.008005.404,82010/91005.005006005.403,2402005.401,08010/187005.764,0322005.407005.765,11210/202005.401,0806005.763,4561005.7657610/298005.904,7201005.768005.90$5,296


PROBLEM 5-11 (Concluded)c.LIFO:PurchasesSalesBalanceUnitTotalUnitTotalUnitDateUnitsCostCostUnitsCostCostUnitsCostBalance10/1600$5.00$3,00010/4500$5.00$2,5001005.0050010/8800$5.40$4,3201005.008005.404,82010/97005.403,7801005.001005.401,04010/187005.764,0321005.001005.407005.765,07210/207005.764,0321005.405401005.0050010/298005.904,7201005.008005.90$5,220


2.The Total column represents the pool of costs (beginning inventory plus purchases) to be distributed between an asset, ending inventory on the balance sheet, and an expense, cost of goods sold, on the income statement. In accounting, this pool of costs is called cost of goods available for sale.3.Income statements for the month of October:MovingAverageFIFOLIFOSales*$20,800$20,800$20,800Cost of goods sold10,78510,77610,852Gross profit$10,015$10,024$9,948Operating expenses3,0003,0003,000Income before taxes$7,015$7,024$6,948Income tax expense (30%)2,1052,1072,084Net income$4,910$4,917$4,864

*Sales = 500($10) + 700($10) + 800($11) = $20,800

4.The company will pay $23 more in taxes if it uses FIFO:FIFO tax$2,107LIFO tax2,084Difference$23

LO 5,6,7PROBLEM 5-12 INVENTORY COSTING METHODSPERIODIC SYSTEM

1.Units in beginning inventory200Add: Units purchased (250 + 220 + 150 + 200)820Units available1,020Less: Units sold (300 + 380 + 110)790Units in ending inventory230

EndingCost ofInventoryGoods SoldTotala.FIFO$4,410$14,663$19,073b.LIFO4,15514,91819,073c.Weighted average4,30114,77219,073

a.Ending inventory:200$19.20=$3,8403019.00=570230$4,410

Cost of goods sold:200$18.00=$3,60025018.50=4,62522018.90=4,15812019.00=2,280790$14,663

b.Ending inventory: 200$18.00=$3,6003018.50=555230$4,155

Cost of goods soldLIFO:220$18.50=$4,07022018.90=4,15815019.00=2,85020019.20=3,840790$14,918

c.Beginning inventory200$18.00=$3,600Nov. 425018.50=4,625Nov. 1322018.90=4,158Nov. 1815019.00=2,850Nov. 2420019.20=3,8401,020$19,073

Weighted average cost = $19,073/1,020 = $18.699Ending inventory = 230 $18.699 = $4,301Cost of goods sold = 790 $18.699 = $14,772

PROBLEM 5-12 (Concluded)2.WeightedFIFOLIFOAverageSales*$33,480$33,480$33,480Cost of goods sold14,66314,91814,772Gross profit$18,817$18,562$18,708Operating expenses:Selling and administrative expenses10,80010,80010,800Depreciation4,0004,0004,000Income before taxes$4,017$3,762$3,908Income tax expense (35%)1,4061,3171,368Net income$2,611$2,445$2,540

*Sales = (300 $42) + (380 $42.50) + (110 $43) = $33,480

3.Oxendine pays the least taxes under the last-in, first-out method since it has the highest cost of goods sold.

4.If Oxendine Company prepares its financial statements in accordance with IFRS, then it is not allowed to use LIFO. Under IFRS, LIFO cannot be used, so the weighted average method will result in larger cost of goods sold than with FIFO, lower income, and consequently a lower income tax than with FIFO.

LO 5,6,7PROBLEM 5-13 INVENTORY COSTING METHODSPERIODIC SYSTEM

1.a.Weighted average:

Beginning inventory5,000$10=$50,000Feb. 43,0009=27,000Apr. 124,0008=32,000Sept. 102,0007=14,000Dec. 51,0006=6,00015,000$129,000

Weighted average cost = $129,000/15,000 = $8.60Units available for sale15,000Units sold12,500Ending inventory2,5008.60 =$21,500Cost of goods sold12,5008.60 =$107,500

PROBLEM 5-13 (Concluded)b.FIFO:

Ending inventory1,000$6=$6,0001,5007=10,5002,500$16,500

Cost of goods sold500$7=$3,5004,0008=32,0003,0009=27,0005,00010=50,00012,500$112,500c.LIFO:

Ending inventory2,500$10=$25,000

Cost of goods sold2,500$10=$25,0003,0009=27,0004,0008=32,0002,0007=14,0001,0006=6,00012,500$104,000

2.Income statements for the year ended December 31, 2012:WeightedAverageFIFOLIFOSales*$150,000$150,000$150,000Cost of goods sold107,500112,500104,000Gross profit$42,500$37,500$46,000Operating expenses20,00020,00020,000Income before taxes$22,500$17,500$26,000Income tax expense (30%)6,7505,2507,800Net income$15,750$12,250$18,200

*Sales = 12,500 $12 = $150,000

3.Weaver can minimize its tax bill by using FIFO. In a period of declining prices, FIFO results in the highest amount of cost of goods sold, the least amount of income before taxes, and thus the least amount of income tax expense.4.A company is not free to change inventory methods from year to year to take advantage of changing patterns in the level of prices. The company needs to be consistent, and it must be able to justify any change in the method used on some basis other than saving taxes, such as a better matching of costs with revenues.

LO 1,7,9PROBLEM 5-14 INTERPRETING GANNETT CO.S INVENTORY ACCOUNTING POLICY

1.Newsprint costs are comparable to raw materials in a manufacturing company. A newspaper company, however, does not keep an inventory of finished goods. Its newspapers either are sold within hours after being printed or become worthless if not sold.2.Some companies use more than one method to value different types of inventory. The methods should be chosen because they provide the most accurate matching of costs with the revenues generated. Although Gannett has determined FIFO is appropriate for most of its inventories, it does use LIFO for certain U.S. newspapers.

alternate problems

LO 1PROBLEM 5-1A INVENTORY COSTS IN VARIOUS BUSINESSES

1.Classification of an item as inventory depends on the companys intent. DVDs offered by the company for resale should be classified as part of inventory and charged to cost of goods sold at the time they are sold. Alternatively, rental DVDs are income-producing assets and should not be classified as inventory. They should be classified as current assets because it is unlikely that any DVDs will be kept as rentals for more than one year.2.When DVDs are transferred because they will be offered for resale, the asset account DVDs for Rent would be credited and the asset account DVD Inventory would be debited.

LO 4PROBLEM 5-2A CALCULATION OF GROSS PROFIT RATIO FOR COCA-COLA AND PEPSICO

1.Gross profit ratios (dollar amounts in millions):

Coca-Cola:2010: ($35,119 $12,693)/$35,119 = $22,426/$35,119 = 63.9%2009: ($30,990 $11,088)/$30,990 = $19,902/$30,990 = 64.2%

PepsiCo:2010: ($57,838 $26,575)/$57,838 = $31,263/$57,838 = 54.1%2009: ($43,232 $20,099)/$43,232 = $23,133/$43,232 = 53.5%

2.In terms of the gross profit ratios, Coca-Cola has a ratio that is about 10% higher than PepsiCos. The mix of products sold by the two companies and the normal markups on the various products could certainly affect the ratios. A comparison with prior years and industry averages would also be important to consider.

LO 7PROBLEM 5-3A EVALUATION OF INVENTORY COSTING METHODS

1.No, the three companies will not be equally affected by the decline in prices. If the decline continues, Company Y (FIFO) will begin to show higher cost of goods sold and a lower gross profit than Company Z (LIFO). Because gross profit will be lower, Company Y will report lower income before tax and thus have less tax to pay.2.It should be noted that it is not acceptable for a company to change inventory valuation methods to save taxes. An acceptable explanation of the justification for the change is this:During the year recently completed, the company changed its method of valuing inventory on the balance sheet and recognizing cost of sales on the income statement. The company changed from the LIFO to the FIFO method because it believes that the latter results in a better matching of cost of sales with the revenues of the period.

LO 8PROBLEM 5-4A INVENTORY ERROR

1.Revised income statements:20122011Revenues$35,982$26,890Cost of goods sold12,094**10,412*Gross profit$23,888$16,478Operating expenses13,48810,578Net income$10,400$5,900

*Because ending inventory in 2011 was overstated, cost of goods sold was understated. Correct amount is $9,912 + $500 = $10,412.**Because beginning inventory in 2012 was overstated, cost of goods sold was overstated. Correct amount is $12,594 $500 = $12,094.

Revised balance sheets:12/31/1212/31/11Cash$9,400$4,100Inventory4,5004,900*Other current assets1,6001,250Long-term assets, net24,50024,600Total assets$40,000$34,850Current liabilities$9,380$10,600Capital stock18,00018,000Retained earnings12,6206,250Total liabilities and stockholders equity$40,000$34,850

*$5,400 $500 overstatement = $4,900*

PROBLEM 5-4A (Concluded)2.Current ratio:

Before revision:

= = 1.01 to 1

After revision: = = 0.97 to 1

Yes, if the lender required a current ratio of at least 1 to 1, Planter would have been eligible for the loan with the error. After the correction, however, Planter would not have been eligible for the loan. The company should notify the bank of the error. Practically, however, the bank might not consider a current ratio of 0.97 to 1 to be materially different from a current ratio of 1 to 1 and might be willing to grant the loan.

3.Net income for two years, before revision: $6,400 + $9,900 = $16,300Net income for two years, after revision: $5,900 + $10,400 = $16,300Thus, there is no net over- or understatement of net income for the two-year period.Retained earnings at December 31, 2012, before the revision: $12,620Retained earnings at December 31, 2012, after the revision: $12,620Thus, there is no over- or understatement of retained earnings at December 31, 2012. This illustrates the nature of a counterbalancing error.

4.Even though the error counterbalances over the two-year period, it is still important to restate the statements for the two years. It is important for comparative purposes that the correct amount of net income be known for each of the two years. The company needs to restate the income statements for each of the two years and restate the balance sheets at the end of each year.

LO 10PROBLEM 5-5A INVENTORY TURNOVER FOR WAL-MART AND TARGET

1.Inventory turnover ratios (amounts in millions):

Wal-Mart (year ending January 31, 2011):$315,287/[($36,318 + $32,713)/2] = $315,287/$34,515.5 = 9.13 times

Target (year ending January 29, 2011):$45,725/[($7,596 + $7,179)/2] = $45,725/$7,387.5 = 6.19 times

2.Wal-Marts inventory turnover is higher than Targets during the most recent fiscal year, 9.13 versus 6.19. Another measure to consider is the number of days sales in inventory:

Wal-Mart:360/9.13 = 39.43 days

Target:360/6.19 = 58.16 days

It takes Wal-Mart an average of 39 days to sell an item of inventory; Target requires an average of 58 days. On the basis of inventory turnover and days sales in inventory, Wal-Mart appears to be performing better.It would be helpful to measure these statisticsinventory turnover and days sales in inventorywith the same measures for prior years. It would also be helpful to compare these measures with the industry averages.

LO 11PROBLEM 5-6A EFFECTS OF CHANGES IN INVENTORY AND ACCOUNTS PAYABLE BALANCES ON STATEMENT OF CASH FLOWS

1.Statement of cash flows:CARPETLAND CITYSTATEMENT OF CASH FLOWSFOR THE YEAR ENDED DECEMBER 31, 2012

Net income$78,500Adjustments to reconcile net income to net cash providedby operating activities:Increase in inventory ($105,500 $84,900)$(20,600)Decrease in accounts payable ($23,900 $93,700)(69,800)(90,400)Cash flows from operating activities$(11,900)Cash, December 31, 201126,300Cash, December 31, 2012$14,400

2.Memo to the president:TO:President of Carpetland CityFROM:Students nameDATE:January 20, 2013SUBJECT:Cash FlowsYou recently expressed concern about the decrease in the companys cash balance in spite of the profitable year that was reported on this years income statement. My thoughts and a copy of the companys 2012 statement of cash flows follow.Although net income on an accrual basis was $78,500, the companys cash balance declined by $11,900 during the year for two reasons. Most importantly, the amount owed to the companys suppliers decreased by $69,800 during the year from $93,700 to $23,900; this decrease in accounts payable drained our cash balance. In addition, the amount of inventory on hand increased by $20,600 during the year from $84,900 to $105,500; this increase in inventory required an additional outflow of cash.We can better manage our cash flow by carefully timing the payment of bills to coincide with the due dates on invoices. In addition, we can improve cash flow by closely monitoring our inventory levels and adding to inventory levels only when increases in sales warrant an addition.

ALTERNATE MULTi-CONCEPT problems

LO 2,3,11PROBLEM 5-7A PURCHASES AND SALES OF MERCHANDISE, CASH FLOWS

1.Journal entries:

JournalOct. 1Purchases249


AnalysisTo record purchase of merchandise

on account.




JournalOct. 10Accounts Payable249

EntryCash244



$249 (1 0.02) = $244.




5



JournalOct. 15Cash200


AnalysisTo record cash sale.



Cash200200


PROBLEM 5-7A (Continued)

JournalOct. 18Purchases800


AnalysisTo record purchase of merchandise

on account.




JournalOct. 25Cash600


AnalysisTo record cash sales: 3 $200.



Cash600600


JournalOct. 30Accounts Payable800

EntryCash800

AnalysisTo record payment on account.




2.Units on hand on October 31:October 1 purchase3unitsOctober 15 sale(1)October 18 purchase10October 25 sale(3)Ending inventory9units

PROBLEM 5-7A (Concluded)3.Cash balance at end of month:Beginning cash balance$2,000October 10 payment(244)October 15 sale200October 25 sale600October 30 payment(800)Cash balance at end of month$1,756

The cash balance decreased during the month even though the company reported a profit because cash outflows exceeded expenses. This was the case because the entire inventory purchased (and paid for) was not yet sold (expensed).

LO 2,3,4PROBLEM 5-8A WALGREENS SALES, COST OF GOODS SOLD, AND GROSS PROFIT

1.Summary journal entries for the year ended August 31, 2010 (in millions):

JournalCash2,496

EntryAccounts Receivable2,496

AnalysisTo record collection of beginning accounts

receivable.



Cash2,496Accounts Receiv-able(2,496)

JournalAccounts Receivable67,420

EntrySales67,420

AnalysisTo record sales on account.



Accounts Receiv-able67,42067,420

Sales67,420

67,420

PROBLEM 5-8A (Concluded)

JournalCash64,970

EntryAccounts Receivable 64,970

AnalysisTo record cash collections: $67,420 $2,450.



Cash64,970Accounts Receivable(64,970)

2.Walgreens would deduct sales returns and allowances, and the amount of any sales discounts taken by its customers from sales, to arrive at the amount of net sales reported on its income statement. Either because they do not feel the amounts are material enough or they would rather not divulge information about returns and allowances to competitors, some companies choose not to separately report them.

3.Cost of Goods Sold section of 2010 income statement (in millions):Inventory, August 31, 2009$6,789Cost of goods purchased49,033**Cost of goods available for sale$55,822*Less: Inventory, August 31, 2010(7,378)Cost of goods sold$48,444

*$48,444 + $7,378 = $55,822**$55,822 $6,789 = $49,033

4.Gross profit ratios:(In millions)20102009Net sales$67,420$63,335Cost of sales48,44445,722Gross profit$18,976$17,613Divided by net sales67,42063,335Gross profit ratio28.1%27.8%

Walgreens gross profit ratio was virtually unchanged from 2009 to 2010. Factors affecting Walgreens gross profit ratio include changes in the selling prices of merchandise, changes in the costs of goods purchased, and/or changes in the mix of merchandise sold (that is, a slight shift from selling products that have higher gross profit ratios to selling those with lower gross profit ratios).

LO 2,3PROBLEM 5-9A FINANCIAL STATEMENTS

1.Cost of goods sold for 2012:

Beginning inventory$6,400Purchases$62,845Less: Purchase discounts1,237Net purchases$61,608Add: Transportation-in375Cost of goods purchased61,983Cost of goods available for sale$68,383Less: Ending inventory5,900Cost of goods sold$62,483

2.Net income for 2012:

Sales$112,768Less: Sales returns1,008Net sales$111,760Cost of goods sold [from part (1)]62,483Gross profit$49,277Operating expenses:Wages and salaries expense$23,000Advertising expense12,900Utilities expense1,800Total operating expenses37,700Income before tax$11,577Income tax expense1,450Net income$10,127

PROBLEM 5-9A (Concluded)3.LLOYD INC.BALANCE SHEETAT DECEMBER 31, 2012

AssetsCash$22,340Accounts receivable56,359Inventory5,900Total assets$84,599

LiabilitiesSalaries payable$650Wages payable120Income tax payable1,450Total liabilities$2,220

Stockholders EquityCapital stock$50,000Retained earnings32,379*Total stockholders equity82,379Total liabilities and stockholders equity$84,599

*Beginning retained earnings+Net incomeDividends$28,252+$10,127$6,000

LO 5,6,7PROBLEM 5-10A COMPARISON OF INVENTORY COSTING METHODSPERIODIC SYSTEM

1.Cost ofEndingGoods SoldInventoryTotala.Weighted average$5,120$4,655$9,775b.FIFO4,8754,9009,775c.LIFO5,3754,4009,775

a.Beginning inventory300$4.00=$1,200Nov.85004.50=2,250Nov.187004.75=3,325Nov.296005.00=3,0002,100$9,775

Weighted average cost = $9,775/2,100 = $4.655Units sold: 200 + 500 + 400 = 1,100 unitsUnits Available Units Sold = Ending Inventory2,100 1,100 = 1,000 unitsEnding inventory = 1,000 $4.655 = $4,655Cost of goods sold = 1,100 $4.655 = $5,120**Rounded to agree with total cost.

b.Ending inventory:600$5.00=$3,0004004.75=1,9001,000$4,900


c.Ending inventory: 300$4.00=$1,2005004.50=2,2502004.75=9501,000$4,400

Cost of goods sold:600$5.00=$3,0005004.75=2,3751,100$5,375

PROBLEM 5-10A (Concluded)2.The Total column represents the pool of costs (beginning inventory plus purchases) to be distributed between an asset, ending inventory on the balance sheet, and an expense, cost of goods sold on the income statement. In accounting, the pool of costs is called cost of goods available for sale.3.Income statements for the month of November:WeightedAverageFIFOLIFOSales*$10,100$10,100$10,100Cost of goods sold5,1204,8755,375Gross profit$4,980$5,225$4,725Operating expenses2,0002,0002,000Income before taxes$2,980$3,225$2,725Income tax expense (25%)745806681Net income$2,235$2,419$2,044

*Sales = 200($9) + 500($9) + 400($9.50) = $10,100

4.The company will pay $125 more in taxes if it uses FIFO:

FIFO tax$806LIFO tax681Difference$125

LO 5,7,12PROBLEM 5-11A COMPARISON OF INVENTORY COSTING METHODSPERPETUAL SYSTEM (Appendix)

1.Cost ofEndingGoods SoldInventoryTotala.Moving average$4,892$4,883$9,775b.FIFO4,8754,9009,775c.LIFO4,9504,8259,775

PROBLEM 5-11A (Continued)a.Moving average:PurchasesSalesBalanceUnitTotalUnitTotalUnitDateUnitsCostCostUnitsCostCostUnitsCostBalance11/1300$4.00$1,20011/4200$4.00$8001004.0040011/8500$4.50$2,2506004.41712,65011/95004.4172,2091004.41744111/187004.753,3258004.70823,76611/204004.7081,8834004.7081,88311/296005.003,0001,0004.8833$4,883


All amounts rounded to agree with total cost.

1100$4.00=$4005004.50=2,250600$2,650;$2,650/600 = $4.417

2100$4.417=$4417004.75 =3,325800$3,766;$3,766/800 = $4.708

3400$4.708=$1,8836005.00=3,0001,000$4,883;$4,883/1,000 = $4.883

b.FIFO:PurchasesSalesBalanceUnitTotalUnitTotalUnitDateUnitsCostCostUnitsCostCostUnitsCostBalance11/1300$4.00$1,20011/4200$4.00$8001004.0040011/8500$4.50$2,2501004.005004.502,65011/91004.004004004.501,8001004.5045011/187004.753,3251004.507004.753,77511/201004.504503004.751,4254004.751,90011/296005.003,0004004.756005.00$4,900


PROBLEM 5-11A (Concluded)c.LIFO:PurchasesSalesBalanceUnitTotalUnitTotalUnitDateUnitsCostCostUnitsCostCostUnitsCostBalance11/1300$4.00$1,20011/4200$4.00$8001004.0040011/8500$4.50$2,2501004.005004.502,65011/95004.502,2501004.0040011/187004.753,3251004.007004.753,72511/204004.751,9001004.003004.751,82511/29 6005.003,0001004.003004.756005.00$4,825


2.The Total column represents the pool of costs (beginning inventory plus purchases) to be distributed between an asset, ending inventory on the balance sheet, and an expense, cost of goods sold on the income statement. In accounting, this pool of costs is called cost of goods available for sale.

3.Income statements for the month of November:MovingAverageFIFOLIFOSales*$10,100$10,100$10,100Cost of goods sold4,8924,8754,950Gross margin$5,208$5,225$5,150Operating expenses2,0002,0002,000Income before taxes$3,208$3,225$3,150Income tax expense (25%)802806788Net income$2,406$2,419$2,362

*Sales = 200($9) + 500($9) + 400($9.50) = $10,100

4.The company will pay $18 more in taxes if it uses FIFO:FIFO tax$806LIFO tax788Difference$18

LO 5,6,7PROBLEM 5-12A INVENTORY COSTING METHODSPERIODIC SYSTEM

1.Units in beginning inventory300Add: Units purchased (375 + 330 + 225 + 300)1,230Units available1,530Less: Units sold (450 + 570 + 165)1,185Units in ending inventory345

EndingCost of InventoryGoods SoldTotala.FIFO$8,643$31,190$39,833b.LIFO9,29330,54039,833c.Weighted average8,98230,85139,833

a.Ending inventory300$25.00=$7,5004525.40=1,143345$8,643

Cost of goods sold:300$27.00=$8,10037526.50=9,93833026.00=8,58018025.40=4,5721,185$31,190

b.Ending inventory:300$27.00=$8,1004526.50=1,193345$9,293

Cost of goods sold:300$25.00=$7,50022525.40=5,71533026.00=8,58033026.50=8,7451,185$30,540

PROBLEM 5-12A (Concluded)c.Beginning inventory300$27.00=$8,100Nov.437526.50=9,938Nov.1333026.00=8,580Nov.1822525.40=5,715Nov.2430025.00=7,5001,530$39,833

Weighted average cost = $39,833/1,530 = $26.035Ending Inventory = Units in Ending Inventory Average Cost = 345 $26.035 = $8,982Cost of Goods Sold = Units Sold Average Cost = 1,185 $26.035 = $30,851

2.WeightedFIFOLIFOAverageSales*$75,330$75,330$75,330Cost of goods sold31,19030,54030,851Gross profit$44,140$44,790$44,479Operating expenses:Selling and administrative expenses16,20016,20016,200Depreciation6,0006,0006,000Income before taxes$21,940$22,590$22,279Income tax expense (35%)7,6797,9077,798Net income$14,261$14,683$14,481

*Sales = (450 $63.00) + (570 $63.75) + (165 $64.50) = $75,330

3.Story pays the least taxes under the first-in, first-out method since it has the highest cost of goods sold.

LO 5,6,7PROBLEM 5-13A INVENTORY COSTING METHODSPERIODIC SYSTEM

1.a.Weighted average:Beginning inventory4,000$20=$80,000Feb.42,00018=36,000Apr.123,00016=48,000Sept.101,00014=14,000Dec.52,50012=30,00012,500$208,000

Weighted average cost = $208,000/12,500 = $16.64Units available for sale12,500Units sold11,000Ending inventory1,500 $16.64=$24,960Cost of goods sold11,000 $16.64=$183,040

b.FIFO:Ending inventory1,500$12=$18,000


c.LIFO:Ending inventory1,500$20=$30,000


PROBLEM 5-13A (Concluded)2.Income statements for the year ended December 31, 2012:WeightedAverageFIFOLIFOSales*$330,000$330,000$330,000Cost of goods sold183,040190,000178,000Gross profit$146,960$140,000$152,000Operating expenses60,00060,00060,000Income before taxes$86,960$80,000$92,000Income tax expense (30%)26,08824,00027,600Net income$60,872$56,000$64,400

*Sales = 11,000 $30 = $330,000

3.Fees can minimize its tax bill by using FIFO. In a period of declining prices, FIFO results in the highest cost of goods sold, the least amount of income before taxes, and thus the least amount of income tax expense.

4.A company is not free to change inventory methods from year to year to take advantage of changing patterns in the level of prices. The company needs to be consistent, and it must be able to justify any change in the method used on some basis other than saving taxes, such as a better matching of costs with revenues.

LO 1,7,8PROBLEM 5-14A INTERPRETING THE NEW YORK TIMES COMPANYS FINANCIAL STATEMENTS

1.The company carries two types of inventory: newsprint and magazine paper, and other inventory. Newsprint costs are comparable to raw m

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