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CHAPTER 6
Inventories
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives Questions
Brief Exercises Exercises
A Problems
B Problems
- Describe the steps in determining inventory quantities.
1, 2, 3, 4, 5
1 1, 2 1A 1B
- Explain the accounting for inventories and apply the inventory cost flow methods.
5, 7, 8, 9, 10,
2, 3, 4 3, 4, 5, 6, 7, 8
2A, 3A, 4A, 5A, 6A, 7A
2B, 3B, 4B, 5B, 6B, 7B
- Explain the financial effects of the inventory cost flow assumptions.
6, 11, 12 5, 6 3, 6, 7, 8 2A, 3A, 4A, 5A, 6A, 7A
2B, 3B, 4B, 5B, 6B, 7B
- Explain the lower-of- cost-or-market basis of accounting for inventories.
13, 14, 15 7 9, 10
- Indicate the effects of inventory errors on the financial statements.
16 8 11, 12
- Compute and interpret the inventory turnover ratio.
17, 18 9 13, 14
*7. Apply the inventory cost flow methods to perpetual inventory records.
19, 20 10 15, 16, 17 8A, 9A 8B, 9B
*8. Describe the two methods of estimating inventories.
21, 22, 23, 24
11, 12 18, 19, 20 10A, 11A 10B, 11B
*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendices to the chapter.
ASSIGNMENT CHARACTERISTICS TABLE
Problem Number Description
Difficulty Level
Time Allotted (min.) 1A Determine items and amounts to be recorded in inventory. Moderate 15– 2A Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis.
Simple 30–
3A Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis.
Simple 30–
4A Compute ending inventory, prepare income statements, and answer questions using FIFO and LIFO.
Moderate 30–
5A Calculate ending inventory, cost of goods sold, gross profit, and gross profit rate under periodic method; compare results.
Moderate 30–
6A Compare specific identification, FIFO, and LIFO under periodic method; use cost flow assumption to influence earnings.
Moderate 20–
7A Compute ending inventory, prepare income statements, and answer questions using FIFO and LIFO.
Moderate 30–
*8A Calculate cost of goods sold and ending inventory for FIFO, average-cost, and LIFO, under the perpetual system; compare gross profit under each assumption.
Moderate 30–
*9A Determine ending inventory under a perpetual inventory system.
Moderate 40–
*10A Estimate inventory loss using gross profit method. Moderate 30– *11A Compute ending inventory using retail method. Moderate 20– 1B Determine items and amounts to be recorded in inventory. Moderate 15– 2B Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis.
Simple 30–
3B Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis.
Simple 30–
4B Compute ending inventory, prepare income statements, and answer questions using FIFO and LIFO.
Moderate 30–
5B Calculate ending inventory, cost of goods sold, gross profit, and gross profit rate under periodic method; compare results.
Moderate 30–
6B Compare specific identification, FIFO, and LIFO under periodic method; use cost flow assumption to justify price increase.
Moderate 20–
BLOOM’S TAXONOMY TABLE
Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems Study Objective
Knowledge Comprehension
Application
Analysis
Synthesis
Evaluation
inventory quantities.Describe the steps in determining
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inventory cost flow methods.inventories and apply theExplain the accounting for
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inventory cost flow assumptions.Explain the financial effects of the
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basis of accounting for inventories.Explain the lower-of-cost-or-market
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errors on the financial statements.Indicate the effects of inventory
BE6-8Q6-
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turnover ratio.Compute and interpret the inventory
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*7.
records.methods to perpetual inventoryApply the inventory cost flow
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*8.
estimating inventories.Describe the two methods of
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Broadening Your Perspective
OrganizationAcross theDecision MakingFinancial Reporting
WebExploring theCommunication
Comp. AnalysisEthics CaseAll About You
6-
ANSWERS TO QUESTIONS
- Agree. Effective inventory management is frequently the key to successful business operations. Management attempts to maintain sufficient quantities and types of goods to meet expected customer demand. It also seeks to avoid the cost of carrying inventories that are clearly in excess of anticipated sales.
- Inventory items have two common characteristics: (1) they are owned by the company and (2) they are in a form ready for sale in the ordinary course of business.
- Taking a physical inventory involves actually counting, weighing or measuring each kind of inventory on hand. Retailers, such as a hardware store, generally have thousands of different items to count. This is normally done when the store is closed.
- (a) (1) The goods will be included in Reeves Company’s inventory if the terms of sale are FOB destination. (2) They will be included in Cox Company’s inventory if the terms of sale are FOB shipping point. (b) Reeves Company should include goods shipped to a consignee in its inventory. Goods held by Reeves Company on consignment should not be included in inventory.
- Inventoriable costs are $3,020 (invoice cost $3,000 + freight charges $50 – purchase discounts $30). The amount paid to negotiate the purchase is a buying cost that normally is not included in the cost of inventory because of the difficulty of allocating these costs. Buying costs are expensed in the year incurred.
- There are three distinguishing features in the income statement of a merchandising company: (1) a sales revenues section, (2) a cost of goods sold section, and (3) gross profit.
- Actual physical flow may be impractical because many items are indistinguishable from one another. Actual physical flow may be inappropriate because management may be able to manipulate net income through specific identification of items sold.
- The major advantage of the specific identification method is that it tracks the actual physical flow of the goods available for sale. The major disadvantage is that management could manipulate net income.
- No. Selection of an inventory costing method is a management decision. However, once a method has been chosen, it should be consistently applied.
- (a) FIFO. (b) Average-cost. (c) LIFO.
- Plato Company is using the FIFO method of inventory costing, and Cecil Company is using the LIFO method. Under FIFO, the latest goods purchased remain in inventory. Thus, the inventory on the balance sheet should be close to current costs. The reverse is true of the LIFO method. Plato Company will have the higher gross profit because cost of goods sold will include a higher proportion of goods purchased at earlier (lower) costs.
Questions Chapter 6 (Continued)
*22. In the gross profit method, the average is the gross profit rate, which is gross profit divided by net sales. The rate is often based on last year’s actual rate. The gross profit rate is applied to net sales in using the gross profit method.
In the retail inventory method, the average is the cost-to-retail ratio, which is the goods available for sale at cost divided by the goods available for sale at retail. The ratio is based on current year data and is applied to the ending inventory at retail.
*23. The estimated cost of the ending inventory is $40,000: Net sales ...................................................................................................................................... $400, Less: Gross profit ($400,000 X 35%) .................................................................................... 140, Estimated cost of goods sold ................................................................................................... $260,
Cost of goods available for sale .............................................................................................. $300, Less: Cost of goods sold.......................................................................................................... 260, Estimated cost of ending inventory......................................................................................... $ 40,
*24. The estimated cost of the ending inventory is $28,000:
Cost-to-retail ratio: 70% =
$84, $120,
Ending inventory at retail: $40,000 = ($120,000 – $80,000)
Ending inventory at cost: $28,000 = ($40,000 X 70%)
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 6-
(a) Ownership of the goods belongs to the consignor (Smart). Thus, these goods should be included in Smart’s inventory.
(b) The goods in transit should not be included in the inventory count because ownership by Smart does not occur until the goods reach the buyer.
(c) The goods being held belong to the customer. They should not be included in Smart’s inventory.
(d) Ownership of these goods rests with the other company (the consignor). Thus, these goods should not be included in the physical inventory.
BRIEF EXERCISE 6-
The items that should be included in inventoriable costs are:
(a) Freight-in (b) Purchase Returns and Allowances (c) Purchases (e) Purchase Discounts
BRIEF EXERCISE 6-
(a) The ending inventory under FIFO consists of 200 units at $8 + 160 units at $7 for a total allocation of $2,720 or ($1,600 + $1,120).
(b) The ending inventory under LIFO consists of 300 units at $6 + 60 units at $7 for a total allocation of $2,220 or ($1,800 + $420).
BRIEF EXERCISE 6-
Inventory Categories Cost Market LCM Cameras $12,000 $12,100 $12, Camcorders 9,500 9,700 9, VCRs 14,000 12,800 12, Total valuation $34,
BRIEF EXERCISE 6-
The understatement of ending inventory caused cost of goods sold to be overstated $10,000 and net income to be understated $10,000. The correct net income for 2008 is $100,000 or ($90,000 + $10,000).
Total assets in the balance sheet will be understated by the amount that ending inventory is understated, $10,000.
BRIEF EXERCISE 6-
Inventory turnover:
( $60,000 + $40,000^ ) ÷ 2
Days in inventory:
= 67.6 days
*BRIEF EXERCISE 6-
(1) FIFO Method Product E2-D
Date Purchases
Cost of Goods Sold Balance May 7 (50 @ $10) $500 (50 @ $10) $ June 1 (30 @ $10) $300 (20 @ $10) $ July 28 (30 @ $13) $390 (20 @ $10) (30 @ $13) }^ $ Aug. 27 (20 @ $10) (20 @ $13) }^ $460^ (10 @ $13) $
*BRIEF EXERCISE 6-10 (Continued)
(2) LIFO Method Product E2-D
Date Purchases
Cost of Goods Sold Balance May 7 (50 @ $10) $500 (50 @ $10) $ June 1 (30 @ $10) $300 (20 @ $10) $ July 28 (30 @ $13) $390 (20 @ $10) (30 @ $13) }^ $ Aug. 27 (30 @ $13) (10 @ $10) }^ $490^ (10 @ $10) $
(3) Average-Cost Product E2-D
Date Purchases
Cost of Goods Sold Balance May 7 (50 @ $10) $500 (50 @ $10) $ June 1 (30 @ $10) $300 (20 @ $10) $ July 28 (30 @ $13) $390 (50 @ $11.80)* $ Aug. 27 (40 @ $11.80) $472 (10 @ $11.80) $
*($200 + $390) ÷ 50
*BRIEF EXERCISE 6-
(1) Net sales $330, Less: Estimated gross profit (35% X $330,000) 115, Estimated cost of goods sold $214,
(2) Cost of goods available for sale $230, Less: Estimated cost of goods sold 214, Estimated cost of ending inventory $ 15,
*BRIEF EXERCISE 6-
At Cost At Retail Goods available for sale $35,000 $50, Net sales 40, Ending inventory at retail $10,
Cost-to-retail ratio = ($35,000 ÷ $50,000) = 70% Estimated cost of ending inventory = ($10,000 X 70%) = $7,
EXERCISE 6-2 (Continued)
- Subtract from inventory: GAAP require that inventory be valued at the lower of cost or market. Obsolete parts should be adjusted from cost to zero if they have no other use.......................................................................................... (40,000) Correct inventory........................................................................................ $515,
EXERCISE 6-
(a) FIFO Cost of Goods Sold
(#1012) $100 + (#1045) $90 = $
(b) It could choose to sell specific units purchased at specific costs if it wished to impact earnings selectively. If it wished to minimize earnings it would choose to sell the units purchased at higher costs—in which case the Cost of Goods Sold would be $190. If it wished to maximize earnings it would choose to sell the units purchased at lower costs—in which case the cost of goods sold would be $170.
(c) I recommend they use the FIFO method because it produces a more appropriate balance sheet valuation and reduces the opportunity to manipulate earnings.
(The answer may vary depending on the method the student chooses.)
EXERCISE 6-
FIFO
Beginning inventory (26 X $97)..................................................... $ 2, Purchases Sept. 12 (45 X $102).................................................................. $4, Sept. 19 (20 X $104).................................................................. 2, Sept. 26 (50 X $105).................................................................. 5,250 11, Cost of goods available for sale................................................... 14, Less: Ending inventory (20 X $105) ........................................... 2, Cost of goods sold............................................................................ $12,
EXERCISE 6-4 (Continued)
Proof Date Units Unit Cost Total Cost 9/1 26 $ 97 $ 2, 9/12 45 102 4, 9/19 20 104 2, 9/26 30 105 3, 121 $12,
LIFO Cost of goods available for sale.................................................................... $14, Less: Ending inventory (20 X $97)............................................................... 1, Cost of goods sold............................................................................................. $12,
Proof Date Units Unit Cost Total Cost 9/26 50 $105 $ 5, 9/19 20 104 2, 9/12 45 102 4, 9/1 6 97 582 121 $12,
(b)
FIFO $2,100 (ending inventory) + $12,342 (COGS) = $14,
LIFO $1,940 (ending inventory) + $12,502 (COGS) = $14,442 }^
Cost of goods available for sale
Under both methods, the sum of the ending inventory and cost of goods sold equals the same amount, $14,442, which is the cost of goods available for sale.
EXERCISE 6-
FIFO
Beginning inventory (30 X $8) ....................................................... $ Purchases May 15 (25 X $11) ...................................................................... $ May 24 (35 X $12) ...................................................................... 420 695 Cost of goods available for sale................................................... 935 Less: Ending inventory (25 X $12).............................................. 300 Cost of goods sold............................................................................ $
EXERCISE 6-6 (Continued)
(b) The FIFO method will produce the higher ending inventory because costs have been rising. Under this method, the earliest costs are assigned to cost of goods sold and the latest costs remain in ending inventory. For Yount Company, the ending inventory under FIFO is $840 or (120 X $7) compared to $600 or (120 X $5) under LIFO.
(c) The LIFO method will produce the higher cost of goods sold for Yount Company. Under LIFO the most recent costs are charged to cost of goods sold and the earliest costs are included in the ending inventory. The cost of goods sold is $5,700 or [$6,300 – (120 X $5)] compared to $5,460 or ($6,300 – $840) under FIFO.
EXERCISE 6-
(a) 1. FIFO Beginning inventory .................................................. $10, Purchases...................................................................... 26, Cost of goods available for sale ............................ 36, Less: ending inventory (80 X $130) ..................... (10,400) Cost of goods sold ..................................................... $25,
- LIFO Beginning inventory .................................................. $10, Purchases...................................................................... 26, Cost of goods available for sale ............................ 36, Less: ending inventory (80 X $100) ..................... (8,000) Cost of goods sold ..................................................... $28,
- AVERAGE Beginning inventory .................................................. $10, Purchases...................................................................... 26, Cost of goods available for sale ............................ 36, Less: ending inventory (80 X $120) ..................... (9,600) Cost of goods sold ..................................................... $26,
(b) The use of FIFO would result in the highest net income since the earlier lower costs are matched with revenues.
(c) The use of FIFO would result in inventories approximating current cost in the balance sheet, since the more recent units are assumed to be on hand.
(d) The use of LIFO would result in Jones paying the least taxes in the first year since income will be lower.
EXERCISE 6-
(a) Cost of Goods Available for Sale $6,
÷
Total Units Available for Sale 1,
Weighted Average Unit Cost $6.
Ending inventory (120 X $6.30) $ 756 Cost of goods sold (880 X $6.30) 5,
(b) Ending inventory is lower than FIFO ($840) and higher than LIFO ($600). In contrast, cost of goods sold is higher than FIFO ($5,460) and lower than LIFO ($5,700).
(c) The average-cost method uses a weighted-average unit cost, not a simple average of unit costs.
EXERCISE 6-
Cost Market
Lower of Cost or Market: Cameras Minolta $ 850 $ 780 $ 780 Canon 900 912 900 Total 1,750 1,
Light meters Vivitar 1,500 1,380 1, Kodak 1,680 1,890 1, Total 3,180 3, Total inventory $4,930 $4,962 $4,
EXERCISE 6-
Cost Market
Lower of Cost or Market: VCRs $ 6,500 $ 7,100 $ 6, DVD players 11,250 10,350 10, Ipods 10,000 9,750 9, Total inventory $27,750 $27,200 $26,
EXERCISE 6-12 (Continued)
The error also affects the balance sheet at the end of 2008. The inven- tory reported in the balance sheet is overstated; therefore, total assets are overstated. The overstatement of the 2008 net income results in the capital account balance being overstated. The balance sheet at the end of 2009 is correct because the overstatement of the capital account at the end of 2008 is offset by the understatement of the 2009 net income and the inventory at the end of 2009 is correct.
Thank you for allowing me to bring this to your attention. If you have any questions, please contact me at your convenience.
Sincerely,
EXERCISE 6-
2007 2008 2009 Inventory $900,000 $1,120,000 $1,300, turnover (^) ($100,000 + $300,000) ÷ 2 ($300,000 + $400,000) ÷ 2 ($400,000 + $480,000) ÷ 2 $900,000 $1,120,000 $1,300, $200,000 = 4.5^ $350,000 = 3.2^ $440,000 = 2. Days in 365 365 365 inventory (^) 4.5 = 81.1 days^ 3.2 = 114.1 days^ 2.95 = 123.7 days Gross $1,200,000 – $900,000 $1,600,000 – $1,120,000 $1,900,000 – $1,300, profit rate (^) $1,200,000 = .25^ $1,600,000 = .30^ $1,900,000 =.
The inventory turnover ratio decreased by approximately 34% from 2007 to 2009 while the days in inventory increased by almost 53% over the same time period. Both of these changes would be considered negative since it’s better to have a higher inventory turnover with a correspondingly lower days in inventory. However, Santo’s Photo gross profit rate increased by 28% from 2007 to 2009, which is a positive sign.
EXERCISE 6-
(a) O’Brien Company Weinberg Company Inventory Turnover $190,000 $292, ($45,000 + $55,000)/ = 3.
Days in Inventory 365/3.80 = 96 days 365/4.17 = 88 days
(b) Weinberg Company is moving its inventory more quickly, since its inven- tory turnover is higher, and its days in inventory is lower.
*EXERCISE 6-
(1) FIFO
Date Purchases Cost of Goods Sold Balance Jan. 1 (3 @ $600) $1, 8 (2 @ $600) $1,200 (1 @ $600) 600 10 (6 @ $660) $3,960 (1 @ $600) (6 @ $660) 4, 15 (1 @ $600) (3 @ $660) $2,580 (3 @ $660) 1,
(2) LIFO
Date Purchases Cost of Goods Sold Balance Jan. 1 (3 @ $600) $1, 8 (2 @ $600) $1,200 (1 @ $600) 600 10 (6 @ $660) $3,960 (1 @ $600) (6 @ $660) 4, 15 (4 @ $660) $2,640 (1 @ $600) (2 @ $660) 1,
