financial accounting tools for business decision making solutions 7e chapter 06

Because units of the same inventory item are typically purchased at different prices, it is necessary to determine which unit costs to use in the calculation of the cost of the goods sol

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CHAPTER 6 REPORTING AND ANALYZING INVENTORY

LEARNING OBJECTIVES

1 Describe the steps in determining inventory quantities

2 Apply the cost formulas using specific identification, FIFO, and average cost under

a perpetual inventory system

3 Explain the effects on the financial statements of choosing each of the inventory

cost formulas

4 Identify the effects of inventory errors on the financial statements

5 Demonstrate the presentation and analysis of inventory

6.* Apply the FIFO and average cost inventory cost formulas under a periodic inventory

system (Appendix 6A)

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AND BLOOM’S TAXONOMY

Item LO BT Item LO BT Item LO BT Item LO BT Item LO BT

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Legend: The following abbreviations will appear throughout the solutions manual file

Time: Estimated time to prepare in minutes

AACSB Association to Advance Collegiate Schools of Business

Reflec Thinking Reflective Thinking

CPA CM CPA Canada Competency

cpa-e001 Ethics Professional and Ethical Behaviour

cpa-e002 PS and DM Problem-Solving and Decision-Making

cpa-e003 Comm Communication

cpa-e004 Self-Mgt Self-Management

cpa-e005 Team & Lead Teamwork and Leadership

cpa-t001 Reporting Financial Reporting

cpa-t002 Stat & Gov Strategy and Governance

cpa-t003 Mgt Accounting Management Accounting

cpa-t004 Audit Audit and Assurance

cpa-t005 Finance Finance

cpa-t006 Tax Taxation

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1 Taking a physical inventory involves actually counting, weighing or

measuring each kind of inventory on hand Retailers, such as hardware

stores, generally have thousands of different items to count This is

normally done when the store is closed to minimize errors due to the

movement of merchandise Tom will probably count items and mark the

quantity, description, and inventory number on pre-numbered inventory

tags (unless the company has more advanced technology that can read

bar codes on inventory products – we will assume that they do not) He

should only include items in the inventory that are in saleable condition

Ideally, strong internal control should be exerted over the physical

inventory count For example, Tom should not have responsibility for the

custody or record-keeping for the inventory He should also count in teams

of two, or there should be a second counter checking the accuracy of the

count

Adjustments may also have to be made to the physical inventory count for

any goods in transit For example, inventory purchased FOB shipping point

that is still in transit will have to be included in inventory Inventory that has

been shipped by Kikujiro to customers FOB destination and not received

by the customer before year-end will also have to be included in the count

Finally, any of Kikujiro’s inventory held by other retailers on consignment

will have to be included in the count as well

LO 1 BT: C Difficulty: M Time: 20 min AACSB: None CPA: cpa-t001 CM: Reporting

2 In a consignment agreement, the consignor is the business that owns the

goods, and the consignee is the business that will sell the goods, without

having to purchase and own the goods before they are sold The consignee

will sell the goods for the consignor for a fee or a percentage of the sales

price Only the owner of goods, the consignor, includes the goods in its

inventory even though the goods are physically located on the consignee’s

premises

3 (a) The goods will be included in Janine Ltd.’s (the seller’s) inventory if

the terms of sale are FOB destination

(b) The goods will be included in Fastrak Corporation’s (the buyer’s)

inventory if the terms of sale are FOB shipping point

LO 1 BT: K Difficulty: S Time: 5 min AACSB: None CPA: cpa-t001 CM: Reporting

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4 (a) Include: the inventory items belong to Kingsway as Kingsway is the

consignor

(b) Include: the inventory items belong to Kingsway while in transit

because the terms are FOB shipping point

(c) Exclude: the customer has purchased the inventory item and legal

ownership has passed to the customer

5 (a) The unit cost of an inventory item is needed for the entry to record the

cost of goods sold and remove the cost of the items sold from inventory Because units of the same inventory item are typically purchased at different prices, it is necessary to determine which unit costs to use in the calculation of the cost of the goods sold

(b) When using the perpetual system, an entry to record the cost of goods

sold and remove the cost of the items sold from inventory is recorded

at the same time as the sales transaction The information from the perpetual system is updated, using the cost formula adopted by the business The cost formula is also used in the detailed perpetual records for every increase in inventory caused by purchases, freight-

in, etc transactions On the other hand, since a record is not kept of the individual inventory item transactions under the periodic system, the entry to record the cost of goods sold and remove the cost of the items sold from inventory can only be made at the end of a reporting period, when ending inventory is determined by a physical count

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inventory items, matching the cost of the actual item sold against the revenue from that item The FIFO inventory cost formula assumes the first inventory purchased is the first inventory sold The most recent purchases are assumed to remain in ending inventory The average cost formula assumes that all goods available for sale are indistinguishable or homogeneous

(b) An example of inventory where the specific identification would be

appropriate would be for goods that are not ordinarily interchangeable, such as automobiles with unique vehicle identification numbers

Inventory such as groceries could be accounted for using the FIFO

cost formula as older items are normally sold first

Inventory such as hardware could be accounted for using an average

cost formula

7 (a) Average cost or FIFO can be used if the goods available for sale are

identical Specific identification cannot be used if the goods are not specifically identifiable

(b) FIFO assumes that the first goods purchased are the first to be sold

(c) Specific identification matches the actual physical flow of

merchandise

8 A new weighted average unit cost must be calculated after each purchase

because a new cost amount is added to the “cost pool” This changes the

total dollars in the cost pool and the quantity of units on hand in the cost

pool A sale withdraws units and total dollars from the cost pool at the

weighted average cost This does not affect the weighted average cost of

the remaining units That is, the weighted average cost of the remaining

units is unchanged after a sale

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9 A company should consider:

• Whether the goods are interchangeable or not, or whether they are produced or segregated for specific projects;

• Whether the formula corresponds most closely to the physical flow

of goods;

• Whether the formula reports inventory on the statement of financial

position that is close to the inventory’s most recent cost; and

• Whether the formula is used for other inventories with a similar nature

and usage

10 Average cost produces the better income statement valuation because the

cost of goods sold is determined using more recent inventory prices This

better matches current costs with current revenues

FIFO produces the better valuation on the statement of financial position

because the ending inventory is determined using the most recent prices

Since the normal intent is to replace the inventory after it is sold, the most

recent prices are more relevant for decision-making

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formulas

(b) In a period of declining prices, FIFO will produce a lower ending

inventory as inventory is determined using the most recent (lower) prices Average cost will produce a higher ending inventory as ending inventory incorporates the higher older prices

(c) The cost of goods sold effect is opposite to that of ending inventory

Hence, cost of goods sold will be higher under FIFO and lower under the average cost formula

(d) Because of the effect on the cost of goods sold as outlined in (c), net

income will be lower under FIFO and higher under average cost

(e) The impact on retained earnings will be the same as the impact on

net income and ending inventory—lower in a period of declining prices using FIFO and higher using average cost

LO 2 BT: C Difficulty: C Time: 10 min AACSB: None CPA: cpa-t001 CM: Reporting

12 The error should be corrected if it will change the figures presented on the

financial statements While retained earnings may not change, other

financial statement items and comparative figures may change This

information may impact a user’s decision

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13 (a) Mila Ltd.’s 2018 income before tax will be understated by $43,000

This is because an understatement of ending inventory will result in

an overstatement of cost of goods sold If cost of goods sold is overstated, then income before tax will be understated

(b) 2018 retained earnings will be understated by $43,000 because net

income is understated (see (1) above)

because the retained earnings balance is understated (see (b) above)

(d) 2019 net income will be overstated $43,000 This is because

beginning inventory is understated by $43,000, which will result in an understatement of cost of goods sold (recognizing that 2018 ending inventory is 2019 beginning inventory) If cost of goods sold is understated, then income before tax will be overstated

(e) 2019 retained earnings will be correct because the understatement in

net income in 2018 and overstatement in 2019 will cancel each other

(f) 2019 total shareholders’ equity will be correct because the retained

earnings balance is correct

LO 4 BT: C Difficulty: C Time: 15 min AACSB: Analytic CPA: cpa-t001 CM: Reporting

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inventory count, Shediac’s assets (Inventory) would be overstated and its liabilities would be overstated (Accounts Payable) There would be no effect on shareholders’ equity

(b) Since the merchandise is not on hand at the time of the inventory

count, the shipment from Bathurst would not be counted This in turn would cause the inventory count to be lower than the perpetual inventory record Normally when such a discrepancy arises, the Inventory account will be adjusted downward with a credit to reflect the amount of merchandise actually on hand The corresponding debit in this adjusting entry would be to Cost of Goods Sold The summary effect of the initial error and the count adjustment would be

an overstatement in Cost of Goods Sold and Accounts Payable

Because Cost of Goods Sold is overstated, gross profit and net

income are understated as well as Retained Earnings At the end of Shediac’s current year, after the adjustment is made for the results of the inventory count, the overall impact on the accounting equation is

no effect on assets, an overstatement of liabilities (Accounts Payable), and an understatement of shareholders’ equity (Retained Earnings)

15 (a) Cost refers to the original cost of inventory as determined by using

specific identification, FIFO, or average cost formulas Net realizable value is the selling price less any costs required to make the goods ready for sale

(b) The lower of cost and net realizable value rule should be applied at

the end of the accounting period, before financial statements are prepared

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16 (a) Cost of Goods Sold is debited when recording a decline in inventory

value under the lower of cost and net realizable value rule and the asset account Inventory is credited

(b) These declines are usually considered part of the risk associated with

carrying inventory and part of the costs of carrying a variety and quantity of goods on hand Since the inventory has specifically been purchased for resale, the net realizable value becomes the most relevant measure of the asset on the statement of financial position

17 An increase in the days in inventory ratio from one year to the next would

be seen as a deterioration in the company’s efficiency in managing

inventory It means that the inventory is being held for a longer period of

time, which increases the risk of spoilage and obsolescence

LO 5 BT: K Difficulty: S Time: 5 min AACSB: None CPA: cpa-t001 cpa-t005 CM: Reporting

18 (a) An inventory turnover ratio that is too high may indicate that the

company is losing sales opportunities because of inventory shortages Inventory shortages may also cause customer ill will and result in lost future sales

(b) If the inventory turnover is too low, it may indicate that the company

is having difficulty selling its inventory, and the inventory may become obsolete

LO 5 BT: C Difficulty: M Time: 5 min AACSB: None CPA: cpa-t001 and cpa-t005 CM: Reporting and

Finance

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for inventories Under a perpetual inventory system, inventory records are

updated for every purchase and sale transaction The cost of goods sold

is recorded each time a sale is made Under a periodic system, the

inventory is only updated at the end of the period when a physical inventory

count is performed Inventory purchases throughout the year are debited

to a Purchases account in a periodic inventory system rather than an

Inventory account When a sale is recorded in a periodic inventory system,

no entry is made to record the cost of the sale Cost of goods sold is

calculated separately, after the physical inventory count is performed

LO 2,6 BT: C Difficulty: M Time: 5 min AACSB: None CPA: cpa-t001 CM: Reporting

*20 Ending inventory is known from the physical inventory count The total

amount of inventory available for sale needs to be determined first in order

to determine what inventory has been sold (goods available for sale –

ending inventory = cost of goods sold) Goods sold are not tracked

separately in a periodic inventory system

*21 In both systems, the first (oldest) costs are the costs assigned to the goods

sold No matter what system is used, the cost of goods sold will always

consist of the oldest units and these units are assumed to be on hand when

using either formula

*22 In a perpetual system, the average cost per item is recalculated every time

a purchase transaction takes place In a periodic system, the average cost

is determined based on the total goods available for sale during the period

If there are cost changes during the period, the average cost per item will

differ in a perpetual and periodic inventory system

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SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 6-1

(a) Ownership of the goods belongs to the consignor (Helgeson) Thus, these

goods should be included in Helgeson’s inventory

(b) Goods held on consignment belong to the other company and should not

be included in Helgeson’s inventory

(c) The goods in transit belong to Helgeson because ownership does not

transfer until the customer receives the goods They should be included in

Helgeson’s inventory

(d) The goods purchased belong to the buyer, Helgeson as the terms of

shipment are FOB shipping point Title transferred to Helgeson as soon as

the goods were shipped, so even though they have not been received, they

should be included in Helgeson’s inventory

(e) The goods in transit belong to the customer as the terms of shipment are

FOB shipping point They should not be included in Helgeson’s inventory

because title transferred to the customer as soon as the goods were

shipped

(f) The goods in transit should not be included in the inventory count because

ownership by Helgeson does not occur until the goods reach the buyer

(Legal title determines if an item should be included in inventory)

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$91,500 Correct inventory cost

LO 1 BT: AP Difficulty: M Time: 5 min AACSB: Analytic CPA: cpa-t001 CM: Reporting

(Proof: 1 piano @ $600 +

1 piano @ $475 = $1,075)

(b) If management wished higher net income, it could have sold two pianos

from the last shipment, that had a lower cost If it wished lower net income,

it could have sold two of the first pianos purchased

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[9] $3,866.67 (from [8])  20 (from [7]) = $193.3333 rounded to equal [4]

Notice how the average cost does not change after a sale

[10] $2,460  $205 = 12

[11] 20 (from [7]) + 12 (from [10]) = 32

[12] $3,866.67 (from [8]) + $2,460.00 = $6,326.67

[13] $6,326.67 (from [12])  32 (from [11]) = $197.708 rounded to $197.71

LO 2 BT: AN Difficulty: C Time: 15 min AACSB: Analytic CPA: cpa-t001 CM: Reporting

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Solutions Manual 6-17 Chapter 6

(a) FIFO cost formula

Date Description Purchases Cost of Goods Sold Ending Inventory

Check: $55,000 + $120,500 = $175,500

(b) Average cost formula

Date Description Purchases Cost of Goods Sold Ending Inventory

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(a) Average cost The ending inventory is valued at the average of the cost of

the product, including earlier costs Since this cost formula yields a higher

ending inventory than FIFO when prices are falling, the result will not be

closer to replacement cost This result is achieved with the FIFO cost

formula

(b) FIFO The cost of goods is valued using the earlier, higher costs Since

the revenue reflects current lower prices, the FIFO cost formula does not

match current costs against revenue when prices are falling This result is

better achieved by the average cost formula

(c) One of the guidelines that management should consider is choosing an

inventory cost formula that corresponds as closely to the physical flow of

goods as possible A cost formula that provides an ending inventory cost

close to the inventory’s recent cost is also preferable

Total assets in the statement of financial position will be overstated by the amount

that ending inventory is overstated, $25,000 When the purchase of inventory was

recorded, an account payable would have been created, so total liabilities will also

be overstated by $25,000 (assuming the “supplier” was not paid) Shareholders’

equity will not be affected

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When items are not counted, an adjustment would be made to lower the balance

in the Inventory account to reflect the difference between the amount counted

(which is lower) and the amount recorded in the account This would be done by

crediting Inventory The offsetting debit would be to Cost of Goods Sold, thereby

overstating this account and reducing net income

In the following year, assuming these goods are sold, their cost is zero so cost of

goods sold would be understated and net income overstated Assuming there are

no errors when counting inventory at the end of next year, this net income

overstatement when combined with the previous year’s net income

understatement, would cancel each other out and make retained earnings

correctly stated at the end of next year

These effects are summarized below

Current Year Next Year Assets Understated $7,000 No impact

Shareholders’ equity Understated $7,000 No impact

LO 4 BT: AN Difficulty: M Time: 15 min AACSB: Analytic CPA: cpa-t001 CM: Reporting

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3654.6 = 79 days

Inventory Turnover

(2014)

$8,033.2($1,623.8 + $1,481.0) ÷ 2= 5.2 times Days in Inventory (2014)

365 5.2 = 70 days

(b) The inventory management deteriorated in 2015 as evidenced by the

increase in number of days in inventory from 70 days in 2014 to 79 days in

2015 This was corroborated by the declining inventory turnover This

deterioration signifies that it took longer to sell the inventory in 2015

LO 5 BT: AN Difficulty: M Time: 10 min AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and

Finance

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Ending inventory: (600 units @ $11) = $6,600

Cost of goods sold = Goods available for sale – ending inventory

$20,530 – $6,600 = $ 13,930

Proof: Cost of goods sold = (370 × $9) + (700 × $12) + (200 x $11) = $ 13,930

(b) Average cost

Note: Unrounded numbers have been used in the average cost

calculations, although the numbers have been rounded to the nearest cent

for presentation purposes Because of this, some amounts may not appear

to multiply exactly because of the rounding in the presentation

Weighted average cost = $20,530 ÷ 1,870 = $10.98

Ending inventory: 600 × $10.98 = $ 6,587.17

$20,530 – $ 6,587.17 = $ 13,942.83

Proof: Cost of goods sold = 1,270 × ($20,530 ÷ 1,870) = $ 13,942.83

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*BRIEF EXERCISE 6-14

(a) Ending Inventory: (1,300 × $45.00) + (200 × $50.00) = $68,500

$216,000 – $68,500 = $147,500

Proof: Cost of goods sold = (1,500 × $45.00) + (1,600 × $50.00) = $147,500

(b) No, the answer under a perpetual system would be the same, since the

first goods purchased are assumed to be the first goods sold

LO 2,6 BT: AN Difficulty: M Time: 15 min AACSB: Analytic CPA: cpa-t001 CM: Reporting

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(a) FIFO Perpetual

Jan 3 Accounts Receivable 8,400

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SOLUTIONS TO EXERCISES

EXERCISE 6-1

1 Do not include – Shippers Ltd does not own items held on consignment

These goods will be recorded in the owner’s inventory

2 Include in inventory – Shipping terms FOB destination means that Shippers

Ltd owns the items until they reach the customer

3 Include in inventory – Shippers Ltd still owns the items as they were only

shipped on consignment

4 Do not include in inventory Freight costs on goods shipped to customers

are included in Freight Out or Delivery Expense

5 Do not include in inventory – The shipping terms are FOB destination point

so ownership has not transferred to the buyer Shippers Ltd should not

record anything until the goods arrive

6 Include in inventory – Shipping terms FOB shipping point means that

ownership transferred at the time of shipping and therefore, Shippers Ltd

owns the goods in transit

7 Do not include in inventory The shipping terms are FOB shipping point, so

Shippers Ltd no longer owns the goods They will be part of cost of sales

on the income statement

(Legal title determines if an item should be included in inventory.)

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(a) Ending inventoryphysical count $285,000

1 Add to inventory Title remains with Novotna until purchaser

receives goods 35,000

2 Add to inventory Title passed to Novotna when goods were shipped 95,000

3 Add to inventory Title passed to Novotna when goods were shipped 28,000

4 No effect Title passes to purchaser upon shipment when terms are

FOB shipping point 0

5 Add to inventory Novotna owns the goods out on consignment 30,500

6 Deduct from inventory Obsolete inventory should be written off to

cost of goods sold (15,000) Correct inventory $458,500

(Legal title determines if an item should be included in inventory)

(b) Since inventory is usually the largest current asset on a company’s

statement of financial position, errors can have a significant impact In

deciding to grant a short-term bank loan, the bank will be looking at

Novotna’s liquidity by calculating the current ratio as well as the inventory

turnover and days sales in inventory Any error in the inventory count will

affect these ratios In addition, the errors will also affect Novotna’s

profitability by impacting the cost of goods sold on the income statement

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EXERCISE 6-3

(a) The company would identify, by serial number, the items remaining in

inventory The sum of the cost of the items remaining in inventory would

become the ending inventory balance Then, the company would identify

the cost of the items sold, again by using serial numbers to determine the

cost of each item sold The total cost of items sold would become the cost

of goods sold

(b) It could choose to sell specific units purchased at specific costs if it wished

to impact net income selectively If it wished to minimize net income it

would choose to sell the units purchased at higher costs–in which case the

cost of goods sold would be $4,300 ($2,400 + $1,900) and gross profit

would be $900 [($2,600 x 2) – $4,300] If it wished to maximize net income

it would choose to sell the units purchased at lower costs; in which case

the cost of goods sold would be $3,580 ($1,900 + $1,680) and gross profit

would be $1,620 [($2,600 x 2) – $3,580]

(c) Discount Electronics should consider the nature of the inventory items The

specific identification system is best suited to inventory items are clearly

identified from each other and that are not ordinarily interchangeable, or to

products that are produced and segregated for specific projects The

specific identification system produces the most accurate measure of

ending inventory and matching of cost of goods sold to sales It is however

more time-consuming and expensive to apply If the inventory items are

interchangeable, Discount Electronics would not be able to use specific

identification and would have to use either the FIFO or average cost flow

formulas

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Gross profit margin = $71,250  $210,000 = 33.9%

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EXERCISE 6-4 (CONTINUED)

(c) The gross profit is higher than if the average cost formula had been used

in a perpetual inventory system because cost of goods sold is lower under

FIFO in a period of rising prices than it would be using the average cost

formula Under FIFO, ending inventory is higher, cost of goods sold is lower

and gross profit is higher

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calculations, although the numbers have been rounded to the nearest cent for presentation purposes Because of this, some amounts may not appear

to multiply exactly because of the rounding in the presentation

(c) The gross profit is lower than it would be using the FIFO cost formula

because the cost of the product being purchased is rising

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Solutions Manual 6-31 Chapter 6

EXERCISE 6-6

(a) (1) FIFO

June 1 Beginning inventory 1,500 @ $5 = $ 7,500

4,400 @ $7 = 38,600

100 @ $7 1,500 @ $8 = 12,700 Total $57,300 $52,100 $12,700

Check: $52,100 + $12,700 = $64,800 ($7,500 + $57,300)

(a) (2) Average cost

Note: Unrounded numbers have been used in the average cost calculations,

although the numbers have been rounded to the nearest cent for presentation

purposes Because of this, some amounts may not appear to multiply exactly

because of the rounding in the presentation

(b) The average cost formula results in a higher cost of goods sold because

the cost of inventory is rising

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(c) The FIFO cost formula results in a higher net income because it produces

the lower cost of goods sold when prices are rising, as the lower costs from

earlier units are assigned to cost of goods sold, while the higher costs are

assigned to ending inventory

(d) The FIFO cost formula results in a higher ending inventory because the cost

of inventory is rising and these higher unit prices are used to determine

ending inventory

(e) Both cost formulas result in the same pre-tax cash flow The cost formulas

do not change the pre-tax cash flows of a company

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EXERCISE 6-7

(a) FIFO cost formula

Date Units Cost Total Units Cost Total Units Cost Total

Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Oct 2 9,000 $12 $108,000 9,000 $12.00 $108,000

Income tax expense (30%) 10,500 10,050

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(d) (1) Currently, as shown in (a) above, FIFO results in a higher net income

than the average cost formula This is anticipated when costs are rising, as is the case above

If instead costs fall, the use of the FIFO cost formula will result in a

lower net income compared to the average cost formula The cost of goods sold will then be composed of higher costs than the average cost formula and this will generate lower net incomes

(2) If costs remain stable, the two cost formulas will produce the same

net incomes

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(b) (1) and (2) Cost of goods sold and income before income tax: The

inventory error for 2017 will cause the cost of goods sold to be overstated by $4,000, which will cause net income and retained earnings to be understated by the same amount Assuming the error was not corrected, when it reverses in 2018, cost of goods sold will

be understated and net income will be overstated by $4,000 Over the two years the error will reverse and therefore the retained earnings balance will be correct at the end of 2018 (with respect to this particular error, taken alone)

The $2,000 overstatement of inventory in 2018 will cause the cost of goods sold to be understated and the net income and retained earnings to be overstated by $2,000

When the two errors are taken together, in 2018 cost of goods sold will be understated by $6,000 ($4,000 for 2017 error and $2,000 for

2018 error) Net income will be overstated by $6,000 in 2018

(3) The inventory error for 2017 will cause the inventory—an asset

account—to be understated by $4,000

The inventory error for 2018 will cause the inventory (asset) account

to be overstated by $2,000

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(b) (continued)

(4) The errors will not affect liabilities

(5) As explained above in (1) and (2), retained earnings is understated

by $4,000 in 2017 In 2018, retained earnings is overstated by $2,000

Because of this, shareholders’ equity will be understated by $4,000 in

(c) Errors should be corrected as soon as they are discovered so that users

have a more accurate account of inventory on hand, gross profit and net

income

LO 4 BT: AN Difficulty: C Time: 30 min AACSB: Analytic CPA: cpa-t001 CM: Reporting

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EXERCISE 6-9

(a)

Sales $265,000 $250,000 Cost of goods sold (see 1 and 2) 213,000 186,000 Gross profit $ 52,000 $ 64,000 (1) $194,000 – $8,000 = $186,000

(2) $205,000 + $8,000 = $213,000

(b) The cumulative effect on total gross profit for the two years is zero as

shown below:

Incorrect gross profits: $56,000 + $60,000 = $116,000

Correct gross profits: $64,000 + $52,000 = 116,000

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Units Cost/Unit Total Cost NRV/Unit Total NRV

(a) LCNRV Cameras:

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$2,959,238 = 24.7%

Inventory Turnover (2015): $1,701,311

(779,407 + $595,794)÷2= 2.5 times Days in Inventory (2015): 365

2.5 = 146 days Gross Profit Margin (2015): ($2,359,994 - $1,701,311)

$2,359,994 = 27.9%

(b) In 2016, Gildan Activewear experienced an improvement in liquidity but a

deterioration in profitability The liquidity has been improved due to the

decrease in time required to turn over its inventory, from 146 days to 135

days The company has experienced deteriorated profitability due to a

significant drop in its gross profit margin from 27.9% to 24.7%

LO 5 BT: AN Difficulty: M Time: 15 min AACSB: Analytic CPA: cpa-t001 cpa-t005 CM: Reporting and

Finance

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(a)

Inventory turnover (FIFO)

$750,000

$222,500= 3.4 times Inventory turnover (Average Cost)

($450,000 + $227,500)

$350,000 = 1.9 times

(c) The FIFO cost formula appears to show a slightly better turnover ratio

because it has a lower ending inventory The current ratios are the same

The two cost formulas will generally yield the same overall assessment of

liquidity when combining the inventory turnover ratio and the current ratio

The trend analysis for the inventory turnover and the current ratio produced

by either formula will be the same since the formulas involve allocating the

same costs In reality, there is no economic difference between the two

formulas and any differences in ratios are artificial ones caused solely by

the different cost formulas Consequently, there is no real difference in

liquidity

LO 3,5 BT: AN Difficulty: M Time: 15 min AACSB: Analytic CPA: cpa-t001 and cpa-t005 CM: Reporting

and Finance

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