Solution manual intermediate accounting 9e by nicolai ch07

Cost of goods sold and ending inventory under FIFO, LIFO, and average cost.. The most recent costs in inventory used in LIFO would be less than the earliest costs used in FIFO, causing a

CHAPTER 7

INVENTORIES: COST MEASUREMENT AND FLOW ASSUMPTIONS

CONTENT ANALYSIS OF EXERCISES AND PROBLEMS

E7-1 Inventory Manufacturing company Computation of ending

E7-2 Goods in Transit FOB destination FOB shipping point Items

E7-3 Items in Inventory Determine if numerous items should be

ending inventory under FIFO, LIFO, and average cost 10-15 E7-8 Inventory Methods Perpetual system Cost of goods sold and

ending inventory under FIFO, LIFO, and average cost 10-15 E7-9 (AICPA adapted) Inventory Methods Periodic system

Ending inventory under FIFO, LIFO, and weighted average 15-20 E7-10 LIFO Perpetual and periodic systems Ending inventory, cost of

E7-13 (AICPA adapted) Dollar-Value LIFO Computation of

E7-14 (AICPA adapted) Dollar-Value LIFO Computation of

Number Content Time Range (minutes)

E7-15 Inventory Pools Dollar-value LIFO Computation of ending

E7-16 Use of Different Methods FIFO used internally, LIFO used

externally Journal entries to convert accounts Comparative balance sheet disclosure Difference in cost of goods sold

10-20

E7-17 Interim Financial Reports LIFO Accounting for inventory

liquidation in different quarters Worksheet entry 10-20 E7-18 (Appendix) Exchange Gains and Losses Record journal

E7-19 (Appendix) Exchange Gains and Losses Record journal

P7-1 Items in Inventory Analyze several transactions to determine if

P7-2 Valuation of Inventory Adjustment of ending inventory value

to account for transactions not considered 20-30 P7-3 Cost of Sales FIFO, LIFO, and average cost Ending inventory,

P7-4 Discounts Gross price and net price methods Income

P7-5 Inventory Methods FIFO, LIFO, and average cost under

periodic and perpetual systems Cost of goods sold, ending inventory Reconcile LIFO periodic and LIFO perpetual

25-35

P7-6 Inventory Methods FIFO, LIFO, and average cost under

periodic and perpetual systems Cost of goods sold, ending inventory Reconcile LIFO periodic and LIFO perpetual

Inventory turnover ratio and related issues

30-40

P7-7 Inventory Methods FIFO, LIFO, and average cost Periodic

Gross profit determination Return on assets and related issues 30-45 P7-8 (AICPA adapted) LIFO and Inventory Pools Computation of

P7-9 Dollar-Value LIFO Determination of year-end inventory for five

P7-10 Dollar-Value LIFO Determination of year-end inventory for five

P7-11 Dollar-Value LIFO and Inventory Pools Computation of ending

Number Content Time Range (minutes) P7-13 (AICPA adapted) Double-Extension: Dollar Value LIFO

Multiple-pools Compute internal conversion cost indexes

Compute year-end inventory for 2 years

45-60

P7-14 LIFO Liquidation Profit Unit sales exceed unit purchases

Computation of LIFO liquidation profit Determine effect on income taxes of additional purchases and use of LIFO Prepare disclosures

40-60

P7-15 Comprehensive Determination of ending inventory Cost of

goods sold from purchases, from beginning inventory 30-45 P7-16 (AICPA adapted) Inventory Valuation FIFO, perpetual Early

year-end physical count Inventory value determination 30-45 P7-17 AICPA adapted) Comprehensive: Inventory Adjustments

Preparation of schedule of adjustments to compute ending inventory, accounts payable, and sales

25-35

ANSWERS TO QUESTIONS

Q7-1 A merchandising company acquires goods for resale and does not alter their physical

form, so it needs only one type of inventory account, usually called Merchandise Inventory A manufacturing company does change the physical form of the goods, and typically uses three inventory accounts in the financial statements to reflect the stage of completion The three accounts are usually called: (1) Raw Materials

Inventory; (2) Goods in Process Inventory; and (3) Finished Goods Inventory Both types

of companies may use more accounts internally

Q7-2 Raw materials inventory includes the tangible goods acquired for direct use in the

production process

Goods (or work) in process inventory includes the products that have started in the manufacturing process but have not yet been completed The cost includes three components:

1 Raw materials that have entered into the production process,

2 Direct labor, which is the cost of the labor used directly in the manufacture of the product,

3 Manufacturing (or factory) overhead, which includes the costs other than raw materials and direct labor that are associated with the production of the product These costs include variable manufacturing overhead, such as supplies and some indirect labor, and fixed manufacturing overhead, such as insurance, utilities, and depreciation on the assets used in the production process

Finished goods inventory includes the same three cost components as the goods in

Q7-3 Under a perpetual inventory system, a company maintains a continuous record of

inventory on hand It records every purchase and use of each item of inventory in

detailed subsidiary records, sometimes in units only and sometimes with costs attached

A company maintains an Inventory account and a Cost of Goods Sold account as

summary accounts on a current basis, so inventory and cost of goods sold are

continually known

Under a periodic inventory system, a company periodically determines its inventory

quantity and cost by a physical count of the goods on hand It typically does not debit

the costs of purchases to an inventory account, but to an account entitled Purchases

A company determines its cost of goods sold by adding the purchases for the period

to beginning inventory (which is the ending inventory from the previous period) and

subtracting ending inventory, which it calculates from an actual physical count at the

end of the period

Use of the perpetual system does not eliminate the need for taking a physical inventory

count A physical count is taken periodically to confirm the balances in the perpetual

records

Q7-4 The general rule for determining whether a company includes an item in inventory is to

include all items that are under the economic control of the company, regardless of

their location or legal ownership Goods in transit shipped F.O.B destination are

included in the inventory of the seller until they are received by the buyer, and are

included in the inventory of the buyer when they are actually received Goods in

transit shipped F.O.B shipping point are no longer included in the seller's inventory, and

are included in the inventory of the buyer Goods on consignment, plus the handling

and shipping costs incurred in delivery to the consignee, are included at cost in the

inventory of the consignor, since the consignor retains economic control

Q7-5 a Goods in transit purchased F.O.B shipping point for which the invoice has been

received are included in the Raw Materials Inventory account since they are in

transit and economic control has been transferred

b Raw materials are included in the Raw Materials Inventory account

c Since the consignor retains ownership (and control) of goods out on consignment,

these are included in its Consignment-Out Inventory account

d Since economic control of goods shipped F.O.B destination does not transfer to

the purchaser until the goods are actually received, these are included in the

inventory of the seller while in transit

e Manufacturing supplies may be included in Raw Materials Inventory, but could also

be isolated in a separate account entitled Manufacturing Supplies, Factory

Supplies, or Indirect Materials

Q7-6 a Sales commission are not included in the determination of inventory cost

b A supervisor's salary, if directly related to the production of inventory, is included in

the determination of inventory cost

Q7-6 (continued)

c Freight-in charges are included in inventory cost, unless they are the result of shipping errors, such as sending merchandise to the wrong warehouse and having

it sent back Freight-out charges are included in selling costs

d Indirect factory production labor, such as the salaries of machine maintenance personnel, is included in inventory cost if it can be allocated in a reasonable manner

e Storage costs are included in inventory cost

f The salaries of corporate executives are a period expense and are not included in the determination of inventory cost

Q7-7 Standard costs are only acceptable for financial reporting purposes if adjusted for cost

variances that occur during the period A company can account for standard cost variances in two different ways: it can expense them in the period, or it can allocate them between cost of goods sold and ending inventory

Note to Instructor The following comments are not required or discussed in the

chapter but may be useful for class discussion

The advantages of expensing the variances as period expenses are that it is very simple and it avoids any arbitrary allocation to individual units of favorable or

unfavorable variances The advantages of allocating the variances between ending inventory and cost of goods sold on the basis of relative total costs is that it spreads the cost variances evenly over all units produced Note that it is also possible to allocate the variances to the units in ending inventory, but this alternative has little support Q7-8 Under variable, or direct, costing only the variable costs incurred in production are

included in inventory cost All fixed costs are treated as a period expense and are not allocated to inventory items Under absorption, or full, costing fixed manufacturing overhead costs are allocated to inventories and are expensed through the sale of inventory items Only the absorption, or full, costing method is acceptable for financial reporting purposes

Q7-9 The gross price method, in which purchases are recorded at their gross price and

discounts are only recorded when they are taken, is the easiest of the two methods to use It results in an Accounts Payable balance that reflects the maximum liability resulting from the purchase It has the disadvantage of hiding inefficiencies in the payment of Accounts Payable because discounts available but not taken are not known Also, inconsistent costing of inventories occurs when discounts taken are treated as a reduction in inventory cost Discounts lost, which result from inefficiencies

in payment or poor cash flow control and add no value to inventory, are included in the cost of inventory under the gross price method

The net price method isolates the discounts lost, thereby highlighting inefficiencies It also states the inventory at the cost management should expect to pay; that is, the invoice price less all available discounts The net price method has the disadvantage

of possibly understating Accounts Payable, since some discounts may be lost, thus causing Accounts Payable to be higher However, proper adjusting entries will ensure that the correct liability appears on the financial statements

Q7-10 Generally accepted accounting principles require that an inventory cost flow

assumption be systematic, based on cost, and match costs as expenses against

revenues appropriately The assumed flow of costs does not represent the actual

physical flow of goods

The LIFO method matches the most recent costs with revenues, and thereby excludes

some of the holding gain from gross profit (income) since the most recent costs are

closer to replacement cost The LIFO method also results in lower gross profit (income)

under conditions of rising costs, which produces the benefit of reduced cash payments

for income taxes LIFO may only be used for tax purposes if it is used for financial

accounting purposes, and management may not want to show a lower gross profit

(income) on financial statements

When a company using LIFO liquidates inventory during a period (sells some, or all, of

the beginning inventory, which is valued at the costs of previous periods), costs of

goods that may be carried at extremely old and unrealistically low costs are matched

against current selling prices This matching produces a higher gross profit (income)

that may be considered unrealistic The LIFO method enables management to

manipulate profit by delaying purchases or liquidating inventory Alternatively,

management may manipulate profit by avoiding a liquidation of inventory through a

purchase at the end of the period The FIFO and average cost methods do not

produce unusual results when inventory liquidation occurs, nor are they susceptible to

profit manipulation by management

The LIFO ending inventory value bears little or no relationship to the costs of the current

period, and therefore is not relevant

LIFO is not allowed in most other countries because LIFO is not permitted to be used for

income tax purposes in those countries Therefore there has been no incentive to allow

its use for financial reporting

Q7-11 During a period of rising costs, the LIFO cost flow assumption results in a lower gross

profit (income) as compared with the FIFO method The cost of goods sold amount is

higher under the LIFO method because the most recent costs are higher than the

earliest costs During a period of falling costs, just the opposite is true The most recent

costs in inventory (used in LIFO) would be less than the earliest costs (used in FIFO),

causing a company's cost of goods sold to be lower and gross profit (income) to be

higher under the LIFO cost flow assumption

Q7-12 Under the LIFO method, the most recent costs are included in cost of goods sold, while

earlier costs remain in inventory This results in the matching of the most recently

incurred costs with current revenues in the determination of gross profit (income) and

an inventory valuation at the earliest costs A company's ending inventory differs

between a perpetual and a periodic LIFO system because of the difference in the

assumptions about the timing of the sales Under the periodic method, cost of goods

sold is determined at the end of the period, and therefore includes the costs of the

latest purchases of the period Under the perpetual method, cost of goods sold is

determined at each sale, and therefore includes the costs of the most recent

purchase(s) at that time

Q7-13 When a company using the LIFO method sells more units than it has acquired during

the period (liquidates inventory), the cost of units which were purchased in previous periods are brought into cost of goods sold Assuming inflation exists, these units have lower costs attached to them with the result that gross profit (income) is higher An extreme case of liquidation profits will result if there is a liquidation of inventory down to the base

Inventory liquidation is an issue only with the LIFO method There is a build-up of layers

in inventory that contain unit costs dating back many years Manipulation of profits can be achieved through intentional inventory liquidation under the LIFO method This

is accomplished by delaying purchases until after the close of the reporting period, thereby matching costs of past periods against current revenues

Q7-14 A holding gain is the difference between the historical cost and the replacement cost

of the units sold It is not real income since it cannot be distributed to the owners without leaving the company worse off In a company that plans to continue as a going concern, inventory must be maintained Units sold are replaced with units acquired at current costs, so holding gains must be reinvested in inventory Since the FIFO method matches the earliest costs against current revenues, there is likely to be a substantial amount of holding gains included in gross profit (income) Since the LIFO method matches the most recent costs against current revenues, there are fewer holding gains included in gross profit (income) When inventory liquidation occurs, however, the opposite is true: there will be more holding gains included in gross profit (income) resulting from the liquidated inventory under the LIFO method than under the FIFO method

Q7-15 The dollar value LIFO method simplifies some of the technical problems and

record-keeping detail involved in the LIFO method First, the inventory is grouped into pools of similar items The current cost of each inventory pool as of the end of the year is

determined, and this amount is converted into base-year costs by using a cost index to eliminate the effects of cost changes This converted ending inventory amount at base-year costs is compared with the beginning inventory at base-year costs to

determine whether there has been a real increase or decrease in the physical quantity

of the inventory If there is an increase, it is converted back to the current year costs to determine the cost of the layer added If there is a decrease at base-year costs, the decrease is converted to the costs of the most recently added layer(s) of inventory Dollar value LIFO has several advantages as compared with the simple LIFO method First, it eliminates the necessity for detailed record-keeping of the flow of physical quantities and unit costs on a LIFO basis Second, it eliminates the effects of

fluctuations in similar inventory items that may cause the LIFO base of one inventory item to be effectively eliminated, thus negating the advantages of LIFO Finally, strict application of the LIFO method requires that a new LIFO base be started for each new inventory item With the rate of technological development that exists in many

industries the advantages of LIFO would be lost, but the inventory pools of the dollar value LIFO method eliminate the need for establishing new bases for each new

inventory item

Q7-16 The double-extension and link-chain methods are used when a company computes an

internal cost index Typically, each index is prepared using a sample of the total

inventory Under the double-extension method, the ending inventory is priced at

current year costs and at base year costs, and the cost index is computed as follows:

100xCostsYearBase

atInventoryEnding

ofSample

CostYear-Currentat

InventoryEnding

ofSampleIndex

Cost

This method should be used by companies which have little change in the types of

their inventory items

Under the link-chain method, the sample of ending inventory is priced at current cost

at the end of the current year and at the beginning of the current year The current

year cumulative index is computed as follows:

Index

CostYear

Previousx

CostsCurrentYear

Previousat

InventoryEnding

ofSample

CostYearEndingat

InventoryEnding

ofSampleIndex

Cost

This method should be used by companies which have frequent changes in the types

of their inventory items

Q7-17 In a period of rising costs, cost of goods sold is higher and ending inventory is lower

under LIFO than under FIFO As a result, net income is usually lower when a company

switches to LIFO from FIFO Working capital (current assets minus current liabilities) is

also less when a company switches to the LIFO method because of the valuation of

ending inventory, a current asset, at lower costs

If the effect on prior periods is determinable, it is included in net income in the year of

the change as a cumulative effect change If the effect of the change on the results

of prior periods is not determinable, only disclosure of the effect on the current period is

required

Q7-18 The impact of LIFO inventory liquidation on a company's interim financial statements is

addressed in APB Opinion No 28, which states that interim financial statements do not

give effect to the inventory liquidation if there is expected to be no inventory

liquidation by the end of the annual period Thus, when a company incurs an

inventory liquidation at the end of an interim reporting period, it must forecast its

year-end physical quantities in inventory If it is forecasted that there will be no inventory

liquidation at the end of the year, the quantity of the base that has been liquidated

during the interim period is valued at its replacement cost instead of its LIFO historical

cost for financial reporting purposes

Q7-19 An exchange gain or loss is caused by a change in the exchange rate between the

date of a purchase or sale on credit and the date of the payment or receipt An

exchange gain occurs when the exchange rate declines (increases) between the

date a company records a payable (receivable) and the date of the cash payment

(receipt) An exchange loss occurs when the exchange rate increases (declines)

between the date a company records a payable (receivable) and the date of the

ANSWERS TO CASES

C7-1 (AICPA adapted solution)

1 a Inventories are unexpired costs and represent future benefits to the owner A

statement of financial position includes a listing of unexpired costs and future benefits

as the owner's assets at a specific point in time Because inventories are assets owned

at the specific point in time for which a statement of financial position is prepared, they are included in order that the owner's financial position is presented fairly

b Beginning and ending inventories are included in the computation of net income only for the purpose of arriving at the cost of goods sold during the period of time covered

by the statement Goods included in the beginning inventory that are no longer on hand are expired costs matched against revenues earned during the period Goods included in the ending inventory are unexpired costs carried forward to a future period

2 Financial accounting has as its goal the proper reporting of financial transactions and events in accordance with generally accepted accounting principles Income tax

accounting has as its goal the reporting of taxable transactions and events in conformity with income tax laws and regulations While the primary purpose of an income tax is the production of tax revenues to finance the operations of government, income tax laws and regulations are often produced by various forces The income tax may be used as a tool of fiscal policy to stimulate or to decelerate the economy Some income tax laws may be passed because of political pressures brought to bear by individuals or industries When the purposes of financial accounting and income tax accounting differ, it is often desirable to report transactions or events differently and to employ income tax allocation in financial statement reporting to achieve simultaneously the conflicting goals of financial accounting and income tax accounting

3 FIFO and LIFO are inventory costing methods employed to measure the flow of cost FIFO matches the first cost incurred with the first revenue produced whereas LIFO matches the most recent cost incurred with the first revenue produced after the cost is incurred (This, of course, assumes that a perpetual inventory system is in use and may not be precisely true if

a periodic inventory system is employed.) If prices are changing, different costs are

matched with revenue for the same quantity sold, depending upon whether the LIFO or FIFO system is in use In a period of rising prices, FIFO tends to value inventories at

approximate market value in the balance sheet and LIFO tends to match approximately the current replacement cost of an item with the revenue produced

4 The advantages of the dollar value LIFO method result from the use of a cost index and inventory pools The dollar value LIFO method requires less detailed record-keeping,

because it is not necessary to record continuously the value of each item in inventory, or to record the liquidations of LIFO layers as they occur The method also maintains some of the advantages of LIFO when fluctuations in the levels of inventory of similar items occur The use of a pool evens the fluctuations in the levels of individual items and only accounts for the liquidation of a LIFO layer when the quantity of inventory in the total pool declines The dollar value LIFO method also helps maintain the advantages of LIFO when technological change occurs New products can be added to the pool and obsolete items removed from the pool so that a new LIFO base is not required when a more technologically

advanced product replaces an existing product

C7-2 (AICPA adapted solution)

a 1 When using LIFO, the most recently incurred costs are included in cost of goods sold on

the earnings statement, and the earlier costs are included in the inventory reported on

the statement of financial position When using FIFO, the earlier costs are included in

cost of goods sold on the earnings statement, and the later, more current costs are

included in the inventory on the statement of financial position

If all prices remain constant and inventory quantities remain constant, there will be no

effect upon net earnings or working capital resulting from the use of LIFO rather than

FIFO

If prices are rising and inventory quantities remain constant or increase, LIFO will

produce a larger cost of goods sold and a smaller net earnings than FIFO The change

from FIFO to LIFO would thus reduce net earnings Likewise, rising prices yield a lower

LIFO inventory cost on the statement of financial position than the corresponding FIFO

inventory cost Therefore, the change to LIFO would reduce working capital

If prices are falling and inventory quantities remain constant or increase, LIFO would

produce a smaller cost of goods sold and, therefore, a larger net earnings than FIFO

The change to LIFO thus would increase net earnings Likewise, falling prices yield a

higher LIFO inventory cost on the statement of financial position than the

corresponding FIFO inventory cost Therefore, the change to LIFO would increase

working capital

If inventory quantities decrease, the relative effects of using LIFO rather than FIFO

cannot be determined without giving consideration to the direction of price changes

and the magnitude of the inventory change

a 2 The use of FIFO as an inventory method results in recognizing all elements of earnings at

the time of sale Holding gains (or losses) are combined with the operating (trading)

earnings and are not separately identified Holding gains arise from holding inventory

during periods of rising prices Operating earnings result from selling a product at a

price above current cost

Under FIFO, the operating cycle is viewed as cash to merchandise and back to cash

again; therefore, reported earnings are net of goods (actually) sold An assumed FIFO

cost flow generally is a good approximation of specific identification for most goods in

most industries According to FIFO proponents, FIFO generally matches the actual cost

of the (actual) goods sold with the revenue produced

Because FIFO ignores the cost of the replacement of the inventory at possible higher

prices (in a period of rising prices), it includes a "paper" profit that is not really available

for distribution to owners because it is needed to replace inventory

The use of LIFO as an inventory method matches the most recently incurred costs with

the revenue produced It, therefore, largely excludes holding gains from the reported

earnings if inventory quantity remains constant or increases Reported earnings from

the period are more likely to include a deduction for goods sold in an amount that

approximates more closely the higher cost required to replace inventory (during

periods of rising prices) and, thereby, represent the distributable earnings accruing to

to the reporting of an amount of net earnings that is distorted simply because replacement did not occur prior to the end of the accounting period

Assuming that the inventory decline is temporary, LIFO proponents would suggest avoiding this potential distortion by charging cost of goods sold with current costs even though some

of the goods sold may have been carried at older, lower costs The reserve account is then credited for the excess of the current replacement cost over the LIFO carrying cost for the inventory temporarily liquidated, as the alternative account title implies When this

inventory is replenished, the temporary reserve (credit) is removed, and the goods acquired are placed in inventory at their old LIFO costs While it exists, the reserve account is shown among the current liabilities on the Statement of Financial Position to currently reflect the expected reduction of reported working capital of this amount when the goods are

replaced

Under the dollar value LIFO method, changes in actual units are ignored, and the concern shifts to dollars invested in inventories This often permits rather drastic shifts in inventory mix without causing a recovery of any of the older LIFO costs This may be affected by the number of inventory pools a firm establishes; the fewer the inventory pools, the less

likelihood of any invasion of LIFO base costs

C7-3 (AICPA adapted solution)

1 a Cash discounts should not be accounted for as financial income when payments are

made Income should be recognized when the earning process is complete (when Taylor sells the inventory) Furthermore, cash discounts should not be recorded when the payments are made because in order to properly match a cash discount with the related purchase, the cash discount should be recorded when the related purchase is recorded

b Cash discounts should not be accounted for as a reduction of cost of goods sold for the period when payments are made Cost of goods sold should be reduced when the earning process is complete (when Taylor sells the inventory which has been

reduced by the cash discounts) Furthermore, cash discounts should not be recorded when the payments are made because in order to properly match a cash discount with the related purchase, the cash discount should be recorded when the related purchase is recorded

C7-3 (continued)

1 (continued)

c Cash discounts should be accounted for as a direct reduction of purchase cost

because they reduce the cost of the inventories Purchases should be recorded net of

cash discounts to reflect the net cash to be paid The primary basis of accounting for

inventories is cost, which represents the price paid or consideration given to acquire an

asset

2 Inventories would be lower using the LIFO inventory method instead of the FIFO method

over a substantial time period when purchase prices of household appliances are rising

because the inventories are at the oldest (lower) purchase prices instead of the most

recent (higher) purchase prices Correspondingly, cost of goods sold would be higher

because the cost of goods sold is at more recent (higher) purchase prices instead of older

(lower) purchase prices Consequently, net income and retained earnings would be lower

More cash flow would generally be available using the LIFO inventory method instead of

the FIFO method because taxable income is decreased, resulting generally in accrual and

payment of lower income taxes Correspondingly, income tax expense would generally be

lower

C7-4 (AICPA adapted solution)

1 a The specific identification method requires each unit to be clearly distinguished from

similar units either by description, identification number, location, or other

characteristic Costs are accumulated for specific units and expensed as the units are

sold Thus, the specific identification method results in recognized cost flows being

identical to actual physical flows Ideally, each unit is relatively expensive and the

number of such units relatively few so that recording of costs is not burdensome Under

the specific identification method, if similar items have different costs, cost of goods

sold is influenced by the specific units sold

b It is appropriate for Happlia to use the specific identification method because each

appliance is expensive, and easily identified by number and description The specific

identification method is feasible because Happlia already maintains records of its units

held by individual retailers Management's ability to manipulate cost of goods sold is

minimized because once the inventory is in retailer's hands Happlia's management

cannot influence the units selected for sales

2 a Happlia should include in inventory carrying amounts all necessary and reasonable

costs to get an appliance into a useful condition and place for sale Common (or

joint) costs should be allocated to individual units Such costs exclude the excess costs

incurred in transporting refrigerators to Minneapolis and their reshipment to Kansas City

These units costs should only include normal freight costs from Des Moines to Kansas

City In addition, costs incurred to provide time utility to the goods, i.e ensuring that

they are available when required, will also be included in inventory carrying amounts

b Examples of inventoriable costs include the unit invoice price, plus an allocated

proportion of the port handling fees, import duties, freight costs to Des Moines and to

retailers, insurance costs, repackaging, and warehousing costs

C7-4 (continued)

3 The 2004 income statement should report in cost of goods sold all inventory costs

related to units sold in 2004, regardless of when cash is received from retailers Excess freight costs incurred for shipping the refrigerators from Minneapolis to Kansas City should be included in determining operating income

C7-5 (AICPA adapted solution)

Arguments in favor of the procedure of the Atgar Corporation are:

1 The net cash price is all that is "surrendered" by the company in exchange for the goods and, therefore, is the real cost of the purchases

2 The net amount is a better measure of the liability for balance sheet purposes if the

corporation has a good cash position and normally pays within the discount period

3 The income statement shows only income and does not treat a cost saving (cash discount

on purchases) as income One cannot "make a profit" by buying goods

4 The cost of lost discounts is clearly shown and administrative control is made easier

5 In the usual instance, there will be only four identical figures that show the net amount payable to be recorded If the gross amount is entered, there will be a figure for it, another for the discount, and a third for the net amount paid Five figures will be used and the chance of error is increased

Arguments against the procedure are principally those of expediency:

1 The gross amount is always shown on the order and on the supplier's invoice, but the

discounted amount is rarely shown It is easier to record the invoice as rendered

2 The gross amount of the invoice is much more likely to be a round amount than is the discounted amount This is of practical importance in determining unit costs under several methods of keeping inventory records

3 Confirmations are usually based on gross amounts

4 No material difference in the financial statements will result from recording the gross invoice amounts in most instances The differences from one year-end to another are unlikely to be significant Therefore, the easiest method may be used

C7-6

1 The correct inventory cost is the invoice price less all available discounts plus related

acquisition and overhead costs:

C7-6 (continued)

2 The correct cost would not change if the discount was not taken The additional $2,000 is

treated as a finance expense for the period and is not included in inventory cost because

its incurrence does not increase the economic benefit to be derived from the inventory It

should be noted that under the gross price method, the $2,000 discount not taken typically

is added to the acquisition cost, but this does not produce the correct inventory cost The

$2,000 is really the cost of delaying payment for 20 days a finance charge

3 According to Accounting Research Bulletin No 43: "As applied to inventories, cost means in

principle the sum of the applicable expenditures and charges directly or indirectly incurred

in bringing an article to its existing condition and location." Even if the storage and handling

costs are fixed and not dependent on the volume of material stored, they still meet the

criteria for being included in inventory cost As a practical matter, some method of

allocating these fixed costs to the units of inventory must be developed However, if the

cost of allocating is not warranted by the benefit of increased accuracy in inventory

valuation, or if any allocation method is very arbitrary in nature, these costs might be

excluded from inventory entirely, on grounds of the cost/benefit relationship or

immateriality

C7-7 (AICPA adapted solution)

1 The average cost method is based on the assumption that the average costs of the goods

in the beginning inventory and the goods purchased during the period should be used for

both the inventory and the cost of goods sold

The FIFO (first-in, first-out) method is based on the assumption that the first costs incurred are

the first costs of items sold As a result, the inventory is at the most recent purchase prices,

while cost of goods sold is at older purchase prices

The LIFO (last-in, first-out) method is based on the assumption that the most recent costs

incurred are the first costs of items sold As a result, the inventory is at the oldest purchase

prices, while cost of goods sold is at more recent purchase prices

2 In an inflationary economy, LIFO provides a better matching of current costs with current

revenue because cost of goods sold is at more recent purchase prices Net cash inflow is

generally increased because taxable income is generally decreased, resulting in payment

of lower income taxes

3 Where there is evidence that the utility of goods to be disposed of in the ordinary course of

business will be less than cost, the difference is recognized as a loss in the current period,

and the inventory is stated at market value in the financial statements In accordance with

the concept of conservatism, inventory is valued at the lower of cost or market

C7-8

1 In an economy of continuing inflation, the LIFO method provides a better matching of current costs with current revenue, thereby eliminating effects of holding gains (inventory profit) from net income Since the units that are sold are replaced at current costs, the holding gain is not a real profit in the sense that it cannot be distributed to the owners

without leaving the company worse off In inflationary times, the LIFO method does yield a lower net income than the FIFO method, but it should be noted that lower income results in lower taxes, which means reduced cash outflows, a real economic benefit For a company like Ford, the benefits resulting from lower taxes must have been substantial enough to convince management to accept the reporting of a lower net income to its stockholders

2 Adoption of the LIFO method results in a lower valuation of inventory on the balance sheet, which affects the computation and evaluation of current assets, working capital, and any financial ratios that include inventory, thereby affecting comparability between

companies Because of the unrealistically high profits that can arise if there is a liquidation

of inventory, manipulation of net income becomes a problem, either through intentional or unintentional liquidation Finally, the LIFO method presents more complexities and

variations in application than other methods, and can be more costly to implement

3 Prior years' earnings are not adjusted because a change from another inventory cost flow assumption to LIFO is one of the exceptions to the general rule that is discussed in

paragraph 26 of APB Opinion No 20 If the cumulative effect of the change is not

determinable, no cumulative effect change is reported and disclosure is limited to showing the effect of the change on operations of the period of the change and on per share data

It must be explained that the cumulative effect of the change and pro forma amounts for prior years, had LIFO been used since the first acquisition of the types of items currently held

in inventory, are not reported because the information is simply not available

4 There is a difference between the effect of the change to LIFO on earnings and on the inventory valuation because of two factors First, the Ford Motor Company was using the lower of cost or market method of inventory valuation, with FIFO determining the cost If the inventory being carried over has been reduced to market, an appropriate adjustment to bring it back to cost is needed Second, the effect of the change to LIFO on the inventory valuation is a before-tax effect; the effect on earnings is computed after local, state, and federal income taxes are considered

5 Probably, for a Ford dealer (an automobile retailer), the specific identification method of inventory valuation would be preferable to LIFO It is the most relevant and consistent method of matching cost with revenues, when the items are of such high value and are so easily identifiable The disadvantages of using LIFO (high costs of implementing the system, susceptibility to profit manipulation, and chances for LIFO liquidation profits) may outweigh any benefits that might be derived from using the LIFO method

C7-9

1 The Kelly Company has continued to use FIFO even though it has experienced rising costs for the last 5 years and expects that trend to continue It is likely that the primary reason is

to manipulate income because the policy has some significant negative aspects:

a The payment of additional income taxes

C7-9 (continued)

1 (continued)

b The overstatement of the company's income because holding gains are included in

income

c The inconsistency with the findings of efficient capital markets research that indicate

that stock prices are not affected by the adoption of an inventory method

However, there are several appropriate reasons for the company's use of FIFO:

a To report higher income, perhaps in order to positively affect ratios or management

compensation

b To report inventory on the balance sheet at a cost that approximates replacement

cost

c To avoid LIFO liquidation profits and the related temptation to manipulate income

d To better reflect the physical flow of the inventory

e To affect the stock price under the belief that higher reported income will have a

positive affect on the company's stock price

f To avoid paying additional taxes when LIFO is adopted because of the recovery of

previous writedowns

g To avoid the violation of bond indentures or other borrowing agreements

h To avoid the additional costs of operating a LIFO method, including following detailed

IRS rules

The decision by the King Company to increase the number of LIFO pools it uses to account

for its inventory is difficult to explain The use of a larger number of pools means that fewer

types of inventory are included in each pool Therefore, the advantages of LIFO are more

easily lost as quantities of some items decline in a period It is most likely a change that is

made to manipulate income through the recognition of LIFO liquidation profits, even

though it would result in paying higher income taxes

2 Students may raise ethical issues such as:

a Conflicts between the interests of different stakeholders particularly management and

stockholders

b The issue of management compensation versus payment of additional taxes

c Is there such a concept as true income? Does the inclusion of holding gains in income

distort the message about the economic performance of the company that is given to

shareholders in the financial statements?

d The issue of expert versus unsophisticated users of financial statements and the impact

of efficient markets on each group

holding gain - the LIFO liquidation profit that increases net income and is reported in the notes to the financial statements Among the most likely causes are:

1 The adoption of a just-in-time (JIT) inventory system

2 A temporary reduction in inventory due to an interruption of supply, such as a strike by employees

3 Poor forecasting of sales

4 Income manipulation

In the first situation, the holding gain does represent an increase in the wealth of the

company because the inventory will not be replaced However, you should exclude it from income in any trend analysis you do because it cannot occur again It is likely that there will also be gains in the next year or two as the company continues to implement the system

In the second and third situations, you should exclude the holding gain from income in your analysis because the inventory will be replaced

In the fourth situation, you should not invest in the company because management is manipulating the income it reports to its shareholders and is using company resources to do that (the additional taxes that will be paid)

Of course, it may be difficult to determine which of the four causes is relevant for a

particular company

2 Students may raise ethical issues, such as:

a Conflicts between the interests of different stakeholders particularly management and stockholders

b Manipulation of income

c Agency theory

C7-11

Note to the Instructor: The student is required to base the answer on the selection of a

particular business

To avoid exchange gains and losses entirely, and thereby avoid volatile earnings, the

company would have to specify that all its transactions are expressed in terms of dollars

This ensures that all risks of exchange gains and losses are born by the other entity

Since the CEO is more willing to accept volatility if earnings are higher than they otherwise

would be, it would be necessary to try and ensure that the company only recognizes

exchange gains An exchange gain occurs when either (1) the exchange rate declines

between the date a payable is incurred for the purchase of inventory and the date of the

cash payment or (2) the exchange rate increases between the date a receivable is

acquired from the sale of inventory and the date of the cash receipt Therefore, the

company should only engage in purchases expressed in a foreign currency if the exchange

rate is expected to decline, and make sales expressed in a foreign currency if the

exchange rate is expected to increase Of course, since this policy requires predictions

about exchange rate changes, it would be very difficult to implement

Another alternative, that is beyond the scope of the book, would be to use exchange rate

futures to protect the company's exposure to exchange rate fluctuations

C7-12

1 Coca-Cola uses the average cost and FIFO methods (p 62) The company presumably

based its selection on the cost trends in the various parts of its business Both average cost

and FIFO are consistent with a falling (or constant) cost environment Average cost may

also have been selected for commodities the company purchases because of the

fluctuating costs that often exist in those markets Also, since LIFO is generally not used

outside the US, even rising cost inventories in other countries would be accounted for under

the average cost or FIFO methods

2 2001: $6,044 $1,055 = 5.73; 2000: $6,204 $1,066 = 5.82 (p 57 and p 58)

Coca-Cola appears to have used its inventory less efficiently in 2001 than 2000 because it

has a lower inventory turnover Therefore, the company's operating cycle is longer and it is

generating less cost of goods sold (and sales) from approximately the same inventory

Note to Instructor: This case does not have a definitive answer From a financial reporting

perspective, GAAP is identified and summarized From an ethical perspective, various issues

are raised for discussion purposes

C7-13 (continued)

From a financial reporting perspective, the issue is the costs that should be included in the cost of the inventory GAAP specify that cost includes the price paid or the consideration given to acquire an asset Therefore, the cost to the used book company includes the amount paid to the professor It could also include the commission paid to the rep,

especially if that is directly related to each book acquired, rather than being based on meeting a quota Although not mentioned in the case, shipping costs could also be

included It could also be argued that travel costs could be included by using the analogy

of a manufacturing company, but that probably would be considered an "aggressive" interpretation of GAAP

From an ethical perspective, the primary stakeholders are the professors, the used book company and its employees, the publisher of the textbook, the authors of the textbook, the bookstore, and students The professor receives money, the used book company makes a profit and its employees have jobs, and students are able to buy "used" books at a lower cost However, fewer new books are purchased by students Therefore, the publisher earns lower profits, the authors receive lower royalties, and the bookstore receives less revenue Also, the fixed cost of publishing the book must now be allocated over fewer copies,

thereby raising the price for students who purchase new books Also, many students may make a distinction between the situation in which professors solicit the book as compared

to books that are sent unsolicited Another issue is if the publisher makes it easy for the professor to return the book by, for example, providing a prepaid return envelope Also, does the stamping of "For Faculty Use Only" impose an obligation on the professor not to sell

it, and the used book company, the bookstore, and the student not to buy it?

C7-14

Note to Instructor: Students are expected to cite paragraphs from the FASB Original

Pronouncements in their research of this issue Since the Statements of Concepts are not included in the FASB Current Text, the solution provides references from Intermediate

Accounting

To: President, Philip Morris

From: Student

I have researched the issue of "trade loading." According to the FASB Original

Pronouncements, Statement of Concepts No 5, par 83, revenues are recognized when they are (a) realized or realizable and (b) earned (Intermediate Accounting, p 107) Also, according to the FASB Current Text, par R75.107 (FASB Original Pronouncements, FAS 48, par 6) when the right of return exists revenues are recognized if all the following conditions are met (a) the seller's price is substantially fixed or determinable at the date of sale, (b) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product, (c) the buyer's obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product, (d) the buyer has economic substance apart from the seller, (e) the seller does not have significant obligations for future performance to directly bring about resale of the product to the buyer, and (f) the amount of future returns can be reasonably estimated

C7-14 (continued)

Unless there are "hidden" agreements between Philip Morris and the distributors, the

transactions do meet the two general revenue recognition criteria and the six specific

criteria that apply when the right of return exists Therefore revenue may be recognized in

full at the time of the transfer of the cigarettes to the distributors, with an allowance for

expected returns, if any

Of course, the additional sales made in the period will be offset by reduced sales in the

following period This process will tend to make the company's earnings more volatile

C7-15

Note to Instructor: Students are expected to cite paragraphs from the FASB Current Text or

FASB Original Pronouncements in their research of this issue

To: President, Fenimore Company

From: Student

I have researched the issue of which method of accounting for manufacturing cost

variances is consistent with GAAP According to the FASB Current Text, par I78.108, fn 4

(FASB Original Pronouncements, ARB 43, Chapter 4, par 6, fn 3) standard costs are

acceptable for inventory valuation if they are adjusted at reasonable intervals to reflect

current conditions so that at the balance sheet date standard costs reasonably

approximate costs computed under one of the recognized bases For example, the

company could disclose that its inventory is reported at "standard costs, approximating

average costs."

The current policy of expensing all variances appears to be in violation of generally

accepted accounting principles because the cost of the ending inventory is not adjusted

for the actual experience of the current period Instead the cost is based on budgeted

standard costs However, when the variances are negative, including them in cost of

goods sold is consistent with the conservatism convention

The new policy of allocating the variances between cost of goods sold and inventory

clearly is consistent with par I78.108 (ARB 43, Chapter 4, par 6) Therefore, I recommend

that the new policy be adopted

Another issue to consider is materiality If the variances are never material, then either

method may be used and the company should adopt the method that can be

implemented at the lowest cost Please note that my recommendation only considers

external financial reporting and ignores any managerial issues

ANSWERS TO MULTIPLE CHOICE

Transferred from raw material $ 81,400

Depreciation on manufacturing equipment 3,000

Property tax on manufacturing equipment 3,500

Production supervisor's salary 20,000

Total cost of goods in process $143,900

E7-2

The second purchase for $4,000 shipped F.O.B shipping point is included in the inventory on December 31, 2004, since legal title to the goods is transferred to the buyer at the shipping point The cost assigned to the purchase is $4,000 (net

of any purchases discounts) plus any payments directly associated with the inventory such as freight, receiving, unpacking, inspecting, storage, insurance, applicable taxes, and similar costs The first purchase of $3,000 shipped F.O.B destination is excluded from the inventory

E7-3

1 These goods are not included in inventory until they are actually received

2 These purchases are included in inventory (unless they are goods received on consignment)

E7-3 (continued)

3 This product (unit sold) is included in inventory until received by the purchaser

4 Since these purchases are still in the control of the Golosow Company, they are

included in inventory

5 The product is included in inventory until shipped, if shipped F.O.B shipping

point, or until they are received by the purchaser, if shipped F.O.B destination

6 This product is included in inventory

E7-4

Dec Purchase Rebate Receivable ($25 x 1,100) 27,500

To account for rebate claimed on washing

machines purchased this year

To account for receipt of rebate on

washing machines purchased last year

The effect of this rebate is to reduce the cost of each washing machine

purchased during the year by $25, thereby reducing the cost of the ending

inventory by the number of washing machines purchased this year and not

sold multiplied by $25 per unit The rebate has no effect on the valuation of

ending inventory if the LIFO method is used and all units purchased during

the year are sold

To record payment of three-fourths of

inventory purchase within the discount period

To record payment of $12,500

after the discount period

To record payment of three-fourths of

inventory purchase within the discount period

Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold

$1,750 + [(300 x $4) + (200 x $5)] - $2,200 = Cost of Goods Sold

$1,750 +$2,200 - $2,200 = $1,750

or 500 units @ $3.50 = $1,750

2 LIFO: Ending Inventory (500 units):

500 units @ $3.50 = $1,750 Cost of Goods Sold (500 units):

Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold

Cost of Goods Available for Sale $3,950

Units Available for Sale 1,000

Average Cost (Cost Number of Units) $ 3.95

Ending Inventory 500 units @ $3.95 $1,975

Cost of Goods Sold:

Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold

$1,750 + $2,200 - $1,975 = $1,975

or 500 units @ $3.95 = $1,975

E7-8

1 FIFO: Cost of Goods Sold (650 units):

June 6 300 units: 200 units @ $3.20 $ 640

100 units @ $3.50 350 June 21 200 units: 100 units @ $3.50 350

100 units @ $3.60 360 June 27 150 units: 150 units @ $3.60 540

Ending Inventory (300 units):

Beginning Inventory + Purchases - Cost of Goods Sold = Ending Inventory (200 x $3.20) + [(200 x $3.50) + (250 x $3.60) + (300 x $3.65)] - $2,240 =

$640 + $2,695 - $2,240 = $1,095*

*300 units @ $3.65 = $1,095

2 LIFO: Cost of Goods Sold (650 units):

June 6 300 units: 100 units @ $3.20 $ 320.00

200 units @ $3.50 700.00 June 21 200 units @ $3.60 720.00

June 27 150 units @ $3.65 547.50

$2,287.50 Ending Inventory (300 units):

Beginning Inventory + Purchases - Cost of Goods Sold = Ending Inventory $640 + $2,695 - $2,287.50 = $1,047.50*

*100 units @ $3.20 = $ 320.00

50 units @ $3.60 = 180.00

150 units @ $3.65 = 547.50

$1,047.50

E7-8 (continued)

3 Average Cost:

June 1, Beginning Inventory 200 units @ $3.20 $ 640

June 3, Purchases 200 units @ $3.50 700

June 3, Balance 400 units @ $3.35 $1,340

June 6, Sales 300 units @ $3.35 (1,005)

June 6, Balance 100 units @ $3.35 $ 335

June 17, Purchases 250 units @ $3.60 900

June 17, Balance 350 units @ $3.53* $1,235#

June 21, Sales 200 units @ $3.53 (706)

June 21, Balance 150 units @ $3.53 $ 529#

June 24, Purchases 300 units @ $3.65 1,095

June 24, Balance 450 units @ $3.61 $1,624#

June 27, Sales 150 units @ $3.61 (541)*

June 30, Balance 300 units @ $3.61 $1,083#

Cost of Goods Sold (650 units) $1,005 + $706 + $541 $2,252

Ending Inventory (300 units @ $3.61) $1,083#

*Rounded

#A slightly different answer may result due to rounding error

E7-9 (AICPA adapted solution)

February 17, 2005 600 11.00 6,600

January 24, 2005 (portion) 100 10.50 1,050

March 31, 2005 inventory 1,600 $18,000

Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold

$4,340 + [(400 x $6.40) + (600 x $6.70)] - $4,980 = Cost of Goods Sold

$4,340 + $6,580 - 4,980 = $5,940

E7-10 (continued)

or 600 units @ $6.70 = $4,020

300 units @ $6.40 = 1,920

$5,940 LIFO - perpetual: Cost of Goods Sold (900 units):

June 15 300 units @ $6.40 = $1,920

June 22 600 units: 100 units @ $6.40 = 640

500 units @ $6.20 = 3,100

$5,660 Ending Inventory (900 units):

Beginning Inventory + Purchases - Cost of Goods Sold = Ending Inventory

$4,340 + $6,580 - $5,660 = $5,260

or 300 units @ $6.20 = $1,240

600 units @ $6.70 = 4,020

$5,260 The difference in the final inventory valuations results from the difference in the

assumptions about the timing of the sales Under the periodic method, sales

are assumed to take place at the end of the period and, therefore, the cost of

goods sold includes the costs of the latest purchases of the period, even though

those purchases were made after the sales took place Under the perpetual

method, the cost of goods sold is calculated when each sale is made and,

therefore, includes the costs of the most recent purchases at that time

E7-11

Base-year cost index = 100 Current cost index = 105

costs year

base Inventory at index

-cost Current

index cost

year - Base x

costs current

at inventory

Increase index

cost year - Base

index cost

Relevant x

costs year

base at

LIFO value Dollar

costs current

at Increase inventory

ending year

-Base

At Current Costs

x Cost Index Base Year Current Cost Index

= Inventory At Base-Year Costs

Increase (Decrease)

at Base-Year Costs

x Cost Index Relevant Base-Year Cost Index

=

Increase (Decrease)

at Relevant Current Costs

Ending Inventory

at LIFO Ending Inventory Layers in LIFO

E7-13 (AICPA adapted solution)

THE BELSTOCK COMPANY Dollar-Value LIFO Computations Inventory at Price Index Inventory at Respective (Base Year Base-Year Year Year-End Prices 2003) (2003) Prices

ACUTE COMPANY Computation of Inventories Under the Dollar-Value

LIFO Inventory Method Inventory at External Inventory at Year Ended Respective Price Index Base-Year (2003) December 31, Year-End Prices (base year 2003) Price

2004 $363,000 1.10 $330,000

2005 420,000 1.20 350,000

2006 430,000 1.25 344,000

1 Ending inventory (in units):

(70,000X$1 5)

(60,000x$1 6)

(90,000X$1

8) (20,000x$1 4)

(70,000x$1 6)

(60,000x$1 9)

(90,000x$1 index

Cost

100 x

$3,660,000

$4,010,000

109.5628

E7-15 (continued)

1 (continued)

$4,010,000 x

109.5628

100 costs

year - base at inventory

Ending

= $3,660,000 (rounded) Increase in inventory at base-year costs = $3,660,000 - $3,250,000

= $ 410,000

Layer increase at current-year costs = $ 410,000 x

100 109.5628

= $ 449,207 Total LIFO ending inventory cost = $3,250,000 + $449,207

Note that the difference is seldom recognized formally in the accounts When it

is, however, a debit is made to Cost of Goods Sold at the end of the period and

a credit to a LIFO Valuation Allowance account to bring the cumulative

balance in the allowance account up to the current difference between

ending inventory LIFO and ending inventory FIFO

2 Comparative balance sheets

2004 2003 Current Assets:

Less: Allowance to adjust the carrying

value of inventory to a last-in,

first-out (LIFO) basis (25,000) (20,000)

or

E7-16 (continued)

2 (continued)

2004 2003 Current Assets:

Inventory, LIFO basis (net of LIFO

valuation allowance of $25,000

in 2004 and $20,000 in 2003) $115,000 $ 80,000

3 If the company used FIFO, cost of goods sold would be different in 2004 by

$5,000, the change in the allowance ($25,000 - $20,000)

E7-17

1 The inventory liquidation is not reflected in the first quarter interim financial

statements if it is expected to be replaced by the end of the annual period (no

liquidation will exist at the end of the year)

The amount of this worksheet entry is the difference between the replacement

cost and the LIFO cost of the quantity of the base liquidated The cost of goods

sold is increased to the amount that it would have been if the liquidation had

not occurred, and the inventory is reduced so that when the replacement

occurs the inventory is restored to the level before the liquidation occurred,

which is $80,000 in this example

SOLUTIONS TO PROBLEMS

P7-1

1 The merchandise is included in inventory because it was owned by the Hayes Company on December 31, 2004, when it was shipped F.O.B supplier's

warehouse (i.e., shipping point)

2 The product is included in inventory because the sale did not occur until

January 10, 2005 (at the earliest)

3 This involves judgment (and perhaps a legal opinion) The machine is excluded from inventory if the customer's inspection constitutes an acceptance

Otherwise, it is included in inventory

4 The merchandise is excluded from inventory because they are consignment."

"goods-on-5 The merchandise is excluded from inventory because it is not owned by the Hayes Company until January 2, 2005, when received

P7-2

Ending inventory on hand (before adjustments) $87,450

1 Goods in transit (FOB shipping point) 3,700

2 Goods out on consignment [($2,800 1.40) + $210*] 2,210

3 Goods sold to Grina Company, FOB destination

4 Not recorded in inventory by consignee -0-

5 Not recorded in inventory until received by customer -0-

*Shipping costs for goods out on consignment are included

as a cost of inventory

#Freight charges to deliver the goods (freight-out) are not

included in inventory or cost of goods sold