Solutions manual intermediate accounting 18e by stice and stice ch09

Because the cost of purchases during a period is usually several times more than the value of the opening inventory, the price used is heavily influenced by current costs.. b LIFO reserv

301

CHAPTER 9 QUESTIONS

1 Four questions associated with accounting

for inventory are as follows:

When is inventory considered to have

been purchased?

Similarly, when is inventory considered to

have been sold?

Which costs are considered to be part of

the cost of inventory, and which are

sim-ply business expenses for that period?

How should total inventory cost be divided

between the inventory that was sold (cost

of goods sold) and the inventory that

re-mains (ending inventory)?

2 Vehicles are classified as inventory on the

balance sheets of companies that sell

ve-hicles in the normal course of business

However, for a firm that uses vehicles but

does not sell them, such as a delivery

ser-vice business, the vehicles would be shown

as property, plant, and equipment instead of

as inventory

3 Direct materials are applied directly to the

manufacturing process and become part of

the finished product

Indirect materials are auxiliary materials, or

materials that are not incorporated directly

into the finished product They include such

items as oil, fuels, and cleaning supplies

They may also include materials of minor

significance that are embodied in the final

product but are too immaterial to account for

as direct materials

4 (a) The three cost elements found in work in

process and finished goods are direct

materials, direct labor, and

manufactur-ing overhead

(b) Manufacturing overhead is composed of

all manufacturing costs other than direct

materials and direct labor It includes

in-direct labor, inin-direct materials,

deprecia-tion, repairs, insurance, taxes, and the

portion of managerial costs identified

with production efforts

5 The general rule of thumb is that

inventory-related costs incurred inside the factory wall

are allocated to the cost of inventory, and

costs incurred outside the factory wall (e.g.,

in the finished goods warehouse) are pensed as incurred

ex-6 Computers are characteristic of perpetual

in-ventory systems The recordkeeping quirements of a perpetual system are greater than those for a periodic system, so a com- puter can greatly aid in managing the data In fact, periodic systems can be operated with just an old-fashioned cash register The de- crease in computing costs over the past 20 years has greatly increased the use of perpe- tual systems

re-7 The inventory system must be cost effective

That is, cost vs benefit must be considered Also, it should provide effective control over the use and management of the asset The perpetual inventory system, because it is more costly to maintain and implement, should be used for items of relatively high unit value and for which management of the asset’s use is desired Therefore, items (a), (b), and (d) would most likely use the perpe- tual method

However, with information technology stantly bringing down the cost of perpetual inventory systems, it is possible that a perpe- tual system is used in all the cases

con-8 When a perpetual inventory system is used,

the company knows how much inventory should be on hand at any point in time Comparing the inventory records to the result

of a physical count allows the company to compute the amount of inventory shrinkage

9 (a) Merchandise in transit is legally reported

as inventory by the seller if it was shipped FOB destination

(b) Merchandise in transit is legally reported

as inventory by the buyer if it was shipped FOB shipping point or if it was shipped FOB destination and received before the year-end but not yet unloaded

or moved into the inventory storage area

10 (a) Consigned goods should be included in

the inventory of the shipper/consignor, not in the inventory of the dealer holding the goods The consigned inventory should be reported in the shipper's in- ventory at the sum of its cost and the

302 Chapter 9

handling and shipping costs incurred in

the transfer to the dealer

(b) Inventory sold under an installment sale

may continue to be shown in the

in-ventory of the seller because the seller

retains title to the goods If the seller

re-ports the inventory, it should be reduced

by the buyer’s equity in the inventory as

established by collections However, in

the usual case when the possibilities of

returns and defaults are very low, the

seller, anticipating completion of the

con-tract and the ultimate passing of title,

re-cognizes the transaction as a regular

sale and removes the goods from

re-ported inventory at the time of the sale

11 The substance of an inventory sale

accom-panied by a repurchase agreement is that

the inventory is being used as collateral for a

loan Accordingly, the inventory continues to

be reported as part of the seller’s inventory

The proceeds from the ―sale‖ are reported as

a loan A note describes the repurchase

agreement

12 An activity-based cost (ABC) system is one

in which overhead costs are allocated to

in-ventory based on clearly identified cost

driv-ers, which are characteristics of the

produc-tion process known to create overhead costs

13 (a) Cash discounts may be accounted for

under the gross method or the net

me-thod Under the gross method,

purchas-es of merchandise are recorded at the

gross amount of the invoice and

dis-counts taken at the time of payment are

recognized in a contra purchases

ac-count Under the net method, purchases

of merchandise are recorded at the net

amount of the invoice and any discounts

not taken are recognized as an expense

of the period

(b) The net method of accounting for

pur-chases is strongly preferred By

separate-ly reporting purchase discounts lost, the

failure of a company to take advantage

of cash discounts is highlighted It is

nor-mally considered advantageous for a

company to take the purchase discount

Failure to do so is considered a lapse in

efficient financial management of a

com-pany

14 Although the specific identification method

may be considered a highly satisfactory proach in matching costs with revenues, it is often difficult or even impossible to apply If there are many items in the inventory with acquisition occurring at different times and at different prices, cost identification procedures may be very slow, burdensome, and costly When the units are in effect identical, the specific identification method opens the door

ap-to possible profit manipulation through the choice of specific units for sale

15 The average cost method of inventory

valua-tion has the advantage of evening out the

fluctuations of inventory pricing and generally

is easier to apply than either the FIFO or LIFO method As prices vary, the average price used to cost inventory sold is automati- cally adjusted Because the cost of purchases during a period is usually several times more than the value of the opening inventory, the price used is heavily influenced by current costs

16 For most businesses, a FIFO assumption

better matches the physical flow of goods A

LIFO physical flow would mean that the oldest inventory would never be recycled but in- stead would stay in the company for years

On the other hand, a LIFO assumption better

matches current costs with current revenues

because cost of goods sold is computed based on the costs of the most recently ac- quired inventory

17 Computation of average cost and LIFO under

a perpetual system is complicated because the average cost of units available for sale changes every time a purchase is made, and the identification of the ―last in‖ units also changes with every purchase

18 (a) A new LIFO layer is created in each year

in which the number of units purchased

or manufactured exceeds the number of units sold As long as inventory contin- ues to grow, a new LIFO layer is created each year and the old LIFO layers re- main untouched

(b) LIFO reserve is the difference between

the LIFO ending inventory amount and the amount obtained using another in- ventory valuation method (such as FIFO

or average cost)

19 (a) The LIFO conformity rule requires

com-panies using the LIFO method for tax

reporting to also use it for financial

re-porting

(b) In 1981, the IRS relaxed the LIFO

con-formity rule by permitting companies to

use non-LIFO disclosures as long as

they are not presented on the face of the

income statement and to apply LIFO

dif-ferently for book purposes than for tax

purposes

20 In periods of increasing prices, FIFO

histori-cal cost flow will reflect the greatest dollar

value of ending inventory because the

histor-ical unit cost assigned to the asset reflects

the most recent unit price LIFO inventory will

reflect the oldest relevant unit costs, thereby

causing the highest cost of goods sold Even

though the quantity of inventory does not

change, the dollar value of the asset will

change when using FIFO because the

be-ginning inventory reflects the most recent

unit prices for the prior year and the current

year’s ending inventory reflects the most

re-cent unit prices for the current year LIFO

in-ventory value would not change since there

has been no change in LIFO quantities and

layers LIFO will result in higher cost of

goods sold and lower payment of income

taxes

21 The primary reason for using LIFO is to

de-crease income taxes paid during times of

in-flation For firms with small inventory levels

or with flat or decreasing inventory costs,

LIFO gives little, if any, tax benefit Such

firms are unlikely to use LIFO

22 Under IAS 2, LIFO is not currently an

ac-ceptable inventory valuation method

23 The lower-of-cost-or-market rule is an

appli-cation of the general valuation concept for

inventories that they should not be valued at

a price that would exceed the net realizable

values If market is defined as replacement

cost and there is no evaluation of net

realiz-able value, the resulting valuation using the

lower-of-cost-or-market concept could be

ultraconservative On the other hand, if a

de-cline in value has occurred, such dede-cline

should be reflected in the year the loss

occurred Similar arguments could be sented for recording gains in value if they occur

pre-24 Movement in replacement cost (entry cost)

may not result in immediate movement in sales price (exit value) If sales price does not change, no downward adjustment to cost

is justified Thus, the floor limitation prevents charging a loss in one period to obtain a higher than normal profit in a subsequent period On the other hand, sales price may decline and replacement cost may not Thus, the net realizable value for an item might fall below replacement cost This decline should

be recognized in the period when the loss occurs, not in a subsequent period when the sale takes place

25 Application of the lower-of-cost-or-market

method to individual inventory items results

in a lower inventory value When LCM is plied to the inventory as a whole, the in- creased market value of some inventory items offsets decreases in the value of other items

ap-26 The value assigned to inventory can be very

important in determining how profits and losses are allocated among different report- ing units within the business A manager wants any inventory he or she receives from another department to be transferred at the lowest possible value When transferred in- ventory is reported at a low value, higher profits are recognized on the subsequent sale of the item Reported profits of a de- partment may be used in the evaluation and bonus computation for the manager of the department

27 Under IAS 2, the rule governing inventory

write-downs can best be labeled ―lower of cost or net realizable value.‖ Also, inventory write-downs can be reversed if inventory sell- ing prices subsequently recover

28 In developing a reliable gross profit

percen-tage, reference is made to the historical centage, with adjustments for changes in current circumstances For example, the his- torical gross profit percentage would be ad- justed if the pricing strategy has changed (e.g., because of increased competition), if the sales mix has changed, or if a different inventory valuation method has been adopted (e.g., a switch from FIFO to LIFO)

was not recognized in

recording ending

Net income is overstated by the amount of the error

Current assets and owners’

equity are overstated by the amount of the error

No effect on net income, though both ending inventory and purchases are understated

al-by the amount of the omission

Both current assets and current liabilities are understated by the amount of the omission

Net income is understated by the amount of the error

Current assets and owners’

equity are understated by the amount of the error

(2) Effect on Statements of Succeeding Period

Net income is understated by the amount of the error

No effect on the balance sheet

No effect on net income cause the understatement in the beginning inventory is counterbalanced by the over- statement of purchases

be-No effect on the balance sheet

Net income is overstated by the amount of the error

No effect on the balance sheet

30 Generally, a higher inventory turnover ratio

is a sign of a company that is managing its

inventory more efficiently Therefore,

Com-pany B, with an inventory turnover ratio of

10.0 times, is managing its inventory more

efficiently than Company A, with a ratio of

8.0 times However, as illustrated in the

chapter, inventory turnover ratios for

com-panies that do not use the same inventory

valuation method cannot be compared For

example, comparison of the ratios for

Companies A and B would not be valid if

one company used FIFO and the other

used LIFO

31. ‡ The retail inventory method is more flexible

than the gross profit method in that it allows

estimates to be based on FIFO, LIFO, or

average cost assumptions and even

per-mits estimation of lower-of-cost-or-market

values The retail inventory method also

of-fers the advantage that when a physical

in-ventory is actually taken for financial

state-ment purposes, the inventory can be taken

at retail and then converted to cost without

reference to individual costs and invoices,

thus saving time and expense

32. ‡ FIFO and LIFO assumptions can be

incor-porated into the retail inventory method by

computing a different cost percentage for

beginning inventory and for purchases If a

FIFO assumption is made, the cost tage used to convert ending inventory at re- tail into cost is the cost percentage for the purchases If a LIFO assumption is made, the conversion from retail to cost is done by first using the cost percentage applicable to beginning inventory and then applying the purchases cost percentage to the new LIFO layer, if any

percen-33. ‡ a When using the retail inventory method

to estimate average cost, markdowns are included in the computation of the cost percentage

b When using the retail inventory method

to estimate lower of cost or market, markdowns are excluded from the computation of the cost percentage However, markdowns are included in the computation of ending inventory at retail

34.‡ The purpose of forming LIFO pools is to simplify the LIFO calculations, so simplifica- tion should be a major factor In addition, all items in the pool should have some simi- larity, such as being in the same product line Finally, a company should carefully consider potential income tax effects when forming LIFO pools

‡

Relates to Expanded Material

35. ‡ Dollar-value LIFO has the advantage of

using dollar values identified with the

inven-tory rather than physical units, and

there-fore the LIFO inventory valuation process is

simplified Dollar-value LIFO makes the

clerical routine less tedious and costly and

permits the use of the LIFO valuation

me-thod in situations where it would not be

feasible to use the unit method

36. ‡ Indexes are used to adjust current prices to

a base-year period This adjustment is

ne-cessary to identify incremental layers If

there is a new layer, another index must

be used to adjust the incremental layer to

current-year prices The incremental layer

may be computed using beginning-of-year

prices, average prices, or end-of-year

prices

37. ‡ When using dollar-value LIFO, a new LIFO

layer can be valued using a year-end price

index, a first purchase price index, or an

average price index Use of a first purchase

price index is most consistent with the LIFO

assumption

38. ‡ a When computing the cost percentage

for the dollar-value LIFO retail method,

beginning inventory values are ignored

Any new inventory layer is converted

from retail to cost using the cost

per-centage applicable to current year

purchases

b Both markdowns and markups are

in-cluded in the retail number used to compute the cost percentage for use with the dollar-value LIFO retail me- thod

39. ‡ No journal entry is made when a purchase commitment is originally entered into A purchase commitment is not an inventory purchase but a commitment to purchase inventory in the future This type of contract

is an exchange of promises about future actions and is known as an executory con- tract

40. ‡ No, all transactions with foreign companies are not classified as foreign currency trans- actions The currency specified by the in- voice determines if a transaction is a for- eign currency transaction For example, if

an invoice is denominated in U.S dollars, then—for a U.S company—the transaction

is a domestic transaction regardless of to whom the merchandise is sold

41. ‡ The FASB requires an adjustment on the balance sheet date to ensure that gains and losses from exchange rate changes are included in the period in which the changes took place

‡

Relates to Expanded Material

Inventory 4,500 Cash 9,750

Less: Ending inventory 145,000

Cost of goods sold $ 795,000

2

Beginning inventory $ 220,000

Plus: Purchases 720,000

Inventory 85,000

PRACTICE 9–3 GOODS IN TRANSIT AND ON CONSIGNMENT

Direct materials:

Direct labor 198,000 Manufacturing overhead:

Depreciation on factory building $ 32,000

Factory supervisor’s salary 56,000

Indirect labor 36,000

Inventory 500,000

Accounts Payable 500,000

Cash 500,000

Units remaining: 400, meaning that 2,000 (2,400 – 400) units were sold

PRACTICE 9–7 INVENTORY VALUATION: COMPLICATIONS WITH A PERPETUAL

$30,855/1,700 = $18.150 per unit

310 Chapter 9

1 LIFO reserve: Difference between LIFO ending inventory and ending inventory computed using FIFO (which approximates current replacement cost)

LIFO reserve $ 60

2 Cost of goods sold in Year 4: 200 units sold $4.00 = $800

3 Cost of goods sold in Year 4 if the number of units purchased had been 150:

Total cost of goods sold $740

It can be seen that dipping into the LIFO layers, as in (3), increases reported profit

as the old LIFO layers, with lower costs, are assumed to be sold

PRACTICE 9–10 LIFO AND INCOME TAXES

1 LIFO income taxes

2 FIFO income taxes

PRACTICE 9–11 LOWER OF COST OR MARKET

A: Ceiling = $650, Replacement cost = $600, Floor = $550; Market = $600

B: Ceiling = $740, Replacement cost = $550, Floor = $590; Market = $590

C: Ceiling = $1,150, Replacement cost = $1,100, Floor = $850; Market = $1,100 Lower of cost or market:

Item A $ 575

Item B 590

Item C 1,100

Total $2,265

312 Chapter 9

PRACTICE 9–12 LOWER OF COST OR MARKET: INDIVIDUAL VS AGGREGATE See the solution for Practice 9–11 for computation of the market amounts for the in-dividual inventory items

Original

The market value of the inventory as a whole is $2,290 Market is less than cost ($2,290 < $2,455), so the amount of the inventory that should be reported is $2,290 PRACTICE 9–13 LOWER-OF-COST-OR-MARKET JOURNAL ENTRIES

1 Loss on Decline in Value of Inventory 400

Allowance for Decline in Value of Inventory 400

2 Allowance for Decline in Value of Inventory 300

Cost of Goods Sold 300

$300 = $400 beginning balance in the allowance account – $100 required ending balance PRACTICE 9–14 RETURNED INVENTORY 1 Loss on return: $250,000 recorded amount of returned inventory – $250,000 orig-inal cost = $0 loss Sales $ 225,000 Cost of goods sold (250,000) Gross profit (loss) $ (25,000) 2 Loss on return: $225,000 recorded amount of returned inventory – $250,000 orig-inal cost = $25,000 loss Sales $ 225,000 Cost of goods sold (225,000) Gross profit $ 0

orig-inal cost = $105,775 loss

Sales $ 225,000

Cost of goods sold (144,225)

Gross profit $ 80,775

PRACTICE 9–15 GROSS PROFIT METHOD

-

PRACTICE 9–16 INVENTORY ERRORS

1 Year 1

Correct net income: $3,000 – $2,200 = $800

2 Year 2

Correct net income: $3,000 + $2,650 = $5,650

Note that the effect of the inventory error in Year 1 was reversed in Year 2

3 Year 3

Correct net income: $3,000 – $450 = $2,550

Note that the effect of the inventory error in Year 2 was reversed in Year 3

314 Chapter 9

PRACTICE 9–17 COMPUTING INVENTORY RATIOS

1 Inventory turnover = Cost of goods sold/Average inventory

Average Cost

Inventory, January 1 $25,000 $ 50,000 Purchases in January 40,000 70,000

Markups 30,000 Markdowns (25,000)

$ 125,000 Cost percentage:

Average cost: ($65,000 ÷ $125,000) = 52.0%

Goods available for sale $ 125,000

Inventory, January 31, at estimated cost:

Average cost: ($45,000 52.0%) $23,400

Ending inventory in units = 40 (160 available for sale less 120 units sold)

$830 (25 units @ $20 + 15 units @ $22)

‡

Relates to Expanded Material

PRACTICE 9–21 ‡ DOLLAR-VALUE LIFO

316 Chapter 9

Loss: 250,000 ounces ($1,075.10 – $1,110.20) = $8,775,000

Gain: 250,000 ounces ($1,092.00 – $1,075.1) = $4,225,000

Gold Inventory 273,000,000

Cash 277,550,000 Remaining balance in Estimated Loss: $8,775,000 – $4,225,000 = $4,550,000

$10,989 – $10,000 = $989

‡

Relates to Expanded Material

Accounts Receivable 5,900 Sales 5,900 Cost of Goods Sold 3,200

Inventory 3,200

Inventory 400

318 Chapter 9

Total required $ 1,665,000

Purchases—2013 $ 1,065,000

December purchases:

Date of Order Dec 11, 2012 8,000 Dec 13, 2012 13,000 Total available for sale 171,000 units

Less: December sales:

Other sales (25,000)

inven-tory until shipped An exception would be special orders

on a consignment basis and therefore does not possess legal title

point and therefore would be included in the inventory on the shipping date

segregated for shipment

destina-tion and was not received until January 3,

2014

collect the full purchase price, so the sale is recognized even though legal title has not passed This treatment as a sale and exclusion

of inventory may be opposed by Anson’s

audi-tor because SAB 101 typically requires that

le-gal title pass before a sale is recognized

loan with the inventory as collateral

9–30 Oakeson Mfg Inc

Schedule of Cost of Goods Manufactured For the Quarter Ended March 31, 2013 Raw materials:

Beginning inventory $ 520

Purchases [(75 $8) + (120 $8.50)] 1,620

Cost of raw materials available for use $ 2,140

Less: Ending inventory (80 $8.50) 680

Direct labor 3,100

$ 8,252

9–31 Aug 15 Purchases 15,225*

To record purchase of inventory at net price

*$15,536 2% = $311; $15,536 – $311 = $15,225 Aug 28 Accounts Payable 15,225

Discounts Lost 311 Cash 15,536

To record payment of invoice

*$10,300 0.03 = $309; $10,300 – $309 = $9,991

16 Accounts Payable 17,169 Discounts Lost 222 Cash 17,391

To record payment of December 3 and 10 invoices

9–34 Periodic inventory system

350 units $18.66 (average unit cost) = $6,531

322 Chapter 9

9–35 (Concluded)

Chapter 9

324

(b) $7,500 ($86,000 – $78,500) (c) $15,000 ($86,000 – $71,000)

2 Theoretically, specific identification should be used in every case ever, there are many instances where the costs of using the specific identification method far exceed the benefits In cases in which the in- ventory item can be easily identified and the resulting information is beneficial, the use of specific identification is warranted Expensive items such as automobiles and houses are typically accounted for using specific identification In this case, by carefully choosing the semitrailer to sell, Dutch has managed to maximize reported income

How-if specHow-ific identHow-ification is used Thus, there is some potential for come manipulation

in-9–37

1 Computation of FIFO inventory, October 31:

August purchases 5,500 units @ $5.10 = $28,050

October purchases 5,100 @ 5.30 = 27,030 FIFO:

Most recent purchases, October 5,100 units @ $5.30 = $27,030 *

*It can be assumed that all of the October purchases remain in the

inventory because $36,390 exceeds $27,030 ($27,030/$5.30 = 5,100 units)

= 1,800 units from the September purchase

Computation of LIFO inventory, October 31:

Earliest cost relating to goods, August 5,500 units @ $5.10 = $ 28,050

*Total number of units in inventory (from FIFO method

shown above) 6,900 units Less August purchases 5,500

2 In the notes to its financial statements, White Farm could disclose that its LIFO reserve as of October 31 is $1,060 ($36,390 – $35,330)

$0.40

value) inventory

(Beginning

of (Quantity 302,500

sale) for available units

of (Cost

$145,210

= $0.48 per unit cost*

*An alternative method would be:

000 , 60

800 , 28

$

= $0.48

4 Ending inventory value = 60,000 units $0.48 (unit cost) = $28,800

? – 82,100 = 24,000 units Quantity available for sale = 106,100 units

Beginning inventory + Purchases = Quantity available for sale

? + 71,900 = 106,100 units Beginning inventory = 34,200 units

Sales – Cost of goods sold = Gross profit on sales

$738,900 – ? = $358,100 Cost of goods sold = $380,800

Cost of Goods Sold

Beginning inventory value = $145,350

*Because the company uses the FIFO inventory method, the earliest tory costs are used to compute cost of goods sold The beginning inven- tory is used, and then purchases are added until the total units sold is reached Thus, only 13,100 units of the July 12 purchase are included

Cost of Goods Sold (Based on LIFO inventory costing)

9–40 (Concluded)

Gross profit on sales $4,275 $5,395

The inability to replenish the LIFO layers at month-end required son to dip into past LIFO layers that were valued at a cost lower than current costs The result was an increased gross profit simply from the inability to replenish inventories

(difference between LIFO layer and the most recent historical cost)

Difference in price 10 Unit average cost of inventory sold from

beginning inventory $15

Value of units sold 1,500,000*

*$15.00 100,000 units equal the value of the units sold, $1,500,000

328 Chapter 9

9–42

Debit Credit Debit Credit Debit Credit Debit Credit

Reduction in inventory due to

change from FIFO to LIFO:

Proof: Total income reported, 2010–2013 $ 184,250

Total income as redetermined using LIFO, 2010–2013 173,550 Reduction in total income $ 10,700 December 31, 2013, inventory at FIFO $ 125,000 December 31, 2013, inventory at LIFO 114,300 Difference $ 10,700

9–43 1 FIFO Method Year

in-330 Chapter 9

Market

Sales price less selling expenses

exceeds cost of $251,000

Year 2

Lowest cost of goods sold is with FIFO ($44,900), so FIFO yields the highest net income in 2013

Lowest cost of goods sold is with LIFO ($61,900), so LIFO yields the highest net income in 2014

3 The beginning inventory was $0 with all four methods Therefore, the one with the lowest inventory at the end of three years would have the highest aggregate cost of goods sold for the 3-year period LIFO has the lowest inventory at the end of 2015 ($11,600), so LIFO has the lowest aggregate net income for the three years

4 Refer to part (2) FIFO cost of goods sold is $63,500 LCM cost of goods sold is $63,000 So, FIFO cost of goods sold is higher by $500; there- fore, FIFO net income is lower by $500

332 Chapter 9

Less: Estimated reconditioning expenses $ 600 Normal profit (35% of $4,500) 1,575 2,175 Floor value of trade-in $2,325 Cash 4,500

Sales 4,500 Cost of Goods Sold 2,325

Inventory 2,325

2 Cash 4,500

Sales 4,500 Cost of Goods Sold 5,300

Inventory 5,300

3 The list price is apparently higher than the amount for which Napali will sell the equipment The value placed on the returned inventory under the second method exceeds the sales price of a reconditioned return The first entry is preferred and would be based on a generally accepted valuation method

Credit sales:

*Average gross profit percentage of sales: 32%

Cost of goods sold as percentage of sales: 100% – 32% = 68%

Estimated Inventory Loss on August 15:

9–50 Magna Corporation

Computation of Value of Work-in-Process Inventory Lost

June 30, 2013 Sales $ 584,000

Purchases 88,000 Total available $ 137,300

Direct labor $ 130,000

Adjustments (see explanations on next page):

Item (a) 7,200 (7,200) Item (b) 17,500 (17,500) Item (c) (2,900) 2,900

(b)—Although the merchandise was not in the physical possession of the Martin Company, the merchandise should have been recorded in the ending inventory As a result of the exclusion, ending inventory was understated Cost of goods sold was overstated, and income before taxes was understated In 2013, the beginning inventory would be un- derstated, causing income before taxes to be overstated

(c)—The merchandise had been sold and should not have been cluded in the ending inventory count This overstatement of ending inventory would cause cost of goods sold to be understated, and hence income before taxes would be overstated In 2013, the begin- ning inventory would be overstated, causing income before taxes to

in-be understated The sale was correctly recorded in 2012

(d)—Ending inventory was understated because the purchased goods had not arrived at Martin Company and were not included in the ending inventory count However, purchases were also understated because the purchase was not recorded until 2013 The understatement of pur- chases and understatement of ending inventory net out, and the effect

is eliminated In 2013, beginning inventory would be understated and purchases would be overstated Again, the errors would net out

2 The total income before taxes for the two years is the same

9–52 (Concluded)

3 2013

Feb 28 Inventory 23,300*

Retained Earnings 21,800 † Purchases 1,500

Retained earnings correction:

$ 21,800 9–53

2011: Purchases 8,200 units @ $4.30

Less: Sales 5,800

Less: Sales 9,200

Less: Sales 6,300 Ending inventory 2,600 units Value of 2013 ending inventory:

Earliest cost relating

to goods, 2011 2,100 units @ $4.30 = $ 9,030

365 5

=

$275,000)/

+ ($175,000

$1,125,000

4.1

365 .1 4

=

$405,000)/

+ ($275,000

2 If this company were in the business of selling fresh fruits and bles, customers may begin to wonder just how fresh the produce is For firms in this industry, an increase in the days in inventory measure would be bad news On the other hand, in the housing market an in- crease in the number of days required to sell a house must be meas- ured against the possible increase in selling price from waiting If the 73-day figure was achieved by lowering prices, then 89 days may be a desirable wait for selling a house

Computation of Estimated Inventory Under the Retail Inventory Method

November 30, 2013

Inventory, November 1 $ 107,600 $ 160,000 Purchases 308,608 440,000 Goods available for sale $ 416,208 $ 600,000

1 FIFO cost percentage: $308,608/$440,000 = 70.14%

Estimated FIFO inventory cost, November 30:

$112,000 0.7014 = $78,557

‡

Relates to Expanded Material.

9–55. ‡ (Concluded)

2 LIFO cost percentages:

$107,600/$160,000 = 67.25%

$308,608/$440,000 = 70.14%

Comparing beginning inventory at retail ($160,000) to ending inventory

at retail ($112,000), it can be seen that no new LIFO layer was added Therefore, ending inventory is converted to cost using the cost percen- tage applicable to beginning inventory only

Estimated LIFO inventory cost, November 30:

$112,000 0.6725 = $75,320

3 Average cost percentage: $416,208/$600,000 = 69.37%

Estimated inventory at average cost, November 30:

$112,000 0.6937 = $77,694

Beginning inventory $ 2,400 $ 3,000 Purchases 27,000 36,000 Freight-in 1,800

Goods available for sale $31,200 $ 39,000 Cost percentage ($31,200 ÷ $39,000) = 80.0%

Deduct: Sales (31,200)

Ending inventory at lower of cost

or market ($5,200 0.800) $ 4,160

Beginning inventory $ 2,400 $ 3,000 Purchases 27,000 36,000 Freight-in 1,800

Markdowns (2,600) Goods available for sale $31,200 $36,400 Cost percentage ($31,200 ÷ $36,400) = 85.7%

Deduct: Sales 31,200

Ending inventory at average cost ($5,200 0.857) $ 4,456

‡

Relates to Expanded Material.

338 Chapter 9

Beginning inventory $ 26,550 $ 45,000 Purchases 309,000 435,000 Purchase discounts (4,200)

1 Average cost method Cost percentage: $336,600/($510,000 – $40,000) = 71.62%

Ending inventory at estimated average cost:

$40,000 0.7162 = $28,648

2 Lower-of-cost-or-market method Cost percentage: $336,600/$510,000 = 66.00%

Ending inventory at estimated lower of cost or market:

9–59 ‡

340 Chapter 9

9–60 ‡