Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
CHAPTER 6
Reporting and Analysing Inventory
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives
Questions
Brief
Exercises
Exercises
A
Problems
B
Problems
1.
Describe the steps in
determining inventory
quantities.
1, 2, 3
1
1, 2
1A, 7A
1B, 7B
2.
Explain the basis of accounting for inventories
and apply the inventory
cost flow assumptions
under a periodic inventory system.
4, 5, 6, 7
2
3, 4, 5,
12*, 13*
2A, 3A,
4A, 8A*
2B, 3B,
4B, *8B
3.
Explain the financial
statement effects of
each of the inventory
cost flow assumptions.
8, 9, 10
3
5
2A, 3A,
7A, 9A*,
10A*
2B, 3B,
7B, 9B*,
10B*
4.
Indicate the effects of
inventory errors on the
financial statements.
11, 12
4, 5
6, 7
5A, 6A
5B, 6B
5.
Explain the lower of
cost and market basis
of accounting for inventories.
13, 14
6
8
4A
4B
6.
Calculate and interpret
inventory turnover.
15, 16, 17
7, 8
9, 10
4A, 5A, 7A 4B, 7B
7.
*Apply the inventory
cost flow assumptions
under a perpetual inventory system (Appendix A).
18*, 19*,
20*
9*, 10*, 11* 11*, 12*,
13*
8A*, 9A*,
10A*
8B*, 9B*,
10B*
*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the
appendices to each chapter.
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ASSIGNMENT CHARACTERISTICS TABLE
Problem
Number
Description
Difficulty
Level
Time
Allotted (min.)
Simple
30-40
1A
Identify items in inventory.
2A
Apply cost flow assumptions in periodic inventory
system, and assess financial statement effects.
Moderate
30-40
3A
Apply cost flow assumptions in periodic inventory
system, prepare statements of earnings, and answer
questions.
Moderate
30-40
4A
Prepare journal entries for purchaser and seller using
FIFO periodic; apply lower of cost and market.
Moderate
30-40
5A
Determine effects of inventory errors.
Moderate
15-20
6A
Determine effects of inventory errors.
Moderate
15-20
7A
Calculate ratios; comment on liquidity and effect of
cost flow assumptions on ratios.
Moderate
20-30
*8A
Apply average cost flow assumption in periodic and
perpetual inventory system.
Moderate
40-50
*9A
Apply cost flow assumptions in perpetual inventory
systems, and assess financial statement effects.
Moderate
40-50
*10A
Prepare journal entries under perpetual inventory
system. Assess financial statement effects.
Moderate
30-40
Simple
30-40
1B
Identify items in inventory.
2B
Apply cost flow assumptions in periodic inventory
system and assess financial statement effects.
Moderate
30-40
3B
Apply cost flow assumptions in periodic inventory
system, prepare statement of earnings, and answer
questions.
Moderate
30-40
4B
Prepare journal entries for purchaser and seller using
average periodic; apply lower of cost and market.
Moderate
30-40
5B
Determine effects of inventory errors.
Moderate
15-20
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Problem
Number
6B
Financial Accounting, Second Canadian Edition
Description
Determine effects of inventory errors.
Difficulty
Level
Moderate
Time
Allotted (min.)
15-20
7B
Calculate ratios; comment on liquidity and effect of
cost flow assumptions on ratios.
Moderate
20-30
*8B
Apply FIFO cost flow assumption in periodic and perpetual inventory system.
Moderate
40-50
*9B
Apply cost flow assumptions in perpetual inventory
systems, and assess financial statement effects.
Moderate
40-50
*10B
Prepare journal entries under perpetual system. Assess financial statement effects.
Moderate
30-40
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ANSWERS TO QUESTIONS
1. Inventoriable costs are $3,010 (invoice cost $3,000 + freight charges $70  purchase discounts $60). The amount paid to negotiate the purchase is a buying cost that normally is not
included in the cost of inventory because of the difficulty of allocating these costs. Buying
costs are expensed in the year incurred.
2. Taking a physical inventory involves actually counting, weighing or measuring each kind of
inventory on hand. Retailers, such as hardware stores, generally have thousands of different
items to count. This is normally done when the store is closed. Tom will probably count
items and mark the quantity, description, and inventory number on prenumbered inventory
tags.
Purchased inventory in transit shipped FOB shipping point will have to be included in inventory. Inventory that has been shipped to customers FOB destination and not received by the
customer before year-end will also have to be included in the count. Finally, any inventory
held by other retailers on consignment will have to be included in the count as well.
3. (a) (1) The goods will be included in Janine Ltd.’s inventory if the terms of sale
are FOB destination.
(2) They will be included in Fastrak Corporation’s inventory if the terms of sale are FOB
shipping point.
(b) Janine Ltd. should include goods shipped to a consignee in its inventory. Goods held by
Janine Ltd. on consignment should not be included in inventory
4. Actual physical flow may be impractical because many items are indistinguishable from one
another. Actual physical flow may also be inappropriate because management may be able
to manipulate net income through specific identification of items sold.
5
Because the specific identification method requires that records be kept of the original cost
of each individual inventory item it is possible to manipulate the cost of goods sold by deliberately selecting to sell inventory items with higher or lower costs.
LIFO values the cost of goods sold at the most recent purchase price, therefore a company
could decide to buy or delay buying inventory at year-end to manipulate the cost of goods
sold.
6. (a) Average cost
(b) LIFO
(c) FIFO
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Questions (Continued)
7.
(1) No effect – cash is not affected by inventory cost flow assumptions
(2) In a period of declining prices FIFO will produce a lower ending inventory as inventory is
valued using the most recent (lower) prices; LIFO will produce a higher ending inventory
as ending inventory is valued at the higher older prices.
(3) The cost of goods sold effect is opposite to that of ending inventory. Hence, cost of
goods sold will be higher under FIFO and lower under LIFO.
(4) Because of the effect on the cost of goods sold, net earnings will be lower under FIFO
and higher under LIFO.
8. Plato Ltd. is using the FIFO cost flow assumption of inventory costing, and York Ltd. is using
the LIFO cost flow assumption. Under FIFO, the latest goods purchased remain in inventory.
Thus, the inventory on the balance sheet should be close to current costs. The reverse is
true of the LIFO cost flow assumption. Plato Ltd. will have the higher gross profit because
cost of goods sold will include a higher proportion of goods purchased at earlier (lower)
costs.
9. Swift Corporation may experience severe cash shortages if this policy continues. All of its
net earnings is being paid out as dividends, yet some of the earnings must be reinvested in
inventory to maintain inventory levels. Some earnings must be reinvested because net earnings is calculated with cost of goods sold based on older, lower costs while the inventory
must be replaced at current, higher costs. Because of this factor, net earnings under FIFO
are sometimes referred to as “phantom profits.”
10. No. Selection of an inventory cost flow assumption is a management decision made to best
match costs to revenues. However, once an assumption has been chosen, it should be consistently applied.
11. (a) Mila Ltd.’s 2004 net earnings will be understated $5,000; (b) 2005 net earnings will be
overstated $5,000; and (c) the 2005 retained earnings will be correct.
12. Assets will be understated because the items will not be included in inventory. If the items
are not in inventory, management will assume they have been sold or lost through spoilage
or theft. If the items are not in the inventory they will be expensed and therefore the shareholders’ equity will also be understated. Liabilities will not be affected.
13. Lucy should know the following:
(a) A departure from the cost basis of accounting for inventories is justified when the value
of the goods is no longer as great as its cost. The write down to market should be recognized in the period in which the price decline occurs.
(b) Market means current replacement cost or net realizable value. For a merchandising
company, current replacement cost is the cost at the present time from the usual suppliers in the usual quantities. Other companies use net realizable value, which is the selling price less the purchase cost and any disposal costs.
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Questions (Continued)
14. Rock Music Centre should report the CD players at $320 each for a total of $1,600. $320 is
the net realizable value under the lower of cost and market basis of accounting for inventories. A decline in replacement cost recognizes losses as soon as they are evident so as not
to impact decision making unfavourably. Valuation at LCM is conservative.
15. Agree. Effective inventory management is frequently the key to successful business operations. Management attempts to maintain sufficient quantities and types of goods to meet expected customer demand. It also seeks to avoid the cost of carrying inventories that are
clearly in excess of anticipated sales.
16. An inventory turnover ratio that is too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory outages may also cause customer ill
will and result in lost future sales.
17. An increase in the days in inventory ratio from one year to the next would be seen as deterioration in the company’s efficiency in managing inventory. It means that more inventory is
being held relative to sales.
18. Periodic and perpetual inventory systems differ in the accounting treatment for inventories.
Under a perpetual inventory system inventory records are updated for every purchase and
sale transaction. The cost of goods sold is recorded each time a sale is made. Under a periodic system, the inventory is only updated at the end of the period when a physical inventory count is performed. Inventory purchases throughout the year are debited to a purchases account. When a sale is recorded, no entry is made to record the cost of the sale. Cost
of goods sold is calculated separately after the physical inventory count is performed.
*19. Disagree. The results under the FIFO cost flow assumption are the same but the results under the LIFO cost flow assumption are different. The reason is that the pool of inventoriable
costs (costs of goods available for sale) is not the same. Under a periodic system, the pool
of costs is the goods available for sale for the entire period, whereas under a perpetual system, the pool is the goods available for sale up to the date of sale.
*20. In a periodic system, the average is a weighted average based on total goods available for
sale for the period. In a perpetual system, the average is a moving average of goods available for sale after each purchase.
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SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 6-1
(a) Ownership of the goods belongs to the consignor (Helgeson). Thus, these goods should be
included in Helgeson’s inventory.
(b) Goods held on consignment belong to the other company and should not be included in
Helgeson’s inventory.
(c) The goods being held belong to the customer. They should not be included in Helgeson’s
inventory.
(d) The goods in transit should not be included in the inventory count because ownership by
Helgeson does not occur until the goods reach the buyer.
(e) The goods in transit belong to the customer because ownership transferred at the point of
shipping. They should not be included in Helgeson’s inventory.
BRIEF EXERCISE 6-2
Units
0
1,000
1,000
(600)
400
Beginning inventory
Purchases (300@$6 + 400@$7 +300@$8)
Goods available for sale
Goods sold
Ending inventory
Dollars
$
0
7,000
$7,000
(a) FIFO
Cost of Goods Sold: (300 x $6) + (300 x $7) = $3,900
Ending Inventory: (300 x $8) + (100 x $7)
= 3,100
Total
$7,000
(b) Weighted Average
Weighted Average Cost = $7,000 ÷ 1,000 = $7
Cost of Goods Sold: 600 x $7 = $4,200
Ending Inventory: 400 x $7
= 2,800
Total
$7,000
(c) LIFO
Cost of Goods Sold: (300 x $8) + (300 x $7)
Ending Inventory: (300 x $6) + (100 x $7)
Total
= $4,500
= 2,500
$7,000
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BRIEF EXERCISE 6-3
(a) LIFO. The ending inventory is valued at the earlier, higher costs.
(b) FIFO. The cost of goods is valued using the earlier, higher costs.
(c) Cash flow is not affected by the inventory cost flow assumptions, therefore the pretax income will be the same under all assumptions.
(d) The factor that management should consider when choosing an inventory cost flow assumptions is which assumption results in the fairest matching of costs to revenues.
BRIEF EXERCISE 6-4
The overstatement of ending inventory caused cost of goods sold to be understated $7,000 and
net earnings to be overstated $7,000. The correct net earnings for 2004 is $83,000 ($90,000 $7,000).
Total assets in the balance sheet will be overstated by the amount that ending inventory is overstated, $7,000.
BRIEF EXERCISE 6-5
Assets
Liabilities
Shareholders’ Equity
2004
Understated
No effect
Understated
2005
No effect
No effect
No effect
BRIEF EXERCISE 6-6
Inventory Categories
Cameras
Camcorders
VCRs
Total valuation
Cost
$12,000
“.9,000
14,000
$35,000
Market
$10,200
9,500
12,800
$32,500
The lower of cost and market is $32,500.
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BRIEF EXERCISE 6-7
Inventory Turnover Ratio:
Days in Inventory:
$2,592
 5.6 times
($478  $438)  2
365 days
 65 days
5.6
BRIEF EXERCISE 6-8
(a) Increase
(b) Decrease
(c) No effect
*BRIEF EXERCISE 6-9
(1) FIFO
Date
May 7
June 1
July 28
Purchases
Cost of Goods Sold
50 @ $10 = $500
30 @ $10 = $300
30 @ $15 = 450
August 27
Total
GAS
20 @ $10
13 @ $15 = 395
$950 CGS
$695
Balance
50 @ $10 = $500
20 @ $10 = 200
20 @ $10
30 @ $15 = 650
17 @ $15 = 255
EI
$255
(2) Average Cost
Date
May 7
June 1
July 28
August 27
Total
Purchases
Cost of Goods Sold
50 @ $10 = $500
30 @ $10 = $300
30 @ $15 = 450
33 @ $13 = 429
GAS
$950 CGS
$729
Balance
50 @ $10 = $500
20 @ $10 = 200
50 @ $13 = 650
17 @ $13 = 221
EI
$221
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*BRIEF EXERCISE 6-10
Beginning inventory
Purchases (300 @ $6 + 400 @ $7 + 300 @ $8)
Goods available for sale
Goods sold
Ending inventory
Units
0
1,000
1,000
(600)
400
Dollars
$
0
7,000
$7,000
(a) FIFO
Cost of Goods Sold: (200 x $6) + [(100 x $6) + (300 x $7)] = $3,900
Ending Inventory: (100 x $7) + (300 x $8)
= 3,100
Total
$7,000
(b) Moving Average
Cost of Goods Sold: (200 x $6) + (400 x $6.801) = $3,920
Ending Inventory: 400 x $7.702
= 3,080
Total
$7,000
1 (100
2
x $6) + (400 x $7) = $3,400; $3,400 ÷ 500 = $6.80
(100 x $6.80) + (300 x $8) = $3,080; $3,080 ÷ 400 = $7.70
(c) LIFO
Cost of Goods Sold: (400 x $7) + (200 x $6) = $4,000
Ending Inventory: (300 x $8) + (100 x $6)
= 3,000
Total
$7,000
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*BRIEF EXERCISE 6-11
(a) FIFO Periodic
Date
Jan.
Account Titles and Explanation
1
No entry required
3
Accounts Receivable .............................................
Sales ............................................................
2,500
Purchases .............................................................
Accounts Payable .........................................
4,000
Cash ......................................................................
Sales .............................................................
6,400
9
15
(b)
Credit
2,500
4,000
6,400
FIFO Perpetual
Date
Jan.
Debit
Account Titles and Explanation
Debit
1
No entry required
3
Accounts Receivable ............................................
Sales ...........................................................
2,500
Cost of Goods Sold ..............................................
Merchandise Inventory .................................
1,500
Merchandise Inventory .........................................
Accounts Payable ........................................
4,000
Cash .....................................................................
Sales ............................................................
6,400
Cost of Goods Sold (200 @ $3 + 600 @ $4) ........
Merchandise Inventory .................................
3,000
9
15
Credit
2,500
1,500
4,000
6,400
3,000
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SOLUTIONS TO EXERCISES
EXERCISE 6-1
(a) Do not include – Shippers does not own items held on consignment
(b) Include in inventory – Shippers’ still owns the items as they were only shipped on consignment.
(c) Include in inventory – Shipping terms FOB destination means that Shippers owns the items
until they reach the customer.
(d) Do not include in inventory - Because the shipping terms are FOB shipping point, ownership
has transferred to the customer. Shippers Ltd should record this amount as a sale on the
statement of earnings.
(e) Do not include in inventory – Because the shipping terms are FOB destination, Shippers
does not own the supplies until they arrive at Shippers’ premises.
(f) Include in inventory – Shipping terms FOB shipping point means that ownership transferred
at the time of shipping and therefore, Shippers Ltd. owns the goods in transit.
(g) Record as supplies inventory on the balance sheet.
EXERCISE 6-2
Ending inventoryPhysical count……………………………….
1. No effectTitle passes to purchaser upon shipment
when terms are FOB shipping point……………………..
2. No effectTitle does not transfer to Novotna until
goods are received…………………………………………
3. Add to inventory: Title passed to Novotna when
goods were shipped……………………………………….
4. Add to inventory: Title remains with Novotna until
purchaser receives goods…………………………………
Correct inventory…………………………………………………..
$295,000
0
0
25,000
40,000
,$360,000
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EXERCISE 6-3
(a) FIFO Cost of Goods Sold
(#1012) $500 + (#1045) $450 = $950
(b) It could choose to sell specific units purchased at specific costs if it wished to impact earnings selectively. If it wished to minimize earnings it would choose to sell the units purchased
at higher costs–in which case the Cost of Goods Sold would be $950. If it wished to maximize earnings it would choose to sell the units purchased at lower costs–in which case the
cost of goods sold would be $850.
(c) I recommend they use the FIFO cost flow assumption because it provides a more appropriate balance sheet valuation and reduces the opportunity to manipulate earnings.
(The answer may vary depending on the assumption the student chooses.)
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EXERCISE 6-4
(a)
FIFO
Beginning inventory (30 X $8) ................................................
Purchases
May 15 (25 X $10) .......................................................
May 24 (35 X $12) .......................................................
Cost of goods available for sale (90 units) ..............................
Less: Ending inventory [(90 - 70) X $12].................................
Cost of goods sold ..................................................................
$240
$250
420
670
910
240
$670
(b)
Weighted Average
Beginning inventory (30 X $8) ................................................
Purchases
May 15 (25 X $10) .......................................................
May 24 (35 X $12) .......................................................
Cost of goods available for sale (90 units) ..............................
Less: Ending inventory [(90 - 70) X $10.11*] ..........................
Cost of goods sold ..................................................................
$240
$250
420
670
910
202
$708
*$910.00 ÷ 90 units = $10.11/unit
(c)
LIFO
Beginning inventory (30 X $8) ................................................
Purchases
May 15 (25 X $10) .......................................................
May 24 (35 X $12) .......................................................
Cost of goods available for sale (90 units) ..............................
Less: Ending inventory [(90 - 70) X $8] ..................................
Cost of goods sold ..................................................................
$240
$250
420
670
910
160
$750
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EXERCISE 6-5
(a)
(1) FIFO
Beginning inventory (200 X $5) ..............................................................
Purchases
June 12 (300 X $6) .........................................................................
June 23 (500 X $7) .........................................................................
Cost of goods available for sale ..............................................................
Less: Ending inventory (160 X $7)..........................................................
Cost of goods sold ..................................................................................
$1,000
$1,800
3,500
5,300
6,300
1,120
$5,180
(2) Average Cost
Cost of Goods
Available for Sale
$6,300
Ending inventory
Cost of goods sold

Total Units
Available for Sale
1,000
=
Weighted Average
Unit Cost
$6.30
160 X $6.30 = $1,008
840 X $6.30 = $5,292 or
$6,300 – $1,008 = $5,292
(3) LIFO
Cost of goods available for sale ..............................................................
Less: Ending inventory (160 X $5) ..........................................................
Cost of goods sold ..................................................................................
$6,300
800
$5,500
(b) The FIFO cost flow assumption will produce the highest ending inventory because costs
have been rising. Under this assumption, the earliest costs are assigned to cost of goods
sold, and the latest costs remain in ending inventory.
(c) The LIFO cost flow assumption will produce the highest cost of goods sold for Lakshmi Ltd.
Under LIFO the most recent costs are charged to cost of goods sold and the earliest costs
are included in the ending inventory.
(d) The selection of a cost flow assumption does not affect cash flow. Cash flow is determined
by purchases and payments not the allocation of costs between cost of goods sold and ending inventory.
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EXERCISE 6-6
(a)
Beginning inventory ......................................................................
Cost of goods purchased ..............................................................
Cost of goods available for sale ....................................................
Corrected ending inventory...........................................................
Cost of goods sold ........................................................................
a $30,000
b $35,000
2004
$ 20,000
160,000
180,000
26,000a
$154,000
2005
$ 26,000
175,000
201,000
38,000b
$163,000
- $4,000 = $26,000
+ $3,000 = $38,000
(b)
Inventory error for 2004 will cause 2004 cost of goods sold to be understated by $4,000, which
will cause the 2004 net earnings and retained earnings to be overstated by the same amount.
When the error reverses in 2005, cost of goods sold will be overstated and 2005 net earnings
will be understated. Over the two years the error will reverse and therefore the 2005 retained
earnings balance will be correct.
The $3,000 understatement of inventory in 2005 will cause the 2005 cost of goods sold to be
overstated and the 2005 net earnings and retained earnings to be understated by $3,000.
EXERCISE 6-7
(a)
Sales ...........................................................................................
Cost of goods sold ......................................................................
Beginning inventory ..............................................................
Cost of goods purchased .....................................................
Cost of goods available for sale ...........................................
Ending inventory ($40,000 - $4,000) ....................................
Cost of goods sold ...............................................................
Gross profit .................................................................................
2004
2005
$210,000
$250,000
32,000
173,000
205,000
36,000
169,000
$ 41,000
36,000
202,000
238,000
52,000
186,000
$ 64,000
(b) The cumulative effect on total gross profit for the two years is zero as shown below:
Incorrect gross profits:
Correct gross profits:
Difference
$45,000 + $60,000 =
$41,000 + $64,000 =
$105,000
105,000
$
0
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EXERCISE 6-7 (Continued)
(c) Gross Profit Margin
2004
2005
Before correction
$45,000 ÷ $210,000
= 21.4%
$60,000 ÷ $250,000
= 24.0%
After correction
$41,000 ÷ $210,000
$64,000 ÷ $250,000
=19.5%
= 25.6%
(d) Dear Mr./Ms. President:
Because your ending inventory of December 31, 2004 was overstated by $4,000, your net
earnings for 2004 were overstated and net earnings for 2005 were understated by $4,000.
In a periodic system, the cost of goods sold is calculated by deducting the cost of ending inventory from the total cost of goods you have available for sale in the period. Therefore, if
this ending inventory figure is overstated, as it was in December 2004, the cost of goods
sold is understated and therefore net earnings will be overstated by that amount. Consequently, this overstated ending inventory figure goes on to become the next period’s beginning inventory amount and is a part of the total cost of goods available for sale. Therefore,
the mistake repeats itself in the reverse.
The effect on the gross profit margin is significant. Before correction the margin was 21.4%
in 2004 and increased 2.6% to 24.0% in 2005. After the error is corrected the margin for
2004 is19.5% and the increase is 6.1% to 25.6% in 2005.
Thank you for allowing me to bring this to your attention. If you have any questions, please
contact me at your convenience.
Sincerely,
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EXERCISE 6-8
Units
Cameras:
Minolta
Canon
Light Meters:
Vivitar
Kodak
Total
Cost/Unit Total Cost
(a)
Market
Total Market
Value/Unit Value (b)
5
7
$175
150
$ 875
1,050
$160
152
$ 800
1,064
12
10
125
115
1,500
1,150
$4,575
119
135
1,428
1,350
$4,642
(c)
Cody Camera Shop should report its inventory at the lower of cost or market. In this case, the
total cost of $4,575 is lower than the market of $4,642 and therefore the inventory should be reported on Cody’s financial statements at $4,575.
EXERCISE 6-9
Inventory Turnover
2002
=
$14,858.0
 7.4 times
($2,258.0  $1,766.9)  2
2001
=
$12,100.1
 8.2 times
($1,766.9  $1,183.7)  2
Days in Inventory
2002
=
365
 49 days
7.4 times
2001
=
365
 45 days
8.2 times
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EXERCISE 6-9 (Continued)
Gross Profit Margin
2002
=
$19,597.0 - $14,858.0
 24.2%
$19,597.0
2001
=
$15,326.6 - $12,100.1
 21.1%
$15,326.6
The inventory turnover ratio decreased by approximately 10% [(7.4-8.2) ÷ 8.2] from 2002 to
2001. The days in inventory increased by approximately the same amount over the same time
period. Both of these changes would be considered negative since it appears it is taking the
company longer to turn over its inventory.
Best Buy’s gross profit margin increased slightly from 21.1% to 24.2%. This means that Best
Buy’s selling prices increased faster than their cost of sales.
EXERCISE 6-10
(a) There was probably an insignificant difference between the two cost flow assumptions on
the total inventory because overall, prices may not have changed significantly. Inventory
cost flow assumptions assume that prices are rising or falling, with such a variety of inventory items, price increases on some items may be offset by decreases on other items causing
the inventory changes between the two assumptions to be minimal.
(b) Inventory Turnover
FIFO: $191,808 ÷ $23,902
= 8.03
LIFO: $191,838 ÷ $23,752
= 8.08
(c) LIFO gives the higher inventory turnover
(d) The choice of inventory cost flow assumption is a way of matching the cost of inventory to
revenue. The actual physical movement of inventory will be the same regardless of which
cost flow assumption is adopted. Therefore, Wal-Mart’s inventory will turn over at the same
rate regardless which cost flow assumption is used by the company.
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*EXERCISE 6-11
(a) (1) FIFO
Date
Purchases
Cost of Goods Sold
Balance
June 1 BI 200 @ $5 = $1,000
200 @ $5 = $1,000
June 12 P 300 @ $6 = $1,800
200 @ $5
300 @ $6 = $2,800
June 15
200 @ $5
200 @ $6 = $2,200 100 @ $6 = $600
June 23 P 500 @ $7 = $3,500
100 @ $6
500 @ $7 = $4,100
June 27
100 @ $6
340 @ $7 = $2,980 160 @ $7 = $1,120
Total
GAS
$6,300 CGS
$5,180 EI
$1,120
(a) (2) Average Cost
Date
June 1
June 12
June 15
June 23
June 27
Total
Purchases
BI 200 @ $5 = $1,000
P 300 @ $6 = $1,800
Cost of Goods Sold
400 @ $5.60 = $2,240
P 500 @ $7 = $3,500
GAS
$6,300
440 @ $6.77 = $2,978
CGS
$5,218
Balance
200 @ $5 =
$1,000
500 @ $5.60 = $2,800
100 @ $5.60 = $560
600 @ $6.77* = $4,060
160 @ $6.77 = $1,082
EI
$1,082
* $6.766666 rounded to $6.77
(a) (3) LIFO
Date
June 1
June 12
Purchases
Cost of Goods Sold
Balance
BI 200 @ $5 = $1,000
200 @ $5 = $1,000
P 300 @ $6 = $1,800
200 @ $5
300 @ $6 = $2,800
June 15
300 @ $6
100 @ $5 = $2,300 100 @ $5 = $500
June 23 P 500 @ $7 = $3,500
100 @ $5
500 @ $7 = $4,000
June 27
440 @ $7 = $3,080 100 @ $5
60 @ $7 = $920
Total
GAS
$6,300 CGS
$5,380 EI
$920
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*EXERCISE 6-11 (Continued)
(b)
FIFO—Periodic
FIFO—Perpetual
Cost of Goods Sold Ending Inventory
$5,180
$1,120
05,180
01,120
Weighted Average—Periodic
Moving Average—Perpetual
05,292
05,218
01,008
01,082
LIFO—Periodic
LIFO—Perpetual
05,500
05,380
800
0920
FIFO: The results do not change.
Average cost: Cost of goods sold is $74 lower and ending inventory $74 higher using a perpetual
system.
LIFO: Cost of goods sold is $120 lower and ending inventory $120 higher using a perpetual system.
(c) The average cost is not the simple average or a weighted average because average cost
under the perpetual inventory system is referred to as a moving weighted average, which
means that the inventory cost is recalculated each time inventory is purchased.
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*EXERCISE 6-12
(a)
Date
Sept. 1
Purchases
(26 @ $97)
Sept. 5
FIFO
Sales
(12 @ $97)=$1,164
Sept. 12 (45 @ $102) = $4,590
Sept. 16
Balance
$2,522
(14 @ $97) = $1,358
(14 @ $97) +
(45 @ $102) =$5,948
(14 @ $97) +
(36 @ $102)=$5,030
Sept. 19 (28 @ $104) = $2,912
(9 @ $102) = $918
(9 @ $102) +
(28 @ $104) =$3,830
Cost of Goods Sold: $1,164 + $5,030 = $6,194
Ending Inventory: $3,830
Date
Sept. 1
Purchases
(26 @ $97)
Sept. 5
AVERAGE COST
Sales
(12 @ $97) = $1,164
(14 @ $97)=$1,358
(59@$100.81) a = $5,948
Sept. 12 (45 @ $102) = $4,590
Sept. 16
Balance
$2,522
(50 @ $100.81) =$5,041*
Sept. 19 (28 @ $104) $2,912
(9@ $100.81) = $907
(37@$103.22) b=$3,819
*Rounded
a $5,948 ÷ 59 = $100.81
b $3,819 ÷ 37 = $103.22
Cost of Goods Sold: $1,164 + $5,041 = $6,205
Ending Inventory: $3,819
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*EXERCISE 6-12 (Continued)
(a) (Continued)
Date
Sept. 1
Purchases
(26 @ $97)
Sept. 5
LIFO
Sales
(12 @ $97)=$1,164
Sept. 12 (45 @ $102) =$4,590
Sept. 16
Balance
$2,522
(14 @ $97) = $1,358
(14 @ $97) +
(45 @ $102) = $5,948
(5 @ $97) +
(45 @ $102) =$5,075
Sept. 19 (28 @ $104) = $2,912
(9 @ $97) = $873
(9@ $97)+
(28 @ $104) =$3,785
Cost of Goods Sold: $1,164 + $5,075 = $6,239
Ending Inventory: $3,785
(b)
FIFO
Beginning inventory (26 X $97) .........................................................
Purchases
Sept. 12 (45 X $102) .........................................................................
Sept. 19 (28 X $104) .........................................................................
$2,522
$4,590
2,912
Cost of goods available for sale .........................................................
Less: Ending inventory (9 @$102) + (28 @ $104) ............................
Cost of goods sold .............................................................................
7,502
10,024
3,830
$6,194
AVERAGE COST
Cost of goods available for sale .........................................................
Less: Ending inventory (37 X $101.251) .........................................
Cost of goods sold .............................................................................
$10,024
3,746
$ 6,278
1$10,024
÷ 99 = $101.25
LIFO
Cost of goods available for sale .........................................................
Less: Ending inventory (26 @ $97) + (11@ $102) .........................
Cost of goods sold .............................................................................
$10,024
3,644
$ 6,380
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*EXERCISE 6-12 (Continued)
(b) (Continued)
FIFO
Average cost
LIFO
Ending
Inventory
$3,830
$3,746
$3,644
Periodic
Cost of Goods
Sold
$6,194
$6,278
$6,380
Ending
Inventory
$3,830
$3,819
$3,785
Perpetual
Cost of Goods
Sold
$6,194
$6,205
$6,239
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*EXERCISE 6-13
(a)
Sept. 5 Cash
Sales
5 Cost of Goods Sold
Inventory
12 Inventory
Accounts Payable
16 Cash
Sales
16 Cost of Goods Sold
Inventory
19 Inventory
Accounts Payable
FIFO
Dr.
Cr.
02,388
02,388
01,164
01,164
04,590
04,590
09,950
09,950
05,030
05,030
02,912
02,912
Moving Average
Dr.
Cr.
02,388
02,388
01,164
01,164
04,590
04,590
09,950
09,950
05,041
05,041
02,912
02,912
LIFO
Dr.
Cr.
02,388
02,388
01,164
01,164
04,590
04,590
09,950
09,950
05,075
05,075
02,912
02,912
FIFO
Dr.
Cr.
02,388
02,388
04,590
04,590
09,950
09,950
02,912
02,912
Weighted Average
Dr.
Cr.
02,388
02,388
04,590
04,590
9,950
09,950
02,912
2,912
LIFO
Dr.
Cr.
02,388
02,388
04,590
04,590
09,950
09,950
2,912
02,912
(b)
Sept. 5 Cash
Sales
12 Purchases
Accounts Payable
16 Cash
Sales
19 Purchases
Accounts Payable
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SOLUTIONS TO PROBLEMS
PROBLEM 6-1A
(a) The goods should not be included in inventory as they were shipped FOB
shipping point and shipped February 26. Title to the goods transfers to the customer February 26. Banff should have recorded the transaction in the Sales
and Accounts Receivable accounts.
(b) The amount should not be included in inventory as they were shipped FOB
destination and not received until March 1. The seller still owns the inventory.
No entry is recorded.
(c) Include $500 in inventory.
(d) Include $400 in inventory.
(e) $750 should be included in inventory as the goods were shipped FOB shipping
point. (They were received March 1–assume they were shipped at least one
day prior.)
(f) The sale will be recorded on March 2. The goods should be included in inventory at the end of February at their cost of $320.
(g) The damaged goods should not be included in inventory. They should be recorded in a cost of goods sold (loss) account since they are not able to be sold.
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PROBLEM 6-2A
(a)
Date
Feb. 1
Feb.20
May 5
Aug.12
Dec. 8
(b)
COST OF GOODS AVAILABLE FOR SALE
Explanation
Units
Unit Cost
Beginning inventory
400
$8
Purchase
700
9
Purchase
500
10
Purchase
300
11
Purchase
100
12
Total
2,000
Total Cost
$ 3,200
6,300
5,000
3,300
1,200
$19,000
FIFO
Step 1: Cost of Goods Sold
Step 2: Ending Inventory
Unit
Total
Units Cost
Cost
Date Units Unit Cost Total Cost
400
$8
$ 3,200
Aug. 12 300
$11
$3,300
700
9
6,300
Dec. 8 100
12
1,200
500
10
5,000
400
$4,500
1,600
$14,500
Average Cost
Step1: Cost of Goods Sold
Step 2:
Weighted Average Total
Units Unit Cost
Cost
1,600 $9.50* = $15,200
Ending Inventory
Weighted Average Total
Units
Unit Cost
Cost
400
$9.50 =
$3,800
*$19,000  2,000 = $9.50
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PROBLEM 6-2A (Continued)
(b) Continued
LIFO
Step 1: Cost of Goods Sold
Unit
Total
Units Cost
Cost
100 $ 12
$ 1,200
300
11
3,300
500
10
5,000
700
9
6,300
1,600
$15,800
Step 2: Ending Inventory
Date
Beg.
Units Unit Cost Total Cost
400
$8
$3,200
(c) LIFO results in the lowest inventory amount for the balance sheet, $3,200.
FIFO results in the lowest cost of goods sold for the statement of earnings,
$14,500.
Cash flow is not affected by the inventory cost flow assumption; therefore
cash flow will be the same under all three assumptions.
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PROBLEM 6-3A
(a)
Quarter
1
2
3
4
COST OF GOODS AVAILABLE FOR SALE
Explanation
Units
Unit Cost Total Cost
Beg. Inventory
15,000
$2.25
$ 33,750
Purchase
60,000
2.30
138,000
Purchase
50,000
2.50
125,000
Purchase
50,000
2.60
130,000
Purchase
70,000
2.65
185,500
Total
245,000
$612,250
FIFO: Cost of Goods Sold:
Unit Total
Units
Cost
Cost
15,000 $ 2.25 $ 33,750
60,000
2.30
138,000
50,000
2.50
125,000
50,000
2.60
130,000
50,000
2.65
132,500
225,000
$559,250
Average Cost: Cost of Goods Sold
Weighted Average
Units
Unit Cost
225,000
$2.50*
Total
Cost
=$562,500
*$612,250  245,000 = $2.50 (rounded)
LIFO: Cost of Goods Sold
Unit
Total
Units
Cost
Cost
70,000 $ 2.65 $185,500
50,000
2.60
130,000
50,000
2.50
125,000
55,000
2.30
126,500
225,000
$567,000
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PROBLEM 6-3A (Continued)
(b)
REAL NOVELTY INC.
Condensed Statements of Earnings
Year Ended December 31, 2004
Sales .....................................................
Cost of goods sold
Beginning inventory ........................
Cost of goods purchased ...............
Cost of goods available for sale .....
Ending inventory ............................
Cost of goods sold .........................
Gross profit............................................
Operating expenses ..............................
Earnings before income taxes ...............
Income tax expense ..............................
Net earnings ..........................................
a
b
c
FIFO AVERAGE
$900,000 $900,000
LIFO
$900,000
33,750
33,750
33,750
578,500
578,500
578,50
612,250
612,250
612,250
a
b
53,000
49,750
45,250c
559,250
562,500
567,000
340,750
337,500
333,000
147,000
147,000
147,000
193,750
190,500
186,000
60,000
60,000
60,000
$133,750 $130,500 $126,000
20,000 x $2.65 = $53,000
20,000 x $2.50 = $49,750 (adjusted for rounding errors)
(15,000 x $2.25) + (5,000 x $2.30) = $45,250
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PROBLEM 6-3A (Continued)
(c) Dear Real Novelty Inc.
After preparing the comparative condensed statement of earnings for the year
ended December 31, 2004 under the FIFO, average cost, and LIFO cost flow
assumptions, we have found the following:
1. The FIFO cost flow assumption produces the most meaningful inventory
amount for the balance sheet because the units are costed at the most recent purchases. This assumption is most likely to approximate actual
physical flow because the oldest goods are usually sold first to minimize
spoilage and obsolescence.
2. The LIFO cost flow assumption produces the most meaningful net earnings because the costs of the most recent purchases are matched against
sales.
3. The LIFO cost flow assumption produces the most meaningful gross profit
figure because it values the cost of goods sold at the most current prices.
4. The FIFO cost flow assumption is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence.
5. None of the cost flow assumptions have an impact on cash flow. Therefore cash available to management should be the same under all assumptions.
Sincerely,
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PROBLEM 6-4A
(a)
Purchaser
Date
Oct.
Account Titles and Explanation
Debit
1
No entry required
9
Purchases .................................................
Accounts Payable ..............................
1,680
Accounts Receivable .................................
Sales ..................................................
5,250
Sales Returns and Allowances ..................
Accounts Receivable ..........................
875
Purchases .................................................
Accounts Payable ..............................
910
Accounts Payable ......................................
Purchase Returns and Allowances .....
65
Accounts Receivable .................................
Sales ..................................................
2,250
11
13
17
22
29
(b)
Seller
Credit
1,680
5,250
875
910
65
2,250
Pataki Inc.–General Journal
Date
Oct.
Schwinghamer Inc.–General Journal
9
17
22
Account Titles and Explanation
Debit
Accounts Receivable .................................
Sales ..................................................
1,680
Accounts Receivable .................................
Sales ..................................................
910
Sales Returns and Allowances ..................
Accounts receivable ...........................
65
Credit
1,680
910
65
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PROBLEM 6-4A (Continued)
(c)
Ending Inventory
Unit
Date
Units Cost
Oct. 17
45*
$13
Total
Cost
$585
*60 + 120 – 150 + 25 + 70 – 5 – 75 = 45
(d) The inventory should be valued at $540, 45 units @ $12. This is the lower of
cost and market.
(e) Inventory turnover is calculated by dividing cost of goods sold by average inventory. Reducing the value of the inventory will increase the inventory turnover ratio.
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PROBLEM 6-5A
(a) (INCORRECT)
PELLETIER INC.
Statement of Earnings
Year Ended July 31
Sales
Cost of goods sold
Beginning inventory
Purchases
Cost of goods available for sale
Ending inventory
Cost of goods sold
Gross profit
Operating expenses
Earnings before taxes
Income tax expense
Net earnings
2004
$300,000
2005
$320,000
30,000
200,000
230,000
22,000
208,000
92,000
60,000
32,000
12,000
$ 20,000
22,000
240,000
262,000
31,000
231,000
89,000
64,000
25,000
0
$ 25,000
(CORRECT)
PELLETIER INC.
Statement of Earnings
For the Year Ended July 31
Sales
Cost of goods sold
Beginning inventory
Purchases
Cost of goods available for sale
Ending inventory
Cost of goods sold
Gross profit
Operating expenses
Earnings (loss) before taxes
Income tax expense
Net earnings (loss)
2004
$300,000
2005
$320,000
30,000
200,000
230,000
25,000
205,000
95,000
60,000
35,000
12,000
$ 23,000
25,000
265,000
290,000
31,000
259,000
61,000
64,000
(3,000)
0
$ (3,000)
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PROBLEM 6-5A (Continued)
(b) Inventory turnover
(INCORRECT)
2004:
$208,000
 8.0 times
($30,000 $22,000) 2
2005:
$231,000
 8.7 times
($22,000 $31,000) 2
(CORRECT)
2004:
$205,000
 7.5 times
($30,000 $25,000) 2
2005:
$259,000
 9.3 times
($25,000 $31,000) 2
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PROBLEM 6-6A
2004
2005
(a)
(b)
Cost of
Net
Goods Sold
Earnings
Understated Overstated
Overstated Understated
(c)
Retained
Earnings
Overstated
No effect
(d)
Ending
Inventory
Overstated
No effect
(e)
Inventory
Turnover
Understated
Understated
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PROBLEM 6-7A
(a)
2002
2001
Inventory Turnover
Days In Inventory
$11,497
365
 8.7 times
 42 days
($1,342  $1,310)  2
8.7 times
Current Ratio
$6,413
 1.06 : 1
$6,052
365
$10,750
 42.4 days
 8.6 times
8.6 times
($1,310  $1,192)  2
$5,853
 1.17 : 1
$4,998
PepsiCo’s liquidity appears to be low. Its current ratio is just over 1:1. This means
that its current assets are just sufficient to cover its current liabilities. It has 42 days
sales in inventory, which seems reasonable and is likely normal for the industry.
The problem may be in its immediate liquidity, or its receivables.
(b)
2002
2001
2000
Raw Materials as % of
Total Inventory
$525 ÷ $1,342
= 39%
$535 ÷ $1,310
= 40.8%
$503 ÷ $1,192
= 42.2%
Work in Progress as %
of Total Inventory
$214 ÷ $1,342
= 16%
$205 ÷ $1,310
= 15.6%
$160 ÷ $1,192
= 13.4%
Finished Goods as % of
Total Inventory
$603 ÷ $1,342
= 45%
$570 ÷ $1,310
= 43.6%
$529 ÷ $1,192
= 44.4%
Pepsi Co’s total inventory has increased over the past three years. However, the
company seems to be carrying a higher level of work in progress and finished
goods and fewer raw materials. It would seem that the company is taking steps to
minimize the amount of resources tied up in raw materials while having more finished goods on hand.
(c) Slightly higher inventories would result in a small decrease in then inventory
turnover ratio. In this case however, the inventory turnover ratio increased
slightly meaning that cost of goods sold increased at a greater percentage
than the inventory.
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*PROBLEM 6-8A
SALES
Oct. 11
29
Total
Units
150
80
230
Unit Cost
$35
$40
Total Cost
$5,250
3,200
$8,450
COST OF GOODS AVAILABLE FOR SALE
Date
Oct. 1
9
22
Total
Explanation
Beginning inventory
Purchase
Purchase
00Units
60
120
70
250
Unit Cost
$25
26
27
Total Cost
$1,500
3,120
1,890
$6,510
(a) 1. Average Cost – Periodic
Ending Inventory
Unit
Date
Units Cost
Oct. 31
20 $26.04*
*
Total
Cost
$521
Cost of Goods Sold
Cost of goods
available
$6,510
Less: Ending inventory
521
Cost of goods sold
$5,989
$6,510  250 = $26.04
Sales
Less: Cost of goods sold
Gross profit
$8,450
5,989
$ 2,461
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*PROBLEM 6-8A (Continued)
(a) (Continued)
2. Average Cost - Perpetual
Date
Oct. 1
9
11
22
29
Unit
Total
Units
Cost
Cost
60 $25.00 $1,500
120 26.00 3,120
180
4,620
(150) 25.67 (3,851)
30
769
70 27.00 1,890
100
2,659
(80) 26.59 (2,127)
20
$ 532
Sales
Less: Cost of goods sold
Gross profit
Average
Cost
$25.00
Cost of
Goods Sold
25.67
$3,851
26.59
2,127
$5,978
$8,450
5,978
$ 2,472
(b)
Gross profit
Ending inventory
Average Cost
Periodic
Perpetual
$2,461
$2,472
$ 521
$ 532
The results for the average cost flow assumption differ depending on whether a
perpetual or periodic system is used. This is because using a perpetual system the
average cost is recalculated after each purchase.
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*PROBLEM 6-9A
(a) (1) FIFO:
Date
Description
May 1 Purchase
Purchases
05
$90
$450
04 0$99
‘396
2 90
0’3 99 ‘477
14 Sale
21 Purchase
03 0103
‘309
1 99
1 103 202
27 Sale
29 Purchase
30 Balance
2
14
106
Ending Inventory
5
0’3 $90 $270
6 Sale
11 Purchase
CGS
212
$1,367 ‘10
$949
$90 0$$450
02
90
0180
2
04
90
99
0576
01
99
099
1
03
99
103
0$408
2
103
206
2
02
103
106
418
44
,
$418
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*PROBLEM 6-9A (Continued)
(a) (Continued)
(2) Average
Date
Description
May 1 Purchase
Purchases
05
$90
0’5
03 0103
30 Balance
96
2 101.25
2
106
14
$270
‘480
‘309
27 Sale
29 Purchase
$90
‘396
14 Sale
21 Purchase
5
0’3
04 0$99
Ending Inventory
$450
6 Sale
11 Purchase
CGS
212
$1,367 ‘10
202.50
$90 0$$$450
02
90
0180
06
96*
0576
01
96
096
04 101.25**
0$405
2
101.25
202.50
04 103.63***
414.50
$952.50 40
, $414.50
* $576  6 = $96
** $405  4 = $101.25
*** $414.50  4 = $103.63
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*PROBLEM 6-9A (Continued)
(a) (Continued)
(3) LIFO
Date Description
May 1 Purchase
Purchases
05
$90
CGS
$450
11 Purchase
04
0$99
1
0’4
03
0103
29 Purchase
30 Balance
90
0180
2
04
90
99
0576
01
90
090
1
03
90
103
0$399
1
01
90
103
193
1
01
2
90
103
106
405
$962 40
,
$405
90
99 ‘486
‘309
27 Sale
2 103 206
2
14
106
212
$1,367 ‘10
$90 0$$$450
02
‘396
14 Sale
21 Purchase
5
0’3 $90 $270
6 Sale
Ending Inventory
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*PROBLEM 6-9A (Continued)
(b)
Because prices are rising, FIFO will produce the highest gross profit and net
earnings.
(c)
Because the ending inventory is valued using the most recent prices, the
FIFO cost flow assumption produces the highest ending inventory.
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*PROBLEM 6-10A
(a)
FIFO
Jan. 1
No entry required
(150 @ $17 = $2,550)
2
Inventory ...................
Cash ....................
(100 @ $21 = $2,100)
2,100
Cash .........................
Sales ....................
(175 @ $40 = $7,000)
7,000
Cost of Goods Sold ...
Inventory ..............
3,075
6
Moving
Average Cost
2,100
2,100
00000
2,100
00
7,000
7,000
7,000
00
3,255
00
3,255
3,075
FIFO: (150 @ $17) +(25 @ $21)= $3,075; Balance 75 @ $21 = $1,575
Average Cost: ($2,550 + $2,100) / (150 + 100) = $18.60
175 @ $18.60 = $3,255; Balance 75 @ $18.60 = $1,395
9
Inventory ...................
Cash ....................
(50 @ $24 = $1,200)
1,200
1,200
1,200
1,200
00
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*PROBLEM 6-10A (Continued)
(a) (Continued)
Jan. 15
Cash .........................
Sales ....................
(75 @ $45 = $3,375)
3,375
Cost of Goods Sold ...
Inventory ..............
1,575
3,375
3,375
3,375
1,557
1,575
1,557
FIFO:(75 @ $21) = $1,575; Balance 50 @ $24 = $1200
Average Cost: ($1,395 + $1,200)  (75 +50) = $20.76
75 @ $20.76 = $1,557; Balance 50 @ $20.76 = $1,038
23
(b)
Inventory ...................
Cash ....................
(100 @ $28 = $2,800)
2,800
2,800
2,800
2,800
0
FIFO produces the higher ending inventory balance because inventory is
valued at the most recent costs.
Net cash flow will be the same under either assumption, as cash flow is not
affected by the inventory cost flow assumption used.
Gross profit will be higher under the FIFO assumption as it produces a lower
cost of goods sold because CGS is valued at the oldest (lowest) prices.
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PROBLEM 6-1B
(a)
Title to the goods does not transfer to the customer until March 2. Include
the $800 in ending inventory.
(b)
Kananaskis owns the goods once they are shipped on February 26. Include
inventory of $375.
(c)
Include $500 in inventory.
(d)
Exclude the items from Kananaskis’ inventory. Craft Producers Ltd. still
owns the inventory.
(e)
Title of the goods does not transfer to Kananaskis until March 2. Exclude this
amount from the February 28 inventory.
(f)
The sale will be recorded on February 26. The goods (cost, $280) should be
excluded from Kananaskis’ inventory at the end of February.
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PROBLEM 6-2B
(a)
COST OF GOODS AVAILABLE FOR SALE
Date
Jan. 1
Mar.15
July 20
Sept. 4
Dec. 2
Explanation
Beginning inventory
Purchase
Purchase
Purchase
Purchase
Total
(b)
Units
100
300
200
300
100
1,000
Unit Cost Total Cost
$20
$ 2,000
24
7,200
25
5,000
28
8,400
30
3,000
$25,600
FIFO
Step 1: Cost of Goods Sold
Unit
Total
Units Cost
Cost
100 $ 20
$ 2,000
300
24
7,200
200
25
5,000
200
28
5,600
800
$19,800
Step 2: Ending Inventory
Date Units Unit Cost Total Cost
Sept. 4 100
$28
$2,800
Dec. 2 100
30
3,000
200
$5,800
AVERAGE COST
Step1: Cost of Goods Sold
Step 2:
Ending Inventory
Weighted Average Total
Units Unit Cost
Cost
800
$25.60* = $20,480
Weighted Average Total
Units
Unit Cost
Cost
200
$25.60 =
$5,120
*$25,600  1,000 = $25.60
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PROBLEM 6-2B (Continued)
(b) (Continued)
LIFO
Step 1: Cost of Goods Sold
Unit
Total
Units Cost
Cost
100 $ 30
$ 3,000
300
28
8,400
200
25
5,000
200
24
4,800
800
$21,200
Step 2: Ending Inventory
Date Units Unit Cost Total Cost
Beg.
100
$20
$ 2,000
Mar.15 100
24
2,400
200
$ 4,400
(c) FIFO results in the highest inventory amount for the balance sheet, $5,800.
LIFO results in the highest cost of goods sold for the statement of earnings,
$21,200.
Cash flow is not affected by the inventory cost flow assumption; therefore
cash flow will be the same under all assumptions.
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PROBLEM 6-3B
(a)
COST OF GOODS AVAILABLE FOR SALE
Date
May 10
Aug. 15
Nov. 20
Explanation
Beg. Inventory
Purchase
Purchase
Purchase
Total
Units
10,000
40,000
50,000
20,000
120,000
Unit Cost
$3.50
4.00
4.25
4.50
Total Cost
$ 35,000
160,000
212,500
90,000
$497,500
FIFO: Cost of Goods Sold:
Units
10,000
40,000
45,000
95,000
Unit
Cost
$3.50
4.00
4.25
Total
Cost
$ 35,000
160,000
191,250
$386,250
Average Cost: Cost of Goods Sold
Weighted Average
Units
Unit Cost
95,000
$4.15*
=
Total
Cost
$393,854
*$497,500  120,000 = $4.15 (rounded)
LIFO: Cost of Goods Sold
Units
20,000
50,000
25,000
95,000
Unit
Total
Cost
Cost
$4.50 $ 90,000
4.25
212,500
4.00
100,000
$402,500
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PROBLEM 6-3B (Continued)
(b)
TUMATOE INC.
Condensed Statement of Earnings
Year Ended December 31, 2004
Sales
...................................................
Cost of goods sold
Beginning inventory ...........................
Cost of goods purchased ..................
Cost of goods available for sale ........
Ending inventory ...............................
Cost of goods sold ............................
Gross profit...............................................
Operating expenses .................................
Income before income taxes ....................
Income tax expense .................................
Net earnings .............................................
FIFO
$665,000
AVERAGE
LIFO
$665,000 $665,000
35,000
35,000
462,500
462,500
497,500
497,500
a
111,250
103,646b
386,250
393,854
278,750
271,146
120,000
120,000
158,750
151,146
50,000
50,000
$108,750 $101,146
35,000
462,500
497,500
95,000c
402,500
262,500
120,000
142,500
50,000
$ 92,500
a
(20,000 @ $4.50) + (5,000 @ $4.25) = $111,250
(25,000 @ $497,500  120,000) = $103,646
c
(10,000 @ $3.50) + (15,000 @ $4.00) = $95,000
b
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PROBLEM 6-3B (Continued)
(c) Dear Tumatoe Inc.
After preparing the comparative condensed statement of earnings for the year
ended December 31, 2004 under the FIFO, average cost, and LIFO cost flow
assumptions, we have found the following:
1. The FIFO cost flow assumption produces the most meaningful inventory
amount for the balance sheet because the units are costed at the most recent purchases.
2. The LIFO cost flow assumption produces the most meaningful net earnings because the costs of the most recent purchases are matched against
sales.
3. The FIFO cost flow assumption is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence.
4. None of the cost flow assumptions have an impact on cash flow.
5. The factors that management should consider when choosing an inventory
cost flow assumption is which assumption results in the fairest matching of
costs to revenues.
You should choose the cost flow assumption that best fits the nature of your
inventory items and your pattern of selling.
Sincerely,
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PROBLEM 6-4B
(a) Purchaser
Date
July 5
8
15
25
26
AMELIA INC.
General Journal
Account Titles and Explanation
Purchases .................................................
Cash ...................................................
Debit
540
Credit
540
Cash ..........................................................
Sales ..................................................
715
Sales Returns and Allowances ..................
Cash ...................................................
110
Purchases .................................................
Cash ...................................................
200
Cash ..........................................................
Purchase Returns and Allowances .....
40
715
110
200
40
(b) Seller
KARINA INC.
General Journal
Date
July 5
July
July
25
26
Account Titles and Explanation
Cash ..........................................................
Sales ..................................................
Debit
540
Cash ..........................................................
Sales ..................................................
200
Sales Returns and Allowances ..................
Cash ...................................................
40
Credit
540
200
40
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PROBLEM 6-4B (Continued)
(c)
Average Cost = $950  105 = $9.05
Ending Inventory = 501 @ $9.05 = $452.50
1
25 + 60 – 65 + 10 + 25 - 5 = 50
(d)
Ending inventory should be valued at $350 (50 units @ $7.00) which is
the lower of cost or market.
(e)
The decline in the inventory would cause the inventory turnover ratio to increase and therefore cause the days in inventory ratio to decrease.
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PROBLEM 6-5B
(a) (INCORRECT)
ALYSSA INC.
Statement of Earnings
Year Ended July 31
2004
Sales ............................................................ $300,000
Cost of goods sold
Beginning inventory ..................................
30,000
Purchases .................................................
200,000
Cost of goods available for sale ................
230,000
Ending inventory .......................................
22,000
Cost of goods sold ....................................
208,000
Gross profit....................................................
92,000
Operating expenses ......................................
60,000
Earnings before taxes ...................................
32,000
Income tax expense ......................................
12,000
Net earnings ................................................. $ 20,000
2005
$320,000
22,000
240,000
262,000
31,000
231,000
89,000
64,000
25,000
10,000
$ 15,000
(CORRECT)
ALYSSA INC.
Statement of Earnings
Year Ended July 31
2004
Sales ............................................................ $300,000
Cost of goods sold
Beginning inventory ..................................
30,000
Purchases .................................................
200,000
Cost of goods available for sale ................
230,000
Ending inventory .......................................
27,000
Cost of goods sold ....................................
203,000
Gross profit....................................................
97,000
Operating expenses ......................................
60,000
Earnings before taxes ...................................
37,000
Income tax expense ......................................
12,000
Net earnings ................................................. $ 25,000
2005
$320,000
27,000
240,000
267,000
31,000
236,000
84,000
64,000
20,000
10,000
$ 10,000
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PROBLEM 6-5B (Continued)
(b) The impact of this error on retained earnings at July 31, 2005 is zero. The error in the 2004 ending inventory is offset by the error in the 2005 beginning
inventory. The total earnings for the two years is $35,000 in both the incorrect
and correct Statement of Earnings.
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PROBLEM 6-6B
2004
2005
(a)
(b)
Cost of
Net
Goods Sold
Earnings
Overstated Understated
Understated Overstated
(c)
Retained
Earnings
Understated
No effect
(d)
Ending
Inventory
Understated
No effect
(e)
Days in
Inventory
Overstated
Overstated
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PROBLEM 6-7B
(a)
Inventory Turnover
2002
2001
Days In Inventory
$129,246
365
 6.2 times
 59 days
($25,361  $16,539)  2
6.2 times
$98,190
365
 8.3 times
 44 days
($16,539  $7,047)  2
8.3 times
Current Ratio
$131,839
 1.77 : 1
$74,485
$93,937
 1.86 : 1
$50,529
CoolBrands current ratio declined slightly in 2002 but is still above the industry average of 1.42:1. This indicates that CoolBrands appears to have sufficient current assets to cover its current liabilities. However, this may not be
the case because there is a very slow moving inventory included in this figure. In 2002 Cool Brands inventory turnover declined to levels below that
experienced by the rest of the industry. This may indicate that the company
is having trouble selling its inventory, which could have an impact on future
liquidity.
(b)
If CoolBrands were to switch to LIFO and prices are rising it would be expected that inventory levels would be lower since inventory would now be
carried at the earlier lower costs versus the most recent costs (as is the case
under FIFO). The inventory turnover ratio should increase since the denominator (average inventory) would be lower and the days in inventory should
decrease. The current ratio would also decrease because current assets
would be lower.
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*PROBLEM 6-8B
(a) (1) Perpetual Inventory System
Date Description
Purchases
Sales
CGS
Ending Inventory
June1 Beginning
inventory
4 Purchase
025 $60.00 $1,500
10 Sale
18 Purchase
25
85
60.00
64.00 06,940
25 $60.00
090 $90 ‘$8,100 0’65 64.00 $5,660 020
64.00 01,280
20
035
64.00
68.00 03,660
085 $64 $5,440
035 068 ‘2,380
25 Sale
050 0$95
28 Purchase
020 072 ‘1,440
30 Balance
140
$9,260 140
20 64.00
‘4,750 0’30 68.00‘ ‘3,320
$12,850 ‘140
$8,980
05
68
0340
5
020
68.00
72.00 01,780
25
, $1,780
Cost of Goods Sold: $8,980
Ending Inventory:
$1,780
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*PROBLEM 6-8B (Continued)
(a) (Continued)
(2) Periodic Inventory System
COST OF GOODS AVAILABLE FOR SALE
Date
June 1
June 4
June 18
June 28
Explanation
Beginning inventory
Purchase
Purchase
Purchase
Total
Units
25
85
35
20
165
Unit Cost Total Cost
$60
$ 1,500
64
5,440
68
2,380
72
1,440
$10,760
FIFO
Units Sold = 90+50 = 140
Units in Ending inventory = 165 – 140 = 25
Step 1: Cost of Goods Sold
Unit
Total
Units Cost
Cost
25 $ 60
$1,500
85
64
5,440
30
68
2,040
140
$8,980
(b)
Step 2: Ending Inventory
Units Unit Cost Total Cost
5
$68
$ 340
20
72
1,440
25
$1,780
The results under FIFO in a perpetual system as the same as in a periodic
system. Under both inventory systems, the first costs in inventory are the
ones assigned to the cost of goods sold.
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*PROBLEM 6-9B
(a) (1) FIFO
Date Description
July 1 Purchase
Purchases
06
$90
CGS
$540
14
6
0’3 $90 $270
6 Sale
11 Purchase
Ending Inventory
04
0$99
‘396
3
0’2
Sale
21 Purchase
05
30 Balance
15
0106
90
99
‘468
‘530
$1,466
‘8
$738
$90 0$$$540
03
90
0270
3
04
90
99
0666
02
99
0198
2
05
99
106
0$728
7
,
$728
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PROBLEM 6-9B (Continued)
(a) (Continued)
(2) Average
Date Description
July 1 Purchase
Purchases
06
$90
CGS
$540
14
6
0’3 $90.00 $270
6 Sale
11 Purchase
Ending Inventory
04
0$99
‘396
0’5
Sale
21 Purchase
05
30 Balance
15
0106
95.14
‘476
‘530
$1,466
‘8
$746
$90 0$$$540
03
90
0270
07
95.14
0666
02
95.14
0190
07
102.86
0$720
7
,
$720
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PROBLEM 6-9B (Continued)
(a) (Continued)
(3) LIFO
Date Description
July 1 Purchase
Purchases
06
$90
CGS
$540
6
0’3 $90 $270
6 Sale
11 Purchase
Ending Inventory
04
0$99
‘396
4
0’1
14 Sale
21 Purchase
05
30 Balance
15
0106
99
90
‘486
‘530
$1,466
‘8
$756
$90 0$$$540
03
90
0270
3
04
90
99
0666
02
90
0180
2
05
90
106
0$710
7
,
$710
(b)
FIFO produces the highest gross profit and net earnings, because it has the
lowest cost of goods sold.
(c)
FIFO produces the highest ending inventory valuation.
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*PROBLEM 6-10B
(a)
Moving
Average Cost
FIFO
Jan. 1
5
7
No entry required
(50 @ $12= $600)
Inventory ...................
Accounts Payable
(100 @ $14= $1,400)
1,400
Accounts Receivable
Sales ....................
(110 @ $25 = $7,000)
2,750
Cost of Goods Sold ...
Inventory ..............
1,440
1,400
1,400
00000
1,400
00
2,750
2,750
2,750
00
1,466
00
1,466
1,440
FIFO:.............................
(50 @ $12) + (60 @ $14)= $1,440; Balance 40 @ $14 = $560
Average Cost: ($600 + $1,400) ÷ (50 + 100) = $13.33
110 @ $13.33 = $1,466; Balance 40 @ $13.33 = $534
14
Inventory ...................
Accounts Payable
(30 @ $16 = $480)
480
480
480
480
00
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*PROBLEM 6-10B (Continued)
(a) (Continued)
Jan. 20 Accounts Receivable
Sales ....................
(60 @ $25 = $1,500)
1,500
Cost of Goods Sold ...
Inventory ..............
880
1,500
1,500
1,500
869
880
869
FIFO:(40 @ $14) + (20 @ $16) = $880; Balance 10 @ $16 = $160
Average Cost: ($534 + $480)  (40 +30) = $14.49
60 @ $14.49 = $869; Balance 10 @ $14.49 = $145
25
Inventory ...................
Accounts Payable
(20 @ $18 = $360)
360
360
360
360
0
(b)
1.
Net cash flow will be the same under either assumption, as cash flow is not affected by the inventory cost assumption used.
2.
Gross profit will be higher under the FIFO cost flow assumption as it produces
a lower cost of goods sold because cost of goods sold is valued at the oldest
(lowest) prices.
3.
FIFO produces the higher ending inventory balance because inventory is valued at the most recent costs.
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BYP 6-1 FINANCIAL REPORTING PROBLEM
(Note: All dollar amounts are in millions)
(a)
Inventories were $1,702 in 2002 and $1,512 in 2001.
(b)
Inventories increased $190 in 2002. Using 2001 as the base year, the increase was approximately 12.6% ($190  $1,512). In 2002, inventories were 48.3% of current assets
($1,702  $3,526). In 2001 they were 49% ($1,512  $3,086).
(c)
Cost of sales is not reported separately in Loblaw’s statement of earnings. Cost of sales
are reported with selling and administrative expenses. Loblaw may not report it separately
because it feels it would provide competitors with valuable information.
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BYP 6-2 COMPARATIVE ANALYSIS PROBLEM
(a)
Loblaw
1.
Sobeys
Inventory turnover
$9,964.4
$444.0
$21,425
$1,702
2002
= 12.6 times
2003
$20,035
$1,512
2001
2.
= 13.3 times
$9,334.9
$394.6
2002
= 23.7 times
Days in inventory
365 days
22.4
365 days
12.6
2002
= 29 days
2003
365 days
13.3
2001
(b)
= 22.4 times
= 27.4 days
= 16.3 days
365 days
23.7
2002
= 15.4 days
Generally, companies that are able to keep their inventory at lower levels and higher turnovers and still satisfy customer needs are the most successful. Both companies’ inventory
ratios have deteriorated in the most recent year. Sobeys’ inventory ratios are better than
Loblaw’s.
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BYP 6-3 RESEARCH CASE
(a)
If the inventory is no longer needed then its market value will decline. If the companies have entered into long-term supply contracts they may be forced to purchase the
inventory at the higher contract price and then immediately write it down because of
the decline in the market price due to excess supply.
(b)
Nortel’s inventory write-off in 2001 was $1.1 billion.
(c)
Nortel’s inventory turnover in 2001 was 11.1 and 7.3 in 2000. The turnover ratio increased in 2001 because the large inventory write down decreased the carrying value
of the inventory on the balance sheet. This caused the denominator of the inventory
turnover ratio to be less, leading to a higher inventory turnover ratio.
(d)
A danger sign to watch for concerning the carrying values of inventory is when the inventory value is growing faster than the value of sales.
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BYP 6-4 INTERPRETING FINANCIAL STATEMENTS
(a)
By not valuating its inventory in excess of market Cooper is using the lower of cost or
market to value its inventory.
(b)
The company may be taking steps to better manage its inventories and reduce the
amount of working capital tied up in inventory by introducing inventory management techniques such as reducing the need for raw materials though improving supplier relationships or by reducing finished goods inventory by implementing better customer ordering
systems.
(c)
The company probably uses FIFO to value its nondomestic inventories due to the fact
that many countries do not permit the use of LIFO as a means of inventory valuation.
Therefore for foreign reporting it is easier to value the nondomestic inventories initially using FIFO rather then having to convert LIFO based numbers to FIFO after the fact.
(d)
Inventory Turnover
2002
$2,839,757
 9.7 times
($280,641  $306,478)  2
2001
$2,724,692
 9.0 times
($306,478  $296,460)  2
Days In Inventory
365
 37.6 days
9.7 times
365
 40.6 days
9.0 times
The company’s inventory turnover improved slightly in 2002. This company’s inventory is
also turning over faster than the industry average of 6.8 times per year. This may indicate
that the company is better managing its inventory costs when compared to other companies in the industry.
(e)
If the company had used FIFO the 2002 ending inventory would have been ($280,641+
$52,336 = $332,977). This would be an immaterial difference from the perspective of the
analyst as it causes very little change in the company’s inventory turnover ratios.
FIFO is a better measure of ending inventory as it values ending inventory at the most recent purchase costs.
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BYP 6-5 A GLOBAL FOCUS
(a)
One reason Fuji makes adjustments is that by reporting using U.S. accounting standards it
makes it easier for U.S. investors to evaluate the company. This increases the chances
that it will attract U.S. investors. The U.S. financial markets are the largest in the world, and
thus represent a huge source of potential capital. The second reason it might adjust its figures to comply with U.S. standards is that the United States represents a huge market for
its product. In recent years Fuji has taken a large share of the U.S. film market away from
Kodak. If it attracts U.S. citizens to invest in its shares, these people are also more likely to
buy its products.
(b)
Fuji uses the perpetual inventory system to account for most of its inventory. The note on
Inventories state that it uses moving average cost flow assumption, which is consistent with
a perpetual inventory system.
(c)
They may use different cost flow assumptions because the cost of using moving average
for some inventories may be greater than the benefit it provides.
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BYP 6-5 (Continued)
(d)
Fuji
(millions of dollars)
Kodak
(millions of dollars)
Inventory turnover
FIFO/Average
$9,537.8
 3.4
($2,695.5  $2,857.4)  2
$8,670
 4.6
($1,581  $2,167)  2
LIFO
$8,675
 6.08
($1,137  $1,718)  2
Average days in inventory
FIFO/Average
365 days
 107.4 days
3.4
365 days
 79.3 days
4.6
LIFO
365 days
 60 days
6.08
The comparison with both inventories at FIFO/Average is the more relevant for decision-making
purposes. This comparison is more relevant because it uses the same measurement.
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BYP 6-5 (Continued)
(e)
Finished goods
Work in progress
Raw materials
Total
Fuji
000(millions of dollars) 00%
$1,673.1
494.1
528.3
$2,695.5
62.1%
18.3
19.6
100.0%
Kodak
(millions of dollars)
$ 851
318
412
$1,581
%
53.8%
20.1
26.1
100.0%
Fuji is holding a higher percentage of finished goods, while Kodak is holding a higher percentage
of work-in-process and raw materials. This difference could be explained by a difference in their
respective forecasts of the future. For example, maybe Fuji predicted an upturn in demand before Kodak did. Or, it could be a reflection of their different manufacturing practices. Perhaps
Kodak holds items in finished goods for a shorter period of time. The difference also might be
due to differences in the amount of work that they outsource. That is, it may be that one buys
some of its product at least partially manufactured.
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BYP 6-6 FINANCIAL ANALYSIS ON THE WEB
Due to the frequency of change with regard to information available on the world wide web, the
Accounting on the Web cases are updated as required. Their suggested solutions are also updated whenever necessary, and can be found online in the Instructor Resources section of our home
page <www.wiley.com/canada/kimmel>.
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BYP 6-7 COLLABORATIVE LEARNING ACTIVITY
(a)
1.
2.
3.
4.
5.
6.
7.
8.
(b)
1.
4.
6.
7.
Items were shipped FOB destination – title had not transferred at year-end so exclude from the inventory of office supplies.
Goods were shipped FOB shipping – ownership passed to JIT Auto Parts on July 31
and should therefore be included in the ending inventory. Increase inventory.
Items were shipped FOB Shipping before year-end – items should not be included in
ending inventory.
This transaction involves the purchase of property, plant and equipment and therefore does not affect inventory.
Goods were shipped FOB shipping – ownership passed to JIT Auto Parts on July 30
and should therefore be included in the ending inventory. Increase inventory.
This is not an inventory transaction.
This purchase represents a cost of the building not inventory.
Items were shipped FOB destination – title had not transferred at year-end so include
in JIT Auto Part’s inventory. Increase inventory.
Office Max till owns the office supplies, as the shipping terms were FOB Destination.
Nadeau Furniture still owns the office furniture, as the shipping terms were FOB Destination.
JIT Auto Parts does not own the cars at year-end, as the shipping terms were FOB
Destination.
The steel was shipped FOB shipping point and is therefore owned by JIT Auto Parts
at year-end. It should be reported as a cost of the building.
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BYP 6-8 COMMUNICATION ACTIVITY
MEMO
To:
Joy Small, President
From:
Student
Date:
Today
Subject:
2003 Ending Inventory Error
The combined gross profit and net earnings for 2003 and 2004 are correct. However, the gross
profit and net earnings for each year are incorrect.
As you know, 2003 ending inventory was overstated by $1 million. This error will cause 2003 net
earnings to be incorrect because the ending inventory is used to calculate 2003 cost of goods
sold. Since the ending inventory is subtracted in the calculation of cost of goods sold, an overstatement of ending inventory results in an understatement of cost of goods sold and therefore
and overstatement of net earnings.
Unless corrected, this error will also affect 2004 net earnings. The 2003 ending inventory is also
the 2004 beginning inventory. Therefore, 2004 beginning inventory is also overstated, which
causes an overstatement of cost of goods sold and an understatement of 2004 net earnings.
If the error is not corrected the gross profit and net earnings for 2003 and 2004 will be incorrect.
Because the error one year reverses in the next year the trend will be misleading.
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BYP 6-9 ETHICS CASE
(a)
Specific Identification
Maximize
Gross Profit
Sales ...........................................................
Cost of goods sold ......................................
Gross profit .................................................
Goods Available for Sale
Date
Units
0Cost
Mar.
1
150
“$300
3
200
350
10
350
0375
$433,000
238,750
$194,250
00Minimize
Gross Profit
“$433,000
240,250
“$192,750
Total
$ 45,000
70,000
131,250
$246,250
Specific Identification–Maximize gross profit (minimize cost of sales by deciding to
sell the diamonds purchased at the lowest cost)
Cost of Goods Sold
Date
Units
Mar.
5
150
30
25
170
330
0Cost
0$300
,,,,350
…350
375
Total
$ 45,000
10,500
59,500
123,750
$238,750
Ending Inventory
Date
0 Units
Mar. 25
20
Cost
$375
0 Total
$7,500
Specific Identification–Minimize gross profit (maximize cost of sales by selling the diamonds purchased at the highest cost)
Cost of Goods Sold
Date
Units
Mar.
5
180
Mar. 25
350
20
130
0Cost
,,$350
375
350
300
Total
$ 63,000
131,250
7,000
39,000
$240,250
Ending Inventory
Date
0Units
Mar. 25
20
00Cost
$300
0 Total
$6,000
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BYP 6-9 (Continued)
(b)
FIFO
Sales ...................................................................
Cost of goods sold ..............................................
Gross profit..........................................................
Goods Available for Sale
Date
Units
0Cost
Mar.
1
150
“$300
3
200
350
10
350
375
Cost of Goods Sold
Date
Units
0Cost
Mar.
5
150“”””””””$300
30
350
25
170
350
330
375
$433,000
238,750
$194,250
Total
$ 45,000
70,000
131,250
$246,250
Total
$ 45,000
10,500
59,500
123,750
$238,750
Ending Inventory
Date
0Units
Mar. 25
20
0 Cost
$375
00Total
$7,500
(c)
The stakeholders are the shareholders, customers, and staff of Discount Diamonds. The
practice is unethical if management selects which diamonds to sell based solely on a desire
to manipulate profits.
(d)
Discount Diamonds should select FIFO. This cost flow assumption provides the best balance sheet valuation and is not subject to manipulation.
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