CHAPTER 7
7-1 Sales transactions are accompanied by recording of the cost
of goods sold (or cost of sales). This is literally true under the
perpetual system and conceptually descriptive under the
periodic system.
7-2 The two steps are obtaining (1) a physical count and (2) a cost
valuation.
7-3 Perpetual systems provide continuous inventory and cost of
goods sold records. Periodic systems rely on physical
inventory taking to record cost of goods sold at the end of the
period.
7-4 It is true that the periodic method requires a physical count to
measure cost of goods sold and the perpetual method does
not. However, for control purposes, it is important to undertake
at least annual physical counts of inventory under the
perpetual method, as well.
7-5 F.O.B. destination means the shipper pays the freight bill.
F.O.B shipping point means the customer bears the cost of the
freight bill. F.O.B. stands for "free on board."
7-6 Freight out is not shown as a direct offset to sales. Unlike sales
discounts and returns, freight out is not a part of gross
revenue that never gets collected. Instead, it is an expense,
entailing ordinary cash disbursements.
298
7-7 The four methods are:
1.
Specific identification – charges the actual cost of the
specific item sold.
2.
FIFO – items purchased first are assumed to be sold first.
3.
LIFO – items purchased most recently are assumed to be
sold first.
4.
Weighted average – the average cost of all items
available is charged for each item sold.
7-8 The specific identification method is normally used for low
volume, high value items. Therefore, we would expect this to
be used for a, b, d, and f.
7-9 Yes. Under FIFO the oldest costs are assigned to the cost of
goods sold first, so the timing of purchases cannot affect cost
flows.
7-10 The good news is that LIFO reduces taxes in times of rising
prices. The bad news is that reported profit is lower.
7-11 Yes. Purchases under LIFO can affect income immediately,
because the unit costs of the latest purchases are assigned to
units sold.
7-12 No. The weighted average must take into account the number
of units purchased at each price. For Gamma Company, the
weighted average unit cost of inventory is: [(2 x $4.00) + (3 x
$5.00)] ÷ 5 = $4.60.
7-13 Ending inventory is lower under LIFO in a period of rising prices
and constant or growing inventory. FIFO produces the higher
ending inventory value.
Chapter 7
Inventories and Cost of Goods Sold
299
7-14 Falling prices reverse the normal relation, so FIFO produces
higher cost of goods sold and, therefore, lower net earnings.
This helps explain why computer and electronics firms typically
use FIFO in order to lower their taxes.
7-15 Consistency requires the maintaining of constant accounting
methods from period to period.
Switching accounting
methods hinders comparisons of current results to those of
preceding periods.
7-16 Companies have adopted LIFO primarily because it saves
income taxes during times of rising prices by reporting higher
cost of goods sold and lower profits.
7-17 An inventory profit is fictitious because, for a going concern, it
represents an amount necessary for replenishing inventory
and is therefore not "available" in the form of cash for
distribution as dividends. It arose from change in unit costs of
the products purchased, not from the company's value added
activities.
7-18 LIFO inventory valuations can be absurd because inventory
valuation is based on older and older costs as the years pass.
7-19 Conservatism does result in lower immediate profits, but higher
profits are then shown in later periods.
7-20 This convention is called conservatism.
300
7-21 "Market" generally means cost of replacement at the date of
the physical inventory.
7-22 The inconsistency is the willingness of accountants to have
replacement costs used as a basis for write-downs below
historical costs, even though a market exchange has not
occurred, but their unwillingness to have replacement costs
used as a basis for write-ups above historical costs.
7-23 Many inventory errors do counterbalance. For example, an
ending inventory that is overstated will overstate current
income. But the same overstated inventory becomes the
beginning inventory the next year; hence, next year's income
will be understated. To show this you might use the following
schematic:
BI
+ Purchase
Goods Available
–Ending Inventory
Cost of Goods Sold
Year 1
OK
OK
OK
Too Large
Too Small
Year 2
Too Large
OK
Too Large
OK
Too Large
This exercise stresses the fact that the ending inventory of one
year becomes the beginning inventory of the subsequent year
and the errors correct themselves.
7-24 Cost of goods sold = Beginning inventory + Purchases –
Ending inventory.
7-25 Past gross profit percentages are sometimes applied to
current revenue as interim estimates of gross profit for a
month or quarter. Thus, the time and cost of taking physical
inventories can be saved.
Chapter 7
Inventories and Cost of Goods Sold
301
7-26 Grocery stores have a low profit margin. If the profit margin is
2%, a savings of $100 in shrinkage would be equivalent to a
$5,000 increase in sales.
7-27 Your boss has a point. This is a cost benefit question. If we do
not give the discount, we may lose customers to competitors
of ours that treat them better. But if it is not currently a custom
in the industry, you may not have to do it. If offering the
discount does not cause customers to buy more, it is giving
money away. However, if it is not an industry custom and it
attracts new customers, that may lead to a different
conclusion. Compare how much your operating income would
rise from newly attracted customers versus the discounts
received by existing customers.
7-28 Phar Mor overstated its assets by overstating inventories. This
means that either liabilities or stockholders’ equity must also be
overstated (to keep the balance sheet equation in balance).
Most likely Phar Mor used a periodic inventory method, so that
overstating ending inventory would reduce cost of goods sold
and increase pretax profit. If the company used a perpetual
inventory system, management must have made inappropriate
credits to cost of goods sold or some other expense account
to offset the additional debits to the inventory account.
7-29 Under the FIFO method, the cost of sales will be based on old
acquisition costs. Under the LIFO method, the cost of sales will
be based on the most recent acquisition costs. Thus, under
LIFO, if additional units are acquired on the last day of the year,
the cost of those units will be included in cost of sales. Thus,
under LIFO, additional purchases would produce higher cost of
goods sold in this instance and lower evaluations for the
purchasing officer. Thus, under LIFO he would be less likely to
purchase additional oil on the last day of the year.
302
7-30 There are many advantages to a perpetual inventory system. It
allows a continuous tracking of inventories, allowing better
control of inventory. It provides an up-to-date measure of cost
of goods sold without having to take a physical count. Its
biggest disadvantage is cost; a periodic inventory system is
simpler and less costly. However, with the use of optical
scanning and computers the cost of a perpetual inventory
system has come down quickly. If the Zen Bootist is willing to
invest in a system that codes each individual product and
tracks its progress through the inventories, then many
advantages of a perpetual inventory system can be achieved.
7-31 (10-15 min.)
GOODMAN’S JEWELRY WHOLESALERS
Schedule of Gross Profit
For the Year Ended December 31, 20X8
(In Thousands)
Gross sales
Deduct: Sales returns and allowances
Cash discounts on sales
Net sales
Cost of goods sold:
Inventory, December 31, 20X7
Add: Gross purchases
Deduct: Purchase returns
and allowances
$27
Cash discounts on purchases
6
Net purchases
Add Freight-in
Cost of merchandise acquired
Cost of goods available for sale
Deduct: Inventory, December 31, 20X8
Cost of goods sold
Gross profit
Chapter 7
Inventories and Cost of Goods Sold
$985
$40
5
45
940
$103
$650
33
617
50
667
770
185
585
$355
303
7-32 (20 min.)
Sales
$71,200
Sales returns
2,300
Net sales
$68,900
Cost of goods sold:
Inventory, January 1*
x
= $39,864
Purchases
$54,000
Purchase returns
2,000
Net purchases
$52,000
Freight in
500
52,500
Cost of goods available for sale
$92,364
Inventory, January 15
40,000
Cost of goods sold, .76 x $68,900
52,364
Gross margin, .24 x $68,900
$16,536
* $52,364 + $40,000 – 52,500 = $39, 864
or:
Cost of goods sold (.76 x 68,900)
Cost of goods purchased
Inventory increase
Beginning Balance = Ending Balance + Change =
$40,000 - $136
304
$
$52,364
52,500
136
$39,864
7-33 (5 min.) Amounts are in millions of dollars.
Perpetual
Accounts receivable* 19
Sales revenue
Cost of goods sold
Merchandise
inventory
19
15
Periodic
Accounts receivable 19
Sales revenue
19
No entry
15
* Could be a debit to cash if sales were for cash.
7-34 (10-15 min.)
Cost of Goods Available = £21,400
(8,000 + 4,200 + 4,400 + 2,300 + 2,500)
LIFO Ending Inventory = (4,000 @ £2) + (1,500 @ £2.10) = £11,150
FIFO Ending Inventory = 1,000 @ £2.50
=
£ 2,500
1,000 @ £2.30
=
2,300
2,000 @ £2.20
=
4,400
1,500 @ £2.10
=
3,150
5,500
£12,350
Weighted average = £21,400/10,000 = £ 2.14 per unit
Ending inventory
5,500 @ £2.14 = £11,770
Cost of Goods Sold Calculation:
Cost of goods available
Less Ending Inventory
Cost of Goods Sold
Chapter 7
Inventories and Cost of Goods Sold
Weighted
LIFO
FIFO
Average
£21,400
£21,400
£21,400
(11,150)
(12,350)
(11,770)
£10,250
£ 9,050
£ 9,630
305
7-35 (10-15 min.)
This is straightforward. Answers are in Swiss francs.
Aug. 2 Purchases
Accounts payable
350,000
Aug. 3 Freight-in
Cash
15,000
Aug. 7 Accounts payable
Purchase returns
and allowances
30,000
Aug. 11 Accounts payable
Cash discounts on purchases
Cash
306
350,000
15,000
30,000
320,000
6,400
313,600
7-36 (10-15 min.)
1.
Invoice price
Add: Freight-in
Deduct: Purchase allowance
Deduct: Cash discount
Total cost of steel acquired
*2% x ($200,000 – $15,000)
2.
Purchases (or Inventory)*
Accounts payable
$200,000
10,000
(15,000)
(3,700)*
$191,300
200,000
200,000
*The debit is to Purchases under the periodic inventory
method and to Inventory under the perpetual inventory
system.
Freight-in
Accounts payable (or cash)
10,000
Accounts payable
Purchase returns and allowances
15,000
Accounts payable
Cash discounts on purchases
Cash
Chapter 7
Inventories and Cost of Goods Sold
10,000
15,000
185,000
3,700
181,300
307
7-37 (15 min.) Amounts are in thousands of dollars.
See Exhibit 7-37 for the balance sheet equation. Although not
required, the balance sheet equation provides a good framework for
understanding.
Journal Entries
a.
b.
c.
Returns and allowances:
As goods are sold:
Accounts payable
Inventory
Cost of goods sold
Inventory
960
960
80
80
890
890
d1. and d2.
No entry
a.
Periodic System
Purchases
960
Accounts payable
b.
Gross purchase:
Returns and allowances:
c.
As goods are sold:
d1.
Transfer to cost of
goods sold:
d2.
308
Gross purchase:
Perpetual System
Inventory
Accounts payable
Accounts payable
Purchase returns
and allowances
960
80
80
No entry
Cost of goods sold
Purchase returns
and allowances
Purchases
Inventory
Recognize ending inventory: Inventory
990
80
960
110
100
Cost of goods sold
Chapter 7
Inventories and Cost of Goods Sold
100
309
EXHIBIT 7-37
Entries are in thousands of dollars.
A
PERPETUAL SYSTEM
Inventory
Balance, 12/31/X7
a.
Gross purchases
b.
Returns and allowances
+110
+960
– 80
c.
–890
As goods are sold
=
L
Accounts
Payable
=
=
=
+ 110
+ 960
– 80
+
SE
Retained
Earnings
Increase Cost 
–890 of
Goods Sold 

Closing the accounts at end of period:
d1.
No entry
d2.
No entry
Ending balances, 12/31/X8
310
____
+100
=
+990
____
–890

EXHIBIT 7-37
(continued)
A
PERIODIC SYSTEM
=
Purchase
Returns and
Inventory Purchases Allowances
Balance, 12/31/X7
+110
a. Gross purchases
b. Returns and allowances
c. As goods are sold (no entry)
L
+
Accounts
Payable
SE
Retained
Earnings
–80
=
=
=
+80
=
Increase Cost 
– 990 of
 Goods Sold 
=
Cost 
+ 100 Decrease
of
Goods
Sold 

+960
+ 110
+ 960
– 80
Closing the accounts at
end of period:
d1. Transfer to cost of goods sold–110
–960
d2. Recognize ending inventory +100
Ending balances, 12/31/X8
Chapter 7
Inventories and Cost of Goods Sold
___
+100
___
0
___
0
=
+990
– 890
311
7-38 (10 min.)
This is straightforward.
1.
2.
3.
4.
Purchases
Accounts payable
880,000
880,000
Accounts payable
Purchase returns and allowances
50,000
Freight-in
Cash
74,000
Accounts payable
Cash
Cash discounts on purchases
50,000
74,000
830,000
812,000
18,000
7-39 (10 min.)
The entries could be compounded.
Accounts receivable (or Cash)
Sales
1,250,000
1,250,000
Cost of goods sold
Purchase returns and allowances
Cash discounts on purchases
Purchases
Freight-in
Inventory
957,000
50,000
18,000
Inventory
Cost of goods sold
120,000
Chapter 7
Inventories and Cost of Goods Sold
880,000
74,000
71,000
120,000
313
7-40 (10-15 min.)
Compound entries could be prepared. (Amounts are in
millions.)
Purchases
Accounts payable
130
Accounts receivable
Sales
239
239
Sales returns and allowances
Accounts receivable
5
Accounts payable
Purchase returns and allowances
6
Freight-in
Cash
314
130
5
6
14
14
Accounts payable
Cash discounts on purchases
Cash
124
Cash
Cash discounts on sales
Accounts receivable
226
8
Cost of goods sold
Purchase returns and allowances
Cash discounts on purchases
Inventory
Purchases
Freight-in
162
6
1
1
123
234
25
130
14
Inventory
Cost of goods sold
45
Other expenses
80
45
Cash (or other accounts)
80
7-41 (5 min.) Amounts are in millions of dollars.
Beginning inventory
Purchases
Cost of goods available
Ending inventory
Cost of goods sold
Chapter 7
Inventories and Cost of Goods Sold
$
45
4,510
4,555
(56)
$4,499
315
7-42 (15-20 min.)
This problem develops familiarity with the gross profit section.
The answer, $51,200, is computed by filling in the gross profit
section and solving for the unknown, or: $192,000 – 55%($256,000)
= $51,200.
Gross sales
Deduct: Sales returns
and allowances
Net sales
Cost of goods sold:
Inventory, December 31, 20X7
Gross purchases
Deduct: Purchase returns
and allowances
Cash discounts
on purchases
Net purchases
Inward transportation
Cost of goods acquired
Cost of goods available
for sale
Inventory, May 3, 20X8*
Cost of goods sold,
55% of $256,000
Gross profit, 45% of $256,000
$280,000
24,000
$256,000
$38,000
$160,000
$8,000
2,000 (10,000)
150,000
4,000
154,000
x=
192,000
51,200
140,800
$115,200
* Calculated as the difference between cost of goods available for sale,
$192,000, and cost of goods sold $140,800.
316
7-43 (15 min.)
Sales
Cost of goods sold:
Inventory, January 1
Purchases
Purchase returns and allowance
Net purchases
Freight-in
Cost of goods available for sale
Inventory, March 9*
Cost of goods sold,
80% of $200,000
Gross margin, 20% of $200,000
$200,000
$65,000
$195,000
10,000
$185,000
15,000
200,000
$265,000
x = 105,000
160,000
$ 40,000
* The answer, $105,000, is obtained by filling in the schedule of
cost of goods sold and solving for the unknown, or: $265,000 –
80%($200,000) = $265,000 – $160,000 = $105,000.
7-44 (10-15 min.)
Beginning inventory
Purchases
Cost of goods available for sale
Less estimated cost of goods sold:
75%* of $280,000
Estimated ending inventory
$ 55,000
200,000
$255,000
210,000
$ 45,000
*100% – 25% = 75%
The difference between $45,000 and the amount of inventory
remaining is an estimate of the amount missing.
Chapter 7
Inventories and Cost of Goods Sold
317
7-45 (10-15 min.)
1 & 2. To calculate the effect use the following approach:
20X5
Beginning inventory
+ Purchases
Goods available
−Ending inventory
Cost-of-goods sold
OK
OK
OK
Too low $20,000
Too high $20,000
20X6
Too low $20,000
OK
Too low $20,000
OK
Too low $20,000
Cost-of-goods sold is too high by $20,000 in 20X5 so taxable
income will be too low by $20,000. Taxes will be too low by $8,000 so
net income and retained earnings will be too low by $12,000.
Taxable income for 20X6 will be overstated by $20,000 and taxes will
be $8,000 too high. Net income in 20X6 will be too high by $12,000
and retained earnings will be correct again at December 31, 20X6.
318
7-46 (10-15 min.)
1.
Inventory turnover =
inventory
=
=
cost of goods sold* ÷ average
$1,080,000 ÷ $1,080,000
1.00
*Cost of goods sold = $2,400,000 – $1,320,000 = $1,080,000
2.
The gross profit would fall from $1,320,000 to $1,260,000, so a
change in pricing strategy would be undesirable for Custom
Gems. The current 20X3 data follow:
Inventory turnover
Gross profit percentage:
$1,320,000 ÷ $2,400,000
This percentage is not unusual.
1.0
55%
If prices are cut 20 percent in 20X4 without affecting inventory
turnover, new sales would be .8 x $2,400,000 = $1,920,000.
Cost of goods sold on those sales would still be $1,080,000.
Therefore Mr. Siegl would be reducing his gross profit from
$1,320,000 to $1,920,000 - $1,080,000 = $840,000 and its gross
profit percentage to 44% [($1,920,000 − $1,080,000) ÷
$1,920,000]. However, an increase in inventory turnover to 1.5
would produce the following:
Sales, $1,920,000 x 1.5
Cost of goods sold, $1,080,000 x 1.5
Gross profit
$2,880,000
1,620,000
$1,260,000
Gross profit would be only $60,000 below the 20X3 level.
Chapter 7
Inventories and Cost of Goods Sold
319
7-47 (15-20 min.)
1.
2.
LIFO Method:
Inventory shows: 1,100 tons on hand at July 31.
Costs:
1,000 tons @ $ 9.00
100 tons @ $10.00
July 31 inventory cost.
$ 9,000
1,000
$10,000
FIFO Method:
Inventory shows: 1,100 tons on hand at July 31.
Costs:
900 tons @ $12.00
200 tons @ $11.00
July 31 inventory cost.
$10,800
2,200
$13,000
Purchases:
5,000 tons @ $10
1,000 tons @ $11
900 tons @ $12
Total purchases
Beginning inventory:
1,000 tons @ $ 9
Cost of goods available for sale
Less ending inventory
Cost of goods sold
Sales
Cost of goods sold
Gross profit
320
$50,000
11,000
10,800
$71,800
9,000
$80,800
LIFO
FIFO
$ 80,800 $ 80,800
(10,000)
(13,000)
$ 70,800 $ 67,800
$102,000
70,800
$ 31,200
$102,000
67,800
$ 34,200
7-48 (5-10 min.)
The inventory would be written down from $200,000 to
$185,000 on December 31, 20X1. The new $185,000 valuation is
"what's left" of the original $200,000 cost. In other words, the
$185,000 is the unexpired cost and may be thought of as the new
cost of the inventory for future accounting purposes. Thus,
because subsequent replacement values exceed the $185,000 cost,
and write-ups above "cost" are not acceptable accounting practice,
the valuation remains at $185,000 until it is written down to $180,000
on the following December 31, 20X2.
7-49 (10-15 min.) Amounts are in millions of dollars.
The cost of inventory acquired during the year ending August
31, 2003, can be calculated as follows.
Beginning Inventory
Purchases
Cost of goods available
Ending inventory
Cost of merchandise sold
Y
X
Chapter 7
$ 3,127
X
=
Y
=
(3,339)
$37,325
37,537
40,664
= 37,325 + 3,339 = 40,664
= 40,664 – 3,127 = 37,537
Inventories and Cost of Goods Sold
321
7-50 (10 min.) Dollar amounts are in millions.
2003:
2002:
2001:
($11,305 − $7,799) ÷ $11,305 = 31.01%
($11,019 − $7,604) ÷ $11,019 = 30.99%
($11,332 − $7,815) ÷ $11,332 = 31.04%
The gross profit percentage was very steady over these three
years, with just a slight dip in 2002 followed by a small recovery.
Though not in the problem, it might be interesting to note that
the gross profit percentage has ranged for 27% to 31% over the past
ten years.
7-51 (10-15 min.)
1.
ISLAND BUILDING SUPPLY
Statement of Gross Profit
For the Year Ended December 31, 20X1
Sales
Cost of goods sold:
Inventory, beginning
Add net purchases
Cost of goods available for sale
Deduct ending inventory
Cost of goods sold
Gross profit
2.
322
$1,200,000
$ 240,000
1,035,000
$1,275,000
(330,000)
945,000
$255,000
Inventory turnover = Cost of goods sold ÷ Average inventory
= $945,000 ÷ [1/2 x (240,000 + 330,000)]
= 945,000 ÷ 285,000
= 3.3 times
7-52 (30-40 min.)
The detailed income statement is in the accompanying exhibit.
Note the classification of operating expenses into a selling category
and a general and administrative category. The list of accounts in
the problem contained one item that belongs in a balance sheet
rather than an income statement, the Allowance for Bad Debts (an
offset to Accounts Receivable).
The delivery expenses and the bad debts expense are shown
under selling expenses. Some accountants prefer to show the bad
debts expense as an offset to gross sales or as administrative
expenses.
Chapter 7
Inventories and Cost of Goods Sold
323
7-52 (continued)
BACKBAY BATHROOM SUPPLY COMPANY
Income Statement
For the Year Ended December 31, 20X5
(In Thousands)
Revenues:
Gross sales
Deduct: Sales returns and allowances
Cash discounts on sales
Net sales
Cost of goods sold:
Inventory, December 31, 20X4
Add purchases
Less: Purchase returns
and allowances
$40
Cash discounts on purchases
15
Net purchases
Add Freight in
Cost of merchandise acquired
Cost of goods available for sale
Deduct: Inventory, December 31, 20X5
Cost of goods sold
Gross profit from sales
Operating expenses:
Selling expenses:
Sales salaries and commissions
Rent expense, selling space
Advertising expense
Depreciation expense, trucks
and store fixtures
Bad debts expense
Delivery expenses
Total selling expenses
General and administrative expenses:
Office salaries
Rent expense, office space
Depreciation expense, office equipment
Office supplies used
Miscellaneous expenses
Total general and administrative expenses
Total operating expenses
Income before income tax
Income tax expense
324
$1,091
$ 50
16
66
$1,025
$200
$600
55
$545
50
595
$795
300
495
$ 530
$160
90
45
29
8
20
$352
46
10
3
6
13
78
430
$ 100
42
Net income
Chapter 7
Inventories and Cost of Goods Sold
$ 58
325
7-53 (15-25 min.)
Under the FIFO cost-flow assumption, the periodic and
perpetual procedures give identical results. The ending inventory
will be valued on the basis of the last purchases during the period.
Beginning Inventory
Purchases
Units
120
290
$
600
2,050
Goods available
Units sold
410
255
2,650
1,465**
Units in ending Inventory
155
1,185*
* 155 units remain in ending inventory
100 will be valued at the $8 cost from the October 21 purchase and
the remaining 55 will be valued at the $7 cost from the May 9
purchase
100 x $8 = $ 800
55 x $7 =
385
$1,185 Ending inventory
** Reconciliation:
255 Units:
326
Cost of Goods Sold:
120 x $5 =
$ 600
80 x $6 =
480
55 x $7 =
385
$1,465
7-54 (30-35 min.)
1.
Gross profit percentage = $1,600,000 ÷ $4,000,000 = 40%
Inventory turnover
= $2,400,000 ÷
$850,000 + 750,000
2
= 3 times
2.
Inventory turnover = $2,400,000 ÷ $600,000 = 4 times, a 1/3
increase in turnover.
3.
With a lower average inventory and constant inventory
turnover, cost of sales must fall. Total cost of goods sold =
$600,000 x 3 = $1,800,000. To achieve a gross profit of
$1,600,000, total sales must be $1,800,000 + $1,600,000, or
$3,400,000. The gross profit percentage must be $1,600,000 ÷
$3,400,000 = 47.1%. Requirements 2 & 3 show that if inventory
levels are reduced you must increase either inventory turnover
or margins to maintain profitability.
4.
Summary (computations are shown below):
Sales
Cost of goods sold
Gross profit
Chapter 7
Inventories and Cost of Goods Sold
Succeeding Year
Given Year
4a
4b
$4,000,000 $3,857,143 $4,125,000
2,400,000 2,160,000 2,640,000
$1,600,000 $1,697,143 $1,485,000
327
7-54 (continued)
a.
New gross profit percentage, 40% + .10(40%) = 44%
New inventory turnover, 3 – .10(3) = 2.7
New cost of goods sold, $800,000 x 2.7 = $2,160,000
New sales = $2,160,000 ÷ (1 – .44)
= $2,160,000 ÷ .56
= $3,857,143
Note that this is a more profitable alternative, assuming that the
gross profit percentage and the inventory turnover can be
achieved. In contrast, alternative 4b is less attractive than the
original 40% gross profit and turnover of 3.
b.
5.
328
New gross profit percentage, 40% – .10(40%) = 36%
New inventory turnover, 3 + .10(3) = 3.3
New cost of goods sold, $800,000 x 3.3 = $2,640,000
New sales = $2,640,000 ÷ (1 −.36)
= $2,640,000 ÷ .64
= $4,125,000
Retailers find these ratios (and variations thereof) helpful for a
variety of operating decisions, too many to enumerate here.
An obvious help is the quantifying of the options facing
management regarding what and how much inventory to carry,
and what pricing policies to follow. You may want to stress that
this analysis ignores one benefit of higher inventory turnover—
the firm reduces its investment in inventory and reduces
storage and display requirements.
7-55 (25-35 min.)
The detailed income statement is in the accompanying exhibit.
Some accountants prefer to show the provision for uncollectible
accounts as an offset to gross sales. The data for the allowance for
doubtful accounts does not affect the income statement.
SEARS, ROEBUCK & COMPANY
Income Statement
For the Year Ended December 31, 2002
(In Millions)
Revenues:
Gross revenues (Plug)
Deduct: Sales returns and allowances
Cash discounts on sales
Net revenues
Cost of goods sold:
Inventory, December 31, 2001
Add purchases
Less: Purchase returns
and allowances
$1,200
Cash discounts on
purchases
180
Net purchases
$24,744
Add Freight in
Cost of merchandise acquired
Cost of goods available for sale
Deduct: Inventory, December 31, 2002
Cost of sales
Grossprofit
Operating expenses:
Selling and administrative
Provision for uncollectible accounts
Depreciation
Other operating expenses
Operating income
Interest expense
Other income, net
Income before tax
Chapter 7
Inventories and Cost of Goods Sold
$44,316
$ 2,100
850
2,950
$41,366
$4,912
$26,124
1,380
1,100
25,844
$30,756
5,115
25,646
$15,720
$9,249
2,261
875
111
12,496
$ 3,224
1,143
(372)
$ 2,453
329
7-56 (20-30 min.)
1.
CONTRACTOR SUPPLY CO.
Comparison of Inventory Methods
Statement of Gross Profit of Kemtone Cooktops
For the Year Ended December 31, 20X8
(In Dollars)
FIFO
Sales, 260 units
Deduct cost of goods sold:
Inventory, December 31,
20X7, 110 @ $50
Purchases, 300 units
Cost of goods available for
sale, 410 units
Deduct: Inventory, December
31, 20X8, 150 units:
100 @ $80
50 @ $70
110 @ $50
40 @ $60*
150 @ ($26,700 ÷ 410),
150 @ $65.12
Cost of goods sold,
260 units
Gross profit
26,200
8,000
3,500
Weighted
Average
LIFO
26,200
26,200
5,500
21,200
5,500
21,200
5,500
21,200
26,700
26,700
26,700
11,500
5,500
2,400
7,900
9,768
15,200
11,000
18,800
7,400
16,932
9,268
* This is a periodic LIFO. Students are using perpetual LIFO if they answer 20 @ $60 plus 20 @
$80 = $2,800.
2.
330
Income taxes would be lower by .40($11,000 – $7,400) = $1,440.
The income tax rate is assumed to be identical at all levels of
taxable income.
Some students will wonder why no
information is given regarding other expenses and net income.
Such information is unnecessary because other expenses,
whatever their amounts, will be common among all inventory
methods. Thus gross profits provide sufficient information to
measure the differences in income taxes among various
inventory methods.
7-57 (15-20 min.)
There would be no effect on gross profit, net income, or
income taxes under FIFO, although the balance sheet would show
ending inventory as $8,000 higher. The income statement would
show purchases and ending inventory as higher by $8,000, so the
net effect on cost of goods sold would be zero.
LIFO would show a lower gross profit, $6,000, as compared
with $7,400, a decrease of $1,400. Hence, the impact of the late
purchase on income taxes would be a savings of 40% of $1,400 =
$560.
The tabulation below compares the results under LIFO (in
dollars):
Without Late Purchase
26,200
Sales, 260 Units
Deduct: Cost of goods sold:
Inventory, December 31, 20X7,
110 @ $50
5,500
Purchases, 300 units at various
costs
21,200
100 units @ $80
−
Cost of goods available for sale
26,700
Deduct: Inventory, December
31, 20X8:
First layer (pool) 110 @ $50
5,500
Second layer (pool) 40 @ $60
2,400 7,900
Second layer (pool) 80 @ $60
Third layer (pool) 60 @ $70
Cost of goods sold, 260 units
18,800
Gross profits
7,400
Income taxes @ 40%
2,960
Chapter 7
Inventories and Cost of Goods Sold
With Late Purchase
26,200
5,500
21,200
8,000
34,700
5,500
4,800
4,200
14,500
20,200
6,000
2,400
331
7-57 (continued)
Although purchases are $8,000 higher than before, the new
LIFO ending inventory is only $14,500 – $7,900 = $6,600 higher. The
$1,400 difference in gross profit is explained by the fact that the late
purchase resulted in changes to both ending inventory and cost of
goods sold. LIFO cost of goods sold is $1,400 higher ($20,200 –
$18,800).
To see this from another angle, compare layers. Without the
late purchase, the second layer had 40 units @ $60. With the late
purchase:
Late purchase released as expense, 100 @ $80
Second layer is 40 units higher @ $60
Third layer is 60 units @ $70
Amount held as ending inventory that
would otherwise have been released as
expense in the form of cost of goods sold
Difference in cost of goods sold
$8,000
= $2,400
= 4,200
6,600
$1,400
7-58 (15 min.)
1.
LIFO:
2.
Replacement cost: 120 units @ $12 = $1,440.
LIFO is lower than replacement cost. Therefore, no inventory
write-down takes place, and the balance sheet shows $1,240.
3.
FIFO:
4.
Replacement cost is $1,440 (see Requirement 2). Because
replacement cost is lower than FIFO, the balance sheet should
332
100 units @ $10
20 units @ $12
20 units @ $12
100 units @ $13
$1,000
240
$1,240
$ 240
1,300
$1,540
include the lower amount, $1,440. Most companies would treat
the $100 inventory write-down as an increase in cost of sales.
Chapter 7
Inventories and Cost of Goods Sold
333
7-59 (10-15 min.)
1. O is used for overstated, U for understated, and N for not
affected.
Beginning inventory*
Ending inventory*
Cost of goods sold
Gross margin
Income before income taxes
Income tax expense
Net income
(In Thousands)
20X1
20X2
N
O $15
O $15
N
U 15
O 15
O 15
U 15
O 15
U 15
O
6
U
6
O
9
U
9
*The ending inventory for 20X1 becomes the beginning
inventory for 20X2.
2.
Retained earnings would be overstated by $9,000 at the end of
the first year. However, the error would be offset in the second
year, assuming no change in the 40% income tax rate.
Therefore, retained earnings would be correct at the end of the
second year.
7-60 (20-30 min.)
1.
See Exhibit 7-60 on the following page.
2.
LIFO results in more cash by the difference in income tax effects. LIFO
results in a lower cash outflow of .40 x ($116,000 – $96,000) = $8,000.
3.
FIFO results in more cash when inventory prices are falling. Why?
Because income tax cash outflow would be more under LIFO by
.40($144,000 – $124,000) = $8,000.
334
EXHIBIT 7-60
Purchases @ $12 Unit
Purchases @ $8
Requirement a
FIFO
LIFO
Requirement b
FIFO
LIFO
$240,000
$240,000
$240,000$240,000
100,000
156,000
256,000
100,000
156,000
256,000
100,000 100,000
104,000 104,000
204,000 204,000
Unit
Sales, 12,000 @ $20
Deduct cost of goods sold:
Inventory, December 31, 20X1, 10,000 @ $10
Purchases: 13,000 @ $12 and $8, respectively
Cost of goods available for sale
Deduct: Inventory, December 31, 20X2,
11,000 units:
11,000 @ $12 =
or
10,000 @ $10 = $100,000
1,000 @ $12 = 12,000
or
11,000 @ $ 8 =
or
10,000 @ $10 = $100,000
1,000 @ $ 8 =
8,000
Cost of goods sold
Gross margin
Chapter 7
Inventories and Cost of Goods Sold
132,000
112,000
88,000
124,000
$116,000
144,000
$ 96,000
108,000
116,000 96,000
$124,000$144,000
335
7-61 (20 min.)
1.
Units
Sales
Cost of goods sold:
Inventory, December 31, 20X7
Purchases
Cost of goods available for sale
Inventory, December 31, 20X8
Cost of goods sold
Gross margin or gross profit
* 14,000 @ £6
22,000 @ £7
36,000
**
2.
336
LIFO
FIFO
30,000
£330,000
£330,000
14,000
52,000
66,000
36,000
30,000
84,000
84,000
394,000
394,000
478,000
478,000
238,000* 282,000**
240,000
196,000
£ 90,000 £134,000
= £ 84,000
= 154,000
£238,000
30,000 @ £8
6,000 @ £7
36,000
=
£240,000
=
42,000
£282,000
Gross margin is higher under FIFO. However, cash will be
higher under LIFO by .40(£134,000 – £90,000) = .40 x £44,000 =
£17,600. Cash payments for inventory and cash receipts from
sales are unaffected by the cost flow assumption. Only the
effect on tax obligations affects cash flow.
7-62 (35 min.)
1.
(Dollars In Thousands)
Sales
Deduct cost of goods sold:
Beginning inventory:
10,000 tons @ $50
Purchases:
30,000 tons @ $60
20,000 tons @ $70
Cost of goods
available for sale
Ending inventory:
10,000 tons @ $50
5,000 tons @ $60
Cost of goods sold
Gross profit
Other expenses
Income before
income taxes
Income taxes at 40%
Net income
Chapter 7
Lastin Company
Firstin Company
(LIFO)
(FIFO)
$4,500
$ 500
$1,800
1,400
$ 500
300
Inventories and Cost of Goods Sold
$4,500
$ 500
3,200
3,200
$3,700
$3,700
800
15,000
@ $70
2,900
$1,600
600
$ 1,000
400
$ 600
1,050
2,650
$1,850
600
$1,250
500
$ 750
337
7-62 (continued)
2.
Note first that the underlying events are identical, but the
inventory method chosen will yield radically different results.
When prices are rising, and if she had a choice, the manager
would choose the method that is most harmonious with her
objectives. Clearly the company is better off economically
under the LIFO method, even though reported earnings are
less. LIFO saved $100 thousand in income taxes:
LIFO
Cash receipts:
Sales
Cash disbursements:
Purchases
Other expenses
Income taxes
Total disbursements
Net increase in cash
$3,200
600
FIFO
$4,500
$4,500
$3,800
400
$4,200
$ 300
$3,800
500
$4,300
$ 200
On the other hand, reported net income is dramatically better
under FIFO, $750 versus $600. In times of rising prices and
stable or increasing inventory levels, the general guide is that
LIFO saves income taxes and results in a better cash position;
nevertheless, FIFO shows the higher reported net income.
338
7-63 (30 min.)
1.
20X1
20X2
20X3
20X4
20X5
Total
FIFO:
Sales
Cost of goods sold
Income before taxes
Income taxes
Net income
$5,000
1,000
4,000
1,600
$2,400
$5,000
2,000
3,000
1,200
$1,800
$5,000
2,000
3,000
1,200
$1,800
LIFO:
Sales
Cost of goods sold
Income before taxes
Income taxes
Net income
$5,000
2,000
3,000
1,200
$1,800
$5,000
2,500
2,500
1,000
$1,500
$5,000 $5,000 $20,000 $40,000
3,000
4,000
9,000 20,500
2,000
1,000 11,000 19,500
800
400
4,400
7,800
$1,200$ 600
$ 6,600 $11,700
2.
$5,000 $20,000 $40,000
2,500 13,000 20,500
2,500
7,000 19,500
1,000
2,800
7,800
$1,500 $ 4,200 $11,700
LIFO is most advantageous because it defers tax payments.
This provides additional cash and reduces the need for
borrowing. One way to think about the benefit is to think of the
interest saved each year. For example, assume that if higher
taxes were paid, that amount would be borrowed at an interest
rate of 10%.
20X1
20X2
FIFO tax
$1,600
LIFO tax
1,200
Annual cash benefit /(loss) $ 400 $
Cumulative cash benefit $ 400 $
Interest saved @ 10%
$ 40 $
20X3
20X4
20X5
Total
$1,200 $1,200 $1,000 $2,800 $7,800
1,000 800
400
4,400
7,800
200 $ 400 $ 600
$(1,600)$ 0
600
$1,000 $1,600 –
–
60 $ 100 $ 160
–
$ 360
This analysis does not consider the time value of money in that
interest savings are simply added together, but it does provide
a vivid illustration of the concept.
Chapter 7
Inventories and Cost of Goods Sold
339
7-64 (30-40 min.)
1, 2.
Sales, 5,000 units
Less cost of goods sold:
Purchase cost,
Less ending inventory:
FIFO: 4,000 @ $15
LIFO:
2,000 @ $10 = $20,000
1,000 @ $11 = 11,000
1,000 @ $13 = 13,000
Cost of goods sold
Other expenses
Total deductions
Income before taxes
Income taxes @ 40%
Net income
3.
Sales, 5,000 units
Less cost of goods sold:
Purchase cost*
Other expenses
Total deductions
Income before taxes
Income taxes @ 40%
Net income
FIFO
LIFO
1(a)
2(a)
1(b)
2(b)
$120,000
$96,000
$120,000
$96,000
$118,000
$118,000
60,000
$ 58,000
30,000
$ 88,000
$ 32,000
$ 12,800
$ 19,200
$60,000
30,000
$90,000
$ 6,000
$ 2,400
$ 3,600
FIFO
44,000
$ 74,000
30,000
$104,000
$ 16,000
$ 6,400
$ 9,600
$44,000
30,000
$74,000
$22,000
$ 8,800
$13,200
LIFO
1(a)
2(a)
1(b)
2(b)
$120,000
$96,000
$120,000
$96,000
$ 58,000
30,000
$ 88,000
$ 32,000
$ 12,800
$ 19,200
$60,000
30,000
$90,000
$ 6,000
$ 2,400
$ 3,600
$ 58,000
30,000
$ 88,000
$ 32,000
$ 12,800
$ 19,200
$60,000
30,000
$90,000
$ 6,000
$ 2,400
$ 3,600
The timing of purchases does not affect FIFO income but
affects LIFO income. LIFO cost of goods sold declined from $74,000
to $58,000 as a result of the delay in purchase. Managers can
directly influence LIFO net income by choices to replenish inventory.
* In this example all purchases are sold each year and no inventories
accumulate. Therefore, FIFO and LIFO give identical results.
340
7-65 (20-30 min.)
The major point here is to demonstrate that changes in LIFO
reserves can be used as a shortcut measure of the differences in
cost of goods sold under FIFO and LIFO. (All amounts are in
dollars.)
1.
(1)
FIFO
(2)
LIFO
40
32
8
156
196
156
188
8
56
140
32
156
24
(16)
a. Beginning inventory
40
Purchases (as above)
156
Cost of goods available for sale 196
Ending inventory
3 @ $28 + 1 @ $24
108
2 @ $16 + 2 @ $24
___
Cost of goods sold
88
32
156
188
8
80
108
28
(20)
b. Beginning inventory
Purchases
Available for sale
Ending inventory
Cost of goods sold
32
156
188
0
188
8
Beginning inventory, 2 @ $20,
2 @ $16
Purchases:
3 @ $24 + 3 @ $28 =
Cost of goods available for sale
Ending inventory, 2 @ $28,
2 @ $16
Cost of goods sold
2.
LIFO
Reserve
(1) – (2)
Chapter 7
Inventories and Cost of Goods Sold
40
156
196
0
196
8
8
0
8
341
7-65 (continued)
3.
From Part 1, the beginning LIFO Reserve is 8, the difference
between FIFO inventory of 40 and LIFO inventory of 32. At year
end the LIFO Reserve is 24, an increase of 16. This 16 is
exactly the difference between FIFO cost of goods sold of 140
and LIFO cost of goods sold of 156. If prices are rising, cost of
goods sold includes more of these recent higher costs under
LIFO than under FIFO. Hence, if physical quantities are held
constant, the LIFO reserve will rise by the difference between
the cost of goods sold. Why? Because old LIFO unit costs will
still be held in ending inventory, whereas recent higher unit
costs will apply to the ending FIFO inventory.
If physical quantities of ending inventory rise along with rises in
unit prices, the LIFO difference in higher cost of goods sold
becomes larger. Compare 2a. with 1.
If the older LIFO layers are liquidated, the LIFO cost of goods
sold becomes less than FIFO cost of goods sold. As 2b.
demonstrates, the total liquidation of inventories will result in
FIFO cost of goods sold exceeding LIFO cost of goods sold by
the amount of the LIFO reserve at the start of the year.
342
7-66 (15-20 min.)
1.
O is used for overstated; U is used for understated:
Beginning inventory*
Cost of goods available
Ending inventory*
Cost of goods sold
Gross margin
Income before income taxes
Income tax expense
Net income
20X3
Correct
Correct
U $5
O 5
U 5
U 5
U 2
U 3
(In Millions)
20X2
20X1
O $10
Correct
O 10
Correct
Correct
O $10
O 10
U 10
U 10
O 10
U 10
O 10
U
4
O
4
U
6
O
6
* The ending inventory for a given year becomes the beginning
inventory for the following year.
2.
Retained earnings would be overstated by $6 million at the end
of 20X1. However, the error would be offset in the second year.
Therefore, retained earnings would be correct at the end of
20X2. Retained earnings is understated by $3 million at the end
of 20X3.
7-67 (30-40 min.)
1.
See Exhibit 7-67 on the following page.
2.
a.
Income before income taxes will be lower under LIFO than
under FIFO: $149,000 – $124,000 = $25,000. The income
tax will be lower by .40 x $25,000 = $10,000.
b.
Income before income taxes will be lower under LIFO than
under weighted-average: $135,950 – $124,000 = $11,950.
The income tax will be lower by .40 x $11,950 = $4,780.
Chapter 7
Inventories and Cost of Goods Sold
343
EXHIBIT 7-67
FIFO
Net revenue from sales
(150 @ $900) + (160 @ $1,000)
Deduct cost of products sold:
Inventory, February 1, 2002,
100 @ $400
Purchases (200 @ $500) + (160 @ $600)
Cost of goods available for sale, 460 units
Deduct: Inventory, January 31, 2003, 150 units:
150 @ $600
or
100 @ $400 =$40,000
50 @ $500 = 25,000
or
150 @ ($236,000 ÷ 460) or 150 @ $513
or
100 @ $400 =$40,000
50 @ $500 = 25,000
Cost of goods sold
Gross margin
344
LIFO
Weighted
Specific
Average Identification
$295,000
$295,000
$295,000 $295,000
40,000
196,000
236,000
40,000
196,000
236,000
40,000 40,000
196,000 196,000
236,000 236,000
90,000
65,000
76,950
146,000
$149,000
171,000
$124,000
65,000
159,050 171,000
$135,950 $124,000
7-68 (20-30 min.) This problem explores the effects of LIFO layers.
There would be no effect on gross margin, income taxes, or
net income under FIFO. The balance sheet would show a higher
inventory by $42,000. A detailed income statement would show both
purchases and ending inventory as higher by $42,000, so the net
effect on cost of goods sold would be zero.
LIFO would show a lower gross margin, $112,000, as compared
with $124,000, a decrease of $12,000. Hence, the impact of the late
purchase would be a savings of income taxes of 40% of $12,000 =
$4,800. For details, see the following tabulation.
Without Late
Purchase
Net revenues from sales as
before
Deduct cost of goods sold:
Inventory, February 1, 2002,
100 @ $400
Purchases, 360 units, as before,
and 420 units
Cost of goods available for sale
Ending inventory:
First layer 100 @ $400 plus
second layer 50 @ $500
First layer 100 @ $400 plus
second layer 110 @ $500
Cost of goods sold
Gross margin
$295,000
With Late
Purchase
$295,000
$ 40,000
$ 40,000
196,000
$236,000
238,000*
$278,000
65,000
171,000
$124,000
95,000
183,000
$112,000
*360 units, as before $196,000
60 units @ $700
42,000
$238,000
Chapter 7
Inventories and Cost of Goods Sold
345
7-68 (continued)
Although purchases are $42,000 higher than before, the new
LIFO ending inventory is only $95,000 – $65,000 = $30,000
higher. The cost of sales is $183,000 – $171,000 = $12,000
higher.
To see this another way, compare the ending inventories:
Late purchase added to cost of
goods available for sale: 60 @ $700
= $42,000
Deduct 60-unit increase in ending inventory:
Second layer is 110 – 50 = 60 units higher @ $500 =
30,000
Cost of sales is higher by: 60 @ ($700 - $500) = $12,000
7-69 (30-40 min.)
See Exhibit 7-69 on the following page.
346
EXHIBIT 7-69
1.
TEXAS INSTRUMENTS
Comparison of Inventory Methods
Income Statement
For the Year Ended December 31, 2002
FIFO
Average
Net sales, 200 units
Deduct cost of sales:
Beginning inventory, 80 @ $5
Purchases, 220 units*
Available for sale, 300 units**
Ending inventory, 100 units:
90 @ $8
10 @ $7
or
80 @ $5
20 @ $6
or
100 @ ($1,980 ÷ 300), or
100 @ $6.60
Cost of sales, 200 units
Gross margin
Other expenses
Pretax income
Income taxes at 40%
Net income
*
LIFO
$2,380
$2,380
$ 400
1,580
$1,980
$720
70
Weighted
$ 400
1,580
$1,980
$2,380
$ 400
1,580
$1,980
790
$400
120
520
660
1,190
$1,190
600
$ 590
236
$ 354
1,460
$ 920
600
$ 320
128
$ 192
1,320
$1,060
600
$ 460
184
$ 276
Always equal across all three methods.
Chapter 7
Inventories and Cost of Goods Sold
347
**
348
These amounts will not be equal across the three methods usually, because the beginning
inventories will generally be different. The amounts are equal here only because beginning
inventories are assumed to be equal.
7-69 (continued)
2.
Income taxes would be lower under LIFO by .40($590 − $320) =
.40($270) = $108.
3.
Cost of goods available for sale
Ending inventory
(90 @ $8) + (10 @ $7)
(60 @ $5) + (40 @ $8)
Cost of sales
Sales
Gross Margin
a
$1,980
b
$1,980
790
$1,190
2,380
$1,190
620
$1,360
2,380
$1,020
The specific identifications are often cumbersome, although
technology has reduced the cost of using them. They
obviously affect income and income taxes. This method
permits the most latitude in determining income for a given
period.
7-70 (15-20 min.)
This problem explores the effects of LIFO layers.
There would be no effect on gross margin, income before
income taxes, or income taxes under FIFO. The balance sheet
would show a higher inventory by $400. A detailed income
statement would show both purchases and ending inventory as
higher by $400, so the net effect on cost of goods sold would be
zero.
LIFO would show a lower income before income taxes, $240, as
compared with $320, a decrease of $80. Hence, the impact of the
late purchase would be a savings of income taxes of 40% of $80 =
$32. For details, see the accompanying tabulation.
Chapter 7
Inventories and Cost of Goods Sold
349
7-70 (continued)
The tabulation given below compares the results under LIFO:
Without Late
Purchase
Net sales, 200 units
Deduct cost of sales:
Beginning inventory 80 @ $5
$ 400
Purchases, 220 units
and 270 units
1,580
Available for sale
$1,980
Ending inventory:
First layer (pool) 80 @ $5 $400
Second layer (pool)
20 @ $6
120
520
First layer (pool) 80 @ $5
Second layer (pool)
50 @ $6
Third layer (pool) 20 @ $7
Cost of sales
Gross margin
Other expenses
Pretax income
Income taxes
Net income
$
*Purchases for 220 units
New purchases, 50 units
350
$1,580
400
$1,980
With Late
Purchase
$2,380
$2,380
$ 400
1,980*
$2,380
$400
300
140
1,460
920
600
320
128
192
840
1,540
840
600
240
96
$ 144
7-70 (continued)
Although purchases are $400 higher than before, the new LIFO
ending inventory is only $840 – $520 = $320 higher. The cost of
sales is $1,540 – $1,460 = $80 higher.
To see this from another angle, compare the ending
inventories:
Late purchase added to cost of goods
available for sale
Deduct 50-unit increase in ending inventory:
Second layer is 50 – 20 = 30
units higher @ $6
= $180
Third layer is 20 – 0 = 20
units higher @ $7
= 140
Cost of sales is higher by
$400
320
$ 80
7-71 (20-30 min.)
This is a classic problem. Knowledge of discounted cash flow
is not necessary.
The discounted cash flow model implies that, other things
being equal, it is always desirable to take a tax deduction earlier
rather than later. Moreover, if prices rise, LIFO will generate earlier
tax deductions than FIFO. By switching from LIFO to FIFO, Chrysler
deliberately boosted its tax bills by $53 million in exchange for real or
imagined benefits in terms of its credit rating and the attractiveness
of its common stock as compared with its competitors in the auto
industry.
Chapter 7
Inventories and Cost of Goods Sold
351
7-71 (continued)
Was this a wise decision? Many critics thought it harmed
rather than helped stockholders because the supposed benefits
were illusory. For example, these critics maintain that mounting
evidence about efficient stock markets shows that the investment
community is not fooled by whether a company is on LIFO or FIFO -that its stock price will be unaffected. An American Accounting
Association committee (Accounting Review, Supplement to Vol.
XLVIII, p. 248) commented: "If the capital markets are efficient in the
semi-strong form, this change was totally unnecessary and, from
the point of view of Chrysler's shareholders, constitutes a waste of
resources."
In sum, Chrysler gave up badly needed cash in the form of
higher income taxes in exchange for a higher current ratio (FIFO
inventory would be much higher than LIFO inventory) and higher
reported net income. In light of Chrysler's deteriorating cash
position in the late 1970s, Chrysler's tradeoff was unwise.
352
7-72 (40-60 min.)
1.
LIFO
Sales: 1,100,000 @ $5
Cost of goods sold (LIFO basis):
300,000 units, @ $3 =
800,000 units, @ $2 =
or
400,000 units, @ $4 =
300,000 units, @ $3 =
400,000 units, @ $2 =
Gross profit
Other expenses
Income before taxes
Income taxes
Net income
Earnings per share
Buy
Do Not Buy(a) More Units(b)
$5,500,000 $5,500,000
$ 900,000
1,600,000
$1,600,000
900,000
800,000
$
(a) Ending inventory, 100,000 units @ $2,
(b) Ending inventory, 500,000 units @ $2,
2.
2,500,000
3,300,000
$3,000,000 $2,200,000
1,400,000
1,400,000
$1,600,000$ 800,000
800,000
400,000
$ 800,000
$ 400,000
8.00
$
4.00
$ 200,000
$1,000,000
FIFO
Sales: 1,100,000 @ $5
Cost of goods sold (FIFO basis):
900,000 units, @ $2
=
200,000 units, @ $3
=
Gross profit
Other expenses
Income before taxes
Income taxes
Net income
Earnings per share
(c) Ending inventory, 100,000 units @ $3
(d) Ending inventory, 400,000 units @ $4
100,000 units @ $3
Total
Chapter 7
Inventories and Cost of Goods Sold
Buy
Do Not Buy(c)More Units(d)
$5,500,000 $5,500,000
$1,800,000
600,000
$
2,400,000
2,400,000
$3,100,000 $3,100,000
1,400,000
1,400,000
$1,700,000 $1,700,000
850,000
850,000
$ 850,000 $ 850,000
8.50 $
8.50
$ 300,000
1,600,000
300,000
$1,900,000
353
7-72 (continued)
3.
Consider this question from a strict financial management
standpoint – ignoring earnings per share. When prices are
rising, it may be advantageous – subject to prudent restraint as
to maximum and minimum inventory levels – to buy unusually
heavy amounts of inventory at year-end, particularly if income
tax rates are likely to fall. Under LIFO, the current year tax
savings would be a handsome $400,000. This is at least a
deferral of the tax effect. The effects on later years' taxes will
depend on inventory levels, prices, and tax rates.
Tax savings can be generated because LIFO permits
management to influence immediate net income by its
purchasing decisions. In contrast, FIFO results would be
unaffected by this decision.
However, if management buys the 400,000 units and uses
LIFO, the first year earnings per share would be only $4.00.
Note too that LIFO will show less earnings per share than FIFO
($8.00 as compared to $8.50), even if the 400,000 units are not
bought. Such results may cause management to reject LIFO.
Earnings per share (EPS) is a critical number, and many
managements are reluctant to adopt accounting policies that
hurt EPS.
The shame of the matter is that the same business events can
dramatically affect measures of performance, depending on
whether LIFO or FIFO is adopted ($4.00 versus $8.50).
Although, the smart decision would be to adopt LIFO and buy
the 400,000 units, this decision produces the worst earnings
record!
4a. The income statement for year two would show the same net
income and earnings per share whether additional inventory is
purchased or not, because prices do not change.
354
Chapter 7
Inventories and Cost of Goods Sold
355
7-72 (continued)
LIFO
In year 2
Do not Buy
Buy
Sales
$5,500,000 $5,500,000
Cost of goods sold
4,400,000(a) 4,400,000(b)
Gross profit
$1,100,000 $1,100,000
Other expenses
800,000
800,000
Income before taxes $ 300,000 $ 300,000
Income taxes
120,000
120,000
Net income
$ 180,000 $ 180,000
Earnings per share
$
1.80 $
1.80
FIFO
Do not Buy
Buy
$5,500,000
$5,500,000
(c)
4,300,000
4,300,000(d)
$1,200,000
$1,200,000
800,000
800,000
$ 400,000
$ 400,000
160,000
160,000
$ 240,000
$ 240,000
$
2.40
$
2.40
Year 2 Cost of Goods Sold Calculations
(a)
(b)
(c)
(d)
Beginning inventory,
see parts (1) and (2)
$ 200,000 $1,000,000 $ 300,000 $1,900,000
Purchases:
1,700,000 units @ $4
6,800,000
6,800,000
1,300,000 units @ $4
5,200,000
5,200,000
Available for sale
$7,000,000 $6,200,000 $7,100,000 $7,100,000
Ending inventory:
100,000 units @ $2 = $ 200,000
600,000 units @ $4 =
2,400,000 2,600,000
500,000 units @ $2 =
1,000,000
200,000 units @ $4 =
800,000
1,800,000
700,000 units @ $4 =
2,800,000 2,800,000
Cost of goods sold
$4,400,000 $4,400,000 $4,300,000 $4,300,000
4b. FIFO shows $100,000 higher income before taxes ($60,000
after taxes) because 100,000 units of old, lower-cost inventory
is in Cost of Goods Sold:
LIFO
FIFO
1,000,000 units @ $4 = $4,000,000
100,000 units @ $3 =
300,000
1,100,000 units @ $4 = $4,400,000
$4,300,000
356
7-72 (continued)
4c. The ending LIFO inventory is $800,000 higher in column (a)
because the 400,000 more units in ending inventory are priced
at $4 a unit when the inventory is not replenished at the end of
year one. In column (b), the 400,000 units purchased @ $4
near the end of the first year were charged immediately to Cost
of Goods Sold, leaving 400,000 more of the ending inventory
units at the old unit cost of $2. Under the LIFO assumption,
this inventory is regarded as untouched in the second year, so
the old $2 unit cost applies to the ending inventory of the
second year.
4d.
Income tax for the two years
Alternatives
a
b
c
d
$920,000 $520,000
$1,010,000 $1,010,000
Unless the LIFO layers are depleted, the adoption of LIFO will
result in permanent postponement of income taxes. However, if
the layers are invaded, these low-cost layers will cause higher
tax payments in later years than under FIFO.
4e. As far as the financial decision is concerned, the computations
in part (4) substantiate the conclusions in part (3). As far as EPS
is concerned, note that all EPS numbers decline in the second
year.
Chapter 7
Inventories and Cost of Goods Sold
357
7-73 (30 min.)
This problem highlights the fact that LIFO theory of matching
current costs against current revenues breaks down when the socalled LIFO-base inventory is invaded. Then the costs matched
against current revenue are a conglomeration of old (often ancient)
costs and current costs. If prices have been rising for a long time,
the income tax liability can be unusually severe:
Requirement (1)
Sales, 500,000
units @ $3.00
Cost of goods sold:
340,000 @ $2.00 =
30,000 @ 1.20 =
50,000 @ 1.10 =
80,000 @ 1.00 =
Gross profit
Operating expenses
Net income before taxes
Income taxes @ 60%
Net income
358
Requirement (2)
$1,500,000
$680,000
36,000
55,000
80,000
$1,500,000
500,000 @ $2.00
851,000
649,000
500,000
149,000
89,400
$ 59,600
1,000,000
$
−
−
−
500,000
500,000
7-74 (15-20 min.)
1.
Figures are in millions of dollars.
Lower of LIFO
LIFO Cost
Cost or Market
2003
2004 2003
2004
20
8
20
8
14
13
14
8
–
–
5
–
Sales
Cost of goods sold
Write-down of ending inventory
Total costs charged
against sales
14
Gross margins without write-down 6
Gross margin after write-down
13
(5)
19
8
1*
0
* Accountants use various formats for presenting the effects of writedowns. Some deduct the write-down as a special loss immediately
after gross margin rather than having it affect gross margin. Thus,
under LIFO some would calculate the standard LIFO gross margin
and then adjust it.
Gross margin
Write-down
Gross margin less inventory write-down
5
4
1
The total gross margin for the two years combined is the same
for LIFO and lower-of-LIFO-or-market. The lower-of-cost-ormarket method is labeled as more conservative because it
shows gloomier results earlier in a series of periods.
2.
If replacement cost were $9 million on January 31, 2004, no
restoration of the December write-down would be permitted. In
brief, the $8 million December 31 valuation became the "new
cost" of the inventory. Inasmuch as only write-downs below
cost are allowed in historical cost accounting for inventories,
no subsequent write-ups are allowed.
Chapter 7
Inventories and Cost of Goods Sold
359
7-75 (15-20 min.)
1.
The change in the LIFO reserve is the annual effect on cost of
goods sold; in this instance $86.094 million – $83.829 million =
$2.265 million. Because the LIFO reserve rose, the use of LIFO
in this year decreased pretax income by $2.265 million.
Therefore, using FIFO, pretax income would have been
$359.495 million + $2.265 million = $361.760 million.
2.
LIFO = .34 x $359,495,000
FIFO = .34 x $361,760,000
Difference
=
Difference
=
3.
Yes. LIFO use reduced taxes in the current year by $770,100.
Historically the cumulative effect can be estimated by
multiplying the tax rate times the LIFO Reserve. .34 x $86.094
million = $29.272 million. Think of this as an interest free loan
from the government.
360
= 122,228,300
= 122,998,400
770,100
.34 x 2,265,000 = 770,100
7-76 (15-20 min.)
1.
Increasing. FIFO reports the most recent costs on the balance
sheet; LIFO reports older costs. Because FIFO amounts
exceed LIFO amounts, the most recent costs must be higher
than older costs. Therefore, costs have been increasing.
2.
Amounts in millions:
Sales revenue
Cost of goods sold
Gross profit
(a)
LIFO
$700.0
546.9
$153.1
(b)
FIFO
$700.0
632.6*
$ 67.4
* $546.9 + $85.7 = $632.6
Gross profit is higher under LIFO. Old LIFO layers are charged
as cost of goods sold. Because prices have been increasing,
the cost of old LIFO layers is less than more recent costs.
Therefore, LIFO cost of goods sold is less than FIFO cost of
goods sold, resulting in more gross profit under LIFO when
existing inventories are completely liquidated.
Chapter 7
Inventories and Cost of Goods Sold
361
7-77 (10-15 min.)
O is used for overstated, U for understated, and N for not
affected. All amounts are $10 million unless otherwise indicated.
1.
Beginning inventory
Ending inventory
Cost of sales
Gross profit
Income before taxes
Taxes on income
Net income
Effects of Fiscal Year
2002
2001
O
N
N
O
O
U
U
O
U
O
U by $4mil*
O by $4 mil*
U by $6 mil**
O by $6 mil**
*. 40 x $10 million = $4 million
** (1 – .40) x $10 million = $6 million
2.
362
Retained earnings would be overstated by $6 million at the end
of fiscal 2001. However, the error would be offset in the next
year assuming no change in the 40% rate of income tax.
Therefore, retained earnings would be correct at the end of
fiscal 2002.
7-78 (20-30 min.)
1.
Lancaster Colony’s cost of goods sold would have been $7.1
million more (charging the more recent costs) and its pretax
income $7.1 million less if it had replenished its inventories,
resulting in pretax income of $180.8 million - $7.1 million =
$173.7 million.
2.
Because the LIFO reserve declines, LIFO earnings are higher
than FIFO rather than the opposite. The pre-tax difference is
merely the change in the LIFO reserve = $14.5 million – $7.4
million = $7.1 million.
FIFO pretax earnings = $180.8 million – $7.1 million = $173.7
million.
3.
Chapter 7
The LIFO liquidation per se increased earnings by $7.1 million
in 2003. The net change in the reserve incorporates both
decreases due to liquidations and increases ( or decreases)
due to rising (or falling) prices.
Inventories and Cost of Goods Sold
363
7-79 (10-15 min.)
1.
2.
364
Cost of goods sold:
With the purchase, $380 x 8,000
Without the purchase, $250 x 8,000
Difference
Income tax savings, .40 x $1,040,000
$3,040,000
2,000,000
$1,040,000
$ 416,000
This is an actual case. The only change is that the original
numbers were $300 and $160 rather than the $380 and $250
used here. The Tax Court held that raw materials may be
entered as inventory only if they have been acquired for the
purpose of sale in the ordinary course of business or for the
purpose of being physically incorporated into merchandise
intended for sale. Therefore, the taxpayer's cost of goods sold
should have included the cost of the lower-priced inventory
instead of the higher-priced year-end purchase.
7-80 (15-20 min.)
Gross Profit Percentage
Inventory Turnover
Penney 03
00
95
$9,774÷$32,347 = .302
$9,136÷$32,510 = .281
$6,410÷$20,380 = .315
$22,573÷$4,938 = 4.57
$23,374÷$6,004 = 3.89
$13,970÷$3,711 = 3.76
Kmart
$4,504÷$30,762 = .146
$7,823÷$35,925 = .218
$8,033÷$34,025 = .236
$26,258÷$5,311 = 4.94
$28,102÷$6,819 = 4.12
$25,992÷$7,317 = 3.55
03
00
95
J.C. Penney has a consistently higher gross profit percentage
than Kmart. J.C. Penney generated higher inventory turnover than
Kmart in 1995 but not in 2000 or 2003. For J.C. Penney, gross profit
percentage fell while inventory turnover improved in 2000 compared
to 1995, but both ratios improved significantly by 2003. Kmart
consistently improved its inventory turnover but had a significant
decline in gross profit percentage.
Penney's higher gross margin percentage no doubt reflects its
chosen market niche which places more emphasis on style and
fashion and less on price. It is strange, however, that given Kmart's
low price strategy that Kmart's turnover was lower than J.C.
Penney's in 1995. In 2000 and 2003 Kmart’s inventory turnover
exceeded that of J.C. Penney, as one would normally expect. It is
instructive to relate these values to those for a company like The
Gap. The Gap’s 2002 gross profit percentage was about 34% and
inventory turnover was about 5.
Chapter 7
Inventories and Cost of Goods Sold
365
7-81 (15 min.) Amounts are in millions.
2003: Gross profit = KRW 59,569 − KRW 36,952 = KRW 22,617
Gross profit percentage = KRW 22,617 ÷ KRW 59,569 = 38.0%
Inventory turnover = KRW 36,952 ÷KRW 3,954 = 9.3
2002: Gross profit = KRW 46,444 − KRW 32,657 = KRW 13,787
Gross profit percentage = KRW 13,787 ÷ KRW 46,444 = 29.7%
Inventory turnover = KRW 32,657 ÷ KRW 3,611 = 9.0
The gross profit percentage increased from 29.7% to 38.0%,
and the inventory turnover increased from 9.0 to 9.3. Both of these
are good news to Samsung. The large increase in gross profit
percentage is especially significant.
366
7–82 (15 min.)
1.
If the purchase were made in 2005, the cost of goods sold for
this instrument in 2004 would be:
30,000 units @ $60
=
+ 2,500 units @ $50
=
Total cost-of-goods sold =
$1,800,000
125,000
$1,925,000
If the purchase were made in 2004, the cost-of-goods sold for
this instrument in 2004 would be:
15,000 units @ $70
=
+ 17,500 units @ $60
=
Total cost-of-goods sold =
$1,050,000
1,050,000
$2,100,000
Therefore, if the purchase is made in 2004 instead of 2005,
cost-of-goods sold will be $2,100,000 – $1,925,000 = $175,000
higher, pretax income will be $175,000 lower, and taxes will be
$175,000 x .45 = $78,750 lower.
Chapter 7
Inventories and Cost of Goods Sold
367
7–82 (continued)
2.
The LIFO inventory method allows managers and accountants
to manipulate income by purchases made near the end of the
year. A manager in Yokohama may want to maximize net
income, even if it results in higher taxes for the company.
Perhaps the manager has a bonus that depends on the
company’s net income. Such a manager might prefer the
purchase to be delayed until 2005.
It is not clear whether a 2004 or 2005 purchase (if either) is best
for Yokohama. The savings in taxes by purchasing in 2004,
which will be offset by higher taxes in subsequent years, is
beneficial because it defers the taxes, giving Yokohama the
$78,750 to use in the meantime. However, maybe there is a
debt covenant that may be violated if the extra $175,000 of
pretax income (and, therefore, an extra $96,250 net income) is
not generated in 2004. Or maybe the current ratio will drop
below an acceptable level if purchase is delayed to 2005.
Although there is not enough information to decide what is the
best decision for Yokohama, it is clear that manipulation of
income is possible under LIFO. This is likely to create ethical
dilemmas for managers whose performance evaluations (and
possibly personal wealth) may be linked to financial results or
who envision reported earnings affecting share price or debt
covenants.
368
7-83 (15 min.)
1.
Balance
Balance
Inventory
135,000
630,000
X
590,000
Let X be the ending inventory balance:
X
X
2.
=
=
=
Beginning balance + Purchases − Cost of goods sold
$135,000 + $630,000 − $590,000
$175,000
Inventory shrinkage = $175,000 − $140,000 = $35,000
Inventory shrinkage expense
Inventory
Cost of goods sold
3.
=
=
35,000
35,000
$590,000 + $35,000
$625,000
Inventory shrinkage as a percent of sales is $35,000 ÷ $700,000
= 5.0%. This is high. Lola should look for ways that inventory
might be stolen, either by employees or by others. She also
may want to examine the new perpetual inventory system to
make sure that all costs of goods sold are being recorded.
Chapter 7
Inventories and Cost of Goods Sold
369
7-84 (15-20 min.)
1.
An understatement of ending inventories overstates cost of
goods sold and understates taxable income by $500,000.
Taxes evaded would be .40 x $500,000 = $200,000.
2.
This news story provides a good illustration of why a basic
knowledge of accounting is helpful in understanding the
business press. The news story is incomplete or misleading in
one important respect. The business owner's understated
ending inventory becomes the understated beginning
inventory of the next year. If no other manipulations occur, the
owner will understate cost of goods sold during the next year,
overstate taxable income, and pay an extra $200,000 in income
taxes. Thus, the owner will have postponed paying income
taxes for one year, paying no interest on the money
"borrowed" from the government.
To continue to evade the $200,000 of income taxes of year
one, the ending inventory of the second year must be
understated by $500,000 again. However, if only the $500,000
understatement persists year after year, the owner is enjoying a
perpetual loan of $200,000 (based on a 40% tax rate) from the
government. Data follow (in dollars):
370
7-84 (continued)
Honest Reporting
First Year
Beginning inventory
Purchases
Available for sale
Ending inventory
Cost of goods sold
Income tax savings @ 40%
Income tax savings for
two years together
Second Year
3,000,000
10,000,000
13,000,000
2,500,000
10,500,000
4,200,000
2,500,000
10,000,000
12,500,000
2,500,000
10,000,000
4,000,000
8,200,000
Dishonest Reporting
First Year
3,000,000
10,000,000
13,000,000
2,000,000
11,000,000
4,400,000
Second Year
2,000,000
10,000,000
12,000,000
2,000,000
10,000,000
4,000,000
8,400,000
Some students may incorrectly reason that understating
inventory each year has a cumulative effect. You may wish to
emphasize that the second year has the same cost of goods
sold in each column, because in the "dishonest" case both
beginning and ending inventory are understated by the same
amount. To evade an additional $200,000 of income taxes in
the second year, the ending inventory must be understated by
$1,000,000 (not $500,000) in the second year.
Chapter 7
Inventories and Cost of Goods Sold
371
7-85 (15-20 min.)
1.
Raw material used
= 1,500 shirts @ $3
=
$4,500
Wages paid
= 1 month
=
1,600
Depreciation
= 1,500 units
@ [$5,000 ÷ 10,000 = .50]
=
Studio rent
=
750
500
Total production costs
$7,350
Cost per unit produced
= $7,350 ÷ 1,500
=$ 4.90
Cost of goods sold
= 1,200 x $4.90
=
$5,880
=
$1,500
=
1,470
Ending inventory:
Raw material available
500 shirts @ $3
Finished goods
1,500 – 1,200 =
300 shirts @ $4.90
Total inventory
2.
SAM’S T-SHIRTS
Income Statement for January
Revenue 1,200 shirts @ $9
Cost of goods sold
Income before tax
Tax expense
Net Income
372
$2,970
$10,800
5,880
4,920
1,476
$ 3,444
7-86 (60 min. or more)
The purpose of this exercise is to develop an understanding of
inventory methods and to be able to explain an inventory method to
others. An individual student could compute the operating income
using all three methods, but using a team has two main advantages:
1.
Each student can become thoroughly familiar with one
inventory method; students do not need to spend time making
calculations for all methods.
2.
Explaining the computations involved with one inventory
method requires a deeper understanding than merely carrying
out the calculations.
A good starting point is to examine the 1987 and 1988 Taccounts for inventory under LIFO and FIFO (amounts are in
thousands):
1987:
Inventory (FIFO)
Beg. Bal.
Purchases
End. Bal.
151,918
562,125
180,688
CGS
Inventory(LIFO)
533,355*
Beg. Bal.
Purchases
End. Bal.
140,918
562,125
169,488
CGS
533,555
* FIFO CGS is $200,000 less than LIFO CGS because FIFO inventory increased $200,000 more than did
LIFO inventory in 1997.
1988:
Inventory (FIFO)
Beg. Bal.
Purchases
End. Bal.
180,688
560,233
181,088
CGS
Inventory(LIFO)
559,883
Beg. Bal.
Purchases
End. Bal.
169,488
560,233
169,488
CGS
560,233
The operating income statements for each inventory method
are:
Chapter 7
Inventories and Cost of Goods Sold
373
7-86 (continued)
FIFO:
Sales
Cost of goods sold (using FIFO)
Other operating expenses
Operating income
$1,015,198
559,833
417,283
$ 38,082
LIFO:
Sales
Cost of goods sold (using LIFO)
Other operating expenses
Operating income
$1,015,198
560,233
417,283
$ 37,682
Specific identification:
There is not enough information to compute a definitive profit
under specific identification.
Probably the physical flow of
merchandise is closest to FIFO, so operating income would be close
to $46,716. However, to the extent that a strict FIFO flow is not
maintained, operating income would fall short of $38,082. Why?
Because some of the recent purchases, which cost 5% more than
earlier purchases, would be sold and the earlier purchases would
remain in inventory, boosting cost of goods sold and decreasing
inventory from the FIFO levels.
7–87 (45-60 min.)
Each solution will be unique and will change each year. The
purpose of this problem is to recognize different inventory
methods and their relationship to gross profit percentage and
inventory turnover.
374
7–88 (35-45 min.) Amounts are in thousands.
1.
Inventory Calculation
Beginning + Purchases – Sales = Ending
263,174 + Purchases – 1,348,742 = 342,944
Inventory
263,174
1,428,512 1,348,742*
Purchases = 342,944 + 1,348,742 – 263,174
342,944
Purchases = $1,428,512
*$1,685,928 x .8 = $1,348,742
2.
3.
Inventory turnover = Cost of sales ÷ average inventory
Inventory turnover =
$1,348,742 ÷ ($342,944 + $263,174) ÷
2
=
$1,348,742 ÷ $303,059
=
4.45
Error!
$4,075,522 − $1,348,742
= .67 2003
$4,075,522
$3,288,908 − $1,080,009
$3,288,908
$2,648,980 − $890,228
$2,648,980
=
.67 2002
=
.66 2001
The gross margin percentage has risen very slightly over the
three years.
Gross margins for Starbucks are high. This is because of the
industry and Starbucks’ strategy. Starbucks charges a
premium price for its coffee and other drinks.
Chapter 7
Inventories and Cost of Goods Sold
375
7-89 (30-60 min.)
NOTE TO INSTRUCTOR. This solution is based on the web site as it
was in late 2004. Be sure to examine the current web site before
assigning this problem, as the information there may have changed.
1.
In 2003 Teva represented 60.1% of Deckers’ sales. This
percentage has dropped steadily in the last 5 years from 72.9% in
1999, even though total sales of Tevas have increased.
2.
Inventories are reported at the lower of FIFO cost or market.
The costs of inventories are probably not increasing fast enough to
give LIFO a large tax advantage. Using LCM is important to a
company such as Deckers because shoes can become out-of-style
and therefore have market values below cost. In 2003 Deckers has
a write-down of inventory of $882,000.
3.
In 2003 the gross profit was $51,345,000, up from $41,530,000
in 2002. The gross profit percentage increased from 41.9% to 42.4%
over the same year. Management indicated that “The increase in
gross margin was due to several factors, including an above
average gross margin at the newly acquired Internet and catalog
retailing business, the favorable impact of the strong Euro, and
lower production overhead costs per pair, partially offset by an
increase in close-out sales.”
376