CHAPTER 6
INVENTORIES
DISCUSSION QUESTIONS
1. The receiving report should be reconciled to
the initial purchase order and the vendor’s
invoice before recording or paying for inventory purchases. This procedure will verify
that the inventory received matches the type
and quantity of inventory ordered. It also verifies that the vendor’s invoice is charging the
company for the actual quantity of inventory
received at the agreed-upon price.
2. A physical inventory should be taken periodically to test the accuracy of the perpetual
records. In addition, a physical inventory will
identify inventory shortages or shrinkage.
3. No, they are not techniques for determining
physical quantities. The terms refer to cost
flow assumptions, which affect the determination of the cost prices assigned to items in
the inventory.
4. a. LIFO c. LIFO
b. FIFO d. FIFO
5. FIFO
6. LIFO. In periods of rising prices, the use of
LIFO will result in the lowest net income and
thus the lowest income tax expense.
7. Net realizable value (estimated selling price
less any direct cost of disposition, such as
sales commissions).
8. a. Gross profit for the year was understated by $23,950.
b. Merchandise inventory and stockholders’ equity (retained earnings) were understated by $23,950.
9. Mistletoe Company. Since the merchandise
was shipped FOB shipping point, title
passed to Mistletoe Company when it was
shipped and should be reported in Mistletoe
Company’s financial statements at October
31, the end of the fiscal year.
10. Manufacturer’s; The manufacturer retains title
until the goods are sold. Thus, any unsold
merchandise at the end of the year is part of
the manufacturer’s (consignor’s) inventory,
even though the merchandise is in the hands
of the retailer (consignee).
PRACTICE EXERCISES
PE 6–1A
Gross Profit
July
Ending Inventory
July 31
a. First-in, first-out (FIFO)
$65 ($225 – $160)
$344 ($168 + $176)
b. Last-in, first-out (LIFO)
$49 ($225 – $176)
$328 ($160 + $168)
c. Average cost
$57 ($225 – $168)
$336 ($168 × 2)
PE 6–1B
Gross Profit
April
Ending Inventory
April 30
a. First-in, first-out (FIFO)
$19 ($29 – $10)
$26 ($12 + $14)
b. Last-in, first-out (LIFO)
$15 ($29 – $14)
$22 ($10 + $12)
c. Average cost
$17 ($29 – $12)
$24 ($12 × 2)
PE 6–2A
a.
Cost of merchandise sold (August 28):
20 units @ $80
5 units @ $85
25
$1,600
425
$2,025
b. Inventory, August 31: $2,975 = 35 units × $85
PE 6–2B
a.
Cost of merchandise sold (March 24):
12 units @ $15
63 units @ $18
75
$ 180
1,134
$1,314
b. Inventory, March 31: $1,116 = 62 units × $18
PE 6–3A
a. Cost of merchandise sold (November 26):
$5,040 = (84 units × $60)
b. Inventory, November 30:
18 units @ $50
16 units @ $60
34
$ 900
960
$1,860
PE 6–3B
a. Cost of merchandise sold (January 27):
$1,440 = (80 units × $18)
b. Inventory, January 31:
15 units @ $17
$ 255
45 units @ $18
810
60
$1,065
PE 6–4A
a. First-in, first-out (FIFO) method: $594 = 11 units × $54
b. Last-in, first-out (LIFO) method: $495 = 11 units × $45
c. Average cost method: $550 (11 units × $50), where average cost = $50 =
$2,250/45 units
PE 6–4B
a. First-in, first-out (FIFO) method: $2,722 = (20 units × $119) + (3 units × $114)
b. Last-in, first-out (LIFO) method: $2,682 = (10 units × $120) + (13 units × $114)
c. Average cost method: $2,645 (23 units × $115), where average cost = $115 =
$18,400/160 units
PE 6–5A
A
B
Inventory
Quantity
C
Unit
Cost
Price
D
Unit
Market
Price
3
Commodity
4
IA17
TX24
Total
200
150
$40
55
$38
60
A
B
3
Commodity
Inventory
Quantity
C
Unit
Cost
Price
D
Unit
Market
Price
4
MT22
WY09
Total
1,500
900
$ 7
22
$ 4
25
1
2
5
6
E
F
Total
Cost
Market
$ 8,000
8,250
$16,250
G
Lower
of C or M
$ 7,600 $ 7,600
9,000
8,250
$16,600 $15,850
PE 6–5B
1
2
5
6
E
F
Total
G
Cost
Market
Lower
of C or M
$10,500
19,800
$30,300
$ 6,000
22,500
$28,500
$ 6,000
19,800
$25,800
PE 6–6A
Amount of Overstatement
(Understatement)
Balance Sheet:
Merchandise inventory understated* ...........
Current assets understated ..........................
Total assets understated ...............................
Stockholders’ equity understated ................
$(7,525)
(7,525)
(7,525)
(7,525)
Income Statement:
Cost of merchandise sold overstated ..........
Gross profit understated ...............................
Net income understated ................................
$ 7,525
(7,525)
(7,525)
*$90,700 – $83,175 = $7,525
PE 6–6B
Amount of Overstatement
(Understatement)
Balance Sheet:
Merchandise inventory overstated* ..............
Current assets overstated .............................
Total assets overstated .................................
Stockholders’ equity overstated ...................
$35,000
35,000
35,000
35,000
Income Statement:
Cost of merchandise sold understated ........
Gross profit overstated..................................
Net income overstated ...................................
$(35,000)
35,000
35,000
*($580,000 – $545,000 = $35,000)
PE 6–7A
a. Inventory Turnover
2012
2011
Cost of merchandise sold ...
Inventories:
Beginning of year ............
End of year .......................
$882,000
$680,000
$200,000
$290,000
$140,000
$200,000
Average inventory ...............
$245,000
$170,000
[($200,000 + $290,000) ÷ 2] [($140,000 + $200,000) ÷ 2]
Inventory turnover ...............
b. Number of Days’ Sales in
Inventory
Cost of merchandise sold ...
Average daily cost of
merchandise sold ............
3.6
4.0
($882,000 ÷ $245,000)
($680,000 ÷ $170,000)
2012
2011
$882,000
$680,000
$2,416.4
($882,000 ÷ 365 days)
Average inventory ...............
$245,000
$1,863.0
($680,000 ÷ 365 days)
$170,000
[($200,000 + $290,000) ÷ 2] [($140,000 + $200,000) ÷ 2]
Number of days’ sales in
inventory ..........................
101.4 days
($245,000 ÷ $2,416.4)
91.3 days
($170,000 ÷ $1,863.0)
PE 6–7A
(Concluded)
c. The decrease in the inventory turnover from 4.0 to 3.6 and the increase in the
number of days’ sales in inventory from 91.3 days to 101.4 days indicate unfavorable trends in managing inventory.
PE 6–7B
a. Inventory Turnover
Cost of merchandise sold ...
Inventories:
Beginning of year ............
End of year .......................
Average inventory ...............
2012
2011
$1,800,000
$1,428,000
$570,000
$630,000
$600,000
$450,000
$570,000
$510,000
[($570,000 + $630,000) ÷ 2] [($450,000 + $570,000) ÷ 2]
Inventory turnover ...............
b. Number of Days’ Sales in
Inventory
Cost of merchandise sold ...
Average daily cost of
merchandise sold ............
Average inventory ...............
3.0
2.8
($1,800,000 ÷ $600,000)
($1,428,000 ÷ $510,000)
2012
2011
$1,800,000
$1,428,000
$4,931.5
$3,912.3
($1,800,000 ÷ 365 days)
($1,428,000 ÷ 365 days)
$600,000
$510,000
[($570,000 + $630,000) ÷ 2] [($450,000 + $570,000) ÷ 2]
Number of days’ sales
in inventory ......................
121.7 days
130.4 days
($600,000 ÷ $4,931.5)
($510,000 ÷ $3,912.3)
c. The increase in the inventory turnover from 2.8 to 3.0 and the decrease in the
number of days’ sales in inventory from 130.4 days to 121.7 days indicate favorable trends in managing inventory.
EXERCISES
Ex. 6–1
Switching to a perpetual inventory system will strengthen A4A Hardware’s internal controls over inventory, since the store managers will be able to keep track of
how much of each item is on hand. This should minimize shortages of goodselling items and excess inventories of poor-selling items.
On the other hand, switching to a perpetual inventory system will not eliminate
the need to take a physical inventory count. A physical inventory must be taken to
verify the accuracy of the inventory records in a perpetual inventory system. In
addition, a physical inventory count is needed to detect shortages of inventory
due to damage or theft.
Ex. 6–2
a. Appropriate. The inventory tags will protect the inventory from customer
theft.
b. Inappropriate. The control of using security measures to protect the inventory
is violated if the stockroom is not locked.
c. Inappropriate. Good controls include a receiving report, prepared after all inventory items received have been counted and inspected. Inventory purchased should only be recorded and paid for after reconciling the receiving
report, the initial purchase order, and the vendor’s invoice.
Ex. 6–3
a.
Date
June 1
6
14
Purchases
Unit
Quantity
Cost
90
42
Total
Cost
80
30
Balances
45
60
40
2,400
15
35
20
40
42
42
600
1,470
840
3,780
19
25
30
Portable Video Players
Cost of Merchandise Sold
Unit
Total
Quantity
Cost
Cost
3,600
Inventory
Unit
Quantity
Cost
Total
Cost
75
15
15
90
55
40
40
40
42
42
3,000
600
600
3,780
2,310
35
35
80
42
42
45
1,470
1,470
3,600
5,070
5,310
b. Since the prices rose from $40 for the June 1 inventory to $45 for the purchase on June 30, we would expect
that under last-in, first-out the inventory would be lower.
Note to Instructors: Exercise 6–4 shows that the inventory is $5,040 under LIFO.
Ex. 6–4
Date
June 1
6
14
Purchases
Unit
Quantity
Cost
Total
Cost
Portable Video Players
Cost of Merchandise Sold
Unit
Total
Quantity
Cost
Cost
60
40
2,400
19
50
42
2,100
25
20
42
840
90
30
80
30
Balances
42
45
3,780
3,600
5,340
Quantity
75
15
15
90
15
40
15
20
15
20
80
Inventory
Unit
Cost
40
40
40
42
40
42
40
42
40
42
45
Total
Cost
3,000
600
600
3,780
600
1,680
600
840
600
840
3,600
5,040
Ex. 6–5
a.
Date
July
1
10
Purchases
Unit
Quantity
Cost
500
50
Total
Cost
25,000
12
14
20
450
31
31
Balances
52
Prepaid Cell Phones
Cost of Merchandise Sold
Unit
Total
Quantity
Cost
Cost
500
200
300
50
45
45
25,000
9,000
13,500
250
52
13,000
23,400
Quantity
Inventory
Unit
Cost
Total
Cost
800
800
500
600
45
45
50
45
36,000
36,000
25,000
27,000
300
300
450
300
200
45
45
52
45
52
13,500
13,500
23,400
13,500
10,400
23,900
60,500
b. Since the prices rose from $45 for the July 1 inventory to $52 for the purchase on July 20, we would expect
that under first-in, first-out the inventory would be higher.
Note to Instructors: Exercise 6–6 shows that the inventory is $25,900 under FIFO.
Ex. 6–6
Date
July
1
10
Purchases
Unit
Quantity
Cost
500
50
Total
Cost
Prepaid Cell Phones
Cost of Merchandise Sold
Unit
Total
Quantity
Cost
Cost
25,000
12
700
45
31,500
14
100
200
45
50
4,500
10,000
250
50
12,500
20
450
31
31
Balances
52
23,400
58,500
Quantity
Inventory
Unit
Cost
Total
Cost
800
800
500
100
500
45
45
50
45
50
36,000
36,000
25,000
4,500
25,000
300
300
450
50
450
50
50
52
50
52
15,000
15,000
23,400
2,500
23,400
25,900
Ex. 6–7
a. $15,540 ($84 × 185 units)
b. $15,100 [($80 × 60 units) + ($82 × 100 units) + ($84 × 25 units)] = $4,800 + $8,200 + $2,100
Ex. 6–8
a. $7,812 (12 units at $495 plus 4 units at $468) = $5,940 + $1,872
b. $6,138 (9 units at $360 plus 7 units at $414) = $3,240 + $2,898
c. $7,056 (16 units at $441; $26,460/60 units = $441)
Cost of merchandise available for sale:
9 units at $360 ........................................................
18 units at $414 ........................................................
21 units at $468 ........................................................
12 units at $495 ........................................................
60 units (at average cost of $441) ..........................
$ 3,240
7,452
9,828
5,940
$26,460
Ex. 6–9
Cost
Inventory Method
Merchandise
Inventory
FIFO .....................
$4,986
$ 9,639
b. LIFO .....................
4,365
10,260
c.
4,680
9,945
a.
Average cost .......
Merchandise
Sold
Cost of merchandise available for sale:
21 units at $180 ........................................................
29 units at $195 ........................................................
10 units at $204 ........................................................
15 units at $210 ........................................................
75 units (at average cost of $195) ..........................
$ 3,780
5,655
2,040
3,150
$14,625
a. First-in, first-out:
Merchandise inventory:
15 units at $210 ........................................................
9 units at $204 ........................................................
24 units .....................................................................
Merchandise sold:
$14,625 – $4,986 .......................................................
$3,150
1,836
$4,986
$9,639
b. Last-in, first-out:
Merchandise inventory:
21 units at $180 ........................................................
3 units at $195 ........................................................
24 units .....................................................................
Merchandise sold:
$14,625 – $4,365 .......................................................
c. Average cost:
$3,780
585
$4,365
$10,260
Merchandise inventory:
24 units at $195 ($14,625/75 units) .........................
Merchandise sold:
$14,625 – $4,680 .......................................................
$4,680
$9,945
Ex. 6–10
a.
1.
2.
3.
4.
FIFO inventory
FIFO cost of goods sold
FIFO net income
FIFO income tax
> (greater than)
< (less than)
> (greater than)
> (greater than)
LIFO inventory
LIFO cost of goods sold
LIFO net income
LIFO income tax
b. In periods of rising prices, the income shown on the company’s tax return would be lower than if FIFO were
used; thus, there is a tax advantage of using LIFO.
Note to Instructors: The federal tax laws require that if LIFO is used for tax purposes, LIFO must also be used for
financial reporting purposes. This is known as the LIFO conformity rule. Thus, selecting LIFO for tax purposes
means that the company’s reported income will also be lower than if FIFO had been used. Companies using LIFO
believe the tax advantages from using LIFO outweigh any negative impact of reporting a lower income to shareholders.
Ex. 6–11
A
B
Inventory
Quantity
C
Unit
Cost
Price
D
Unit
Market
Price
3
Commodity
4
AL65
CA22
LA98
SC16
UT28
Total
40
50
110
30
75
$28
70
6
40
60
$30
65
5
30
62
1
2
5
6
7
8
9
E
F
Total
G
Cost
Market
Lower
of C or M
$ 1,120
3,500
660
1,200
4,500
$10,980
$ 1,200
3,250
550
900
4,650
$10,550
$ 1,120
3,250
550
900
4,500
$10,320
Ex. 6–12
The merchandise inventory would appear in the Current Assets section, as follows:
Merchandise inventory—at lower of cost (FIFO) or market ........
$10,320
Alternatively, the details of the method of determining cost and the method of valuation could be presented in a
note.
Ex. 6–13
a.
Balance Sheet
Merchandise inventory.............
Current assets ..........................
Total assets ...............................
Stockholders’ equity
(retained earnings) ..............
$11,350* understated
$11,350 understated
$11,350 understated
$11,350 understated
*$11,350 = $451,000 – $439,650
b.
Income Statement
Cost of merchandise sold ........
Gross profit ...............................
Net income ................................
c.
$11,350 overstated
$11,350 understated
$11,350 understated
Income Statement
Cost of merchandise sold ........
Gross profit ...............................
Net income ................................
$11,350 understated
$11,350 overstated
$11,350 overstated
d. The December 31, 2013, balance sheet would be correct, since the 2012 inventory error reverses itself in
2013.
Ex. 6–14
a.
Balance Sheet
Merchandise inventory.............
Current assets ..........................
Total assets ...............................
Stockholders’ equity
(retained earnings) ..............
*$12,000 = $350,000 – $338,000
$12,000* overstated
$12,000 overstated
$12,000 overstated
$12,000 overstated
b.
Income Statement
Cost of merchandise sold ........
Gross profit ...............................
Net income ................................
c.
$12,000 understated
$12,000 overstated
$12,000 overstated
Income Statement
Cost of merchandise sold ........
Gross profit ...............................
Net income ................................
$12,000 overstated
$12,000 understated
$12,000 understated
d. The December 31, 2013, balance sheet would be correct, since the 2012 inventory error reverses itself in
2013.
Ex. 6–15
When an error is discovered affecting the prior period, it should be corrected. In this case, the merchandise inventory account should be debited and the retained earnings account credited for $18,000.
Failure to correct the error for 2011 and purposely misstating the inventory and the cost of merchandise sold in
2012 would cause the income statements for the two years to not be comparable. The balance sheet at the end of
2012 would be correct, however, since the 2011 inventory error reverses itself in 2012.
Ex. 6–16
a. Apple: 48.5 {$23,397,000,000/[($455,000,000 + $509,000,000)/2]}
American Greetings: 3.9 {$809,956,000/[($203,873,000 + $216,671,000)/2]}
b. Lower. Although American Greetings’ business is seasonal in nature, with most of its revenue generated during the major holidays, much of its non-holiday inventory may turn over very slowly. Apple, on the other
hand, turns its inventory over very fast because it maintains a low inventory, which allows it to respond
quickly to customer needs. Additionally, Apple’s computer products can quickly become obsolete, so it cannot risk building large inventories.
Ex. 6–17
a. Number of Days’ Sales in Inventory =
Kroger,
$4,859  $4,855  / 2  $4,857 
$58,564/36 5
Safeway,
160.4
30 days
$2,591  $2,798  / 2  $2,694.5 
$31,589/36 5
Winn-Dixie,
86.5
$665  $649 / 2  $657 
$5,269/365
Inventory Turnover =
Kroger,
Average Inventory
Cost of Goods Sold/365
14.4
31 days
46 days
Cost of Goods Sold
Average Inventory
$58,564
 12.1
($4,859  $4,855)/2
Safeway,
$31,589
 11.7
($2,591  $2,798)/2
Winn-Dixie,
$5,269
 8.0
($665  $649)/2
b. The number of days’ sales in inventory and inventory turnover ratios are relatively the same for Kroger and
Safeway. Winn-Dixie has significantly higher number of days sales in inventory and significantly lower inventory turnover than Kroger and Safeway. These results suggest that Kroger and Safeway are more efficient
than Winn-Dixie in managing inventory.
Ex. 6–17
(Concluded)
c. If Winn-Dixie matched Kroger’s days’ sales in inventory, then its hypothetical ending inventory would be determined as follows,
Number of Days’ Sales in Inventory =
30 days =
Average Inventory
Cost of Goods Sold/365
X
$5,269/365
X = 30 × ($5,269/365) = 30 × $14.4 per day
X = $432
Thus, the additional cash flow that would have been generated is the difference between the actual average
inventory and the hypothetical average inventory, as follows:
Actual average inventory .........................
Hypothetical average inventory...............
Positive cash flow potential ....................
$657 million
432
$225 million
That is, a lower average inventory amount would have required less cash than actually was required.
Appendix Ex. 6–18
$507,000 ($780,000 × 65%)
Appendix Ex. 6–19
$380,000 ($475,000 × 80%)
Appendix Ex. 6–20
$648,000 ($900,000 × 72%)
Appendix Ex. 6–21
A
1
4
Merchandise inventory, November 1
Purchases in November (net)
Merchandise available for sale
5
Ratio of cost to retail price:
6
Sales for November (net)
Merchandise inventory, November 30, at retail price
Merchandise inventory, November 30,
at estimated cost ($450,000 × 75%)
2
3
7
8
B
Cost
$ 300,000
2,100,000
$2,400,000
C
Retail
$ 400,000
2,800,000
$3,200,000
$2,400,000
 75%
$3,200,000
2,750,000
$ 450,000
$ 337,500
Appendix Ex. 6–22
a.
A
B
1
7
Merchandise inventory, January 1
Purchases (net), January 1–December 11
Merchandise available for sale
Sales (net), January 1–December 11
Less estimated gross profit ($6,500,000 × 36%)
Estimated cost of merchandise sold
8
Estimated merchandise inventory, December 11
2
3
4
5
6
C
Cost
$ 500,000
4,280,000
$4,780,000
$6,500,000
2,340,000
4,160,000
$ 620,000
b. The gross profit method is useful for estimating inventories for monthly or quarterly financial statements. It is
also useful in estimating the cost of merchandise destroyed by fire or other disasters.
Appendix Ex. 6–23
Merchandise available for sale ..........................................................
Less cost of merchandise sold [$5,260,000 × (100% – 40%)] ..........
Estimated ending merchandise inventory ........................................
$3,380,000
3,156,000
$ 224,000
Appendix Ex. 6–24
Merchandise available for sale ..........................................................
Less cost of merchandise sold [$2,080,000 × (100% – 37%)] ..........
Estimated ending merchandise inventory ........................................
$1,400,000
1,310,400
$ 89,600