U.C. Berkeley
Haas School of Business
Chapter 7, SW
April 12, 2001
Spring 2001
BA230B
Inventory is an asset. When it is removed as an asset it becomes an expense
called Cost of Goods Sold. Therefore changing your inventory values effectively
changes your profit for the period.
Important Identity
Beginning Inventory + Purchases = Cost of Goods Sold + Ending Inventory
Cost Bases for Inventory Valuation
- Acquisition cost p.364
- Replacement cost p.364
- Net Realizable Value p.365
- Lower-of-cost-to-market p365 (GAAP Required)
Inventory Method (Timing of Computations)
- Periodic inventory system p.367 (basically says if I know what I started with and
added during the period, whatever isn’t left over (ending inventory), must be
COGS!)
- Perpetual inventory system p.368 (continuously keeps track of inventory)
Cost Flow Assumptions p.370
- First-In First-Out (FIFO)
- Last-In First-Out (LIFO)
- Weighted Average
Solutions to S&W
7.31
(Moon Company; computations involving different cost flow assumptions.)
a.
b.
c.
Weighted
Pounds FIFO
Average
LIFO
Goods Available for Sale ........... 41,000 $128,700 $128,700 $128,700
Less Ending Inventory ............. (12,500) (37,830)a (39,238)c (40,430)e
Goods Sold ................................ 28,500 $ 90,870b $ 89,462d $ 88,270f
a(9,200 X $3.00) + (3,300 X $3.10) = $37,830.
b(8,600 X $3.25) + (12,300 X $3.20) + (7,600 X $3.10) = $90,870.
c$128,700/41,000 = $3.139; 12,500 X $3.139 = $39,238.
d28,500 X $3.139 = $89,462.
e(8,600 X $3.25) + (3,900 X $3.20) = $40,430.
f(9,200 X $3.00) + (10,900 X $3.10) + (8,400 X $3.20) = $88,270.
Prepared by Gavin Cassar
[ Inventory Method and Valuation ]
Page 1
U.C. Berkeley
Haas School of Business
7.32
Chapter 7, SW
April 12, 2001
Spring 2001
BA230B
(Benton Company; over sufficiently long time spans, income equals cash
inflows minus cash outflows; cost flow assumptions.)
a.
FIFO
Year
Revenue
–
Cost of Goods Sold =Income
1
7,000 X $25 = $ 175,000 7,000 X $20 = $140,000 $ 35,000
2 10,000 X $28 =
280,000 8,000 X $20 = $160,000
2,000 X $22 =
44,000
$204,000
76,000
3 12,000 X $30 =
360,000 10,000 X $22 = $220,000
2,000 X $24 =
48,000
$268,000
92,000
4 15,000 X $33 =
495,000 8,000 X $24 = $192,000
7,000 X $26 = 182,000
$374,000
121,000
Totals.................
$1,310,000
$986,000 $324,000
b.
LIFO
Year
Revenue
–
Cost of Goods Sold =Income
1
7,000 X $25 = $ 175,000 7,000 X $20 = $140,000 $ 35,000
2 10,000 X $28 =
280,000 10,000 X $22 = $220,000
60,000
3 12,000 X $30 =
360,000 10,000 X $24 = $240,000
2,000 X $22 =
44,000
$284,000
76,000
4 15,000 X 33 =
495,000 7,000 X $26 = $182,000
8,000 X $20 = 160,000
$342,000
153,000
Totals.................
$1,310,000
$986,000 $324,000
c.
Over the four-year period, income is the same—cash inflows minus cash
outflows—independent of the cost flow assumption. The cost flow
assumption affects the timing of income recognition and this may well
matter: it affects the timing of income tax payments, potential
management bonuses, and potential violation of covenants in borrowing
instruments and other contracts with outsiders, including labor contracts.
Prepared by Gavin Cassar
[ Inventory Method and Valuation ]
Page 2
U.C. Berkeley
Haas School of Business
7.35
Chapter 7, SW
April 12, 2001
Spring 2001
BA230B
(EKG Company; LIFO provides opportunity for income manipulation.)
a.
Largest cost of goods sold results from producing 70,000 (or more)
additional units at a cost of $22 each, giving cost of goods sold of
$1,540,000.
b.
Smallest cost of goods sold results from producing no additional units,
giving cost of goods sold of $980,000 [= ($8 X 10,000) + ($15 X 60,000)].
c.
Income Reported
Minimum Maximum
Revenues ($30 X 70,000) ............................ $2,100,000
$2,100,000
Less Cost of Goods Sold
........................... (1,540,000)
(980,000)
Gross Margin
........................................ $ 560,000
$1,120,000
Additional Questions (if required or interested or bored)
7.30
Like 7.31
7.45
Like 7.30 and 7.31, only extend to a two year situation
7.51
A question that makes you think about inventory ending balances and it’s
consequences for income
7.52 & 7.55 As they are in the reader
Prepared by Gavin Cassar
[ Inventory Method and Valuation ]
Page 3