Chapter 8: Cost-Based Inventories and Cost of Sales
Case
8-1
8-2
8-3
Alliance Appliance Ltd.
Terrific Titles Inc.
Siegfried Air Control Ltd.
Suggested Time
Technical Review
TR-1
TR-2
TR-3
TR-4
TR-5
Assignment A8-1
A8-2
A8-3
A8-4
A8-5
A8-6
A8-7
A8-8
A8-9
A8-10
A8-11
A8-12
A8-13
A8-14
A8-15
A8-16
A8-17
A8-18
A8-19
A8-20
A8-21
A8-22
A8-23
A8-24
A8-25
A8-26
A8-27
A8-28
A8-29
A8-30
*W
Inventory Holding Gains/Losses ..............................
Lower of Cost or NRV .............................................
Onerous Contract .....................................................
Gross Margin Method ..............................................
Retail Inventory Method ..........................................
Inventory Cost—items to Include in Inventory........
Inventory Cost—items to Include in Inventory........
Inventory Cost—items to Include in Inventory........
Inventory Discounts and Rebates .............................
Inventory Policy Issues ............................................
Lower of Cost or NRV .............................................
Lower of Cost or NRV—Income Effects .................
Lower of Cost or NRV—Direct Writedown
versus Allowance Method ........................................
Lower of Cost or NRV—Allowance Method ..........
Lower of Cost or NRV—Allowance Method (*W) .
Lower of Cost or NRV—Two Ways to Apply.........
Lower of Cost or NRV and Foreign Currency .........
Obsolete Inventory ...................................................
Purchase Commitment .............................................
Loss on Purchase Commitment ................................
Inventory—Error Correction ....................................
Inventory-Related Errors ..........................................
Inventory Errors .......................................................
Gross Margin Method ..............................................
Gross Margin Method (*W) .....................................
Retail Inventory Method ..........................................
Retail Inventory Method (*W) .................................
Gross margin and Retail Inventory Methods ...........
Inventory Concepts—Recording, Adjusting,
Closing, Reporting ...........................................
Statement of Cash Flows ..........................................
ASPE—Accounting Policies ....................................
Inventory Cost Methods (Appendix) (*W) ..............
Inventory Cost Methods (Appendix)........................
Inventory Cost Methods (Appendix)........................
Inventory Policy Comparison (Appendix) ...............
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The solution to this assignment is on the text website, Connect.
This solution is marked WEB.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-1
Questions
1.
Inventory is important because it is a material high-risk current asset, and, if properly
managed, inventory systems can be used to enhance profits. If inventory is poorly
managed and controlled, there are many opportunities for both error and fraud.
2.
Trading Entity
Merchandise Inventory—Goods on hand purchased for resale.
Manufacturing Entity
Raw Materials Inventory—Goods held for manufacturing products
Work-in-Process—Goods in the process of being manufactured
Finished Goods—Goods completed by the manufacturing process
Production Supplies Inventory—Items needed to perform plant maintenance.
Both entities can have miscellaneous inventories (e.g., office supplies)
3.
a.
b.
c.
d.
e.
f.
g.
h.
Include in inventory
Include
Exclude*
Include**
Exclude
Include***
Include
Include
*
Do not include in regular inventory. If the goods can be returned make no entry.
If the goods cannot be returned, the purchaser should include the damaged goods
in a special inventory—damaged goods.
** Inclusion or exclusion depends on the provisions of the sale agreement. This
answer assumed returns are allowed.
*** Not yet irrevocably sold; answer may depend on past history of sales (and
revenue recognition policy).
4.
a.
b.
c.
d.
e.
f.
Include
Exclude (recoverable)
Exclude
Exclude
Exclude
Include
5.
The purpose of the LC/NRV rule is to avoid overstating the future economic benefit
of inventory.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
6.
Raw material is used in production of a final product. If the NRV of the final product
is greater than the total cost of production, the full cost of the raw materials will be
recovered in the final sale. Therefore, the raw material should not be written down.
7.
Computation:
1.
2.
3.
4.
5.
Cost of goods available......................................................
Net sales revenue ............................................................... $160,000
Gross margin ($160,000 × 0.30) ........................................
48,000
Cost of goods sold ($160,000 – $48,000) ..........................
Ending inventory ($180,000 – $112,000) ..........................
$180,000
112,000
$ 68,000
8.
The degree of aggregation (items vs. categories) is important because it establishes
the extent of netting that will be permitted in calculating the need for writedowns. If
the test is done item-by-item, decreases in the NRV of some items cannot be offset
against increased NRV of other items; if the test is done by categories, offsetting is
allowed within that individual inventory category. The result can affect net income.
9.
An onerous contract is a purchase contract that locks the buyer into a price that is
higher than the going market price. The necessary are conditions are that:
a. the purchase contract is not open to revision or cancellation, and
b. a loss is likely to be material, and
c. the loss can reasonably be estimated.
10. When a purchase is made under an onerous contract, the portion of the cost that is
recorded as inventory is only the current market value of the items purchased. The
excess amount is a loss, charged against earnings as a loss in the net income section
of the CSI, thereby reducing the current period’s net income.
11. Required inventory disclosures are:
– basis of valuation for each inventory category
– carrying values of major categories of inventory
– amount of inventories carried at fair value less costs to sell (that is, not valued at
historical cost or LC/NRV)
– amount of inventories recognized as expense during the period
– the amount of any writedown recognized as expense in the period (IFRS only)
– the amount of any writedown reversal, and the reasons therefore (IFRS only)
– carrying value of any inventories pledged as collateral (IFRS only)
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8-3
12. The reasons for which an enterprise would use a valuation method are:
a. The inventory is valued at NRV by groups rather than individually, thereby
eliminating the possibility of directly reducing individual items’ cost basis.
b. The company wishes to maintain the integrity of the original costs in the
records so as to more easily reconcile them to the SFP control account.
c. Possible subsequent reversals are much easier under the valuation method
because it’s not necessary to go back and restate the original inventory
amounts.
13. The gross margin method is used to estimate the value of the ending inventory
independent of a physical count of the goods on hand. The method uses the average
gross margin (gross margin divided by sales). The rate, which must be estimated on
the basis of past experience, is applied to current data provided by the records, that
is, sales, beginning inventory, and purchases. The critical assumption is that the past
gross margin rates provide a reliable basis for projecting the current rate.
14. The approach of the retail method of estimating inventories is to account for
merchandise activities at retail and cost. From such data, a cost/retail ratio is used to
convert retail amounts to cost. It is necessary to maintain a record of the beginning
inventory, purchases, and adjustments thereto at both cost and retail. With this data,
the average relationship between cost and retail (i.e., the cost ratio) can be computed
on the basis of actual data for the period. The total goods available for sale at retail
is reduced by the sales amount, giving the ending inventory valued at retail prices.
The cost ratio is then applied to the retail value to provide the estimated ending
inventory at cost.
15. The year-end inventory cut-off is important because it affects inventories,
receivables, revenues and cost of sales. The goods shipped must correspond to the
goods invoiced during the periods. If goods are invoiced to the customer (and
included in the sales revenue) but not shipped until after the cut-off date (and
therefore not included in cost of sales), matching will not be achieved and net
income will be misstated.
16. Cost of goods sold can be measured using the following cost flow assumptions:
a) Specific identification
b) FIFO
c) Average cost
– Cost of specific items sold is expensed
– Oldest costs are expensed, recent purchases retained
– Average cost of purchases is used to value inventory
and cost of goods sold.
When prices are rising, FIFO will always result in the highest net income, as old
cheaper units are expensed. Specific identification may have the same result, but not
“always”, depending on the exact units sold. Average cost blends the various levels
of cost, which yields a higher inventory level and lower net income than FIFO.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
17. The weighted-average method is used with a periodic inventory system. A weightedaverage is computed at the end of the period by using total purchase costs, beginning
inventory costs, and the number of units in the beginning inventory and purchases. It
is used because it is theoretically sound and systematic, and it is relatively easy to
apply when the periodic inventory system is used.
The moving-average method is used with a perpetual inventory system. A new
average is computed after each purchase to allow recognition of cost of goods sold at
the most recent average cost after each sale.
18. Under a periodic inventory system, the ending inventory each period is determined
by a physical count; the unit costs are then applied by using one of the inventory cost
flow policies. Cost of goods sold is calculated only after a physical count.
Under a perpetual inventory system, all receipts and issues of inventory items are
directly recorded in detailed inventory records so that a continuous inventory balance
is maintained in the records. Cost of goods sold is recorded after each sale. Any one
of the inventory cost flow policies may be used.
Perpetual systems are more expensive to maintain, and are common when an entity
needs to know detailed information on a daily basis regarding specific inventory
units and costs. It is also more common when accurate interim (monthly) results are
needed. Otherwise, periodic systems are used.
19. The HST is an “input tax credit” on purchases and will reduce the amount of HST on
sales that Zena will pay to the government. The materials cost is recorded net of HST
and the HST is debited to the “HST payable” account:
Inventory (or purchases)
HST payable
Accounts payable
200,000
24,000
224,000
Note: HST paid on purchases is an “input tax credit”, deducted when computing the
amount of HST payable to the government. Thus, the debit is to “HST payable”
rather to a receivable.
20. A perpetual inventory system does not eliminate the need for a physical count of
inventories. To verify the accuracy of the perpetual inventory records, it is necessary
that physical inventory counts be taken from time to time. This should be done
annually or on a rotation basis throughout the year. Any errors found in the perpetual
inventory records are corrected so that such records agree with the physical count.
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8-5
Cases
Case 8-1 Alliance Appliance Ltd.
Overview
This case is designed to highlight the differences in financial reporting under IFRS as
compared to ASPE. The student must adopt an advisory role and prepare a report to the
CFO concerning ten specific issues. The issues mostly are general presentation issues, but
a few also include more specific treatments, such as held-for-sale properties, inventory
valuation, and an onerous contract.
Sample response
To: Chief Financial Officer, Alliance Appliance Ltd.
From: Maxwell Davies, Henry & Higgins
Date: 04 April 20X4
I have reviewed the reporting issues that you raised concerning a potential switch from
ASPE to IFRS. I am happy to provide my advice, enumerated in the points that follow:
a. IFRS does not require specific financial statement titles; the titles you presently use
are quite acceptable, with one exception. The exception is that instead of “Statement
of Retained Earnings”, AAL would need to provide a “statement of changes in
shareholders’ equity”. “Retained earnings” would be just one column within this
statement.
b. On the income statement, expenses would need to be organized either by function
within AAL or by nature (that is, by type of expense). For example, a functional
classification could be by ‘assembly’ and by ‘distribution’. A classification by type of
expense would, in contrast, be items such as employee expense (that is, wages,
salaries, and benefits) and by depreciation expense. Therefore, consistent
classification is necessary.
c. There will be no change in reporting preferred dividends under IFRS. Retained
earnings will be one column in the statement of changes in shareholders’ equity, and
dividends paid will continue to be a component displayed in that column.
d. The estimated cost of fulfilling the guarantees is treated as a liability under IFRS.
However, under IFRS, a portion of the sales revenue you deferred as a separate source
of revenue and recognized only as the guarantees run and lapse.1
e. Gains and losses from foreign currency transactions would continue to be shown on
the income statement under IFRS, unless they are hedged, in which case they may
pass through Other Comprehensive Income, which is a category of shareholders’
equity and be shown in the statement of changes in shareholders’ equity rather than on
the income statement.
1
Whether students get this point will depend on what they’ve learned about revenue recognition in their
previous courses. They shouldn’t be penalized if they don’t know what to do with it.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
f. The Japanese contract would qualify as an “onerous contract” under IFRS; the amount
by which the contract price is greater than the fair value would be recognized as a loss
at the balance sheet date. ASPE doesn’t use that particular terminology, but the
potential loss should be recorded under ASPE also.
g. Under both ASPE and IFRS, inventory written down can be written back up if fair
value recovers, but no higher than their originally recorded cost. No adjustment or
change in practice would be required.
h. Under ASPE, the asset exchange can be valued at either the value of the consideration
or the value of the asset acquired, whichever is the more reliable measure. In contrast,
IFRS requires that the value of the consideration be used, regardless of which measure
is more reliable. The carrying value of the acquired lot will need to restated if and
when AAL switches to IFRS.
i. The cumulative currency translation difference (CCTD) is treated essentially the same
under ASPE and IFRS—a separate component of shareholder’s equity. The only
difference is that under IFRS, the cumulative amount is shown on the statement of
changes in shareholders’ equity as one component of other comprehensive income.
j. The building has been written down prematurely. It should be continue to be reported
at its depreciated cost (and depreciation should continue) until it has been abandoned.
Once it is abandoned in 20X7, depreciation can cease and the asset should be written
down to its recoverable value. Under IFRS, however, it cannot be reclassified as a
held-for-sale asset unless it is likely to be sold within the next year. If no process for
sale has begun, then the asset cannot be reclassified but must remain in the buildings
account as an idle asset.
I hope my responses will help you in AAL’s potential shift to IFRS. Please do not hesitate
to contact me if you’d like more information.
Best wishes,
Maxwell Davies, staff auditor
Henry & Higgins
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8-7
Case 8-2 Terrific Titles Inc.
Overview
This case raises several issues, some of which are obvious and some are less obvious. The
issues are:
 Inventory valuation
 Revenue recognition
 Expense recognition
 Intangible assets and deferred charges
If TTI acquires ABC, ABC will need to change its policies to conform with IFRS since
ABC will be consolidated into TTI’s results, and therefore must follow IFRS.
There is some conflict between the accounting policies that ABC will have to adopt in the
future and TTI’s immediate objective to establish a bid price based on earnings projects.
A bid price would be based on TTI’s evaluation of (1) earnings potential and (2) volatility
of earnings and/or cash flows. High earnings is good, but volatility is bad—the risk vs.
return trade-off
Sample response
Dear Ms. O’Malley:
I am pleased to report my findings concerning Ashwin Book Corporation’s accounting
policies and practices. I believe that it will be necessary to make some adjustments to
ABC’s reported numbers for 20X3 as well as take some additional factors into account
when we project the company’s earnings into the future in order to establish a bid price.
One overriding consideration is that ABC, as a private company, seems to use an
amalgam of Canadian accounting standards for private enterprises and some eclectic
accounting policies that appear to be rather unorthodox. In effect, ABC uses a disclosed
basis of accounting. If we acquire ABC, the company will need to change its accounting
policies to conform with IFRS, since we use IFRS and we will need to consolidate ABC.
My discussion of the major issues is as follows:
a. Inventory valuation. ABC develops and produces its own books. All of each title’s
development, production, and printing costs are included in inventory and allocated
over the number of copies in each edition’s initial press run. The result is that the first
print run has a huge unit cost while succeeding press runs (if any) bear only the cost
of that particular print run. As a result, cost of goods sold will be very high for the
initial run, quite likely yielding a negative gross margin for that initial run, even for a
very successful book. For performance evaluation and for earnings prediction, these
numbers are apt to be very misleading. As well, loading all of these costs into the
inventoriable cost will usually result in an inventory value that is significantly higher
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8-1
than net realizable value. Therefore, the development costs should be removed from
inventory and accounted for separately.
b. Development and production costs. We have a dichotomy in this regard. For financial
reporting purposes, ABC will have to change their accounting policy for development
costs to accord with IFRS, once we acquire them. One option is to expense
development costs when they are incurred—even for historically successful books.
An edition’s success may not be predictable with assurance, because new competitors
enter the market regularly.
On the other hand, spreading the development and production costs over the 3-year
life span of the book will assist with our prediction of future earnings (on which we
base the bid price) as well as ongoing evaluation of ABC’s management. However, it
is questionable as to whether these costs can properly be considered as an intangible
asset, and thereby capitalized and amortized. IFRS discourages treating expenditures
for new products as intangible assets (IAS 38, paragraph 69). Every new edition is, in
effect, a new product, and therefore I recommend that ABC’s policy for these costs
should be to expense them when incurred.
For our analytical purposes in developing a bid price, however, I suggest that we
remove development and pre-production costs from inventories in recent prior years
and amortize them over 3-year periods just so we can discern the underlying earnings.
Then we can look at the cash flow volatility over the years to measure the risk
potential of the erratic production levels.
c. Revenue recognition. ABC recognizes revenue when books are shipped. However,
there is a 6-month official return policy that is unofficially stretched for college and
university bookstores, which account for 90% of total sales. The return rate seems to
be difficult to predict. If it is not feasible to make a reliable estimate of the return rate,
either overall or book-by-book, revenue recognition probably should be deferred until
the 6-month “official” return period has ended.
d. Supporting material for instructors. The cost of providing free supporting materials
for instructors can be considerable. They have no inventory value in the usual sense
because their net realizable value is zero (even though students would love to get their
hands on solutions manuals). The significant cost of these items suggests that instead
of inventorying the costs, ABC should instead defer some of the revenue and treat
each book’s sale as really being a multi-deliverable contact: (1) a book delivered to
the students when they buy them, and (2) supporting material prepared and made
available for instructors. While there is no measurable value for the second
deliverable, an allocation of revenue could be based on the relative costs of the two
deliverables. ABC shouldn’t be pouring more money into production and support that
can be received in revenue. Such a revenue allocation would give ABC managers a
better idea of the “real” price that they should be charging for the book.
e. Inventory valuation of returned books. ABC restores returned books to inventory at
the unit cost they originally bore. This has two problems: (1) the original assigned
cost is too high, as discussed above, and (2) if large quantities of a book are returned,
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
it probably indicates that the book is unsuccessful and therefore that its net realizable
value is much lower than the original unit cost. We will need to determine how much
of the current inventory is comprised of returned books, and probably write off those
books for our estimation process.
f. Inventory of old editions. An inventory of old editions should not be assigned any
value as assets. By definition, they are obsolete, even if there may be some residual
sales. By retaining some inventory at normal cost, ABC management may be tempted
to retain more than necessary in order to avoid depressing earnings by a write-down.
g. Website development costs. It is doubtful that these costs would qualify as an
intangible asset under IFRS. The success of the website is not predictable with
reasonable assurance. The costs should be expensed when incurred. However, we
should take into account in our projects that delivering support material electronically
will significantly reduce the cost of printing and distributing instructors’ supporting
materials. That cost reduction may be offset, however, by the necessity to put more
resources into development of electronic learning aids in order to keep up with the
competition.
h. Sales discounts. The company currently is charging “discounts taken” on accounts
receivable to interest expense. Instead, the discounts should be deducted from
revenue.
I hope that I have identified the major issues that I see with ABC accounting. If you wish
me to pursue any of these matters further, I will be happy to visit the company again and
take a closer look at their accounting records.
Sincerely,
Ian Fanwick
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8-3
Case 8-3 Siegfried Air Control Ltd.
Overview
This case focusses on inventory valuation and related aspects such as (1) lower of cost or
NRV, (2) unrealized foreign currency gains/losses and hedges thereof, and (3) revisions
of cost estimates on uncompleted projects. It provides an overview of material covered in
Chapter 3 (other comprehensive income) and Chapter 6 (revenue recognition for
contracts). The issues presented in the case can be treated individually.
Sample response
To: Vice President, Finance
From: Theresa Tie, accounting advisor
Subject: Recommendations on accounting policies
I am pleased to provide my recommendations on the five inventory-related issues that you
raised. First, however, SAC must establish the reporting standards on which your
financial statements should be prepared.
As a Canadian private company, you can use either international standards (IFRS) or the
CICA’s accounting standards for private enterprises (ASPE). The bank is your only
external user. The bank been happy (so far) with unaudited statements, and thus are not
likely to expect statements prepared on international standards; they will be very familiar
with ASPE since undoubtedly a lot of their other corporate clients also use it. Therefore I
would strongly recommend adopting Canadian accounting standards for private enterprise
(ASPE).
After establishing the basis for SAC’s financial statements, I will move to the specific
issues that you raised. My recommendations follow below.
1. The company seems not to be including any overhead in the cost of manufacturing and
inventory. Overhead should be charged as a manufacturing (and inventory) cost, not
only direct materials and direct labour. Overhead should be charged to inventory on a
normal-capacity basis, with no increase in charges due to idle capacity.
2. SAC has an unrealized foreign currency gain of $156,000. On the balance sheet date,
the account payable must be restated. However, since the Euro payable has been
hedged, the SAC should not recognize the gain in income. Instead, the unrealized gain
should be credited to accumulate other comprehensive income and reported as a
component of other comprehensive income for 20X5.
3. The practice of charging warranty costs to expense when incurred may be justified
when the costs are immaterial or are difficult to predict. Historically, that seems to
have been the case. With the new units, however, it seems that a significant portion of
the sales revenue is actually going to providing servicing under provisions of the
warranty. This suggests that the company should take an alternative approach and start
deferring a portion of the sales revenue and allocating it over the warranty period.
Incurred warranty costs would then be recognized directly as expenses on the income
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8-4
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
statement, deducted from the deferred revenue recognized in the period. This change
would be a change in accounting policy, however, and should be implemented in the
next fiscal year, not in the current year.
Based on experience to date, SAC should estimate the costs of servicing under
warranty for the remaining warranty period of Sigmunds (the new model) that have
been installed as of the end of 20X5.
4. The older model (Erda) is about to become obsolete under legislation in Ontario. Some
may still be sold in Ontario prior to the effective date of the new legislation, and it still
can be sold in the U.S. at a reduced price (wholesale). The Erdas must be written down
to lower of cost or recoverable value. The writedown should be 10% of the current
book value plus the estimated average cost of shipping the units to the U.S. Although
some units may still be sold domestically, they probably will need to be discounted as
well. Therefore, all remaining Erda inventory should be written down to their net
recoverable value—that is, to their fair value minus costs to sell (including
transportation).
5. There are two issues concerning the building conversion project: (a) should SAC
recognize any revenue and profit from this contract, and (b) how much should be
reported as the value of inventory relating to this project at the end of the year.
The original estimate was that the project would earn SAC a profit of $200,000 (that
is, $1,200,000 contract price minus $1,000,000 estimated cost)The project supervisor
estimates that the project is 40% complete, which implies the possibility of
recognizing 40% of the profit. However, estimated total costs have risen to
$1,150,000, leaving a potential profit of $50,000. Of the estimated total costs, SAC has
incurred $600,000, or 52% of estimated total costs. The 40% estimate is based on
physical work (i.e., labour cost). Under ASPE, either percentage could be used to
estimate the proportion of profit to the recognized in 20X5.
The company has incurred costs of $600,000 so far, including the major materials cost
of the compression and air-handling equipment. There is no indication as to whether
overhead is included in the $350,000 of non-equipment costs—that is, the $600,000 in
total costs minus the $250,000 in equipment costs. If not, then overhead should be
added to that amount.
The question then becomes whether the full estimated cost of the project can be
recovered. If more than $50,000 in overhead is added to the inventory amount, the
company would suffer a loss on the project and the inventory should be written down
to an amount equal to $1,200,000 minus the estimated cost to complete.
I hope that you find my recommendations helpful. Please do not hesitate to contact me if
you have any questions about my recommendations or have additional issues that need to
be addressed.
Sincerely,
Theresa Tie
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-5
Technical Review
Technical Review 8-1
The holding loss (gain) can be computed as follows:
Year-end
20x4
20x5
20x6
20x7
20x8
(a)
Allowance to reduce
inventory to LC/NRV—
Opening balance
$
0
0
2,000
1,000
4,000
(b)
Allowance to reduce
inventory to LC/NRV—
Amount required*
$
0**
2,000
1,000
4,000
0**
(b) – (a)
Holding loss
(gain)
$
0
2,000
(1,000)
3,000
(4,000)
* Cost less NRV, if NRV is less than cost.
** NRV is in excess of cost; no allowance is required.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Technical Review 8-2
Computations:
Type
#
Cost
Per unit
Total
NRV
Per unit
Total
LCNRV
By type
By class
Class 1
Basic
50
$ 100
$ 5,000
$ 120
$ 6,000
$ 5,000
Super
30
150
4,500
140
4,200
4,200
Total, Class 1
$ 9,500
$10,200
90 $ 10,800
100 $ 12,000
$ 9,500
Class 2
Regular
120
Deluxe
60
130
7,800
140
8,400
7,800
Super deluxe
40
200
8,000
150
6,000
6,000
Total, Class 2
$ 26,600
Totals
$ 36,100
10,800
$ 26,400
$ 26,400
$ 33,800
$ 35,900
Requirement 1
By item, the writedown is the total cost for all items minus the sum of the individual
LCNRV:
Writedown = $36,100 – $33,800 = $2,300
Requirement 2
By class, the writedown is the sum of the cost of all items minus the sum of the LCNRV
for each class:
Writedown = $36,100 – ($9,500 + $26,400) = $200
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-7
Technical Review 8-3
18 November:
Loss on onerous purchase commitment (850 kg × $3 loss) ...............
Estimated liability on onerous purchase contract (850 × $3) .....
2,550
2,550
[The remaining commitment in the purchase contract is for 850 kg: 1,500 – 650. Issuing
an order for 110 kg triggers recognition of the potential total loss. No entry is necessary to
record the purchase order at this point.]
27 November:
Inventory (110 kg × $17) ...................................................................
Estimated liability on onerous purchase commitment
(110 kg @ $3 loss) ...............................................................
Accounts payable (110 kg × $20) ...............................................
1,870
330
2,200
Note: Any inventory remaining in storage at year-end should be written down to market
price if fair value is lower than cost.
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8-8
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Technical Review 8-4
(in thousands of dollars)
Sales revenue [1]
Cost of goods sold:
Beginning inventory
Purchases [2]
Goods available for sale
Ending inventory [5]
Cost of sales [4]
Gross margin [3]
Cost data (known)
$1,460,000
$ 400,000
966,000
1,366,000
Partially estimated amounts
$1,460,000
$ 400,000
966,000
1,366,000
344,000
1,022,000
$ 438,000
[1] $1,500 gross sales – $40 returns = $1,460
[2] $900 purchases + $26 shipping + $40 import duties = $966
[3] $1,460 net sales × 30% gross margin = $438
[4] $1,460 net sales – $438 gross margin = $1,022
[5] $1,366 goods available for sale – $1,022 cost of sales = $344
Notes:

Students may be tempted to include HST on both sales and purchases in their
calculations. However, those amounts are credited/charged directly to the HST
Payable account and are not included in either sales amounts or in inventory.

Import duties are included in purchases, however, as they must be absorbed by the
vendor (i.e., Tate Tasers Inc.)

Storage costs are not included in inventory but are expensed as a period cost.

Shipping to customers is a selling cost, not part of goods available for sale.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-9
Technical Review 8-5
At cost
Inventory, 1 July
+ Purchases
– Purchase returns and allowances
+ Markups (net) ($195,000 – $38,000)
Retail value goods available for sale
– Markdowns (net) ($60,000 – $23,000)
Goods available for sale
– Sales (net of returns: $1,680,000 – $80,000)
Inventory, 30 September, at retail
Inventory, 30 September, at cost:
($532,000 × 54 % cost ratio*)
At retail
$ 362,000
830,000
(16,000)
$ 537,000
1,500,000
(25,000)
$ 1,176,000
157,000
2, 169,000
(37,000)
$2,132 ,000
(1,600,000)
$ 532,000
$
287,280
* Cost ratio = $1,176,000 ÷ $2,169,000 = 54%
Since the retail method is an estimate, there is no point in carrying the cost ratio out to
more than two significant digits.
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8-10
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignments
Assignment 8-1
Cost of inventory:
a.
Bookkeeper’s inventory count
Less HST included above (refundable by the government)
$30,000
(4.100)
b.
2% cash discount on $6,000 worth of goods
(120)
c.
This is an overhead cost, not to be included in inventory
0
d.
The title for these goods now resides with the buyer, despite return
privilege
0
e.
Items must be reduced to cost by deducting $1,000 gross margin*
(1,000)
f.
Add goods on consignment, not included in the original count, at
cost**
8,000
g.
Correction to reduce inventory value to cost actually incurred:
$14,000 × (1.00 – 0.40)
Corrected inventory count
(8,400)
$24,380
* Cost = $3,000 ÷ 150% = $2,000
Markup = $1,000
** Assumes that the goods will be sold at retail for $10,000; therefore 20% commission =
$2,500 and cost = ($10,000  $2,000) = $8,000.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-11
Assignment 8-2 (WEB)
Items to be included in inventory:
Physical count
$ 120,000
California sales tax
3,000
Import excise tax
4,000
Bonded inventory in U.S. dollars:
US$22,000 × C$1.05
Total
23,100
$150,100
Notes:

Payments in advance (item b) are a receivable (or prepaid asset) until the goods are
received.

HST (item c) is not included as it decreases the amount of HST on sales that is due to
the government.

California sales tax (item d) is not recoverable and should be included as part of the
cost of inventory.

The items being tested (item e) are already included in the physical count and should
not be added in again.
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8-12
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-3
Requirement 1
Inventory
Preliminary value
(a) Sale not recorded
(b) Goods in transit
(c) Invoice unrecorded
(d) Freight for goods in inventory*
(e) Goods on consignment
(f) Purchase discount accrued
Revised total
(g) Net realizable value
Required allowance
Existing allowance
Holding loss
$689,600
(54,300)
37,500
—
5,000
(21,900)
(4,000)
$651,900
605,000
46,900
32,200
$ 14,700
Accounts
Payable
$456,300
—
37,500
51,100
5,000
—
(4,000)
$545,900
Inventory would be reported net on the balance sheet at $605,000. Accounts payable has a
corrected balance of $545,900.
* An alternative would be to charge this amount to a separate expense account as “freight
in”, a practice often used when it is impracticable to allocate shipping costs to various
inventory items.
Requirement 2
The holding loss on inventory is $14,700. See calculations in requirement 1.
Requirement 3
Corrected cost of goods sold:
Preliminary value
Increase in purchases [(b) $37,500 + (c) $51,100
+ (d) 5,000 – (f) $4,000]
$2,211,400
89,600
Holding loss for 20X6
14,700
Decrease in closing inventory ($689,600 – $651,900)
37,700
$2,353,400
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-13
Assignment 8-4 (WEB)
Requirement 1
Cost per unit of inventory ...................................................................................
Less: 2% discount (note 2) ..................................................................................
Less: Quantity rebate...........................................................................................
Total cost — 30 units × $465 ..............................................................................
$500.00
(10.00)
(25.00)
$465.00
$13,950
Notes:
1.
The freight charges are not included because the shipping is FOB destination,
wherein “destination” is at Majestic Store, and thus the shipper pays the freight cost.
2.
IFRS requires that the discount be deducted regardless of whether or not Majestic
takes the discount.
Requirement 2
Accounts receivable ...........................................................................
Cost of sales (170 × $25) ............................................................
Inventory (30 × $25) ...................................................................
5,000
4,250
750
Because receipt of the rebate is certain by the end of the year, inventory and cost of goods
sold should reflect the net cost.
Requirement 3
Cash.......................................................................................................... 5,000
Accounts receivable (consistent with requirement 2) ........................
5,000
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8-14
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-5
Case A Inventory cost should be recorded net of early-payment discount regardless of
whether it was taken or not. Inventory should be reduced by $56,000 × 2% =
$1.120. The restated inventory will be $54,880.
Case B The policy of defining market value as replacement cost is not acceptable.
Market value should be defined as net realizable value. If sales price has not
declined, NRV is likely unimpaired and no LC/NRV write-down would be
needed. As a result of the write-down, inventory is potentially understated and
income understated.
Case C Company policy is unacceptable. Goods on consignment belong to the company,
and cannot be regarded as sold until re-sold to a final customer. Inventory is
understated, accounts receivable overstated, and income is overstated by the
$32,000 gross profit on the sale.
Case D Company policy is unacceptable. The company is recording goods at cost, but
has not recognized the adverse purchase commitment agreement as an onerous
contract liability relating to the 35 remaining units (of the 150 contracted) yet to
be acquired.
In 20x5, the company should have recognized a loss on the purchase agreement
of $160,000 (i.e., $2,000 per unit × 80 units remaining in the commitment).
In 20X6, the company should have recognized a recovery of $1,500 per unit, or
$120,000 total, which is calculated on the remaining units from year-end 20X5,
not 20X6. The 45 units acquired at $16,000 in 20X6 should be written down by
$500 per unit × 45 units = $22,500, to their current value at year-end. Income
and retained earnings are overstated in 20x5 and liabilities are understated.
Currently, inventory is overstated in 20x6; the impairment must be recorded.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-15
Assignment 8-6
Requirement 1
Average discount — 40% of sales at 10% discount; 60% of sales at 3% discount =
(0.40 × 0.10) + (0.60 × 0.03) = 0.04 + 0.018 = 5.8% average discount
NRV = [($70,000 – $5,000) × (1.0 – 0.058)] × (1 – .06)
= $65,000 × 0.942 × 94%
= $61,230 × 94%
= $57,556
Writedown = ($60,000 – $57,556) × 20 = $2,444 × 20 = $48,880
Requirement 2
Revenue = $63,000 × 94% × 5 = $296,100
Cost of goods sold = $57,556 × 5 = $287,780
Gross profit = $8,320
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8-16
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-7
Requirement 1
Holding loss on inventory (CGS) .....................................
Inventory ..................................................................
4,000
4,000
Requirement 2
Accounts receivable ($20,000 × 150% × 60% sold) .........
Sales .........................................................................
18,000
Cost of goods sold ($16,000 × 60% sold) .........................
Inventory ..................................................................
9,600
Inventory (40% × $4,000 original writedown)..................
Cost of goods sold ....................................................
1,600
18,000
9,600
1,600
Requirement 3
The writedown had the effect of reducing net income by $4,000 in 20X6. In 20X7,
income was increased by $2,400 through the sale of 60% of the written-down inventory.
Income increased again 20X7 by the write-up of the $1,600 for year-end inventory. The
effect was to transfer all of amount of the writedown from 20X6 to 20X7, based on the
best estimates at the time. Therefore, 20X7 net income increased by $4,000, the full
amount of the 20X6 writedown.
Without the writedown, 20X6 earnings would have been $54,000 while 20X7 earnings
would have been $56,000.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-17
Assignment 8-8 (WEB)
Calculations:
Individual
LC/NRV
Individual
writedown
$ 8,000
$ 8,000
$ 500
10,400
11,700
10,400
—
$18,900
$ 19,700
Item
#
Cost
NRV
A
100
$ 8,500
B
260
A+B
C
150
10,500
7,500
7,500
3,000
D
200
10,000
12,000
10,000
—
C+D
$20,500
$19,500
Total
$39,400
$35,900
$ 3,500
Group
LC/NRV
Group
writedown
$18,900
nil
$19,500
$ 1,000
$38,400
$ 1,000
Requirement 1
Item-by-item, the writedown would be $3,500:
Cost of goods sold (LC/NRV loss on inventory*) ............
Inventory ..................................................................
3,500
3,500
Requirement 2
Treating the four items as two classes, the write down would be:
$39,400 – $38,400 = $1,000
Cost of goods sold (LC/NRV loss on inventory*) ............
Allowance to reduce inventory to LC/NRV.............
1,000
1,000
Requirement 3
a. With an individual writedown, the recovery for Item A can be reversed, but only to
the extent of the original writedown:
Inventory ...........................................................................
Cost of goods sold ....................................................
500
500
b. When inventory is grouped by class, no recovery is recorded because none of the
writedown (of $1,000) pertains to class A+B.
* The loss must be disclosed in the notes. Alternatively, these amounts can be debited to a
separate account for “Loss on inventory”.
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8-18
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Requirement 4
The advantage of using an allowance is that the individual subsidiary inventory records
do not need to be adjusted for the writedown (nor for any subsequent recovery in value).
The allowance method is essential when LC/NRV is performed by inventory class rather
than item-by-item, because there would be no way to make the detailed inventory records
conform to the general ledger control account.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-19
Assignment 8-9
20X6
NRV: $300,000 × (1.00 – 0.10 – 0.05) = $300,000 × 85% = $255,000
Cost – NRV: $340,000 – $255,000 = $85,000 writedown at the end of 20X6
Holding loss on inventory (CGS)......................................
Allowance to reduce inventory to LC/NRV.............
45,000
45,000
20X7
Cost (without writedown): $340,000 + $50,000 = $390,000
NRV: $370,000 × 90% = $333,000
Allowance required at the end of 20X7: $390,000 – $333,000 = $57,000
Adjustment from 20X6 allowance balance to 20X7 balance: $45,000 – $17,000 =
$28,000 reversal of writedown
Allowance to reduce inventory to LC/NRV......................
Holding gain on inventory (CGS) ............................
28,000
28,000
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8-20
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-10 (WEB)
Requirement 1—Loss for 20X1
a)
Individual items
Allowance
A ........................................ $1,000
B.........................................
5,000
C.........................................
0
D ........................................
1,500
E ......................................... 16,000
F .........................................
0
Total ................................... $23,500
b) Category
A - C Cost, $75,000, NRV, $77,000 ..................
0
D - F Cost, $80,000, NRV, $62,500 .................. $17,500
Total ......................................................... $17,500
Requirement 2
a) By individual items:
Holding loss on inventory .................................................
Allowance to reduce inventory to LC/NRV.............
23,500
23,500
b) By category:
Holding loss on inventory .................................................
Allowance to reduce inventory to LC/NRV.............
17,500
17,500
Requirement 3—Loss for 20X2
a)
Individual items
Allowance
A ........................................ $2,000
B.........................................
1,000
C.........................................
0
D ........................................
1,500
E .........................................
3,000
F .........................................
2,000
Total ................................... $9,500
b) Category
A - C Cost, $60,000, NRV, $64,000 ..................
D - F Cost, $72,000, NRV, $65,500 ..................
Total .........................................................
0
$6,500
$6,500
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-21
Journal entries
a) By individual items:
Allowance to reduce inventory to LC/NRV1 ...................
Inventory ..................................................................
14,000
14,000
b) By category:
Allowance to reduce inventory to LC/NRV2 ....................
Inventory ..................................................................
11,000
1
Adjusting entry: reduces the valuation account from $23,500 to $9,500.
2
Adjusting entry: reduces the valuation account from $17,500 to $6,500.
11,000
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8-22
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-11 (WEB)
Requirement 1
Keyboards:
A
B
C
Hard drives:
X
Y
CD Burners:
D
E
Lower of cost or NRV applied by
Items
Classification
Req. (a)
Req. (b)
Cost
NRV
$ 564
760
900
2,224
$ 480
700
990
2,170
$ 480
700
900
2,700
4,800
7,500
2,550
5,400
7,950
2,550
4,800
2,280
10,000
12,280
1,980
11,600
13,580
1,980
10,000
Total cost
$22,004
Lower of cost or NRV
$ 2,170
7,500
12,280
$21,410
$21,950
Requirement 2
(a)
Items
Periodic inventory;
allowance method:
Holding loss on inventory
Allowance to reduce
inventory to LC/NRV
(b)
Classification
594*
54**
594
54
* $22,004 – $21,410 = $594
** $22,004 – $21,950 = $54
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-23
Requirement 3
The application of lower of cost or NRV to individual items may be theoretically
preferable because this represents a pure application of the LCNRV method and is
entirely consistent with the concepts underlying the method.
In some cases, however, the difference in inventory valuations produced by the two
alternatives may be so small as to make the item-by-item applications not practicable.
This is particularly true when items within a category are homogeneous, which means
that the computations of “cost” and “NRV” may be conducted at a broader level of
aggregation. In this particular situation, this appears to be the case; therefore, both
applications derive very similar results. Of course, this difference also should be
compared to cost of goods sold and net income, etc., in assessing its materiality.
Another factor to consider is the reliability of estimates; use of categories rather than
individual items may compensate for imprecision of estimated values.
One further note is that classifying can net profitable items with unprofitable ones and
thereby, sometimes, generate misleading information. There may be ethical dimensions
in how management defines a “classification” which may allow them to reduce their
write-downs by grouping high-margin and negative-margin items together.
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8-24
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-12
Requirement 1— Direct writedown
December 20X7:
Holding losses on inventory..............................................
Inventory, Class A....................................................
Inventory, Class B ....................................................
600,000
400,000
200,000
June 20X8:
Inventory Class B ..............................................................
Recovery of inventory value ....................................
80,000
80,000
November 20X8:
Accounts receivable ..........................................................
Cost of goods sold .............................................................
Sales revenue ...........................................................
Inventory Class B .....................................................
380,000
365,000
380,000
365,000
March 20X9:
Accounts receivable (€200,000 × C$1.70)........................
Cost of goods sold ............................................................
Sales revenue ...........................................................
Inventory, Class A....................................................
340,000
300,000
340,000
300,000
April 20X9:
Cash (€200,000 × C$1.62) ................................................
Foreign currency loss [€200,000 × (1.70 – 1.62)].............
Accounts receivable .................................................
324,000
16,000
340,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-25
Requirement 2 — Allowance method
December 20X7:
Holding loss on inventory .................................................
Allowance to reduce inventory to LC/NRV.............
600,000
600,000
June 20X8:
Allowance to reduce inventory to LC/NRV Inventory .....
Recovery of inventory value ....................................
80,000
80,000
November 20X8:
Accounts receivable ..........................................................
Cost of goods sold .............................................................
Allowance to reduce inventory to LC/NRV Inventory .....
Sales revenue ...........................................................
Inventory, Class B ....................................................
380,000
365,000
60,000
380,000
425,000
March 20X9:
Accounts receivable (€200,000 × C$1.70)........................
Cost of goods sold ............................................................
Allowance to reduce inventory to LC/NRV......................
Sales revenue ...........................................................
Inventory, Class A ....................................................
340,000
300,000
400,000
340,000
700,000
April 20X9:
Cash (€200,000 × C$1.62) ................................................
Foreign currency loss [€200,000 × (1.70 – 1.62)].............
Accounts receivable .................................................
324,000
16,000
340,000
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8-26
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-13
The inventory that is being sold through the distributor must be written down to lower of
cost or NRV. Net realizable value is $220 minus $44 commission per unit, which yields a
NRV of $176. Original cost was $250. Therefore, the writedown is as follows:
Writedown = ($250 – $176) × 600 units = $44,400.
Holding loss on inventory* ..............................................
Inventory, Model T ..................................................
44,400
44,400
*Students may choose to use an allowance rather than a direct writedown, which is
completely satisfactory. The credit then would be to “Allowance to reduce inventory to
LC/NRV.”
No adjustment is necessary for the remaining 400 units because the new sales price is still
higher than production cost. However, this assumes there is evidence that the Model Ts
actually can be sold at the reduced price of $280.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-27
Assignment 8-14
Requirement 1
To record the purchase of 50,000 crates @ $12:
Crate Inventory (including 7% PST).................................
GST payable ($600,000 × 5%) .........................................
Accounts payable .....................................................
642,000
30,000
672,000
Requirement 2
The potential loss on the onerous contract is $3 × 150,000 = $450,000:
Estimated loss on onerous purchase contract ....................
Estimated liability on onerous contract ...................
450,000
450,000
This loss should be recorded only if (1) the low price of the crates is expected to continue
throughout the fiscal period and (2) Lumber Products Ltd. refuses to renegotiate the
contract.
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8-28
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-15
Requirement 1
The necessary contractual and economic conditions that would require only disclosure of
the contract terms by means of a note in the financial statements would be either: (a) the
contract is subject to revision or cancellation, or (b) a future loss cannot be reasonably
estimated.
Note: At the end of 20x5, a purchase contract for a maximum of $900,000 for
subassemblies during 20x6 was in effect. At the end of 20x5, the subassemblies
had a current replacement cost of $850,000.
Requirement 2
The necessary contractual and economic conditions that would require accrual of a loss
would be (a) the contract is not subject to revision or cancellation, (b) a future loss is
likely and material, and (c) the loss can be reasonably estimated.
Loss on purchase commitment* ............................................................ 50,000
Estimated liability—noncancellable purchase commitment ...........
50,000
*The amount of the loss is based on the estimated current replacement cost ($900,000 –
$850,000).
Requirement 3
Purchases............................................................................................... 830,000
Estimated liability—noncancellable purchase commitment ................. 50,000
Loss on purchase commitment .............................................................. 20,000
Cash.................................................................................................
900,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-29
Assignment 8-16
Requirement 1
Cost of Inventory:
a. Merchandise in store ($490,000 retail ÷ 1.4) ................................................ $350,000*
b. Goods held for later shipment ($16,800 ÷ 1.4) .............................................
12,000
c. Merchandise on consignment [$24,000 × (1 – .50)].....................................
12,000
d. Office equipment (should be reclassified as capital assets) ..........................
0
e. Goods out on approval (not yet accepted by customer), at cost ...................
4,000
Corrected inventory, 31 December 20x5 ............................................................. $378,000
* Goods in transit are not included because they were shipped FOB destination, which
means that title has not yet transferred to the buyer.
Requirement 2
Statement of Comprehensive Income:
a.
b.
c.
d.
e.
f.
g.
Ending inventory overstatement ($490,000 – $378,000) ........................... $112,000
Cost of goods sold understated ................................................................... 112,000
Gross margin overstated ............................................................................. 112,000
Pretax income overstated ............................................................................ 112,000
Income taxes overstated ($112,000 × .30) ..................................................
33,600
Net income overstated ($112,000 – $33,600).............................................
78,400
Amortization expense understated on office equipment; amount not
determinable. Also affects tax expense and net income.
h. Sales may be overstated, depending on how consignment and “on approval”
items have been accounted for. Also affects gross margin, tax expense and net
income.
Statement of Financial Position:
Current assets: inventory overstated ............................................................. $112,000
Capital assets, understated ............................................................................
20,000
[Also understated is accumulated amortization, amount undeterminable.
This also affects deferred income taxes and retained earnings.]
Current liabilities: income taxes payable overstated ....................................
33,600
Retained earnings overstated ........................................................................
78,400
Note: there is also a potential overstatement of accounts receivable, and, as a result,
incorrect deferred income taxes and retained earnings, if sales were improperly
recorded.
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8-30
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-17
1. Corrected net income:
Draft net income, 20X4
$ 550,000
a. Understatement of purchases (and cost of sales)
– 25,000
b. Cut-off error: sale not recognized until 20X5, mismatch of revenue
and expense
+ 120,000
c. Understatement of 20X4 ending inventory (overstatement of cost of
+ 50,000
sales)
d. Consignment recorded as a sale (125,000 revenue – 80,000 CGS)
Corrected net income
– 45,000
$ 650,000
2. Correcting entry, if errors are discovered after release of the 20X4 financial statements:
Inventory (opening) [50,000(c) + 80,000(d)]
130,000
Sales (for 20X5)
120,000(b)
Purchases (for 20X5)
25,000(a)
Accounts receivable
125,000(d)
Retained earnings
100,000*
* 50,000(c) + 120,000(b) – 45,000(d) – 25,000(a) = $100,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-31
Assignment 8-18
Case A
1. The inventory in transit was recorded as a 20X4 purchase but was not included in the
ending inventory. Therefore, the 20X4 ending inventory was understated and 20X4
cost of sale was overstated.
2. Correcting entry in 20X5:
Inventory (opening)
Retained earnings
265,000
265,000
The 20X4 financial statements must be restated.
Case B
1. The year-end inventory was properly stated in the 20X3 financial statements, which
means that the $400,000 of inventory was not included in ending inventory on the
20X3 SFP. When the physical count was compared to the perpetual inventory
records, there would have been a $400,000 discrepancy that would have been viewed
as either missing inventory or a recording error. As a result, the cost of sales will
have been properly calculated for that year because it is based on the physical count.
Although COS was correct (using the physical count of the ending inventory),
20X3 revenue and accounts receivable were both understated by $640,000, the
unrecorded sale. Net income for 20X3 was similarly understated by $640,000.
2. Correcting entry in 20X4:
Accounts receivable
Retained earnings (to restate 20X3 earnings)
640,000
640,000
The 20X3 financial statements must be restated by increasing (1) sales revenue and (2)
accounts receivable by $640,000.
Since the inventory was properly stated at year-end 20X3, the shipment must have been
recorded in cost of sales on 31 December 20X3 when the goods left the warehouse.
We’ve assumed that the 4 January 20X4 entry was only for issuance of the sales invoice
and not for cost of sales, and therefore no correction is needed for cost of sales in 20X4.
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8-32
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-19 (WEB)
Cost of goods available for sale:
Beginning inventory .....................................................................
$320,000
Purchases...................................................................................... $500,000
Freight-in......................................................................................
16,000
516,000
Less: Purchase returns and allowances .......................................
14,000 502,000
Cost of goods available for sale ..................................................
822,000
Deduct estimated cost of goods sold:
Sales revenue ............................................................................... 800,000
Less: Returns ...............................................................................
35,000
Net sales ................................................................................. 765,000
Less: Estimated gross margin ($765,000 × 30%) ....................... 229,500 535,500
Estimated cost of ending inventory....................................................
$286,500
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-33
Assignment 8-20 (WEB)
Requirement 1
Gross margin: $750,000 × 33.3% = $250,000
Cost of goods sold: $750,000 – $250,000 = $500,000
Cost of goods available for sale: $140,000 + $800,000 + $7,000 = $947,000
Ending inventory: $947,000 – $500,000 = $447,000
Requirement 2
Fiction:
Gross margin: $590,000 × 28.6% = $168,740
Cost of goods sold: $590,000 – $168,740 = $421,260
Cost of good available for sale: $100,000 + $600,000 + $5,000 = $705,000
Ending inventory: $705,000 – $421,260 = $283,740
Non-fiction:
Gross margin: $160,000 × 37.5% = $60,000
Cost of goods sold: $160,000 – $60,000 = $100,000
Cost of goods available for sale: $40,000 + $200,000 + $2,000 = $242,000
Ending inventory: $242,000 – $100,000 = $142,000
Total ending inventory (fiction and non-fiction) $283,740 + $142,000 = $425,740
Requirement 3
In this situation, applying the gross margin method separately to fiction and non-fiction
and aggregating the results is preferable because (1) the markup percentages are different
for the two categories and (2) the categories represent different proportions of total sales,
purchases, and inventory on hand. A physical count should be much closer to the
separate application of the gross margin method ($425,740) than the aggregate
application ($447,000).
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8-34
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-21 (WEB)
Requirement 1
At cost
Inventory, 1 June
+ Purchases
– Purchase returns and allowances
$ 226,000
519,600
(9,000)
+ Markups (net) ($122,000 – $38,000)
Retail value goods available for sale
– Markdowns (net) ($88,000 – $43,000)
Goods available for sale
– Sales (net of returns: $1,050,000 – $50,000)
Inventory, 30 June, at retail
Inventory, 30 June, at cost:
($299,000 × 55 % cost ratio*)
At retail
$
336,000
940,000
(16,000)
84,000
1,344,000
(45,000)
$ 736,600
$ 1,299,000
(1,000,000)
$ 299,000
$ 164,450
* Cost ratio = $736,600 ÷ $1,344,000 = 55%
Since the retail method is an estimate, there is no point in carrying the cost ratio out to
more than two significant digits.
Requirement 2
If the estimate of ending inventory were based on the ratio between cost and retail value,
the estimated inventory would reflect approximate purchase cost. However, the retail
method increases the ratio by deducting markdowns from the denominator of the cost
ratio. The resulting cost ratio takes into account that some goods have been marked down,
and thus approximates lower of cost or NRV valuation.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-35
Assignment 8-22 (WEB)
Requirement 1
At cost
Goods available for sale:
Beginning inventory .......................................................... $ 180,500
Purchases (net) ..................................................................
955,000
Freight-in...........................................................................
15,000
Additional markups ...........................................................
Additional markup cancellations ......................................
Retail value, before markdowns..............................................
Markdowns .......................................................................
Employee discounts (a markdown) ...................................
Total goods available for sale ....................................... $1,150,500
Cost ratio $1,150,500 ÷ ($1,770,000 + $10,000) = 65%
Deduct:
Sales ..................................................................................
Ending inventory
At retail .............................................................................
At cost, ($460,000 × 65%) ................................................
299,000
Ending inventory per physical count:
At retail .............................................................................
At cost, ($475,000 × 65%) ................................................
308,750
Indicated excess:
At retail .............................................................................
At cost ............................................................................... $ 9,750
At retail
$ 300,000
1,453,000
31,000
(14,000)
1,770,000
(8,000)
(2,000)
1,760,000
(1,300,000)
460,000
475,000
$ 15,000
Requirement 2
The above computations indicate a general correspondence between the two
independently derived totals. The difference, at cost, of $9,750 is only 3.16% of the cost
of the inventory from the physical count; thus, this difference would probably not be
investigated at great length because it is not material. Nevertheless, the auditor would
consider whether:
a.
The physical count was correct. Presumably, the auditors observed the physical
count and made their own test counts. In this follow-up phase of the audit, attention
will be given to any items for which the audit test counts disagreed with those of the
client.
b.
The ending inventory in fact comprises items which have the average cost/retail ratio
for the period. (Note that use of this estimation method implicitly assumes that the
ending inventory comprises the average merchandise available during the period.) In
the case of Acton for this period, the ending inventory may comprise goods with a
lower than average cost/retail ratio. This could account for the fact that the
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8-36
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
computed estimate of ending inventory is less than the total per the physical count.
(Note that the physical count includes the specific units that are on hand at yearend—not necessarily an average of the units available during the period.)
c.
The book data used in the above analysis is valid.
In summary, the auditor would in general place greater confidence in the physical count
total, unless there were clear reasons to suspect that it was not correct. This conclusion is
strengthened in this case because the count exceeds the estimated total. Do not overlook
the fact that the retail method computations are estimates.
Requirement 3
Based on the above reasoning, the $9,750 discrepancy would probably not be accorded
any accounting treatment (i.e., no entry) because (a) the count total is more reliable than
the estimated total and (b) the difference is not material in amount.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-37
Assignment 8-23 (EXCEL) (WEB)
Requirement 1
Net Sales ($800,000 – $2,000) ................................
Opening Inventory .................................................. $ 45,000
Net purchases1 ........................................................ 464,300
509,300
Gross Margin ($798,000 × .51)...............................
Cost of Goods Sold ($798,000 – $406,980) ...........
Ending Inventory ($509,300 – $391,020) ...............
$798,000
406,980
$391,020
$118,280
1$459,500 + $7,000 – $2,200 = $464,300
Requirement 2
Goods available for sale:
Beginning inventory .......................................
Purchases........................................................
Purchase returns .............................................
Freight on purchases ......................................
Additional markups ........................................
Additional markup cancellations ...................
Markdowns ....................................................
Markdown cancellations ................................
Total goods available for sale ....................
Cost ratio = $509,300 ÷ $930,000 = 55%
Deduct:
Sales ...............................................................
Less: Sales returns .........................................
Net sales .....................................................
Ending inventory (at retail) ..................................
Ending inventory (at cost) $128,000 × .55...........
Cost of goods sold ($509,300 – $70,400) ............
Actual gross margin achieved,
($798,000 – $438,900) ÷ $798,000 ................
At cost
$ 45,000
459,500
(2,200)
7,000
$509,300
At retail
$ 80,000
850,000
(4,000)
9,000
(5,000)
930,000
(7,000)
3,000
926,000
$800,000
(2,000)
(798,000)
$128,000
70,400
$438,900
45%
Requirement 3
The gross profit method yields an inventory cost that approximates average cost. In
contrast, the retail method estimates inventory at lower of cost or fair value because it
excludes markdowns in calculating the cost ratio but then applies that cost ratio to the
retail inventory including markdowns. As well, the retail sales method is likely to be
more accurate as it uses the actual mark-up for the current year, not last year. The
difference between last year and this (55% vs. 51%) explains the $47,880 ($118,280 –
$70,400) difference (6% of $798,000) in ending inventory.
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8-38
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-24
Requirement 1
Current entries:
a.
No entry required for beginning inventory.
b.
Purchases ($200,000 × 98%) ....................................................
Cash ($196,000 × 85%) .......................................................
Accounts payable ($196,000 × 15%) ...................................
196,000
Purchases (or Freight-in) ..........................................................
Cash......................................................................................
10,000
Accounts payable ($29,400 × 40%)..........................................
Cash......................................................................................
11,760
Cash ($3,000 × 98%) ................................................................
Purchase returns ...................................................................
2,940
Cash ..........................................................................................
Accounts receivable ..................................................................
Sales revenue .......................................................................
333,000
37,000
c.
d.
e.
f.
g.
Inventory—damaged goods ......................................................
Loss on goods returned .............................................................
Cash......................................................................................
*Sales price ............................
Repair costs ..........................
Selling costs .........................
Net realizable value .............
h.
i.
j.
k.
166,600
29,400
10,000
11,760
2,940
370,000
180*
220
400
$240
(50)
(10)
$180
Operating expenses ...................................................................
Cash......................................................................................
120,000
Purchases ..................................................................................
Accounts payable .................................................................
(Ownership has passed by 31 December 20x5)
7,000
Inventory—damaged goods ......................................................
Cash......................................................................................
50
Cash ..........................................................................................
Inventory—damaged goods ($180 + $50) ...........................
Gain on sale of damaged goods ...........................................
Operating expenses* ...........................................................
* selling expenses allocated and assumed to have been
previously recorded when paid.
120,000
7,000
50
245
230
5
10
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-39
Requirement 2
Entries at end of period:
Ending inventory, at cost ($110,000 (l) + $7,000 (i)) ......................
Cost of goods sold ............................................................................
Purchase returns ...............................................................................
Purchases ($196,000 + $10,000 + $7,000) ...............................
Beginning inventory, at cost .....................................................
117,000
198,060
2,940
Holding loss on inventory (LC/NRV) ..............................................
Allowance to reduce inventory to LC/NRV .............................
($110,000 + $7,000) – ($107,000 + $7,000) = $3,000
3,000
Income tax expense (from income statement, Req’t 3) ...................
Income taxes payable ................................................................
19,494
213,000
105,000
3,000
19,494
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8-40
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Requirement 3
GAMIT LTD.
Income Statement
For Year Ended 31 December 20x5
Sales revenue ...................................................................................
$370,000
Cost of goods sold:
Beginning inventory ................................................................. $105,000
Plus: Purchases ........................................................................ 213,000
Less: Purchase returns .............................................................
(2,940)
Goods available for sale............................................................ 315,060
Less: Ending inventory ............................................................ 117,000 198,060
Gross margin ....................................................................................
171,940
Holding loss on inventory (LC/NRV) ......................................
(3,000)
*Gain on sale of damaged goods ..............................................
5
*Loss on goods returned ...........................................................
(220)
Operating expenses ($120,000 – $10) ......................................
(119,990)
Income before income taxes ............................................................
48,735
Less: income tax expense ($48,735 × .40) ......................................
19,494
Net income .......................................................................................
$ 29,241
*Shown separately for illustrative purposes.
Earnings per share on common stock outstanding:
Net income, $29,241 ÷ shares outstanding, 20,000 = $1.46
Requirement 4
GAMIT LTD.
Balance Sheet
At 31 December 20x5
Current Assets:
Inventory, at cost .............................................................................. $117,000
Less: Allowance for reduction to NRV ...................................
(3,000)
Inventory, at LC/NRV ......................................................................
$114,000*
*May also be shown net.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-41
Assignment 8-25
Requirement 1—indirect method
Operating Activities
Add back: non-cash charges relating to inventories
Loss on purchase commitment .............................................
Add/(deduct)
Increase in inventories (net) .............................................
Increase in accounts payable ............................................
Total adjustment ............................................................
8,000
(110,000)
20,000
$ (82,000)
Requirement 2—direct method
Cash payments
Cost of goods sold, excluding change in LC/NRV allowance
[$4,900,000 – ($65,000 – $46,000)] ................................. $4,881,000
Less: loss on purchase commitment............................................
(8,000)
Less: increase in accounts payable ..............................................
(20,000)
Plus: increase in inventories (at cost)
($951,500 + $65,000) – ($841,000 + $46,000) ..................
129,000
Net cash out flow for inventory purchases ................................... $4,982,000
Alternatively:
$4,900,000 – $20,000 – $8,000 + $110,000 = $4,982,000
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8-42
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-26 (ASPE) (EXCEL)
Requirement 1
1
Income
Revenue
Cost of goods sold
Depreciation
Advertising and promotion
$48,000
(12,000)1
2
Average
cost
3
S-L
Deprec.
4
Amortization
(1,200)
(4,800)
(2,400)
$2,400
$1,920
5
Total
∑col. 2-4
$48,000
(13,200)
(2,400)
(480)
(5,000)
(24,200)
(5,000)
(21,080)
Income before income tax
23,800
26,920
Income tax expense (20%)
(4,760)
240
(480)
(384)
(5,384)
$19,040
$ (960)
$1,920
$1,536
$21,536
Other expenses
Net income/effect of change
1
Using FIFO inventory
Requirement 2
Management’s financial reporting objectives merit discussion together with user needs. If
maximization of earnings per share is among management’s objectives, the accounting
policy choices should be FIFO, straight-line depreciation, and amortization of advertising
and promotion. On this basis, earnings per share would be $16.40 [($18,844 + $840) ÷
1,200], an increase of approximately 18% over the $13.88 amount reported in column 1.
Alternative accounting principles confer considerable latitude on management with
respect to the specifics of income measurement. This latitude, however, is constrained by
the accounting standard of consistency.
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-43
Assignment 8-27 (WEB)
1.
Weighted average (periodic inventory system):
Goods available for sale:
Units
1.
2.
3.
4.
Inventory ........................................................... 30
Purchase ............................................................ 45
Purchase ............................................................ 50
Purchase ............................................................ 50
Goods available for sale ............................... 175
Unit cost
Amount
$19.00
20.00
20.80
21.60
$
570
900
1,040
1,080
$3,590
$20.51
20.51
$3,589
1,538
$2,051
$3,590  175 = $20.51 per unit
Goods available for sale.......................................... 175
Ending inventory .................................................... 75
Cost of goods sold (includes rounding error) ......... 100
2.
Moving average (perpetual inventory system):
Units
1. Inventory ...........................................................
2. Purchase ............................................................
Balance .........................................................
3. Sale ...................................................................
Balance .........................................................
4. Purchase ............................................................
Balance .........................................................
5. Sale ...................................................................
Balance .............................................................
6. Purchase ............................................................
Balance .........................................................
30
45
75
(50)
25
50
75
(50)
25
50
75
Goods available for sale.......................................... 175
Ending inventory .................................................... 75
Cost of goods sold .................................................. 100
Moving
average
$19.00
20.00
19.60
19.60
20.80
20.40
20.40
21.60
21.20
Amount
$ 570
900
1,470
(980)
490
1,040
1,530
(1,020)
510
1,080
$1,590
$3,590
1,590
$2,000*
*$980 + $1,020 = $2,000
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
3.
FIFO:
Goods available (from above) .................
Ending inventory (75 units):
50 units × $21.60 ................................
25 units × $20.80 ................................
Cost of goods sold ..........................
Units
175
(50)
(25)
100
Amount
$3,590
75
(1,080)
( 520)
$1,990
$1,600
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-45
Assignment 8-28 (WEB)
Requirement 1
a.
b.
c.
FIFO ........................................................
Weighted average ...................................
Moving average ......................................
*Rounded.
Ending
inventory
Cost of
goods sold
$51,750
47,970
50,790*
$180,150
183,885
181,110
Gross
margin
$280,350
276,615
279,390
Computations:
a.
FIFO:
Goods available for sale:
Units
1.
2.
4.
6.
3,000
27,000
9,000
4,500
43,500
Inventory ...............................................
Purchase ................................................
Purchase ................................................
Purchase ................................................
Total .................................................
Unit cost
$5.00
5.20
5.50
6.00
Ending inventory (43,500 – 34,500 = 9,000 units):
Out of (6) 4,500 at $6.00 ...................... (4,500)
Out of (4) 4,500 at $5.50 ...................... (4,500)
Cost of goods sold ................................ 34,500
Gross margin:
10,500 × $13.00 =
24,000 × $13.50 =
Total sales
Cost of goods sold
Gross margin
b.
Amount
$ 15,000
140,400
49,500
27,000
231,900
(27,000)
(24,750)
$180,150
$51,750
$ 136,500
324,000
460,500
180,150
$280,350
Weighted average (rounding error in cost of goods sold):
Average unit cost = $231,900 ÷ 43,500 = $5.33
Ending inventory, 9,000 units:
9,000 units × $5.33 = $ 47,970
Sales
$460,500
Cost of goods sold
183,885
Gross margin
$276,615
Cost of goods sold:
34,500 units × $5.33 = $183,885
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
c.
Moving average:
Units
1. Inventory ........................................................
3,000
2. Purchase ......................................................... 27,000
Balance ...................................................... 30,000
3. Sale ................................................................ (10,500)
Balance ...................................................... 19,500
4. Purchase .........................................................
9,000
Balance ...................................................... 28,500
5. Sale ................................................................ (24,000)
Balance ......................................................
4,500
6. Purchase .........................................................
4,500
Ending inventory .......................................
9,000
Cost of goods sold:
$231,900 – $50,790 =
$181,110
Sales
Cost of goods sold
Gross margin
$460,500
181,110
$279,390
Moving
average
$5.00
5.20
5.18
5.18
5.50
5.28
5.28
6.00
$5.64
Amount
$ 15,000
140,400
155,400
(54,390)
101,010
49,500
150,510
(126,720)
23,790
27,000
$ 50,790
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Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-47
Requirement 2
Weighted Average
Periodic
1.
Opening inventory, both methods.....
2.
Purchases (27,000 × $5.20) .............. 140,400
Inventory ...........................................
Accounts payable .........................
3.
4.
5.
6.
7.
$ 15,000
Accounts receivable .......................... 136,500
Sales (10,500 × $13.00) ...............
Cost of goods sold ............................
N/A
Inventory (10,500 × $5.18) ..........
Purchases ..........................................
Inventory (9,000 × $5.50) .................
Accounts payable .........................
$ 15,000
140,040
140,400
140,040
136,500
136,500
136,500
54,390
54,390
49,500
49,500
49,500
Accounts receivable .......................... 324,000
Sales (24,000 × $13.50) ...............
Cost of goods sold ............................
N/A
Inventory (24,000 × $5.28) ..........
Purchases ..........................................
Inventory (4,500 × $6) ......................
Accounts payable .........................
Moving Average
Perpetual
49,500
324,000
324,000
324,000
126,720
126,720
27,000
Cost of goods sold ........................... 183,885*
Inventory, closing (9,000 × $5.33) ... 47,970
Inventory, opening .......................
Purchases......................................
27,000
27,000
27,000
N/A
15,000
216,900
*(34,500 × $5.33), rounded
Requirement 3
If a standard cost system were used, all items entering inventory would be costed at
$5.50. Amounts paid more or less than this amount would be entered as price variances.
All inventory items sold would cost $5.50—making the entries vastly more simple, and
independent of cost flow assumptions.
©2014 McGraw-Hill Ryerson Ltd. All rights reserved
8-48
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-29 (EXCEL) (WEB)
a.
b.
c.
Ending
inventory
(9,000 units)
Cost of
goods sold
(22,000 units)
Gross
margin
$69,780
$162,680
$194,320
67,500
164,960
192,040
69,690
162,770
194,230
FIFO ......................................................
Weighted average, periodic inventory
system .................................................
Moving average, perpetual inventory
system .................................................
Computations:
Goods available for sale:
1.
2.
3.
6.
8.
Inventory .......................................................
Purchase ........................................................
Purchase ........................................................
Purchase ........................................................
Purchase ........................................................
Total available ........................................
Sales (4,000 + 9,000 + 9,000) ..............................
Ending inventory ..........................................
Units
Unit cost
3,000
6,000
5,000
11,000
6,000
31,000
22,000
9,000
$6.90
7.20
7.50
7.66
7.80
Amount
$ 20,700
43,200
37,500
84,260
46,800
$232,460
Sales Revenue: (13,000 × $15) + (9,000 × $18) = $357,000.
a.
FIFO:
Units
Amount
Total available ......................................................................
Ending inventory: 6,000 × $7.80 = $46,800
3,000 × $7.66 = $22,980 .......................
Cost of goods sold ...............................................................
31,000
$232,460
9,000
22,000
69,780
$162,680
Gross margin: $357,000 – $162,680 = $194,320
b.
Weighted average:
Average unit cost: $232,460 ÷ 31,000
Ending inventory: 9,000 × $7.50
Cost of goods sold: $232,460 – $67,500
Gross margin: $357,000 – $164,960
=
$7.50
= $67,500
= $164,960
= $192,040
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-49
c.
Moving average:
Inventory .......................................................
Purchase ........................................................
Balance ...................................................
Sale ............................................................
Balance ...................................................
Purchase ........................................................
Balance ...................................................
Sale ............................................................
Balance ...................................................
Purchase ........................................................
Balance ...................................................
Sale ............................................................
Balance ...................................................
Purchase ........................................................
Balance (ending inventory) .....................
Units
Unit cost
3,000
6,000
9,000
(4,000)
5,000
5,000
10,000
(9,000)
1,000
11,000
12,000
(9,000)
3,000
6,000
9,000
$6.90
7.20
7.10
7.10
7.50
7.30
7.30
7.66
7.63
7.63
7.80
$7.74
Amount
$ 20,700
43,200
63,900
(28,400)*
35,500
37,500
73,000
(65,700)
7,300
84,260
91,560
(68,670)
22,890
46,800
$ 69,690
Cost of goods sold: $232,460 – $69,690 = $162,770
Gross margin: $357,000 – $162,770 = $194,230
*$63,900 – $35,500 = $28,400, alternatively, 4,000 × $7.10
©2014 McGraw-Hill Ryerson Ltd. All rights reserved
8-50
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
Assignment 8-30
Requirement 1
Dennis’s inventory note indicates that if it were to change completely to FIFO,
inventories would increase. Since a change to FIFO would mean more recent costs are
used to value the inventory, prices in the current year supplier markets must be
increasing.
Carlton also states that average cost inventories would have been lower compared to a
FIFO basis. Turning that comment around, using all FIFO will give a higher inventory
than average cost.
Requirement 2
The obvious comment is that Carlton Corporation, with half its inventory stated at FIFO,
will have higher inventory and higher income, assuming that prices have been rising.
Using the data in the problem, Dennis has $6,215 ÷ $174,429 = 3.6% of its total assets
invested in inventory while Carlton has $3,571 ÷ $43,076 = 8.3%. Since prices were
rising during this period and Dennis has a greater percent of its inventory on an average
cost basis, using FIFO would increase Dennis's inventory more than Carlton’s. However,
even if Dennis used FIFO for its entire inventory, the percentage would only rise to
($6,215 + $1,323) ÷ ($174,429 + $1,323) = 4.29%. Carlton has a much greater
proportion of its assets in inventory.
Requirement 3
Comparability obviously suffers when companies in the same industry use different
accounting policies. Comparability is enhanced when disclosure notes, such as the one
provided by both Carlton and Dennis, quantify the effect on inventory. However, such
disclosure means that inventory costing records must be kept on two bases, and are more
expensive for the company.
While comparability is desirable, firms are at liberty to pick accounting policies that best
serve their reporting objectives. Firms operate in different environments, and flexibility
recognizes this. Standard setters appear comfortable with this.
© 2014 McGraw-Hill Ryerson Ltd. All rights reserved
Solutions Manual to accompany Intermediate Accounting, Volume 1, 6th edition
8-51