CHAPTER 6
Inventory Costing
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives
Brief
Exercises
Questions
Problems
Set A
Exercises
Problems
Set B
1. Describe the steps in determining
inventory quantities.
1, 2, 3, 4
1, 2
1
1
1
2. Prepare the entries for purchases
and sales of inventory under a
periodic inventory system.
6, 8
3
2, 10
2, 8, *9
2, 8, *9
3. Determine the cost of goods sold
under a periodic inventory system.
5, 7, 8
4, 5
3, 4
2
2
4. Identify the unique features of the
income statement for a
merchandising company using a
periodic inventory system.
9
5, 6
5
2, 3
2, 3
5. Explain the basis of accounting for
inventories and use the inventory
cost flow methods.
10, 11, 12
7
6, 7, 8, 9
4, 5, 8, *9
4, 5, 8, *9
6. Demonstrate the effects on the
financial statements of each of the
inventory cost flow methods.
13, 14
8
8, 9, 10
4, 5, 6, *10
4, 5, 6
7. Determine the effects of inventory
errors on the financial statements.
15
9, 10
11, 12
6, 7
6, 7
8. Explain and use the lower of cost
and market basis of accounting for
inventories.
16, 17, 18
11
13
8
8
*9. Apply the inventory cost flow
methods to perpetual inventory
records (Appendix 6A).
*19
*12, *13
*14
*9, *10
*9, *10
*10. Use the two methods of estimating
inventories (Appendix 6B).
*20, *21, *22
*14, *15
*15, *16
*11, *12
*11, *12
ASSIGNMENT CHARACTERISTIC TABLE
Problem
Number
Description
Difficulty
Level
Time
Allotted min.)
1A
Determine items and amounts to be recorded in inventory.
Moderate
25-30
2A
Journalize, post, and prepare trial balance and partial income
statement.
Simple
30-40
3A
Prepare a multiple-step income and closing entries.
Simple
15-20
4A
Determine cost of goods sold and ending inventory, using
periodic FIFO, weighted average, and LIFO. Answer questions
about financial statement effects.
Simple
20-30
5A
Calculate ending inventory using FIFO and weighted average
periodic inventory methods, prepare income statements, and
answer questions.
Moderate
20-35
6A
Indicate effect of errors and identify cost flow assumptions.
Moderate
20-25
7A
Illustrate impact of inventory error.
Simple
15-20
8A
Prepare journal entries for purchaser and seller using weighted
average cost. Apply lower of cost and market.
Moderate
25-30
*9A
Calculate and journalize FIFO transactions in perpetual and
periodic inventory systems.
Moderate
25-35
*10A
Calculate cost of goods and inventory using perpetual inventory
system with FIFO and moving average cost. Answer questions
about financial statement effects.
Moderate
20-30
*11A
Estimate inventory loss using gross profit method.
Moderate
15-20
*12A
Estimate ending inventory using retail method.
Moderate
15-20
1B
Determine items and amounts to be recorded in inventory.
Moderate
25-30
2B
Journalize, post, and prepare trial balance and partial income
statement.
Simple
30-40
3B
Prepare a multiple-step income statement and closing entries.
Simple
15-20
4B
Determine cost of goods sold and ending inventory using
periodic FIFO, weighted average, and LIFO. Answer questions
about financial statement effects.
Simple
20-30
5B
Calculate ending inventory using FIFO and LIFO periodic
inventory methods, prepare income statements, and answer
questions.
Moderate
20-35
6B
Indicate effect of errors and identify cost flow assumptions.
Moderate
20-25
7B
Illustrate impact of inventory error.
Simple
15-20
Problem
Number
Description
Difficulty
Level
Time
Allotted min.)
8B
Prepare journal entries for purchaser and seller using FIFO
periodic method. Apply lower of cost and market.
Moderate
25-30
*9B
Calculate and journalize average cost transactions in perpetual
and periodic inventory systems.
Moderate
25-35
*10B
Calculate ending inventory and gross profit using perpetual
inventory system with FIFO costing.
Moderate
20-30
*11B
Estimate inventory loss using gross profit method.
Moderate
15-20
*12B
Estimate ending inventory using retail method.
Moderate
15-20
BLOOM’S TAXONOMY TABLE
Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Material
Study Objective
1. Describe the steps
in determining
inventory
quantities.
Knowledge
Q6-2
BE6-1
2. Prepare the entries
for purchases and
sales of inventory
under a periodic
inventory system.
3. Determine the cost
of goods sold
under a periodic
inventory system.
Q6-7
Comprehension
Q6-1
Q6-3
Q6-4
Application
BE6-2
Analysis
E6-1
P6-1A
P6-1B
Q6-6
Q6-8
BE6-3
E6-2
P6-2A
P6-8A
E6-10
Q6-5
Q6-8
BE6-4
BE6-5
E6-3
P6-2A
P6-2B
BE6-5
BE6-6
E6-5
P6-2A
P6-3A
Q6-9
4. Identify the unique
features of the
income statement
for a
merchandising
company using a
periodic inventory
system.
Q6-10
BE6-7
E6-7
E6-8
E6-9
6. Demonstrate the
effects on the
financial
statements of each
of the inventory
cost flow methods.
Q6-13
Q6-14
E6-8
E6-9
*P6-10A
7. Determine the
effects of inventory
errors on the
financial
statements.
Q6-15
BE6-9
BE6-10
E6-11
Q6-16
Q6-17
BE6-11
E6-13
P6-8A
P6-8B
5. Explain the basis of
accounting for
inventories and use
the inventory cost
flow methods.
8. Explain and use
the lower of cost
and market basis
of accounting for
inventories.
Q6-11
Q6-12
Q6-18
*P6-9A
P6-2B
P6-8B
*P6-9B
Synthesis
E6-4
P6-2B
P6-3B
P6-8A
*P6-9A
P6-8B
*P6-9B
E6-6
P6-4A
P6-5A
P6-4B
P6-5B
BE68
E610
P64A
P65A
P6-6A
P6-7A
P6-6B
P6-7B
P6-6A
P6-4B
P6-5B
P6-6B
E6-12
Evaluation
Study Objective
*9. Apply the inventory
cost flow methods
to perpetual
inventory records
(Appendix 6A).
*10. Use the two
methods of
estimating
inventories
(Appendix 6B).
Broadening Your
Perspective
Knowledge
*Q6-19
*Q6-20
Comprehension
Application
*BE6-12 *P6-10A
*BE6-13 *P6-9B
*E6-14
*P6-10B
*P6-9A
*Q6-21
*Q6-22
*BE6-14
*BE6-15
*E6-15
BYP6-5
Analysis
Synthesis
Evaluation
BYP6-7
BYP6-8
*E6-16
*P6-11A
*P6-12A
*P6-11B
*P6-12B
BYP6-1
BYP6-2
BYP6-3
BYP6-4
BYP6-6
ANSWERS TO QUESTIONS
01. Agree. Effective inventory management is frequently the key to
successful business operations. Management attempts to maintain
sufficient quantities and types of goods to meet expected customer
demand. It also seeks to avoid the cost of carrying inventories that
are clearly in excess of anticipated sales.
02. Inventory items have two common characteristics: (1) they are owned
by the company and (2) they are in a form ready for sale to customers
in the ordinary course of business.
03. Taking a physical inventory involves counting, weighing or measuring
each kind of inventory on hand. This is normally done when the store
is closed. Tom will probably count items, and mark the quantity,
description, and inventory number on prenumbered inventory tags.
Retailers, such as a hardware store, generally have thousands of
different items to count. Later, unit costs will likely be applied to the
inventory quantities using either specific identification or an assumed
cost flow method.
04. (a) (1) The goods will be included in Janine Company's inventory if
the terms of sale are FOB destination.
(2) They will be included in Laura Corporation's inventory if the
terms of sale are FOB shipping point.
(b) Janine Company should include goods shipped to a consignee in
its inventory. Goods held by Janine Company on consignment
should not be included in its inventory.
5.
Account
Purchases
Purchase returns
and allowances
Freight in
(a) Added or Deducted (b) Normal Balance
Added
Debit
Deducted
Added
Credit
Debit
Purchases – Purchase returns and allowances = Net purchases +
Freight in = Cost of goods purchased
Questions Chapter 6 (Continued)
6.
Recording sales in either system requires an entry to record the
revenue generated by the transaction (e.g., Dr. Cash or Accounts
Receivable; Cr. Sales). Under the perpetual inventory system, a
second entry is made to record the cost of the sale (e.g., Dr. Cost of
Goods Sold; Cr. Merchandise Inventory). Under a periodic system the
cost of goods sold is not determined until the end of the accounting
period. At that time, it is not recorded but rather is a calculation
detailed within the income statement.
7.
(1)
(2)
(3)
(4)
8.
Under a periodic inventory system, cost of goods sold is determined
at the end of an accounting period. Under a perpetual inventory
system, the cost of goods sold is determined throughout the period
as each sale takes place.
9.
The distinguishing feature is that cost of goods sold is detailed, rather
than shown as one amount. These details consist of:
Purchase returns and allowances
Freight in
Cost of goods purchased
Ending inventory
Beginning inventory
+ Cost of goods purchased
+ Purchases
- Purchase returns and allowances
= Net purchases
+ Freight in
= Cost of goods purchased
= Goods available for sale
- Ending inventory
= Cost of goods sold
10. Actual physical flow may be impractical because many items are
indistinguishable from one another. And, even if the items are
individually identifiable, it may be too costly and too complex to track
the physical flow of each inventory item. Actual physical flow may
also be inappropriate because management may be able to
manipulate net income through specific identification of items sold.
Questions Chapter 6 (Continued)
11. An advantage of the specific identification method is that it tracks the
actual physical flow of the goods available for sale. A disadvantage is
that management could manipulate net income by directing the flow
of items and hence costs.
12. (a) FIFO
(b) FIFO
(c) Average cost
13. Plato Company is using the FIFO method of inventory costing. York
Company is using the LIFO or average cost flow method. Under FIFO,
the latest goods purchased remain in inventory. Thus, the inventory
on the balance sheet should be close to current costs. The reverse is
true of the LIFO cost flow method and average cost falls somewhere
in between the FIFO and LIFO results.
Plato Company will probably have the higher gross profit, because
cost of goods sold will include a higher proportion of goods
purchased at earlier (lower) costs.
14. No. Selection of an inventory costing method is a management
decision. The accountants may provide input for management
consideration, but the decision is that of the management. Once a
method has been chosen, it should be used consistently.
15. (a) Mila Company's 2002 net income will be understated $5,000.
BI + CGP – EI = CGS
-U=O
Sales – CGS = NI
-O=U
(b) Mila’s 2003 net income will be overstated $5,000 since the ending
inventory of 2002 becomes the beginning inventory of 2003.
BI + CGP – EI = CGS
U
=U
Sales – CGS = NI
-U=O
(c) The combined net income for the two years will be correct
because the errors offset each other (U$5,000 in 2002 and O$5,000
in 2003).
Questions Chapter 6 (Continued)
16. Lucy should know the following:
(a) A departure from the cost basis of accounting for inventories is
justified when the utility (revenue-producing ability) of the goods
is no longer as great as its cost. The writedown to market should
be recognized in the period in which the price decline occurs.
(b) Market can mean current replacement cost (cost to replace) or the
net realizable value (selling price less any costs required to make
the goods ready for sale) of the goods. The net realizable value is
more commonly used.
17. Rock Music Centre should report the five CD players at $320 each, for
a total of $1,600. $320 is the estimated net realizable value (NRV)
under the lower of cost and market basis of accounting for
inventories. NRV represents the net revenue which can be expected
from the sale of the goods, and therefore constitutes a logical
maximum on the value of the items.
18.
Maureen & Nathan Company should disclose (1) the major inventory
classifications, (2) the basis of accounting (cost or lower of cost and
market), and (3) the costing method used (specific identification,
FIFO, average cost, or LIFO).
*19. In a periodic system, the average is a weighted average based on
total goods available for sale at the end of the period. In a perpetual
system, the average is calculated the same (GAS $ ÷ GAS units) but
it becomes a moving average as the weighted average is recalculated
after each purchase.
*20. Inventories must be estimated when (1) management wants interim
(monthly or quarterly) financial statements but a physical inventory is
only taken annually, or (2) a fire or other type of casualty makes it
impossible to take a physical inventory.
Questions Chapter 6 (Continued)
*21. The estimated cost of the ending inventory is $20,000:
Net sales ...........................................................................
Less: Gross profit ($400,000 X 30%) ..............................
Estimated cost of goods sold .........................................
$400,000
120,000
$280,000
Cost of goods available for sale .....................................
Less: Cost of goods sold ...............................................
Estimated cost of ending inventory ................................
$300,000
280,000
$ 20,000
*22. The estimated cost of the ending inventory is $21,000:
Cost-to-retail ratio:
$84,000  $120,000 = 70%
Ending inventory at retail: $120,000 – $100,000 = $20,000
Ending inventory at cost:
$20,000 X 70% = $14,000
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 6-1
1.
Ownership of the goods belongs to the consignor (Helgeson). Thus,
these goods should be included in Helgeson’s inventory.
2.
The goods in transit should not be included in the inventory count because ownership by Helgeson does not occur until the goods reach
its warehouse.
3.
The goods being held belong to the customer. They should not be included in Helgeson’s inventory.
4.
Ownership of these goods rests with the other company (the
consignor). These goods should not be included in Helgeson’s
inventory.
5.
The goods in transit to a customer should be included in inventory as
title does not pass to the customer until they reach the destination.
BRIEF EXERCISE 6-2
Inventoriable costs are $3,070 (invoice cost $3,000 + freight charges $70).
The amount paid to negotiate the purchase is a buying cost that normally
is not included in the cost of inventory because of the difficulty of
allocating these costs, or other employee-related costs (e.g., wages),
directly to the product Buying costs such as these are usually expensed in
the year incurred.
BRIEF EXERCISE 6-3
(1) Buyer Company
(a) March 2
(b) March 6
(c) March 29
Purchases ............................... 900,000
Accounts Payable ............
900,000
Accounts Payable ................... 130,000
Purchases Returns and
Allowances...................
130,000
Accounts Payable ................... 770,000
Cash ($900,000 - $130,000)
770,000
(2) Seller Company
(a) March 2
(b) March 6
(c) March 29
Accounts Receivable .............. 900,000
Sales .................................
900,000
Sales Returns and Allowances 130,000
Accounts Receivable .......
130,000
Cash ($900,000 - $130,000)..... 770,000
Accounts Receivable .......
770,000
BRIEF EXERCISE 6-4
Purchases ..........................................................................
Less: Purchase returns and allowances ........................
Net purchases ...................................................................
Add: Freight in .................................................................
Cost of goods purchased .................................................
$400,000
11,000
389,000
16,000
$405,000
BRIEF EXERCISE 6-5
Net sales ...........................................................
$630,000
Beginning inventory ........................................
$ 60,000
Add: Purchases ............................................. $400,000
Less: Purchase returns and allowances .......
11,000
Net purchases .................................................. 389,000
Add: Freight in ...............................................
16,000
Cost of goods purchased ................................
405,000
Cost of goods available for sale .....................
465,000
Less: Ending inventory ...................................
90,000
Cost of goods sold ..........................................
0 375,000
Gross profit ......................................................
$255,000
BRIEF EXERCISE 6-6
Dec. 31 Sales ............................................................
Merchandise Inventory (December 31) ......
Purchase Returns and Allowances............
Capital...................................................
630,000
90,000
11,000
Dec. 31 Capital ..........................................................
Merchandise Inventory (January 1) ....
Purchases ............................................
Freight In ..............................................
476,000
731,000
60,000
400,000
16,000
BRIEF EXERCISE 6-7
Goods available for sale (GAS):
Units
Dollars
P
300 X $6 = $1,800
P
400 X $7 = 2,800
P
300 X $8 = 2,400
GAS 1,000
$7,000
-EI
400
CGS
600
(a) FIFO
CGS:
300 x $6 = $1,800
300 x $7 = 2,100
600
= $3,900
EI:
300 x $8 = $2,400
100 x $7 =
700
400
= $3,100
Check: CGS + EI = GAS
$3,900 + $3,100 = $7,000
(b) Weighted Average Cost
Weighted average unit cost: $7,000  1,000 = $7
CGS:
600 x $7 = $4,200
EI:
400 x $7 = $2,800
Check: CGS + EI = GAS
$4,200 + $2,800 = $7,000
BRIEF EXERCISE 6-7 (Continued)
(c) LIFO
CGS:
300 x $8 = $2,400
300 x $7 = 2,100
600
= $4,500
EI:
300 x $6 = $1,800
100 x $7 =
700
400
= $2,500
Check: CGS + EI = GAS
$4,500 + $2,500 = $7,000
BRIEF EXERCISE 6-8
(a) LIFO gives the highest inventory valuation when prices are falling.
This is because the cost of the units purchased earlier, at a higher
cost, are assumed to be still in inventory.
(b) FIFO gives the highest cost of goods sold amount. This is because the
cost of the units purchased earlier, at a higher cost, are assumed to
have been sold first and are allocated to cost of goods sold.
(c) In selecting a cost flow method, the company should consider their
type of inventory and its actual physical flow. While it is not essential
to match the actual physical flow to the assumed cost flow method, it
does give the company an indication as to its flow of costs throughout
the period. What is important is choosing a method that best matches
these costs to the revenue they generate.
BRIEF EXERCISE 6-9
BI + CGP = GAS – EI
= CGS
- U$7,000 = O$7,000
Sales – CGS
= NI
- O$7,000 = U$7,000
The understatement of ending inventory caused cost of goods sold to be
overstated $7,000 and net income to be understated $7,000. The correct
net income for 2002 is $97,000 ($90,000 + $7,000).
A
= L + OE
U$7,000 =
U$7,000
Total assets and owner’s equity in the balance sheet will both be
understated by the amount that ending inventory is understated, $7,000.
Remember that if net income is understated, then owner’s equity is also
understated as net income is a component of owner’s equity. Check your
work by ensuring that the accounting equation balances.
BRIEF EXERCISE 6-10
Assets =
Liabilities +
Owner’s Equity
2002
U$25,000
No Effect
U$25,000
2003
No Effect
No Effect
No Effect
2002
BI + CGP = GAS – EI
= CGS
- U$25,000 = O$25,000
Sales – CGS
= NI
- O$25,000 = U$25,000
Note that if Net Income is understated $25,000, then Owner’s Equity is also
understated $25,000.
2003
BI + CGP = GAS
– EI = CGS
U$25,000 = U$25,000
= U$25,000
Sales – CGS
= NI
- U$25,000 = O$25,000
Note that if net income is overstated $25,000 and added to the prior year’s
understatement of $25,000, that the two errors cancel out. The Owner’s
Equity at the end of the period is correct. The ending inventory is also
correct at the end of 2003.
BRIEF EXERCISE 6-11
Inventory Categories
Cost
Market
LCM
Cameras
Camcorders
VCRs
Total valuation
$12,000
9,000
14,000
$35,000
$11,200
9,500
12,800
$33,500
$33,500
*BRIEF EXERCISE 6-12
(1) Buyer Company
(a) March 2
(b) March 6
(c) March 29
Merchandise Inventory ..........
Accounts Payable ...........
900,000
Accounts Payable ..................
Merchandise Inventory ...
130,000
Accounts Payable ..................
Cash .................................
770,000
900,000
130,000
770,000
(2) Seller Company
(a) March 2
(b) March 6
Accounts Receivable .............
Sales ................................
900,000
Cost of Goods Sold ...............
Merchandise Inventory ...
($900,000 ÷ 1.45 = $620,689)
620,689
620,689
Sales Returns and Allowances 130,000
Accounts Receivable .......
Merchandise Inventory ...........
Cost of Goods Sold .........
($130,000 ÷ 1.45 = $89,655)
(c) March 29
900,000
130,000
89,655
Cash......................................... 770,000
Accounts Receivable .......
89,655
770,000
*BRIEF EXERCISE 6-13
(a) FIFO
Date
May 5
Purchased
(50 X $10)
(30 X $10)
(25 X $12)
Balance
$500
June 1
July 29
Sold
$300
$300
(20 X $10)
(15 X $12)
Aug. 27
$380
(50 X $10)
$500
(20 X $10)
$200
(20 X $10)
(25 X $12)
$500
(10 X $12)
$120
Cost of goods sold = $300 + $380 = $680
Ending inventory = $120
Check: CGS + EI =GAS; $680 + $120 = $800
(b) Moving Average
Date
May 5
Purchased
(50 X $10)
Aug. 27
(30 X $10)
(25 X $12)
Balance
$500
June 1
July 29
Sold
$300
$300
(35 X $11.11) $389
Cost of goods sold = $300 + $389 = $689
Ending inventory = $111
Check: CGS + EI =GAS; $689 + $111 = $800
(50 X $10)
$500
(20 X $10)
$200
(20 X $10)
(25 X $12)
$500
Average $500 ÷ 45
= $11.11
(10 X $11.11) $111
*BRIEF EXERCISE 6-13
(c) LIFO
Date
May 5
Purchased
(50 X $10)
Sold
$500
June 1
July 29
(30 X $10)
(25 X $12)
Balance
$300
$300
(25 X $12)
(10 X $10)
Aug. 27
$400
(50 X $10)
$500
(20 X $10)
$200
(20 X $10)
(25 X $12)
$500
(10 X $10)
$100
Cost of goods sold = $300 + $400 = $700
Ending inventory = $100
Check: CGS + EI =GAS; $700 + $100 = $800
Recap:
CGS
EI
GAS
FIFO
$680
120
$800
Moving
Average
$689
111
$800
LIFO
$700
100
$800
*BRIEF EXERCISE 6-14
Net sales ...................................................................................
Less: Estimated gross profit (40% X $350,000) ....................
Estimated cost of goods sold .................................................
$350,000
140,000
$210,000
Cost of goods available for sale .............................................
Less: Estimated cost of goods sold ......................................
Estimated cost of ending inventory .......................................
$310,000
210,000
$100,000
*BRIEF EXERCISE 6-15
At Cost
Goods available for sale
Net sales
Ending inventory at retail
$35,000
At Retail
$50,000
40,000
$10,000
Cost-to-retail ratio = $35,000 ÷ $50,000 = 70%
Estimated cost of ending inventory = $10,000 X 70% = $7,000