Chapter 07 - Reporting and Interpreting Inventories and Cost of Goods Sold

Chapter 7
Reporting and Interpreting Inventories and Cost of Goods Sold
ANSWERS TO EXERCISES E71 Req. 1 PC Malls shipping terms are FOB destination because the company retains ownership of the inventory until it arrives at the customers location. Req. 2 2008 Balance sheet: $25,000 reported as inventory Income statement: no amounts related to this transaction 2009 Balance sheet: $30,000 reported as accounts receivable (until collected) Income statement: $30,000 reported as sales revenue and $25,000 reported as cost of goods sold. Req. 3 PC Malls balance sheet Req. 4 FOB shipping point

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Chapter 07 - Reporting and Interpreting Inventories and Cost of Goods Sold

E711 Req. 1 Item Air Flow B Buster Coolonite Dudesly Quantity 20 75 35 10 Total x x x x Total Cost $12 = 40 = 55 = 30 = $ 240 3,000 1,925 300 $5,465 x x x x Total Market $14 38 50 35 = = = = $ 280 2,850 1,750 350 $5,230 LCM Valuation $ 240 2,850 1,750 300 $5,140 $5,140

Inventory valuation that should be used (LCM) Req. 2

The write-down to lower of cost or market will increase Cost of Goods Sold by the amount of the write-down, $325: Total Cost LCM Valuation = Write-down $5,465 $5,140 = $325 Write-down Req. 3 Sandals Company is using FIFO, so a switch to IFRS would not require the company to change its inventory costing assumption. The only possible change is that if Sandals Company records a write-down to the lower of cost or market (LCM), the company could later record a reversal of that write-down under IFRS, if conditions warrant.

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Chapter 07 - Reporting and Interpreting Inventories and Cost of Goods Sold

E713 Purchases ($1,200 + $900 + $350) Less: Purchase discount from Green ($1,200 x 2%) Cost of inventory as of February 28 $2,450 (24)* $2,426

* Green was paid 8 days after the purchase (within the discount period). Munoz was paid 27 days after the purchase (outside the discount period). E714 Jan. 6 Jan. 6 Jan. 14 dr Inventory (+A).................................................................. 1,200 cr Accounts Payable (+L)............................................... dr Inventory (+A).................................................................. 00 9 cr Accounts Payable (+L)............................................... dr Accounts Payable ( L)..................................................... 1,200 cr Inventory ( ($1,200 x 2%)...................................... A) cr Cash ( ($1,200 x 98%).......................................... A) dr Accounts Payable ( L)..................................................... 00 9 cr Cash ( A).................................................................... dr Inventory (+A).................................................................. 50 3 cr Accounts Payable (+L)............................................... 1,200 900 24 1,176 900 350

Feb. 2 Feb. 28

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Chapter 07 - Reporting and Interpreting Inventories and Cost of Goods Sold

E718 Req. 1 Units Sold = 80 + 56 = 136. Ending Inventory Units = Units Available Units Sold = 188 136 = 52 units. FIFO Beginning Inventory 38 units x $ 14 + Purchase 50 units x $ 15 + Purchase 100 units x $ 16 Goods Available for Sale 188 units Ending Inventory (LIST) (52 $16) Cost of Goods Sold (FIFO) (38 x $14)+(50 $15)+(48 x $16) LIFO Beginning Inventory 38 units x $ 10 + Purchase 50 units x $ 15 + Purchase 100 units x $ 16 Goods Available for Sale 188 units Ending Inventory (FIST) (38 $10) + (14 x $15) Cost of Goods Sold (LIFO) (100 x $16) + (36 x $15) Req. 2 FIFO Inventory turnover = LIFO Inventory turnover = Cost of Goods Sold = Average Inventory Cost of Goods Sold = Average Inventory $2,050 ($532 + $832)/2 $2,140 ($380 + $590)/2 = 3.01 $ 532 750 1,600 2,882 832 $ 2,050 $ 380 750 1,600 2,730 590 $ 2,140

= 4.41

Req. 3 The inventory method used does make a significant difference in the inventory turnover ratio. If analysts are comparing across companies, they must take this into account before deciding whether one company has better inventory management than another. If they are comparing the same company over time, however, it is not as important provided the company is consistent in the method it uses.

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Chapter 07 - Reporting and Interpreting Inventories and Cost of Goods Sold

ANSWERS TO GROUP A PROBLEMS PA71 Req. 1 Goods available for sale for all methods: Beginning inventory, January 1, 2009 Purchase, January 30, 2009 Purchase, May 1, 2009 Goods available for sale Goods sold Ending inventory Unit Units Cost 1,800 $5.00 2,500 6.20 1,200 8.00 5,500 3,350 2,150 units Total Cost $ 9,000 15,500 9,600 $34,100

Ending inventory and Cost of goods sold: a. Last-in, first-out: Ending inventory (1,800 units x $5.00) ( 350 units x $6.20) Cost of goods sold b. Weighted-average cost: Average unit cost Ending inventory Cost of goods sold c. First-in, first-out: Ending inventory Cost of goods sold d. Specific identification: Ending inventory Cost of goods sold (1,200 units x $8.00) (2,150 units x $6.20) $34,100 5,500 = $6.20 (2,150 units x $6.20) (3,350 units x $6.20) (1,200 units x $8.00) (950 units x $6.20) (1,800 units x $5.00) (1,550 units x $6.20) (520 units x $8.00) (1,630 units x $6.20) ( 580 units x $5.00) ( 870 units x $6.20) (1,220 units x $5.00) ( 680 units x $8.00)

$11,170 $22,930

$13,330 $20,770

$15,490 $18,610

$14,266

$19,834

Req. 2 The method that results in the highest gross profit is the method with the lowest cost of goods sold first-in, first-out (FIFO). The method that results in the lowest income tax expense is the method with the highest cost of goods sold last-in, first-out (LIFO).

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Chapter 07 - Reporting and Interpreting Inventories and Cost of Goods Sold

ANSWERS TO SKILLS DEVELOPMENT CASES S75 Req. 1 The cost of goods sold using LIFO is (2,500 units @ $50) + (500 units @ $45) which totals $147,500. This is the exact figure used in calculating the reported gross profit of $17,500. Req. 2 Yes it is likely that both FIFO and the weighted average cost method would produce lower cost of goods sold figures because product costs are rising. In times of rising costs, LIFO produces the highest cost of goods sold because the last-in goods have the highest cost per unit. Req. 3 The cost of goods sold using FIFO amounts to $112,500* which, when subtracted from sales of $165,000, produces a gross profit of $52,500. Use of this method would indeed make the new product line appear more profitable. * $112,500 = (1,500 units @ $30) + (1,500 units @ $45) Req. 4 Yes, it is acceptable within GAAP for companies to use different inventory methods for different product lines included in inventory as long as the methods are used consistently over time. Req. 5 Although generally accepted accounting principles do allow different inventory costing methods to be used for different product lines, the choice of FIFO for the new product line would raise some questions (and suspicions). One question that should be raised is whether taxes have been fully considered before deciding to adopt FIFO. Because costs are rising, FIFO produces a higher gross profit than LIFO, which translates into higher income taxes. The companys history of using LIFO for boats suggests that tax minimization might be a primary objective of the company, which suggests a decision to use FIFO might not be aligned with the best interests of the company. One suspicion that should be raised is whether the inventory costing method is being used as a tactic to mislead the boards evaluation of the new product line. With the company using LIFO for the boats, the board might reasonably assume the same method is used to present the results for the water skis and infer from the reported gross profit that the new product line is more profitable than it otherwise would appear under LIFO. Clearly, if the sole motivation for the choice of inventory method is to mislead the board, it must be considered unethical. Should you equip David with the new FIFO numbers? This is a tricky question because your position as corporate controller requires that you support the CEO in his decision
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Chapter 07 - Reporting and Interpreting Inventories and Cost of Goods Sold

making. Also, you dont know that David will attempt to mislead the board with the FIFO numbers. However, the significant commitment that David made to gain approval for the ski division makes this seem likely. Perhaps a reasonable balance between withholding the new numbers and making them freely available is to ensure that your analyses present the results under both the FIFO and LIFO methods, not unlike what GAAP would require in the notes to the year-end financial statements.

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