Solution Manual CH 05 FInancial Accounting Reporting and Analyzing Inventories

Chapter 5
Reporting and Analyzing Inventories

QUESTIONS
1.
(a) FIFO: The first (earliest) items purchased in inventory are assumed to be the first
items sold. (b) LIFO: The last (most recent) items purchased in inventory are assumed
to be the first items sold.
2.
Merchandise inventory is disclosed on the balance sheet as a current asset. It is also

sometimes reported in the income statement as part of the calculation of cost of
goods sold.
3.
Incidental costs sometimes are ignored in computing the cost of inventory because
the expense of tracking such costs on a precise basis can outweigh the benefits
gained from the increased accuracy. The principle of materiality permits such
practices when the effects on the financial statements are not significant (that is,
when such practices do not impact business decisions).
4.
LIFO will result in the lower cost of goods sold when costs are declining.
5.
The full-disclosure principle requires that the nature of the accounting change, the
justification for the change, and the effect of the change on net income be disclosed in
the notes or in the body of a company's financial statements.
6.
No; changing the inventory method each period would violate the accounting principle
of consistency.
7.
No; the consistency principle does not preclude changes in accounting methods from
ever being made. Instead, a change from one acceptable method to another is
allowed if the company justifies the change as an improvement in financial reporting.
8.
Many people make important business decisions based on period-to-period

fluctuations in a company's financial numbers, including gross profit and net income.
As such, inventory errorswhich can substantially impact gross profit, net income,
current assets, and cost of salesshould not be permitted to cause such fluctuations
and impair business decisions. (Note: Since such errors are self-correcting, they
will distort net income in only two consecutive accounting periodsthe period of the
error and the next period.)
9.
An inventory error that causes an understatement (or overstatement) for net income in
one accounting period, if not corrected, will cause an overstatement (or
understatement) in the next. Since an understatement (overstatement) of one period
offsets the overstatement (understatement) in the next, such errors are said to correct
themselves.
10. Market usually means replacement cost of inventory when applied in the LCM.
Solutions Manual, Chapter 5
McGraw-Hill Companies, Inc., 2005
31
11. The principle of conservatism guides preparers of accounting reports to select the
less optimistic estimate in uncertain situations where two estimates of amounts are
about equally likely. Users of information must also be cognizant of the potential
conservatism in accounting reports when making business decisions.
12. Factors that contribute to inventory shrinkage are breakage, loss, deterioration,
decay, and theft.
13.A Accounts that are used only in a periodic inventory system include Purchases,
Purchase Discounts, Purchase Returns and Allowances, and Transportation-In.
14.B For interim reporting, companies can estimate costs of goods sold and ending
inventory by either the retail inventory method or the gross profit method.
15. Inventory as a percent of current assets on February 2, 2003 is ($ in thousands):
$24,365 / $141,128 = 17.3%.
16. Cost of goods available for sale equals ending inventory plus cost of sales. As of
December 28, 2002 this is computed as:
Ending Inventory of $6,777,152 + Cost of Sales of $111,187,357 = $117,964,509
17. Merchandise inventory comprises 10.6% ($218,156 / $2,066,586) of Harley-Davidsons
current assets as of December 31, 2002, and 10.9% ($181,115 / $1,665,264) of its
current assets as of December 31, 2001. ($ in thousands)
QUICK STUDIES
Quick Study 5-1 (25 minutes)
(a) FIFO
Date
Goods Purchased
Cost of Goods Sold
Inventory Balance
12/ 7
10 @ $ 6 = $ 60
10 @ $ 6
= $ 60
12/14
20 @ $12 = $240
10 @ $ 6
20 @ $12
= $300
15 @ $12
= $180
15 @ $12
15 @ $14
= $390
12/15
12/21
10 @ $ 6 = $120
5 @ $12
15 @ $14 = $210
____
$120
32
Financial Accounting, 3rd Edition
Quick Study 5-1 (continued)

(b) LIFO
Date
Goods Purchased
Cost of Goods Sold
Inventory Balance
12/7
10 @ $ 6 = $ 60
10 @ $ 6
= $ 60
12/14
20 @ $12 = $240
10 @ $ 6
20 @ $12
= $300
10 @ $ 6
5 @ $12
= $120
10 @ $ 6
5 @ $12
15 @ $14
= $330
12/15
12/21
15 @ $12 = $180
15 @ $14 = $210
____
$180
(c) Weighted Average

Date
Goods Purchased
12/7
10 @ $6 = $60
12/14
20 @ $12 = $240
Cost of Goods Sold
12/15
12/21
Inventory Balance
10 @ $6
10 @ $6
20 @ $12
(avg cost is $10)
15 @ $10 =$150
15 @ $10
____
$150
15 @ $10
15 @ $14
(avg cost is $12)
15 @ $14 = $210
= $ 60
= $300
= $150
= $360
(d) Ending inventory under specific identification:

(2 units x $6) + (13 units x $12) + (15 units x $14) = $378.
Beginning inventory.....................................
Plus:
1st week purchase........................................
2nd week purchase.......................................
3rd week purchase.......................................
4th week purchase........................................
Units Available for sale................................
Cost of Goods Available for Sale................
10 units @ $50
$ 500
10 units @ $51
10 units @ $52
10 units @ $55
10 units @ $60
50 units
510
520
550
600
$2,680
33

(a) FIFO
Date
1/1
1/9
1/25
Goods Purchased
Cost of Goods Sold
75 @ $3.20
100 @ $3.35
1/26
Inventory Balance
310 @ $3.00
= $ 930
310 @ $3.00
= $1,170
75 @ $3.20
310 @ $3.00
75 @ $3.20
= $1,505
100 @ $3.35
40 @ $3.20
= $ 463
100 @ $3.35
310 @ $3.00 = $ 930

35 @ $3.20 =
112
$1,042
(b) LIFO
Date
1/1
1/9
1/25
Goods Purchased
Cost of Goods Sold
75 @ $3.20
100 @ $3.35
1/26
100 @ $3.35 = $ 335

75 @ $3.20 =
240
170 @ $3.00 =
510
$1,085
Inventory Balance
310 @ $3.00
= $ 930
310 @ $3.00
= $1,170
75 @ $3.20
310 @ $3.00
75 @ $3.20
= $1,505
100 @ $3.35
140 @ $3.00
= $ 420
(c) Weighted Average

Date
1/1
1/9
1/25
Goods Purchased
75 @ $3.20
345 @ $3.10 = $1,069.5
Inventory Balance
310 @ $3.00
= $ 930
310 @ $3.00
75 @ $3.20
= $1,170
(avg. cost is $3.04)
310 @ $3.00
75 @ $3.20
= $1,505
100 @ $3.35
140 @ $3.10
= $ 434
100 @ $3.35
1/26
34
Cost of Goods Sold
Quick Study 5-3 (continued)

Alternate solution format:
(a) FIFO:
100 @ $3.35 =
40 @ $3.20 =
140
$ 335
128
$ 463 Ending inventory cost
(b) LIFO:
140 @ $3.00 =
(c) Weighted average:

310 @ $3.00 =
75 @ $3.20 =
100 @ $3.35 =
485
$ 930
240
335
$1,505 Cost of goods available for sale
$1,505/485 = $3.10 weighted average cost per unit

140 units @ $3.10 =

1.
2.
3.
4.
5.
Specific identification
LIFO
LIFO
LIFO
FIFO

1. The title will pass at destination which is China Companys receiving
dock. Jolie should show the $850 in its inventory at year-end as Jolie
retains title until the goods reach China Company.
2. The consignor is Jolie Company. The consignee is China Company. The
consignor, Jolie Company, should include any unsold and consigned
goods in its inventory.
35

Units in ending inventory
Units stored in basement............................
Less damaged (unsalable) units.................
Plus units in transit......................................
Plus units on consignment.........................
Total units in ending inventory...................
1,500 units
(30)
250
70
1,790 units

Cost..............................................................
Plus
Transportation-in.....................................
Import duties............................................
Insurance..................................................
Inventory Cost..........................................
$3,000
150
200
50
$3,400
The $25 advertising cost and the $250 cost for sales staff salaries are included
in operating expensesnot part of inventory costs. Those two costs are not
necessary to get the vehicle in a place and condition for sale.

Cost of inventory (estates contents)
Price............................................................ $37,500
Transportation-in.......................................
1,200
Insurance on shipment.............................
150
Cleaning and refurbishing........................
490
Total cost of inventory.............................. $39,340

Inventory Items
Mountain bikes
Skateboards
Gliders
Units
9
12
25
Per Unit
Cost
Market
$360
210
480
Total
Cost
$330 $ 3,240
270
2,520
420 12,000
$17,760
Total
Market
LCM applied to:

Items
Whole
$ 2,970
3,240
10,500
$16,710
$ 2,970
2,520
10,500
$15,990
______
$16,710
a. LCM for inventory as a whole...................................................
$16,710
b. LCM applied to each product ...................................................
$15,990
36
37

a.
b.
c.
d.
e.
Overstates 2005 cost of goods sold.

Understates 2005 gross profit.
Understates 2005 net income.
Overstates 2006 net income.
The understated 2005 net income and the overstated 2006 net income
combine to yield a correct total income for the two-year period.
f. The 2005 error will not affect years after 2006.
Inventory turnover
= Cost of goods sold/Average merchandise inventory

= $1,600,000 / [($200,000 + $230,000)/2 ] = 7.44 times
Days sales in inventory = Ending Inventory/Costs of goods sold x 365

= ($230,000 / $1,600,000) x 365 = 52.47 days
Quick Study 5-12A (15 minutes)

Ending
Inventory
a. FIFO
(15 x $12) + (15 x $14)....................................
(10 x $6) + (5 x $12).........................................
$390
b. LIFO
(10 x $6) + (20 x $12).......................................
(15 x $14) ........................................................
$300
c. Weighted Average ($510/ 45 = $11.33 cost per unit)

(30 x $11.33)...................................................
(15 x $11.33)...................................................
$340
d. Specific Identification
(2 x $6) + (13 x $12) + (15 x $14)....................
(8 x $6) + (7 x $12)...........................................
$378
38
Cost of
Goods Sold
$120
$210
$170
$132
Quick Study 5-13A (15 minutes)

Ending
Inventory
a. FIFO
(40 x $3.20) + (100 x $3.35)..............................
(310 x $3.00) + (35 x $3.20)...............................
$463
b. LIFO
(140 x $3.00).......................................................
(100 x $3.35) + (75 x $3.20) + (170 x $3.00).....
$420
Cost of
Goods Sold
$1,042
$1,085
c. Weighted Average ($1,505/ 485 = $3.10* cost per unit)

(140 x $3.10)...................................................... $434
(345 x $3.10)......................................................
$1,071*
*rounded
Quick Study 5-14B (15 minutes)

Goods available for sale
Inventory, January 1...................................................
Cost of goods purchased (net)..................................
Goods available for sale (at cost).............................
Net sales at retail..........................................................
Estimated cost of goods sold [$675,000 x (1 - 42%)]......
Estimated September 5 inventory destroyed.............
$180,000
342,000
522,000
$675,000
(391,500)
$130,500
39
EXERCISES
Exercise 5-1 (30 minutes)
a. Specific identification
Ending inventory400 units from July 28 and 100 units from December 19
Computations
Ending
Inventory
(400 x $5.00) + (100 x $4.10)..........................
$2,410
Cost of
Goods Sold
$6,380 - $2,410 ...............................................
$3,970
b. Weighted average perpetual

Date
Goods Purchased
Cost of Goods Sold
1/1
1/10
70 @ $ 6.00 = $ 420
3/7
200 @ $5.50
3/15
Inventory Balance
120 @ $6.00
= $ 720
50 @ $6.00
= $ 300
50 @ $6.00
200 @ $5.50
125 @ $5.60 = $ 700
125 @ $5.60
7/28
500 @ $5.00
125 @ $5.60
500 @ $5.00
10/3
375 @ $4.40
125 @ $5.60
500 @ $5.00
375 @ $4.40
10/5
600 @ $4.85 = $2,910
12/19
100 @ $4.10
_____
$4,030
40
400 @ $4.85
400 @ $4.85
100 @ $4.10
= $1,400
= $ 700
= $3,200
= $4,850
= $1,940
= $2,350
Exercise 5-1 (Continued)

c. FIFO Perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
1/10
3/7
70 @ $6.00
= $ 420
200 @ $5.50
3/15
50 @ $6.00
75 @ $5.50
= $712*
Inventory Balance
120 @ $6.00
= $ 720
50 @ $6.00
= $ 300
50 @ $6.00
200 @ $5.50
= $1,400
125 @ $5.50
= $ 688*
7/28
500 @ $5.00
125 @ $5.50
500 @ $5.00
= $3,188
10/3
375 @ $4.40
125 @ $5.50
500 @ $5.00
375 @ $4.40
= $4,838
10/5
12/19
125 @ $5.50
475 @ $5.00
= $3,063*
100 @ $4.10
_____
$4.195
25 @$5.00
375 @ $4.40
25 @ $5,00
375 @ $4.40
100 @ $4.10
= $1,775
= $2,185
* rounded to the nearest dollar
41

d. LIFO Perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
1/10
70 @ $6.00
3/7
=$
420
200 @ $5.50
3/15
125 @ $5.50
7/28
=$
687*
500 @ $5.00
10/3
375 @ $4.40
10/5
375 @ $4.40
225 @ $5.00
12/19
= $ 2,775
100 @ $4.10
______
$ 3,882
Inventory Balance
120 @ $6.00
= $ 720
50 @ $6.00
= $ 300
50 @ $6.00
200 @ $5.50
= $1,400
50 @ $6.00
75 @ $5.50
= $ 713*
50 @ $6.00
75 @ $5.50
500 @ $5.00
= $3,213*
50 @ $6.00
75 @ $5.50
500 @ $5.00
375 @ $4.40
= $4,863*
50 @ $6.00
75 @ $5.50
275 @ $5.00
= $2,088*
50 @ $6.00
75 @ $5.50
275 @ $5.00
100 @ $4.10
= $2,498
* rounded to the nearest dollar
42

Alternate Solution Format for FIFO and LIFO Perpetual:
Ending
Computations:
Inventory
c. FIFO
(100 x $4.10) + (375 x $4.40)+(25 x $5.00).......................
$2,185
(70 x $6.00) + (50 X $6.00) + (75 x $5.50) +
(125 x $5.50)+ (475 x $5.00)........................................
d. LIFO:
(50 x $6.00) + (75 x $5.50) + (275 x $5.00) +
(100 x $4.10).................................................................
Cost of
Goods Sold
$4,195
$2,498
(70 x $6.00) + (125 x $5.50) + (375 x $4.40) +

(225 x $5.00).................................................................
$3,882

LAKIA CORPORATION
Income Statements
For Year ended December 31, 2005
Specific
Identification
Sales...............................
Weighted
Average
FIFO
LIFO
$11,925
$11,925
$11,925
$11,925
3,940
7,985
1,250
6,735
2,021*
$ 4,714
4,030
7,895
1,250
6,645
1,994*
$ 4,651
4,195
7,730
1,250
6,480
1,944
$ 4,536
3,882
8,043
1,250
6,793
2,038*
$ 4,755
(795 units x $15 price)
Cost of goods sold........

Gross Profit...................
Expenses.......................
Income before taxes.....
Income tax expense (30%).
Net Income.....................
* Rounded to the nearest dollar.
1. LIFO method results in the highest net income of $4,755.

2. Weighted average net income of $4,651 falls between the FIFO net
income ($4,536) and the LIFO net income ($4,755).
3. If costs were rising instead of declining, then the FIFO method would
yield the highest net income.
43

a. FIFO Perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
Inventory Balance
100 @ $10
1/10
90 @ $10 = $ 900
3/14
250 @ $15 = $ 3,750
3/15
10 @ $10
130 @ $15 = $2,050
7/30
400 @ $20 = $ 8,000
10/5
120 @ $15
180 @ $20 = $5,400
10/26
600 @ $25 = $15,000

_____
$8,350
10 @ $10
= $ 1,000
=$
100
10 @ $10
250 @ $15
= $ 3,850
120 @ $15
= $ 1,800
120 @ $15
400 @ $20
= $ 9,800
220 @ $20
= $ 4,400
220 @ $20
600 @ $25
= $19,400
b. LIFO Perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
100 @ $10
1/10
90 @ $10 = $ 900
3/14
250 @ $15 = $ 3,750
3/15
140 @ $15 = $2,100
7/30
400 @ $20 = $ 8,000
10/5
300 @ $20 = $6,000
10/26
600 @ $25 = $15,000

_____
$9,000
44
Inventory Balance
10 @ $10
= $ 1,000
= $
100
10 @ $10
250 @ $15
= $ 3,850
10 @ $10
110 @ $15
= $ 1,750
10 @ $10
110 @ $15
400 @ $20
= $ 9,750
10 @ $10
110 @ $15
100 @ $20
= $ 3,750
10 @ $10
110 @ $15
100 @ $20
600 @ $25
= $ 18,750
Exercise 5-3 (Concluded)

Alternate Solution Format
Ending
Inventory
a. FIFO:
(600 x $25) + (220 x $20)................................................
(90 x $10) + (10 x $10) + (130 x $15) +
(120 x $15)+ (180 x $20)..................................................
b. LIFO:
(10 x $10) + (110 x $15) + (100 x $20) + (600 x $25).....
(90 x $10) + (140 x $15) + (300 x $20)............................
Cost of
Goods Sold
$19,400
$8,350
$18,750
$9,000
FIFO Gross Margin

Sales Revenue (530 units sold x $40 selling price)...............
Less: FIFO cost of goods sold................................................
Gross margin.............................................................................
$21,200
8,350
$12,850
LIFO Gross Margin

Sales Revenue (530 units sold x $40 selling price)...............
Less: LIFO cost of goods sold................................................
Gross margin.............................................................................
$21,200
9,000
$12,200

a. Specific identification methodCost of goods sold
Cost of goods available for sale.....................................
Ending inventory under specific identification
3/14 purchase (200 @ $15) ....................................... $ 3,000
7/30 purchase ( 20 @ $20)........................................
400
10/26 purchase (600 @ $25)........................................ 15,000
Total ending inventory under specific identification. .
Cost of goods sold under specific identification........
$27,750
18,400
$ 9,350
b. Specific identification methodGross margin

Sales Revenue (530 units sold x $40 selling price)......
Less: Specific identification cost of goods sold..........
Gross margin....................................................................
$21,200
9,350
$11,850
45

Inventory Items
Unit
Helmets.......
Bats..............
Shoes...........
Uniforms......
22
15
36
40
Per Unit
Cost Market
$50
78
95
36
$54
72
91
36
Total
Cost
$1,100
1,170
3,420
1,440
$7,130
Total
Market
$1,188
1,080
3,276
1,440
$6,984
LCM applied to:

Products
Whole
$1,100
1,080
3,276
1,440
$6,896
a.
Lower of cost or market of inventory as a whole = $6,984
b.
Lower of cost or market of inventory by product = $6,896
$6,984

1. Gross profit = $900,000 - $500,000 = $400,000 (for each year)
2.
Year 2004
Year 2005
Year 2006
Sales..............................
$900,000
$900,000
$900,000
Cost of goods sold
Beginning inventory..... $200,000
$180,000
$200,000
Cost of purchases........ 500,000
500,000
500,000
Good available for sale..... 700,000
680,000
700,000
Ending inventory.......... 180,000
200,000
200,000
Cost of goods sold.......
520,000
480,000
500,000
Gross profit....................
$380,000
$420,000
$400,000

2004 Inventory turnover
2004 Days' Sales in Inventory
$426,650/[($91,500 + $86,750)/2]
= 4.8 times
$86,750/$426,650 x 365 days = 74.2 days
2005 Inventory turnover
2005 Days' Sales in Inventory
$643,825/[($86,750 + $96,400)/2]
= 7.0 times
$96,400/$643,825 x 365 days = 54.7 days
46
Analysis comment: It appears that during a period of increasing sales, Ryder

has been efficient in controlling its amount of inventory. Specifically inventory
turnover increased by 2.2 times (7.0 - 4.8) from 2004 to 2005. In addition, days'
sales in inventory decreased by 19.5 days (74.2 - 54.7).
47

1. a. LIFO ratio computations
LIFO current ratio (2005) = $210/$190 = 1.1
LIFO inventory turnover (2005) = $730/ [($150+$100)/2] = 5.8
LIFO days sales in inventory (2005) = ($150/$730) x 365 = 75 days
b. FIFO ratio computations
FIFO current ratio (2005) = $280/$190 = 1.5
FIFO inventory turnover (2005) = $685/ [($220+$125)/2] = 4.0
FIFO days sales in inventory (2005) = ($220/$685) x 365 = 117.2 days
2. The use of LIFO versus FIFO for Checkers markedly impacts the ratios
computed. Specifically, LIFO makes Checkers appear worse in
comparison to FIFO numbers on the current ratio (1.1 vs. 1.5) but better
on inventory turnover (5.8 vs. 4.0) and days sales in inventory (75 vs.
117.2). These results can be generalized. That is, when costs are rising
and quantities are stable or rising, the FIFO inventory exceeds LIFO
inventory. This suggests that (relative to FIFO) the LIFO current ratio is
understated, the LIFO inventory turnover is overstated, and the days
sales in inventory is understated. Overall, users prefer the FIFO numbers
for these ratios because they are considered more representative of
current replacement costs for inventory.
48
Exercise 5-9A (20 minutes)

Cost of goods available for sale
= (120 x $6.00) + (200 x $5.50) + (500 x $5.00)

+ (375 x $4.40) + (100 x $4.10)
= $6,380
Ending
Inventory
Cost of
Goods Sold
a. Specific Identification
(400 x $5.00) + (100 x $4.10)...................................... $2,410
$6,380 - $2,410 ..........................................................
$3,970
b. Weighted Average
($6,380 / 1295 units = $4.927* average cost per unit)
500 x $4.927................................................................ $2,463*

795 x $4.927................................................................
$3,917*
c. FIFO
(100 x $4.10) + (375 x $4.40 )+ (25 x $5.00).............. $2,185
(70 x $6.00) + (50 x $6.00) + (75 x $5.50) +
(125 x $5.50)+ (475 x $5.00).....................................
$4,195
d. LIFO
(120 x $6.00) + (200 x $5.50) + (180 x $5.00)............ $2,720
(100 x $4.10) +(375 x $4.40) + (125 x $5.00) +
(125 x $5.00) + (70 x $5.00).....................................
$3,660
*rounded
49

Cost of goods available for sale = (100 x $10) + (250 x $15) + (400 x $20)
+ (600 x $25)
= $27,750
Ending
Cost of
Inventory Goods Sold
a. FIFO
(600 x $25) + (220 x $20)............................................ $19,400
(90 x $10) + (10 x $10) + (130 x $15) +
(120 x $15)+ (180 x $20)...........................................
$8,350
b. LIFO
(100 x $10) + (250 x $15) + (400 x $20) + (70 x $25).... $14,500
530 x $25....................................................................
$13,250
c.
50
FIFO Gross Margin

Sales Revenue (530 units sold x $40 selling price)..........
Less: FIFO cost of goods sold...........................................
Gross margin........................................................................
$21,200
8,350
$12,850
LIFO Gross Margin

Sales Revenue (530 units sold x $40 selling price)..........
Less: LIFO cost of goods sold...........................................
Gross margin........................................................................
$21,200
13,250
$ 7,950

Ending
Inventory
(100 x $2.90) + (100 x$2.80) + (100 x $2.50)........
$7,706 - $820.........................................................
b. Weighted average ($7,706/3,000 = $2.57*)
$2.57 x 300.............................................................
$7,706 - $771.........................................................
c. FIFO
(300 x $2.90) .........................................................
(200 x $2.00) + (440 x $2.25) + (1,080 x $2.50) +
(960 x $2.80) + (20 x 2.90)...............................
d. LIFO
(200 x $2.00) + (100 x $2.25).................................
(320 x $2.90) + (960 x $2.80) + (1,080 x $2.50) +
(340 x $2.25)......................................................
Cost of
Goods Sold
$820
$6,886
771
6,935
870
6,836
625
7,081
*rounded
Income effect: FIFO provides the lowest cost of goods sold, the highest
gross profit, and the highest net income.
Ending
Inventory
(100 x $2.00) + (100 x $2.30) + (100 x $2.50).......
$7,550 - $680.........................................................
b. Weighted average ($7,550/3,030 = $2.49*)
$2.49 x 300.............................................................
$7,550 - $747.........................................................
c. FIFO
(250 x $2.00) + (50 x $2.30)...................................
(280 x $3.00) + (600 x $2.80) + (800 x $2.50) +
(1,050 x $2.30)..................................................
d. LIFO
(280 x $3.00) + (20 x $2.80)...................................
(250 x $2.00) + (1,100 x $2.30) + (800 x $2.50) +
(580 x $2.80).....................................................
Cost of
Goods Sold
$680
$6,870
747
6,803
615
6,935
896
6,654
*rounded
Income effect: FIFO provides the highest cost of goods sold, the lowest
gross profit, and the lowest net income.
51
Exercise 5-13B (20 minutes)

Beginning inventory..................................................
Cost of goods purchased.........................................
Goods available for sale...........................................
Deduct net sales at retail.............................................
Ending inventory at retail............................................
At Cost
At Retail
$31,900
57,810
$89,710
$ 64,200
98,400
162,600
130,000
$ 32,600
Cost ratio: ($89,710/$162,600) = 0.55.............................

Ending inventory at cost ($32,600 x 55%)..................
$17,930
Exercise 5-14B (20 minutes)

Inventory, January 1............................................... $ 450,000
Net cost of goods purchased*................................
1,604,500
Goods available for sale.........................................
2,054,500
Less estimated cost of goods sold
Net sales...................................................................
$2,000,000
Estimated cost of goods sold
[$2,000,000 x (1 30%)]..................................... (1,400,000)
Estimated March 31 inventory.................................. $ 654,500
*
$1,590,000 - $23,100 + $37,600 = $1,604,500
52
PROBLEM SET A
Problem 5-1A (40 minutes)
1. Calculate cost of goods available for sale and units available for sale
Beginning inventory........................
Feb. 10
Mar. 13..............................................
Aug. 21..............................................
Sept. 5..............................................
Units available..................................
600 units @ $44

200 units @ $40
100 units @ $20
160 units @ $60
280 units @ $48
1,340 units
$26,400
8,000
2,000
9,600
13,440
$59,440
2. Units in ending inventory

Units available (from part 1)........... 1,340
Less: Units sold (400+200)..............
600
Ending Inventory (units).................
740
53
Problem 5-1A (Continued)

3a. FIFO perpetual
Date
Goods Purchasd
Cost of Goods Sold
1/1
2/10
3/13
200 @ $40 = $ 8,000

100 @ $20 = $ 2,000
9/5
600 @ $44
= $26,400
600 @ $44
200 @ $40
= $34,400
600 @ $44
200 @ $40
100 @ $20
3/15
8/21
Inventory Balance
400 @ $44 = $17,600
160 @ $60 = $ 9,600
200 @ $44
200 @ $40
100 @ $20
200 @ $44
200 @ $40
100 @ $20
160 @ $60
280 @ $48 = $13,440
200 @ $44
200 @ $40
100 @ $20
160 @ $60
280 @ $48
9/10
200 @ $44 = $ 8,800

______
$26,400
FIFO Alternate Solution Format

Less: Cost of sales
400 @ $44
$17,600
200 @ $44
8,800
Total cost of goods sold

Ending Inventory
200 @ $40
100 @ $20
160 @ $60
280 @ $48
= $36,400
= $18,800
= $28,400
= $41,840
= $33,040
$59,440
26,400
$33,040
Proof of Ending Inventory
Ending Inventory............
54
200
100
160
280
740
@ $40
@ 20
@ 60
@ 48
units
$ 8,000
2,000
9,600
13,440
$33,040

3b. LIFO perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
2/10
3/13
200 @ $40 = $ 8,000

100 @ $20 = $ 2,000
3/15
8/21
9/5
100 @ $20
200 @ $40
100 @ $44
280 @ $48 = $13,440
200 @ $48
600 @ $44
= $26,400
600 @ $44
200 @ $40
= $34,400
600 @ $44
200 @ $40
100 @ $20
= $36,400
500 @ $44
= $22,000
500 @ $44
160 @ $60
= $31,600
= $14,400
160 @ $60 = $ 9,600
9/10
Inventory Balance
= $ 9,600
______
$24,000
500 @ $44
160 @ $60
280 @ $48
= $45,040
500 @ $44
160 @ $60
80 @ $48
= $35,440
LIFO alternate solution format

Less: Cost of sales
100 @ $20
200 @ 40
100 @ 44
200 @ 48
Cost of Goods Sold
Ending Inventory
$59,440
$ 2,000
8,000
4,400
9,600
24,000
$35,440
Ending Inventory
500 @ $44
160 @ 60
80 @ 48
740 units
$22,000
9,600
3,840
$35,440
55

3c. Specific Identification
Cost of goods available for sale........

Less: Cost of Goods Sold
500 @ $44...............................
100 @ $20...............................
Total cost of goods sold.....................
Ending Inventory.................................
$59,440
$22,000
2,000
24,000
$35.440
Ending Inventory.
100 @ $44
200 @
40
160 @
60
280 @
48
740 units
$ 4,400
8,000
9,600
13,440
$35,440
3d. Weighted Average

Date
Goods Purchased
Cost of Goods Sold
1/1
Inventory Balance
600 @ $44.00
= $26,400
2/10
200 @ $40 = $ 8,000
600 @ $44.00
= $34,400
200 @ $40.00
3/13
100 @ $20 = $ 2,000
600 @ $44.00
200 @ $40.00
= $36,400
100 @ $20.00
(avg. cost is $40.44*)
3/15
400 @ $40.44 = $16,176
500 @ $40.44
= $20,220
8/21
160 @ $60 = $ 9,600
500 @ $40.44
= $29,820
160 @ $60.00
9/5
280 @ $48 = $13,440
660 @ $45.18
280 @ $48.00
= $43,259**
9/10
200 @ $46.02 = $ 9,204

$25,380
740 @ $46.02
= $34,055***
* rounded to nearest cent

** rounded to nearest dollar
*** Total cost of goods sold plus ending inventory = $25,380 + $34,055 = $59,435 (the $5
difference from cost of goods available for sale of $59,440 is due to rounding)
56
Problem 5-1A (Concluded)

4.
Sales (600 x $75)..................

Less: Cost of goods sold....
Gross profit..........................
FIFO
LIFO
Specific
Identification
$45,000
26,400
$18,600
$45,000
24,000
$21,000
$45,000
24,000
$21,000
Weighted
Average
$45,000
25,380
$19,620
5. Parkers manager would likely prefer the LIFO method or the Specific
Identification method since these methods gross profit is the largest at
$21,000. This would give the manager his/her highest bonus based on
gross profit. It is only by coincidence that the LIFO and Specific
Identification method have the same cost of goods sold and gross profit.
This would not necessarily be the case.
57

Part 1
(a)
Cost of goods sold:
Reported
Adjustments: 12/31/2004 error.. .
2004
$ 715,000
- 66,000
12/31/2005 error.. .
Corrected...................................
$ 649,000
(b)
Net income:
Reported....................................
2004
$ 220,000
+ 66,000
12/31/2005 error.. .
Corrected...................................
$ 286,000
(c)
Total current assets:
Reported....................................
2004
$1,155,000
+ 66,000
12/31/2005 error.. .
Corrected...................................
(d)
Equity:
Reported
12/31/2005 error.. .
Corrected...................................
$1,221,000
2004
$1,287,000
+ 66,000
_________
$1,353,000
2005
$ 847,000
+ 66,000
+ 30,000
$ 943,000
2006
$ 770,000
2005
$ 275,000
- 66,000
- 30,000
$ 179,000
2006
$ 231,000
2005
$1,265,000
2006
$1,100,000
- 30,000
$1,235,000
$1,100,000
2005
$1,430,000
2006
$1,232,000
- 30,000
$1,400,000
$1,232,000
- 30,000
$ 740,000
+ 30,000
$ 261,000
Part 2
Total net income for the combined three-year period is not affected by the
errors. This is because these errors are "self-correcting"that is, each
overstatement (or understatement) of net income is offset by a matching
understatement (or overstatement) in the following year.
Part 3
The understatement of inventory by $66,000 results in an overstatement of cost of
goods sold by that same amount. The $66,000 overstatement of cost of goods sold
results in an understatement of gross profit by the same amount. This
understatement of gross profit carries through to an understatement of net income.
58
Since the understated net income is closed to equity, the final equity figure is
understated by the amount of the inventory understatement.
59

Per Unit
Inventory Items Units Cost Market
Audio equipment:
Receivers........ 335
CD players...... 250
DVD players....
Speakers.........
Subtotal..........
316
194
Video equipment:
Televisions...... 470
VCRs.............. 281
Video cameras
Subtotal..........
Car audio
equip:
DVD radios......
CD radios........
202
175
160
$ 90
111
86
52
150
93
310
70
97
Subtotal..........
Total.................
$ 98
100
95
41
125
84
322
84
105
Total
Cost
Total
Market
LCM applied to:

Items
Categorie
Whole
s
$ 30,150
27,750
27,176
10,088
95,164
$ 32,830
25,000
30,020
7,954
95,804
$ 30,150
25,000
27,176
7,954
70,500
26,133
62,620
159,253
58,750
23,604
65,044
147,398
58,750
23,604
62,620
12,250
15,520
27,770
$282,187
14,700
16,800
31,500
$274,702
12,250
15,520
_______
$263,024
$ 95,164
147,398
a. Lower of cost or market for the inventory as a whole
27,770
$270,332
= $274,702
b. Lower of cost or market for the inventory by major category =

$95,164 + $147,398 + $27,770 = $270,332
c. Lower of cost or market for inventory applied separately
60
= $263,024
$274,702
Problem 5-4AA (25 minutes)

Part 1
Number and total cost of units available for sale:
20,000 units in beginning inventory @ $15........................... $ 300,000
28,000 units purchased @ $18................................................
504,000
30,000 units purchased @ $22................................................
660,000
20,000 units purchased @ $24................................................
480,000
33,000 units purchased @ $27................................................
891,000
131,000 units available for sale ............................................... $2,835,000
Part 2
a. FIFO periodic
Total cost of 131,000 units available for sale.........
Less ending inventory on a FIFO basis
33,000 units @ $27.................................................
2,000 units @ $24.................................................
Cost of units sold......................................................
$2,835,000
$891,000
48,000
939,000
$1,896,000
b. LIFO periodic
Total cost of 131,000 units available for sale.........
Less ending inventory on a LIFO basis
20,000 beginning inventory units @ $15.............
15,000 units @ $18.................................................
Cost of units sold......................................................
$2,835,000
$300,000
270,000
570,000
$2,265,000
c. Weighted average periodic

Total cost of 131,000 units available for sale..........
Less ending inventory at weighted average
($2,835,000/131,000) x 35,000................................
Cost of units sold.......................................................
*
$2,835,000
757,443
$2,077,557
Amount can slightly vary due to differences in rounding.
61
*
*

Part 1
TRUE BLUE CORP.
Income Statements Comparing FIFO, LIFO, and Weighted Average
For Year Ended December 31, 2005
FIFO
LIFO
Weighted
Average
Sales
Cost of goods sold
Inventory, Dec. 31, 2004........................
Cost of purchases..................................
Cost of goods available for sale...........
Inventory, Dec. 31, 2005..........................
Cost of goods sold................................
Gross profit..............................................
$247,500
$247,500
$247,500
10,800
123,500
134,300
22,000
112,300
135,200
10,800
123,500
134,300
18,400
115,900
131,600
10,800
123,500
134,300
20,662 *
113,638 *
133,862 *
Expenses..................................................
Income before taxes................................
Income taxes expense.............................
Net income...............................................
33,000
102,200
30,660
$ 71,540
33,000
98,600
29,580
$ 69,020
33,000
100,862 *
30,259 *
$ 70,603 *
FIFO
$ 10,800
LIFO
$ 10,800
Weighted
Average
$ 10,800
$123,500
$123,500
$123,500
Dec. 31, 2005, inventory (6,500 - 5,500 = 1,000 units)

FIFO: 1,000 x $22 = $22,000
$ 22,000
LIFO:
600 x $18 = $10,800
400 x $19 = $ 7,600
W.A.:
($134,300/6,500) x 1,000
$18,400
*Amounts can slightly vary due to differences in rounding.
Supporting calculations:
Dec. 31, 2004, inventory (600 x $18).................
Purchases
1,500 x $19 = $28,500
700 x $20 = 14,000
400 x $21 = 8,400
3,300 x $22 = 72,600
$20,662*
62
Problem 5-5AA (Concluded)

Part 2
If True Blue, Corp. had been experiencing declining costs in the acquisition
of inventory, we would observe the opposite results in our comparisons.
Specifically, LIFO would have resulted in a higher ending inventory, lower
cost of goods sold, higher gross profit, and higher net income. FIFO would
have resulted in a lower ending inventory, higher cost of goods sold, lower
gross profit, and lower net income.
Part 3
Advantages:
LIFO: Given the cost trends in the problem, the advantage of using LIFO is
that the lower net income will result in a lower tax obligation (tax deferral).
Also, LIFO is likely to better match current costs against revenues.
FIFO: The advantage of using FIFO is that the inventory figure reported on
the balance sheet is likely similar to the current replacement cost.
Disadvantages:
LIFO: Given the cost trends in the problem, the disadvantage of using LIFO
is that the inventory figure, which is also reported on the income statement,
will likely be understated in comparison to the current replacement costs.
FIFO: The disadvantage of using FIFO is that it will produce a greater tax
obligation for the current period as a result of a higher reported net income.
63

Part 1
NILSON COMPANY
Estimated Inventory
December 31
At Cost
At Retail

Beginning inventory...........................................
Cost of goods purchased...................................
Goods available for sale.....................................
$ 471,350 $ 927,150
3,276,030
6,279,350
$3,747,380 $7,206,500
Sales.......................................................................
Less: Sales returns.............................................
Net sales.................................................................
$5,495,700
44,600
$5,451,100
Ending inventory at retail ($7,206,500 - $5,451,100)
$1,755,400
Cost-to-retail ratio: $3,747,380/$7,206,500 = 0.52 or 52%

Ending inventory at cost ($1,755,400 x 52%)......
$ 912,808
Part 2
Estimated physical inventory at cost: $1,675,800 x 52% = $871,416
NILSON COMPANY
Inventory Shortage
December 31
Estimated inventory (from part 1).....................
Physical inventory*............................................
Inventory shortage.............................................
At Cost
At Retail
$ 912,808
871,416
$ 41,392
$ 1,755,400
1,675,800
$
79,600
* $871,416 = $1,675,800 (given) x 52% (from part 1).
64
Problem 5-7AB (25 minutes)

WAYMAN COMPANY
Estimated Inventory at March 31
Inventory, January 1.......................................... $ 300,260
Cost of goods purchased.................................
939,050
Goods available for sale................................... 1,239,310
Sales....................................................................
Less sales returns.............................................
Net sales.............................................................
[$1,181,700 x (1 35%)]................................
(768,105)
Estimated March 31 inventory............................. $ 471,205
$1,191,150
(9,450)
$1,181.700
65
PROBLEM SET B
Problem 5-1B (40 minutes)
1. Calculate cost of goods available for sale and units available for sale:
Beginning inventory........................
Jan. 10..............................................
Feb. 13..............................................
July 21..............................................
Aug. 5..............................................
Units available.................................
Cost of goods available for sale....
600 units @ $55 =
$ 33,000
450 units @ $56 =

200 units @ $57 =
230 units @ $58 =
345 units @ $59 =
1,825 units
25,200
11,400
13,340
20,355
$103,295
2. Units in ending inventory:

Units available (from part 1)........... 1,825
Less: Units sold (given)..................
765
Ending Inventory.............................. 1,060
66
Problem 5-1B (Continued)

3a. FIFO perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
Inventory Balance
600 @ $55
= $33,000
= $58,200
1/10
450 @ $56 = $25,200
600 @ $55
450 @ $56
2/13
200 @ $57 = $11,400
600 @ $55
450 @ $56
200 @ $57
= $69,600
170 @ $55
450 @ $56
200 @ $57
= $45,950
2/15
7/21
8/5
430 @ $55 = $23,650
230 @ $58 = $13,340
170 @ $55
450 @ $56
200 @ $57
230 @ $58
345 @ $59 = $20,355
170 @ $55
450 @ $56
200 @ $57
230 @ $58
345 @ $59
8/10
170 @ $55
165 @ $56 = $18,590
______
$42,240
285 @ $56
200 @ $57
230 @ $58
345 @ $59
= $59,290
= $79,645
= $61,055
Alternate FIFO solution format

Cost of goods available for sale......................
430 @ $55....................................
170 @ 55....................................
165 @ 56....................................
765
Total cost of goods sold..................................
Ending Inventory...............................................
$103,295
$23,650
9,350
9,240
42,240
$ 61,055
Ending Inventory
285 @ $56
200 @ 57
230 @ 58
345 @ 59
1,060 units
$ 15,960
11,400
13,340
20,355
$ 61,055
67

3b. LIFO perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
1/10
2/13
450 @ $56 = $25,200

200 @ $57 = $11,400
2/15
7/21
8/5
600 @ $55
= $33,000
600 @ $55
450 @ $56
= $58,200
600 @ $55
450 @ $56
200 @ $57
200 @ $57
230 @ $56 = $24,280
230 @ $58 = $13,340
345 @ $59 = $20,355
8/10
Inventory Balance
335 @ $59 = $19,765

______
$44,045
600 @ $55
220 @ $56
= $69,600
= $45,320
600 @ $55
220 @ $56
230 @ $58
= $58,660
600 @ $55
220 @ $56
230 @ $58
345 @ $59
= $79,015
600 @ $55
220 @ $56
230 @ $58
10 @ $59
= $59,250
Alternate LIFO solution format

Cost of goods available for sale......................
200 @ $57....................................
230 @ 56....................................
335 @ 59....................................
765
Cost of Goods Sold..........................................
Ending Inventory...............................................
$103,295
$11,400
12,880
19,765
44,045
$ 59,250
Ending inventory...
68
600 @ $55
220 @ 56
230 @ 58
10 @ 59
1,060 units
$ 33,000
12,320
13,340
590
$ 59,250

3c. Specific Identification
Cost of goods available for sale.......
600 @ $55...........................
165 @ $57...........................
765 .....................................
Cost of Goods Sold............................
Ending inventory................................
$103,295
$33,000
9,405
42,405
$ 60,890

450 @ $56
35 @ 57
230 @ 58
345 @ 59
Ending inventory................. 1,060 Units
$25,200
1,995
13,340
20,355
$60,890
3d. Weighted Average

Date
Goods Purchased
Cost of Goods Sold
Inventory Balance
1/1
600 @ $55.00
= $33,000
1/10
450 @ $56 = $25,200
600 @ $55.00
= $58,200
450 @ $56.00
2/13
200 @ $57 = $11,400
600 @ $55.00
450 @ $56.00
= $69,600
200 @ $57.00
2/15
430@ $55.68 = $23,942**
820 @ $55.68
= $45,658**
7/21
230 @ $58 = $13,340
820 @ $55.68
= $58,998**
230 @ $58.00
8/5
345 @ $59 = $20,355
820 @ $55.68
230 @ $58.00
= $79,353**
345 @ $59.00
8/10
335@ $56.88 = $19,055**

$42,997
1,060@ $56.88
= $60,293**
* rounded to nearest cent

** rounded to nearest dollar
69
Note: Total cost of goods sold plus ending inventory = $42,997 + $60,293 = $103,290. The $5
difference from the cost of goods available for sale of $103,295 is due to rounding.
70
Problem 5-1B (Concluded)

4.
FIFO
LIFO
Sales (765 x $90).................... $68,850 $68,850

Less: Cost of goods sold......
42,240 44,045
Gross profit............................ $26,610 $24,805
Specific
Identification
Weighted
Average
$68,850
$68,850
42,405
$26,445
42,997
$25,853
5. The manager of Venus Company likely will prefer the FIFO method
because it would yield the largest gross profit. This would give the
manager his/her highest bonus based on gross profit.
71

Part 1
(a)
Cost of goods sold:
Reported....................................
Adjustments: 12/31/2004 error
12/31/2005 error
Corrected..................................
(b)
Net income:
Reported....................................
12/31/2005 error
Corrected..................................
(c)
Total current assets:
Reported....................................
12/31/2005 error
Corrected..................................
(d)
Equity:
Reported.....................................
12/31/2005 error
Corrected....................................
2004
$ 205,200
+ 17,000
________
$ 222,200
2005
$ 212,800
- 17,000
- 25,000
$ 170,800
2006
$ 196,030
2004
$ 174,800
- 17,000
________
$ 157,800
2005
$ 211,270
+ 17,000
+ 25,000
$ 253,270
2006
$ 183,910
2004
$ 266,000
- 17,000
________
$ 249,000
2005
$ 276,500
2006
$ 262,950
+ 25,000
$ 301,500
________
$ 262,950
2004
$ 304,000
- 17,000
________
$ 287,000
2005
$ 316,000
2006
$ 336,000
+ 25,000
$ 341,000
________
$ 336,000
+ 25,000
$ 221,030
- 25,000
$ 158,910
Part 2
Total net income for the combined three-year period is not affected by the errors.
This is because these errors are "self-correcting"that is, each overstatement (or
understatement) of net income is offset by a matching understatement (or
overstatement) in the following year.
Part 3
The overstatement of inventory by $17,000 results in an understatement of cost of
goods sold by that same amount. The $17,000 understatement of cost of goods
sold results in an overstatement of gross profit by the same amount. This
72
overstatement of gross profit carries through to an overstatement of net income.

Since the overstated net income is closed to equity, the final equity figure is
overstated by the amount of the inventory overstatement.
73

Inventory Items
Unit
s
Per Unit
Cost Market
Total
Cost
Total
Market
Items
LCM applied to:

Categories
Whole
Office furniture
Desks.............
Credenzas.......
Chairs.............
Bookshelves...
Subtotal..........
436
$26
$305
$113,796
$132,980
$113,796
295
587
321
1
227
49
93
256
43
82
66,965
28,763
29,853
239,377
75,520
25,241
26,322
260,063
66,965
25,241
26,322
17,334
53,730
18,200
89,264
14,980
48,556
20,650
84,186
14,980
48,556
18,200
72,240
172,765
44,000
289,005
$617,646
86,000
156,960
41,184
284,144
$628,393
72,240
156,960
41,184
_______
$584,444
$239,377
Filing cabinets
Two-drawer.....
Four-drawer....
Lateral.............
Subtotal..........
214
398
175
81
135
104
70
122
118
84,186
Office equipment
Fax machine. . .
Copiers...........
Telephones.....
430
545
352
168
317
125
Subtotal..........
Total.................
200
288
117
a. Lower of cost or market for the inventory as a whole
284,144 _______
$607,707 $617,646
= $617,646
b. Lower of cost or market for the inventory by major category =

$239,377 + $84,186 + $284,144 = $607,707
c. Lower of cost or market for inventory applied separately
74
= $584,444
Problem 5-4BA (25 minutes)

Part 1
Number and total cost of units available for sale
6,300 units in beginning inventory @ $35.............................
10,500 units purchased @ $33.................................................
13,000 units purchased @ $32.................................................
12,000 units purchased @ $29.................................................
15,500 units purchased @ $26.................................................
57,300 units available for sale..................................................
$ 220,500
346,500
416,000
348,000
403,000
$1,734,000
0
Part 2
a. FIFO periodic
Total cost of 57,300 units available for sale......
Less ending inventory on a FIFO basis
15,500 units @ $26.............................................
1,000 units @ $29.............................................
Cost of units sold.................................................
$1,734,000
$403,000
29,000
432,000
$1,302,000
b. LIFO periodic
Less ending inventory on a LIFO basis
6,300 beg. inv. units @ $35...............................
10,200 units @ $33...............................................
$1,734,000
$220,500
336,600
557,100
$1,176,900
c. Weighted average periodic

Less ending inventory at weighted average cost
($1,734,000/57,300) x 16,500 units....................
$1,734,000
499,319*
$1,234,681*
*Amount can slightly vary due to differences in rounding.
75
Problem 5-5BA (30 minutes)

Part 1
RIKKERS CORP.
Income Statements Comparing FIFO, LIFO, and Weighted Average
For Year Ended December 31, 2005
FIFO
LIFO
Weighted
Average
Sales
$245,000 $245,000
Cost of goods sold
Inventory, Dec. 31, 2004.............................
42,920
42,920
Cost of purchases......................................
161,900
161,900
Cost of goods available for sale................
204,820
204,820
Inventory, Dec. 31, 2005.............................
54,560
48,820
Cost of goods sold.....................................
150,260
156,000
Gross profit...................................................
94,740
89,000
$245,000
Expenses.......................................................
35,000
Income before taxes.....................................
59,740
Income taxes expense.................................
14,935
Net income.................................................... $ 44,805 $
35,000
56,692 *
14,173 *
$ 42,519 *
35,000
54,000
13,500
40,500
42,920
161,900
204,820
51,512 *
153,308 *
91,692 *
Supporting calculations:
Dec. 31, 2004, inventory (740 x $58).................
Purchases
700 x $59 = $41,300
600 x $61 = 36,600
500 x $64 = 32,000
800 x $65 = 52,000
Dec. 31, 2005, inventory
FIFO:
800 x $65 = $52,000
40 x $64 =
2,560
LIFO:
W.A.:
FIFO
$ 42,920
LIFO
$ 42,920
Weighted
Average
$ 42,920
$161,900
$161,900
$161,900
$ 54,560
740 x $58 = $42,920

100 x $59 =
5,900
($204,820/3,340) x 840
$ 48,820
$ 51,512*
76
Problem 5-5BA (Concluded)

Part 2
If Rikkers Corp. had been experiencing decreasing costs in the acquisition of
inventory, we would observe the opposite results in our comparisons.
Specifically, LIFO would have resulted in a higher ending inventory, lower
cost of goods sold, higher gross profit, and higher net income. FIFO would
have resulted in a lower ending inventory, higher cost of goods sold, lower
gross profit, and lower net income.
Part 3
Advantages:
LIFO: Assuming a trend of increasing costs, the advantage of using LIFO is
that the lower net income will result in a lower tax obligation (tax deferral).
Also, LIFO is likely to better match current costs against revenues.
FIFO: The advantage of using FIFO is that the inventory figure reported on
the balance sheet is likely similar to the current replacement cost.
Disadvantages:
LIFO: Assuming a trend of increasing costs, the disadvantage of using LIFO
is the inventory figure, which is also reported on the income statement, will
likely be understated in comparison to the current replacement costs.
FIFO: The disadvantage of using FIFO is that it will produce a greater tax
obligation for the current period as a result of a higher reported net income.
77
Problem 5-6BB (25 minutes)

Part 1
ALAINA CO.
Estimated Inventory
December 31
Goods available for sale:
Beginning inventory..............................................
Cost of goods purchased.....................................
Goods available for sale.......................................
At Cost
At Retail
$ 81,670
492,250
$573,920
$114,610
751,730
$866,340
Sales
Less: Sales returns..................................................
Net sales...................................................................
$786,120
(4,480)
$781,640
Ending inventory at retail ($866,340 - $781,640)...
$ 84,700
Cost ratio: $573,920/$866,340 = 0.66 or 66%

Ending inventory at cost ($84,700 x 66%)............
$ 55,902
Part 2
Estimated physical inventory at cost: $84,700 x 66% = $55,902
ALAINA CO.
Inventory Shortage
December 31
Estimated inventory (from part 1).........................
Physical inventory*................................................
Inventory shortage.................................................
At Cost
At Retail
$55,902
51,843
$ 4,059
$84,700
78,550
$ 6,150
* $51,843 = $78,550 (given) x 66% (from part 1).
78
Problem 5-7BB (25 minutes)

ERNST EQUIPMENT CO.
Estimated Inventory at March 31
At Cost
Inventory, January 1.......................................
Cost of goods purchased..............................
Goods available for sale................................
Sales.................................................................
Less sales returns..........................................
Net sales..........................................................
[$3,636,050 x (1 - 30%)]..............................
Estimated March 31 inventory..........................
At Retail
$ 752,880
2,159,630
2,912,510
$3,710,250
(74,200)
$3,636,050
(2,545,235)
$ 367,275
SERIAL PROBLEM
Serial Problem, Success Systems (20 minutes)
1. Ratio computations for the three months ended March 31, 2005:
Inventory Turnover
= Cost of Goods Sold / Average Inventory

= $14,052 / [($0 + $704)/2]
= 40 times (Since this is the first period of carrying
inventory, it is acceptable to substitute ending inventory for
average inventory. This would yield a turnover of 20 times.)
Days Sales in Inventory = (Ending Inventory/Cost of Goods Sold) x 365

= ($704 / $14,052) x 365 = 18.3 days
2. Success Systems outperforms its competitors on both ratios. Its inventory
turnover is 40 (or 20) times versus competitors 10 times. Also, its days sales
in inventory is 18.3 days versus competitors 29 days. Thus, Success
Systems appears to be successfully managing its inventory.
79
Reporting in Action BTN
5-1
($ thousands)
1. Ending inventories at February 2, 2003, were $24,365. Ending

inventories at February 3, 2002, were $16,159.
2.
2003:
$24,365
$410,487
= 0.059 or 5.9%
2002:
$16,159
$255,376
= 0.063 or 6.3%
3. Krispy Kreme reports 14 different types of assets on its balance sheet.

Inventory is the fifth largest asset behind property and equipment ,
accounts receivable, cash and cash equivalents, and intangible assets at
both February 2, 2003, and at February 3, 2002.
4. As stated in the summary of significant accounting policies (Note 2),
Krispy Kreme uses the FIFO method of inventory costing for inventories.
Its inventories are stated at the lower of average cost (FIFO) or market.
5. a. Inventory turnover =
Cost of sales
Average inventory
$16,159 + 24,365
2
Average inventory =
= $20,262
$ 381,489
Inventory turnover = $ 20,262
= 18.8 times
b. Days sales in inventory =
=
Ending inventory
Cost of sales
$24,365
$381,489
x 365
x 365 = 23.3 days
6. Solution depends on the financial statement information obtained.
80
Comparative Analysis
BTN 5-2
($ thousands)
1. Inventory turnover =
Cost of sales
Average inventory
Krispy Kreme current year

$381,489
($24,365 + $16,159)/2
Inventory turnover =
= 18.8 times
Krispy Kreme one year prior

$316,946
($16,159 + $12,031)/2
= 22.5 times
Tastykake current year

$111,187
($6,777 + $8,412)/2
= 14.6 times
Tastykake one year prior

2. Days sales in inventory =
$103,297
($8,412 + $5,930)/2
= 14.4 times
Ending Inventory x 365

Costs of Goods Sold
Current year Krispy Kremes days sales in inventory

$24,365
$381,489 x 365
= 23.3 days
One year prior Krispy Kremes days sales in inventory

$16,159
$316,946 x 365
= 18.6 days
Two years prior Krispy Kremes days sales in inventory

$12,031
$250,690 x 365
= 17.5 days
81
Comparative Analysis (Concluded)

2. Continued
Current year Tastykakes days sales in inventory
$6,777
$111,187
x 365
= 22.2 days
One year prior Tastykakes days sales in inventory

$8,412
$103,297
x 365
= 29.7 days
Two years prior Tastykakes days sales in inventory

$ 5,930
$105,036
x 365
= 20.6 days
3. For two of the three years Krispy Kreme manages its inventory more
efficiently than Tastykake. For the current (prior) year(s), Krispy Kreme
holds 23.3 (18.6 and 17.5) days of sales in inventory and turns its
inventory 18.8 (22.5) times. For the current (prior) year(s), Tastykake
holds 22.2 (29.7 and 20.6) days of sales in inventory and only turns its
inventory 14.6 (14.4) times.
82
Ethics Challenge
BTN 5-3
1. Profit Margin: In an economic environment of rising costs, the use of

FIFO results in a lower cost of goods sold than LIFO. If cost of goods
sold is lower, then net income will be higher. A higher net income will
improve the profit margin ratio, which is calculated as net income
divided by net sales.
Current Ratio: With rising costs, FIFO results in the most recent, higher
costs being reflected in ending inventory. This means that the balance
sheet FIFO inventory figure will be larger than under LIFO. In the
numerator of the current ratio, inventory is included as part of the
current asset total. A larger inventory from FIFO, therefore, results in a
larger numerator and therefore a larger current ratio than under LIFO.
2. First, it is true that managers have discretion in choosing an inventory
costing method. It appears, however, that Golf Aways owner does not
understand that changing methods can only be done very selectively
over time. A change in method must be justified by management for
improving the financial reporting of the company.
Second, the consistency principle does not allow frequent changes in
inventory costing methods by management. If Golf Aways owner can
justify the method change as improving the financial reports of the
company, then the owners action is ethical. However, the owner must
realize that changing methods can only be an infrequent occurrence
given that consistency in financial reporting is required.
Third, the full disclosure principle requires the owner to disclose to the
bank that the company has implemented a change in inventory costing
method from LIFO to FIFO.
Finally, if LIFO is currently being used for tax reporting, then the tax
reporting method must also change due to the LIFO Conformity Rule
which demands that if LIFO is used for tax reporting, it must be used for
financial reporting.
83
Communicating in Practice
BTN 5-4
[Note: An acceptable memorandum format should be used.]
The body of the memo should recommend use of the LIFO method. The
memo should explain that this would allow for the matching of the most
recent (higher) costs against revenue through cost of goods sold. It should
further explain that this would result in a lower net income and, therefore,
lower tax. The justification for this method is a better matching of current
costs against revenue to more fairly reflect the results of operation. A
statement could be made that the actual physical flow of goods does not
dictate the inventory method a business uses.
Taking It to the Net
BTN 5-5
1. One especially popular product with college students that Oakley sells is
Oakley sunglasses.
2. The summary of significant accounting policies reports that Oakley
reports its inventory at the lower of cost to purchase and/or manufacture
or the current estimated market value.
3. Oakleys gross margin for 2002 is ($ in thousands)
Sales
Cost of sales.....................................
Gross margin....................................
$489,552
(211,962)
$277,590
Gross margin ratio is: $277,590 / $489,552 = 0.567 or 56.7%

4. 2002 Inventory turnover*
=
$211,962 / [($87,007+$77,270)/2] = 2.6 times
2002 Days sales in inventory*
=
($87,007 / $211,962) x 365 = 150 days
* $ thousands
84
Teamwork in Action
BTN 5-6
Concepts and procedures to illustrate in expert presentation:

Specific Identification Expert:
(a) and (b) Concept:
Purchases are always recorded at the actual specific costs. The specific
identification cost flow assumption requires units sold be assigned their
actual cost. Total cost of goods sold is tallied based on these individual
cost assignments. The new inventory balance is perpetually determined to
be the amount after sales at actual cost is deducted.
(a) and (b) Procedures:
Date
Goods Purchased
Cost of Goods Sold
Jan. 1
50 @ $10 = $ 500
Jan.10
Jan.14
Inventory Balance
30 @ $10 = $ 300
150 @ $12 = $1,800
Feb.15
20 @ $10 =
20 @ $10 =
150 @ $12 =
100 @ $ 12 = $1,200
$ 200
$
200
1,800
$2,000
20 @ $10 = $
200
50 @ $12 =
600
$ 800
Apr.30
200 @ $15 = $3,000
20 @ $10 =
50 @ $12 =
200 @ $15 =
Sept 26
300 @ $20 = $6,000
20
50
200
300
@
@
@
@
$10 = $
$12 =
$15 =
$20 =
$9,800
20
50
100
50
@
@
@
@
$10=
$12 =
$15 =
$20 =
Oct. 5
100 @ $ 15 = $1,500
250 @ $ 20 = $5,000
_____
$8,000
200
600
3,000
$3,800
200
600
3,000
6,000
200
600
1,500
1,000
$3,300
85
Teamwork in Action (Continued)

LIFO Expert:
Purchases are always recorded at actual costs. The LIFO cost flow
assumption requires (i) units sold be assigned the most recent costtotal
cost of goods sold is tallied based on these individual cost assignments,
and (ii) that the inventory balance be perpetually determined to be the
amount after goods sold (using the most recent costs) are deducted.
Date
Goods Purchased
Cost of Goods Sold
Jan. 1
Jan.10
Jan.14
30 @ $10 = $
300
150 @ $12 = $1,800
Feb.15
Inventory Balance
50 @ $10 =
500
20 @ $10 =
200
20 @ $10 =
150 @ $12 =
100 @ $12 = $ 1,200
20 @ $10 =
50 @ $12 =
$ 200
1,800
$ 2,000
$
$
Apr.30
200 @ $15 =$3,000
20 @ $10 =
50 @ $12 =
200 @ $15 =
Sept 26
300 @ $20 = $6,000
20
50
200
300
$10 =
$12 =
$15 =
$20 =
$
20 @ $10 =
50 @ $12 =
150 @ $15 =
Oct. 5
86
300 @ $20 = $ 6,000

50 @ $15 = $ 750
______
$ 8,250
@
@
@
@
200
600
800
200
600
3,000
$ 3,800
200
600
3,000
6,000
9,800
200
600
2,250
$ 3,050

FIFO Expert:
Purchases are always recorded at actual costs. The FIFO cost flow
assumption requires units sold be assigned the first (earliest) cost of
purchases. Total cost of goods sold is tallied based on these individual cost
assignments. The inventory balance is perpetually determined to be the
amount after deducting goods sold using the earliest costs.
Date
Goods Purchased
Cost of Goods Sold
Inventory Balance
Jan. 1
Jan.10
Jan.14
30 @ $10 = $
300
150 @ $12 = $1,800
Feb.15
50 @ $10 = $
500
20 @ $10 = $
200
20 @ $10 = $ 200
150 @ $12 = 1,800
$ 2,000
20 @ $ 10 = $ 200
80 @ $ 12 =
960
70 @ $12 = $
840
Apr.30
200 @ $15 = $3,000
70 @ $12 = $ 840
200 @ $15 = 3,000
$ 3,840
Sept 26
300 @ $20 = $6,000
70 @ $12 = $ 840
200 @ $15 = 3,000
300 @ $20 = 6,000
$ 9,840
Oct. 5
70 @ $12 = $ 840
200 @ 15 = 3,000
80 @ 20 = 1,600
______
$ 6,900
220 @ $20 = $ 4,400

______
$ 4,400
87

Weighted Average Expert:
Purchases are always recorded at actual costs. The Weighted Average cost
flow assumption requires units sold be assigned a cost based on running
weighted average cost per unit in the inventory balance. This requires the
computation of a new weighted average cost per unit after each purchase.
The total cost of goods sold is tallied based on cost assignments. The new
inventory balance is perpetually determined to be the residual amount after
goods sold are deducted using this weighted average cost.
Date
Goods Purchased
Cost of Goods Sold
Jan. 1
Jan.10
Jan.14
30 @ $10
= $ 300
150 @ $12 = $1,800
Inventory Balance
50 @ $10
= $ 500
20 @ $10
= $ 200
170 @ $11.7647 = $2,000

(200 +1,800) / (20+150)
Feb.15
Apr.30
100 @ $11.7647 = $1,176*

200 @ $15 = $3,000
70 @ $11.7647 = $ 824*
270 @ $14.163* = $3,824*
(824+3,000) / (70 +200)
Sept 26
300 @ $20 = $6,000
570 @ $17.24*
= $9,824*
(3,824 +6,000) / (270 +300)
Oct. 5
* rounded
88
350 @ $17.24
= $6,034
_____
$7,510
220 @ $17.24*
=
$3,790**
** adjusted for rounding
Teamwork in Action (Concluded)

(c) Cost Flow versus Actual Physical Flow
Typical comments experts may express in response to (c):
Physical flow of goods can be affected by the type of products in inventory

and/or the way inventory is stored and/or displayed.
Actual physical flow of goods is not relevant in selecting an acceptable

method of accounting for inventory. Any one of the four methods is
acceptable. The method chosen should be consistently applied.
More Specific Expert Comments to (c):
Specific Identification--Always reflects the actual cost flow. Electronic
scanning has increased the ability to use this method in businesses that sell
homogeneous goods.
FIFOMost businesses try to move their older or earlier acquired inventory
first, particularly if they sell perishable goods. Therefore, FIFO will frequently
reflect the physical flow of goods.
LIFOFew actually sell their most recently acquired inventory first. This could
follow actual physical flow if inventory is stocked in a manner that requires
accessing most recent cost first.
Weighted Average--This cost is rarely the actual cost flow. This would require
the mixing or combining of units on hand. This is possible for inventory such
as oil but it still unlikely that the actual blending would be as complete as the
averaging of costs.
(d) Impact of Methods
Typical comments experts may express in response to (d):
In a period of rising prices LIFO will generally result in the highest cost of
goods sold and therefore the lowest net income and lowest tax. However, LIFO
must be used for financial reporting if it is used for tax purposes.
In a period of rising prices FIFO will generally result in the lowest cost of goods
sold and therefore the highest net income and highest tax.
Weighted Average will usually result in a reported net income and tax
consequences somewhere in between LIFO and FIFO.
Specific Identification will result in a cost of goods sold, net income and tax
expense dependent on whether the actual cost of units sold were the higher or
lower priced items.
(e) Valuation
Typical comments experts may express in response to (e):
FIFO tends to value ending inventory closest to replacement cost whereas
LIFO does not. Weighted average tends to value inventory between old and
new market values, and specific identification depends on whether the items
remaining in inventory have costs similar to current replacement costs.
89
Business Week Activity
BTN 5-7
1. Apple has a 2.5% share of the U.S. market for digital music players.
2. Toshiba with Mobilphile, and SONICblue.
3. Toshibas Mobilphile has a removable hard drive. Toshiba could choose
to ship players and different size removable drives separately to stores.
The separate shipment would allow retailers to meet customer demand
for product specifications quite efficiently onsite.
This flexibility will hold down inventory costs as retailers will not be
stocking players with drives of certain sizes that consumers do not
demand. In contrast, iPods hard drives are not removable and a retailer
might not be fortunate enough to stock the size iPod that is most in
demand by consumers.
4. Unit sales of the iPod are forecast to grow from 1 million in 2002 to 9
million in 2006.
Entrepreneurial Decision
BTN 5-8
Part 1
(a) Under current conditions, the inventory turnover is 2.1. This is computed
as its cost of sales of $1,050,000 divided by its average merchandise
inventory of $500,000. Also, days sales in inventory is 174 days. This is
computed as its ending inventory of $500,000 divided by its cost of sales
of $1,050,000, and then this result is multiplied by 365.*
*Ratio definitions:
Cost of goods sold
Average inventory
Days sales in inventory =
Ending inventory
Cost of goods sold x 365
(b) Under the proposal, its inventory turnover would be 8.4. This is computed
as its cost of sales of $1,050,000 divided by its average proposed
merchandise inventory of $125,000. Also, its days sales in inventory
under the proposal is 43 days. This is computed as its proposed ending
inventory of $125,000 divided by its cost of sales of $1,050,000, and then
this result is multiplied by 365.
90
Entrepreneurial Decision (Concluded)

Part 2
Beckers proposal would yield a much improved inventory turnover of 8.4
vis--vis the current turnover of 2.1. On the downside, its days sales in
inventory would dramatically decline from 174 days to 43 days. Assuming
an inventory buffer of 43 days is sufficient, then Becker should implement
this proposal.
We need to recognize that the major concern with this proposal is with
the companys confidence in both maintaining its current sales level and
with not losing or alienating its current and future customers due to
delays in acquiring merchandise. Assuming the companys predictions
are reasonable, we need to focus on the customer concern. That is, we
need to be certain that Becker can continue to satisfactorily serve
customers with a 43-day buffer in inventory. If not, then current and future
sales could suffer to an extent that would outweigh the benefit of slashing
inventory.
Hitting the Road
BTN 5-9
There is no formal solution for this field activity. The required solution does
allow students to see the relevance of studying merchandise activities and
inventory accounting.
91
Global Decision
1. Inventory turnover =
BTN 5-10
Cost of sales
Average inventory
Current year Grupo Bimbo (pesos millions):

19,156
(905 + 767) / 2
= 22.9 times
One year prior Grupo Bimbo (pesos millions):

15,708
(767 + 725) / 2
Days sales in inventory =
= 21.1 times
Ending Inventory x 365

Costs of Goods Sold
Current year Grupo Bimbos days sales in inventory (pesos millions):

905
19,156 x 365
= 17.2 days
One year priorGrupo Bimbos days sales in inventory (pesos millions):

767
15,708 x 365
Company
= 17.8 days
Inventory Turnover
Current Prior Year
Days Sales in Inventory

Current
Prior Year
Grupo Bimbo...........................
22.9
21.1
17.2
17.8
Krispy Kreme...........................
18.8
22.5
23.3
18.6
Tastykake.................................
14.6
14.4
22.2
29.7
Note: Computations for Krispy Kreme and Tastykake are in BTN 5-2.
2. In the current year Grupo Bimbo manages its inventory more efficiently
than Krispy Kreme or Tastykake. Its inventory turnover is higher and its
days sales in inventory are less than both Krispy Kreme and Tastykake.
92

Solution Manual CH 05 FInancial Accounting Reporting and Analyzing Inventories

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Solution Manual CH 05 FInancial Accounting Reporting and Analyzing Inventories

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Chapter 5

Reporting and Analyzing Inventories

Merchandise inventory is disclosed on the balance sheet as a current asset. It is also

Many people make important business decisions based on period-to-period

McGraw-Hill Companies, Inc., 2005

Cost of Goods Sold

McGraw-Hill Companies, Inc., 2005

Financial Accounting, 3rd Edition

Quick Study 5-1 (continued)

Cost of Goods Sold

(c) Weighted Average

Cost of Goods Sold

(d) Ending inventory under specific identification:

Solutions Manual, Chapter 5

McGraw-Hill Companies, Inc., 2005

Quick Study 5-3 (25 minutes)

Cost of Goods Sold

310 @ $3.00 = $ 930

Cost of Goods Sold

100 @ $3.35 = $ 335

(c) Weighted Average

345 @ $3.10 = $1,069.5

McGraw-Hill Companies, Inc., 2005

Cost of Goods Sold

Financial Accounting, 3rd Edition

Quick Study 5-3 (continued)

$ 420 Ending inventory cost

(c) Weighted average:

$1,505/485 = $3.10 weighted average cost per unit

$ 434 Ending inventory cost

Quick Study 5-4 (10 minutes)

Quick Study 5-5 (10 minutes)

Solutions Manual, Chapter 5

McGraw-Hill Companies, Inc., 2005

Quick Study 5-6 (10 minutes)

Quick Study 5-7 (5 minutes)

Quick Study 5-8 (10 minutes)

Quick Study 5-9 (20 minutes)

LCM applied to:

a. LCM for inventory as a whole...................................................

b. LCM applied to each product ...................................................

McGraw-Hill Companies, Inc., 2005

Financial Accounting, 3rd Edition

Solutions Manual, Chapter 5

McGraw-Hill Companies, Inc., 2005

Quick Study 5-10 (15 minutes)

Overstates 2005 cost of goods sold.

= Cost of goods sold/Average merchandise inventory

Days sales in inventory = Ending Inventory/Costs of goods sold x 365

Quick Study 5-12A (15 minutes)

c. Weighted Average ($510/ 45 = $11.33 cost per unit)

McGraw-Hill Companies, Inc., 2005

Financial Accounting, 3rd Edition

Quick Study 5-13A (15 minutes)

c. Weighted Average ($1,505/ 485 = $3.10* cost per unit)

Quick Study 5-14B (15 minutes)

Solutions Manual, Chapter 5

McGraw-Hill Companies, Inc., 2005

(400 x $5.00) + (100 x $4.10)..........................

$6,380 - $2,410 ...............................................

b. Weighted average perpetual

Cost of Goods Sold

600 @ $4.85 = $2,910

McGraw-Hill Companies, Inc., 2005