SM05 PorterNoASfsfddrton FA 8e

CHAPTER 5
Inventories and
Cost of Goods Sold
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Exercises
Estimated
Time in
Minutes
Level
1
2
10
10
Easy
Mod
2. Show that you understand how wholesalers and retailers

account for sales of merchandise.
3
4
21*
22*
25
10
25
15
Mod
Easy
Mod
Mod

account for cost of goods sold.
5
6
7
8
9
15
21*
22*
23*
27*
15
20
25
20
15
20
25
15
10
10
Easy
Mod
Mod
Mod
Mod
Mod
Mod
Mod
Mod
Mod
4. Use the gross profit ratio to analyze a companys ability

to cover its operating expenses and earn a profit.
10
24*
10
10
Mod
Mod
5. Explain the relationship between the valuation of inventory

and the measurement of income.
11
26*
15
20
Mod
Mod
6. Apply the inventory costing methods of specific identification,

weighted average, FIFO, and LIFO by using a periodic system.
12
23*
24*
25*
20
10
10
25
Easy
Mod
Mod
Mod
7. Analyze the effects of the different costing methods on

inventory, net income, income taxes, and cash flow.
13
25*
28*
15
25
40
Mod
Mod
Mod
8. Analyze the effects of an inventory error on various financial

statement items.
14
25
Mod
9. Apply the lower-of-cost-or-market rule to the valuation of

inventory.
26*
20
Mod
Learning Outcomes
1. Identify the forms of inventory held by different types of

businesses and the types of costs incurred.
5-1
2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
CHAPTER 5 INVENTORIES AND COST OF GOODS SOLD
5-2
Exercises
Estimated
Time in
Minutes
Level
10. Analyze the management of inventory.
16
17
20
10
Mod
Diff
11. Explain the effects that inventory transactions have on the

statement of cash flows.
18
19
20
27*
10
15
15
10
Easy
Mod
Mod
Mod
12. Explain the differences in the accounting for periodic and

perpetual inventory systems and apply the inventory
costing methods using a perpetual system (Appendix).
28*
40
Mod
Learning Outcomes (Continued)
*Exercise, problem, or case covers two or more learning outcomes

Level = Difficulty levels: Easy, Moderate (Mod), Difficult (Diff)
5-3
Problems
and
Alternates
Estimated
Time in
Minutes
Level
1
14*
25
20
Mod
Mod

7*
8*
9*
45
40
40
Mod
Mod
Mod

7*
8*
9*
45
40
40
Mod
Mod
Mod

2
8*
25
40
Mod
Mod

10*
11*
12*
13*
45
60
30
30
Mod
Diff
Mod
Mod

10*
12*
13*
45
30
30
Mod
Mod
Mod

3
10*
11*
12*
13*
14*
20
45
60
30
30
20
Mod
Mod
Diff
Mod
Mod
Mod

statement items.
4
14**
45
20
Diff
Mod

inventory.
14*#
20
Mod
30
Mod

6
7*
25
45
Mod
Mod

11*
60
Diff
Learning Outcomes


**Alternate problem only
#Original problem only
5-4
FINANCIAL ACCOUNTING SOLUTIONS MANUAL
Learning Outcomes
Cases
Estimated
Time in
Minutes
Level

1*
25
Mod

4*
5*
9
20
20
30
Mod
Mod
Mod

1*
4*
5*
6
25
20
20
25
Mod
Mod
Mod
Mod

4*
5*
20
20
Mod
Mod
2*
3*
7*
25
25
40
Mod
Mod
Mod
2
7*
10
25
40
30
Mod
Mod
Mod
30
Mod
3*
11
25
30
Mod
Mod

statement items.
inventory.
5-5
QUESTIONS
1. The three distinct types of costs incurred by a manufacturer are direct materials,
direct labor, and manufacturing overhead. Direct, or raw, materials are the
ingredients used in making a product. Direct labor consists of the amounts paid to
factory workers to manufacture the product. Manufacturing overhead includes all the
other costs that are related to the manufacturing process but cannot be directly
matched to specific units of output.
2. The use of a contra-revenue account to record cash refunds and other types of
allowances allows a company to monitor the size and frequency of these
occurrences. For example, a relatively large amount of returns in any one period
may be an indication that the quality of the product has slipped. The information
provided by the use of these contra-revenue accounts would be lost if all returns and
allowances were recorded as reductions of the Sales Revenue account. Also, if this
practice were followed, the actual amount of sales would be understated for the
period to the extent of any returns and allowances.
3. Terms of 3/20, n/60 mean that the customer may deduct 3% from the selling price if
the bill is paid within 20 days. Otherwise, the full amount is due within 60 days of the
date of the invoice. Assuming a sale for $1,000, a 3% discount would save the
customer $30, resulting in a net amount due of $970. The amount saved is the result
of paying 40 days earlier than is required by the 60-day term. Assuming 360 days in
a year, there are 360/40, or 9 periods of 40 days each, in a year. Thus, a savings of
$30 for 40 days is equivalent to a savings of $30 9, or $270 for the year. This is
equivalent to an annual return of $270/$970, or 27.8%. Conclusion: The customer
should pay in the first 20 days unless another investment can be found offering a
return in excess of 27.8%.
4. The two inventory systems differ with respect to how often the Inventory account is
updated. Under the perpetual system, the Merchandise Inventory account is updated
each time a sale or purchase is made. Therefore, the perpetual system continuously
shows the inventory on hand and cost of goods sold. With the periodic system, the
Inventory account is updated only at the end of the period. A temporary account,
called Purchases, is used to keep track of the acquisitions of inventory during the
period. The periodic method relies on a count of the inventory on hand at the end of
the period to determine the amount to assign to ending inventory on the balance
sheet and to cost of goods sold expense on the income statement.
5. A point-of-sale terminal gives the merchandiser the ability to update the inventory
records each time a sale is made. As an item is slid over the sensing glass, a bar
code on the product is read by the computer. In this way, the unit can be removed
from the inventory at the point of sale. In some instances, however, merchandisers
use the terminals only to update the quantity of units on hand, not necessarily the
dollar amount.
5-6
6. The Purchases account is neither an asset nor an expense account. It is simply a

temporary holding account for the purchases of merchandise, which is closed at the
end of the period. The effect of purchases made during the period is to increase the
cost of goods sold expense. It is included in the income statement as an integral part
of the calculation of cost of goods sold and is therefore shown as a reduction of
stockholders equity in the accounting equation.
7. For inventory in transit at the end of the year, the terms of shipment dictate whether
the buyer should record the purchase of the inventory. FOB shipping point means
that the goods belong to the buyer as soon as they are shipped, and the purchases
should be recorded at this point in time. Alternatively, FOB destination point means
that the goods do not belong to the buyer until they are received and therefore
should not be recorded if they are in transit at year-end.
8. Transportation-in represents the freight costs incurred on purchases of merchandise
and is therefore added to the purchases of the period in determining cost of goods
sold expense. Alternatively, transportation-out indicates the freight costs incurred in
selling merchandise and is therefore reported as a selling expense on the income
statement in the period of sale.
9. Gross profit is computed by deducting cost of goods sold from net sales. The gross
profit ratio indicates how well the company controlled its product costs during the
year. For example, a 30% gross profit ratio indicates that for every dollar of net
sales, the company has a gross profit of 30 cents. That is, after deducting 70 cents
on every dollar for the cost of the inventory that is sold, the company has 30 cents to
cover its operating costs and earn a profit.
10. According to the cost of goods sold model, beginning inventory plus purchases
minus ending inventory equals cost of goods sold. Therefore, the amount assigned
to inventory on the balance sheet has a direct effect on the measurement of cost of
goods sold on the income statement. Any errors in valuing inventory will flow through
to cost of goods sold and thus have an impact on the measurement of net income.
11. The justification for treating freight costs on incoming inventory as a cost incurred in
acquiring the asset, rather than as an expense of the period, is the matching
principle. Freight costs are necessary to put the inventory into a position to be sold
and should therefore be included in the cost of the asset. This is a significant
decision, since the cost will become an expense only at the time the inventory is
sold. If freight costs are not included in the cost of the inventory, they are expensed
immediately as they are incurred. Thus, if the inventory is not sold at the end of the
period, the decision to treat freight costs as a cost of the inventory will result in
higher net income than if the costs had been included as an expense of the period.
12. The specific identification method is appropriate only for certain types of inventory. It
is normally used for situations in which the inventory is relatively high-priced and
subject to a low amount of turnover. Although it is not a necessary condition, each
unit of inventory is often unique. For example, an automobile dealer uses the
specific identification method, as would a jewelry company.
5-7
13. When used on an inventory of identical units, the specific identification can lead to
the manipulation of income. Because all units are identical, management can select
which units to sell based on the relative high or low cost of the units on hand. For
example, in a bad year, a company might be tempted to select for sale all units that
had a relatively low unit cost, regardless of when they were acquired. The use of a
cost flow assumption, such as weighted average, FIFO, or LIFO, eliminates the
ability of management to select units for sale based solely on the effect this decision
will have on the income of the period.
14. The weighted average cost method does not rely on a simple arithmetic average of
the unit cost for the various purchases of the period. Instead, more weight is
assigned to unit costs at which more units were purchased. For example, assume
that beginning inventory consists of 100 units with a unit cost of $10 per unit.
Assume that during the period, 100 units were purchased at $15 per unit and 200
units were purchased at $20 per unit. The arithmetic average unit cost for the period
would be ($10 + $15 + $20)/3 = $15. However, the weighted average unit cost would
be [100($10) + 100($15) + 200($20)]/400 units, or $16.25. The acquisition of twice
as many units at $20 as opposed to those purchased at $10 and $15 drives the
weighted average up to $16.25.
15. The FIFO method more nearly approximates the physical flow of products in most
businesses. This is particularly true for perishable products such as fresh fruits and
vegetables. Most businesses prefer as a matter of good customer relations to sell
their goods on a first-in, first-out basis. This minimizes the likelihood that units of
inventory will become obsolete and spoiled.
16. The use of LIFO will have the effect of maximizing net income if a company is
experiencing a decline in the unit cost of inventory. Last-in, first-out charges the most
recent purchases to cost of goods sold. If prices are declining, the amounts charged
to cost of goods sold will be less than if either the weighted average method or FIFO
is used. Because less is charged to cost of goods sold, net income will be higher.
17. In a period of rising prices, the use of LIFO will result in a lower tax bill. Because the
most recent purchases are charged to cost of goods sold under LIFO, in a period of
rising prices, these units will be higher-priced. Thus, the result will be lower gross
margin as well as lower net income before tax. Lower net income will result in a
lower amount of tax to pay. If prices are declining during the period, FIFO will result
in a lower tax bill.
18. No, the president should not be enthralled with the new controller. The controller is
suggesting something that is not allowed under the tax law. The Internal Revenue
Services LIFO conformity rule requires that a company that wants to use LIFO for
tax purposes must also use it in preparing its income statement. Note that this rule
applies only to the use of LIFO on the tax return. A company is free to use different
methods in preparing its tax return and its income statement as long as the method
used for the tax return is not LIFO.
5-8
19. A LIFO liquidation occurs when a company using the LIFO inventory method sells
more units during the period than it purchases. A liquidation of some or all of the
older, relatively lower-priced units (assuming rising prices) will result in a low cost of
goods sold amount and a correspondingly higher gross margin. This may present a
dilemma to a company. If the company sells the lower-priced units, its net income
will improve, but higher taxes will have to be paid. To avoid facing this situation, a
company might buy inventory at the end of the year to avoid these consequences of
a liquidation. Unfortunately, the somewhat forced purchase of inventory to avoid the
liquidation may not be in the best interests of the company.
20. FIFO, LIFO, and weighted average are all cost-based methods to value inventory.
These three methods assign historical costs to inventory. Many accountants argue
that the use of historical cost in valuing inventory leads to what is called inventory
profit, particularly when FIFO is used in a period of rising prices. In a period of rising
prices, FIFO can result in significant inventory profits. In comparison with LIFO, the
use of FIFO in a period of rising prices charges less to cost of goods sold because it
is the older, lower-priced units that are assumed to be sold. However, in a period of
significant inflation, there may be a large difference between the gross margin that
results from using FIFO and the much smaller amount that would result from using
the current cost of the inventory (replacement cost). This difference, called inventory
profit, is simply the result of holding the units during a period of inflation. However, a
replacement cost approach is not acceptable under the professions current
standards, although many believe it provides more relevant information to users.
21. No, it is not acceptable for a company to indicate to its stockholders that it is
switching to LIFO to save on taxes. While the ability to save taxes may be an
important
result of the change, the company must be able to demonstrate that LIFO does a
better job of matching costs with revenues. This is normally the justification offered in
the annual report for a companys change to LIFO.
22. Because a certain section of the warehouse is double-counted, ending inventory will
be overstated. According to the cost of goods sold model, ending inventory is
subtracted from cost of goods available to sell to arrive at cost of goods sold
expense. Therefore, an overstatement of ending inventory will lead to an
understatement of cost of goods sold expense. An understatement of an expense
results in an overstatement of net income for the period.
23. The lower-of-cost-or-market rule is invoked when the utility of inventory is less than
its cost to the company. It is a departure from the historical cost principle and is
justified on the basis of conservatism. The rule is a reaction to uncertainty by
anticipating a decline in the value of inventory and writing down the asset before it is
sold.
5-9
24. Application of the lower-of-cost-or-market rule on a total basis, compared with an

item-by-item basis, will usually yield a different result. The reason is that with the
total approach, increases in market value above cost are allowed to offset decreases
in value. Alternatively, when the item-by-item approach is used, any increases in
value are essentially ignored and it is the declines in value for each item that are
recognized.
25. Inventory turnover equals cost of goods sold (cost of sales) divided by average
inventory. If the cost of sales remains constant while the denominator (average
inventory) increases, inventory turnover will decrease. This indicates that inventory
is staying on the shelf for a longer time. The company should probably evaluate the
salability of its inventory.
26. When a perpetual inventory system is used, the dollar amount of inventory is
calculated after each sale. Thus, when it is used in conjunction with the weighted
average cost method, a new average cost is calculated after each sale. The
weighted average changes each time a sale is made; therefore, the unit cost is
called a moving average.
5-10
BRIEF EXERCISES
LO 1
BRIEF EXERCISE 5-1 TYPES AND FORMS OF INVENTORY COSTS FOR A

MANUFACTURER
The three types of cost incurred by a manufacturer are direct or raw materials, direct
labor, and manufacturing overhead. The three forms that inventory can take for a
manufacturer are direct or raw materials, work in process or work in progress, and
finished goods.
LO 2
BRIEF EXERCISE 5-2 NET SALES
Sales revenue
Less: Sales returns and allowances
Sales discounts
Net sales
LO 3
$ 85,000
6,500
6,500
$ 72,000
BRIEF EXERCISE 5-3 COST OF GOODS SOLD
Purchases: I
Beginning inventory: I
Purchase discounts: D
Transportation-in: I
Ending inventory: D
Purchase returns and allowances: D
LO 4
BRIEF EXERCISE 5-4 GROSS PROFIT RATIO
Gross profit ratio: ($50,000 $30,000)/$50,000 = 40%
LO 5
BRIEF EXERCISE 5-5 VALUATION OF INVENTORY AND MEASUREMENT OF

INCOME
Examples of costs that should be added to the purchase price of inventory are freight
costs on purchases, insurance during the time inventory is in transit, storage costs
before inventory is ready to be sold, and various taxes such as excise and sales taxes.
LO 6
5-11
BRIEF EXERCISE 5-6 INVENTORY COSTING METHODS
Ending Inventory:
FIFO: 500 $6 = $3,000
LIFO: 500 $5 = $2,500
LO 7
BRIEF EXERCISE 5-7 SELECTING AN INVENTORY COSTING METHOD
Cost of goods sold: L

Gross profit: H
Income before taxes: H
Income taxes: H
Cash outflow: H
LO 8
BRIEF EXERCISE 5-8 INVENTORY ERROR
If ending inventory is overstated by $50,000, then cost of goods sold will be understated
by $50,000 and gross profit will overstated by $50,000. Net income will be overstated,
but the effect of the overstatement will not be for the same amount because of the effect
of taxes. Retained earnings will also be overstated.
Hint: To summarize, if ending inventory is overstated, then cost of goods sold will be
understated and both net income and retained earnings will be overstated. On the other
hand, if ending inventory is understated, then cost of goods sold is overstated and both
net income and retained earnings will be understated.
LO 9
BRIEF EXERCISE 5-9 LOWER-OF-COST-OR-MARKET RULE
Journal Dec. 31 Loss on Decline in Value of Inventory.....

Entry
Inventory.............................................
Analysis
To record decline in value of inventory.
Balance Sheet
ASSETS
Inventory
(20,000)
LIABILITIES
20,000
20,000
Income Statement
+
STOCKHOLDERS
EQUITY
(20,000)
REVENUES
EXPENSES
Loss on Decline
in Value of
Inventory
20,000
NET
INCOME
(20,000)
5-12
LO 10
BRIEF EXERCISE 5-10 INVENTORY TURNOVER
Company As inventory turnover is $10,000,000/$100,000, or 100 times. Company Bs

turnover is $10,000,000/$1,000,000, or 10 times. Company A with the much higher
turnover is the wholesaler of fresh fruits and vegetables. Company B is the car dealer
because its inventory would not turn over nearly as often given the nature of its
products.
LO 11
BRIEF EXERCISE 5-11 CASH FLOW EFFECTS
The increase in inventory would be deducted from net income on the statement of cash
flows prepared using the indirect method since the buildup of inventory required cash
outflow. The increase in accounts payable would be added to net income since this
indicates a net cash inflow.
LO 12
BRIEF EXERCISE 5-12 INVENTORY METHODS USING A PERPETUAL SYSTEM
Yes, the dollar amount assigned to ending inventory will differ when a company uses the
average cost method, depending on whether a periodic or perpetual system is used.
This is because when the average method is applied in a perpetual system a new
average has to be computed each time a purchase is made, resulting in a moving
average.
5-13
EXERCISES
LO 1
EXERCISE 5-1 CLASSIFICATION OF INVENTORY COSTS
Inventory Item
Fabric
Lumber
Unvarnished tables
Chairs on the showroom floor
Cushions
Decorative knobs
Drawers
Sofa frames
Chairs in the plant warehouse
Chairs in the retail storeroom
Raw
Material
Classification
Work in
Finished Merchandise
Process
Goods
Inventory
X
X
X
X
X
X
X*
X
X
X
X
*Cushions produced by the company would be work in process, but if purchased from a
supplier, they would be raw materials.
LO 1
EXERCISE 5-2 INVENTORIABLE COSTS
List price: $100 200 units.................................................................

Less: 10% volume discount................................................................
Freight costs........................................................................................
Insurance for goods in transit..............................................................
Total cost........................................................................................
$20,000
(2,000)
56
32
$18,088
Under the cost principle, all of these costs are necessary to put the inventory into a
position where it can be sold.
Other classifications:
The phone charges and purchasing department salary would both be difficult to match
directly with the sale of any particular product and therefore should be treated as
operating expenses of the period. The labeling supplies are immaterial in amount and
should also be reported as operating expenses. The interest paid to suppliers is a
financing cost and would be reported as interest expense on the income statement.
5-14
LO 2
EXERCISE 5-3 PERPETUAL AND PERIODIC INVENTORY SYSTEMS
1. Company A is using a perpetual inventory system because it has the account Cost of
Goods Sold. Company B is using the periodic inventory system because it uses the
accounts Purchases, Purchase Discounts, and Purchase Returns and Allowances.
2. Assuming no losses due to theft, breakage or shrinkage, Company As end-of-year
inventory is the balance in its Merchandise Inventory account, $12,000. Its cost of
goods sold is $38,000, the balance in that account.
3. Cost of goods sold in a periodic system is computed as: Beginning inventory + net
purchases ending inventory. Company Bs Merchandise Inventory account
represents beginning inventory. Ending inventory is obtained by conducting a
physical count. Because you are not given the ending inventory figure, you cannot
compute cost of goods sold.
LO 2
EXERCISE 5-4 PERPETUAL AND PERIODIC INVENTORY SYSTEMS
PerpetualAppliance store
PerpetualCar dealership
PeriodicDrugstore
PerpetualFurniture store
PeriodicGrocery store
PeriodicHardware store
PerpetualJewelry store
Changes in technology may lessen the costs of maintaining perpetual inventory
systems. Merchandisers will convert to perpetual inventory systems when the benefits
of maintaining such systems exceed the costs.
5-15
EXERCISE 5-5 MISSING AMOUNTS IN COST OF GOODS SOLD MODEL
LO 3
Case 1:
(a) Beginning inventory: cost of goods available for sale cost of goods purchased =
$7,110 ($6,230 $470 $200 + $150) = $7,110 $5,710 = $1,400
(b) Ending inventory: cost of goods available for sale cost of goods sold = $7,110
$5,220 = $1,890
Case 2: (must first solve d, then c)
(d) Cost of goods available for sale: cost of goods sold + ending inventory = $5,570 +
$1,750 = $7,320
(c) Purchase discounts:
1. Cost of goods available for sale beginning inventory = cost of goods
purchased = $7,320 $2,350 = $4,970
2. Gross purchases purchase returns and allowances purchase discounts +
transportation-in = cost of goods purchased; $5,720 $800 purchase discounts
+ $500 = $4,970; purchase discounts = $5,420 $4,970 = $450
Case 3:
(e) Gross purchases:
1. Cost of goods purchased = cost of goods available for sale beginning
inventory = $8,790 $1,890 = $6,900
2. Gross purchases purchase returns and allowances purchase discounts +
transportation-in = cost of goods purchased; gross purchases $550 $310 +
$420 = $6,900; gross purchases = $6,900 + $550 + $310 $420 = $7,340
(f) Cost of goods sold = cost of goods available for sale ending inventory = $8,790
$1,200 = $7,590
5-16
LO 3
EXERCISE 5-6 PURCHASE DISCOUNTS
Journal July 3
Entry
Analysis
Purchases................................................
3,500
Accounts Payable..............................
To record purchases of merchandise on credit.
Balance Sheet
ASSETS
LIABILITIES
Income Statement
+
Accounts Payable 3,500
Journal July 6
Entry
Analysis
STOCKHOLDERS
EQUITY
REVENUES
(3,500)
LIABILITIES
STOCKHOLDERS
EQUITY
REVENUES
(7,000)
3,500
EXPENSES
Purchases
Balance Sheet
LIABILITIES
NET
INCOME
(3,500)
7,000
Income Statement
Journal July 12 Accounts Payable....................................

Entry
Cash...................................................
Analysis
Purchase Discounts...........................
To record payment on account:
$3,500 0.01($3,500) = $3,465.
Purchases................................................
7,000
To record the purchase of merchandise on credit.
ASSETS
EXPENSES
Purchases
Balance Sheet
ASSETS
3,500
NET
INCOME
7,000
(7,000)
3,500
3,465
35
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
Cash (3,465)
NET
INCOME
Accounts
35
Purchase
Payable
(3,500)
Discounts*
(35)
*The Purchase Discounts account has increased. It is shown as a decrease because it is a contra-purchases account and causes
expenses to decrease.
Journal Aug. 5
Entry
Analysis
Accounts Payable....................................
Cash...................................................
To record payment on account.
Balance Sheet
ASSETS
Cash (7,000)
LIABILITIES
Accounts
Payable
35
7,000
7,000
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
NET
INCOME
(7,000)
EXERCISE 5-7 PURCHASESPERIODIC SYSTEM
LO 3
Journal Mar. 3
Entry
Analysis
Purchases................................................
To record purchases on credit.
Balance Sheet
ASSETS
LIABILITIES
Journal Mar. 3
Entry
Analysis
STOCKHOLDERS
EQUITY
REVENUES
Purchases
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
STOCKHOLDERS
EQUITY
REVENUES
(250)
1,400
(1,400)
EXPENSES
Purchases
Balance Sheet
Cash (2,450)
NET
INCOME
1,400
Journal Mar. 12 Accounts Payable....................................

Entry
Cash...................................................
Analysis
To record payment for purchases on credit:
$2,500 0.02($2,500) = $2,450.
LIABILITIES
Income Statement
(2,500)
Transportation-In 250
Balance Sheet
ASSETS
2,500
250
Purchases................................................
LIABILITIES
NET
INCOME
250
(250)
Income Statement
(250)
ASSETS
EXPENSES
Transportation-In.....................................
Cash...................................................
To record payment of freight costs.
LIABILITIES
Journal Mar. 7
Entry
Analysis
2,500
(2,500)
Balance Sheet
ASSETS
2,500
Income Statement
Cash
5-17
NET
INCOME
1,400
(1,400)
2,500
2,450
50
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
NET
INCOME
Accounts
50
Purchase
Payable
(2,500)
Discounts*
(50)
50
5-18
EXERCISE 5-7 (Continued)

Entry
Purchase Returns and Allowances....
Analysis
To record credit on defective merchandise.
Balance Sheet
ASSETS
LIABILITIES
500
500
Income Statement
+
Accounts Payable (500)
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
NET
INCOME
500
Purchase Returns and

500
Allowances* (500)
*The Purchase Returns and Allowances account has increased. It is shown as a decrease because it is a contra-purchases account and
causes expenses to decrease.
Journal Mar. 18 Purchases................................................

Entry
Analysis
Balance Sheet
ASSETS
LIABILITIES
1,600
1,600
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
(1,600)
EXPENSES
Purchases

Entry
Purchase Returns and Allowances....
Analysis
To record credit on returned merchandise.
Balance Sheet
ASSETS
LIABILITIES
1,600
NET
INCOME
(1,600)
400
400
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
NET
INCOME
Purchase Returns and

400
Allowances*
(400)
*The Purchase Returns and Allowances account has increased. It is shown as a decrease because it is a contra-purchases account and
causes expenses to decrease.
Journal Apr. 6
Entry
Analysis
400
Accounts Payable....................................
Cash...................................................
$1,400 $500.
Balance Sheet
ASSETS
Cash
(900)
LIABILITIES
900
900
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
NET
INCOME
5-19
EXERCISE 5-7 (Concluded)
Journal Apr. 18 Accounts Payable....................................

Entry
Cash...................................................
Analysis
$1,600 $400.
Balance Sheet
ASSETS
Cash (1,200)
LO 3
LIABILITIES
Accounts
Payable
1,200
1,200
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
NET
INCOME
(1,200)
EXERCISE 5-8 SHIPPING TERMS AND TRANSFER OF TITLE
1. The seller pays shipping costs when merchandise is shipped FOB destination point.
Miller Wholesalers pays the freight bill and is responsible for the merchandise until it
gets to Michaels warehouse.
2. The inventory should not be included as an asset on Michaels December 31, 2012,
balance sheet because the terms of shipment indicate that the merchandise does
not legally belong to Michael until it arrives, and this is after the end of the year.
Likewise, Miller should not include the sale on its 2012 income statement, since the
goods are not considered sold until they reach the buyers business.
3. If the terms of shipment were FOB shipping point, the answers to both questions in
part (2) above would change. Under these terms, the inventory belongs to Michael
as soon as it is shipped, and because this is on December 23, 2012, the asset
should be recognized on the year-end balance sheet. Similarly, Miller would record a
sale in 2012.
LO 3
EXERCISE 5-9 TRANSFER OF TITLE TO INVENTORY
Purchases of merchandise that are in transit from vendors to Cameron Companies on

December 31, 2012:
D: Shipped FOB shipping point
J: Shipped FOB destination point
Sales of merchandise that are in transit to customers of Cameron Companies on
December 31, 2012:
D: Shipped FOB shipping point
J: Shipped FOB destination point
5-20
LO 4
EXERCISE 5-10 WORKING BACKWARD: GROSS PROFIT RATIO
The prior years gross profit ratio was ($120,000 $90,000)/$120,000 = 25%. The ratio
increased this year by 20%, which means it must be 1.2 25% = 30%. Cost of goods
sold in the current year is $140,000, which means sales must be $140,000/(1 0.30)
200,000.
LO 5
EXERCISE 5-11 INVENTORY AND INCOME MANIPULATION
By ignoring the large order at year-end, and thus including the inventory in the year-end
count, the company will overstate ending inventory. This in turn will lead to an understatement of cost of goods sold and an overstatement of net income. The effects on
next years income are the opposite. Because beginning inventory will be overstated,
cost of goods sold will also be overstated and net income understated. The accountant
has an obligation to the financial statement users to convince the president to make the
necessary adjustments to reduce the inventory balance regardless of whether the
company follows IFRS or U.S. GAAP.
LO 6
EXERCISE 5-12 INVENTORY COSTING METHODS
1. Ending inventory:
(65 55)
(50 35)
(60 45)
(45 5)
80 units
$20
$22
$23
$24
Cost of goods sold:

55 $20
35 $22
45 $23
5 $24
140 units
45 $24
35 $23
80 units
= $ 200
=
330
=
345
=
960
$1,835
= $1,100
=
770
= 1,035
=
120
$3,025
= $1,080
=
805
$1,885
Cost of goods sold:

65 $20 = $1,300
50 $22 = 1,100
25 $23 =
575
140 units
5-21
$2,975
65 $20
15 $22
80 units
= $1,300
=
330
$1,630
Cost of goods sold:

45 $24 = $1,080
60 $23 = 1,380
35 $22 =
770
140 units
$3,230
4. Cost of goods available for sale and units available:
65 $20 = $1,300
50 $22 = 1,100
60 $23 = 1,380
45 $24 = 1,080
220 units
$4,860
Weighted average cost = $4,860/220 = $22.09/unit
Ending inventory: 80 $22.09 = $1,767.20
Cost of goods sold: 140 $22.09 = $3,092.60
Note: Ending inventory and cost of goods sold do not total $4,860 because of
rounding of average cost. Regardless of the inventory method used, the total
amount allocated between cost of goods sold and ending inventory should be the
same:
Specific identification = $1,835 + $3,025 = $4,860
FIFO
= $1,885 + $2,975 = $4,860
LIFO
= $1,630 + $3,230 = $4,860
Weighted average
= $1,767 + $3,093 = $4,860
LO 7
EXERCISE 5-13 EVALUATION OF INVENTORY COSTING METHODS
1. a
4. c
7. b
2. d
5. b
8. c
3. c
6. a
9. d
5-22
LO 8
EXERCISE 5-14 INVENTORY ERRORS
Balance Sheet
Retained
Inventory
Earnings
U
U
O
O
U
U
1.
2.
3.
Income Statement
Cost of
Net
Goods Sold
Income
O
U
U
O
O
U
Hint: To summarize, if ending inventory is understated, then cost of goods sold is

overstated, but both net income and retained earnings will be understated. On the other
hand, if ending inventory is overstated, then cost of goods sold will be understated, but
both net income and retained earnings will be overstated.
LO 3
EXERCISE 5-15 TRANSFER OF TITLE TO INVENTORY
1. Michelson should include the costs in its inventory since the merchandise had not
arrived at its destination, PJs, by the end of the year and it belongs to Michelson
until arrival.
2. Filbrandt should include the costs of the merchandise in its inventory since it has
received the shipment by the end of the year.
3. Randall should include the merchandise in its inventory since the shipment left
James Bros. before the end of the year and it belongs to Randall upon shipment.
4. Barner should include the merchandise in its inventory. It is both shipped by Hinz
and received by Barner before the end of the year.
LO 10
EXERCISE 5-16 INVENTORY TURNOVER FOR NORDSTROM
1. Inventory turnover for 2010 = Cost of goods sold/Average inventory = $5,897/[($977

+ $898)/2] = $5,897/$937.5 = 6.29 times
2. The average length of time it takes to sell an item of inventory can be estimated by
dividing the number of times inventory turns over in a year into the number of days in a
year:
(assuming 360 days in a year): 360/6.29 times = 57.2, or approximately 57 days
5-23
3. It is difficult to determine from the information given whether 57 days is reasonable

as the average length of time it takes to sell inventory. Other information needed to
make this determination includes:
The historical average number of days.
The industry norms for large, national retailers.
Any recent changes in types of inventory, customer base, markets for the
products, and other relevant factors.
LO 10
EXERCISE 5-17 WORKING BACKWARD: INVENTORY TURNOVER
If it takes the company 90 days to sells its inventory, the inventory turnover ratio is
360/90 = 4 times per year. The inventory turnover ratio is:
Cost of goods sold/Average inventory = 4 times
$60,000/Average inventory = 4 times
Average inventory = $60,000/4 = $15,000
If the beginning inventory is $17,000, the ending inventory must be $13,000 to result in
an average of $15,000.
LO 11
EXERCISE 5-18 IMPACT OF TRANSACTIONS INVOLVING INVENTORIES ON

STATEMENT OF CASH FLOWS
Increase in accounts payable: A

Decrease in accounts payable: D
Increase in inventories: D
Decrease in inventories: A
5-24
LO 11
EXERCISE 5-19 EFFECTS OF TRANSACTIONS INVOLVING INVENTORIES ON THE

STATEMENT OF CASH FLOWSDIRECT METHOD
Cash payments for inventory to be reported in the operating activities of Mastheads

2012 statement of cash flows (direct method):
Inventory, December 31, 2011....................................................
Plus: Purchases during 2012......................................................
Less: Cost of goods sold during 2012........................................
Inventory, December 31, 2012....................................................
$180,400 + X $1,200,000 = $241,200
X = $1,260,800*
Accounts payable, December 31, 2011......................................

Plus: Purchases during 2012 (from above)................................
Less: Cash payments during 2012.............................................
Accounts payable, December 31, 2012......................................
$85,400 + $1,260,800 X = $78,400
X = $1,267,800
LO 11
180,400
X
(1,200,000)
$ 241,200
85,400
1,260,800*
(X)
$
78,400
EXERCISE 5-20 EFFECTS OF TRANSACTIONS INVOLVING INVENTORIES ON THE

STATEMENT OF CASH FLOWSINDIRECT METHOD
Cash flows from operating activities:

Net income..........................................................................
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in inventory ($241,200 $180,400)...............
Decrease in accounts payable ($78,400 $85,400)....
Cash flows from operating activities...................................
$ xx,xxx
$(60,800)
(7,000)
(67,800)
$ xx,xxx
5-25
M U LTI - C O N C E P T E X E R C I S E S
LO 2,3
EXERCISE 5-21 INCOME STATEMENT FOR A MERCHANDISER
a. Sales Net sales = Sales returns and allowances

$125,600 $122,040 = $3,560
b. Do (c) first. Net purchases + Purchase discounts = Purchases
$74,600 + $1,300 = $75,900
c. Cost of goods purchased Transportation-in = Net purchases
$81,150 $6,550 = $74,600
d. Net sales Gross profit = Cost of goods sold
$122,040 $38,600 = $83,440
e. Cost of goods available for sale Cost of goods sold = Ending inventory
$104,550 $83,440 = $21,110
f. Gross profit Income before tax = Operating expenses
$38,600 $26,300 = $12,300
g. Income before tax Income tax expense = Net income
$26,300 $10,300 = $16,000
5-26
LO 2,3
EXERCISE 5-22 PARTIAL INCOME STATEMENTPERIODIC SYSTEM
LAPINE COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2012
Sales........................................................................
Less: Sales returns and allowances.......................
Sales discounts.............................................
Net sales..................................................................
Less cost of goods sold:
Beginning inventory............................................
Purchases...........................................................
Less: Purchase returns and allowances...........
Purchase discounts.................................
Net purchases....................................................
Add: Transportation-in........................................
Cost of goods purchased...................................
Cost of goods available for sale.........................
Less: Ending inventory.......................................
Cost of goods sold..............................................
Gross profit...............................................................
$80,000
$
500
1,200
1,700
$78,300
$ 4,000
$30,000
400
800
$28,800
1,000
29,800
$33,800
3,800
30,000
$48,300
The gross profit ratio is ($48,300/$78,300) 61.7%.
LO 3,6
EXERCISE 5-23 COST OF GOODS SOLD, FIFO, AND LIFO
Cost of goods available for sale:

200 units $5 =
500 units $6 =
300 units $7 =
Cost of goods available for sale
$1,000
3,000
2,100
$6,100
If the cost of goods sold expense using FIFO amounted to $4,000, the company must
have sold the 700 units from the first two layers of inventory because the cost of these
two is $1,000 + $3,000 = $4,000. Under LIFO, cost of goods sold for 700 units sold
would be computed as:
300 units $7 = $2,100
400 units $6 = 2,400
Cost of goods sold, LIFO $4,500
LO 4,6
5-27
EXERCISE 5-24 WEIGHTED AVERAGE COST METHOD AND GROSS PROFIT

RATIO
1. Beginning inventory 2,000 units $ 6 = $ 12,000

Purchases:
5,000 units $ 8 = 40,000
8,000 units $10 = 80,000
Cost of goods available for sale
$132,000
Units available for sale
15,000
Weighted average cost
$
8.80 per unit
Cost of goods sold expense = $8.80 9,000 units sold = $79,200
2. Sales =
$15 9,000 units = $135,000
Cost of goods sold expense (from above)
79,200
Gross profit
$ 55,800
Gross profit ratio: $55,800/$135,000 = 41.3%
LO 6,7
EXERCISE 5-25 INVENTORY COSTING METHODSPERIODIC SYSTEM
1. a. Weighted average method:

Cost of goods available for sale and units available:
200
300
400
250
150
1,300
$10
=
$11
$12
$13
$15 =
$
=
=
=
2,000
3,300
4,800
3,250
2,250
$15,600
Weighted average cost = $15,600/1,300 = $12 per unit

Units available
1,300
Units sold
1,000
Units in ending inventory
300
Cost of ending inventory = 300($12) = $3,600
Cost of goods sold = 1,000($12) = $12,000
5-28
b. FIFO method:
Ending inventory cost:
150
$15
150
$13 =
300
Cost of goods sold:
200
$10 =
300
$11
400
$12
100
$13 =
1,000
$2,250
1,950
$4,200
$
=
=
2,000
3,300
4,800
1,300
$11,400
(OR: $15,600 $4,200 = $11,400)

c. LIFO method:
Ending inventory cost:
200
$10
100
$11 =
300
Cost of goods sold:
150
$15 =
250
$13
400
$12
200
$11 =
1,000
$2,000
1,100
$3,100
$
=
=
2,250
3,250
4,800
2,200
$12,500
(OR: $15,600 $3,100 = $12,500)

2. LIFO cost of goods sold...........................................
FIFO cost of goods sold...........................................
Difference in expenses............................................
Tax rate.................................................................
Difference in taxes...................................................
$12,500
11,400
$ 1,100
0.30
$ 330
Conclusion: Because FIFO results in less cost of goods sold, higher income will be
reported, and thus, higher taxes, $330, will be due using FIFO rather than LIFO.
Note: Regardless of the inventory method used, the total amount allocated between
cost of goods sold and ending inventory should be the same:
Weighted average = $3,600 + $12,000 = $15,600
FIFO
= $4,200 + $11,400 = $15,600
LIFO
= $3,100 + $12,500 = $15,600
5-29
3. If Carter Inc. prepares its financial statements in accordance with IFRS, it is not
allowed to use LIFO. Under IFRS, LIFO cannot be used; so the weighted average
method will result in the largest cost of goods sold, the lowest income, and
consequently the lowest income tax for Carter.
LO 5,9
EXERCISE 5-26 LOWER-OF-COST-OR-MARKET RULE
Conservatism is the rationale for carrying inventory on the balance sheet at an amount
less than its cost. It is a departure from the historical cost principle and is used when the
utility of the inventory, as measured by the cost to replace it, is less than the original
cost.
Two accounts are affected by the application of the lower-of-cost-or-market rule. An
income statement account, such as Loss on Decline in Value of Inventory, is debited,
and the Inventory account on the balance sheet is credited or reduced.
The effect of writing down inventory is the reduction of the income of the current year
by the amount debited to the loss account. In future years, however, income will be
higher because of the write-down. This occurs because cost of goods sold will be lower
in the future when the inventory that was written down to a lower amount is eventually
sold.
LO 3,11
EXERCISE 5-27 WORKING BACKWARD: COST OF GOODS SOLD AND THE

Because the change in the Inventory account during the period of $6,000 was added on
the statement of cash flows, the inventory decreased during the period by this amount.
Cost of goods sold was $50,000. Therefore, the company purchased $6,000 less than
what it sold, or $50,000 $6,000 = $44,000.
5-30
EXERCISE 5-28 INVENTORY COSTING METHODSPERPETUAL SYSTEM

(Appendix)
LO 7,12
1. a. Moving average:
Purchases
Unit Total
Units Cost Cost
Date
1/1
2/12
3/5
4/30
6/12
7/7
8/23
9/6
10/2
12/3
Units
Sales
Unit
Cost
150 $10
300
400
Total
Cost
$ 1,500
$11 $3,300
12
200
10.857
2,171
200
11.689
2,338
300
12.235
3,670
150
13.158
1,974
4,800
250
13
3,250
150
15
2,250
Cost of goods sold
$11,653
Units
200
50
350
150
550
350
600
300
450
300
Balance
Unit
Cost Balance
$10
$2,000
10
500
10.8571
3,800
10.857
1,629
11.6892
6,429
11.689
4,091
3
12.235
7,341
12.235
3,671
13.1584
5,921
13.158
$3,947
Ending inventory
All amounts rounded to agree with total cost.

1
50
300
350
$10
11
= $ 500
= 3,300
$3,800;
$3,800/350 = $10.857
2 150
400
550
$10.857 = $1,629
12
= 4,800
$6,429;
$6,429/550 = $11.689
3 350
250
600
$11.689 = $4,091
13
= 3,250
$7,341;
$7,341/600 = $12.235
4 300
150
450
$12.235 = $3,671
15
= 2,250
$5,921;
$5,921/450 = $13.158
5-31
1. b. FIFO:
Date
1/1
2/12
3/5
Purchases
Unit Total
Units Cost Cost
300
400
12
250
13
12/3
$10
$ 1,500
50
150
10
11
500
1,650
150
50
11
12
1,650
600
3,250
9/6
10/2
150
4,800
7/7
8/23
Total
Cost
$11 $3,300
4/30
6/12
Units
Sales
Unit
Cost
300
150
15
12
3,600
2,250
50
100
Cost of goods sold
12
13
600
1,300
$11,400
Units
200
50
50
300
Balance
Unit
Cost Balance
$10
$2,000
10
500
10
11
3,800
150
150
400
11
11
12
1,650
350
350
250
50
250
50
250
150
150
150
12
12
13
12
13
12
13
15
13
15
4,200
6,450
7,450
3,850
6,100
$4,200
Ending inventory
5-32
1. c. LIFO:
Date
1/1
2/12
3/5
Purchases
Unit Total
Units Cost Cost
300
Units
400
12
250
13
150
$ 1,500
200
11
2,200
200
12
2,400
250
50
13
12
3,250
600
150
15
2,250
3,250
9/6
10/2
$10
4,800
7/7
8/23
150
$11 $3,300
4/30
6/12
Sales
Unit
Total
Cost
Cost
15
12/3
2,250
Cost of goods sold
2.
Average cost
FIFO
LIFO
EXERCISE 5-25:
E/I
CGS
$3,600
$12,000
4,200
11,400
3,100
12,500
$12,200
Units
$200
50
50
300
50
100
50
100
400
50
100
200
50
100
200
250
50
100
150
50
100
150
150
50
100
150
Balance
Unit
Cost Balance
$10
$2,000
10
500
10
11
3,800
10
11
1,600
10
11
12
6,400
10
11
12
4,000
10
11
12
13
7,250
10
11
12
3,400
10
11
12
15
5,650
10
11
12
$3,400
Ending inventory
EXERCISE 5-28:
E/I
CGS
$3,947
$11,653 Different
4,200
11,400 Same
3,400
12,200 Different
5-33
3. Cost of goods sold:

LIFO...............................................................................................
FIFO...............................................................................................
Difference in expense....................................................................
Tax rate.......................................................................................
Difference in taxes.........................................................................
$12,200
11,400
$ 800
0.30
$ 240
Conclusion: LIFO results in a higher cost of goods sold and therefore a lower taxable
income and lower income tax by $240.
5-34
PROBLEMS
LO 1
PROBLEM 5-1 INVENTORY COSTS IN VARIOUS BUSINESSES
Accounting Treatment
Expense of
Inventory
Other
the Period
Cost
Treatment
Business
Types of Costs
Retail shoe store
Shoes for sale

Shoe boxes
Advertising signs
Canned goods on the shelves
Produce
Cleaning supplies
Cash registers
Wooden frame supplies
Nails
Glass
Paper
Copy machines
Toner cartridges
Frozen food
China and silverware
Prepared food
Spices
Grocery store
Frame shop
Walk-in print shop
Restaurant
X
X
X
X
X
X*
X**
X
X
X
X
X**
X*
X
X**
X
X
*Record as an asset and charge to expense as used.

**Record as an asset and depreciate over estimated useful life (long-term tangible
asset).
LO 4
PROBLEM 5-2 CALCULATION OF GROSS PROFIT RATIO FOR WAL-MART AND

TARGET
1. Gross profit ratios (dollar amounts in millions):

Wal-Mart: 2010*: ($418,952 $315,287)/$418,952 = $103,665/$418,952 = 24.7%
2009*: ($405,132 $304,444)/$405,132 = $100,688/$405,132 = 24.9%
*Wal-Mart labels these as the 2011 and 2010 fiscal years.
Target:
2010: ($65,786 $45,725)/$65,786 = $20,061/$65,786 = 30.5%

2009: ($63,435 $44,062)/$63,435 = $19,373/$63,435 = 30.5%
5-35
2. In terms of the gross profit ratio, Target appears to be performing better, given a
significantly higher ratio in each year. The mix of products sold by the two
companies and the normal markups on the various products could certainly affect
the ratios. A comparison with prior years and industry averages would also be
important to consider.
PROBLEM 5-3 EVALUATION OF INVENTORY COSTING METHODS
LO 7
1. Company B will have the newest costs in inventory because it uses first-in, first-out.
Because costs are rising, it will have the lowest costs of goods sold and thus the
highest net income.
2. Company C will have the oldest costs in inventory because it uses last-in, first-out.
Because costs are rising, it will have the highest cost of goods sold and thus the
lowest income before taxes. Company C will pay the least in taxes.
3. This question does not lend itself to an easy answer. LIFO matches the most recent
costs with the most recent revenue and thus may be a better indicator of future
potential to investors. Inventory profits are not a major concern with LIFO as they are
with FIFO, because the newer (most recent) costs are assigned to cost of sales.
4. Company C would have the oldest costs in inventory because it uses LIFO. Because
costs are falling, it will have the lowest cost of goods sold and the highest net
income.
Company B will have the newest costs in inventory because it uses FIFO.
Because costs are falling, it will have the highest cost of goods sold and the lowest
income before taxes. Company B will pay the least in taxes.
The answer to part (3) is still not easy. There are advantages and disadvantages
in all methods. The important point is to choose one method and stay with it for
consistency.
5-36
LO 8
PROBLEM 5-4 INVENTORY ERROR
1. Revised income statements:

Revenues...........................................................
Gross profit....................................................
Operating expenses...........................................
Net income....................................................
2012
$20,000
13,600**
$ 6,400
3,000
$ 3,400
2011
$15,000
9,400*
$ 5,600
2,000
$ 3,600
*Because ending inventory in 2011 was understated, cost of goods sold was
overstated. Correct amount is $10,000 $600 = $9,400.
**Because beginning inventory in 2012 was understated, cost of goods sold was
understated. Correct amount is $13,000 + $600 = $13,600.
Revised balance sheets:
12/31/12
12/31/11
.........................................................................Cash
$
1,700 $
........................................................................1,500
..................................................................Inventory
4,200
.......................................................................4,100*
................................................Other current assets
2,500
........................................................................2,000
.....................................................Long-term assets
15,000
...................................................................... 14,000
.................................................................................
Total assets
....................................................................$23,400
$21,600
..................................................................Liabilities
$
8,500 $
........................................................................7,000
.............................................................Capital stock
5,000
........................................................................5,000
....................................................Retained earnings
9,900
........................................................................ 9,600
.................................................................................Total liabilities and stockholders
equity........................................................................
$23,400
$21,600
*$3,500 + $600 understatement = $4,100*
2. Net income for two years, before revision: $3,000 + $4,000 = $7,000
Net income for two years, after revision: $3,600 + $3,400 = $7,000
Thus, there is no net over- or understatement.
Retained earnings at December 31, 2012, before the revision: $9,900
Retained earnings at December 31, 2012, after the revision: $9,900
Thus, there is no over- or understatement. This illustrates the nature of a counterbalancing error.
3. Even though the error counterbalances over the two-year period, it is still important
to restate the statements for the two years. It is important for comparative purposes
5-37
that the correct amount of net income be known for each of the two years. The
company needs to restate the income statements for each of the two years and
restate the balance sheets at the end of each year.
5-38
LO 10
PROBLEM 5-5 INVENTORY TURNOVER FOR APPLE COMPUTER AND HEWLETTPACKARD
1. Gross profit ratios:
Net sales/revenue
Less: Cost of sales/product
Gross profit
Divided by sales
Gross profit ratio
Apple Computer
(in millions)
2010
2009
$ 65,225
$ 42,905
39,541
25,683
$ 25,684
$ 17,222
65,225
42,905
39.4%
40.1%
Hewlett-Packard
(in millions)
2010
2009
$ 84,799 $ 74,051
65,064
56,503
$ 19,735 $ 17,548
84,799 74,051
23.3%
23.7%
2. Inventory turnover ratios for 2010:

Apple Computer:
$39,541/[($1,051 + $455)/2] = $39,541/$753 = 52.51 times
Hewlett-Packard:
$65,064/[($6,466 + $6,128)/2] = $65,064/$6,297 = 10.33 times
3. Both Apples and Hewlett-Packards gross profit ratios remained about the same for
both years. Apples turnover is much higher than Hewlett-Packards. Another
measure to consider is the number of days sales in inventory.
Apple Computer:
360/52.51 = 6.86 days
Hewlett-Packard:
360/10.33 = 34.85 days
It takes Apple an average of less than seven days to sell an item of inventory,
whereas Hewlett-Packard requires nearly 35 days.
On the basis of the gross profit ratio, Apple Computer appears to be performing
better. The higher inventory turnover ratio for Apple may be largely due to the nature
of some of the products that Apple sells, such as its iPods, which would be expected
to turn over more quickly than computers.
It would be helpful to measure all of these statisticsgross profit ratio, inventory
turnover, and days sales in inventorywith the same measures for prior years. It
would also be helpful to compare these measures with the industry averages.
LO 11
5-39
PROBLEM 5-6 EFFECTS OF CHANGES IN INVENTORY AND ACCOUNTS PAYABLE

BALANCES ON STATEMENT OF CASH FLOWS
1. Statement of cash flows:

COPELAND ANTIQUES
Net loss..........................................................................................
Adjustments to reconcile net loss to net cash provided by
operating activities:
...........................Decrease in inventory ($192,600 $214,800)
22,200
..................Increase in accounts payable ($123,900 $93,700)
30,200
Cash flows from operating activities..............................................
Cash, December 31, 2011.............................................................
Cash, December 31, 2012.............................................................
$(33,200)
$ 19,200
46,100
$ 65,300
2. Memo to the president:

TO:
President of Copeland Antiques
FROM:
Students name
DATE:
January 20, 2013
SUBJECT: Cash Flows

You recently questioned the increase in the companys cash balance in light of this
years net loss. My thoughts and a copy of the companys 2012 statement of cash
flows follow.
Copeland Antiques was able to generate a significant amount of cash from
operations even though the company incurred an accrual basis net loss of $33,200
during 2012. First, the amount of inventory on hand decreased by $22,200 during
the year from $214,800 to $192,600; this reduction in inventory generated cash for
the company. Second, the amount owed to the companys suppliers increased by
$30,200 during the year from $93,700 to $123,900; the related bills have not yet
been paid.
Operating expenses need to be decreased relative to gross profit if we are to
improve the companys bottom line. I look forward to discussing our plans to turn
things around.
5-40
M U LTI - C O N C E P T P R O B L EM S
PROBLEM 5-7 PURCHASES AND SALES OF MERCHANDISE, CASH FLOWS
LO 2,3,11
1. Journal entries:
Journal Apr. 1
Entry
Analysis
Purchases................................................
500
To record purchase of merchandise on account.
Balance Sheet
ASSETS
LIABILITIES
Accounts Payable
Income Statement
+
500
STOCKHOLDERS
EQUITY
REVENUES
(500)
Balance Sheet
Cash
(485)
LIABILITIES
EXPENSES
Purchases

Entry
Cash...................................................
Analysis
$500 (1 0.03) = $485.
ASSETS
500
NET
INCOME
500
(500)
500
485
15
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
15
NET
INCOME
Purchase
Discounts*
(15)
Journal Apr. 15 Cash........................................................

Entry
Sales Revenue...................................
Analysis
To record cash sale.
Balance Sheet
ASSETS
Cash
200
LIABILITIES
15
200
200
Income Statement
+
STOCKHOLDERS
EQUITY
200
REVENUES
Sales Revenue
200
EXPENSES
NET
INCOME
200
5-41
PROBLEM 5-7 (Continued)
Journal Apr. 18 Purchases................................................

900
Entry
Analysis
To record purchase of merchandise on account.
Balance Sheet
ASSETS
LIABILITIES
Accounts Payable
Income Statement
+
900
STOCKHOLDERS
EQUITY
REVENUES
(900)
Balance Sheet
Cash
LIABILITIES
STOCKHOLDERS
EQUITY
600
REVENUES
Balance Sheet
Cash
(873)
LIABILITIES
NET
INCOME
900
(900)
600
600
EXPENSES
NET
INCOME
Sales Revenue
600
600

Entry
Cash...................................................
Analysis
Purchase Discounts ($900 3%)......
$900 (1 0.03) = $873.
Income Statement
600
ASSETS
EXPENSES
Purchases
Journal Apr. 25 Cash........................................................

Entry
Sales Revenue...................................
Analysis
To record cash sales: 3 $200.
ASSETS
900
900
873
27
Income Statement
+
STOCKHOLDERS
EQUITY
27
REVENUES
EXPENSES
NET
INCOME
Purchase
Discounts*
(27)
27
5-42
PROBLEM 5-7 (Concluded)
2. Net income for April:

Sales revenue ($200 + $600).............................
Cost of goods sold:
Beginning inventory......................................
Purchases ($500 + $900).............................
Less: Purchase discounts ($15 + $27).........
Net purchases...............................................
Cost of goods available for sale..............
Less: Ending inventory..................................
Gross profit...............................................................
Operating expenses:
Rent expense.....................................................
Miscellaneous expense......................................
Total operating expenses..............................
Net income...............................................................
3. Net cash flow from operating activities for April:
Cash collected from sales ($200 + $600)..........
Cash paid for:
Inventory ($485 + $873)................................
Rent...............................................................
Miscellaneous ..............................................
(1,508)
Net cash flow from operating activities...............
OR:
Net income.........................................................
Deduct: Increase in inventory balance...............
Net cash flow from operating activities...............
$ 800
$
$1,400
42
1,358
$1,358
967
391
$ 409
$ 100
50
150
$ 259
$ 800
$1,358
100
50
$ (708)
$ 259
(967)
$ (708)
4. Net income is $259. Net cash flow from operating activities is a negative $708. The
difference of $967 is attributable to inventory that has not been sold. That is, the
company has paid for $1,358 of inventory (a cash outlay) but has only recognized
cost of goods sold expense of $391. The difference is $967.
5-43
PROBLEM 5-8 GAP INC.S SALES, COST OF GOODS SOLD, AND GROSS
PROFIT
LO 2,3,4
1. Apparently, Gap Inc. does not sell its merchandise on account. If customers want to
pay on credit for their purchases, they would use one of the various credit cards that
Gap accepts.
2. Summary journal entry for sales during the year ended January 29, 2011 (millions of
dollars):
Journal Cash....................................................................
Entry
Sales.............................................................
Analysis To record sales.
Balance Sheet
ASSETS
Cash 14,664
LIABILITIES
14,664
14,664
Income Statement
STOCKHOLDERS
EQUITY
14,664
REVENUES
Sales
EXPENSES
14,664
NET
INCOME
14,664
3. Gap Inc. would deduct sales returns and allowances from sales to arrive at the
amount of net sales reported on its income statement. Since Gap Inc. does not have
any accounts receivable on its balance sheet, it is unlikely that it offers sales
discounts to its customers. Either because they do not feel the amounts are material
enough or they would rather not divulge information about returns and allowances to
competitors, some companies choose not to separately report them.
4. Cost of Goods Sold section of 2010 income statement (millions of dollars):
Merchandise inventory, 1/30/10...............................................
Cost of goods purchased1........................................................
Cost of goods available for sale...............................................
Less: Merchandise inventory, 1/29/11......................................
Cost of goods sold2..................................................................
$ 1,477
8,9184
$10,3953
(1,620)
$ 8,775
Including occupancy expenses.

Described as cost of goods sold and occupancy expenses.
3
$8,775 + $1,620 = $10,395
4
$10,395 $1,477 = $8,918
1
2
5-44

(millions of dollars)
...................................................................................Sales
.................................................................................14,197
..............................................................Less: Cost of sales
................................................................................... 8,473
.........................................................................Gross profit
...................................................................................5,724
..................................................................Divided by sales
................................................................................. 14,197
.................................................................Gross profit ratio
..................................................................................40.3%
2010
$
2009
14,664 $
8,775
5,889 $
14,664
40.2%
Gap Inc.s gross profit ratio was virtually unchanged from 2009 to 2010. If the gross
profit does change from one year to the next, any number of factors can be
responsible. These include changes in the selling prices of merchandise, changes in
the costs of goods purchased, and/or changes in the mix of merchandise sold (that
is, a slight shift between selling products that have lower gross profit ratios and
selling those with higher gross profit ratios).
LO 2,3
PROBLEM 5-9 FINANCIAL STATEMENTS
1. Cost of goods sold for 2012:

....................................................Beginning inventory
$
6,400
...................................................................Purchases
$40,200
Less:...................................Purchase discounts
800
....................................................................................Net purchases
$39,400
Add:.........................................Transportation-in
375
....................................................................................Cost of goods purchased
....................................................................................
39,775
....................................................................................Cost of goods available for
sale ....................................................................................
$46,175
Less:........................................Ending inventory
7,500
....................................................................................Cost of goods sold
.......................................................................$38,675
2.
Net income for 2012:

...........................................................................Sales
Less:..............................................Sales returns
....................................................................................
.......................................................................$83,584
$84,364
780
Net sales
5-45
...............................Cost of goods sold [from part (1)]

38,675
.................................................................................... Gross profit
.......................................................................$44,909
..................................................Operating expenses:
....................................................................................
Salaries
$25,600
.................................................................................... Advertising
4,510
....................................................................................
Utilities
3,600
....................................................................................
Depreciation
...........................................................................2,300
...............................................................................Total operating expenses
................................................................... 36,010
Income before tax.......................................................
$ 8,899
....................................................Income tax expense
3,200
Net income..................................................................
$ 5,699
5-46
3.
MAPLE INC.
BALANCE SHEET
AT DECEMBER 31, 2012
Assets
Current assets:
.........................................................................Cash
$
590
.................................................Accounts receivable
2,359
..................................................................Inventory
7,500
...................................................Interest receivable
100
.................................................................................Total current assets
....................................................................$10,549
Property, plant, and equipment:
.........................................................................Land
$20,000
..................................Buildings and equipment, net
55,550
.................................................................................Total property, plant, and
equipment...........................................................................
75,550
Total assets..............................................................
$86,099
...........................................................................Liabilities
................................................................Current liabilities:
............................................................................................
Salaries payable
..........................................................................................$
650
............................................................................................
Income tax payable
............................................................................................
3,200
.................................................................................Total liabilities
$......................................................................3,850
........................................................Stockholders Equity
.......................................................................Capital stock
...............................................................Retained earnings
................................................................................. 82,249
..............................Total liabilities and stockholders equity
...............................................................................$86,099
$50,000
32,249*
*Beginning retained earnings + Net income Dividends

$32,550
+ $5,699
$6,000
LO 5,6,7
5-47
PROBLEM 5-10 COMPARISON OF INVENTORY COSTING METHODS

PERIODIC SYSTEM
1.
Cost of
Inventory
a. Weighted average...................
b. FIFO........................................
c. LIFO.........................................
$11,084
10,776
11,452
a. Beginning inventory600 $5.00 = $ 3,000

Oct.
8800
5.40
=
Oct.
18700
5.76
=
Oct.
29 800
5.90 =
2,900
Ending
Goods
Total
$4,988
5,296
4,620
Sold
$16,072
16,072
16,072
4,320
4,032
4,720
$16,072
Weighted average cost = $16,072/2,900 = $5.542

Units sold: 500 + 700 + 800 = 2,000 units
Units Available Units Sold = Ending Inventory
2,900 2,000 = 900 units
Ending inventory = 900 $5.542 = $4,988
Cost of goods sold = 2,000 $5.542 = $11,084
b. Ending inventory:
800
$5.90
100
5.76 =
900
Cost of goods sold:
600
$5.76=
800
5.40
600
5.00 =
2,000
c. Ending inventory:
600
$5.00
300
5.40 =
900
Cost of goods sold:
500
$5.40
700
5.76
800
5.90 =
2,000
$4,720
576
$5,296
$
=
3,456
4,320
3,000
$10,776
$3,000
1,620
$4,620
=
=
$
2,700
4,032
4,720
$11,452
5-48
2. The Total column represents the pool of costs (beginning inventory plus purchases)
to be distributed between an asset, ending inventory on the balance sheet, and an
expense, cost of goods sold on the income statement. In accounting, this pool of
costs is called cost of goods available for sale, which, regardless of the inventory
method used, should always be the same. For this problem, the cost of goods
available for sale is $16,072.*
Weighted average = $4,988 + $11,084 = $16,072*

FIFO
= $5,296 + $10,776 = $16,072*
LIFO
= $4,620 + $11,452 = $16,072*
3. Income statements for the month of October:
Sales*.................................................
Cost of goods sold.............................
Gross profit.........................................
Operating expenses...........................
Income before taxes...........................
Income tax expense (30%)................
Net income.........................................
Weighted
Average
$20,800
11,084
$ 9,716
3,000
$ 6,716
2,015
$ 4,701
FIFO
$20,800
10,776
$10,024
3,000
$ 7,024
2,107
$ 4,917
LIFO
$20,800
11,452
$ 9,348
3,000
$ 6,348
1,904
$ 4,444
*Sales = 500($10) + 700($10) + 800($11) = $20,800

4. The company will pay $203 more in taxes if it uses FIFO:
FIFO tax..................
LIFO tax..................
Difference................
LO 5,7,12
$2,107
1,904
$ 203
PROBLEM 5-11 COMPARISON OF INVENTORY COSTING METHODS

PERPETUAL SYSTEM (Appendix)
1.
a. Moving average.......................
b. FIFO........................................
c. LIFO.........................................
Cost of
Goods Sold
$10,785
10,776
10,852
Ending
Inventory
$5,287
5,296
5,220
Total
$16,072
16,072
16,072
5-49
PROBLEM 5-11 (Continued)
a. Moving average:
Date
10/1
10/4
10/8
10/9
10/18
10/20
10/29
Purchases
Unit Total
Units Cost Cost
Units
500
800 $5.40
Sales
Unit
Total
Cost
Cost
$5.00
$ 2,500
$4,320
700
5.76
4,032
800
5.90
4,720
700
5.356
3,749
800
5.67
4,536
Cost of goods sold

1 100
800
900
$5.00
5.40
= $ 500
= 4,320
$4,820;
2 200
700
900
$5.356 = $1,071
5.76 = 4,032
$5,103;
3 100
800
900
$5.67
5.90
$10,785
Units
600
100
900
200
900
100
900
Balance
Unit
Cost Balance
$5.00
$3,000
5.00
500
5.3561
4,820
5.356
1,071
5.672
5,103
5.67
567
5.8743 $5,287
Ending inventory
$4,820/900 = $5.356
$5,103/900 = $5.67
= $ 567
= 4,720
$5,287;
$5,287/900 = $5.874
b. FIFO:
Date
10/1
10/4
10/8
Purchases
Unit Total
Units Cost Cost
800 $5.40
Units
700
5.76
$5.00
$ 2,500
100
600
5.00
5.40
500
3,240
4,032
10/20
10/29
500
$4,320
10/9
10/18
200
600
800
5.90
Sales
Unit
Total
Cost
Cost
5.40
5.76
1,080
3,456
4,720
Cost of goods sold
$10,776
Units
600
100
100
800
Balance
Unit
Cost Balance
$5.00
$3,000
5.00
500
5.00
5.40
4,820
200
200
700
5.40
5.40
5.76
1,080
100
100
800
5.76
5.76
5.90
576
5,112
$5,296
Ending inventory
5-50
c. LIFO:
Date
10/1
10/4
10/8
Purchases
Unit Total
Units Cost Cost
800 $5.40
Units
700
5.76
800
5.90
$5.00
$ 2,500
700
5.40
3,780
700
100
5.76
5.40
4,032
540
4,032
10/20
10/29
500
$4,320
10/9
10/18
Sales
Unit
Total
Cost
Cost
4,720
Cost of goods sold
$10,852
Units
600
100
100
800
100
100
100
100
700
100
100
800
Balance
Unit
Cost Balance
$5.00
$3,000
5.00
500
5.00
5.40
4,820
5.00
5.40
1,040
5.00
5.40
5.76
5,072
5.00
5.00
5.90
500
$5,220
Ending inventory
expense, cost of goods sold, on the income statement. In accounting, this pool of
costs is called cost of goods available for sale.
3. Income statements for the month of October:
Sales*............................................................
Cost of goods sold........................................
Gross profit....................................................
Operating expenses......................................
Income before taxes.....................................
Income tax expense (30%)...........................
Net income....................................................
Moving
Average
$20,800
10,785
$10,015
3,000
$ 7,015
2,105
$ 4,910
FIFO
$20,800
10,776
$10,024
3,000
$ 7,024
2,107
$ 4,917
LIFO
$20,800
10,852
$ 9,948
3,000
$ 6,948
2,084
$ 4,864
*Sales = 500($10) + 700($10) + 800($11) = $20,800

FIFO tax..................
LIFO tax..................
Difference................
$2,107
2,084
$ 23
LO 5,6,7
5-51
PROBLEM 5-12 INVENTORY COSTING METHODSPERIODIC SYSTEM
1. Units in beginning inventory.....................................................

Add: Units purchased (250 + 220 + 150 + 200).......................
Units available..........................................................................
Less: Units sold (300 + 380 + 110)..........................................
Units in ending inventory..........................................................
Ending
Inventory
a. FIFO.............................................. $4,410
b. LIFO..............................................
4,155
c. Weighted average.........................
4,301
a. Ending inventory:
200
$19.20
30
19.00 =
230
Cost of goods sold:
200
$18.00
250
18.50
220
18.90
120
19.00
790
200
$18.00
30
18.50 =
230
Cost of goods soldLIFO:
220
$18.50
220
18.90
150
19.00
200
19.20
790
c. Beginning inventory200
Nov. 4
250
Nov. 13
220
Nov. 18
150
Nov. 24
200
$3,840
570
$4,410
=
=
=
=
$
3,600
4,625
4,158
2,280
$14,663
$3,600
555
$4,155
=
=
=
=
$
4,070
4,158
2,850
3,840
$14,918
$18.00
18.50
18.90
19.00
19.20
1,020
Cost of
Goods Sold
$14,663
14,918
14,772
200
820
1,020
790
230
Total
$19,073
19,073
19,073
= $ 3,600
=
4,625
=
4,158
=
2,850
=
3,840
$19,073

Ending inventory = 230 $18.699 = $4,301
Cost of goods sold = 790 $18.699 = $14,772
5-52
2.
Sales*............................................................
Gross profit....................................................
Operating expenses:
Selling and administrative expenses.......
Depreciation.............................................
Net income....................................................
FIFO
$33,480
14,663
$18,817
LIFO
$33,480
14,918
$18,562
Weighted
Average
$33,480
14,772
$18,708
10,800
4,000
$ 4,017
1,406
$ 2,611
10,800
4,000
$ 3,762
1,317
$ 2,445
10,800
4,000
$ 3,908
1,368
$ 2,540
*Sales = (300 $42) + (380 $42.50) + (110 $43) = $33,480

3. Oxendine pays the least taxes under the last-in, first-out method since it has the
highest cost of goods sold.
4. If Oxendine Company prepares its financial statements in accordance with IFRS,
then it is not allowed to use LIFO. Under IFRS, LIFO cannot be used, so the
weighted average method will result in larger cost of goods sold than with FIFO,
lower income, and consequently a lower income tax than with FIFO.
LO 5,6,7
PROBLEM 5-13 INVENTORY COSTING METHODSPERIODIC SYSTEM
1. a. Weighted average:
Beginning inventory
Feb. 4
Apr. 12
Sept. 10
Dec. 5
5,000
3,000
4,000
2,000
1,000
$10
6
15,000
=
=
=
=
=
$ 50,000
27,000
32,000
14,000
6,000
$129,000

Units available for sale
Units sold
Ending inventory
15,000
12,500
2,500 8.60 =
$21,500
Cost of goods sold
12,500 8.60 =
$107,500
5-53
b. FIFO:
Ending inventory
Cost of goods sold
1,000 $ 6 =
1,500 7
2,500
500 $ 7
4,000
3,000
5,000
12,500
$ 6,000
=
$
=
8
9
10
$ 3,500
=
=
=
Ending inventory
2,500 $10 =
$ 25,000
Cost of goods sold
2,500 $10
3,000
4,000
2,000
1,000
12,500
$ 25,000
=
=
=
=
10,500
16,500
32,000
27,000
50,000
$112,500
c. LIFO:
=
9
8
7
6
27,000
32,000
14,000
6,000
$104,000
2. Income statements for the year ended December 31, 2012:
Sales*............................................................
Gross profit....................................................
Net income....................................................
Weighted
Average
$150,000
107,500
$ 42,500
20,000
$ 22,500
6,750
$ 15,750
FIFO
$150,000
112,500
$ 37,500
20,000
$ 17,500
5,250
$ 12,250
LIFO
$150,000
104,000
$ 46,000
20,000
$ 26,000
7,800
$ 18,200
*Sales = 12,500 $12 = $150,000

3. Weaver can minimize its tax bill by using FIFO. In a period of declining prices, FIFO
results in the highest amount of cost of goods sold, the least amount of income
before taxes, and thus the least amount of income tax expense.
4. A company is not free to change inventory methods from year to year to take
advantage of changing patterns in the level of prices. The company needs to be
consistent, and it must be able to justify any change in the method used on some
basis other than saving taxes, such as a better matching of costs with revenues.
5-54
LO 1,7,9
PROBLEM 5-14 INTERPRETING GANNETT CO.S INVENTORY ACCOUNTING

POLICY
1. Newsprint costs are comparable to raw materials in a manufacturing company. A

newspaper company, however, does not keep an inventory of finished goods. Its
newspapers either are sold within hours after being printed or become worthless if
not sold.
2. Some companies use more than one method to value different types of inventory.
The methods should be chosen because they provide the most accurate matching of
costs with the revenues generated. Although Gannett has determined FIFO is
appropriate for most of its inventories, it does use LIFO for certain U.S. newspapers.
5-55
A L T E R N AT E P R O B L E M S
LO 1
PROBLEM 5-1A INVENTORY COSTS IN VARIOUS BUSINESSES
1. Classification of an item as inventory depends on the companys intent. DVDs

offered by the company for resale should be classified as part of inventory and
charged to cost of goods sold at the time they are sold. Alternatively, rental DVDs
are income-producing assets and should not be classified as inventory. They should
be classified as current assets because it is unlikely that any DVDs will be kept as
rentals for more than one year.
2. When DVDs are transferred because they will be offered for resale, the asset
account DVDs for Rent would be credited and the asset account DVD Inventory
would be debited.
LO 4
PROBLEM 5-2A CALCULATION OF GROSS PROFIT RATIO FOR COCA-COLA AND

PEPSICO
1. Gross profit ratios (dollar amounts in millions):

Coca-Cola:
2010: ($35,119 $12,693)/$35,119 = $22,426/$35,119 = 63.9%

2009: ($30,990 $11,088)/$30,990 = $19,902/$30,990 = 64.2%
PepsiCo:
2010: ($57,838 $26,575)/$57,838 = $31,263/$57,838 = 54.1%

2009: ($43,232 $20,099)/$43,232 = $23,133/$43,232 = 53.5%
2. In terms of the gross profit ratios, Coca-Cola has a ratio that is about 10% higher
than PepsiCos. The mix of products sold by the two companies and the normal
markups on the various products could certainly affect the ratios. A comparison with
prior years and industry averages would also be important to consider.
5-56
LO 7
PROBLEM 5-3A EVALUATION OF INVENTORY COSTING METHODS
1. No, the three companies will not be equally affected by the decline in prices. If the
decline continues, Company Y (FIFO) will begin to show higher cost of goods sold
and a lower gross profit than Company Z (LIFO). Because gross profit will be lower,
Company Y will report lower income before tax and thus have less tax to pay.
2. It should be noted that it is not acceptable for a company to change inventory
valuation methods to save taxes. An acceptable explanation of the justification for
the change is this:
During the year recently completed, the company changed its method of valuing
inventory on the balance sheet and recognizing cost of sales on the income
statement. The company changed from the LIFO to the FIFO method because it
believes that the latter results in a better matching of cost of sales with the revenues
of the period.
LO 8
PROBLEM 5-4A INVENTORY ERROR
1. Revised income statements:

2012
............................................................................Revenues
...............................................................................$26,890
..............................................................Cost of goods sold
.............................................................................. 12,094**
10,412*
............................................................................................ Gross profit
...............................................................................$23,888
$16,478
............................................................Operating expenses
................................................................................. 10,578
............................................................................................ Net income
...............................................................................$10,400
$
2011
$35,982
13,488
5,900
*Because ending inventory in 2011 was overstated, cost of goods sold was
understated. Correct amount is $9,912 + $500 = $10,412.
**Because beginning inventory in 2012 was overstated, cost of goods sold was
overstated. Correct amount is $12,594 $500 = $12,094.
Revised balance sheets:
....................................................................................Cash
...................................................................................4,100
.............................................................................Inventory
..................................................................................4,900*
...........................................................Other current assets
...................................................................................1,250
.........................................................Long-term assets, net
................................................................................. 24,600
12/31/12
$
12/31/11
9,400 $
4,500
1,600
24,500
5-57
............................................................................................ Total assets

...............................................................................$40,000
$34,850
.................................................................Current liabilities
$
9,380
...............................................................................$10,600
.......................................................................Capital stock
18,000
.................................................................................18,000
12,620
................................................................................... 6,250
............................................................................................Total
liabilities
and
stockholders equity............................................................
$40,000
$34,850
*$5,400 $500 overstatement = $4,900*
5-58
PROBLEM 5-4A (Concluded)
2. Current ratio:
Before revision:
Cash + Inventory + Other Current Assets

Current Liabilities
$4,100 + $5,400 + $1,250
$10,750
$10,600
= $10,600 = 1.01 to 1
After revision:
$4,100 + $4,900 + $1,250

$10,250
$10,600
= $10,600 = 0.97 to 1
Yes, if the lender required a current ratio of at least 1 to 1, Planter would have been
eligible for the loan with the error. After the correction, however, Planter would not
have been eligible for the loan. The company should notify the bank of the error.
Practically, however, the bank might not consider a current ratio of 0.97 to 1 to be
materially different from a current ratio of 1 to 1 and might be willing to grant the
loan.
3. Net income for two years, before revision: $6,400 + $9,900 = $16,300
Net income for two years, after revision: $5,900 + $10,400 = $16,300
Thus, there is no net over- or understatement of net income for the two-year period.
Retained earnings at December 31, 2012, before the revision: $12,620
Retained earnings at December 31, 2012, after the revision: $12,620
Thus, there is no over- or understatement of retained earnings at December 31,
2012. This illustrates the nature of a counterbalancing error.
4. Even though the error counterbalances over the two-year period, it is still important
to restate the statements for the two years. It is important for comparative purposes
that the correct amount of net income be known for each of the two years. The
company needs to restate the income statements for each of the two years and
restate the balance sheets at the end of each year.
LO 10
5-59
PROBLEM 5-5A INVENTORY TURNOVER FOR WAL-MART AND TARGET
1. Inventory turnover ratios (amounts in millions):

Wal-Mart (year ending January 31, 2011):
$315,287/[($36,318 + $32,713)/2] = $315,287/$34,515.5 = 9.13 times
Target (year ending January 29, 2011):
$45,725/[($7,596 + $7,179)/2] = $45,725/$7,387.5 = 6.19 times
2. Wal-Marts inventory turnover is higher than Targets during the most recent fiscal
year, 9.13 versus 6.19. Another measure to consider is the number of days sales in
inventory:
Wal-Mart:
360/9.13 = 39.43 days
Target:
360/6.19 = 58.16 days
It takes Wal-Mart an average of 39 days to sell an item of inventory; Target requires
an average of 58 days. On the basis of inventory turnover and days sales in
inventory, Wal-Mart appears to be performing better.
It would be helpful to measure these statisticsinventory turnover and days
sales in inventorywith the same measures for prior years. It would also be helpful
to compare these measures with the industry averages.
5-60
LO 11
PROBLEM 5-6A EFFECTS OF CHANGES IN INVENTORY AND ACCOUNTS

PAYABLE BALANCES ON STATEMENT OF CASH FLOWS
1. Statement of cash flows:

CARPETLAND CITY
..........................................................................Net income
$
.................................................................................78,500
Adjustments to reconcile net income to net cash provided
......................................................by operating activities:
............................................................................................Increase
in
inventory
($105,500 $84,900).........................................................
$(20,600)
............................................................................................
Decrease in accounts
payable ($23,900 $93,700)..............................................
(69,800)
(90,400)
...................................Cash flows from operating activities
.............................................................................$(11,900)
..................................................Cash, December 31, 2011
................................................................................. 26,300
..................................................Cash, December 31, 2012
$
................................................................................. 14,400
2. Memo to the president:
TO:
President of Carpetland City
FROM:
Students name
DATE:
January 20, 2013
SUBJECT:
Cash Flows
You recently expressed concern about the decrease in the companys cash
balance in spite of the profitable year that was reported on this years income
statement. My thoughts and a copy of the companys 2012 statement of cash flows
follow.
Although net income on an accrual basis was $78,500, the companys cash
balance declined by $11,900 during the year for two reasons. Most importantly, the
amount owed to the companys suppliers decreased by $69,800 during the year
from $93,700 to $23,900; this decrease in accounts payable drained our cash
balance. In addition, the amount of inventory on hand increased by $20,600 during
the year from $84,900 to $105,500; this increase in inventory required an additional
outflow of cash.
We can better manage our cash flow by carefully timing the payment of bills to
coincide with the due dates on invoices. In addition, we can improve cash flow by
closely monitoring our inventory levels and adding to inventory levels only when
increases in sales warrant an addition.
5-61
A L T E R N AT E M U L T I - C O N C E P T P R O B L E M S
PROBLEM 5-7A PURCHASES AND SALES OF MERCHANDISE, CASH FLOWS
LO 2,3,11
1. Journal entries:
Journal Oct. 1
Entry
Analysis
Purchases................................................
To record purchase of merchandise
on account.
Balance Sheet
ASSETS
LIABILITIES
Accounts Payable
+
249
STOCKHOLDERS
EQUITY
REVENUES
(249)
Cash
(244)
LIABILITIES
EXPENSES
Purchases
Balance Sheet
=
249
Income Statement
Journal Oct. 10 Accounts Payable....................................

Entry
Cash...................................................
Analysis
$249 (1 0.02) = $244.
ASSETS
249
NET
INCOME
249
(249)
249
244
5
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
NET
INCOME
Purchase
Discounts*
(5)
Journal Oct. 15 Cash........................................................

Entry
Sales Revenue...................................
Analysis
To record cash sale.
Balance Sheet
ASSETS
Cash
200
LIABILITIES
200
200
Income Statement
+
STOCKHOLDERS
EQUITY
200
REVENUES
Sales Revenue
200
EXPENSES
NET
INCOME
200
5-62
PROBLEM 5-7A (Continued)
Journal Oct. 18 Purchases................................................

Entry
Analysis
To record purchase of merchandise
on account.
Balance Sheet
ASSETS
LIABILITIES
Accounts Payable
+
800
STOCKHOLDERS
EQUITY
REVENUES
(800)
Cash
LIABILITIES
STOCKHOLDERS
EQUITY
600
REVENUES
Balance Sheet
Cash
(800)
LIABILITIES
800
NET
INCOME
(800)
600
600
EXPENSES
Sales Revenue
600
NET
INCOME
600
Journal Oct. 30 Accounts Payable....................................

Entry
Cash...................................................
Analysis
To record payment on account.
Income Statement
600
ASSETS
EXPENSES
Purchases
Balance Sheet
=
800
Income Statement
Journal Oct. 25 Cash........................................................

Entry
Sales Revenue...................................
Analysis
To record cash sales: 3 $200.
ASSETS
800
800
800
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
NET
INCOME
2. Units on hand on October 31:

.......................................................October 1 purchase
.............................................................October 15 sale
.....................................................October 18 purchase
.............................................................October 25 sale
............................................................Ending inventory
3
(1)
10
(3)
9
units
units
5-63
3. Cash balance at end of month:

................................................Beginning cash balance
......................................................October 10 payment
.............................................................October 15 sale
.............................................................October 25 sale
......................................................October 30 payment
......................................Cash balance at end of month
$2,000
(244)
200
600
(800)
$1,756
The cash balance decreased during the month even though the company reported a
profit because cash outflows exceeded expenses. This was the case because the
entire inventory purchased (and paid for) was not yet sold (expensed).
PROBLEM 5-8A WALGREENS SALES, COST OF GOODS SOLD, AND GROSS

PROFIT
LO 2,3,4
1. Summary journal entries for the year ended August 31, 2010 (in millions):
Journal Cash....................................................................
Entry
Accounts Receivable....................................
Analysis To record collection of beginning accounts
receivable.
Balance Sheet
ASSETS
LIABILITIES
2,496
2,496
Income Statement
+
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
NET
INCOME
Cash 2,496
Accounts
Receivable (2,496)
Journal Accounts Receivable...........................................

Entry
Sales.............................................................
Analysis To record sales on account.
Balance Sheet
ASSETS
Accounts
Receivable 67,420
LIABILITIES
67,420
67,420
Income Statement
STOCKHOLDERS
EQUITY
67,420
REVENUES
Sales
67,420
EXPENSES
NET
INCOME
67,420
5-64
Journal Cash....................................................................
Entry
Accounts Receivable ...................................
Analysis To record cash collections: $67,420 $2,450.
Balance Sheet
ASSETS
LIABILITIES
64,970
64,970
Income Statement
STOCKHOLDERS
EQUITY
REVENUES
EXPENSES
NET
INCOME
Cash 64,970
Accounts
Receivable
(64,970)
2. Walgreens would deduct sales returns and allowances, and the amount of any sales
discounts taken by its customers from sales, to arrive at the amount of net sales
reported on its income statement. Either because they do not feel the amounts are
material enough or they would rather not divulge information about returns and
allowances to competitors, some companies choose not to separately report them.
3. Cost of Goods Sold section of 2010 income statement (in millions):
Inventory, August 31, 2009.......................................................
Cost of goods purchased.........................................................
Cost of goods available for sale...............................................
Less: Inventory, August 31, 2010.............................................
Cost of goods sold....................................................................
$ 6,789
49,033**
$55,822*
(7,378)
$48,444
*$48,444 + $7,378 = $55,822

**$55,822 $6,789 = $49,033
(In millions)
..................................................................Net sales
......................................................................63,335
............................................................Cost of sales
...................................................................... 45,722
...............................................................Gross profit
......................................................................17,613
.................................................Divided by net sales
...................................................................... 63,335
......................................................Gross profit ratio
.......................................................................27.8%
2010
$
2009
67,420 $
48,444
18,976 $
67,420
28.1%
Walgreens gross profit ratio was virtually unchanged from 2009 to 2010. Factors
affecting Walgreens gross profit ratio include changes in the selling prices of
merchandise, changes in the costs of goods purchased, and/or changes in the mix
5-65
of merchandise sold (that is, a slight shift from selling products that have higher
gross profit ratios to selling those with lower gross profit ratios).
5-66
LO 2,3
PROBLEM 5-9A FINANCIAL STATEMENTS
1.............................................Cost of goods sold for 2012:

............................................................Beginning inventory
$
...................................................................................6,400
...........................................................................Purchases
$62,845
...................................................Less: Purchase discounts
1,237
.....................................................................Net purchases
$61,608
........................................................Add: Transportation-in
375
....................................................Cost of goods purchased
................................................................................. 61,983
.........................................Cost of goods available for sale
...............................................................................$68,383
.......................................................Less: Ending inventory
................................................................................... 5,900
............................................................................................Cost of goods sold
............................................................................................
$62,483
2. Net income for 2012:
...................................................................................Sales
$112,768
.............................................................Less: Sales returns
1,008
............................................................................................
Net sales
............................................................................................
$111,760
.......................................Cost of goods sold [from part (1)]
................................................................................. 62,483
............................................................................................ Gross profit
..........................................................................................$
49,277
...........................................................Operating expenses:
............................................................................................
Wages and salaries
expense..............................................................................
$ 23,000
............................................................................................Advertising expense
.................................................................................12,900
............................................................................................
Utilities expense
............................................................................................
1,800
.................................................................................Total operating expenses
.................................................................................
37,700
...............................................................Income before tax
$
.................................................................................11,577
............................................................................................Income tax expense
............................................................................................
1,450
..........................................................................Net income
$
................................................................................. 10,127
5-67
3.
LLOYD INC.
BALANCE SHEET
AT DECEMBER 31, 2012
Assets
....................................................................................Cash
............................................................Accounts receivable
.............................................................................Inventory
............................................................................................ Total assets
............................................................................................
$84,599
Liabilities
.................................................................Salaries payable
$
...................................................................Wages payable
.............................................................Income tax payable
............................................................................................Total liabilities
..........................................................................................$
2,220
$22,340
56,359
5,900
650
120
1,450
Stockholders Equity
.......................................................................Capital stock
$50,000
32,379*
............................................................................................Total stockholders equity
............................................................................................
82,379
..............................Total liabilities and stockholders equity
...............................................................................$84,599
*Beginning retained earnings + Net income Dividends
$28,252
+ $10,127
$6,000
5-68
LO 5,6,7
PROBLEM 5-10A COMPARISON OF INVENTORY COSTING METHODS

PERIODIC SYSTEM
1.
a. Weighted average....................................
b. FIFO.........................................................
c. LIFO.........................................................
a. Beginning inventory
Nov.8
Nov.18
Nov.29
300
500
700
600
Cost of
Ending
Goods Sold Inventory
$5,120
$4,655
4,875
4,900
5,375
4,400
$4.00
4.50
4.75
5.00
2,100
Total
$9,775
9,775
9,775
= $1,200
= 2,250
= 3,325
= 3,000
$9,775

Units sold: 200 + 500 + 400 = 1,100 units
Units Available Units Sold = Ending Inventory
2,100 1,100 = 1,000 units
Ending inventory = 1,000 $4.655 = $4,655
Cost of goods sold = 1,100 $4.655 = $5,120*
*Rounded to agree with total cost.
600
$5.00
=
400
4.75 =
1,900
1,000
Cost of goods sold:
300
$4.00
500
4.50
300
4.75 =
1,100
c. Ending inventory:
300
$4.00
500
4.50
200
4.75 =
1,000
Cost of goods sold:
600
$5.00
500
4.75 =
1,100
$3,000
$4,900
=
=
$1,200
2,250
1,425
$4,875
=
=
$1,200
2,250
950
$4,400
$3,000
2,375
$5,375
5-69
expense, cost of goods sold on the income statement. In accounting, the pool of
3. Income statements for the month of November:
Sales*.................................................................
Gross profit.........................................................
Income before taxes...........................................
Income tax expense (25%).................................
Net income.........................................................
Weighted
Average
$10,100
5,120
$ 4,980
2,000
$ 2,980
745
$ 2,235
FIFO
$10,100
4,875
$ 5,225
2,000
$ 3,225
806
$ 2,419
LIFO
$10,100
5,375
$ 4,725
2,000
$ 2,725
681
$ 2,044
*Sales = 200($9) + 500($9) + 400($9.50) = $10,100

FIFO tax..................
LIFO tax..................
Difference................
LO 5,7,12
$806
681
$125
PROBLEM 5-11A COMPARISON OF INVENTORY COSTING METHODS

PERPETUAL SYSTEM (Appendix)
1.
a. Moving average.......................................
b. FIFO.........................................................
c. LIFO.........................................................
Cost of
Ending
Goods Sold Inventory
$4,892
$4,883
4,875
4,900
4,950
4,825
Total
$9,775
9,775
9,775
5-70
PROBLEM 5-11A (Continued)
a. Moving average:
Purchases
Unit Total
Units Cost Cost
Date
11/1
11/4
11/8
11/9
11/18
11/20
11/29
Units
200
500 $4.50
Sales
Unit
Cost
$4.00
Total
Cost
$ 800
$2,250
700
4.75
3,325
600
5.00
3,000
500
4.417
2,209
400
4.708
1,883
Cost of goods sold
$4,892
Units
300
100
600
100
800
400
1,000
Balance
Unit
Cost Balance
$4.00
$1,200
4.00
400
4.4171
2,650
4.417
441
4.7082
3,766
4.708
1,883
4.8833 $4,883
Ending inventory
All amounts rounded to agree with total cost.

1
100
500
600
$4.00
4.50
= $ 400
= 2,250
$2,650;
$2,650/600 = $4.417
100
700
800
$4.417 = $ 441
4.75 = 3,325
$3,766;
$3,766/800 = $4.708
400
600
1,000
$4.708 = $1,883
5.00 = 3,000
$4,883;
$4,883/1,000 = $4.883
b. FIFO:
Date
11/1
11/4
11/8
Purchases
Unit Total
Units Cost Cost
500 $4.50
Units
700
4.75
200
$4.00
$ 800
100
400
4.00
4.50
400
1,800
3,325
11/20
11/29
100
300
600
5.00
Total
Cost
$2,250
11/9
11/18
Sales
Unit
Cost
4.50
4.75
450
1,425
3,000
Cost of goods sold
$4,875
Units
300
100
100
500
Balance
Unit
Cost Balance
$4.00
$1,200
4.00
400
4.00
4.50
2,650
100
100
700
4.50
4.50
4.75
400
400
600
4.75
4.75
5.00
450
3,775
1,900
$4,900
Ending inventory
5-71
c. LIFO:
Date
11/1
11/4
11/8
11/9
11/18
Purchases
Unit Total
Units Cost Cost
500 $4.50
700
4.75
Units
600
5.00
Total
Cost
200
$4.00
$ 800
500
4.50
2,250
400
4.75
1,900
$2,250
3,325
11/20
11/29
Sales
Unit
Cost
3,000
Cost of goods sold
Units
300
100
100
500
100
100
700
100
300
100
300
600
$4,950
Balance
Unit
Cost Balance
$4.00
$1,200
4.00
400
4.00
4.50
2,650
4.00
400
4.00
4.75
3,725
4.00
4.75
1,825
4.00
4.75
5.00
$4,825
Ending inventory
expense, cost of goods sold on the income statement. In accounting, this pool of
3. Income statements for the month of November:
Sales*.................................................................
Gross margin......................................................
Income tax expense (25%).................................
Net income.........................................................
Moving
Average
$10,100
4,892
$ 5,208
2,000
$ 3,208
802
$ 2,406
FIFO
$10,100
4,875
$ 5,225
2,000
$ 3,225
806
$ 2,419
LIFO
$10,100
4,950
$ 5,150
2,000
$ 3,150
788
$ 2,362
*Sales = 200($9) + 500($9) + 400($9.50) = $10,100

FIFO tax..................
LIFO tax..................
Difference................
$806
788
$ 18
5-72
LO 5,6,7
PROBLEM 5-12A INVENTORY COSTING METHODSPERIODIC SYSTEM
1. Units in beginning inventory.....................................................

Add: Units purchased (375 + 330 + 225 + 300).......................
Units available..........................................................................
Less: Units sold (450 + 570 + 165)..........................................
Units in ending inventory..........................................................
a. FIFO.........................................................
b. LIFO.........................................................
c. Weighted average....................................
a. Ending inventory
300
$25.00
45
25.40 =
345
Cost of goods sold:
300
$27.00
375
26.50
330
26.00
180
25.40
1,185
b.Ending inventory:
300
$27.00
45
26.50 =
345
Cost of goods sold:
300
$25.00
225
25.40
330
26.00
330
26.50
1,185
Ending
Inventory
$8,643
9,293
8,982
$7,500
1,143
$8,643
=
=
=
=
$
8,100
9,938
8,580
4,572
$31,190
$8,100
1,193
$9,293
=
=
=
=
$
7,500
5,715
8,580
8,745
$30,540
300
1,230
1,530
1,185
345
Cost of
Goods Sold
$31,190
30,540
30,851
Total
$39,833
39,833
39,833
5-73
c. Beginning inventory
Nov.4
Nov.13
Nov.18
Nov.24
300
375
330
225
300
1,530
$27.00
26.50
26.00
25.40
25.00
=
=
=
=
=
$ 8,100
9,938
8,580
5,715
7,500
$39,833

Ending Inventory = Units in Ending Inventory Average Cost = 345 $26.035
= $8,982
Cost of Goods Sold = Units Sold Average Cost = 1,185 $26.035 =
$30,851
2.
Sales*.................................................................
Gross profit.........................................................
Operating expenses:
Selling and administrative expenses............
Depreciation..................................................
Net income.........................................................
FIFO
$75,330
31,190
$44,140
LIFO
$75,330
30,540
$44,790
Weighted
Average
$75,330
30,851
$44,479
16,200
6,000
$21,940
7,679
$14,261
16,200
6,000
$22,590
7,907
$14,683
16,200
6,000
$22,279
7,798
$14,481
*Sales = (450 $63.00) + (570 $63.75) + (165 $64.50) = $75,330

3. Story pays the least taxes under the first-in, first-out method since it has the highest
cost of goods sold.
5-74
LO 5,6,7
PROBLEM 5-13A INVENTORY COSTING METHODSPERIODIC SYSTEM
1. a. Weighted average:
Beginning inventory
Feb.4
Apr.12
Sept.
Dec.5
4,000 $20
2,000 18
3,000 16
101,000
2,500 12
12,500
=
=
=
14
=
$ 80,000
36,000
48,000
=
30,000
14,000
$208,000

Units available for sale 12,500
Units sold
11,000
Ending inventory
1,500 $16.64 =
$ 24,960
Cost of goods sold
$183,040
b. FIFO:
Ending inventory
Cost of goods sold
c. LIFO:
Ending inventory
Cost of goods sold
11,000 $16.64 =
1,500 $12 = $ 18,000

4,000 $20
2,000
3,000
1,000
1,000
11,000
= $ 80,000
18
=
16
=
14
=
12 =
36,000
48,000
14,000
12,000
$190,000
1,500 $20 = $ 30,000

2,500 $12
1,000
3,000
2,000
2,500
11,000
= $ 30,000
14
=
16
=
18
=
20 =
14,000
48,000
36,000
50,000
$178,000
5-75
2. Income statements for the year ended December 31, 2012:
Sales*............................................................
Gross profit....................................................
Net income....................................................
Weighted
Average
$330,000
183,040
$146,960
60,000
$ 86,960
26,088
$ 60,872
FIFO
$330,000
190,000
$140,000
60,000
$ 80,000
24,000
$ 56,000
LIFO
$330,000
178,000
$152,000
60,000
$ 92,000
27,600
$ 64,400
*Sales = 11,000 $30 = $330,000

3. Fees can minimize its tax bill by using FIFO. In a period of declining prices, FIFO
results in the highest cost of goods sold, the least amount of income before taxes,
and thus the least amount of income tax expense.
4. A company is not free to change inventory methods from year to year to take
advantage of changing patterns in the level of prices. The company needs to be
consistent, and it must be able to justify any change in the method used on some
basis other than saving taxes, such as a better matching of costs with revenues.
LO 1,7,8
PROBLEM 5-14A INTERPRETING THE NEW YORK TIMES COMPANYS

FINANCIAL STATEMENTS
1. The company carries two types of inventory: newsprint and magazine paper, and
other inventory. Newsprint costs are comparable to raw materials in a manufacturing
company. A newspaper company, however, does not keep an inventory of finished
goods. Its newspapers either are sold within hours after being printed or become
worthless if not sold.
2. Some companies use different methods to value different types of inventory. The
methods should be chosen because they provide the most accurate matching of
costs with the revenues generated. Apparently, LIFO provides the most accurate
matching of costs with revenue for a majority of the companys inventory.
5-76
D E C IS ION C AS E S
READING AND INTERPRETING FINANCIAL STATEMENTS
LO 1,3
DECISION CASE 5-1 COMPARING TWO COMPANIES IN THE SAME INDUSTRY:

KELLOGGS AND GENERAL MILLS
1. Kelloggs and General Mills are manufacturers, or producers.

2. Kelloggs inventories amount to $1,056 million, which represents $1,056/$11,847, or
8.9% of its total assets. General Millss inventories amount to $1,344.0 million, which
represents $1,344.0/$17,678.9, or 7.6% of its total assets.
3. Kelloggs uses the average cost method to value its inventory. One of the major
advantages of this method is its ease of use.
4. General Mills uses the LIFO and FIFO methods, except for grain inventories which
are valued at market. The fact that Kelloggs and General Mills use different methods
does make it more difficult to compare the two companies but not impossible. The
reader of the statements needs to be aware that the companies are using different
methods.
5. Although the inventory system used by companies is not disclosed in the annual
report, it is possible that the two companies use a perpetual system, given the ability
to maintain computerized records.
LO 6,7
DECISION CASE 5-2 READING AND INTERPRETING WALGREEN CO.S

INVENTORY NOTE
1. Walgreen Co. uses LIFO. A business should employ the method that most
accurately matches inventory costs with the revenues of the period. Walgreen Co.
may use LIFO because prices change frequently and it wants to match the most
recent costs with revenues generated in the current period.
2. The excess of Walgreens inventory valued at FIFO over the value at LIFO, called
the LIFO reserve, is $1,379 million at year-end 2010 and $1,239 million at year-end
2009.
3. The LIFO reserve increased during 2010, from $1,239 million to $1,379 million, or
$140 million. The reserve increases because inventory costs are increasing and cost
of goods sold on a LIFO basis is more than cost of goods sold on a FIFO basis.
Thus, an increase in the reserve during a period indicates that prices are rising.
LO 6,9
5-77
DECISION CASE 5-3 READING AND INTERPRETING GAP INC.S INVENTORY

NOTE
1. Gap Inc. uses the weighted average cost method. A company chooses an inventory
method that it feels most accurately reflects the income of the period. One of the
advantages of the weighted average method is its ease of use.
2. Market is defined as future estimated selling price. The company takes into account
slow-moving merchandise and items no longer in stock in a sufficient range of sizes
in deciding whether to write down its inventory.
MAKING FINANCIAL DECISIONS
LO 2,3,4
DECISION CASE 5-4 GROSS PROFIT FOR A MERCHANDISER
1. According to the income statement prepared by the controller, Emblems gross profit
ratio is $6,750/$15,000, or 45%.
2. Emblems should not lower its selling price. On the surface, it appears that it should,
given that the industry standard for gross margin is 40%. Emblems real gross profit,
however, is not 45%. The reason is that the controller failed to include two important
product costs in cost of sales: shipping and labeling. In error, the controller is
expensing all shipping and labeling costs as incurred, rather than treating them as
product costs. The correct gross profit is as follows:
........................................Selling price
....................................Costs per unit:
............................................................Purchase price
............................................................
Tax (10%)
............................................................
Shipping
............................................................
Labeling
...................................................Total cost per unit
12.25
............................Gross profit per unit
....................... Number of units sold
.........................................Gross profit
$ 20.00
per unit
$10.00
1.00
0.50
0.75
$ 7.75
750
$5,812.50
Thus, the correct gross profit ratio is $5,812.50/$15,000, or 38.75%. On the basis of
this new ratio, Emblems is slightly under the industry standard of 40%, and it should
not lower its selling price.
5-78
LO 2,3,4
DECISION CASE 5-5 PRICING DECISION
1. Cost per pound.........................................................................

Add:.....................................................Sales tax (5% $5.00)
0.25
Gross cost................................................................................
Less:.....................................Purchase discount (2% $5.00)
0.10
Net cost....................................................................................
Add:............................................................................Shipping
0.05
......................................................................................Box
0.70
Total cost..................................................................................
$5.00
$5.25
$5.15
$5.90
2. Selling price $5.90 = 40% (selling price)

60% (selling price) = $5.90
Selling price = $9.83
3. Before deciding whether this is a sufficient profit, Carolines Candy should check
industry averages and the price local competitors are charging. If the price charged is
too much higher than that of the competition, even if its product is superior, Carolines
may not generate as many sales as it needs to cover other costs, such as wages and
commissions for employees, rent, utilities, insurance, advertising, and a return on
owners investment. If its prices are much lower than that of the competition, it may not
be generating as much profit as it reasonably could.
LO 3
5-79
DECISION CASE 5-6 USE OF A PERPETUAL INVENTORY SYSTEM
1. Memo to Darrell:
The purpose of this memo is to clarify for you the costs and benefits of a perpetual
inventory system. The purpose of a perpetual system is to provide a continuously
updated record of the number of units and cost of all inventory items. A perpetual
system is more costly to maintain because of the need to update the records each
time purchases and sales are made. It is likely that you will want to consider a
computerized inventory system. Numerous software packages are available, and
one should be chosen that is particularly suitable to your business.
As mentioned earlier, a perpetual inventory system is considerably more costly to
implement and maintain than a periodic system. A perpetual system would involve
an investment in a scanning device and other necessary hardware and software.
The next step would be to explore the options available to us and the cost of each.
Please call me at your convenience to set up an appointment to discuss these
matters further.
2. The suitability of a perpetual inventory system is certainly dependent on the type of
products a company sells. The system is ideally suited to a product such as
automobiles, since there is a relatively low volume of sales. On the other hand, it
might not be well suited to the needs of a landscaper selling trees, shrubs, and
plants. The turnover of products is very high, and it may not be practical to update
the records each time a sale takes place.
5-80
LO 6,7
DECISION CASE 5-7 INVENTORY COSTING METHODS
1. Georgetown must use the periodic inventory system at least for the first year
because it did not keep a record of the cost of the units sold as each sale was made.
2. Units on hand at the end of the year:
January.....................................................................................
March........................................................................................
October.....................................................................................
Available...................................................................................
Sold..........................................................................................
On hand....................................................................................
1,000
1,200
1,500
3,700
3,000
700
3. Unless a company specifically identifies the cost of each unit sold, it must adopt an
assumption about which particular units were sold. Each of the inventory costing
methods takes the pool of costs (cost of goods available for sale) and makes an
assumption about which units were sold and which units remain on hand.
Because inventory costs have increased during the first year, the company could
minimize taxes paid by adopting LIFO. A comparison of partial income statements
with the use of FIFO and LIFO highlights the taxes that could be saved in the first
year:
FIFO
....................................................................Sales revenue*
...............................................................................$45,000
...........................................................Cost of goods sold**
................................................................................. 25,500
Gross profit.......................................................................
LIFO
$45,000
24,800
$20,200
$19,500
*3,000 units sold at $15 each

**
1,000
1,200
1,500
Available 3,700
$8 = $ 8,000
8 =
9,600
9 = 13,500
$31,100
Ending inventory:
FIFO 700 $9 = $6,300
LIFO 700 $8 = $5,600
Cost of goods sold:
FIFO
$31,100 $6,300 = $24,800
LIFO
$31,100 $5,600 = $25,500
Conclusion: All expenses other than cost of goods sold are not affected by
the use of one inventory method rather than another. Thus, the lower gross profit
with the use of the LIFO method will result in income before taxes that is $20,200
5-81
$19,500, or $700, less than if FIFO is used. Because the expected tax rate is 35%,
the company will save $700 0.35, or $245, by using LIFO.
5-82
LO 8
DECISION CASE 5-8 INVENTORY ERRORS
The first error resulted in an understatement of the ending inventory in 2010 by $28,700.
Thus, cost of goods sold in 2010 was overstated, and gross profit was understated by
the same amount. The effect on net income would be less than the amount of
understatement of gross profit because of the effect of taxes.
The second error resulted in an overstatement of the ending inventory in 2010 by
$45,600. Thus, cost of goods sold in 2010 was understated, and gross profit was
overstated by the same amount. The effect on net income would be less than the
amount of overstatement of gross profit because of the effect of taxes.
The third error was the result of not applying the lower-of-cost-or-market rule to the
inventory at the end of 2011. If the cost of certain inventory was $6,000 higher than its
replacement cost, the inventory should have been written down and a loss recognized.
These three errors that took place in 2010, if material in amount, require a
restatement of the financial statements.
ETHICAL DECISION MAKING
LO 2
DECISION CASE 5-9 SALES RETURNS AND ALLOWANCES
1. The sales manager is interested in reporting the maximum amount of sales.

Although the net amount of sales will be the same regardless of whether returns are
recorded separately or simply netted against sales revenue, the manager would
prefer not to call attention to the level of returns. It is unlikely that the manager truly
believes the present practice is a waste of time.
2. The sales managers recommendation might save a small amount of bookkeeping
time, but at the same time, it would sacrifice certain information. Management needs
to be aware of unreasonably high levels of returns of merchandise so that it can
make whatever adjustments are necessary. If Sales Revenue is simply reduced for
the amount of returns, this information will not be available.
3. Memo to the sales manager:
I received your suggestion that we save time and effort by treating sales returns as a
direct reduction of sales rather than a separate item in our financial statements. I
appreciate your interest in saving the company money, but we would lose valuable
information by not tracking sales returns. It is imperative that we know whether our
customers are satisfied with their purchases, and separate accounting recognition
for sales returns is an important control feature in this respect. Please call me if I can
answer any questions you might have concerning this matter.
LO 7
5-83
DECISION CASE 5-10 SELECTION OF AN INVENTORY METHOD
1. The chief executive officer is primarily concerned with reporting the highest amount
of income possible. Thus, the chief executive officer will be satisfied if the company
uses the FIFO method. This method recognizes as cost of goods sold the oldest
costs, and because prices are rising, the costs charged to cost of goods sold will be
less than if LIFO is used.
2. It would be difficult to state definitively which method is truly in the best interests of
the stockholders. The LIFO method minimizes the amount of income taxes paid in
the first year since this method would report the higher cost of goods sold and thus
the lower income before taxes. From a cash flow perspective, LIFO is the most
advantageous method in a period of rising prices.
3. Memo to the chief executive officer:
TO:
Chief Executive Officer
FROM:
Students name
DATE:
December 31, 20
SUBJECT: Inventory Methods

As we end our first year of operations, I am aware of the need to present a favorable
impression to our stockholders. In this regard, I would like to address the selection of
an inventory valuation method.
I appreciate your interest in maximizing income whenever possible. However, a
method of inventory valuation that addresses this objective will not necessarily
satisfy our other concerns. Certainly, one of our primary concerns should be to
minimize the payment of taxes whenever possible.
Because our inventory purchase costs are rising, FIFO will result in the lower
amount reported as cost of goods sold and thus an income number that is higher
than if LIFO is used. For this reason, however, the use of FIFO will result in a higher
amount of taxes payable than if LIFO is used. It is my opinion that we should attempt
to conserve cash whenever possible, and thus I believe we should adopt the LIFO
method of inventory valuation.
Thank you for the opportunity to present my views on this important matter.
Please call if I can be of any further assistance.
5-84
LO 9
DECISION CASE 5-11 WRITE-DOWN OF OBSOLETE INVENTORY
1. The write-off of the inventory that has become obsolete would reduce the current
years income. The amount of the reduction depends on the extent of the write-off. If
the inventory is written off completely, the reduction in income will be equal to the
book value of the inventory. If the inventory is written down to a lower amount, net
income will be reduced by the amount of the write-down. This analysis ignores the
effect of taxes.
2. If the inventory is not adjusted, total assets on the year-end balance sheet will be
overstated.
3. The materiality of the obsolete inventory should be a major factor in a decision to
persist in the argument that the inventory be written down. If the inventory in
question is not material relative to the total assets of the company, the write-down
may be unnecessary. The materiality of the loss that would be recognized from the
write-down, relative to the income of the period, should also be considered.
4. If the inventory is not written down, readers do not have information that is a faithful
representation. Under the lower-of-cost-or-market rule, readers assume that if
inventory is worth less than its cost, the inventory has in fact been written down to
this lower amount.
5. Both U.S. GAAP and IFRS require the use of the lower-of-cost-or-market rule to
value inventories. However, the two sets of standards differ in two respects. The first
difference is the result of how market value is defined. U.S. GAAP define market
value as replacement cost, subject to a maximum and a minimum amount. In
contrast, IFRS use net realizable value with no upper or lower limits imposed. The
second difference relates to what happens in future periods after inventory has been
written down to a lower market value. Under U.S. standards, this new amount
becomes the basis for any future adjustments. However, under IFRS, write-downs of
inventory can be reversed in later periods. This means that a gain is recognized
when the value of the inventory goes back up.
5-85
REAL WORLD PRACTICE 5-1

Because annual reports do not disclose the inventory system used, it is not possible to
say for certain whether Gap Inc. uses a perpetual or a periodic system. However, it is
possible that the company uses a perpetual system given the ability to maintain
computerized records.
REAL WORLD PRACTICE 5-2

Kelloggs is a producer of a variety of food products. The nature of this business
requires the company to continually monitor its inventory for products that can no longer
be sold, due to spoilage and other factors. If market is less than cost, the company
should write down the inventory to reflect market value. The company uses the average
method for determining cost.

SM05 PorterNoASfsfddrton FA 8e

Загружено:

Сведения о документе

Оригинальное название

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

SM05 PorterNoASfsfddrton FA 8e

Загружено:

Авторское право:

Доступные форматы

CHAPTER 5

2. Show that you understand how wholesalers and retailers

3. Show that you understand how wholesalers and retailers

4. Use the gross profit ratio to analyze a companys ability

5. Explain the relationship between the valuation of inventory

6. Apply the inventory costing methods of specific identification,

7. Analyze the effects of the different costing methods on

8. Analyze the effects of an inventory error on various financial

9. Apply the lower-of-cost-or-market rule to the valuation of

1. Identify the forms of inventory held by different types of

CHAPTER 5 INVENTORIES AND COST OF GOODS SOLD

10. Analyze the management of inventory.

11. Explain the effects that inventory transactions have on the

12. Explain the differences in the accounting for periodic and

Learning Outcomes (Continued)

*Exercise, problem, or case covers two or more learning outcomes

CHAPTER 5 INVENTORIES AND COST OF GOODS SOLD

2. Show that you understand how wholesalers and retailers

3. Show that you understand how wholesalers and retailers

4. Use the gross profit ratio to analyze a companys ability

5. Explain the relationship between the valuation of inventory

6. Apply the inventory costing methods of specific identification,

7. Analyze the effects of the different costing methods on

8. Analyze the effects of an inventory error on various financial

9. Apply the lower-of-cost-or-market rule to the valuation of

10. Analyze the management of inventory.

11. Explain the effects that inventory transactions have on the

12. Explain the differences in the accounting for periodic and

1. Identify the forms of inventory held by different types of

*Exercise, problem, or case covers two or more learning outcomes

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

1. Identify the forms of inventory held by different types of

2. Show that you understand how wholesalers and retailers

3. Show that you understand how wholesalers and retailers

4. Use the gross profit ratio to analyze a companys ability

5. Explain the relationship between the valuation of inventory

CHAPTER 5 INVENTORIES AND COST OF GOODS SOLD

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

6. The Purchases account is neither an asset nor an expense account. It is simply a

CHAPTER 5 INVENTORIES AND COST OF GOODS SOLD

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

CHAPTER 5 INVENTORIES AND COST OF GOODS SOLD

24. Application of the lower-of-cost-or-market rule on a total basis, compared with an

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

BRIEF EXERCISE 5-1 TYPES AND FORMS OF INVENTORY COSTS FOR A

BRIEF EXERCISE 5-2 NET SALES

BRIEF EXERCISE 5-3 COST OF GOODS SOLD

BRIEF EXERCISE 5-4 GROSS PROFIT RATIO

Gross profit ratio: ($50,000 $30,000)/$50,000 = 40%

BRIEF EXERCISE 5-5 VALUATION OF INVENTORY AND MEASUREMENT OF

CHAPTER 5 INVENTORIES AND COST OF GOODS SOLD

BRIEF EXERCISE 5-6 INVENTORY COSTING METHODS

BRIEF EXERCISE 5-7 SELECTING AN INVENTORY COSTING METHOD

Cost of goods sold: L

BRIEF EXERCISE 5-8 INVENTORY ERROR

BRIEF EXERCISE 5-9 LOWER-OF-COST-OR-MARKET RULE

Journal Dec. 31 Loss on Decline in Value of Inventory.....

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

BRIEF EXERCISE 5-10 INVENTORY TURNOVER

Company As inventory turnover is $10,000,000/$100,000, or 100 times. Company Bs

BRIEF EXERCISE 5-11 CASH FLOW EFFECTS

BRIEF EXERCISE 5-12 INVENTORY METHODS USING A PERPETUAL SYSTEM

CHAPTER 5 INVENTORIES AND COST OF GOODS SOLD