Chapter 08 Solutions Manual

CHAPTER 8
INVENTORIES AND THE

COST OF GOODS SOLD
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL THINKING
CASES
Brief
Exercises
Topic
B. Ex. 8.1
B. Ex. 8.2
B. Ex. 8.3
B. Ex. 8.4
FIFO inventory
Specific cost identification inventory
Weighted average cost inventory
FIFO and weighted average cost
inventory
B. Ex. 8.5
Learning
Objectives
Skills
1, 4
1, 4
4
4
Analysis
Analysis
Analysis
Analysis
FIFO and weighted average cost

inventory
Analysis
B. Ex. 8.6
B. Ex. 8.7
B. Ex. 8.8
B. Ex. 8.9
B. Ex. 8.10
Inventory shrinkage
Inventory error
Inventory error
Inventory turnover
Inventory turnover
3
5
5
7
7
Analysis
Analysis
Analysis
Analysis
Analysis
Exercises
8.1
8.2
8.3
8.4
8.5
8.6
8.7
8.8
8.9
8.10
8.11
Topic
Accounting terminology
Cost flow assumptions
Physical flows vs. cost flows
Effects of different cost flows
Transfer of title
Inventory write-downs
Periodic inventory systems
Inventory errors
Gross profit method
Retail method
Real World: Li & Fung Limited
Inventory turnover
8.12
Real World: Marks & Spencer

Inventory analysis
Analysis, communication
8.13
Real World: adidas AG Examining an

annual report
Analysis, communication,
judgment
Learning
Objectives
17
1
4
4
2
3
4
5
6
6
7
The McGraw-Hill Companies, Inc., 2010

Overview
Skills
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
CHAPTER 8
ENTORIES AND THE
ST OF GOODS SOLD
, AND CRITICAL THINKING
Skills
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Skills
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
Analysis
judgment

Overview
Problems
Sets A, B
Topic
8.1 A,B
Inventory valuation
Learning
Objectives
1
Skills
Analysis, judgment
Analysis, judgment
8.2 A,B
Cost flow assumptions: Perpetual
8.3 A,B
8.4 A,B
8.5 A,B
8.6 A,B
8.7 A,B
8.8 A
Cost flow assumptions: Periodic

Inventory shrinkage
Periodic inventory systems
Effects of inventory errors
Retail method
Real World: Marks & Spencer
Retail method and ratio analysis
4
13
4
5
2, 3, 6
6, 7
Analysis, judgment
Analysis, communication, judgment
Analysis, judgment
Analysis
8.8 B
Real World: Wing On

FIFO vs. weighted average cost
comparisons
1, 7
5
3

technology
Critical Thinking Cases

8.1
Inventory errors
8.2
Dealing with the bank
(Ethics, fraud & corporate
governance)
8.3
Real World: Chow Sang Sang and

Sa Sa. Inventory turnover rates
(Internet)
###

Overview(p.2)
DESCRIPTIONS OF PROBLEMS AND

CRITICAL THINKING CASES
Below are brief descriptions of each problem and case. These descriptions are accompanied by the
estimated time (in minutes) required for completion and by a difficulty rating. The time estimates
assume use of the partially filled-in working papers.
Problems (Sets A and B)

8.1 A,B
BassTrack/Dome, Inc. (Perpetual)
35 Medium
A comprehensive problem calling for measurement of the cost of

goods sold and valuation of inventory by specific cost identification
and two different flow assumptions. Requires both journal entries and
maintenance of inventory subsidiary ledger records.
8.2 A,B
Speed World Cycles/Sea Travel (Perpetual)

Compute the cost of goods sold and ending inventory by two different
flow assumptions, and answer questions regarding the characteristics
of these assumptions.
30 Strong
8.3 A,B
Speed World Cycles/Sea Travel (Periodic)

Computations similar to those in Problem 8-2 except that periodic
costing procedures are used in place of a perpetual inventory system.
20 Medium
Marios Nursery/Sam's Lawn Mowers

Adjustments under various flow assumptions to reflect the taking of a
physical inventory. Also requires a write-down of the remaining
inventory to a net realisable value below cost.
20 Medium
Tokyo Audio/Roman Sound

FIFO and weighted average cost in a periodic inventory system.
Students also are asked to answer questions about the characteristics
of these flow assumptions.
25 Easy
8.6 A,B
Hexagon Health Foods/City Software

A series of income statements for a business being offered for sale
indicates a rising trend in gross profit. The student is given
information on errors in inventory and asked to prepare revised
income statements and to evaluate the trend of gross profit.
20 Medium
8.7 A,B
Between the Ears/Sing Along

Illustration of the retail method and its use in estimating inventory
shrinkage.
25 Medium
8.8 A
Marks & Spencer

Using data compiled from the company's financial statements under
retail method, students compute several financial ratios. Requires a
review of ratios introduced in previous chapters. Student is also asked
to estimate the ending inventory at retail prices.
20 Strong
E
x
e8.4 A,B
r
c
i
s
e8.5 A,B
s

Description Problems
Critical Thinking Cases

8.1
Inventory Errors
While interviewing for a position as controller, the job applicant learns
that the employer has an inventory problem. Inventories have been
understated consistently in past profits tax returns.
30 Strong
8.2
Dealing with the Bank

Ethics, Fraud & Corporate Governance
Students are required to evaluate ethical implications of manipulating
financial statement information in order to be in compliance with bank
covenants. Also requires analytical understanding of working capital
relationships.
15 Medium
8.3
Chow Sang Sang and Sa Sa

Internet
Requires an analytical interpretation of inventory performance measures
reported by Chow Sang Sang, a jewellery retail chain, and Sa Sa, a
cosmetics products retail chain.
No time limit
Strong

Desc. of Cases
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

1. The cost of goods acquired represents an assetinventoryuntil the goods is sold. At the date of sale,
the cost of the goods is reclassified as an expensecost of goods soldwhich is matched against the
related sales revenue.
2. The use of a cost flow assumption eliminates the need for separately identifying each unit sold and
looking up its cost. Thus, the time and effort involved in recording the cost of goods sold can be reduced
significantly.
3. IFRS permit the use of inventory cost flow assumptions whenever the items comprising the inventory are
similar in terms of cost, function, and sales price.
In measuring the results of operations, accountants consider the flow of costs to be more important than
the physical flow of specific units of goods. Therefore, a cost flow assumption need not correspond to
the physical movement of the company's goods.
4. a. Under the weighted average cost method, all units in the inventory are valued at the same average
cost. (The weighted average cost is recomputed after every purchase transaction.) Therefore, the cost
of goods sold is based upon this weighted average cost per unit.
b. The FIFO flow assumption means first-in, first-out. Therefore, each sale is assumed to consist of
the oldest units in the inventory, and the unit costs in the oldest cost layers are transferred to the cost
of goods sold.
5. The specific cost identification method should be used by the art gallery. Each item is unique and prices
vary widely. Therefore, the gross profit on a sale can be determined logically only by a method that
offsets the cost of a specific painting against its sales price. The ending inventory will be stated at the
cost incurred for the individual paintings on hand at the end of the year.
6. During a period of rising purchase costs, FIFO results in the highest reported profits, as the cost
of goods sold is measured using the oldest (and lowest) costs. The weighted average cost method results
in the lowest taxable profits, as the cost of goods sold consists of the more recent (and higher) purchase
costs.
As the FIFO method assigns the oldest costs to the cost of goods sold, the most recent purchase costs
remain in the Inventory account. Therefore, FIFO results in a valuation of inventory that is closest to
current replacement costs.
7. Under these unusual circumstances of unchanging purchase prices throughout the year, FIFO and
weighted average cost method would produce exactly the same results in the financial statements. The
ending inventory under both methods would be equal to the number of units on hand at year-end
multiplied by the same unit price.

Q1-7
8. No, Apex is not violating the accounting principle of consistency by using different accounting
methods for different segments of its inventories. The varying nature of inventory items explains in
part why several methods of valuation are generally acceptable. The principle of consistency is
violated when a company changes inventory methods from one year to the next, because such changes
cause profit to differ from what it would have been if the change in accounting method had not
occurred. Consistency is an important aid in making financial statements comparable from one year to
the next.
9. The phrase just-in-time inventory system relates primarily to the management of inventories within
manufacturing companies. With respect to purchase of raw materials, just-in-time means that materials
arrive just in time for use in the production process. With respect to finished goods, the just-in-time
concept means that goods are shipped to customers (sold) immediately upon completion of
production.
An advantage of the just-in-time concept is that it reduces or eliminates the amounts of the
manufacturer's inventories of materials and finished goods. This reduces the amount of capital that the
business must invest in these inventories and also any related costs such as storage and insurance. The
primary risk of the just-in-time approach for goods to be shipped to customers is that promised
delivery dates may not be met due to unavoidable production delays.
10. The primary reason for taking a physical inventory is to adjust the perpetual inventory records for
shrinkage losses such as theft, spoilage, or breakage. The physical inventory usually is taken near the
end of the fiscal year, so that the balance sheet will reflect the correct amount of inventory on hand,
and the income statement will reflect the shrinkage losses for the year.
11. A company might write down its inventory to a carrying amount below cost if the inventory has
become obsolete (or otherwise unsalable), or to reflect a net realizable value below historical cost.
12. A cutoff of transactions means determining that transactions occurring near year-end are recorded in
the proper accounting period.
If goods are in transit at year-end, the ownership of these goods is determined by the terms of
shipment. If the terms are F.O.B. destination, the goods belong to the seller until they reach their
destination. If the terms of shipment are F.O.B. shipping point, the goods in transit belongs to the
buyer.
13. In a periodic inventory system, the cost of goods purchased during the year is debited to a Purchases
account, rather than to the Inventory account. When goods are sold, an entry is made recognizing the
sales revenue, but no entry is made reducing the Inventory account or recognizing the cost of goods
sold.
The inventory on hand and the cost of goods sold are not determined until year-end. At the end of the
year, a complete physical inventory is taken to determine the amount of inventory on hand. The cost of
goods sold then is determined by a computation, as shown below:
Beginning Inventory
+ Purchases
Cost of Goods Available for Sale
- Ending Inventory
Cost of Goods Sold

Q8-13
14.
a. The weighted average cost method begins with a determination of the weighted average per-unit cost
of all units available for sale during the year (cost of goods available for sale divided by the number
of units available for sale). The units in the year-end inventory then are priced at this weighted
average per-unit cost.
b. Under the FIFO flow assumption, the oldest goods (first-in) are assumed to be the first sold.
Therefore, the ending inventory is assumed to consist of the most recently purchased units.
15.
Errors in the valuation of ending inventory are said to be counterbalancing or self-correcting

because these errors have opposite effects upon the gross profit (and profit) reported in each of two
successive years. The cumulative amount of gross profit reported over the two-year period will be
correct, and the balance sheet will be correct at the end of the second year.
This counterbalancing effect stems from the fact that an error in the valuation of the ending inventory
of one year represents an error in the beginning inventory of the following year. Ending and beginning
inventory amounts have opposite effects on the calculation of cost of goods sold.
16.
Under the gross profit method, the cost of goods sold is estimated by applying the historical cost ratio
(100% minus the gross profit rate) to the net sales of the current period. Subtracting this estimated cost
of goods sold from the cost of goods available for sale (beginning inventory plus purchases) provides an
estimate of ending inventory.
Companies that use a periodic inventory system find the gross profit method useful in preparing interim
financial statements. These companies also may use this method in estimating the inventory on hand at
the date of a fire, theft, or other casualty. The method also may be used to confirm the reasonableness of
the amount determined by a year-end physical inventory.
17.
Ending inventory $56,000, computed as follows: $40,000 + $100,000 ($112,000 .75) = $56,000.
18.
No. The inventory must be presented in the balance sheet at cost. The inventory stated at retail price will
be reduced to a cost basis by applying the cost percentage, which is the ratio prevailing between cost and
selling price during the current period.
19.
The inventory turnover is computed by dividing the cost of goods sold by the average amount of
inventory maintained during the period. The higher the inventory turnover, the more efficient is
management's use of the asset to generate sales. This measurement is of interest to short-term creditors
because it indicates how quickly the company is able to sell its goods. This is a major step in converting
the inventory into cash, which, in turn, can be used to pay the short-term creditors' claims.

Q14-19
20.
a. Using weighted average cost method during a period of rising costs should result in a lower profit than
would be reported under the FIFO method. Weighted average cost method assigns the more recent
purchase costs to the cost of goods sold. When costs are rising, the more recent costs also tend to be
higher
costs.
b. Weighted average cost method assigns the more recent (higher) costs to the cost of goods sold, and the
older (lower) costs to inventory. The inventory turnover rate is computed by dividing the cost of goods
sold by the average inventory. Therefore, use of the weighted average cost method method should
indicate a higher inventory turnover rate than would the FIFO method.
c. By assigning the more recent (higher) purchase prices to the cost of goods sold, weighted average cost
method minimizes taxable profit and income taxes expense. This is, perhaps, the primary reason for the
popularity of the weighted average cost method method.
21.
a. In a period of declining prices, use of the FIFO method will minimize the reported rate of gross profit.
This is because the oldest (and therefore highest) purchase costs will be assigned to the cost of goods
a sold.
.
b. The net cash from operating activities will be higher than if Computer Products had used weighted
average cost method. This is because the flow assumption in use has no effect upon the cash receipts
b from customers or cash payments to suppliers, but it does affect income taxes. By using FIFO in this
.
period of declining prices, the older and higher costs will be assigned to the cost of goods sold, thereby
minimizing taxable profit. This, in turn, will minimize income tax paymentsa cash outflow that
enters into the determination of net cash from operating activities.
(Note to instructor: In the more common situation of rising replacement costs, it would be weighted average cost
method that would minimize the gross profit rate and increase net cash from operating activities.)
22.
a. The first company is using the more conservative methodweighted average costin pricing its
inventory. The weighted average cost method of pricing inventory assigns older costs to inventory and
more recent costs to the cost of goods sold. The FIFO method (first-in, first-out), in contrast, assigns
the more recent costs to inventory and the older costs to the cost of goods sold. Thus, during a period of
rising prices, the weighted average cost method results in a lower valuation of inventory and a higher
valuation of the cost of goods sold than does the FIFO method.
b. Again the answer is the first company. As weighted average cost minimizes profit during a period of
rising prices, it also minimizes the amount of income taxes that a company must pay. Tax authorities
require a company to use the same method e.g. weighted average cost method in both its profits
tax returns and in its financial statements. By using FIFO in its financial statements, the second
company is normally precluded from using the weighted average cost method in its profits tax returns.
c. No. An inventory flow assumption affects only the allocation of costs between ending inventory and
the cost of goods sold. It has no effect upon the amounts of cash, either collected from customers or
paid to the suppliers.

Q20-22
hould result in a lower profit than

ethod assigns the more recent
ore recent costs also tend to be
to the cost of goods sold, and the

uted by dividing the cost of goods
cost method method should
d.
oods sold, weighted average cost

erhaps, the primary reason for the
the reported rate of gross profit.

be assigned to the cost of goods
r Products had used weighted

no effect upon the cash receipts
me taxes. By using FIFO in this
to the cost of goods sold, thereby
ymentsa cash outflow that
t would be weighted average cost

erating activities.)
average costin pricing its

igns older costs to inventory and
n, first-out), in contrast, assigns
oods sold. Thus, during a period of
uation of inventory and a higher
mizes profit during a period of

mpany must pay. Tax authorities
cost method in both its profits
ial statements, the second
method in its profits tax returns.
s between ending inventory and

er collected from customers or

Q20-22
SOLUTIONS TO BRIEF EXERCISES

B.Ex. 8.1
50 units @ $2.00 = $100 (the oldest costs)
B.Ex. 8.2
(15 units @ $20) = $300
B.Ex. 8.3
100 units @ $3.05 = $ 305

150 units @ $3.10 =
465
120 units @ $3.15 =
378
370
$1,148
$1,148/370 units = $3.10 per unit
Ending inventory: (370 units - 125 units) x $3.10 = $760
B.Ex. 8.4
Units in ending inventory: 100 + 100 - 75 = 125 units

Weighted average cost: 100 @ $5.00 = $500
100 @ $5.05 = 505
200
$1005
$1,005/200 = $5.025
Weighted average cost: 125 @ $5.025 = $628.13
FIFO: (25 @ $5.00) + (100 @ $5.05) = $630.00
The difference is only $1.87 due to the relatively small difference in price of the two purchases
($.05).
B.Ex. 8.5
Units in ending inventory: 10 + 20 - 25 = 5 units

Weighted average cost: 10 @ $10 = $100
20 @ $11 = 220
30
$320
$320/30 = $10.67
FIFO inventory: 5 units @ $11 = $55 (recent costs)
Weighted average cost inventory: 5 units @ $10.67 = $53.35 (weighted average cost)
B.Ex. 8.6
Inventory Shrinkage Loss
50,000
Inventory
50,000
($1,000,000 x 5%)
B.Ex. 8.7
Sales
$990,000
Cost of goods sold (460,000)

BE8.1,2,3,4,5,6,7,8
Gross profit
B.Ex. 8.8
$530,000
Rather than ending inventory being $670,000, it is correctly restated at $620,000 ($670,000 $50,000). Correction of this error will cause cost of goods sold to increase by $50,000.

BE8.1,2,3,4,5,6,7,8
RIEF EXERCISES
price of the two purchases

BE8.1,2,3,4,5,6,7,8
t $620,000 ($670,000 ase by $50,000.

BE8.1,2,3,4,5,6,7,8
B.Ex. 8.9
Inventory turnover: $5,000,000 / $1,280,000 = 3.91

Average number of days to sell inventory: 365 / 3.91 = 93.35
B.Ex. 8.10
Inventory turnover for 2009: $85 / $27 = 3.15

Inventory turnover for 2010: $90 / $35 = 2.57
The inventory turnover is higher in 2009, indicating that management did a
better job of managing its inventory in 2009 than in 2010. This same
relationship can be seen by calculating the average number of days to sell
inventory, which is lower in 2009, as indicated below:
Average days to sell inventory:
2009 365 / 3.15 = 115.9
2010 365 / 2.57 = 142.0

BE8.9,10
SOLUTIONS TO EXERCISES
Ex. 8.1
a.
b.
c.
d.
e.
f.
Flow assumption
Weighted average cost method
Specific cost identification method
LIFO method
FIFO method
Retail method
Ex. 8.2
a.
Cost of Goods Sold

Inventory
To record the cost of 90 Millenium computers sold to Apex
Publishers. Cost determined by the specific cost
identification method:
62 @ $15,000
28 @ $16,000
Cost of goods sold
b.
1,378,000
$930,000
448,000
$1,378,000
Cost of Goods Sold

Inventory
Publishers. Cost determined by the weighted average cost
method:
1,377,000
90 @ $15,300 ($1,530,000 100 units)

c.
Cost of Goods Sold

1,370,000
Inventory
Publishers. Cost determined by the FIFO flow assumption:
70 @ $15,000
20 @ $16,000
Cost of goods sold
d.
$1,050,000
320,000
$1,370,000
Under FIFO, the cost of goods sold is based on the oldest costs. Thus, relative to using
weighted average cost method, the FIFO method will result in higher profit during
periods of rising prices, which will increase a company's income tax liability. In the
balance sheet, the FIFO method reports inventory at the most current costs. The weighted
average cost method method, on the other hand, reports the same inventory at older, more
conservative costs.

E8.1,2
NS TO EXERCISES
1,378,000
1,377,000
1,370,000
osts. Thus, relative to using

t in higher profit during
ncome tax liability. In the
most current costs. The weighted
he same inventory at older, more

E8.1,2
Ex. 8.3
a.
1.
As heating oil is purchased and put into storage tanks, it mixes

completely with the heating oil remaining in these tanks from prior
purchases. As oil is pumped into the companys delivery trucks, it
actually represents a blend of multiple purchase costs. Thus, the
weighted average cost method appears to best describe the physical flow
of the heating oil inventory.
2.
The companys large coal storage bins are loaded and emptied from the
top by giant machines, making the most recent coal acquired the most
recent coal sold. Thus, relative to the FIFO method, the weighted
average cost method method best describes the physical flow of the coal
inventory.
3.
The kerosene inventory is stored on shelves in 5-gallon containers.

Management probably rotates this stock on a regular basis. Thus, the
FIFO method best describes the physical flow of the kerosene
inventory.
b.
The weighted average cost method would probably result in the lowest
income tax liability for the company (assuming that fuel prices are rising).
The weighted average cost method allocates the more recent purchase prices
to the cost of goods sold for the period. Thus, in periods of rising prices, the
weighted average cost method usually results in a higher cost of goods sold
and, consequently, a lower taxable profit than FIFO method.
c.
In order for a company to account for its entire inventory as a single,

combined, pool, all items should be relatively homogeneous. Obviously, the
physical properties of heating oil, coal, and kerosene differ significantly.
Keeping separate inventory records for each fuel type makes the reported
figures more meaningful and gives management more control over the
operations of the business. If management determined, for example, that one
of its product lines is unprofitable, it might decide to discontinue selling that
product and focus attention on the profitable products.

E8.3
Ex. 8.4
Ex. 8.5
a.
The
weig
hted
aver
age
cost
Because the weighted average cost method assigns the older (lower) costs to inventory, it is
met
reasonable to expect that the weighted average cost inventory would be lower than that resulting
hod
from FIFO valuation, not higher.
resu
b. lts
Dollar amounts stated in thousands:
in a
1.
Profit before taxes (as reported under FIFO) .
high
er
Less: Additional cost of goods sold had weighted average cost
cost
been in use ($1,865,000 - $1,850,000).
of
good Profit before taxes (assuming weighted average cost) ..
s2.
Income taxes expense under weighted average cost ($110,000
sold
than profit before taxes 40%)
does
3.
Profit before taxes (weighted average cost basis, part 1)
FIF
Less: Income taxes expense under weighted average cost (part 2) .
O
whe Profit (assuming weighted average cost)
n
4.
Net cash from operating activities (as reported)
the
repl under FIFO)..
ace Add: Income tax savings had weighted average cost been in use ($52,500
men paid,
paid, minus $44,000 from part 2).
t
Net cash from operating activities (assuming LIFO) .
cost
s of
The the
inventory at 31 December amounts to $7,250,000, computed by adding the $1,250,000 inbound
shipment
good of goods to $6,000,000 of inventory on hand. Terms of the $1,250,000 shipment were F.O.B.
shipping
point; therefore, title passed at the point of shipment on 28 December and the goods were the
s
property
sold of the buyer (Ma) while in transit.
are
risin
The g.
$950,000 outbound shipment was correctly handled. Title to these goods passed to the customer on
30 December
when the goods were shipped, so they are not part of the Ma's inventory at 31 December.
Und
Thiser
shipment was billed on 30 December, so the account receivable is properly included in the balance
sheet.
the
weig
hted to the $1,250,000 increase in inventory, accounts payable should be increased by $1,250,000.
In addition
aver the goods at 31 December and has a liability to pay for it.
Ma owns
age
cost
met
hod,
the
mor
e
rece
nt
(hig
her)
cost
s are
assi
E8.4,5
gned
to
the
costs to inventory, it is
be lower than that resulting
$125,000
15,000
$110,000
$44,000
$110,000
44,000
$66,000
$123,250
8,500
$131,750
ng the $1,250,000 inbound

50,000 shipment were F.O.B.
ember and the goods were the
oods passed to the customer on

Ma's inventory at 31 December.
roperly included in the balance
uld be increased by $1,250,000.

E8.4,5
Ex. 8.6
a. 1.
Loss from Write-down of Inventory

Inventory
To write down the inventory of 28 units of WordCrafter to the
lower-of-cost-and-net-realizable-value:
Cost .
$9,400
Net realiszable value
7,000
Reduction in carrying amount
$2,400
2,400
2.
Cash
Sales ..
To recognize the sales revenue from the sale of 15
WordCrafter programs @ $350, cash.
5,250
Cost of Goods Sold .

Inventory .
3,750
To record cost of 15 WordCrafter programs sold on 9 January

using the FIFO flow assumption. (All units are carried in
inventory at $250 following the year-end reduction to the
lower-of-cost-and-net-realiszable-value.)
b. 1.
Cost of Goods Sold .

Inventory .
To record shrinkage loss of 3 units of WordCrafter software
using the FIFO flow assumption (3 units @ $400).
1,200
2.
Cost of Goods Sold ..

Inventory
To record shrinkage loss of 3 units of WordCrafter software
using the weighted average cost flow assumption, 3 units @
$335.7 ($9,400 / 28).
1007
3.
Using the FIFO method would result in a $193 lower profit figure than using the
weighted average cost method ($1,200 $1,007 = $193). This is due to the reduction in
price paid for the second purchase. Although the company would report a lower profit
figure using FIFO, it would not really be any less efficient in conducting operations. An
inventory valuation method affects only the allocation of costs between ending inventory
and cost of goods sold. It has no effect upon the total costs actually incurred in
purchasing or manufacturing inventory.

E8.6
2,400
5,250
3,750
1,200
1007
igure than using the

s is due to the reduction in
would report a lower profit
conducting operations. An
ts between ending inventory
ctually incurred in

E8.6
Ex. 8.7
a. Weighted average cost $79.60 (20 units @ $3.98). (Weighted average cost = $438/110 units =
$3.98)
b. FIFO, $99.00 (19 units @ $5.00 + 1 unit @ $4.00).
c.
Ex. 8.8
Only the FIFO method results in the same ending inventory valuation in both periodic and
perpetual costing environments. Under the weighted average cost method, periodic and
perpetual systems usually result in different valuations due to the timing of inventory purchases
and sales. Under FIFO, the value assigned to ending inventory is the same using periodic or
perpetual procedures, regardless of when purchases or sales occur during the period.
a. Compute corrected net income figures:

Profit as reported ..
Correction of understatement of inventory at end of 2009
Profit as corrected ..
$
$
2010
3,500,000
(400,000)
3,100,000
b. Compute gross profit amounts and gross profit percentages

for each year based on corrected data:
For 2009: Adjusted gross profit ($6,000,000 + $400,000) .
Gross profit rate ($6,400,000 $15,000,000) .
For 2010: Adjusted gross profit ($7,500,000 $400,000)
Gross profit rate ($7,100,000 $20,000,000)
c.
Correction of owner's equity:

Owners equity at the end of 2009 should be increased by $400,000 to $5,400,000. At the end of
2010 the owner's equity of $5,800,000 requires no correction because the inventory error
counterbalanced, as evidenced by the fact that the combined profit for the two years was
$6,000,000, both before and after the correction of profit for the individual years.

E8.7,8
ge cost = $438/110 units =
tion in both periodic and

method, periodic and
iming of inventory purchases
he same using periodic or
during the period.
$
$
2009
2,500,000
400,000
2,900,000
$6,400,000
42.67%
$710,000
35.50%
to $5,400,000. At the end of

use the inventory error
for the two years was
dividual years.

E8.7,8
Ex. 8.9
Ex. 8.10
a. Inventory at time of theft is $915,000, computed as follows:

Beginning inventory, 1 January
Net purchases, 129 January
Cost of goods available for sale
Deduct: Estimated cost of goods sold:
Net sales
$
Cost percentage (100% - 45%)
Estimated cost of goods sold
Estimated ending inventory (at cost):
700,000
55%
b.
Cha must use the periodic inventory method. Had the perpetual method been used,
Cha would have had the actual inventory figure at 29 January, making it
unnecessary to compute an estimated figure using the gross profit method.
a.
Cost ratio during July ($522,000 $900,000)

Estimated cost of goods sold ($600,000 58%)
Estimated ending inventory (at cost):
Cost of goods available for sale during July
Less: Estimated cost of goods sold (above)
Estimated ending inventory
b.
It appears that the cost of Phillips inventory as a percentage of retail sales in July is
lower than it was in June. At 30 June, the percentage was 60% ($300,000
$500,000). During July, however, the percentage was only 55.5%, based upon
Phillips' purchases ($222,000 $400,000).

E8.9,10
$
$
500,000
800,000
1,300,000
385,000
915,000
perpetual method been used,

January, making it
gross profit method.
58%
$348,000
$522,000
348,000
$174,000
entage of retail sales in July is

was 60% ($300,000
nly 55.5%, based upon

E8.9,10
Ex. 8.11 a. Inventory turnover rate (dollar amounts in millions):

Cost of Goods Sold
Average Inventory
= $99,119.1
$99,119.1
($2,059.6 + $2,328.9) 2
$2,194.3
b. Number of days required to sell the average amount of inventory:

= 8.1 days
Days in Year
365
=
Inventory Turnover Rate
45.2
c. Operating cycle:
Days Required to Sell
Amount of Avg. Inventory
8.1 days
Days Required to Collect

Amount of Avg. Receivable
47 days
d. You would like to have two types of information:

1. The historical pattern for Li &
Fung. Is the operating cycle in this year longer, shorter, or the same as recent years? 2.
The operating cycle of Li & Fung's competitors. Is Li & Fung's operating cycle longer,
shorter or about the same as competing companies?

E8.11
45.2 times
y:
55.1 days
orical pattern for Li &

ame as recent years? 2.
operating cycle longer,

E8.11
* Ex. 8.12
a.
Inventory turnover:
Year ended 28 March 2009:
Cost of goods sold (5,690 million)/Inventory [(536 million - 488.9 million )/2] = 11.1
Cost of goods sold (5,535.2 million)/Inventory [(488.9 million - 416.3 million)/2] =12.23
b.
Average number of days required to sell inventory:

365 days / 11.1 = 32.88
365 days / 12.23 = 29.84
c.
The company was less efficient in managing its inventory in the year ended 28 March 2009. The inven
turnover in 2009 was 11.1, compared to 12.23 in the previous year. This resulted in an average number
required to sell inventory being approximately two days more in the current year (32.88) compared to
most recent prior year (29.84). The longer the time required to sell inventory, the less efficient the com
is.
* Supplemental Topic, "LIFO Reserves."

E8.12
536 million - 488.9 million )/2] = 11.1
488.9 million - 416.3 million)/2] =12.23
y:
ventory in the year ended 28 March 2009. The inventory

he previous year. This resulted in an average number of days
wo days more in the current year (32.88) compared to the
me required to sell inventory, the less efficient the company

E8.12
Ex. 8.13
a.
(1)
Cost of sales year ended 31 Dec 2009

Inventories 31 Dec 2008
Inventories 31 Dec 2009
(2)
(3)
Average inventories year ended 31 Dec 2008

Inventory turnover (1) (2)
b. (1)
c.
Days in a year
Average days in inventory (365 3.27)
Average days goods are in inventory (see b)

Average days receivables remain outstanding
Days in operating cycle
5,669,000,000
1,995,000,000
1,471,000,000
3,466,000,000
2
1,733,000,000
3.27 times
365 days
111.58 days
111.58 days
53.68 days
165.26 days
Given an operating cycle of approximately 165 days, inventory accounts for almost 68% of the
company's total operating cycle. Accounts receivable days account for only about 32% of the total
time in the operating cycle. Thus, the accounts receivable turnover influences the company's
operating cycle much less than does its inventory turnover.
* The average days a receivable remains outstanding is computed as follows:

(1) Net sales year ended 31 Dec 2009
Accounts receivable 31 Dec 2008
Accounts receivable 31 Dec 2009
(2) Average receivable year ended 31 Dec 2008

Receivables turnover rate (1) (2)
Average days outstanding 365 6.8

E8.13
10,381,000,000
1,624,000,000
1,429,000,000
3,053,000,000
2
1,526,500,000
6.8 times
53.68 days
nts for almost 68% of the

r only about 32% of the total
fluences the company's
ollows:

E8.13
35 Minutes, Medium
SOLUTIONS TO PROBLEM SET A

PROBLEM 8.1A
BASSTRACK
a.
General Journal
2010
(1) Specific cost identification method:
15 Jan Cost of Goods Sold
Inventory
To record cost of 1,000 Ace-5 reels sold to Angler's
Warehouse: 500 units @ $290; 500 units @$320.
305,000
305,000
(2) Weighted average cost method:

Inventory
Warehouse by the weighted average cost method:
1,000
units @$308 ($462,000 total cost, divided by 1,500
Exer
units).
cises
308,000
308,000
(3) First-in, First-out (FIFO) method:

Inventory
Warehouse. Cost determined by the FIFO flow
assumption: 600 units @$290, plus 400 units
@ $320 = $302,000.

P8.1A
302,000
302,000
PROBLEM 8.1A
BASSTRACK (continued)
b. Inventory subsidiary ledger records:

Date
Units
12 Dec 09
09 Jan 10
600
900
PURCHASED
Unit
Cost
$
290
320
Total
$
$
SOLD
Unit
Cost
Units
Cost of
Goods Sold
174,000
288,000
15 Jan 10
500
500
290
320
305,000
Units
600
600
900
100
400
BALANCE
Unit
Cost
$
Balance
290 $
290
320
290
320
174,000
462,000
157,000
Date
12 Dec 09
09 Jan 10
15-Jan-10
Units
600
900
PURCHASED
Unit
Cost
$
290
320
Total
$
SOLD
Unit
Cost
Units
Cost of
Goods Sold
174,000
288,000
* $462,000 total cost 1,500 units = $308 weighted average unit cost.
1,000
308
308,000
Units
600
1,500
500
BALANCE
Unit
Cost
$
Balance
290 $
308
308
174,000
462,000
154,000
(3) First-in, first-out (FIFO) method:
Date
12 Dec 10
09 Jan 10
15 Jan 10
Units
600
900
PURCHASED
Unit
Cost
$
290
320
Total
$
SOLD
Unit
Cost
Units
Cost of
Goods Sold
174,000
288,000
Units
600
600
900
600
400
290
320
302,000

P8.1A (p.2)
500
BALANCE
Unit
Cost
$
290
290
320
320
Balance
$
174,000
462,000
160,000
PROBLEM 8.1A
BASSTRACK (concluded)
c.
No. As shown in part a, the weighted average cost method resulted in the highest cost of
goods sold figure, whereas the FIFO method resulted in the lowest. If the weighted average
cost method is used for tax purposes, income tax regulations require that it also be used
for financial reporting purposes.

P8.1A (p.3)
30 Minutes, Strong
PROBLEM 8.2A
SPEED WORLD CYCLES: PERPETUAL SYSTEM
a. Cost of goods sold and ending inventory

(a) Cost of goods sold on 28 July:
Weighted average cost (as of 22 July; $249,000 5 units)
Cost of goods sold (4 units @ $49,800)
49,800
49,800
153,000
202,800
50,700
(b) Ending inventory (4 units) at 30 September:

Average unit cost following August 3 purchase:
1 unit at 22 July weighted average cost of $49,800
3 units purchased on 3 August
Total
Weighted average unit cost as of 3 August ($202,800 4
units) Ending inventory, 30 September (4 units @ $50,700)
$
$

(a) Cost of goods sold on 28 July:
2 units from 1 July purchase @ $49,500
2 units from 22 July purchase @ $50,000
Cost of goods sold (4 units)
(b) Ending inventory (4 units) at 30 September:
1 unit from 22 July purchase @$50,000
3 units from 3 August purchase @ $51,000
Ending inventory, 30 September

P8.2A
50,000
153,000
PROBLEM 8.2A
ERPETUAL SYSTEM
199,200
202,800
$
$
99,000
100,000
199,000
203,000

P8.2A
Problem 8.2A
SPEED WORLD CYCLES: PERPETUAL SYSTEM (concluded)
b.
(1) The FIFO method will result in the highest profit, as it assigns the oldest (lowest)
costs to the cost of goods sold. FIFO will result in the highest profit whenever the
oldest purchase costs are also the lowestthat is, in the common situation of rising
prices.
(2) In this situation, the weighted average cost method will minimize profits taxes, as it
assigns higher costs to the cost of goods sold. The higher cost of goods sold, in turn,
reduces taxable profit. The weighted average cost method will minimize taxes
whenever the more recent purchase costs are higher, which, as mentioned above, is
the normal situation in an inflationary environment.
(3) No. Speed World may not use FIFO in its financial statements and weighted average
cost in its profits tax returns. Normally a company is not allowed to use different
accounting methods in its financial statements and profits tax returns.

P8.2A(p.2)
20 Minutes, Medium
PROBLEM 8.3A
SPEED WORLD CYCLES: PERIODIC SYSTEM

Ending inventory at 30 September:
Weighted average cost ($402,000 8 units)
Ending inventory (4 units @ $50,250)
50,250
$
201,000
402,000
201,000
201,000
Cost of goods sold through 30 September:

Less: Ending inventory at 30 September(above)
Cost of goods sold

Ending inventory (4 units) at 30 September:
3 units from purchase on 3 August (@$51,000)
1 unit from purchase on 22 July (@$50,000)
$
$
153,000
50,000
203,000
Cost of goods sold through 30 September:

Less: Ending inventory at 30 September (above)
Cost of goods sold
b.
$
$
402,000
203,000
199,000
No. If the company selects the FIFO method for income tax reporting, it is required to
choose the same method for financial reporting purposes.

P8.3A
PROBLEM 8.4A
MARIO'S NURSERY
20 Minutes, Medium
a.
Shrinkage loss - 40 trees
Weighted average cost method:

Cost of Goods Sold
Inventory
12,080
12,080
To record shrinkage loss of 40 trees using weighted average

cost of $302 ($105,700 350 trees = $302 per tree).
b. Shrinkage loss and LCNRV adjustment

(1) Shrinkage loss, first-in, first-out (FIFO) method:
10,000
Cost of Goods Sold

Inventory
10,000
To record shrinkage loss of 40 trees using the FIFO flow

assumption (40 trees @ $250).
(2) Write-down of inventory to LCNRV:
Cost of Goods Sold
Inventory
33,700
33,700
To write down inventory to a NRV below cost:

Cost (after shrinkage loss: $105,700 - $10,000)
NRV (310 trees x $200 per tree)
Loss from write-down to NRV
c.
$
$
95,700
62,000
33,700
The only unethical act in this situation was committed by the employee against his
employer. There is nothing unethical about using a hidden security camera to protect ones
assets. The camera was not used to entice (or entrap) the employee. In short, he made a
conscious decision to steal trees from his employer and should be held completely
responsible for doing so.

P8.4A
PROBLEM 8.5A
TOKYO AUDIO
25 Minutes, Easy
Units
a.
Unit Cost
Inventory and cost of goods sold:

(1) FIFO:
Inventory:
Fourth purchase (18 Dec.)
Third purchase (4 Oct.)
Ending inventory, FIFO
19
2
3,200
3,150
3,102.80
21
Cost of goods sold:

Less: Ending inventory, FIFO
Cost of goods sold, FIFO
(2) Weighted average cost:
Inventory:
Total goods available for sale
Weighted average unit cost
($223,400 72 units)
72
Ending inventory, weighted

average of $3102.8 per unit
21
3,102.80
51
3,102.80
Cost of goods sold, weighted

average of $3102.8 per unit
$31
0.2
b.
8
per
uni
t
The FIFO method, by assigning the costs of the most recent purchases to inventory, provides the
most realistic year-end amount for inventory in terms of NRV. A weakness in the FIFO method,
however, is that the costs assigned to the cost of goods sold are relatively old costs. Because the
costs of the units has been rising throughout the year, the FIFO method tends to understate the
cost of goods sold in terms of the costs actually being incurred by Tokyo to replenish its
inventory. The inventory method using weighted average cost assigns the more recent costs to the
cost of goods sold and therefore provides a more realistic measure of profit, in terms of NRV, than
does the FIFO method.

P8.5A
PROBLEM 8.5A
TOKYO AUDIO
Total Cost
$
$
$
60,800
6,300
67,100
223,400
67,100
156,300
223,400
65,158
158,242
hases to inventory, provides the

weakness in the FIFO method,
atively old costs. Because the
method tends to understate the
Tokyo to replenish its
igns the more recent costs to the
e of profit, in terms of NRV, than

P8.5A
PROBLEM 8.6A
HEXAGON HEALTH FOODS
20 Minutes, Medium
a.
Net sales
Cost of goods sold
2010
$ 8,750,000
5,630,000
2009
$ 8,400,000
5,272,000
Gross profit on sales
Gross profit percentage
3,120,000
35.66%
3,128,000
37.24%
Cost of Goods Sold:

2008:
$4,800,000 - $400,000 = $4,400,000
2009:
$4,872,000 + $400,000 = $5,272,000
2010:
$4,812,500 + $817,500 = $5,630,000
b.
The current owners of this business have no reason to be enthusiastic over the trend of gross
profit or gross profit rate. After correction of the inventory errors, it is apparent that both the
dollar amount of gross profit and the gross profit rate have declined, rather than increased,
during the last three years.

P8.6A
PROBLEM 8.6A
GON HEALTH FOODS
$
$
2008
8,200,000
4,400,000
3,800,000
46.34%
siastic over the trend of gross

ors, it is apparent that both the
lined, rather than increased,

P8.6A
PROBLEM 8.7A
BETWEEN THE EARS
25 Minutes, Medium
a.
(1) Estimated cost of goods sold:
Cost ratio for the current year:
Retail prices of goods available for sale
Cost ratio ($4,620,000 $8,400,000)
Estimated cost of goods sold (net sales, $7,440,000 x
cost ratio, 55%)
(2) Estimated ending inventory:
Cost of goods available for sale (given)
4,620,000
8,400,000
55%
4,092,000
4,620,000
4,092,000
528,000
Exer
b.
cises
(1) Restating physical inventory from retail prices to cost:

Physical inventory stated in retail prices
Cost ratio (per part a, above)
Ending inventory at cost ($844,800 x 55%)
(2) Estimated shrinkage losses at cost:

Estimated ending inventory per part a
Physical count of ending inventory, restated
at cost (per part b)
Estimated shrinkage loss, stated at cost
844,800
55%
464,640
528,000
464,640
63,360
7,440,000
4,155,360
3,284,640
(3) Computation of gross profit:

Net sales
Cost of goods sold:
Less: Ending inventory per physical count, at cost
Gross profit
c.
4,620,000
464,640
Tapes and CDs can easily fit into someones pocket and walk out of the warehouse.
Thus, it is important that effective controls be in place to reduce inventory shrinkage. Four
common controls include: (1) security cameras, (2) security personnel, (3) shelves for
safeguarding employee handbags while they work, and (4) magnetic sensor strips to sound
an alarm if someone leaves the warehouse in possession of a tape or CD. The sensor strips
would be deactivated when units of inventory are packed for shipment to customers.

P8.7A
PROBLEM 8.8A
Marks & Spencer
20 Minutes, Strong
a.
Computations based on retail method valuation of inventory:

(in millions)
(1) Inventory turnover rate:
Cost of Goods Sold
Average inventory
5,690.00
512.50
11.10 times
1,389.80
2,306.90
0.60 : 1
3,371.90
9,062.10
37.21%
(2) Current ratio:

Current Assets
Current Liabilities
(3) Gross profit rate:
Gross Profit
Net Sales
b.
Average inventory at cost (in millions) *

Cost ratio
Estimated ending inventory at retail prices (in millions)
*Assume average inventory is very close to the ending inventory

P8.8A
512.50
63.00%
813.49
PROBLEM 8.8A
Marks & Spencer (concluded)
c.
The average days required to collect outstanding receivables is computed by dividing 365
days by a company's trade receivable turnover rate. The turnover rate is computed by
dividing net sales by average trade receivable. Thus, the lower a company's average trade
receivable, the higher its trade receivable turnover rate will be, and the lower its average
collection time will be.
Marks & Spencer turns over its trade receivable at a rate of 107.35 times per year (365
days 122 times = 3.4 days average collection time). In short, the company's impressive
collection performance results from its trade receivable being very low relative to its total
sales. This makes sense, given that most of Marks & Spencer's revenue is in the form of
cash sales or credit card sales which are quickly turned into cash.

P8.8A(p.2)
35 Minutes, Medium
SOLUTIONS TO PROBLEMS SET B

PROBLEM 8.1B
DOME, LIMITED
a.
General Journal
2010
Inventory
To record cost of 700 cartridges sold to Maxine
Supplies: 300 units @ $200; 400 units @ $220.
148,000
148,000

Inventory
Supplies by theweighted average cost method: 700
units @$215 ($344,000 total cost, divided by 1,600
Exer
units).
cises
150,500
150,500
(3) First-in, First-out (FIFO) method:

Inventory
Supplies by the FIFO flow assumption:
400 units @$200, plus 300 units @ $220.

P8.1B
146,000
146,000
PROBLEM 8.1B
DOME, INC. (continued)
b. Inventory subsidiary ledger records:

Date
Units
12 Dec 09
16 Jan 10
400
1,200
PURCHASED
Unit
Cost
$
200
220
Total
$
SOLD
Unit
Cost
Units
Cost of
Goods Sold
Units
400
400
1,200
100
800
80,000
264,000
22 Jan10
300
400
200
220
148,000
BALANCE
Unit
Cost
$
200
200
220
200
220
Balance
$
80,000
344,000
196,000
Date
12 Dec 09
16 Jan 10
22-Jan-10
Units
400
1,200
PURCHASED
Unit
Cost
$
200
220
Total
$
SOLD
Unit
Cost
Units
Cost of
Goods Sold
Units
BALANCE
Unit
Cost
400
1,600
900
$
$
$
Units
BALANCE
Unit
Cost
80,000
264,000
* $344,000 total cost 1,600 units = $215 weighted average unit cost.
700
215
150,500
200
215
215
Balance
$
80,000
344,000
193,500
Date
12 Dec 09
16 Jan 10
22 Jan10
Units
400
1,200
PURCHASED
Unit
Cost
$
200
220
Total
$
SOLD
Unit
Cost
Units
Cost of
Goods Sold
80,000
264,000
400
400
1,200
400
300
200
220
146,000

P8.1B (p.2)
900
200
200
220
220
Balance
$
80,000
344,000
198,000
PROBLEM 8.1B
DOME, INC. (concluded)
c.
No. As shown in part a, the weighted average cost method resulted in the highest cost of
goods sold figure, whereas the FIFO method resulted in the lowest. If the FIFO method is
used for tax purposes, income tax regulations require that it also be used for financial
reporting purposes.

P8.1B (p.3)
PROBLEM 8.2B
SEA TRAVEL: PERPETUAL SYSTEM
30 Minutes, Strong

(a) Cost of goods sold on 28 April:
Weighted average cost (as of 28 April; $730,000 9 units)
Cost of goods sold (5 units @ $81,111)
81,111
324,445
255,000
579,445
82,778
(b) Ending inventory (7 units) at 30 June:

Weighted average unit cost following 19 April purchase:
4 units at 19 April weighted average cost of $81,111
3 units purchased on 8 May at $85,000 each
Total
Weighted average unit cost as of 8 May ($579,445 7 units)
Ending inventory, 30 June (7 units @ $82,778)
$
$

(a) Cost of goods sold on 28 April:
4 units from 1 April purchase @ $80,000
1 unit from 19 April purchase @ $82,000
Cost of goods sold (5 units)
(b) Ending inventory (7 units) at 30 June:
4 units from 19 April purchase @ $82,000
3 units from 8 May purchase @ $85,000
Ending inventory, 30 June

P8.2B
328,000
255,000
PROBLEM 8.2B
ERPETUAL SYSTEM
405,555
579,445
$
$
320,000
82,000
402,000
583,000

P8.2B
Problem 8.2B
SEA TRAVEL: PERPETUAL SYSTEM
(concluded)
b.
(1) The weighted average cost method will result in the lowest profit, as it assigns higher
costs to the cost of goods sold. Weighted average cost will result in the lowest profit
whenever the most recent purchase costs are also the highestthat is, in the common
situation of rising prices.
(2) In this situation, the FIFO method will maximize profits taxes, as it assigns the oldest
(and lowest) costs to the cost of goods sold. The low cost of goods sold, in turn,
increases taxable profit. The FIFO method will increase taxes whenever the oldest
purchase costs are the lowest, which as mentioned above is the normal situation in
an inflationary environment.
(3) No, Sea Travel may not use weighted average cost in its financial statements and
FIFO in its profits tax returns. Normally a company is not allowed to use different
accounting methods in its financial statements and profits tax returns.

P8.2B(p.2)
PROBLEM 8.3B
SEA TRAVEL: PERIODIC SYSTEM
20 Minutes, Medium

Ending inventory at 30 June:
Weighted average cost ($985,000 12 units)
Ending inventory (7 units @ $82,083.3)
82,083.30
$
574,583
985,000
574,583
410,417
Cost of goods sold through 30 June:

Less: Ending inventory at 30 June (above)
Cost of goods sold

Ending inventory at 30 June:
3 units from purchase on 8 May (@ $8,500)
4 units from purchase on 19 April (@$8,200)
$
$
255,000
328,000
583,000
Cost of goods sold through 30 June:

Less: Ending inventory at 30 June (above)
Cost of goods sold
b.
$
$
985,000
583,000
402,000
No. If the company selects the weighted average cost method for profits tax reporting, it is
required to choose the same method for financial reporting purposes.

P8.3B
PROBLEM 8.4B
SAM'S LAWN MOWERS
20 Minutes, Medium
a.
Shrinkage loss-one lawn mower
Weighted average cost method:

Cost of Goods Sold
Inventory
1,070
To record shrinkage loss of one lawn mower using weighted

average cost of $1,070 ($214,000 200 mowers = $1,070 per mower).
b. Shrinkage loss and LCNRV adjustment

(1) Shrinkage loss, first-in, first-out (FIFO) method:
1,000
Cost of Goods Sold

Inventory
To record shrinkage loss of one lawn mower using the FIFO
flow assumption (one mower @ $1,000).
(2) Write-down of inventory to the lower-of-cost-and-NRV:
Cost of Goods Sold
Inventory
33,900
To write down inventory to a NRV below cost:

Cost (after shrinkage loss: $214,000 - $1,000)
Market (199 mowers @ $900 per lawn mower)
Loss from write-down to NRV
c.
$
$
213,000
179,100
33,900
The only unethical act in this situation was committed by the employee against his employer.
There is nothing unethical about using a hidden security camera to protect ones assets. The
camera was not used to entice (or entrap) the employee. In short, he made a conscious decision to
steal lawn mowers from his employer and should be held completely responsible for doing so.

P8.4B
PROBLEM 8.4B
M'S LAWN MOWERS
1,070
1,000
33,900
ployee against his employer.

to protect ones assets. The
he made a conscious decision to
tely responsible for doing so.

P8.4B
PROBLEM 8.5B
ROMAN SOUND
25 Minutes, Easy
Units
a.
Unit Cost
Inventory and cost of goods sold:

(1) FIFO:
Inventory:
Fourth purchase
Third purchase
Ending inventory, FIFO
15
5
1,100
1,060
1,037
20
Cost of goods sold:

Less: Ending inventory, FIFO
Cost of goods sold, FIFO
(2) Weighted average cost:
b.
Inventory:
Total goods available for sale
Weighted average unit cost
($103,700 100 units)
100
Ending inventory, weighted

average of $1037 per unit
20
1,037
Cost of goods sold, weighted

average cost $1037 per unit
80
1,037
The FIFO method, by assigning the costs of the most recent purchases to inventory, provides the
most realistic year end amount for inventory in terms of NRV. A weakness of the FIFO method,
however, is that the costs assigned to the cost of goods sold are relatively old costs. Because the
costs of the units has been rising throughout the year, the FIFO method tends to understate the
cost of goods sold in terms of the costs actually being incurred by Roman Sound to replenish its
inventory. The inventory method using weighted average cost assigns the more recent costs to
the cost of goods sold and therefore provides a more realistic measure of profit, in terms of NRV,
than does the FIFO method.

P8.5B
PROBLEM 8.5B
ROMAN SOUND
Total Cost
$
$
16,500
5,300
21,800
103,700
21,800
81,900
103,700
20,740
82,960
chases to inventory, provides the

A weakness of the FIFO method,
elatively old costs. Because the
method tends to understate the
y Roman Sound to replenish its
ssigns the more recent costs to
easure of profit, in terms of NRV,

P8.5B
PROBLEM 8.6B
CITY SOFTWARE
20 Minutes, Medium
a.
Net sales
Cost of goods sold
2010
10,000,000
6,800,000
Gross profit on sales
3,200,000
Gross profit percentage
2009
9,200,000
5,904,000
3,296,000
32%
35.83%
$
$
$
2008
8,400,000
5,260,000
3,140,000
37.38%
Cost of Goods Sold:

2008:
$5,460,000 - $200,000 = $5,260,000
2009:
$5,704,000 + $200,000 = $5,904,000
2010:
$6,000,000 + $800,000 = $6,800,000
b.
The current owners of this business have no reason to be enthusiastic over the trend of gross
profit or gross profit rate. After correction of the inventory errors, it is apparent that both
the dollar amount of gross profit and the gross profit rate have declined, rather than
increased, during the last three years.

P8.6B
PROBLEM 8.7B
SING ALONG
25 Minutes, Medium
a.
(1) Estimated cost of goods sold:
Cost ratio for the current year:
Retail prices of goods available for sale
Cost ratio ($3,300,000 $6,000,000)
Estimated cost of goods sold (net sales, $5,200,000 x
cost ratio, 55%)
(2) Estimated ending inventory:
Cost of goods available for sale (given)
3,300,000
6,000,000
55%
2,860,000
3,300,000
2,860,000
440,000
Exer
b.
cises
(1) Restating physical inventory from retail prices to cost:

Physical inventory stated in retail prices
Cost ratio (per part a, above)
Ending inventory at cost ($750,000 x 55%)
(2) Estimated shrinkage losses at cost:

Estimated ending inventory (per part a)
Physical count of ending inventory, restated
at cost (per part b)
Estimated shrinkage loss, stated at cost
750,000
55%
412,500
440,000
412,500
27,500
5,200,000
2,887,500
2,312,500
(3) Computation of gross profit:

Net sales
Cost of goods sold:
Less: Ending inventory per physical count, at cost
Gross profit
c.
3,300,000
412,500
Tapes and CDs can easily fit into someones pocket and walk out of the store. Thus, it is
important that effective controls be in place to reduce inventory shrinkage. Four common
controls include: (1) security cameras, (2) security personnel, (3) shelves for safeguarding
employee handbags while they work, and (4) magnetic sensor strips to sound an alarm if
someone leaves the store in possession of a tape or CD. The sensor strips would be
deactivated when units of inventory are sold to customers.

P8.7B
PROBLEM 8.8B
Wing On
20 Minutes, Strong
a.
Computations based on weighted average cost valuation of inventory:

(1) Inventory turnover rate:
Cost of Goods Sold
Average inventory
$
$
599,112
79,724
$ 1,550,211
$ 341,360
$ 501,747
$ 1,100,859
(2) Current ratio:

Current Assets
Current Liabilities
(3) Gross profit rate:
Gross Profit
Net Sales
b.
The company must have encountered increasing replacement costs for its inventory during
the year.
c.
You would expect the ratios to be different under FIFO as follows:

Inventory turnover rate: Cost of goods sold lower, inventory higher, turnover lower
Current ratio: Inventory would be higher, current ratio higher
Gross profit rate: Gross profit higher (due to lower cost of goods sold).
Gross profit rate higher.

P8.8B
PROBLEM 8.8B
Wing On
7.51 times
4.54 : 1
45.6%
costs for its inventory during
higher, turnover lower

P8.8B
PROBLEM 8.8B
Wing On (concluded)
d.
The average days required to collect outstanding receivables is computed by dividing 365
days by a company's trade receivable turnover rate. The turnover rate is computed by
dividing net sales by average trade receivable. Thus, the lower a company's average trade
receivable, the higher its trade receivable turnover rate will be, and the lower its average
collection time will be.
Wing On turned over its trade receivables at a rate of every 0.5 days or 730 times per year
(365 days/0.5). The company's impressive performance in this area results from its trade
receivable being very low relative to its sales. This is explained by the fact that most of the
company's sales are for cash or on bank credit cards which are quickly turned into cash
for the retailer.

P8.8B(p.2)
SOLUTIONS TO CASES
30 Minutes, Strong
CASE 8.1
OUR LITTLE SECRET
a. Lee confronts three related ethical issues. The first is that Our Little Secrets past tax
practices have been both unethical and illegal. Lee cannot be involved in such practices or, if
she is in a position of responsibility, allow them to continue.
Second, Lee has good reason to question the basic integrity of her prospective employer.
Is Simons statement that no one knows how this all got started, or who was
responsible really true? After all, Simon is suggesting that the fraud continue after Amy
comes on board.
Third, there is the issue of confidentiality. Both CPAs and CMAs are ethically bound to treat
as confidential all information obtained in the course of their professional activities. This
means that the accountant should not disclose confidential information without the
employers (or clients) permission.
Technically, Our Little Secret is neither Lees employer nor client. Nonetheless, these
authors would consider a job interview as part of an accountants professional
activities. Thus, we believe that Lee should treat what she has learned about the
companys inventory problem as confidential information. Thus, she should not take it
upon herself to notify the Inland Revenue Department or any other third party about the
companys actions.
b. The solution proposed by Simon is unacceptable. To knowingly understate inventory in a
profits tax return would be unethical and illegal. Lee may not be a party to such action.
c. Lee basically has two ethical courses of action to consider. First, she may decide that she does
not wish to associate herself with the company. Therefore, she simply may decline the job. If
she chooses this course, she should treat Simons disclosures during this interview as
confidential information.
A second course of action would be to accept the position contingent upon the company
agreeing to take immediate steps to rectify the problem. This would include filing amended
profits tax returns for any years known to be in error, and taking steps to ensure that
inventory is reported properly in future returns. A consideration in making this decision
should be whether this is an isolated instance or symptomatic of a recurring pattern of
unethical behavior.
A third course of action would be to be certain that inventory was correctly stated in the next
years tax return, but not amend any returns already filed. This would cause an
overstatement of 2011 taxable profit which would offset the understatement of taxable profit
in all past years. These authors can see the practical appeal of such a simple solution, but
we cannot support it. Our Little Secret owes not only profits taxes on its understated taxable
profit, but also interest and penalties for failing to report this profit in prior years. Saying
nothing and allowing the error to flow through is, in essence, a scheme for evading these
interest charges and penalties.

Case 8.1
we cannot support it. Our Little Secret owes not only profits taxes on its understated taxable
profit, but also interest and penalties for failing to report this profit in prior years. Saying
nothing and allowing the error to flow through is, in essence, a scheme for evading these
interest charges and penalties.

Case 8.1
15 Minutes, Medium
a.
CASE 8.2
DEALING WITH THE BANK
ETHICS, FRAUD & CORPORATE GOVERNANCE
The inventory has been lost. It would be unethical to delay recognition of this loss in the hope that it
may someday be reduced by an insurance settlement. At present, recovery from the insurance company
appears too uncertain to be considered a receivable.
b. It is impossible for the company to increase its current ratio from 0.8 to 1 to 1.2 to 1 by purchasing more
inventory on account. Purchasing inventory on account will increase the current ratio only when it is
below 1 to 1. If the current ratio exceeds 1 to 1, the purchase of additional inventory on account would
decrease the ratio.
c.
The company should be open and honest in dealing with the bank. Most banks work hard to foster
ongoing relationships with their clients and, therefore, are willing to be flexible in situations such as
these.

Case 8.2
No time limit, Strong
CASE 8.3
INVENTORY TURNOVER RATES
INTERNET
Turnover rates of those companies vary, depending on the year of the most recent annual reports
used. The inventory turnover rate for Sa Sa often averages between 3.9 and 4.4 times per year,
whereas that of Chow Sang Sang averages only between 2.8 and 3.6 times per year. The fact is,
both companies manage their inventories well, given the industries in which they operate. Sa Sa's
rate is higher because cosmetics products, on average, sell more quickly than jewellery products.

Case 8.3

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CHAPTER 8

INVENTORIES AND THE

FIFO and weighted average cost

Real World: Marks & Spencer

Real World: adidas AG Examining an

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, AND CRITICAL THINKING

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Cost flow assumptions: Perpetual

Cost flow assumptions: Periodic

Real World: Wing On

Analysis, communication, judgment

Analysis, communication, judgment

Critical Thinking Cases

Real World: Chow Sang Sang and

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DESCRIPTIONS OF PROBLEMS AND

Problems (Sets A and B)

BassTrack/Dome, Inc. (Perpetual)

A comprehensive problem calling for measurement of the cost of

Speed World Cycles/Sea Travel (Perpetual)

Speed World Cycles/Sea Travel (Periodic)

Marios Nursery/Sam's Lawn Mowers

Tokyo Audio/Roman Sound

Hexagon Health Foods/City Software

Between the Ears/Sing Along

Marks & Spencer

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Critical Thinking Cases

Dealing with the Bank

Chow Sang Sang and Sa Sa

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SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

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Errors in the valuation of ending inventory are said to be counterbalancing or self-correcting

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The McGraw-Hill Companies, Inc., 2010

hould result in a lower profit than

to the cost of goods sold, and the

oods sold, weighted average cost

the reported rate of gross profit.

r Products had used weighted

t would be weighted average cost

average costin pricing its

mizes profit during a period of

s between ending inventory and

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SOLUTIONS TO BRIEF EXERCISES

50 units @ $2.00 = $100 (the oldest costs)

(15 units @ $20) = $300

100 units @ $3.05 = $ 305

Units in ending inventory: 100 + 100 - 75 = 125 units

Units in ending inventory: 10 + 20 - 25 = 5 units

Inventory Shrinkage Loss

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price of the two purchases

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t $620,000 ($670,000 ase by $50,000.

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Inventory turnover: $5,000,000 / $1,280,000 = 3.91

Inventory turnover for 2009: $85 / $27 = 3.15

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