Chapter 1



Chapter 7 Merchandise Inventory and Cost of Sales

Questions

1. Incidental costs often are ignored in pricing an inventory because the expense of computing costs on such a precise basis usually outweighs any benefit gained from the extra accuracy. The principle of materiality permits such practices when the effect on the financial statements is not significant.

2. a. First items into the inventory are assumed to be the first items sold.

b. Last items into the inventory are assumed to be the first items sold.

c. The invoice price, less trade discounts, plus any additional incidental costs to put goods into place and condition for sale.

3. LIFO will result in the lower cost of goods sold because the more recent costs are used.

4. Merchandise inventory is disclosed on the balance sheet as a current asset. It also may appear in the income statement as part of the calculation of cost of goods sold.

5. No, changing the inventory pricing method each period would violate the accounting principle of consistency.

6. A change from one acceptable method to another is allowed if the company justifies the change as an improvement in financial reporting.

7. The full-disclosure principle requires that the nature of the change, justification for the change and the effect of the change on net income be disclosed in the notes to the company’s financial statements.

8. The principle of conservatism says when faced with a choice of two or more equally likely amounts, the least optimistic value should be selected as is the case with lower of cost or market for inventory valuation.

9. Market can mean either net realizable value or replacement cost.

10. An inventory error that causes an understatement (or overstatement) of net income one accounting period, if not corrected, will cause an overstatement (or understatement) the next. Therefore, since the understatement (overstatement) of one period offsets the overstatement (understatement) of the next, such errors are said to correct themselves.

11. Many people make important decisions based on the fluctuations in a company’s net income from period to period. Therefore, inventory errors should not be permitted to cause such fluctuations.

12. WestJet’s inventory would be equivalent to 0.28% (6,259/2,213,092) of total assets. This is not merchandise inventory because WestJet is not a merchandiser.

13. Danier’s cost of goods sold figure for the year ended June 25, 2005 is $82,865,000.

Quick Study

QUICK STUDY 7-1

1. The title will pass at the destination, which is Stark Company’s receiving dock. Carefree should show the $500 in its inventory at year-end as Carefree retains title until the goods reach Stark Company.

2. The consignor is Carefree Company. The consignee is Stark Company. The consignor, Carefree Company, should include the consigned goods in inventory.

Quick Study 7-2

1,500 – 30 + 250 + 70 = 1,790 units in ending inventory

Quick Study 7-3

Cost $3,000

Add:

Transportation-In 150

Import duties 200

Insurance 50

Inventory Cost $3,400

Quick Study 7-4

$37,500 + $1,200 + $150 + $490 = $39,340

Quick Study 7-5

Beginning Inventory 10 units @ $50 $ 500

Add:

1st week purchase 10 units @ $51 $ 510

2nd week purchase 10 units @ $52 520

3rd week purchase 10 units @ $55 550

4th week purchase 10 units @ $60 600

Units Available 50 units

Cost of Goods Available for Sale $2,680

Quick Study 7-6

(a) FIFO perpetual

|  Date   | |    Purchases      | |

(b) LIFO perpetual

|  DATE   | |     PURCHASES      | |

Quick Study 7-6 (concluded)

(c) Moving weighted average perpetual

| | | | | | | | | | |

| | | | |

Quick Study 7-8

|  |  |Purchases/Transportation-In/ |Cost of Goods Sold/ |Balance in Inventory |

| | |(Purchase Returns/Discounts) |(Returns to Inventory) | |

|Date |Units |Cost/Unit | Total $ |Units |Cost/Unit |

| | | | | | |A. |B. |

|BOTTLES |12 | 3.50 |  4.25 |     42.00 |51.00 | |     42.00 |

|CANDLES |25 | 8.00 |  7.00 |  200.00 | 175.00 | |   175.00 |

| | | | |$296.00 |$275.50 |$275.50 |$266.50 |

C.

2011

Dec. 31 Cost of Goods Sold 20.50

Merchandise Inventory 20.50

To write inventory down to market; $296 – $275.50 = $20.50.

Quick Study 7-11

a. Understates cost of goods sold.

b. Overstates gross profit.

c. Overstates 2011 net income.

d. Understates 2012 net income.

e. The overstated net income for 2011 and the understated net income for 2012 combine to a correct total income for the two year period.

f. The error in 2011 will not affect years subsequent to 2012.

Quick Study 7-12

Goods available for sale:

Inventory, January 1 $180,000

Purchases (net) 342,000

Goods available for sale $522,000

Less: Estimated cost of goods

sold [$675,000 × (1 – 42%)] 391,500

Estimated September 10 inventory

destroyed in the fire $130,500

Quick Study 7-13

a. Since gross profit for prior periods has been 30%, then Cost of Goods Sold must be 70%. So, 70% x $565,000 net sales for July = $395,500 estimated cost of goods sold for July.

July’s beginning inventory (June’s ending inventory) of $ 65,000

Plus: July purchases    385,500

Equals: Cost of goods available for sale $450,500

Less: Estimated cost of goods sold for July 395,500

Equals: Estimated ending inventory for July $ 55,000

b. The estimated shrinkage is $7,000 ($55,000 - $48,000).

Quick Study 7-14

| |At Cost |At Retail |

|Goods available for sale |$67,600 |$104,000 |

|Deduct: Net sales at retail | | 82,000 |

|Ending inventory at retail | |$ 22,000 |

| | | |

|Cost to retail ratio: $67,600 ( $104,000 = 65% | | |

| | | |

|Estimated ending inventory at cost: $22,000 × 65% = | |$ 14,300 |

Quick Study 7-15

| |September | |October |

| |Cost |Retail | |Cost |Retail |

|Beginning inventory |$ 74,950 |$112,000 | |$ 70,850 |$109,000 |

|Cost of goods purchased | 395,000 | 611,000 | | 461,590 | 674,000 |

|Goods available for sale |$469,950 |$723,000 | |$532,440 |$783,000 |

|Less: Net sales at retail | |614,000 | | | 700,000 |

|Ending inventory at retail | |$109,000 | | |$ 83,000 |

|Cost to retail ratio | | x 65%1 | | | x 68%2 |

|Estimated ending inventory | |$ 70,850 | | |$ 56,440 |

1. 469,950/723,000 = .65 or 65%

2. 532,440/783,000 = .68 or 68%

*Quick Study 7-16

a) FIFO periodic

Ending Inventory = 100 @ $3.35 = $335

40 @ $3.20 = $128

b) LIFO PERIODIC

Ending Inventory = 140 @ $3.00 = $420

c) Average cost periodic

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

140 units in ending inventory @ $3.10/unit = $434 Cost of Ending Inventory

*Quick Study 7-17

Both companies are improving their turnover rates for merchandise. However, Huff Company has a higher turnover which suggests lower levels of inventory selling more rapidly than Mesa Company. It appears that Huff Company is managing inventory more efficiently provided they have enough merchandise to satisfy the needs of their customers (not turning them away because of lack of adequate inventory).

*Quick Study 7-18

a) Days’ sales in inventory

2011:

|$56,195 |× 365 |= 50.00 days |

|$410,225 | | |

2010:

|$82,500 |× 365 |= 87.41 days |

|$344,500 | | |

THE CHANGE FROM 2010 TO 2011 IS GENERALLY CONSIDERED TO BE FAVOURABLE.

b) Merchandise turnover

2011:

|$410,225 | = 5.92 times |

|($56,195 + $82,500)/2 | |

2010:

|$344,500 | = 3.55 times |

|($82,500 + $111,500)/2 | |

The change from 2010 to 2011 is generally considered to be favourable.

EXERCISES

EXERCISE 7-1 (45 MINUTES)

(a) FIFO perpetual

|  Date   | |     Purchases      | |

Gross profit calculation under FIFO:

| |Sales (530 units × $40) |$21,200 |

| |Cost of goods sold | 8,350 |

| |Gross profit |$12,850 |

Exercise 7-1 (continued)

(b) Moving weighted-average perpetual

| | | | | | | | | | |

Gross profit calculation under Weighted-average:

| |Sales (530 units × $40) |$21,200.00 |

| |Cost of goods sold | 8,613.40 |

| |Gross profit |$12,586.60 |

Exercise 7-1 (concluded)

(c) LIFO perpetual

|  Date   | |     Purchases      | |

Gross profit calculation under LIFO:

| |Sales (530 units × $40) |$21,200 |

| |Cost of goods sold | 9,000 |

| |Gross profit |$12,200 |

Exercise 7-2 (20 minutes)

Specific identification

|  Date   | |     Purchases      | |

Gross profit calculation under Specific Identification:

| |Sales (530 units × $40) |$21,200 |

| |Cost of goods sold | 8,650 |

| |Gross profit |$12,550 |

Exercise 7-3 (40 minutes)

1.

|Jan. 1 |120 units |@ |$6.00 |= |$720 |

|Mar. 7 |250 units |@ |5.60 |= |1,400 |

|July 28 |500 units |@ |5.00 |= |2,500 |

|Oct. 3 | 450 units |@ |4.60 |= | 2,070 |

|Totals |1,320 units | | | |$6,690 |

available for cost of goods

sale available for sale

2.

Units sold: Units remaining in ending inventory:

|Jan. 10 |70 units | 1,320 units available for sale less 795 units sold |

|Mar. 15 |125 units | = 525 units remaining in ending inventory. |

|Oct. 5 |600 units | |

|Totals | 795 units | |

3.(a) Moving weighted-average perpetual

| | | | | | | | | | |

| | | | |

Exercise 7-3 (concluded)

3.(c) LIFO perpetual

|  Date   | |     Purchases      | |

Exercise 7-4 (20 minutes)

Specific identification — perpetual

|  Date   | |     Purchases      | |

Exercise 7-5 (30 minutes)

TROUT COMPANY

Income Statement

For year ended December 31, 2011

Moving

Specific Weighted

Identification Average FIFO LIFO

Sales $11,925 $11,925.00 $11,925 $11,925

(795 units × $15 selling price)

Cost of goods sold 4,018 4,092.75 4,245 3,940

Gross profit $ 7,907 $ 7,832.25 $ 7,680 $ 7,985

Operating expenses 1,250 1,250.00 1,250 1,250

Net income  $  6,657    $   6,582.25   $  6,430    $  6,735

1) The LIFO method results in the highest net income with $6,735.

2) The weighted average net income of $6,582.25 does fall between FIFO net income ($6,430) and LIFO net income ($6,735).

3) If costs were rising instead of falling then the FIFO method would probably result in the highest net income.

Exercise 7-6

|  |  |Purchases/Transportation-In/ (Purchase |Cost of Goods Sold/ |Balance in Inventory |

| | |Returns/Discounts) |(Returns to Inventory) | |

|Date |Units |Cost/Unit | Total $ |Units |Cost/Unit |

| | | | | | |a. |b. |

|FM |15 | 156 | 144 | 2,340 | 2,160 | | 2,160 |

|MB |36 | 190 | 182 | 6,840 | 6,552 | | 6,552 |

|SL |40 | 72 | 87 | 2,880 | 3,480 | | 2,880 |

| | | | |$14,260 |$14,568 |$14,260 |$13,792 |

|c. |2011 | | | |

| |Dec. 31 |Cost of Goods Sold |468 | |

| | | Merchandise Inventory | |468 |

| | | To write inventory down to market; | | |

| | |14,260 – 13,792 = 468 | | |

Exercise 7-8 (20 minutes)

|1. $900,000 – $500,000 = $400,000 | | |

2.

| |FOR YEARS ENDED | |INCOME STATEMENT INFORMATION |

| | | |actually reported for |

| | | |years ended December 31, |

| |December 31, 2011, 2012, and 2013 | | |

| |income statement information | | |

| |should have been reported as: | |2011 | |2012 | |2013 |

|Sales | |$900,000 | |$900,000 | |$900,000 | |$900,000 |

|Cost of goods sold: | | | | | | | | |

| Beginning inventory |$200,000 | |$200,000 | |$180,000 | |$200,000 | |

| Add: Purchases |500,000 | |500,000 | |500,000 | |500,000 | |

| Less: Ending inventory | 200,000 | | 180,000 | | 200,000 | | 200,000 | |

| Cost of goods sold | | 500,000 | | 520,000 | | 480,000 | | 500,000 |

|Gross profit | |$400,000 | |$380,000 | |$420,000 | |$400,000 |

Exercise 7-9 (20 minutes)

Goods available for sale:

Inventory, January 1 $ 450,000

Purchases $1,590,000

Purchase returns (23,100)

Transportation-in 37,600 1,604,500

Goods available for sale $2,054,500

Less: Estimated cost of goods sold:

Sales $2,000,000

Estimated cost of goods sold

[$2,000,000 × (1 – 30%)] (1,400,000)

Estimated March 31 inventory $ 654,500

Exercise 7-10 (20 minutes)

At Cost At Retail

Goods available for sale:

Beginning inventory $63,800.00 $ 128,400.00

Net purchases 115,620.00 196,800.00

Goods available for sale $179,420.00 $325,200.00

Deduct net sales at retail 260,000.00

Ending inventory at retail $ 65,200.00

Cost ratio: ($179,420/$325,200) × 100 = 55.17%

Ending inventory at cost ($65,200 × 55.17%) $35,970.84

Exercise 7-11 (15 minutes)

a. $54,600 × 55.17% = $30,122.82

b.

At Cost At Retail

Estimated inventory that should have

been on hand $35,970.84 $65,200.00

Physical inventory 30,122.82 54,600.00

Inventory shrinkage $ 5,848.02 $ 10,600.00

*Exercise 7-12 (20 minutes)

Ending Cost of

Inventory Goods Sold

a. Weighted-average cost ($6,600/1,320 = $5.00):

$5.00 × 50 250

$6,600 – $250 6,350

b. FIFO:

50 × $4.40 220

$6,600 – $220 6,380

c. LIFO:

50 × $6.00 300

$6,600 – $300 6,300

FIFO provides the lowest net income because it has the highest cost of goods sold due to decreasing unit costs.

*Exercise 7-13 (20 minutes)

Ending Cost of

Inventory Goods Sold

a. FIFO:

(50 × $2.86) + (100 × $2.50) 393

(120 × $2.00) + (250 × $2.30) + (400 × $2.50) 1,815

b. LIFO:

(120 × $2.00) + (30 × $2.30) 309

(50 × $2.86) + (500 × $2.50) + (220 × $2.30) 1,899

c. Weighted-average cost ($2,208/920 = $2.40):

$2.40 × 150 360

$2.40 × 770 1,848

LIFO provides the lowest net income because it has the highest cost of goods sold due to rising unit costs.

*Exercise 7-14 (15 minutes)

|Ending inventory: | | | | | |

| | |Units | |Cost/Unit | |Total Cost |

| |Beginning inventory |80 |@ |$2.00 |= |$160.00 |

| |March 7 purchase |22 |@ |2.30 |= |50.60 |

| |July 28 purchase | 48 |@ |2.50 |= | 120.00 |

| | |150 | | | |$330.60 |

|Cost of goods sold: | | | | | |

|Cost of goods available for sale less Ending inventory = Cost of goods sold |

| | | | | | | |

| | |$2,208.00 – $330.60 = |$1,877.40 |

| | | | | | | |

| | | | | | | |

*Exercise 7-15 (10 minutes)

Merchandise turnover

2012:

|$ 643,825 | |= 7.0 times |

|($96,400 + $86,750)/2 | | |

2011:

|$ 426,650 | |= 4.8 times |

|($86,750 + $91,500)/2 | | |

Days’ sales in inventory

2012:

|$ 96,400 |× 365 |= 54.7 days |

|$643,825 | | |

2011:

|$ 86,750 |× 365 |= 74.2 days |

|$426,650 | | |

It appears that Russo has lower levels of merchandise inventory on hand which is generally favourable provided customers are not being turned away because of out-of-stock items.

PROBLEMS

PROBLEM 7-1A (40 MINUTES )

1) (a) FIFO perpetual

| Date   | Purchases          | Sales (at cost)         |   Inventory Balance     |

| |Units | |Unit Cost |

Problem 7-1A (continued)

1) (b) LIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

1) (c) Moving weighted-average perpetual

| | | | | | | | | | |

Problem 7-1A (continued)

2) Specific Identification

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units |Unit Cost | |

Problem 7-1A (concluded)

3)

| | | | | |Moving Weighted Average |Specific Identification |

| | | |FIFO |LIFO | | |

|Feb. |10 |Merchand|

| | |ise |

| | |Inventor|

| | |y |

| |Less: Units sold | 850 |

| |Ending Inventory | 200 |

1) (a) FIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

Problem 7-3A (continued)

1) (b) LIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

(c) Moving weighted-average perpetual

| | | | |

| | | | |

Problem 7-3A (concluded)

2)

| | | |Moving Weighted Average |

| | | | |

| |FIFO |LIFO | |

|Sales (850 x $160) |$136,000 |$136,000 |$136,000 |

|Cost of goods sold |67,400 |64,300 |65,445 |

|Gross profit |$68,600 |$71,700 |$70,555 |

Analysis Component

If Gale Company had been experiencing increasing prices in the acquisition of additional inventory, gross profit would have been highest using a FIFO inventory costing method and lowest under a LIFO inventory costing method. The gross profit under the moving weighted average costing method would have fallen between FIFO and LIFO.

*Problem 7-4A (25 minutes)

a) FIFO basis:

Total cost of the 1,050 units for sale $80,200

Less: Ending inventory on a FIFO basis:

200 units @ $64 12,800

Cost of units sold $67,400

b) LIFO basis:

Total cost of the 1,050 units for sale $80,200

Less: Ending inventory on a LIFO basis:

200 @ $80 16,000

Cost of units sold $64,200

c) Weighted-average cost basis:

Total cost of the 1,050 units for sale $80,200

Less: Ending inventory at weighted-average cost:

($80,200/1,050 = $76.38) × 200 15,276*

Cost of units sold $64,924*

*These amounts may vary if the unit cost/unit was not rounded to two decimal places.

Problem 7-5A (50 minutes)

|FRESH EXPRESS COMPANY |

|Income Statement Comparing FIFO, LIFO and |

|Moving Weighted-Average Inventory Costing Methods |

|For Year Ended December 31, 2011 |

| | | | |

| | | |Moving |

| |FIFO |LIFO |WeightedAverage |

| | | |Cost |

|Sales (5,500 units sold x $90/unit) |$495,000 |$495,000 |$495,000 |

|Cost of goods sold | 225,400 | 227,800 | 225,705 |

|Gross profit |$269,600 |$267,200 |$269,295 |

|Operating expenses (5,500 units sold x $12/unit) | 66,000 | 66,000 | 66,000 |

|Net income |$203,600 |$201,200 |$203,295 |

Supporting calculations:

Calculate units and cost of goods available for sale:

|Beginning inventory |600 |@ |$36 |= |$ 21,600 |

|Purchases: | | | | | |

| Feb. 20 |1,500 |@ |$38 |= |57,000 |

| May 16 |700 |@ |$40 |= |28,000 |

| Dec. 11 |3,300 |@ |$44 |= |145,200 |

|Units available for sale |6,100 | | | | |

|Cost of goods available for sale | | | | |$251,800 |

Problem 7-5A (continued)

(a) FIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

(b) LIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

Problem 7-5A (concluded)

(c ) Moving weighted-average perpetual

| | | | | |

| | | | | | | | | | | |

|*cost per unit changed due to rounding | | | | |

Analysis Component

If the manager of Fresh Express earns a bonus based on a percentage of gross profit, she will prefer the FIFO inventory costing method since it has produced the highest gross profit. FIFO will always produce a higher gross profit than either LIFO or Moving weighted average when the unit costs of merchandise inventory are increasing.

*Problem 7-6A (45 minutes)

|FRESH EXPRESS COMPANY |

|Income Statement Comparing FIFO, LIFO and |

|Weighted Average Inventory Costing Methods |

|For Year Ended December 31, 2011 |

| | | |Weighted Average |

| |FIFO |LIFO | |

|Sales |$495,000 |$495,000 |$495,000 |

|COGS |225,400 |230,200 |227,032 |

|Gross Profit |$269,600 |$264,800 |$267,968 |

|Operating Expenses |66,000 |66,000 |66,000 |

|Net Income |$203,600 |$ 198,800 |$201,968 |

Supporting calculations:

Cost of goods available for sale:

600 units in beginning inventory @ $36 $ 21,600

1,500 @ $38 57,000

700 @ $40 28,000

3,300 @ $44    145,200

6,100 units available for sale $251,800

a) FIFO basis:

Total cost of the 6,100 units $251,800

Less: Ending inventory on a FIFO basis:

600 @ $44 26,400

Cost of units sold $225,400

b) LIFO basis:

Total cost of the 6,100 units $251,800

Less: Ending inventory on a LIFO basis:

600 @ $36 21,600

Cost of units sold $230,200

c) Weighted-average:

Total cost of the 6,100 units $251,800

Less: Ending inventory at weighted-average cost:

($251,800/6,100) = $41.28 × 600 24,768*

Cost of units sold $227,032*

*These amounts may vary if the unit cost/unit was not rounded to two decimal places.

Problem 7-7A (35 minutes)

Cost of goods sold:    2011       2012          2013    

Reported $ 715,000 $ 847,000 $ 770,000

Adjustments: Dec. 31, 2011 error – 66,000 + 66,000

Dec. 31, 2012 error + 30,000 – 30,000

Corrected $ 649,000 $ 943,000 $ 740,000

Net income:        2011           2012          2013    

Reported $ 220,000 $ 275,000 $ 231,000

Adjustments: Dec. 31, 2011 error + 66,000 – 66,000

Dec. 31, 2012 error – 30,000 + 30,000

Corrected $ 286,000 $ 179,000 $ 261,000

Total current assets:     2011              2012            2013    

Reported $1,155,000 $1,265,000 $1,100,000

Adjustments: Dec. 31, 2011 error + 66,000

Dec. 31, 2012 error – 30,000  

Corrected $1,221,000 $1,235,000 $1,100,000

Owner’s equity:     2011              2012            2013    

Reported $1,287,000 $1,430,000 $1,232,000

Adjustments: Dec. 31, 2011 error + 66,000

Dec. 31, 2012 error – 30,000  

Corrected $1,353,000 $1,400,000 $1,232,000

Analysis component:

These errors are “self-correcting” in the year following the error. Each overstatement (or understatement) of net income is offset by a matching understatement (or overstatement) in the following year. Thus, aggregate net income for the three-year period is not affected by the errors.

The understatement of inventory by $66,000 results in an overstatement of cost of goods sold by that same amount. The $66,000 overstatement of cost of goods sold results in an understatement of gross profit by the same amount. This understatement of gross profit carries through to an understatement of net income. Since the understated net income is closed to capital, the final equity figure is understated by the amount of the inventory understatement.

Problem 7-8A (30 minutes)

| |2011 |2012 |2013 |

|Corrected Ending Inventory |$ 345,000 |$ 420,000 |$392,000 |

| |+ $ 55,000 |– $ 16,000 |(no change) |

| |$ 400,000 |$ 404,000 | |

|Corrected Cost of Goods Sold |$1,300,000 |$1,750,000 |$2,100,000 |

| |– $ 55,000 |+ $ 55,000 |– $ 16,000 |

| |$1,245,000 |+ $ 16,000 |$2,084,000 |

| | |$1,821,000 | |

|Corrected Net Income |$ 340,000 |$ 516,000 |$ 652,000 |

| |+$ 55,000 |- $ 55,000 |+$ 16,000 |

| |$ 395,000 |- $ 16,000 |$ 668,000 |

| | |$ 445,000 | |

Problem 7-9A (50 minutes)

| | |Per Unit | | |LCM applied to: |

|Inventory |Units on |Cost |Market |Total |Total Market |a. |b. |c. |

|Items |Hand | | |Cost | |Whole |Major Category |Separately to |

| | | | | | | | |Each |

| | | | | | | | |Product |

| Receivers |335 |$ 180 |$ 196 |$ 60,300 |$ 65,660 | | |$ 60,300 |

| CD players |250 |222 |200 |55,500 |50,000 | | |50,000 |

| Cassette decks |316 | 172 | 190 |54,352 |60,040 | | |54,352 |

| Turntables |194 | 104 | 82 | 20,176 | 15,908 | | |15,908 |

| Subtotal | | | |$ 190,328 |$ 191,608 | |$ 190,328 | |

| | | | | | | | | |

|Video: | | | | | | | | |

| Televisions |470 |300 |250 |$ 141,000 |$ 117,500 | | |117,500 |

| VCRs |281 | 186 | 168 |52,266 |47,208 | | |47,208 |

| Video cameras |202 |620 |644 | 125,240 | 130,088 | | |125,240 |

| Subtotal | | | |$318,506 |$294,796 | |294,796 | |

| | | | | | | | | |

|Car Audio: | | | | | | | | |

| Cassette radios |175 | 140 | 168 |$ 24,500 |$ 29,400 | | |24,500 |

| CD radios |160 | 194 |210 | 31,040 | 33,600 | | |31,040 |

| Subtotal | | | |$ 55,540 |$ 63,000 | | 55,540 | |

| | | | | | | | | |

|Totals | | | |$564,374 |$549,404 |$549,404 |$540,664 |$526,048 |

Problem 7-10A (20 minutes)

|2010 Gross margin ratio: | | |

|  Sales | |$6,400,450 |

|  Cost of sales | | 3,521,150 |

|  Gross margin | |$2,879,300 |

| | | |

|  Gross margin ratio | |45%* |

| | | |

|Estimated inventory: | | |

|Goods available for sale: | | |

|  Inventory, December 31, 2010 |$588,200 | |

|  Net purchases, 2011 |364,800 | |

|  Goods available for sale | |$953,000 |

|Less: estimated cost of goods sold: | | |

|  Sales |$701,200 | |

|  Estimated cost of goods sold | | |

|   [$701,200 × (1 – 45%)] | |385,660 |

|Estimated February 10, 2011 inventory | |$567,340 |

|  Less: inventory salvaged | |212,400 |

|Estimated inventory lost in fire | |$354,940 |

| | | |

|*rounded to nearest whole percentage | | |

Problem 7-11A (25 minutes)

ALANOOD COMPANY

Estimated Inventory

March 31, 2011

Goods available for sale:

Inventory, January 1, 2011 $ 150,130

Purchases $472,600

Less: Purchase returns 6,525

Add: Transportation-in 3,450

Net cost of goods purchased 469,525

Goods available for sale $ 619,655

Less: Estimated cost of goods sold:

Sales $ 595,575

Less: Sales returns 4,725

Net sales $ 590,850

Estimated cost of goods sold

[$ 590,850 × (1 – 36%)] 378,144

Estimated March 31, 2011 inventory $ 241,511

Problem 7-12A (25 minutes) Part 1

EARTHLY GOODS

Estimated Inventory

December 31, 2011

    At Cost     At Retail    

Goods available for sale:

Beginning inventory $ 942,700 $ 1,854,300

Purchases 6,657,660 12,797,400

Purchase returns (105,600) (238,700)

Goods available for sale $7,494,760 $14,413,000

Net sales ($10,991,400 – $89,200)   10,902,200

Ending inventory at retail $3,510,800

Cost to retail ratio ($7,494,760 ( $14,413,000)    × 52%

Ending inventory at cost $ 1,825,616

Part 2

Estimated physical inventory at cost: $3,351,600 × 52% = $1,742,832

EARTHLY GOODS

Inventory Shortage

December 31, 2011

At Cost At Retail

Estimated inventory, December 31 $1,825,616 $3,510,800

Physical inventory 1,742,832 3,351,600

Inventory shortage $ 82,784 $ 159,200

Problem 7-13A (20 minutes)

|Part 1 |At Cost | |At Retail | |

|Goods available for sale: | | | | |

| Beginning inventory |$ 150,000 | |$ 187,500 | |

| Purchases |2,550,000 | |3,462,500 | |

| Less: Purchase returns and allowances |30,000 | |40,000 | |

| Add: Transportation-in | 37,500 | |                    | |

| Goods available for sale |$2,707,500 | |$3,610,000 | |

| | | | | |

|Deduct net sales at retail ($3,285,000 – $36,000) | | | 3,249,000 | |

|Ending inventory at retail | | |$ 361,000 | |

| | | | | |

|Cost to retail ratio ($2,707,500 ( $3,610,000): | | | x 75% | |

| | | | |

|Estimated ending inventory at cost ($361,000 × 75%): | | |$ 270,750 | |

| |

Problem 7-13A (concluded)

Part 2

The estimated cost of the stolen inventory is $270,750 – $117,000 = $153,750

*Problem 7-14A (25 minutes) Part 1

Cost of units available for sale:

20,000 units in beginning inventory @ $7.50 $ 150,000

28,000 units purchased @ $9.00 252,000

30,000 units purchased @ $11.00 330,000

20,000 units purchased @ $12.00 240,000

33,000 units purchased @ $13.50 445,500

131,000 units for sale $1,417,500

Part 2

a) FIFO basis:

Total cost of the 131,000 units for sale $1,417,500

Less: Ending inventory on a FIFO basis:

33,000 units @ $13.50 $445,500

2,000 units @ $12.00 24,000 469,500

Cost of units sold $948,000

b) LIFO basis:

Total cost of the 131,000 units for sale $1,417,500

Less: Ending inventory on a LIFO basis:

20,000 beginning inventory units @ $7.50 $150,000

15,000 units @ $9.00 135,000 285,000

Cost of units sold $1,132,500

c) Weighted-average cost basis:

Total cost of the 131,000 units for sale $1,417,500

Less: Ending inventory at weighted-average cost:

($1,417,500/131,000 = $10.82) × 35,000 378,700*

Cost of units sold $1,038,800*

*These amounts may vary if the unit cost/unit was not rounded to two decimal places.

ALTERNATE PROBLEMS

Problem 7-1B (40 minutes)

1) (a) FIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

1) (b) LIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

Problem 7-1B (continued)

1) (c) Moving weighted-average perpetual

| | | | | | |

Problem 7-1B (continued)

2) Specific identification

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

| | | | | | | |

| | | | | | | | | | | |

|Feb. |15 |Accounts Receivable |27,000 | |27,000 | |27,000 | |27,000 | |

| | | Sales | |27,000 | |27,000 | |27,000 | |27,000 |

| | | To record a credit sale; | | | | | | | | |

| | |$90/unit x 300 units = | | | | | | | | |

| | |$27,000. | | | | | | | | |

| | | | | | | | | | | |

| |15 |Cost of Goods Sold |16,500 | |16,900 | |16,650 | |16,750 | |

| | | Merchandise Inventory | |16,500 | |16,900 | |16,650 | |16,750 |

| | | To record the sale of | | | | | | | | |

| | |merchandise. | | | | | | | | |

| | | | | | | | | | | |

|Aug. | 5 |Merchandise Inventory |20,355 | |20,355 | |20,355 | |20,355 | |

| | | Accounts Payable | |20,355 | |20,355 | |20,355 | |20,355 |

| | | To record the purchase of | | | | | | | | |

| | |inventory on credit. | | | | | | | | |

*Problem 7-2B (25 minutes)

a) FIFO basis:

Total cost of the 1,145 units for sale $64,755

Less: Ending inventory on a FIFO basis:

345 units @ $59 $20,355

165 units @ $57 9,405 29,760

Cost of units sold $34,995

b) LIFO basis:

Total cost of the 1,145 units for sale $64,755

Less: Ending inventory on a LIFO basis:

510 beginning inventory units @ $55 28,050

Cost of units sold $36,705

c) Weighted-average cost basis:

Total cost of the 1,145 units for sale $64,755.00

Less: Ending inventory at weighted-average cost:

($64,755/1,145 = $56.55) × 510 28,840.50*

Cost of units sold $35,914.50*

*These amounts may vary if the unit cost/unit was not rounded to two decimal places.

Problem 7-3B (40 minutes)

1) (a) FIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

1)(b) LIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

Problem 7-3B (concluded)

1) c) Moving weighted-average perpetual

| | | | | |

*unit cost changed due to rounding

2)

| | | |Moving Weighted-Average |

| |FIFO |LIFO | |

|Sales (650 × $80) |$52,000 |$52,000 |$52,000 |

|Less: Cost of goods sold |37,060 |36,000 |36,470 |

|Gross profit |$14,940 |$16,000 |$15,530 |

Analysis component:

Gross profits calculated in Part 2 would increase under FIFO and decrease under LIFO if Moran Company had been experiencing increasing prices in the purchase of additional inventory. The moving weighted-average costing method would fall between FIFO and LIFO.

*Problem 7-4B (25 minutes)

a) FIFO basis:

Total cost of the 770 units for sale $43,060

Less: Ending inventory on a FIFO basis:

120 units @ $50 6,000

Cost of units sold $37,060

b) LIFO basis:

Total cost of the 770 units for sale $43,060

Less: Ending inventory on a LIFO basis:

120 @ $60 7,200

Cost of units sold $35,860

c) Weighted-average cost basis:

Total cost of the 770 units for sale $43,060.00

Less: Ending inventory at weighted-average cost:

($43,060/770 = $55.92) × 120 6,710.40*

Cost of units sold $36,349.60*

*These amounts may vary if the unit cost/unit was not rounded to two decimal places.

Problem 7-5B (40 minutes)

THE DENNEY COMPANY

Income Statement Comparing FIFO, LIFO,

and Moving Weighted-Average Inventory Costing Methods

For Year Ended December 31, 2011

| | | |Moving Weighted |

| | | |Average |

| |FIFO |LIFO | |

|Sales ($98 x 2,500 units) |$245,000 | |$245,000 | |$245,000 | |

|Cost of goods sold | 138,440 | | 138,200 | | 138,363 | |

|Gross profit |$106,560 | |$106,800 | |$106,637 | |

|Operating expenses ($14 x 2,500 units) | 35,000 | | 35,000 | | 35,000 | |

|Net income |$ 71,560 | |$ 71,800 | |$ 71,637 | |

Calculations:

Calculate units and cost of goods available for sale:

|BEGINNING INVENTORY |740 |@ |$58 |= |$ 42,920 | | |

|PURCHASES: | | | | | | | |

| APR. 2 | |700 |@ |$56 |= |39,200 | | |

|JUN. 14 | |600 |@ |$54 |= |32,400 | | |

|AUG. 29 | | 500 |@ |$52 |= | 26,000 | | |

|UNITS AVAILABLE |2,540 | | | | | | |

|COST OF GOODS AVAILABLE | | | |$140,520 | | |

Problem 7-5B (continued)

(a) FIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost |

Problem 7-5B (continued)

(b) LIFO perpetual

|Date |      Purchases       |      Sales (at cost)       |      Inventory Balance       |

| |Units | |Unit Cost | |Total Cost |Units | |Unit Cost| |Cost of Goods |

| | | | | | | | | | |Sold |

| |740 |@ |$58.00 |

Problem 7-5B (concluded)

(c) Moving weighted-average perpetual

| | | | | | | | |

|*cost per unit changed due to rounding | | | | | |

Analysis component:

If The Denney Company manager earns a bonus based on a percentage of gross profit, she will prefer the LIFO inventory costing method since it has produced the highest gross profit. LIFA will always produce a higher gross profit than either LIFO or Moving weighted average when the unit costs of merchandise inventory are decreasing.

Problem 7-6B

|The Denney Company |

|Income Statement Comparing FIFO, LIFO and Weighted- |

|Average Inventory Costing Methods |

|FOR YEAR ENDED DECEMBER 31, 2011 |

| | | | | |Weighted |

| |FIFO | |LIFO | |Average |

|Sales (2,500 x $98/unit) |$245,000.00 | |$245,000.00 | |$245,000.00 |

|COGS |138,440.00 | |138,200.00 | |138,307.20 |

|Gross Profit |$106,560.00 | |$106,800.00 | |$106,692.80 |

|Operating Expenses (2,500 x $14/unit) | 35,000.00 | | 35,000.00 | | 35,000.00 |

|Net Income |$ 71,560.00 | |$ 71,800.00 | |$ 71,692.80 |

Supporting calculations:

Cost of units available for sale:

| |740 |units in beginning inventory |@ |$58 |= |$ 42,920.00 |

| |700 |units purchased April 2 |@ |$56 |= |$ 39,200.00 |

| |600 |units purchased June 14 |@ |$54 |= |$ 32,400.00 |

| |500 |units purchased August 29 |@ |$52 |= |$ 26,000.00 |

| |2,540 | | | | |$140,520.00 |

a) FIFO periodic

Total cost of the 2,540 units for sale $140,520.00

Less: Ending inventory on a FIFO basis:

40 units @ 52 = 2,080.00

Cost of units sold $138,440.00

|b) |LIFO periodic | | |

| | Total cost of the 2,540 units for sale | |$140,520.00 |

| | Less: Ending inventory on a LIFO basis: | | |

| |    40 units @$58 | | 2,320.00 |

| |Cost of units sold | |$138,200.00 |

|c) |Weighted-average cost basis: | | |

| | Total cost of the 2,540 units for sale | |$140,520.00 |

| | Less: Ending inventory at weighted-average cost: | | |

| |  ($140,520/2,540) = $55.32 × 40 units = | | 2,212.80* |

| | Cost of units sold | |$138,307.20* |

*These amounts may vary if the unit cost/unit was not rounded to two decimal places.

Problem 7-7B (25 minutes)

Cost of goods sold     2011         2012         2013    

Reported $205,200 $212,800 $196,030

Adjustments: Dec. 31, 2011 error + 17,000 – 17,000

Dec. 31, 2012 error – 25,000 + 25,000

Corrected $222,200 $170,800 $221,030

Net income:     2011         2012         2013    

Reported $174,800 $211,270 $183,910

Adjustments: Dec. 31, 2011 error – 17,000 + 17,000

Dec. 31, 2012 error + 25,000 – 25,000

Corrected $157,800 $253,270 $158,910

Total current assets:     2011         2012         2013    

Reported $266,000 $276,500 $262,950

Adjustments: Dec. 31, 2011 error – 17,000

Dec. 31, 2012 error + 25,000  

Corrected $249,000 $301,500 $262,950

Owner’s equity:     2011         2012         2013    

Reported $304,000 $316,000 $336,000

Adjustments: Dec. 31, 2011 error – 17,000

Dec. 31, 2012 error + 25,000  

Corrected $287,000 $341,000 $336,000

Analysis Component

These errors are “self-correcting” in the year following the error. Each overstatement (or understatement) of net income is offset by a matching understatement (or overstatement) in the following year. Thus, aggregate net income for the three-year period is not affected by the errors.

Problem 7-8B (30 minutes)

1)

| |Incorrect | |Corrected |

| |Income Statement Information | |Income Statement Information |

| |For Years Ended December 31 | |For Years Ended December 31 |

| | 2011     | % |      2012   | % | | 2011 | %   | | 2012 |% |

|Sales |$1,350,000 |100 |$1,690,000 |100 | |

|Inventory |Units on |Cost |Market |Total |Total |a. |b. |c. |

|Items |Hand | | |Cost |Market |Whole |Major Category |Separately to |

| | | | | | | | |Each |

| | | | | | | | |Product |

|Office furniture: | | | | | | | | |

| Desks |436 |$261 |$305 |$113,796 |$132,980 | | |$113,796 |

| Credenzas |295 |227 |256 |66,965 |75,520 | | |66,965 |

| Chairs |587 |49 |43 |28,763 |25,241 | | |25,241 |

| Bookshelves |321 |93 |82 | 29,853 | 26,322 | | |26,322 |

| Subtotals | | | |$239,377 |$260,063 | |$239,377 | |

|Filing cabinets: | | | | | | | | |

| Two-drawer |214 |81 |70 |$ 17,334 |$ 14,980 | | |14,980 |

| Four-drawer |398 |135 |122 |53,730 |48,556 | | |48,556 |

| Lateral |175 |104 |118 | 18,200 | 20,650 | | |18,200 |

| Subtotals | | | |$ 89,264 |$ 84,186 | |84,186 | |

|Office Equip.: | | | | | | | | |

| Fax machines |430 |168 |200 |$ 72,240 |$ 86,000 | | |72,240 |

| Copiers |545 |317 |288 |172,765 |156,960 | | |156,960 |

| Typewriters |352 |125 |117 | 44,000 | 41,184 | | |41,184 |

| Subtotals | | | |$289,005 |$284,144 | |284,144 |   |

| | | | | | | | | |

|Totals | | | |$617,646 |$628,393 |$617,646 |$607,707 |$584,444 |

Problem 7-10B (20 minutes)

|2010 Gross margin ratio: | | |

|  Sales | |$4,245,100 |

|  Cost of sales | | 2,674,350 |

|  Gross margin | |$1,570,750 |

| | | |

|  Gross margin ratio | |37.0% |

| | | |

|Estimated inventory: | | |

|Goods available for sale: | | |

|  Inventory, December 31, 2010 |$262,400 | |

|  Net purchases, 2011 | 829,800 | |

|  Goods available for sale | |$1,092,200 |

|Less: Estimated cost of goods sold: | | |

|  Sales |$1,475,300 | |

|  Estimated cost of goods sold | | |

|   [$1,475,300 × (1 – 37%)] | |929,439 |

|Estimated July 5, 2011 inventory lost | | |

|  in the flood | |$162,761 |

Problem 7-11B (25 minutes)

FOUR CORNERS EQUIPMENT CO.

Estimated Inventory

March 31, 2011

Goods available for sale:

Inventory, January 1, 2011 $ 752,880

Purchases $2,132,100

Less: Purchase returns 38,370

Add: Transportation-in 65,900

Net cost of goods purchased 2,159,630

Goods available for sale $2,912,510

Less: Estimated cost of goods sold:

Sales $3,710,250

Less: Sales returns 74,200

Net sales $3,636,050

Estimated cost of goods sold

[$3,636,050 × (1 – 30%)] 2,545,235

Estimated March 31, 2011, inventory $ 367,275

Problem 7-12B (25 minutes)

Part 1

THE R.E. McFADDEN CO.

Estimated Inventory

December 31, 2011

At Cost At Retail

Goods available for sale:

Beginning inventory $ 81,670.00 $ 114,610.00

Purchases 502,990.00 767,060.00

Purchase returns (10,740.00) (15,330.00)

Goods available for sale $573,920.00 $ 866,340.00

Sales $786,120.00

Sales returns (4,480.00)

Net sales $781,640.00

Ending inventory at retail ($866,340 – $781,640) $ 84,700.00

Cost ratio: ($573,920 ( $866,340)         66.25%

Ending inventory at cost ($84,700 × 66.25%) $ 56,113.75

Part 2

Estimated physical inventory at cost: $78,550 × 66.25% = $52,039.38

THE R.E. McFADDEN CO.

Inventory Shortage

December 31, 2011

At Cost At Retail

Estimated inventory, December 31, 2011 $56,113.75 $84,700.00

Physical inventory ($78,550 × 66.25%) 52,039.38 78,550.00

Inventory shortage $ 4,074.37 $ 6,150.00

Problem 7-13B (20 minutes)

| |At Cost |At Retail |

|Goods available for sale: | | |

| Beginning inventory |$ 150,000 |$ 250,000 |

| Purchases |2,100,000 |3,500,000 |

| Less: Purchase returns and allowances |250,000 |400,000 |

| Add: Transportation-in | 10,000 | - |

| Goods available for sale . |$2,010,000 |$3,350,000 |

| | | |

|Deduct net sales at retail ($2,715,000 – $35,000) | | 2,680,000 |

|Ending inventory at retail | |$ 670,000 |

| | | |

|Cost to retail ratio ($2,010,000 ( $3,350,000): | |× 60% |

| | | |

|Estimated ending inventory at cost ($670,000 × 60%): |$ 402,000 |

Inventory loss = $402,000 × 20%* = $80,400

*Because the insurance company covers 80% of the

loss, JavCo’s estimated loss is 20% (100% – 80%).

*Problem 7-14B (25 minutes) Part 1

Cost of units available for sale:

6,300 units in beginning inventory @ $35 $ 220,500

10,500 units purchased @ $33 346,500

13,000 units purchased @ $32 416,000

12,000 units purchased @ $29 348,000

15,500 units purchased @ $26 403,000

57,300 units for sale $1,734,000

Part 2

a) FIFO basis:

Total cost of the 57,300 units for sale $1,734,000

Less: Ending inventory on a FIFO basis:

15,500 units @ $26 $403,000

1,000 units @ $29 29,000 432,000

Cost of units sold $1,302,000

b) LIFO basis:

Total cost of the 57,300 units for sale $1,734,000

Less: Ending inventory on a LIFO basis:

6,300 beginning inventory units @ $35 . $220,500

10,200 units @ $33 336,600 557,100

Cost of units sold $1,176,900

*Problem 7-14B (concluded) Part 2

c) Weighted-average cost basis:

Total cost of the 57,300 units for sale $1,734,000

Less: Ending inventory at weighted-average cost:

($1,734,000/57,300) = $30.26 × 16,500 units 499,290*

Cost of units sold $1,234,710*

*These amounts may vary if the unit cost/unit was not rounded to two decimal places.

A&R Problem 7-1

Net Net Accounts

Purchases Income Payable Inventory

Balance per company’s books $329,000 $22,100 $29,200 $20,500

(a) 0 + 4,500 0 + 4,500

(b) 0 – 4,100 0 – 4,100

(c) + 3,900 0* + 3,900 + 3,900

(d) – 2,700 + 2,700 – 2,700 0

(e) 0 – 1,800** 0 + 2,400

Correct Balances $330,200 $23,400 $30,400 $27,200

*This has no effect on net income because both net purchases and ending merchandise inventory are increased by $3,900; the net effect on net income is zero.

**The sale price of the goods was $4,200 and the cost of goods sold was $2,400 resulting in a gross profit of $1,800 that caused net income to be overstated by the same amount. Therefore, to correct the error, $1,800 must be subtracted from net income.

Ethics Challenge

1. In an environment of rising prices the use of FIFO results in a lower cost of goods sold than LIFO. If cost of goods sold is lower, net income will be higher. A higher net income will improve the profit margin ratio which is calculated as net income/net sales.

With rising prices FIFO also results in the most recent, higher prices becoming part of ending inventory. This means that the balance sheet inventory figure will be larger than under LIFO. In the numerator of the current ratio, inventory is included as part of the current asset total. A larger inventory, therefore, results in a bigger numerator and therefore a larger current ratio than under LIFO.

2. It is true that managers have discretion in choosing an inventory costing method. It appears, however, that Diversion’s owner does not understand that changing methods can only be done very selectively over time. Furthermore a change in method must be justified by management as “improving the financial reporting for the company.” The consistency principle does not allow frequent changes in inventory costing methods by management. If Diversion’s owner can justify the method change as improving the financial reporting for the company her action is not unethical. However, she must realize that changing methods can only be an infrequent occurrence given that consistency in financial reporting is required. Also, the full disclosure principle requires that the owner disclose to the bank that she has implemented a change in inventory costing method from LIFO to FIFO.

Focus on Financial Statements

FFS 7-1

1.

| | | |Moving Weighted |

| |FIFO |LIFO |Average |

|Merchandise inventory, December 31, 2010 |11,000 |11,000 |11,000 |

|Purchases |156,000 |156,000 |156,000 |

|Merchandise inventory, December 31, 2011 |19,000 |31,000 |24,000 |

|Cost of goods sold |148,000 |136,000 |143,000 |

2. (a) FIFO

|FARDAN STEREO SALES |

|Income Statement |

|For Year Ended December 31, 2011 |

|Revenues | | |

| Net sales (449,000 – 6,000) | |$443,000 |

|Expenses: | | |

| Cost of goods sold |$148,000 | |

| Operating expenses (5,000 + 92,000 + 109,000 + 8,000) |214,000 | |

| Interest expense | 2,000 | |

| Total expenses | | 364,000 |

|Net income | |$ 79,000 |

FFS 7-1 (continued)

2. (a) FIFO

|Fardan Stereo Sales |

|Balance Sheet |

|December 31, 2011 |

|Assets | | | |

| Current assets: | | | |

| Cash | |$ 16,000 | |

| Accounts receivable | |27,000 | |

| Merchandise inventory | |19,000 | |

| Prepaid rent | | 36,000 | |

| Total current assets | | |$ 98,000 |

| Property, plant and equipment: | | | |

| Store fixtures | |$117,000 | |

| Less: Accumulated amortization | | 82,000 |$ 35,000 |

| Intangible assets: | | | |

| Trademark | | | 3,000 |

|Total assets | | |$136,000 |

| | | | |

|Liabilities | | | |

| Current liabilities: | | | |

| Accounts payable |$18,000 | | |

| Unearned sales revenue | 4,000 | | |

| Total current liabilities | |$ 22,000 | |

|  Long-term liabilities: | | | |

|  Notes payable, due in 2014 | |22,000 | |

|  Total liabilities | | |$ 44,000 |

| | | | |

|Owner’s Equity | | | |

|  Mikel Fardan, capital* | | | 92,000 |

|Total liabilities and owner’s equity | | |$136,000 |

*57,000 + 79,000 – 44,000

FFS 7-1 (continued)

2. (b) LIFO

|Fardan Stereo Sales |

|Income Statement |

|For Year Ended December 31, 2011 |

|Revenues | | |

| Net sales | |$443,000 |

|Expenses: | | |

| Cost of goods sold |$136,000 | |

| Operating expenses |214,000 | |

| Interest expense | 2,000 | |

| Total expenses | | 352,000 |

|Net income | |$ 91,000 |

FFS 7-1 (continued)

2. (b) LIFO

|Fardan Stereo Sales |

|Balance Sheet |

|December 31, 2011 |

|Assets | | | |

| Current assets: | | | |

| Cash | |$ 16,000 | |

| Accounts receivable | |27,000 | |

| Merchandise inventory | |31,000 | |

| Prepaid rent | | 36,000 | |

| Total current assets | | |$110,000 |

| Property, plant and equipment: | | | |

| Store fixtures | |$117,000 | |

| Less: Accumulated amortization | | 82,000 |$ 35,000 |

| Intangible assets: | | | |

| Trademark | | | 3,000 |

|Total assets | | |$148,000 |

| | | | |

|Liabilities | | | |

| Current liabilities: | | | |

| Accounts payable |$18,000 | | |

| Unearned sales revenue | 4,000 | | |

| Total current liabilities | |$ 22,000 | |

|  Long-term liabilities: | | | |

|  Notes payable, due in 2014 | |22,000 | |

|  Total liabilities | | |$ 44,000 |

| | | | |

|Owner’s Equity | | | |

|  Mikel Fardan, capital* | | | 104,000 |

|Total liabilities and owner’s equity | | |$148,000 |

*57,000 + 91,000 – 44,000

FFS 7-1 (continued)

2. (c) Moving weighted average

|Fardan Stereo Sales |

|Income Statement |

|For Year Ended December 31, 2011 |

|Revenues | | |

| Net sales | |$443,000 |

|Expenses: | | |

| Cost of goods sold |$143,000 | |

| Operating expenses |214,000 | |

| Interest expense | 2,000 | |

| Total expenses | | 359,000 |

|Net income | |$ 84,000 |

FFS 7-1 (concluded)

2. (c) Moving weighted average

|Fardan Stereo Sales |

|Balance Sheet |

|December 31, 2011 |

|Assets | | | |

| Current assets: | | | |

| Cash | |$ 16,000 | |

| Accounts receivable | |27,000 | |

| Merchandise inventory | |24,000 | |

| Prepaid rent | | 36,000 | |

| Total current assets | | |$103,000 |

| Property, plant and equipment: | | | |

| Store fixtures | |$117,000 | |

| Less: Accumulated amortization | | 82,000 |$ 35,000 |

| Intangible assets: | | | |

| Trademark | | | 3,000 |

|Total assets | | |$141,000 |

| | | | |

|Liabilities | | | |

| Current liabilities: | | | |

| Accounts payable |$18,000 | | |

| Unearned sales revenue | 4,000 | | |

| Total current liabilities | |$ 22,000 | |

|  Long-term liabilities: | | | |

|  Notes payable, due in 2014 | | 22,000 | |

|  Total liabilities | | |$ 44,000 |

| | | | |

|Owner’s Equity | | | |

|  Mikel Fardan, capital* | | | 97,000 |

|Total liabilities and owner’s equity | | |$141,000 |

*57,000 + 84,000 – 44,000

Analysis component:

3. The schedule reflects falling costs because when unit costs are decreasing, FIFO will product the highest cost of goods sold and LIFO the lowest with moving average between FIFO and LIFO.

4. a. To maximize net income, LIFO should be used.

b. To maximize assets, LIFO should be used.

FFS 7-2

a. According to note 3, inventory for Danier represents raw materials, work-in-process, and finished goods whereas inventory for WestJet, according to note 1(f), represents materials and supplies.

b. Note 1(e) to Danier’s financial statements, under the heading “Inventory,” indicates that the weighted average cost method is used.

c. Inventory is classified on Danier’s balance sheet as a current asset.

d. The balance in inventory for Danier decreased by $452 (thousand) from June 26, 2004 to June 25, 2005 (calculated as $29,031 – $29,483 = $452).

Critical Thinking Mini Case

CT 7-1

Note to instructor: Student responses will vary therefore the answer here is only suggested and not inclusive of all possibilities; it is presented in point form for brevity.

Problem(s):

— Benton Beverages’ cost of goods sold is decreasing yet industry information shows that this should not be the case

Goal(s)*:

— To investigate cost of goods sold and its components to ensure that it is being accurately reported

Assumption(s)/Principle(s):

— It appears that inventory levels were inflated given how the pallets of beverages were stacked

Facts:

— as presented

— the year-end adjusting entry is adding progressively larger amounts to merchandise inventory (and correspondingly crediting/decreasing cost of goods sold expense) which is not typical (normally this adjustment records the opposite)

— the year-end adjustment increased from 5.7% of cost of goods sold in 2008 to 13.7% in 2011 (calculated as: 20,000/352,000 × 100 = 5.7%; 63,000/459,000 × 100 = 13.7%).

Conclusion(s)/Consequence(s):

— without additional information this cannot be confirmed but it appears that inventory was subject to fraudulent activities

— given that the CEO instructed staff to stack pallets in a suspicious manner implicates her in the potential fraud

— a thorough investigation is required to determine exactly why the adjusting entry to merchandise inventory is so high and increasing

*The goal is highly dependent on “perspective.”

-----------------------

= $420 Cost of Ending Inventory

= $463 COST OF ENDING INVENTORY

Copyright © 2007 by McGraw-Hill Ryerson Limited. All rights reserved.

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