solution manual ch 05 financial accounting reporting and analyzing inventories

FA Chapter 5 SM

Chapter 5

Reporting and Analyzing Inventories

QUESTIONS

1.(a) FIFO: The first (earliest) items purchased in inventory are assumed to be the first items sold. (b) LIFO: The last (most recent) items purchased in inventory are assumed to be the first items sold.

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

3.Incidental costs sometimes are ignored in computing the cost of inventory because the expense of tracking such costs on a precise basis can outweigh the benefits gained from the increased accuracy. The principle of materiality permits such practices when the effects on the financial statements are not significant (that is, when such practices do not impact business decisions).

4.LIFO will result in the lower cost of goods sold when costs are declining.

5.The full-disclosure principle requires that the nature of the accounting change, the justification for the change, and the effect of the change on net income be disclosed in the notes or in the body of a company's financial statements.

6.No; changing the inventory method each period would violate the accounting principle of consistency.

7.No; the consistency principle does not preclude changes in accounting methods from ever being made. Instead, a change from one acceptable method to another is allowed if the company justifies the change as an improvement in financial reporting.

8.Many people make important business decisions based on period-to-period fluctuations in a company's financial numbers, including gross profit and net income. As such, inventory errorswhich can substantially impact gross profit, net income, current assets, and cost of salesshould not be permitted to cause such fluctuations and impair business decisions. (Note: Since such errors are self-correcting, they will distort net income in only two consecutive accounting periodsthe period of the error and the next period.)

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

10.Market usually means replacement cost of inventory when applied in the LCM.

11.The principle of conservatism guides preparers of accounting reports to select the less optimistic estimate in uncertain situations where two estimates of amounts are about equally likely. Users of information must also be cognizant of the potential conservatism in accounting reports when making business decisions.

12.Factors that contribute to inventory shrinkage are breakage, loss, deterioration, decay, and theft.

13.AAccounts that are used only in a periodic inventory system include Purchases, Purchase Discounts, Purchase Returns and Allowances, and Transportation-In.

14.BFor interim reporting, companies can estimate costs of goods sold and ending inventory by either the retail inventory method or the gross profit method.

15.Inventory as a percent of current assets on February 2, 2003 is ($ in thousands):

$24,365 / $141,128 = 17.3%.

16.Cost of goods available for sale equals ending inventory plus cost of sales. As of December 28, 2002 this is computed as:

Ending Inventory of $6,777,152 + Cost of Sales of $111,187,357 = $117,964,50917. Merchandise inventory comprises 10.6% ($218,156 / $2,066,586) of Harley-Davidsons current assets as of December 31, 2002, and 10.9% ($181,115 / $1,665,264) of its current assets as of December 31, 2001. ($ in thousands)

QUICK STUDIES

Quick Study 5-1 (25 minutes)

(a) FIFO

DateGoods PurchasedCost of Goods SoldInventory Balance

12/ 710 @ $ 6 = $ 6010 @ $ 6= $ 60

12/1420 @ $12 = $24010 @ $ 6= $300

20 @ $12

12/15 10 @ $ 6 15 @ $12= $180

5 @ $12

12/2115 @ $14 = $21015 @ $12= $390

____15 @ $14

$120

Quick Study 5-1 (continued)

(b) LIFO

DateGoods Purchased Cost of Goods SoldInventory Balance

12/710 @ $ 6 = $ 6010 @ $ 6 = $ 60

12/1420 @ $12 = $24010 @ $ 6= $300

20 @ $12

12/1515 @ $12 = $18010 @ $ 6= $120

5 @ $12

12/2115 @ $14 = $21010 @ $ 6

5 @ $12= $330

____15 @ $14

$180

(c) Weighted Average


12/710 @ $6 = $6010 @ $6= $ 60

12/1420 @ $12 = $24010 @ $6 = $300

20 @ $12

(avg cost is $10)

12/1515 @ $10 =$15015 @ $10 = $150

12/21 15 @ $14 = $21015 @ $10= $360

____15 @ $14

$150(avg cost is $12)

(d) Ending inventory under specific identification:

(2 units x $6) + (13 units x $12) + (15 units x $14) = $378.


Beginning inventory

10 units @ $50$ 500

Plus:

1st week purchase

10 units @ $51510

2nd week purchase

10 units @ $52520

3rd week purchase

10 units @ $55550

4th week purchase

10 units @ $60 600

Units Available for sale

50 units

Cost of Goods Available for Sale

$2,680


(a) FIFO

Date Goods PurchasedCost of Goods SoldInventory Balance

1/1310 @ $3.00 = $ 930

1/975 @ $3.20310 @ $3.00 = $1,170

75 @ $3.20

1/25100 @ $3.35310 @ $3.00

75 @ $3.20 = $1,505

100 @ $3.35

1/26310 @ $3.00 = $ 93040 @ $3.20 = $ 463

35 @ $3.20 = 112100 @ $3.35

$1,042

(b) LIFO


1/1310 @ $3.00= $ 930

1/975 @ $3.20310 @ $3.00= $1,170

75 @ $3.20

1/25100 @ $3.35310 @ $3.00

75 @ $3.20= $1,505

100 @ $3.35

1/26100 @ $3.35 = $ 335140 @ $3.00= $ 420

75 @ $3.20 = 240

170 @ $3.00 = 510

$1,085

(c) Weighted Average


1/1310 @ $3.00= $ 930

1/975 @ $3.20310 @ $3.00

75 @ $3.20= $1,170

(avg. cost is $3.04)

1/25100 @ $3.35310 @ $3.00

75 @ $3.20= $1,505

100 @ $3.35


1/26345 @ $3.10 = $1,069.5140 @ $3.10= $ 434

Quick Study 5-3 (continued)

Alternate solution format:

(a) FIFO:100@ $3.35 =$ 335

40@ $3.20 = 128

140$ 463Ending inventory cost

(b) LIFO:

140@ $3.00 =$ 420Ending inventory cost

(c) Weighted average:

310@ $3.00 =$ 930

75@ $3.20 =240

100@ $3.35 = 335

485$1,505Cost of goods available for sale

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

140 units @ $3.10 = $ 434 Ending inventory cost


1.Specific identification

2.LIFO

3.LIFO

4.LIFO

5.FIFO


1. The title will pass at destination which is China Companys receiving dock. Jolie should show the $850 in its inventory at year-end as Jolie retains title until the goods reach China Company.

2. The consignor is Jolie Company. The consignee is China Company. The consignor, Jolie Company, should include any unsold and consigned goods in its inventory.


Units in ending inventory

Units stored in basement

1,500units

Less damaged (unsalable) units

(30)

Plus units in transit

250

Plus units on consignment

70

Total units in ending inventory

1,790units


Cost

$3,000

Plus

Transportation-in

150

Import duties

200

Insurance

50

Inventory Cost

$3,400

The $25 advertising cost and the $250 cost for sales staff salaries are included in operating expensesnot part of inventory costs. Those two costs are not necessary to get the vehicle in a place and condition for sale.


Cost of inventory (estates contents)

Price

$37,500

Transportation-in

1,200

Insurance on shipment

150

Cleaning and refurbishing

490

Total cost of inventory

$39,340


Per UnitTotalTotalLCM applied to:

Inventory ItemsUnitsCostMarketCostMarketItemsWhole

Mountain bikes 9$360$330$ 3,240$ 2,970$ 2,970

Skateboards122102702,5203,2402,520

Gliders25480 420 12,000 10,500 10,500______

$17,760$16,710$15,990$16,710

a. LCM for inventory as a whole

$16,710

b. LCM applied to each product

$15,990


a.Overstates 2005 cost of goods sold.

b.Understates 2005 gross profit.

c.Understates 2005 net income.

d.Overstates 2006 net income.

e.The understated 2005 net income and the overstated 2006 net income combine to yield a correct total income for the two-year period.

f.The 2005 error will not affect years after 2006.


Inventory turnover= Cost of goods sold/Average merchandise inventory

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

= ($230,000 / $1,600,000) x 365 = 52.47 days

Quick Study 5-12A (15 minutes)

Ending Cost ofInventoryGoods Sold

a. FIFO

(15 x $12) + (15 x $14) $390

(10 x $6) + (5 x $12)

$120

b. LIFO

(10 x $6) + (20 x $12)

$300

(15 x $14)

$210

c. Weighted Average ($510/ 45 = $11.33 cost per unit) (30 x $11.33)

$340

(15 x $11.33)

$170

d. Specific Identification

(2 x $6) + (13 x $12) + (15 x $14)

$378

(8 x $6) + (7 x $12)

$132

Quick Study 5-13A (15 minutes)


a. FIFO

(40 x $3.20) + (100 x $3.35) $463

(310 x $3.00) + (35 x $3.20)

$1,042

b. LIFO

(140 x $3.00)

$420

(100 x $3.35) + (75 x $3.20) + (170 x $3.00)

$1,085

c. Weighted Average ($1,505/ 485 = $3.10* cost per unit) (140 x $3.10)

$434

(345 x $3.10)

$1,071*

*rounded

Quick Study 5-14B (15 minutes)

Goods available for sale

Inventory, January 1

$180,000

Cost of goods purchased (net)

342,000

Goods available for sale (at cost)

522,000

Net sales at retail

$675,000

Estimated cost of goods sold [$675,000 x (1 - 42%)]

(391,500)

Estimated September 5 inventory destroyed

$130,500

EXERCISES

Exercise 5-1 (30 minutes)

a. Specific identification

Ending inventory400 units from July 28 and 100 units from December 19

Ending Cost of ComputationsInventoryGoods Sold

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

$2,410

$6,380 - $2,410

$3,970

b. Weighted average perpetual


1/1120 @ $6.00= $ 720

1/10 70 @ $ 6.00 = $ 42050 @ $6.00= $ 300

3/7200 @ $5.5050 @ $6.00 = $1,400

200 @ $5.50


3/15125 @ $5.60 = $ 700125 @ $5.60= $ 700

7/28500 @ $5.00125 @ $5.60= $3,200

500 @ $5.00


10/3375 @ $4.40125 @ $5.60

500 @ $5.00 = $4,850

375 @ $4.40


10/5600 @ $4.85 = $2,910400 @ $4.85= $1,940

12/19 100 @ $4.10400 @ $4.85= $2,350

100 @ $4.10

_____(avg. cost is $4.70)

$4,030

Exercise 5-1 (Continued)c. FIFO Perpetual


1/1120 @ $6.00= $ 720

1/10 70 @ $6.00 = $ 42050 @ $6.00= $ 300

3/7200 @ $5.5050 @ $6.00 = $1,400

200 @ $5.50

3/15 50 @ $6.00

75 @ $5.50125 @ $5.50 = $ 688*

7/28500 @ $5.00125 @ $5.50 = $3,188

500 @ $5.00

10/3375 @ $4.40125 @ $5.50

500 @ $5.00 = $4,838

375 @ $4.40

10/5 125 @ $5.50 25 @$5.00

475 @ $5.00 = $3,063*375 @ $4.40 = $1,775

12/19100 @ $4.1025 @ $5,00

375 @ $4.40 = $2,185

_____100 @ $4.10

$4.195

* rounded to the nearest dollar

Exercise 5-1 (Continued)d. LIFO Perpetual


1/1120 @ $6.00 = $ 720

1/10 70 @ $6.00 = $ 42050 @ $6.00 = $ 300

3/7200 @ $5.5050 @ $6.00 = $1,400

200 @ $5.50

3/15 125 @ $5.50 = $ 687*50 @ $6.00 = $ 713*

75 @ $5.50

7/28500 @ $5.0050 @ $6.00

75 @ $5.50 = $3,213*

500 @ $5.00

10/3375 @ $4.4050 @ $6.00

75 @ $5.50 = $4,863*

500 @ $5.00

375 @ $4.40

10/5 375 @ $4.4050 @ $6.00

225 @ $5.00 75 @ $5.50 = $2,088*

275 @ $5.00

12/19 100 @ $4.1050 @ $6.00 = $2,498

75 @ $5.50

275 @ $5.00

______100 @ $4.10

$ 3,882

* rounded to the nearest dollar

Exercise 5-1 (Continued)

Alternate Solution Format for FIFO and LIFO Perpetual:

Ending Cost of

Computations:

Inventory Goods Sold

c. FIFO

(100 x $4.10) + (375 x $4.40)+(25 x $5.00)

$2,185

(70 x $6.00) + (50 X $6.00) + (75 x $5.50) +

(125 x $5.50)+ (475 x $5.00)

$4,195

d. LIFO:

(50 x $6.00) + (75 x $5.50) + (275 x $5.00) +

(100 x $4.10)

$2,498

(70 x $6.00) + (125 x $5.50) + (375 x $4.40) +

(225 x $5.00)

$3,882


LAKIA CORPORATION

Income StatementsFor Year ended December 31, 2005

Specific IdentificationWeighted AverageFIFO LIFO

Sales

$11,925$11,925$11,925$11,925

(795 units x $15 price)

Cost of goods sold

3,940 4,030 4,195 3,882

Gross Profit

7,9857,8957,7308,043

Expenses

1,250 1,250 1,250 1,250

Income before taxes

6,7356,6456,4806,793

Income tax expense (30%)

2,021* 1,994* 1,944 2,038*

Net Income

$ 4,714$ 4,651$ 4,536 $ 4,755

* Rounded to the nearest dollar.

1.LIFO method results in the highest net income of $4,755.

2.Weighted average net income of $4,651 falls between the FIFO net income ($4,536) and the LIFO net income ($4,755).

3.If costs were rising instead of declining, then the FIFO method would yield the highest net income. Exercise 5-3 (30 minutes)

a. FIFO Perpetual


1/1100 @ $10= $ 1,000

1/10 90 @ $10 = $ 90010 @ $10= $ 100

3/14250 @ $15 = $ 3,75010 @ $10= $ 3,850

250 @ $15

3/15 10 @ $10120 @ $15= $ 1,800

130 @ $15 = $2,050

7/30400 @ $20 = $ 8,000120 @ $15= $ 9,800

400 @ $20

10/5 120 @ $15

180 @ $20 = $5,400220 @ $20= $ 4,400

10/26600 @ $25 = $15,000220 @ $20

_____600 @ $25= $19,400

$8,350

b. LIFO Perpetual


1/1100 @ $10= $ 1,000

1/10 90 @ $10 = $ 90010 @ $10= $ 100

3/14250 @ $15 = $ 3,75010 @ $10= $ 3,850

250 @ $15

3/1510 @ $10= $ 1,750

140 @ $15 = $2,100110 @ $15

7/30400 @ $20 = $ 8,00010 @ $10

110 @ $15 = $ 9,750

400 @ $20

10/510 @ $10

300 @ $20 = $6,000110 @ $15= $ 3,750

100 @ $20

10/26600 @ $25 = $15,00010 @ $10

110 @ $15

100 @ $20= $ 18,750

_____600 @ $25

$9,000

Exercise 5-3 (Concluded)Alternate Solution Format


a. FIFO:

(600 x $25) + (220 x $20) $19,400

(90 x $10) + (10 x $10) + (130 x $15) +

(120 x $15)+ (180 x $20)

$8,350

b. LIFO:

(10 x $10) + (110 x $15) + (100 x $20) + (600 x $25)

$18,750

(90 x $10) + (140 x $15) + (300 x $20)

$9,000

FIFO Gross Margin

Sales Revenue (530 units sold x $40 selling price)

$21,200

Less: FIFO cost of goods sold

8,350

Gross margin

$12,850

LIFO Gross Margin


$21,200

Less: LIFO cost of goods sold

9,000

Gross margin

$12,200


a. Specific identification methodCost of goods sold

Cost of goods available for sale

$27,750

Ending inventory under specific identification

3/14 purchase (200 @ $15)

$ 3,000

7/30 purchase ( 20 @ $20)

400

10/26 purchase (600 @ $25)

15,000

Total ending inventory under specific identification

18,400

Cost of goods sold under specific identification

$ 9,350

b. Specific identification methodGross margin Sales Revenue (530 units sold x $40 selling price)

$21,200

Less: Specific identification cost of goods sold

9,350

Gross margin

$11,850



Inventory ItemsUnits CostMarketCostMarketProductsWhole

Helmets

22$50$54$1,100$1,188$1,100

Bats

1578721,1701,0801,080

Shoes

3695913,4203,2763,276

Uniforms

403636 1,440 1,440 1,440

$7,130$6,984$6,896$6,984

a.Lower of cost or market of inventory as a whole = $6,984b.Lower of cost or market of inventory by product = $6,896Exercise 5-6 (25 minutes)

1. Gross profit = $900,000 - $500,000 = $400,000 (for each year)

2.

Year 2004Year 2005Year 2006

Sales

$900,000$900,000$900,000

Cost of goods sold

Beginning inventory

$200,000$180,000$200,000

Cost of purchases

500,000 500,000 500,000

Good available for sale

700,000680,000700,000

Ending inventory

180,000 200,000 200,000

Cost of goods sold

520,000 480,000 500,000

Gross profit

$380,000$420,000$400,000


2004 Inventory turnover 2004 Days' Sales in Inventory

$426,650/[($91,500 + $86,750)/2]$86,750/$426,650 x 365 days = 74.2 days = 4.8 times 2005 Inventory turnover 2005 Days' Sales in Inventory

$643,825/[($86,750 + $96,400)/2]

= 7.0 times

$96,400/$643,825x 365 days = 54.7 days

Analysis comment: It appears that during a period of increasing sales, Ryder has been efficient in controlling its amount of inventory. Specifically inventory turnover increased by 2.2 times (7.0 - 4.8) from 2004 to 2005. In addition, days' sales in inventory decreased by 19.5 days (74.2 - 54.7).


1.a.LIFO ratio computations

LIFO current ratio (2005) = $210/$190 = 1.1

LIFO inventory turnover (2005) = $730/ [($150+$100)/2] = 5.8

LIFO days sales in inventory (2005) = ($150/$730) x 365 = 75 days

b.FIFO ratio computations

FIFO current ratio (2005) = $280/$190 = 1.5

FIFO inventory turnover (2005) = $685/ [($220+$125)/2] = 4.0

FIFO days sales in inventory (2005) = ($220/$685) x 365 = 117.2 days2.The use of LIFO versus FIFO for Checkers markedly impacts the ratios computed. Specifically, LIFO makes Checkers appear worse in comparison to FIFO numbers on the current ratio (1.1 vs. 1.5) but better on inventory turnover (5.8 vs. 4.0) and days sales in inventory (75 vs. 117.2). These results can be generalized. That is, when costs are rising and quantities are stable or rising, the FIFO inventory exceeds LIFO inventory. This suggests that (relative to FIFO) the LIFO current ratio is understated, the LIFO inventory turnover is overstated, and the days sales in inventory is understated. Overall, users prefer the FIFO numbers for these ratios because they are considered more representative of current replacement costs for inventory.

Exercise 5-9A (20 minutes)

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

+ (375 x $4.40) + (100 x $4.10)

= $6,380


a.Specific Identification

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

$2,410

$6,380 - $2,410

$3,970

b.Weighted Average

($6,380 / 1295 units = $4.927* average cost per unit)

500 x $4.927

$2,463*

795 x $4.927

$3,917*

c.FIFO

(100 x $4.10) + (375 x $4.40 )+ (25 x $5.00)

$2,185

(70 x $6.00) + (50 x $6.00) + (75 x $5.50) +

(125 x $5.50)+ (475 x $5.00)

$4,195

d.LIFO

(120 x $6.00) + (200 x $5.50) + (180 x $5.00)

$2,720

(100 x $4.10) +(375 x $4.40) + (125 x $5.00) +

(125 x $5.00) + (70 x $5.00)

$3,660

*rounded


Cost of goods available for sale= (100 x $10) + (250 x $15) + (400 x $20)

+ (600 x $25)

= $27,750


a.FIFO

(600 x $25) + (220 x $20)

$19,400

(90 x $10) + (10 x $10) + (130 x $15) +

(120 x $15)+ (180 x $20)

$8,350

b. LIFO

(100 x $10) + (250 x $15) + (400 x $20) + (70 x $25)

$14,500

530 x $25

$13,250

c.

FIFO Gross Margin


$21,200

Less: FIFO cost of goods sold

8,350

Gross margin

$12,850

LIFO Gross Margin


$21,200

Less: LIFO cost of goods sold

13,250

Gross margin

$ 7,950


EndingInventoryCost ofGoods Sold


(100 x $2.90) + (100 x$2.80) + (100 x $2.50)

$820

$7,706 - $820

$6,886

b. Weighted average ($7,706/3,000 = $2.57*)

$2.57 x 300

771

$7,706 - $771

6,935

c. FIFO

(300 x $2.90)

870

(200 x $2.00) + (440 x $2.25) + (1,080 x $2.50) + (960 x $2.80) + (20 x 2.90)

6,836

d. LIFO

(200 x $2.00) + (100 x $2.25)

625

(320 x $2.90) + (960 x $2.80) + (1,080 x $2.50) + (340 x $2.25)

7,081

*rounded

Income effect: FIFO provides the lowest cost of goods sold, the highest gross profit, and the highest net income.

Exercise 5-12A (20 minutes)EndingInventoryCost of Goods Sold


(100 x $2.00) + (100 x $2.30) + (100 x $2.50)

$680

$7,550 - $680

$6,870

b. Weighted average ($7,550/3,030 = $2.49*)

$2.49 x 300

747

$7,550 - $747

6,803

c. FIFO

(250 x $2.00) + (50 x $2.30)

615

(280 x $3.00) + (600 x $2.80) + (800 x $2.50) + (1,050 x $2.30)

6,935

d. LIFO

(280 x $3.00) + (20 x $2.80)

896

(250 x $2.00) + (1,100 x $2.30) + (800 x $2.50) + (580 x $2.80)

6,654

*rounded

Income effect: FIFO provides the highest cost of goods sold, the lowest gross profit, and the lowest net income.

Exercise 5-13B (20 minutes)

At CostAt Retail


Beginning inventory

$31,900$ 64,200

Cost of goods purchased

57,810 98,400


$89,710162,600

Deduct net sales at retail

130,000

Ending inventory at retail

$ 32,600

Cost ratio: ($89,710/$162,600) = 0.55

Ending inventory at cost ($32,600 x 55%)

$17,930

Exercise 5-14B (20 minutes)



$ 450,000

Net cost of goods purchased*

1,604,500


2,054,500

Less estimated cost of goods sold

Net sales

$2,000,000

Estimated cost of goods sold

[$2,000,000 x (1 30%)]

(1,400,000)

Estimated March 31 inventory

$ 654,500

* $1,590,000 - $23,100 + $37,600 = $1,604,500

PROBLEM SET A

Problem 5-1A (40 minutes)

1. Calculate cost of goods available for sale and units available for sale

Beginning inventory

600 units @ $44$26,400

Feb. 10

200 units @ $408,000

Mar. 13

100 units @ $202,000

Aug. 21

160 units @ $609,600

Sept. 5

280 units @ $48 13,440

Units available

1,340 units

Cost of goods available for sale$59,440

2. Units in ending inventory

Units available (from part 1)

1,340

Less: Units sold (400+200)

600

Ending Inventory (units)

740

Problem 5-1A (Continued)3a. FIFO perpetual

DateGoods PurchasdCost of Goods SoldInventory Balance

1/1600 @ $44 = $26,400

2/10200 @ $40 = $ 8,000600 @ $44

200 @ $40 = $34,400

3/13100 @ $20 = $ 2,000600 @ $44

200 @ $40 = $36,400

100 @ $20

3/15400 @ $44 = $17,600200 @ $44

200 @ $40 100 @ $20

8/21160 @ $60 = $ 9,600200 @ $44

200 @ $40

100 @ $20 = $28,400

160 @ $60

9/5280 @ $48 = $13,440200 @ $44

200 @ $40

100 @ $20 = $41,840160 @ $60

280 @ $48

9/10200 @ $44 = $ 8,800

______200 @ $40

100 @ $20160 @ $60 = $33,040280 @ $48

$26,400

FIFO Alternate Solution Format


Less: Cost of sales400 @ $44$17,600

200 @ $448,800

Total cost of goods sold 26,400

Ending Inventory$33,040

Proof of Ending Inventory

200 @ $40$ 8,000

100 @ 20 2,000

160 @ 60 9,600

280 @ 48 13,440

Ending Inventory

740 units$33,040

Problem 5-1A (Continued)

3b. LIFO perpetual


1/1600 @ $44 = $26,400

2/10200 @ $40 = $ 8,000600 @ $44

200 @ $40 = $34,400

3/13100 @ $20 = $ 2,000600 @ $44

200 @ $40 = $36,400

100 @ $20

3/15100 @ $20

200 @ $40

100 @ $44 = $14,400 500 @ $44 = $22,000

8/21160 @ $60 = $ 9,600500 @ $44

160 @ $60 = $31,600

9/5280 @ $48 = $13,440500 @ $44

160 @ $60 = $45,040

280 @ $48

9/10200 @ $48 = $ 9,600

______500 @ $44

160 @ $60 = $35,440

80 @ $48

$24,000

LIFO alternate solution format


Less: Cost of sales100 @ $20$ 2,000

200 @ 408,000

100 @ 444,400

200 @ 48 9,600

Cost of Goods Sold 24,000

Ending Inventory$35,440


500 @ $44$22,000

160 @ 609,600

80 @ 48 3,840

Ending Inventory 740 units$35,440

Problem 5-1A (Continued)3c. Specific Identification


$59,440

Less: Cost of Goods Sold

500 @ $44

$22,000

100 @ $20

2,000

Total cost of goods sold

24,000

Ending Inventory

$35.440


100 @ $44$ 4,400

200 @ 40 8,000

160 @ 609,600

280 @ 48 13,440

Ending Inventory. 740 units$35,440

3d. Weighted Average


1/1600 @ $44.00 = $26,400

2/10200 @ $40 = $ 8,000600 @ $44.00

200 @ $40.00


3/13100 @ $20 = $ 2,000600 @ $44.00

200 @ $40.00 = $36,400

100 @ $20.00

(avg. cost is $40.44*)

3/15400 @ $40.44 =$16,176500 @ $40.44 = $20,220

8/21160 @ $60 = $ 9,600500 @ $40.44

160 @ $60.00


9/5280 @ $48 = $13,440660 @ $45.18

280 @ $48.00 = $43,259**


9/10200 @ $46.02 = $ 9,204740 @ $46.02 = $34,055***

$25,380

*rounded to nearest cent

**rounded to nearest dollar

***Total cost of goods sold plus ending inventory = $25,380 + $34,055 = $59,435 (the $5 difference from cost of goods available for sale of $59,440 is due to rounding)

Problem 5-1A (Concluded)4.

FIFOLIFOSpecific

Identifi-cationWeighted

Average

Sales (600 x $75)

$45,000$45,000$45,000$45,000

Less: Cost of goods sold

26,400 24,000 24,000 25,380

Gross profit

$18,600$21,000$21,000$19,620

5.Parkers manager would likely prefer the LIFO method or the Specific Identification method since these methods gross profit is the largest at $21,000. This would give the manager his/her highest bonus based on gross profit. It is only by coincidence that the LIFO and Specific Identification method have the same cost of goods sold and gross profit. This would not necessarily be the case.


Part 1

(a)

Cost of goods sold:200420052006

Reported

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

Adjustments:12/31/2004 error

- 66,000+ 66,000

12/31/2005 error

+ 30,000 - 30,000

Corrected

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

(b)

Net income:200420052006

Reported

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


+ 66,000- 66,000

12/31/2005 error

- 30,000 + 30,000

Corrected

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

(c)

Total current assets:200420052006

Reported

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


+ 66,000

12/31/2005 error

- 30,000

Corrected

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

(d)

Equity:200420052006

Reported

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


+ 66,000

12/31/2005 error

_________ - 30,000

Corrected

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

Part 2Total net income for the combined three-year period is not affected by the errors. This is because these errors are "self-correcting"that is, each overstatement (or understatement) of net income is offset by a matching understatement (or overstatement) in the following year.

Part 3

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



Inventory ItemsUnits CostMarketCostMarketItemsCategoriesWhole

Audio equipment:

Receivers

335$ 90$ 98$ 30,150$ 32,830$ 30,150

CD players

25011110027,75025,00025,000

DVD players

316869527,17630,02027,176

Speakers

1945241 10,088 7,9547,954

Subtotal

95,164 95,804$ 95,164

Video equipment:

Televisions

47015012570,50058,75058,750

VCRs

281938426,13323,60423,604

Video cameras

202310322 62,620 65,04462,620

Subtotal

159,253 147,398147,398

Car audio equip:

DVD radios

175708412,25014,70012,250

CD radios

16097105 15,520 16,80015,520

Subtotal

27,770 31,500_______ 27,770

Total

$282,187$274,702$263,024$270,332$274,702

a. Lower of cost or market for the inventory as a whole= $274,702b. Lower of cost or market for the inventory by major category=

$95,164 + $147,398 + $27,770= $270,332c. Lower of cost or market for inventory applied separately= $263,024

Problem 5-4AA (25 minutes)

Part 1 Number and total cost of units available for sale:

20,000 units in beginning inventory @ $15

$ 300,000

28,000 units purchased @ $18

504,000


660,000


480,000


891,000

131,000 units available for sale

$2,835,000Part 2

a. FIFO periodic

Total cost of 131,000 units available for sale

$2,835,000

Less ending inventory on a FIFO basis

33,000 units @ $27

$891,000

2,000 units @ $24

48,000 939,000

Cost of units sold

$1,896,000

b. LIFO periodic


$2,835,000

Less ending inventory on a LIFO basis

20,000 beginning inventory units @ $15

$300,000

15,000 units @ $18

270,000 570,000

Cost of units sold

$2,265,000

c. Weighted average periodic


$2,835,000

Less ending inventory at weighted average

($2,835,000/131,000) x 35,000

757,443*

Cost of units sold

$2,077,557*

* Amount can slightly vary due to differences in rounding.


Part 1

True Blue Corp.

Income Statements Comparing FIFO, LIFO, and Weighted Average

For Year Ended December 31, 2005

FIFO LIFO Weighted

Average

Sales

$247,500$247,500$247,500

Cost of goods sold

Inventory, Dec. 31, 2004

10,800 10,800 10,800

Cost of purchases

123,500 123,500 123,500


134,300134,300134,300


22,000 18,400 20,662*

Cost of goods sold

112,300 115,900 113,638*

Gross profit

135,200131,600133,862*

Expenses

33,000 33,000 33,000

Income before taxes

102,20098,600100,862*

Income taxes expense

30,660 29,580 30,259*

Net income

$ 71,540$ 69,020$ 70,603*

*Amounts can slightly vary due to differences in rounding.

Supporting calculations:FIFOLIFOWeightedAverage

Dec. 31, 2004, inventory (600 x $18).

$ 10,800$10,800 $ 10,800

Purchases

1,500 x $19 = $28,500

700 x $20 = 14,000

400 x $21 = 8,400

3,300 x $22 = 72,600$123,500$123,500$123,500

Dec. 31, 2005, inventory (6,500 - 5,500 = 1,000 units)

FIFO:1,000 x $22 = $22,000$ 22,000

LIFO: 600 x $18 = $10,800

400 x $19 = $ 7,600

$18,400

W.A.:($134,300/6,500) x 1,000

$20,662*


Problem 5-5AA (Concluded)

Part 2If True Blue, Corp. had been experiencing declining costs in the acquisition of inventory, we would observe the opposite results in our comparisons. Specifically, LIFO would have resulted in a higher ending inventory, lower cost of goods sold, higher gross profit, and higher net income. FIFO would have resulted in a lower ending inventory, higher cost of goods sold, lower gross profit, and lower net income.

Part 3Advantages:

LIFO: Given the cost trends in the problem, the advantage of using LIFO is that the lower net income will result in a lower tax obligation (tax deferral).

Also, LIFO is likely to better match current costs against revenues.

FIFO: The advantage of using FIFO is that the inventory figure reported on the balance sheet is likely similar to the current replacement cost.

Disadvantages:

LIFO: Given the cost trends in the problem, the disadvantage of using LIFO is that the inventory figure, which is also reported on the income statement, will likely be understated in comparison to the current replacement costs.

FIFO: The disadvantage of using FIFO is that it will produce a greater tax obligation for the current period as a result of a higher reported net income.


Part 1NILSON COMPANY

Estimated Inventory

December 31

At Cost At Retail


Beginning inventory

$ 471,350$ 927,150


3,276,030 6,279,350


$3,747,380$7,206,500

Sales

$5,495,700

Less: Sales returns

44,600

Net sales

$5,451,100

Ending inventory at retail ($7,206,500 - $5,451,100)$1,755,400

Cost-to-retail ratio: $3,747,380/$7,206,500 = 0.52 or 52%

Ending inventory at cost ($1,755,400 x 52%)

$ 912,808

Part 2

Estimated physical inventory at cost: $1,675,800 x 52% = $871,416

NILSON COMPANY

Inventory Shortage

December 31

At Cost At Retail

Estimated inventory (from part 1)

$ 912,808$ 1,755,400

Physical inventory*

871,416 1,675,800

Inventory shortage

$ 41,392$ 79,600

* $871,416 = $1,675,800 (given) x 52% (from part 1).

Problem 5-7AB (25 minutes)

WAYMAN COMPANY

Estimated Inventory at March 31



$ 300,260


939,050


1,239,310


Sales

$1,191,150

Less sales returns

(9,450)

Net sales

$1,181.700


[$1,181,700 x (1 35%)]

(768,105)


$ 471,205

PROBLEM SET B

Problem 5-1B (40 minutes)

1. Calculate cost of goods available for sale and units available for sale:

Beginning inventory

600 units @ $55 =$ 33,000

Jan. 10

450 units @ $56 =25,200

Feb. 13

200 units @ $57 =11,400

July 21

230 units @ $58 =13,340

Aug. 5

345 units @ $59 = 20,355

Units available

1,825 units


$103,295

2. Units in ending inventory:

Units available (from part 1)

1,825

Less: Units sold (given)

765

Ending Inventory

1,060

Problem 5-1B (Continued)

3a. FIFO perpetual


1/1600 @ $55 = $33,000

1/10450 @ $56 = $25,200600 @ $55

450 @ $56

2/13200 @ $57 = $11,400600 @ $55

450 @ $56 = $69,600

200 @ $57

2/15430 @ $55 = $23,650170 @ $55

450 @ $56 = $45,950

200 @ $57

7/21230 @ $58 = $13,340170 @ $55

450 @ $56

200 @ $57

230 @ $58

8/5345 @ $59 = $20,355170 @ $55

450 @ $56

200 @ $57 = $79,645

230 @ $58

345 @ $59

8/10170 @ $55

165 @ $56 = $18,590

______285 @ $56

200 @ $57 = $61,055230 @ $58

345 @ $59

$42,240

Alternate FIFO solution format


$103,295


430 @ $55

$23,650

170 @ 55

9,350

165 @ 56

9,240

765

Total cost of goods sold

42,240

Ending Inventory

$ 61,055


285 @ $56$ 15,960

200 @ 57

11,400

230 @ 5813,340

345 @ 59 20,355

Ending Inventory1,060 units$ 61,055


3b. LIFO perpetual


1/1600 @ $55 = $33,000

1/10 450 @ $56 = $25,200600 @ $55450 @ $56 = $58,200

2/13 200 @ $57 = $11,400600 @ $55450 @ $56 = $69,600200 @ $57

2/15200 @ $57

230 @ $56 = $24,280600 @ $55 220 @ $56 = $45,320

7/21 230 @ $58 = $13,340600 @ $55

220 @ $56 = $58,660

230 @ $58

8/5 345 @ $59 = $20,355600 @ $55

220 @ $56

230 @ $58

345 @ $59

8/10335 @ $59 = $19,765

______600 @ $55

220 @ $56

230 @ $58

10 @ $59

$44,045

Alternate LIFO solution format


$103,295


200 @ $57

$11,400

230 @ 56

12,880

335 @ 59

19,765

765

Cost of Goods Sold

44,045

Ending Inventory

$ 59,250


600 @ $55$ 33,000

220 @ 5612,320

230 @ 5813,340

10 @ 59 590

Ending inventory...1,060 units$ 59,250


3c. Specific Identification


$103,295


600 @ $55

$33,000

165 @ $57

9,405

765

Cost of Goods Sold

42,405

Ending inventory

$ 60,890


450@$56$25,200

35 @ 571,995

230 @5813,340

345@59 20,355

Ending inventory 1,060 Units$60,890

3d. Weighted Average


1/1600 @ $55.00 = $33,000

1/10450 @ $56 = $25,200600 @ $55.00 450 @ $56.00


2/13200 @ $57 = $11,400600 @ $55.00450 @ $56.00 = $69,600200 @ $57.00


2/15430@ $55.68 = $23,942**820 @ $55.68 = $45,658**

7/21230 @ $58 = $13,340820 @ $55.68 230 @ $58.00


8/5345 @ $59 = $20,355820 @ $55.68230 @ $58.00 = $79,353**345 @ $59.00


8/10335@ $56.88 = $19,055** 1,060@ $56.88

$42,997

*rounded to nearest cent

**rounded to nearest dollar

Note: Total cost of goods sold plus ending inventory = $42,997 + $60,293 = $103,290. The $5 difference from the cost of goods available for sale of $103,295 is due to rounding.

Problem 5-1B (Concluded)4.

FIFOLIFOSpecific

Identifica-tionWeighted

Average

Sales (765 x $90)

$68,850$68,850$68,850$68,850

Less: Cost of goods sold

42,240 44,045 42,405 42,997

Gross profit

$26,610 $24,805$26,445$25,853

5.The manager of Venus Company likely will prefer the FIFO method because it would yield the largest gross profit. This would give the manager his/her highest bonus based on gross profit.


Part 1

(a)

Cost of goods sold:200420052006

Reported

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

Adjustments:12/31/2004 error+ 17,000- 17,000

12/31/2005 error________ - 25,000 + 25,000

Corrected

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

(b)

Net income:200420052006

Reported

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

Adjustments:12/31/2004 error- 17,000+ 17,000

12/31/2005 error________ + 25,000 - 25,000

Corrected

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

(c)

Total current assets:200420052006

Reported

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

Adjustments:12/31/2004 error - 17,000

12/31/2005 error________ + 25,000________

Corrected

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

(d)

Equity:200420052006

Reported

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

Adjustments:12/31/2004 error- 17,000

12/31/2005 error________ + 25,000________

Corrected

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

Part 2Total net income for the combined three-year period is not affected by the errors. This is because these errors are "self-correcting"that is, each overstatement (or understatement) of net income is offset by a matching understatement (or overstatement) in the following year.

Part 3

The overstatement of inventory by $17,000 results in an understatement of cost of goods sold by that same amount. The $17,000 understatement of cost of goods sold results in an overstatement of gross profit by the same amount. This overstatement of gross profit carries through to an overstatement of net income. Since the overstated net income is closed to equity, the final equity figure is overstated by the amount of the inventory overstatement.



Inventory ItemsUnits CostMarketCost MarketItemsCategoriesWhole

Office furniture

Desks

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

Credenzas

29522725666,96575,52066,965

Chairs

587494328,76325,24125,241

Bookshelves

3219382 29,853 26,32226,322

Subtotal

239,377 260,063$239,377

Filing cabinets

Two-drawer

214817017,33414,98014,980

Four-drawer

39813512253,73048,55648,556

Lateral

175104118 18,200 20,65018,200

Subtotal

89,264 84,18684,186

Office equipment

Fax machine

43016820072,24086,00072,240

Copiers

545317288172,765156,960156,960

Telephones

352125117 44,000 41,18441,184

Subtotal

289,005 284,144_______ 284,144_______

Total

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

a. Lower of cost or market for the inventory as a whole= $617,646b. Lower of cost or market for the inventory by major category=

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

Part 1Number and total cost of units available for sale

6,300 units in beginning inventory @ $35

$ 220,500


346,500


416,000


348,000


403,000

57,300 units available for sale

$1,734,0000

Part 2

a. FIFO periodic


$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 periodic


$1,734,000

Less ending inventory on a LIFO basis

6,300 beg. inv. units @ $35

$220,500

10,200 units @ $33

336,600 557,100

Cost of units sold

$1,176,900

c. Weighted average periodic


$1,734,000

Less ending inventory at weighted average cost

($1,734,000/57,300) x 16,500 units

499,319*

Cost of units sold

$1,234,681*

*Amount can slightly vary due to differences in rounding.

Problem 5-5BA (30 minutes)

Part 1RIKKERS CORP.

Income Statements Comparing FIFO, LIFO, and Weighted Average

For Year Ended December 31, 2005

FIFOLIFO

Weighted Average

Sales

$245,000$245,000$245,000

Cost of goods sold


42,920 42,920 42,920

Cost of purchases

161,900 161,900 161,900


204,820204,820204,820


54,560 48,820 51,512*

Cost of goods sold

150,260 156,000 153,308*

Gross profit

94,74089,00091,692*

Expenses

35,000 35,000 35,000

Income before taxes

59,740 54,00056,692*

Income taxes expense

14,935 13,500 14,173*

Net income

$ 44,805$ 40,500$ 42,519*


Supporting calculations: FIFO LIFOWeighted Average

Dec. 31, 2004, inventory (740 x $58)

$ 42,920$ 42,920$ 42,920

Purchases

700 x $59 = $41,300

600 x $61 = 36,600

500 x $64 = 32,000

800 x $65 = 52,000$161,900$161,900$161,900

Dec. 31, 2005, inventory

FIFO:800 x $65 = $52,000

40 x $64 = 2,560

$ 54,560

LIFO:740 x $58 = $42,920

100 x $59 = 5,900$ 48,820

W.A.:($204,820/3,340) x 840

$ 51,512*


Problem 5-5BA (Concluded)Part 2

If Rikkers Corp. had been experiencing decreasing costs in the acquisition of inventory, we would observe the opposite results in our comparisons. Specifically, LIFO would have resulted in a higher ending inventory, lower cost of goods sold, higher gross profit, and higher net income. FIFO would have resulted in a lower ending inventory, higher cost of goods sold, lower gross profit, and lower net income.

Part 3

Advantages:

LIFO: Assuming a trend of increasing costs, the advantage of using LIFO is that the lower net income will result in a lower tax obligation (tax deferral). Also, LIFO is likely to better match current costs against revenues.

FIFO: The advantage of using FIFO is that the inventory figure reported on the balance sheet is likely similar to the current replacement cost.

Disadvantages:

LIFO: Assuming a trend of increasing costs, the disadvantage of using LIFO is the inventory figure, which is also reported on the income statement, will likely be understated in comparison to the current replacement costs.

FIFO: The disadvantage of using FIFO is that it will produce a greater tax obligation for the current period as a result of a higher reported net income.

Problem 5-6BB (25 minutes)

Part 1

ALAINA CO.

Estimated Inventory

December 31

At CostAt Retail

Goods available for sale:

Beginning inventory

$ 81,670$114,610


492,250 751,730


$573,920$866,340

Sales

$786,120

Less: Sales returns

(4,480)

Net sales

$781,640

Ending inventory at retail ($866,340 - $781,640)

$ 84,700

Cost ratio: $573,920/$866,340 = 0.66 or 66%

Ending inventory at cost ($84,700 x 66%) $ 55,902

Part 2Estimated physical inventory at cost: $84,700 x 66% = $55,902ALAINA CO.

Inventory Shortage

December 31

At CostAt Retail

Estimated inventory (from part 1)

$55,902$84,700

Physical inventory*

51,843 78,550

Inventory shortage

$ 4,059$ 6,150

* $51,843 = $78,550 (given) x 66% (from part 1).Problem 5-7BB (25 minutes)

ERNST EQUIPMENT CO.

Estimated Inventory at March 31

At Cost At Retail



$ 752,880


2,159,630


2,912,510


Sales

$3,710,250

Less sales returns

(74,200)

Net sales

$3,636,050


[$3,636,050 x (1 - 30%)]

(2,545,235)


$ 367,275

Serial Problem

Serial Problem, Success Systems (20 minutes)

1.Ratio computations for the three months ended March 31, 2005:

Inventory Turnover= Cost of Goods Sold / Average Inventory

= $14,052 / [($0 + $704)/2]

= 40 times (Since this is the first period of carrying inventory, it is acceptable to substitute ending inventory for average inventory. This would yield a turnover of 20 times.)

Days Sales in Inventory= (Ending Inventory/Cost of Goods Sold) x 365

= ($704 / $14,052) x 365 = 18.3 days2.Success Systems outperforms its competitors on both ratios. Its inventory turnover is 40 (or 20) times versus competitors 10 times. Also, its days sales in inventory is 18.3 days versus competitors 29 days. Thus, Success Systems appears to be successfully managing its inventory.Reporting in Action BTN 5-1

($ thousands)

1.Ending inventories at February 2, 2003, were $24,365. Ending inventories at February 3, 2002, were $16,159.

2.

2003:

= 0.059 or 5.9%

2002:

= 0.063 or 6.3%

3.Krispy Kreme reports 14 different types of assets on its balance sheet. Inventory is the fifth largest asset behind property and equipment , accounts receivable, cash and cash equivalents, and intangible assets at both February 2, 2003, and at February 3, 2002.

4.As stated in the summary of significant accounting policies (Note 2), Krispy Kreme uses the FIFO method of inventory costing for inventories. Its inventories are stated at the lower of average cost (FIFO) or market.

5.a. Inventory turnover =

Average inventory =

= $20,262

Inventory turnover =

= 18.8 times

b. Days sales in inventory=

x 365

=

x 365 = 23.3 days6.Solution depends on the financial statement information obtained.

Comparative Analysis BTN 5-2

($ thousands)

1.Inventory turnover =

Krispy Kreme current year


= 18.8 times

Krispy Kreme one year prior


= 22.5 times

Tastykake current year


= 14.6 times

Tastykake one year prior


= 14.4 times

2.Days sales in inventory =

x 365

Current year Krispy Kremes days sales in inventory

x 365 = 23.3 days

One year prior Krispy Kremes days sales in inventory

x 365 = 18.6 days

Two years prior Krispy Kremes days sales in inventory

x 365 = 17.5 daysComparative Analysis (Concluded)2.Continued

Current year Tastykakes days sales in inventory

x 365 = 22.2 days

One year prior Tastykakes days sales in inventory

x 365 = 29.7 daysTwo years prior Tastykakes days sales in inventory

x 365 = 20.6 days3.For two of the three years Krispy Kreme manages its inventory more efficiently than Tastykake. For the current (prior) year(s), Krispy Kreme holds 23.3 (18.6 and 17.5) days of sales in inventory and turns its inventory 18.8 (22.5) times. For the current (prior) year(s), Tastykake holds 22.2 (29.7 and 20.6) days of sales in inventory and only turns its inventory 14.6 (14.4) times.

Ethics Challenge BTN 5-31.Profit Margin: In an economic environment of rising costs, the use of FIFO results in a lower cost of goods sold than LIFO. If cost of goods sold is lower, then net income will be higher. A higher net income will improve the profit margin ratio, which is calculated as net income divided by net sales.

Current Ratio: With rising costs, FIFO results in the most recent, higher costs being reflected in ending inventory. This means that the balance sheet FIFO inventory figure will be larger than under LIFO. In the numerator of the current ratio, inventory is included as part of the current asset total. A larger inventory from FIFO, therefore, results in a larger numerator and therefore a larger current ratio than under LIFO.

2.First, it is true that managers have discretion in choosing an inventory costing method. It appears, however, that Golf Aways owner does not understand that changing methods can only be done very selectively over time. A change in method must be justified by management for improving the financial reporting of the company.

Second, the consistency principle does not allow frequent changes in inventory costing methods by management. If Golf Aways owner can justify the method change as improving the financial reports of the company, then the owners action is ethical. However, the owner must realize that changing methods can only be an infrequent occurrence given that consistency in financial reporting is required.

Third, the full disclosure principle requires the owner to disclose to the bank that the company has implemented a change in inventory costing method from LIFO to FIFO.

Finally, if LIFO is currently being used for tax reporting, then the tax reporting method must also change due to the LIFO Conformity Rulewhich demands that if LIFO is used for tax reporting, it must be used for financial reporting.

Communicating in Practice BTN 5-4[Note: An acceptable memorandum format should be used.]

The body of the memo should recommend use of the LIFO method. The memo should explain that this would allow for the matching of the most recent (higher) costs against revenue through cost of goods sold. It should further explain that this would result in a lower net income and, therefore, lower tax. The justification for this method is a better matching of current costs against revenue to more fairly reflect the results of operation. A statement could be made that the actual physical flow of goods does not dictate the inventory method a business uses.

Taking It to the Net BTN 5-51.One especially popular product with college students that Oakley sells is Oakley sunglasses.

2.The summary of significant accounting policies reports that Oakley reports its inventory at the lower of cost to purchase and/or manufacture or the current estimated market value.

3.Oakleys gross margin for 2002 is ($ in thousands)

Sales

$489,552

Cost of sales

(211,962)

Gross margin

$277,590

Gross margin ratio is: $277,590 / $489,552 = 0.567 or 56.7%4.2002 Inventory turnover*

=

$211,962 / [($87,007+$77,270)/2]= 2.6 times

2002 Days sales in inventory*

=

($87,007 / $211,962) x 365= 150 days

* $ thousands

Teamwork in Action BTN 5-6Concepts and procedures to illustrate in expert presentation:

Specific Identification Expert:

(a) and (b) Concept:

Purchases are always recorded at the actual specific costs. The specific identification cost flow assumption requires units sold be assigned their actual cost. Total cost of goods sold is tallied based on these individual cost assignments. The new inventory balance is perpetually determined to be the amount after sales at actual cost is deducted.

(a) and (b) Procedures:


Jan. 150@$10=$ 500

Jan.10 30 @ $10 = $ 300 20 @ $10 = $ 200

Jan.14150 @ $12 = $1,800 20 @ $10 = $ 200

150 @ $12 = 1,800

$2,000

Feb.15 100 @ $ 12 = $1,200 20 @ $10 = $ 200 50 @ $12 = 600

$ 800

Apr.30200 @ $15 = $3,000 20 @ $10 = $ 200 50 @ $12 = 600

200 @ $15 = 3,000

$3,800

Sept 26300 @ $20 = $6,000 20 @ $10 = $ 200 50 @ $12 = 600

200 @ $15 = 3,000

300 @ $20 = 6,000 $9,800

Oct. 5 100 @ $ 15 = $1,500 250 @ $ 20 = $5,000

_____ 20 @ $10= $ 200 50 @ $12 = 600 100 @ $15 = 1,500 50 @ $20 = 1,000

$8,000 $3,300

Teamwork in Action (Continued)

LIFO Expert:


Purchases are always recorded at actual costs. The LIFO cost flow assumption requires (i) units sold be assigned the most recent costtotal cost of goods sold is tallied based on these individual cost assignments, and (ii) that the inventory balance be perpetually determined to be the amount after goods sold (using the most recent costs) are deducted.



Jan. 150@$10= $500

Jan.10 30@$10=$300 20@$10=$200

Jan.14150 @ $12 = $1,800 20@$10= $200

150 @ $12 = 1,800

$2,000

Feb.15100@$12=$1,200 20 @ $10 =$ 200 50 @ $12 =

600

$ 800

Apr.30 200 @ $15 =$3,000 20 @ $10 =$ 200 50 @ $12 = 600

200 @ $15 = 3,000

$3,800

Sept 26300 @ $20 = $6,000 20 @ $10 =$200

50 @ $12 = 600

200 @ $15 = 3,000

300 @ $20 = 6,000 $ 9,800

Oct. 5 300@$20=$6,000

50@ $15 =$ 750

______

$ 8,250 20 @ $10 =$ 200 50 @ $12 = 600

150 @ $15 = 2,250

$3,050

Teamwork in Action (Continued)FIFO Expert:


Purchases are always recorded at actual costs. The FIFO cost flow assumption requires units sold be assigned the first (earliest) cost of purchases. Total cost of goods sold is tallied based on these individual cost assignments. The inventory balance is perpetually determined to be the amount after deducting goods sold using the earliest costs.



Jan. 1 50 @ $10= $ 500

Jan.1030 @ $10 =$ 300 20 @ $10= $ 200

Jan.14150 @ $12 = $1,800 20 @ $10= $ 200

150 @ $12= 1,800

$2,000

Feb.15 20 @ $ 10 =$200 80 @ $ 12=

960

70 @ $12 =$840

Apr.30200 @ $15 = $3,000 70 @ $12 = $840

200 @ $15 =

3,000

$3,840

Sept 26300 @ $20 = $6,000 70 @ $12 = $ 840

200 @ $15 = 3,000

300 @ $20 = 6,000

$ 9,840

Oct. 5 70 @ $12 =$840

200 @ 15 = 3,000 80 @ 20 = 1,600

______220@ $20=$4,400

______

$ 6,900$ 4,400

Teamwork in Action (Continued)Weighted Average Expert:


Purchases are always recorded at actual costs. The Weighted Average cost flow assumption requires units sold be assigned a cost based on running weighted average cost per unit in the inventory balance. This requires the computation of a new weighted average cost per unit after each purchase. The total cost of goods sold is tallied based on cost assignments. The new inventory balance is perpetually determined to be the residual amount after goods sold are deducted using this weighted average cost.



Jan. 1 50 @ $10 = $ 500

Jan.10 30 @ $10 = $ 300 20 @ $10 = $ 200

Jan.14150 @ $12 = $1,800 170 @ $11.7647 = $2,000 (200 +1,800) / (20+150)

Feb.15 100 @ $11.7647 = $1,176* 70 @ $11.7647 = $ 824*

Apr.30200 @ $15 = $3,000 270 @ $14.163* = $3,824* (824+3,000) / (70 +200)

Sept 26

300 @ $20 = $6,000 570 @ $17.24* = $9,824* (3,824 +6,000) / (270 +300)

Oct. 5

350 @ $17.24 = $6,034 220 @ $17.24* =

_____$3,790**

$7,510

* rounded ** adjusted for rounding

Teamwork in Action (Concluded)

(c)Cost Flow versus Actual Physical Flow

Typical comments experts may express in response to (c):

Physical flow of goods can be affected by the type of products in inventory and/or the way inventory is stored and/or displayed.

Actual physical flow of goods is not relevant in selecting an acceptable method of accounting for inventory. Any one of the four methods is acceptable. The method chosen should be consistently applied.

More Specific Expert Comments to (c):

Specific Identification--Always reflects the actual cost flow. Electronic scanning has increased the ability to use this method in businesses that sell homogeneous goods.

FIFOMost businesses try to move their older or earlier acquired inventory first, particularly if they sell perishable goods. Therefore, FIFO will frequently reflect the physical flow of goods.

LIFOFew actually sell their most recently acquired inventory first. This could follow actual physical flow if inventory is stocked in a manner that requires accessing most recent cost first.

Weighted Average--This cost is rarely the actual cost flow. This would require the mixing or combining of units on hand. This is possible for inventory such as oil but it still unlikely that the actual blending would be as complete as the averaging of costs.

(d) Impact of MethodsTypical comments experts may express in response to (d):

In a period of rising prices LIFO will generally result in the highest cost of goods sold and therefore the lowest net income and lowest tax. However, LIFO must be used for financial reporting if it is used for tax purposes.

In a period of rising prices FIFO will generally result in the lowest cost of goods sold and therefore the highest net income and highest tax.

Weighted Average will usually result in a reported net income and tax consequences somewhere in between LIFO and FIFO.

Specific Identification will result in a cost of goods sold, net income and tax expense dependent on whether the actual cost of units sold were the higher or lower priced items.

(e) ValuationTypical comments experts may express in response to (e):

FIFO tends to value ending inventory closest to replacement cost whereas LIFO does not. Weighted average tends to value inventory between old and new market values, and specific identification depends on whether the items remaining in inventory have costs similar to current replacement costs.

Business Week Activity BTN 5-71. Apple has a 2.5% share of the U.S. market for digital music players.

2. Toshiba with Mobilphile, and SONICblue.

3.Toshibas Mobilphile has a removable hard drive. Toshiba could choose to ship players and different size removable drives separately to stores. The separate shipment would allow retailers to meet customer demand for product specifications quite efficiently onsite.

This flexibility will hold down inventory costs as retailers will not be stocking players with drives of certain sizes that consumers do not demand. In contrast, iPods hard drives are not removable and a retailer might not be fortunate enough to stock the size iPod that is most in demand by consumers.

4.Unit sales of the iPod are forecast to grow from 1 million in 2002 to 9 million in 2006.

Entrepreneurial Decision BTN 5-8Part 1

(a) Under current conditions, the inventory turnover is 2.1. This is computed as its cost of sales of $1,050,000 divided by its average merchandise inventory of $500,000. Also, days sales in inventory is 174 days. This is computed as its ending inventory of $500,000 divided by its cost of sales of $1,050,000, and then this result is multiplied by 365.*

*Ratio definitions:


Days sales in inventory =

x 365

(b) Under the proposal, its inventory turnover would be 8.4. This is computed as its cost of sales of $1,050,000 divided by its average proposed merchandise inventory of $125,000. Also, its days sales in inventory under the proposal is 43 days. This is computed as its proposed ending inventory of $125,000 divided by its cost of sales of $1,050,000, and then this result is multiplied by 365.

Entrepreneurial Decision (Concluded)

Part 2

Beckers proposal would yield a much improved inventory turnover of 8.4 vis--vis the current turnover of 2.1. On the downside, its days sales in inventory would dramatically decline from 174 days to 43 days. Assuming an inventory buffer of 43 days is sufficient, then Becker should implement this proposal.

We need to recognize that the major concern with this proposal is with the companys confidence in both maintaining its current sales level and with not losing or alienating its current and future customers due to delays in acquiring merchandise. Assuming the companys predictions are reasonable, we need to focus on the customer concern. That is, we need to be certain that Becker can continue to satisfactorily serve customers with a 43-day buffer in inventory. If not, then current and future sales could suffer to an extent that would outweigh the benefit of slashing inventory.

Hitting the Road BTN 5-9There is no formal solution for this field activity. The required solution does allow students to see the relevance of studying merchandise activities and inventory accounting.

Global Decision BTN 5-10

1.Inventory turnover =

Current year Grupo Bimbo (pesos millions):


= 22.9 times

One year prior Grupo Bimbo (pesos millions):


= 21.1 times

Days sales in inventory =

x 365

Current year Grupo Bimbos days sales in inventory (pesos millions):

x 365 = 17.2 daysOne year priorGrupo Bimbos days sales in inventory (pesos millions):

x 365 = 17.8 daysInventory TurnoverDays Sales in Inventory

CompanyCurrentPrior YearCurrentPrior Year

Grupo Bimbo

22.921.117.217.8

Krispy Kreme

18.822.523.318.6

Tastykake

14.614.422.229.7

Note: Computations for Krispy Kreme and Tastykake are in BTN 5-2.

2.In the current year Grupo Bimbo manages its inventory more efficiently than Krispy Kreme or Tastykake. Its inventory turnover is higher and its days sales in inventory are less than both Krispy Kreme and Tastykake.

= $120

}

}

}

}

}

}

}

}

}

= $712*

= $ 2,775

= $18,800

= $34,400

= $29,820

}

= $58,200

= $59,290

= $59,250

= $79,015

= $58,200

= $58,998**

= $60,293**

$24,365

$410,487

$16,159

$255,376

Cost of sales

Average inventory

$16,159 + 24,365

2

$ 381,489

$ 20,262

Ending inventory

Cost of sales

$24,365

$381,489

Cost of sales

Average inventory

$381,489

($24,365 + $16,159)/2

$316,946

($16,159 + $12,031)/2

$111,187

($6,777 + $8,412)/2

$103,297

($8,412 + $5,930)/2

Ending Inventory

Costs of Goods Sold

$24,365

$381,489

$16,159

$316,946

$12,031

$250,690

$6,777

$111,187

$8,412

$103,297

$ 5,930

$105,036

Cost of goods sold

Average inventory

Ending inventory

Cost of goods sold

Cost of sales

Average inventory

19,156

(905 + 767) / 2

15,708

(767 + 725) / 2

Ending Inventory

Costs of Goods Sold

905

19,156

767

15,708

290

McGraw-Hill Companies, Inc., 2005Financial Accounting, 3rd Edition

289Solutions Manual, Chapter 5McGraw-Hill Companies, Inc., 2005

solution manual ch 05 financial accounting reporting and analyzing inventories

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