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Chapter 8
Inventories: Measurement
QUESTIONS FOR REVIEW OF KEY TOPICS
Question 8-1
Inventory for a manufacturing company consists of (1) raw materials, (2) work in process, and
(3) finished goods. Raw materials represent the cost, primarily purchase price plus freight charges,
of goods purchased from other manufacturers that will become part of the finished product. Workin-process inventory represents the products that are not yet complete. The cost of work in process
includes the cost of raw materials used in production, the cost of labor that can be directly traced to
the goods in process, and an allocated portion of other manufacturing costs, called manufacturing
overhead. When the manufacturing process is completed, these costs that have been accumulated in
work in process are transferred to finished goods.
Question 8-2
Beginning inventory plus net purchases for the period equals cost of goods available for sale.
The main difference between a perpetual and a periodic system is that the periodic system allocates
cost of goods available for sale to ending inventory and cost of goods sold only at the end of the
period. The perpetual system accomplishes this allocation by decreasing inventory and increasing
cost of goods sold each time goods are sold.
Question 8-3
Perpetual System
Periodic System
(1) purchase of merchandise
debit inventory
debit purchases
(2) sale of merchandise
debit cost of goods sold;
credit inventory
no entry
(3) return of merchandise
credit inventory
credit purchase returns
(4) payment of freight
debit inventory
debit freight-in
Question 8-4
Inventory shipped f.o.b. shipping point is included in the inventory of the purchaser when the
merchandise reaches the common carrier. Laetner Corporation records the purchase in 2003 and
includes the shipment in its ending inventory. Bockner Company records the sale in 2003. Inventory
shipped f.o.b. destination is included in the inventory of the seller until it reaches the purchaser’s
location. Bockner would include the merchandise in its 2003 ending inventory and the sale/purchase
would be recorded in 2004.
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-1
Answers to Questions (continued)
Question 8-5
A consignment is an arrangement under which goods are physically transferred to another
company (the consignee), but the transferor (consignor) retains legal title. If the consignee can’t find
a buyer, the goods are returned to the consignor. Goods held on consignment are included in the
inventory of the consignor until sold by the consignee.
Question 8-6
By the gross method purchase discounts not taken are viewed as part of inventory cost. By the
net method purchase discounts not taken are considered interest expense, because they are viewed as
compensation to the seller for providing financing to the buyer.
Question 8-7
1. Beginning inventory
2. Purchases
3. Ending inventory
4. Purchase returns
5. Freight-in
—
—
—
—
—
increase
increase
decrease
decrease
increase
Question 8-8
Four methods of assigning cost to ending inventory and cost of goods sold are (1) specific
identification, (2) first-in, first-out (FIFO), (3) last-in, first-out (LIFO), and (4) average cost. The
specific identification method requires each unit sold during the period or each unit on hand at the
end of the period to be traced through the system and matched with its actual cost. First-in, first-out
(FIFO) assumes that units sold are the first units acquired. The last-in, first-out (LIFO) method
assumes that the units sold are the most recent units purchased. The average cost method assumes
that cost of goods sold and ending inventory consist of a mixture of all the goods available for sale.
The average unit cost applied to goods sold or ending inventory is an average unit cost weighted by
the number of units acquired at the various unit prices.
Question 8-9
When costs are declining, LIFO will result in a lower cost of goods sold and higher income
than FIFO. This is because LIFO will include in cost of goods sold the most recently purchased
lower cost merchandise. LIFO also will provide a higher ending inventory in the balance sheet.
© The McGraw-Hill Companies, Inc., 2004
8-2
Intermediate Accounting, 3/e Update Edition
Answers to Questions (concluded)
Question 8-10
Proponents of LIFO argue that it provides a better match of revenues and expenses because
cost of goods sold includes the costs of the most recent purchases. These are matched with sales that
reflect a current selling price. On the other hand, inventory costs in the balance sheet generally are
out of date because they are derived from old purchase transactions. It is conceivable that a
company’s LIFO inventory balance could be based on unit costs actually incurred several years
earlier. When inventory quantity declines during a period, then these out-of-date inventory layers
will be liquidated and cost of goods sold will match noncurrent costs with current selling prices.
Question 8-11
Many companies choose the LIFO inventory method to reduce income taxes in periods when
prices are rising. In periods of rising prices, LIFO results in a higher cost of goods sold and therefore
a lower net income than the other methods. The companies’ income tax returns will report lower
taxable incomes using LIFO and lower taxes will be paid currently. If a company uses LIFO to
measure its taxable income, IRS regulations require that LIFO also be used to measure income
reported to investors and creditors.
Question 8-12
A LIFO inventory pool groups inventory units into pools based on physical similarities of the
individual units. The average cost for all of a pool’s beginning inventory and for all of a pool’s
purchases during the period is used instead of individual unit costs. If the quantity of ending
inventory for the pool increases, then ending inventory will consist of the beginning inventory plus a
layer added during the period at the average acquisition cost for the pool.
Question 8-13
The dollar-value LIFO method has important advantages. First, it simplifies the recordkeeping
procedures compared to unit LIFO because no information is needed about unit flows. Second, it
minimizes the probability of the liquidation of LIFO inventory layers, even more so than the use of
pools alone, through the aggregation of many types of inventory into larger pools. In addition, firms
that do not replace units sold with new units of the same kind can use the method.
Question 8-14
After determining ending inventory at year-end cost, the following steps remain:
1. Convert ending inventory valued at year-end cost to base year cost.
2. Identify the layers in ending inventory with the years they were created.
3. Convert each layer’s base year cost measurement to layer year cost measurement using the
layer year’s cost index and then sum the layers.
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-3
EXERCISES
Exercise 8-1
1.
2.
To record the purchase of inventory on account and the payment of freight
charges.
Inventory .........................................................................
Accounts payable ........................................................
4,000
Inventory .........................................................................
Cash .............................................................................
300
300
To record purchase returns.
Accounts payable ............................................................
Inventory .....................................................................
3.
4,000
600
600
To record cash sales and cost of goods sold.
Cash .................................................................................
Sales revenue ..............................................................
5,000
Cost of goods sold...........................................................
Inventory .....................................................................
2,800
© The McGraw-Hill Companies, Inc., 2004
8-4
5,000
2,800
Intermediate Accounting, 3/e Update Edition
Exercise 8-2
1.
2.
To record the purchase of inventory on account and the payment of freight
charges.
Purchases ........................................................................
Accounts payable .......................................................
4,000
Freight-in ........................................................................
Cash ............................................................................
300
300
To record purchase returns.
Accounts payable ...........................................................
Purchase returns .........................................................
3.
4,000
600
600
To record cash sales.
Cash ................................................................................
Sales revenue ..............................................................
5,000
5,000
NO ENTRY IS MADE FOR THE COST OF GOODS SOLD.
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-5
Exercise 8-3
Requirement 1
Beginning inventory
Plus net purchases:
Purchases
Less: Purchase discounts
Less: Purchases returns
Plus: Freight-in
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
$ 32,000
$230,000
(6,000)
(8,000)
16,000
232,000
264,000
(40,000)
$224,000
Requirement 2
Cost of goods sold (above)............................................... 224,000
Inventory (ending) ............................................................ 40,000
Purchase discounts ..........................................................
6,000
Purchase returns ..............................................................
8,000
Inventory (beginning) ...................................................
32,000
Purchases .....................................................................
230,000
Freight-in.....................................................................
16,000
© The McGraw-Hill Companies, Inc., 2004
8-6
Intermediate Accounting, 3/e Update Edition
Exercise 8-4
PERPETUAL SYSTEM
PERIODIC SYSTEM
($ in 000s)
Purchases
Inventory
Accounts payable
150
150
Freight
Inventory
Cash
10
Returns
Accounts payable
Inventory
12
Sales
Accounts receivable
Sales revenue
Cost of goods sold
Inventory
End of period
No entry
Purchases
Accounts payable
150
Freight-in
Cash
10
10
Accounts payable
Purchase returns
12
12
250
250
Accounts receivable
Sales revenue
250
143
10
12
250
No entry
143
Cost of goods sold (below)
Inventory (ending)
Purchase returns
Inventory (beginning)
Purchases
Freight-in
Cost of goods sold:
Beginning inventory
Purchases
Less: Returns
Plus: Freight-in
Net purchases
Cost of goods available
Less: Ending inventory
Cost of goods sold
Solutions Manual, Vol.1, Chapter 8
150
143
30
12
25
150
10
$25
$150
(12)
10
148
173
(30)
$143
© The McGraw-Hill Companies, Inc., 2004
8-7
Exercise 8-5
Beginning inventory
Cost of goods sold
Ending inventory
Cost of goods available for sale
Purchases (gross)
Purchase discounts
Purchase returns
Freight-in
2003
275 (1)
627
249 (2)
876
630
18
24
13
2004
249 (3)
621
225
846 (4)
610 (5)
15
30
32
2005
225
584 (6)
216
800
585
12 (7)
14
16
Net purchases = Purchases(gross) - Purchase returns - Purchase discounts + Freight-in
Beginning inventory + Net purchases = Cost of goods available for sale
Cost of goods available for sale - Ending inventory = Cost of goods sold
2003:
(1) Cost of goods available for sale - Net purchases = Beginning inventory
876 - (630 - 18 - 24 + 13) = 275 = Beginning inventory
(2) Cost of goods available for sale - Cost of goods sold = Ending inventory
876 - 627 = 249 = Ending inventory
2004:
(3) 2004 beginning inventory = 2003 ending inventory = 249
(4) Cost of goods sold + Ending inventory = Cost of goods available for sale
621 + 225 = 846 = Cost of goods available for sale
(5) Cost of goods available for sale - Beginning inventory = Net purchases
846 - 249 = 597 = Net purchases
Net purchases + Purchases discounts + Purchase returns - Freight-in = Purchases(gross)
597 + 15 + 30 - 32 = 610 = Purchases (gross)
2005:
(6) Cost of goods available for sale - Ending inventory = Cost of goods sold
800 - 216 = 584 = Cost of goods sold
© The McGraw-Hill Companies, Inc., 2004
8-8
Intermediate Accounting, 3/e Update Edition
Exercise 8-5 (concluded)
(7) Cost of goods available for sale - Beginning inventory = Net purchases
800 - 225 = 575 = Net purchases
Purchases(gross) - Purchase returns + Freight-in - Net purchases = Purchase discounts
585 - 14 + 16 - 575 = 12 = Purchase discounts
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-9
Exercise 8-6
Requirement 1
Purchase price = 1,000 units x $50 = $50,000
July 15, 2003
Purchases .........................................................................
Accounts payable ........................................................
July 23, 2003
Accounts payable ............................................................
Cash (98% x $50,000) ....................................................
Purchase discounts (2% x $50,000) ...............................
50,000
50,000
50,000
49,000
1,000
Requirement 2
July 15, 2003
Purchases .........................................................................
Accounts payable ........................................................
50,000
August 15, 2003
Accounts payable ............................................................
Cash .............................................................................
50,000
50,000
50,000
Requirement 3
Each July 15 entry would include a debit to the inventory account instead of to
purchases, and the July 23 entry would include a credit to the inventory account
instead of to purchases discounts.
© The McGraw-Hill Companies, Inc., 2004
8-10
Intermediate Accounting, 3/e Update Edition
Exercise 8-7
Requirement 1
July 15, 2003
Purchases (98% x $50,000) ................................................
Accounts payable ......................................................
49,000
July 23, 2003
Accounts payable ...........................................................
Cash ............................................................................
49,000
49,000
49,000
Requirement 2
July 15, 2003
Purchases (98% x $50,000) ................................................
Accounts payable ......................................................
49,000
August 15, 2003
Accounts payable ...........................................................
Interest expense ..............................................................
Cash ............................................................................
49,000
1,000
49,000
50,000
Requirement 3
The July 15 entry for 1 and 2 above would include a debit to the inventory
account instead of to purchases.
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-11
Exercise 8-8
Requirement 1
Purchase price = 100 units x $500 = $50,000 x .70 = $35,000
November 17, 2003
Purchases .........................................................................
Accounts payable ........................................................
November 26, 2003
Accounts payable ...........................................................
Purchase discounts (2% x $35,000) ...............................
Cash (98% x $35,000) ....................................................
35,000
35,000
35,000
700
34,300
Requirement 2
November 17, 2003
Purchases .........................................................................
Accounts payable ........................................................
35,000
December 15, 2003
Accounts payable ............................................................
Cash .............................................................................
35,000
© The McGraw-Hill Companies, Inc., 2004
8-12
35,000
35,000
Intermediate Accounting, 3/e Update Edition
Exercise 8-8 (concluded)
Requirement 3
Requirement 1:
November 17, 2003
Purchases (98% x $35,000) ................................................
Accounts payable .......................................................
34,300
November 26, 2003
Accounts payable ...........................................................
Cash ............................................................................
34,300
34,300
34,300
Requirement 2:
November 17, 2003
Purchases (98% x $35,000) ................................................
Accounts payable .......................................................
34,300
December 15, 2003
Accounts payable ...........................................................
Interest expense (2% x $35,000)........................................
Cash ............................................................................
34,300
700
Solutions Manual, Vol.1, Chapter 8
34,300
35,000
© The McGraw-Hill Companies, Inc., 2004
8-13
Exercise 8-9
Inventory balance before additional transactions
Add:
Goods shipped to Kwok f.o.b. shipping point on Dec. 28
Goods shipped to customer f.o.b. destination on December 27
Correct inventory balance
$165,000
17,000
22,000
$204,000
Exercise 8-10
Inventory balance before additional transactions
$220,000
Add:
Merchandise on consignment with Joclyn Corp.
15,000
Deduct:
Merchandise shipped to Raymond f.o.b. destination on December 26
(30,000)
Merchandise held on consignment from the Harrison Company
(12,000)
Correct inventory balance
$193,000
© The McGraw-Hill Companies, Inc., 2004
8-14
Intermediate Accounting, 3/e Update Edition
Exercise 8-11
Cost of goods available for sale:
Beginning inventory (2,000 x $6.10)
Purchases:
10,000 x $5.50
$55,000
6,000 x $5.00
30,000
Cost of goods available (18,000 units)
$12,200
85,000
$97,200
First-in, first-out (FIFO)
Cost of goods available for sale (18,000 units)
Less: Ending inventory (determined below)
Cost of goods sold
$97,200
(15,000)
$82,200
Cost of ending inventory:
Date of
purchase
August 18
Units
3,000
Unit cost
$5.00
Total cost
$15,000
Last-in, first-out (LIFO)
Cost of goods available for sale (18,000 units)
Less: Ending inventory (determined below)
Cost of goods sold
$97,200
(17,700)
$79,500
Cost of ending inventory:
Date of
purchase
BI
August 8
Units
2,000
1,000
Total
Solutions Manual, Vol.1, Chapter 8
Unit cost
$6.10
5.50
Total cost
$12,200
5,500
$17,700
© The McGraw-Hill Companies, Inc., 2004
8-15
Exercise 8-11 (concluded)
Average cost
Cost of goods available for sale (18,000 units)
Less: Ending inventory (determined below)
Cost of goods sold
$97,200
(16,200)
$81,000 *
Cost of ending inventory:
$97,200
Weighted-average unit cost =
= $5.40
18,000 units
3,000 units x $5.40 = $16,200
* Alternatively, could be determined by multiplying the units sold by the average
cost: 15,000 units x $5.40 = $81,000
© The McGraw-Hill Companies, Inc., 2004
8-16
Intermediate Accounting, 3/e Update Edition
Exercise 8-12
First-in, first-out (FIFO)
Cost of goods sold:
Date of
sale
Aug. 14
Aug. 25
Total
Cost of
Units Sold
Units sold
2,000 (from BI)
6,000 (from 8/8 purchase)
4,000 (from 8/8 purchase)
3,000 (from 8/18 purchase)
15,000
Total Cost
$6.10
5.50
5.50
5.00
$12,200
33,000
22,000
15,000
$82,200
Ending inventory = 3,000 units x $5.00 = $15,000
Last-in, first-out (LIFO)
Date
Purchased
Sold
Balance
Beginning
inventory
2,000 @ $6.10 =
$12,200
2,000 @ $6.10
$12,200
August 8
10,000 @ $5.50 =
$55,000
2,000 @ $6.10
10,000 @ $5.50
$67,200
2,000 @ $6.10
2,000 @ $5.50
$23,200
8,000 @ $ 5.50 =
August 14
August 18
6,000 @ $5.00 =
$30,000
August 25
Total cost of goods sold
Solutions Manual, Vol.1, Chapter 8
$44,000
2,000 @ $6.10
2,000 @ $5.50
6,000 @ $5.00
6,000 @ $5.00 =
1,000 @ $5.50 =
$30,000
$ 5,500
=
$79,500
2,000 @ $6.10
1,000 @ $5.50
$53,200
$17,700
Ending
inventory
© The McGraw-Hill Companies, Inc., 2004
8-17
Exercise 8-12 (concluded)
(Note: the perpetual inventory LIFO results are the same as periodic LIFO results
would be, due to the timing of sales and purchases. The same LIFO layers are on
hand at the end of the period under each method. This is unusual. LIFO perpetual
and LIFO periodic normally produce different results for ending inventory and cost of
goods sold.)
Average cost
Date
Beginning
inventory
August 8
Purchased
2,000 @ $6.10 =
$12,200
10,000 @ $5.50 =
$55,000
Sold
Balance
2,000 @ $6.10
$12,200
8,000 @ $5.60 =
$44,800 4,000 @ $5.60
$22,400
7,000 @ $5.24 =
$36,680 3,000 @ $5.24
$15,720
Ending
inventory
$67,200
= $5.60/unit
12,000 units
August 14
August 18
6,000 @ $5.00 =
$30,000
$52,400
= $5.24/unit
10,000 units
August 25
Total cost of goods sold
© The McGraw-Hill Companies, Inc., 2004
8-18
=
$81,480
Intermediate Accounting, 3/e Update Edition
Exercise 8-13
Requirement 1
LIFO will result in the highest cost of goods sold figure because both the cost of
merchandise and the quantity of merchandise rose during the period. FIFO will result
in the highest ending inventory balance for the same reasons.
Requirement 2
Cost of goods available for sale:
Beginning inventory (600 x $80)
Purchases:
1,000 x $ 90
$90,000
800 x $100
80,000
Cost of goods available (2,400 units)
$ 48,000
170,000
$218,000
First-in, first-out (FIFO)
Cost of goods available for sale (2,400 units)
Less: Ending inventory (below)
Cost of goods sold
$218,000
(80,000)
$138,000
Cost of ending inventory:
Date of
purchase
January 21
Units
800
Unit cost
$100
Total cost
$80,000
Last-in, first-out (LIFO)
Cost of goods available for sale (2,400 units)
Less: Ending inventory (below)
Cost of goods sold
$218,000
(66,000)
$152,000
Cost of ending inventory:
Date of
purchase
BI
January 15
Total
Solutions Manual, Vol.1, Chapter 8
Units
600
200
Unit cost
$80
90
Total cost
$48,000
18,000
$66,000
© The McGraw-Hill Companies, Inc., 2004
8-19
Exercise 8-14
Requirement 1
Cost of goods available for sale:
Beginning inventory (5,000 x $10.00)
Purchases:
3,000 x $10.40
$31,200
8,000 x $10.75
86,000
Cost of goods available (16,000 units)
Cost of goods available for sale (16,000 units)
Less: Ending inventory (below)
Cost of goods sold
$ 50,000
117,200
$167,200
$167,200
(73,150)
$ 94,050*
Cost of ending inventory:
$167,200
Weighted-average unit cost =
= $10.45
16,000 units
7,000 units x $10.45 = $73,150
* Alternatively, could be determined by multiplying the units sold by the average
cost:
9,000 units x $10.45 = $94,050
© The McGraw-Hill Companies, Inc., 2004
8-20
Intermediate Accounting, 3/e Update Edition
Exercise 8-14 (concluded)
Requirement 2
Date
Purchased
Beginning
inventory
5,000 @ $10.00 =
$50,000
September 7
3,000 @ $10.40 =
$31,200
Sold
Balance
5,000 @ $10.00
$50,000
4,000 @ $10.15 =
$40,600 4,000 @ $10.15
$40,600
5,000 @ $10.55 =
$52,750 7,000 @ $10.55
$73,850
Ending
inventory
$81,200
= $10.15/unit
8,000 units
September 10
September 25
8,000 @ $10.75 =
$86,000
$126,600
= $10.55/unit
12,000 units
September 29
Total cost of goods sold
Solutions Manual, Vol.1, Chapter 8
=
$93,350
© The McGraw-Hill Companies, Inc., 2004
8-21
Exercise 8-15
Requirement 1
FIFO cost of goods sold:
10,000 units @ $5.00
+ 10,000 units @ $6.00 (determined below)
= $50,000
= 60,000
$110,000
Requirement 2
LIFO cost of goods sold:
20,000 units @ $6.00 (determined below)
= $120,000
Calculations to determine cost per unit of year 2003 purchases:
Cost of goods sold
= Weighted-average cost per unit
Number of units sold
$115,000
= $5.75 per unit
20,000 units
$5.75 x 40,000 units = $230,000 = Cost of goods available for sale
$230,000 - $50,000 (beginning inventory) = $180,000 = Cost of purchases
$180,000
= $6 = Cost per unit of year 2003 purchases
30,000 units purchased
Cost of goods available for sale:
Beginning inventory (10,000 x $5.00)
Purchases (30,000 x $6.00)
Cost of goods available (40,000 units)
© The McGraw-Hill Companies, Inc., 2004
8-22
$ 50,000
180,000
$230,000
Intermediate Accounting, 3/e Update Edition
Exercise 8-16
1.
2.
3.
4.
d
b
b
a
Exercise 8-17
Requirement 1
Cost of goods sold:
50,000 units x $9 =
6,000 units x $7 =
$450,000
42,000
$492,000
Requirement 2
When inventory quantity declines during a period, liquidation of LIFO inventory
layers carried at lower costs prevailing in prior years results in noncurrent costs being
matched with current selling prices. If the resulting effect on income is material, it
must be disclosed. In this case, the effect of the LIFO layer liquidation is to increase
income (ignoring taxes) by $12,000 [6,000 units liquidated x $2 ($9 current year
cost per unit - $7 LIFO layer cost per unit)].
Exercise 8-18
MAYTAG
WHIRLPOOL
Gross profit ratio
= 1,146
4,248
= 27%
2,487
10,325
= 24%
Inventory turnover
= 3,102
406.5
= 7.63
7,838
1,092
= 7.18
Average days
in inventory
=
= 48 days
365
7.18
= 51 days
365
7.63
Maytag's gross profit ratio (27%) is slightly higher than Whirlpool's (24%).
Maytag’s turnover ratio also is higher (7.63 compared to 7.18).
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-23
Exercise 8-19
Date
1/1/03
12/31/03
12/31/04
Inventory Layers
at Base Year Cost
$660,000
= $660,000
1.00
$660,000 (base)
$660,000 x 1.00 = $660,000
$660,000
$660,000 (base)
9,903 (2003)
$660,000 x 1.00 = $660,000
9,903 x 1.03 =
10,200
670,200
$660,000 (base)
9,903 (2003)
30,097 (2004)
$660,000 x 1.00 = $660,000
9,903 x 1.03 =
10,200
30,097 x 1.10 =
33,107
703,307
$690,000
= $669,903
1.03
$770,000
= $700,000
1.10
© The McGraw-Hill Companies, Inc., 2004
8-24
Inventory Layers
Converted to Cost
Ending
Inventory
DVL Cost
Ending Inventory
at Base Year Cost
Intermediate Accounting, 3/e Update Edition
Exercise 8-20
Date
12/31/03
12/31/04
Ending Inventory
at Base Year Cost
Inventory Layers
at Base Year Cost
$200,000
= $200,000
1.00
$200,000 (base)
Inventory Layers
Converted to Cost
Ending
Inventory
DVL Cost
$200,000 x 1.00 = $200,000
$200,000
$200,000 x 1.00 = $200,000
20,000 x 1.05 =
21,000
221,000
$200,000 x 1.00 = $200,000
20,000 x 1.05 =
21,000
40,000 x 1.15 =
46,000
267,000
$200,000 x 1.00 = $200,000
20,000 x 1.05 =
21,000
30,000 x 1.15 =
34,500
255,500
$231,000
= $220,000
Index = 1.05
Index
$200,000 (base)
20,000 (2004)
12/31/05
$299,000
= $260,000
Index = 1.15
Index
$200,000 (base)
20,000 (2004)
40,000 (2005)
12/31/06
$300,000
= $250,000
Index = 1.20
Index
$200,000 (base)
20,000 (2004)
30,000 (2005)
Exercise 8-21
1.
2.
b
c
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-25
Exercise 8-22
List A
i
1. Perpetual inventory system
l
2. Periodic inventory system
a
3. F.o.b. shipping point
c
4. Gross method
g
h
k
5. Net method
6. Cost index
7. F.o.b. destination
e
8. FIFO
List B
f
b
9. LIFO
10. Consignment
j
d
11. Average cost
12. IRS conformity rule
a. Legal title passes when goods are delivered to
common carrier.
b. Goods are transferred to another company but title
remains with transferor.
c. Purchase discounts not taken are included in
inventory cost.
d. If LIFO is used for taxes, it must be used for financial
reporting.
e. Items sold are those acquired first.
f. Items sold are those acquired last.
g. Purchase discounts not taken are considered interest
expense.
h. Used to convert ending inventory at year-end cost to
base year cost.
i. Continuously records changes in inventory.
j. Items sold come from a mixture of goods acquired
during the period.
k. Legal title passes when goods arrive at location.
l. Adjusts inventory at the end of the period.
© The McGraw-Hill Companies, Inc., 2004
8-26
Intermediate Accounting, 3/e Update Edition
PROBLEMS
Problem 8-1
Requirement 1
a. To record the purchase of inventory on account and the payment of freight
charges.
October 12, 2003
Purchases (98% x $22,000) ................................................
Accounts payable ......................................................
Freight-in ........................................................................
Cash ............................................................................
b.
21,560
500
500
To record purchase returns.
October 18, 2003
Accounts payable ...........................................................
Purchase returns .........................................................
c.
21,560
3,000
3,000
To record payment of accounts payable.
October 31, 2003
Accounts payable ...........................................................
Interest expense ..............................................................
Cash ............................................................................
Solutions Manual, Vol.1, Chapter 8
21,560
440
22,000
© The McGraw-Hill Companies, Inc., 2004
8-27
Problem 8-1 (continued)
d.
To record sales on account.
October, 2003
Accounts receivable ........................................................
Sales revenue ..............................................................
No entry is made for the cost of goods sold.
28,000
28,000
Cost of goods sold:
Beginning inventory
Plus net purchases:
Purchases
$21,560
Less: Purchases returns
(3,000)
Plus: Freight-in
500
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
$15,000
19,060
34,060
(16,060)
$18,000
Adjusting entry:
October 31, 2003
Cost of goods sold (above) ...............................................
Inventory (ending).............................................................
Purchase returns ..............................................................
Inventory (beginning) ....................................................
Purchases .....................................................................
Freight-in.....................................................................
© The McGraw-Hill Companies, Inc., 2004
8-28
18,000
16,060
3,000
15,000
21,560
500
Intermediate Accounting, 3/e Update Edition
Problem 8-1 (concluded)
Requirement 2
a.
To record the purchase of inventory on account and the payment of freight
charges.
October 12, 2003
Inventory (98% x $22,000) ................................................
Accounts payable ......................................................
Inventory.........................................................................
Cash ............................................................................
b.
500
500
3,000
3,000
To record payment of accounts payable.
October 31, 2003
Accounts payable ...........................................................
Interest expense ..............................................................
Cash ............................................................................
d.
21,560
To record purchase returns.
October 18, 2003
Accounts payable ...........................................................
Inventory.....................................................................
c.
21,560
21,560
440
22,000
To record sales on account.
October, 2003
Accounts receivable .......................................................
Sales revenue ..............................................................
Cost of goods sold ..........................................................
Inventory.....................................................................
Solutions Manual, Vol.1, Chapter 8
28,000
28,000
18,000
18,000
© The McGraw-Hill Companies, Inc., 2004
8-29
Problem 8-2
1. The transaction is not correctly accounted for. Inventory held on consignment by
another company should be included in the inventory of the consignor. Rasul
should include this merchandise in its 2003 ending inventory.
2. The transaction is not correctly accounted for. Legal title to merchandise shipped
f.o.b. shipping point changes hands when the goods are shipped. Rasul should
record the purchase and corresponding account payable in 2003 and include the
merchandise in its 2003 ending inventory.
3. The transaction is not correctly accounted for. Since the merchandise was shipped
f.o.b. destination and did not arrive at the customer's location until 2004, it should
be included in Rasul’s 2003 ending inventory. The sale should be recorded in
2004.
4. The transaction is correctly accounted for. Merchandise held on consignment
from another company belongs to the consignor and should be excluded from the
inventory of the consignee.
5. The transaction is correctly accounted for. Since the merchandise was shipped
f.o.b. destination and did not arrive at Rasul’s location until 2004, it should not be
included in Rasul’s 2003 ending inventory. The purchase is correctly recorded in
2004.
Problem 8-3
Inventory
$1,250,000
Initial amounts
Adjustments - increase (decrease):
1.
(155,000)
2.
(22,000)
3.
NONE
4.
210,000
5.
25,000
6.
2,000
7.
(5,300)
Total adjustments
54,700
Adjusted amounts
$1,304,700
© The McGraw-Hill Companies, Inc., 2004
8-30
Accounts
Payable
$1,000,000
Sales
$9,000,000
(155,000)
NONE
NONE
NONE
25,000
2,000
(5,300)
(133,300)
$ 866,700
NONE
NONE
40,000
NONE
NONE
NONE
NONE
40,000
$9,040,000
Intermediate Accounting, 3/e Update Edition
Problem 8-4
Requirement 1
Beginning inventory (10,000 x $8.00)
Net purchases:
Purchases (50,000* units x $10.00)
Less: Returns (1,000 units x $10.50)
Less: Purchase discounts
$ 80,000
$500,000
(10,500)
($500,000 x 60% x 2%)
Plus: Freight-in (50,000 units x $.50)
Cost of goods available (59,000 units)
Less: Ending inventory (below)
(6,000)
25,000
Cost of goods sold
508,500
588,500
(122,000)
$466,500
* The 5,000 units purchased on December 28 are not included. The
merchandise was shipped f.o.b. destination and did not arrive at Johnson’s
warehouse until 2004.
Cost of ending inventory:
Date of
purchase
BI
2003
Total
Units
10,000
4,000
14,000
Unit cost Total cost
$ 8.00
$ 80,000
10.50**
42,000
$122,000
** Includes freight charge of $.50 per unit.
Requirement 2
Sales (45,000 units x $18.00)
Less:
Cost of goods sold (above)
Other operating expenses
Income before income taxes
Solutions Manual, Vol.1, Chapter 8
$810,000
$466,500
150,000
(616,500)
$193,500
© The McGraw-Hill Companies, Inc., 2004
8-31
Problem 8-5
Cost of goods available for sale for periodic system:
Beginning inventory (6,000 x $8.00)
Purchases:
5,000 x $ 9.00
$45,000
6,000 x $10.00
60,000
Cost of goods available (17,000 units)
$ 48,000
105,000
$153,000
1. FIFO, periodic system
Cost of goods available for sale (17,000 units)
Less: Ending inventory (determined below)
Cost of goods sold
$153,000
(78,000)
$ 75,000
Cost of ending inventory:
Date of
purchase
Jan. 18
Jan. 10
Totals
Units
6,000
2,000
8,000
Unit cost
$10.00
9.00
Total cost
$60,000
18,000
$78,000
2. LIFO, periodic system
Cost of goods available for sale (17,000 units)
Less: Ending inventory (determined below)
Cost of goods sold
$153,000
(66,000)
$ 87,000
Cost of ending inventory:
Date of
purchase
BI
Jan. 10
Totals
Units
6,000
2,000
8,000
© The McGraw-Hill Companies, Inc., 2004
8-32
Unit cost
$8.00
9.00
Total cost
$48,000
18,000
$66,000
Intermediate Accounting, 3/e Update Edition
Problem 8-5 (continued)
3. LIFO, perpetual system
Date
Beginning
inventory
Purchased
6,000 @ $8.00 =
3,000 @ $8.00 =
5,000 @ $9.00 =
2,000 @ $9.00 =
6,000 @ $10.00 =
6,000 @ $8.00
$48,000
$24,000 3,000 @ $8.00
$24,000
3,000 @ $8.00
5,000 @ $9.00
$69,000
$18,000 3,000 @ $8.00
3,000 @ $9.00
$51,000
$45,000
January 12
January 18
Balance
$48,000
January 5
January 10
Sold
$60,000
3,000 @ $8.00
3,000 @ $9.00
6,000 @ $10.00
4,000 @ $10.00 =
January 20
Total cost of goods sold
=
$40,000 3,000 @ $8.00
3,000 @ $9.00
2,000 @ $10.00
$111,000
$71,000
Ending
inventory
$82,000
4. Average cost, periodic system
Cost of goods available for sale (17,000 units)
Less: Ending inventory (below)
Cost of goods sold
$153,000
(72,000)
$ 81,000*
Cost of ending inventory:
$153,000
Weighted-average unit cost =
= $9.00
17,000 units
8,000 units x $9.00 = $72,000
* Alternatively, could be determined by multiplying the units sold by the average
cost: 9,000 units x $9.00 = $81,000
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-33
Problem 8-5 (concluded)
5. Average cost, perpetual system
Date
Beginning
inventory
Purchased
6,000 @ $8.00 =
5,000 @ $9.00 =
Balance
$48,000
January 5
January 10
Sold
6,000 @ $8.00
$48,000
3,000 @ $8.00 =
$24,000 3,000 @ $8.00
$24,000
2,000 @ $8.625 =
$17,250 6,000 @ $8.625
$51,750
$45,000
$69,000
= $8.625/unit
8,000 units
January 12
January 18
6,000 @ $10.00 =
$60,000
$111,750
= $9.3125/unit
12,000 units
4,000 @ $9.3125 = $37,250 8,000 @ $9.3125
January 20
Total cost of goods sold
© The McGraw-Hill Companies, Inc., 2004
8-34
$74,500
Ending
inventory
= $78,500
Intermediate Accounting, 3/e Update Edition
Problem 8-6
Requirement 1
Cost of goods available for sale for periodic system:
Purchases:
5,000 x $4.00
12,000 x $4.50
17,000 x $5.00
Cost of goods available (34,000 units)
$20,000
54,000
85,000
$159,000
a. FIFO
Cost of goods available for sale (34,000 units)
Less: Ending inventory (determined below)
Cost of goods sold
$159,000
(70,000)
$ 89,000
Cost of ending inventory:
Date of
purchase
March 22
Units
14,000
Unit cost
5.00
Total cost
70,000
b. LIFO
Cost of goods available for sale (34,000 units)
Less: Ending inventory (determined below)
Cost of goods sold
$159,000
(60,500)
$ 98,500
Cost of ending inventory:
Date of
purchase
Jan. 7
Feb. 16
Totals
Solutions Manual, Vol.1, Chapter 8
Units
5,000
9,000
14,000
Unit cost
$4.00
4.50
Total cost
$20,000
40,500
$60,500
© The McGraw-Hill Companies, Inc., 2004
8-35
Problem 8-6 (concluded)
c. Average cost
Cost of goods available for sale (34,000 units)
Less: Ending inventory (below)
Cost of goods sold
$159,000
(65,471)
$ 93,529*
Cost of ending inventory:
$159,000
Weighted-average unit cost =
= $4.6765
34,000 units
14,000 units x $4.6765 = $65,471
* Alternatively, could be determined by multiplying the units sold by the average
cost: 20,000 units x $4.6765 = $93,530 (rounding)
Gross Profit ratio:
FIFO:
$51,000*  $140,000** = 36%
LIFO:
$41,500  $140,000 = 30%
Average:
$46,471  $140,000 = 33%
*Sales less cost of goods sold
**20,000 units x $7 sales price = sales
Requirement 2
In situations when costs are rising, LIFO results in a higher cost of goods sold
and, therefore, a lower gross profit ratio than FIFO.
© The McGraw-Hill Companies, Inc., 2004
8-36
Intermediate Accounting, 3/e Update Edition
Problem 8-7
Requirement 1
Beginning inventory ($60,000 + 60,000 + 63,000)
Purchases:
211
$63,000
212
63,000
213
64,500
214
66,000
215
69,000
216
70,500
217
72,000
218
72,300
219
75,000
Cost of goods available
Ending inventory:
213
$64,500
216
70,500
219
75,000
Cost of goods sold
$183,000
615,300
798,300
(210,000)
$588,300
Requirement 2
Cost of goods available for sale
Less: Ending inventory (below)
Cost of goods sold
$798,300
(219,300)
$579,000
Cost of ending inventory (3 autos):
Car ID
219
218
217
Total
Solutions Manual, Vol.1, Chapter 8
Cost
$ 75,000
72,300
72,000
$219,300
© The McGraw-Hill Companies, Inc., 2004
8-37
Problem 8-7 (concluded)
Requirement 3
Cost of goods available for sale
Less: Ending inventory (below)
Cost of goods sold
$798,300
(183,000)
$615,300
Cost of ending inventory (3 autos):
Car ID
203
207
210
Total
Cost
$ 60,000
60,000
63,000
$183,000
Requirement 4
Cost of goods available for sale (12 units)
Less: Ending inventory (below)
Cost of goods sold
$798,300
(199,575)
$598,725*
Cost of ending inventory:
$798,300
Weighted-average unit cost =
= $66,525
12 units
3 units x $66,525 = $199,575
* Alternatively, could be determined by multiplying the units sold by the average
cost: 9 units x $66,525 = $598,725
© The McGraw-Hill Companies, Inc., 2004
8-38
Intermediate Accounting, 3/e Update Edition
Problem 8-8
Requirement 1
The note indicates that if the company had used FIFO, inventory would have
been higher by $2,065 million and $2,000 million at the end of 2000 and 1999,
respectively. Therefore, 2000 cost of goods sold would have been lower (and income
before tax higher) by $65 million ($2,065 - 2,000).
The note also indicates that net income for 2000 would have been higher by $46
million if FIFO had been used. This means that the tax effect of the difference
between LIFO and FIFO was $19 million ($65 - 46). The effective tax rate is
therefore approximately 29% ($19  $65).
Requirement 2
The information might be useful to a financial analyst interested in comparing
Caterpillar’s performance with another company using the FIFO inventory method
exclusively.
Requirement 3
Retained earning would have been higher by approximately $1,466 million
[$2,065 million x (1-.29)].
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-39
Problem 8-9
Requirement 1
Beginning inventory
Purchases:
30,000 units @ $25
Cost of goods available for sale
Less: Ending inventory (below)
Cost of goods sold
$ 450,000
750,000
1,200,000
(250,000)
$ 950,000
Cost of ending inventory:
Date of
purchase
Units
BI
10,000
BI
5,000
Totals 15,000
Unit cost
$15
20
Total cost
$150,000
100,000
$250,000
Requirement 2
Cost of goods sold assuming all units purchased at the year 2003 price:
40,000 units x $25.00 =
$1,000,000
Less: LIFO cost of goods sold
(950,000)
LIFO liquidation profit before tax
50,000
Multiplied by 1-.40
x .60
LIFO liquidation profit
$ 30,000
Requirement 3
$50,000 x 40% = $20,000
© The McGraw-Hill Companies, Inc., 2004
8-40
Intermediate Accounting, 3/e Update Edition
Problem 8-10
Date
Ending Inventory
at Base Year Cost
1/1/03
$400,000
Inventory Layers
at Base Year Cost
Ending
Inventory
DVL Cost
Inventory Layers
Converted to Cost
= $400,000
$400,000 (base)
$400,000 x 1.00 =
$400,000
$400,000
= $420,000
$400,000 (base)
20,000 (2003)
$400,000 x 1.00 =
20,000 x 1.05 =
$400,000
21,000
421,000
$400,000 (base)
20,000 (2003)
15,000 (2004)
$400,000 x 1.00 =
20,000 x 1.05 =
15,000 x 1.12 =
$400,000
21,000
16,800
437,800
$400,000 (base)
20,000 (2003)
5,000 (2004)
$400,000 x 1.00 =
20,000 x 1.05 =
5,000 x 1.12 =
$400,000
21,000
5,600
426,600
1.00
12/31/03
$441,000
1.05
12/31/04
$487,200
= $435,000
1.12
12/31/05
$510,000
= $425,000
1.20
Problem 8-11
Date
Ending Inventory
at Base Year Cost
1/1/03
$150,000
Inventory Layers
at Base Year Cost
Inventory Layers
Converted to Cost
Ending
Inventory
DVL Cost
= $150,000
$150,000 (base)
$150,000 x 1.00 =
$150,000
$150,000
= $185,185
$150,000 (base)
35,185 (2003)
$150,000 x 1.00 =
35,185 x 1.08 =
$150,000
38,000
188,000
$150,000 (base)
35,185 (2003)
24,815 (2004)
$150,000 x 1.00 =
35,185 x 1.08 =
24,815 x 1.17 =
$150,000
38,000
29,034
217,034
$150,000 (base)
35,185 (2003)
21,815 (2004)
$150,000 x 1.00 =
35,185 x 1.08 =
21,815 x 1.17 =
$150,000
38,000
25,524
213,524
$150,000 (base)
35,185 (2003)
21,815 (2004)
1,000 (2006)
$150,000
35,185
21,815
1,000
$150,000
38,000
25,524
1,100
214,624
1.00
12/31/03
$200,000
1.08
12/31/04
$245,700
= $210,000
1.17
12/31/05
$235,980
= $207,000
1.14
12/31/06
$228,800
= $208,000
1.10
Solutions Manual, Vol.1, Chapter 8
x 1.00
x 1.08
x 1.17
x 1.10
=
=
=
=
© The McGraw-Hill Companies, Inc., 2004
8-41
CASES
Judgment Case 8-1
Advance warning of the company's impending bankruptcy existed at the date of
the financial statements. As a rule, inventories should rise in tandem with sales. If
inventories rise faster, it may be because the goods simply aren't selling. This is
particularly true of companies in faddish or seasonal businesses — Merry-GoRound's world.
The company's report showed that inventories on January 30 were $82.2 million,
up 37 percent from $60 million a year earlier. That's well above the 15 percent sales
growth in the same period, to $877.5 million from $761.2 million. This alone should
have been a major cause for concern. It indicated the company's goods simply
weren't selling as rapidly as it expected, causing its inventories to bulge. The increase
in receivables from $6,195 to over $6 million should also have been cause for
concern.
© The McGraw-Hill Companies, Inc., 2004
8-42
Intermediate Accounting, 3/e Update Edition
Judgment Case 8-2
1.
a. The specific identification method requires each unit to be clearly
distinguished from similar units either by description, identification number, location,
or other characteristic. Costs are accumulated for specific units and expensed as the
units are sold. Thus, the specific identification method results in recognized cost
flows being identical to actual physical flows. Ideally, each unit is relatively
expensive and the number of units relatively few so that recording costs is not
burdensome. Under the specific identification method, if similar items have different
costs, cost of goods sold is influenced by the specific units sold.
b. It is appropriate for Happlia to use the specific identification method
because each appliance is expensive, and easily identified by number and description.
The specific identification method is feasible because Happlia already maintains
records of its units held by individual retailers. Management’s ability to manipulate
cost of goods sold is minimized because once the inventory is in the retailer’s hands,
Happlia’s management cannot influence the units selected for sale.
2.
a. Happlia should include in inventory carrying amounts all necessary and
reasonable costs to get an appliance into a useful condition and place for sale.
Common (or joint) costs should be allocated to individual units. Such costs exclude
the excess costs incurred in transporting refrigerators to Minneapolis and their
reshipment to Kansas City. These units costs should only include normal freight
costs from Des Moines to Kansas City. In addition, costs incurred to provide time
utility to the goods, i.e. ensuring that they are available when required, will also be
included in inventory carrying amounts.
b. Examples of inventoriable costs include the unit invoice price, plus an
allocated proportion of the port handling fees, import duties, freight costs to Des
Moines and to retailers, insurance costs, repackaging, and warehousing costs.
3.
The 2003 income statement should report in cost of goods sold all
inventory costs related to units sold in 2003, regardless of when cash is received from
retailers. Excess freight costs incurred for shipping the refrigerators from
Minneapolis to Kansas City should be included in determining operating income.
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-43
Communication Case 8-3
Suggested Grading Concepts and Grading Scheme:
Content (70%)
_______ 20 Describes the differential effect on ending inventory
and cost of goods sold of using FIFO versus LIFO
when
_____ Prices are increasing.
_____ Prices are decreasing.
_______ 25 Discusses the various motivating factors that
might influence the choice of inventory method.
______ The actual physical flow of product.
______ The better match of expenses with revenues
provided by LIFO.
______ The effect on the balance sheet.
______ The effect on reported income and income
taxes.
______ The cost of implementation of LIFO.
_______ 10 Discusses briefly the methods available to
simplify LIFO.
_______ 15 Discusses the IRS conformity rule with respect to
LIFO and the relaxation of the rule that allows a
a company using LIFO to present supplemental
non-LIFO disclosures.
______
_______ 70 points
Writing (30%)
_______ 6
Terminology and tone appropriate to the audience of
a company president.
_______
12
_______
12
Organization permits ease of understanding.
_____ Introduction that states purpose.
_____ Paragraphs that separate main points.
English
_____ Sentences grammatically clear and well organized,
concise.
_____ Word selection.
_____ Spelling.
_____ Grammar and punctuation.
______
_______ 30 points
© The McGraw-Hill Companies, Inc., 2004
8-44
Intermediate Accounting, 3/e Update Edition
Communication Case 8-4
LIFO produces a higher cost of goods sold, lower taxable income and therefore
lower income taxes currently payable than FIFO only in periods when the costs of the
company’s products are rising. When costs are decreasing, LIFO results in lower cost
of goods sold, higher taxable income, and a higher current tax liability than FIFO. In
the case of the electronics client, you would explain this to the intern concluding that
the costs of the client's products must be decreasing as frequently occurs in this
industry.
Judgment Case 8-5
At the end of a reporting period it is important to ensure that a proper inventory
cutoff is made. A proper cutoff involves the determination of the ownership of goods
that are in transit between the company and its customers as well as the company and
its suppliers. If the shipment is made f.o.b. shipping point, then ownership is
transferred to the buyer when the goods reach the common carrier. If the shipment is
made f.o.b. destination, then ownership is transferred to the buyer when the goods
arrive at the buyer’s location.
In this case, John is incorrect if the goods were shipped f.o.b. destination. If so,
even though the company is not in physical possession of the goods, they should be
included in ending inventory because the shipment had not reached the buyer's
location by the end of the reporting period.
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
8-45
Ethics Case 8-6
Requirement 1
Without purchase of the additional units:
Sales (35,000 @ $60)
Cost of goods sold (35,000 x $30)
Gross profit
$2,100,000
(1,050,000)
$1,050,000
Due Jim Lester ($1,050,000 x 20%) = $210,000
With purchase of the additional units:
Sales
Cost of goods sold:
20,000 x $40
$800,000
15,000 x $30
450,000
Gross profit
$2,100,000
(1,250,000)
$ 850,000
Due Jim Lester ($850,000 x 20%) = $170,000
Requirement 2
Discussion should include these elements.
Facts:
If Moncrief purchases the additional units at year end under a periodic LIFO
inventory system, the transaction results in a reduced payment to Jim Lester, reduced
profits to shareholders, and reduced income tax payments to government entities. By
purchasing the additional units of Zelenex, Moncrief reduces Jim Lester's payment by
$40,000 ($210,000 - $170,000) and decreases gross profit by $200,000 ($1,050,000 $850,000). The net effect on before-tax income is a decrease of $160,000 ($200,000 $40,000). Since Moncrief does not intend to sell the units until 2004, the only logical
reason for purchasing more costly inventory at year-end is profit manipulation.
Ethical Dilemma:
Should Moncrief exercise its right to purchase inventory at will, resulting in a
reduction in net income, or recognize the rights of Jim Lester to receive profit for the
sale of his product, shareholders' rights to have their investment appreciate through
positive earnings, and government entities' rights to collect tax on economic net
income?
© The McGraw-Hill Companies, Inc., 2004
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Intermediate Accounting, 3/e Update Edition
Real World Case 8-7
Requirement 1
In 1981, the LIFO conformity rule was liberalized to permit LIFO users to
present designated supplemental disclosures. These disclosures allow a company
using LIFO to report, in a note, the difference between inventory valued using LIFO
and inventory valued as if another method had been used. Safeway's note provides
this supplemental information.
Requirement 2
2000
Ending
Inventory
Beginning
Inventory
$2,508
80*
$2,588
$2,445
82**
$2,527
($ in millions)
Inventory as stated
Add: Increase in LIFO inventory
FIFO inventory balances
* $1,926 million – 1,846 million
** $1,905 million – 1,823 million
Requirement 3
Cost of goods sold for 2000 would have been $2 million higher had Safeway
used FIFO for its entire inventory. While beginning inventory would have been $82
million higher, ending inventory also would have been higher by $80 million. An
increase in beginning inventory causes an increase in cost of goods sold, but an
increase in ending inventory causes a decrease in cost of goods sold. Purchases for
2000 are the same regardless of the inventory valuation method used.
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
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Real World Case 8-8
Requirement 3
The following is based on Unocal's 2000 financial statements. Answers will
vary depending on the financial statement dates chosen.
a. Unocal uses the last-in, first-out (LIFO method for crude oil and other
petroleum products, market prices for inventories held as energy trading assets,
and various methods for its other inventories.
b. Assuming that replacement cost approximates FIFO cost, disclosure note 13
indicates that, if FIFO had been used to value LIFO inventories, inventories
would have been higher than reported by $7 million at the end of 2000 and $6
million at the end of 1999. Cost of goods sold for 2000 would have been $1
million lower had Unocal used FIFO. Beginning inventory would have been
$6 million higher and ending inventory also would have been higher by $7
million. An increase in beginning inventory causes an increase in cost of
goods sold, while an increase in ending inventory causes a decrease in cost of
goods sold. Purchases for 2000 are the same regardless of the inventory
valuation method used.
c. Inventory turnover = cost of sales divided by average inventory
(dollars in millions)
Inventory turnover =
$5,158 = 38.6
$133.5 *
*($88 + 179) ÷ 2
© The McGraw-Hill Companies, Inc., 2004
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Intermediate Accounting, 3/e Update Edition
Research Case 8-9
(Note: This case requires the student to reference a journal article.]
Median and mean number of pools used by retail and nonretail
companies:
Retailers
Nonretailers
Median number of pools
6
3
Mean number of pools
16.12
6.46
1.
2.
3.
4.
5.
6.
The authors' six conclusions:
Most companies that use LIFO have only a few pools.
Some variation exists in the number of pools used by companies in the study, even
among companies in the same line of business.
Retailers that use LIFO have significantly more pools than nonretailers.
Almost all of the companies pool their LIFO inventories in the same manner for
tax and financial reporting purposes, although such conformity is not required by
tax law or GAAP.
Pooling of LIFO inventories is a substantive managerial decision because it has
significant cash flow implications and important financial statement consequences.
The number of LIFO pools appears to be inversely related to the magnitude of the
income tax benefits that LIFO produces.
Support was not found for the assertion that the number of LIFO pools depends on
the diversity of goods in a company's inventory. Many companies that would
appear to have similar inventories do not use the same number of LIFO pools.
International Case 8-10
As stated in Carlsberg's disclosure note, Denmark, like the U.S.A., values
inventory at the lower of cost or market. More specifically, market is net realizable
value. In the United States, market is replacement cost with a ceiling equal to net
realizable value. The company uses the average method, one of the acceptable
methods in the U.S.A., to measure cost. However, a significant difference exists as to
the production costs included in inventory. Carlsberg does not include indirect
production overhead costs in inventory. Omitting these costs from inventory would be
a violation of GAAP in the U.S.A.
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
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Communication Case 8-11
The dollar-value LIFO inventory estimation technique begins with the
determination of the current year’s ending inventory valued in terms of year-end
costs. It is not necessary for a company using DVL to track the cost of purchases
during the year. All that is needed is to take the physical quantities of goods on hand
at the end of the year and apply year-end costs.
The next step is to convert the ending inventory from year-end costs to base year
costs. This usually is accomplished by dividing the ending inventory at year-end
costs by the year’s cost index. The cost index reflects the change in cost from a base
year to the current year. The ending inventory has been deflated for cost changes
from the base year to the end of the current year.
The next step in the procedure is to identify the layers in ending inventory with
the years they were created by comparing ending inventory at base year cost to the
beginning inventory at base year cost. Applying the LIFO concept, if inventory has
increased, ending inventory at base year cost consists of the beginning inventory layer
plus a current year layer.
The final step converts the layers identified to cost by multiplying the layers at
base year cost by the layer’s cost index. The costs are totaled to obtain ending
inventory at DVL cost.
© The McGraw-Hill Companies, Inc., 2004
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Intermediate Accounting, 3/e Update Edition
Research Case 8-12
Requirement 1
SFAS No. 49, “Accounting for Product Financing Arrangements,” provides
authoritative guidance on this issue. Product financing arrangements include
agreements in which a sponsor (Balboa Lumber in this case):
a.
b.
c.
Sells the product to another entity and in a related transaction agrees to repurchase the
product;
Arranges for another entity to purchase the product on the sponsor’s behalf and, in a
related transaction, agrees to purchase the product from the other entity; or
Controls the disposition of the product that has been purchased by another entity in
accordance with the arrangements described in either (a) or (b) above.
The appropriate accounting treatment for this type of arrangement is for the
sponsor to record a liability at the time the proceeds are received from the other
entity. The sponsor does not record the transaction as a sale and does not remove the
product from its inventory. The cost of the repurchase amount in excess of the
originally recorded liability represents financing and holding costs. These costs are
accounted for in accordance with the sponsor’s accounting policies applicable to
other financing and holding costs. Notice that this is an example of “substance (a
loan) over form (a sale).”
Requirement 2
Journal entry to record the “sale” (cash receipt):
Cash .......................................................................................
Liability – product financing arrangement ........................
160,000
160,000
Journal entry to record the repurchase:
Liability – product financing arrangement ...........................
Holding and financing costs* ...............................................
Cash...................................................................................
Solutions Manual, Vol.1, Chapter 8
160,000
4,000
164,000
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*The treatment of these costs depends on the accounting policies of the sponsor. For
example, if these costs are normally expensed as period costs, then the debit in this case
would be to an expense account (or accounts).
© The McGraw-Hill Companies, Inc., 2004
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Intermediate Accounting, 3/e Update Edition
Analysis Case 8-13
Requirement 1
GM
FORD
Gross profit ratio
=
38,968 = 21%
184,632
15,110 = 11%
141,230
Inventory turnover
=
145,664 = 13.5
10,791.5
126,120 = 19.1
6,599
Average days
in inventory
=
365
13.5
= 27 days
365
19.1
= 19 days
General Motors has a higher gross profit ratio (21% versus 11%). It also has a
higher gross profit ratio than the industry average of 18%. However, Ford turns over
its inventory quicker than GM. On average, it takes 19 days for Ford to sell its
inventory compared to 27 days for GM. The higher gross profit ratio for GM
combined with the lower turnover could indicate that, on average, GM products sell
for a higher markup, but as a result, they take longer to sell. Both companies turn
over their inventory quicker than the industry average of 30 days.
Requirement 2
The objective of this requirement is to motivate students to obtain hands-on
familiarity with actual annual reports and to apply the techniques learned in the
chapter. You may wish to provide students with multiple copies of the same annual
reports and compare responses. Another approach is to divide the class into teams
who evaluate reports from a group perspective.
Solutions Manual, Vol.1, Chapter 8
© The McGraw-Hill Companies, Inc., 2004
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Analysis Case 8-14
Requirement 1
FedEx Corporation earns revenue by providing services to its customers, rather
than by selling goods. That is why there are no merchandise inventories listed on the
company's balance sheet. The balance sheet reports an inventory of "spare parts,
supplies and fuel."
Requirement 2
Note 1 indicates that spare parts are stated principally at weighted-average cost;
supplies and fuel are stated principally at standard cost which approximates actual
cost on a first-in, first-out (FIFO) basis. Many manufacturing companies use a
standard costing system for inventory valuation. A standard cost is an ideal or
expected cost. A standard costing system helps control costs by allowing for a
comparison between standards and actual costs. Standard costs are allowed for
inventory valuation only if they approximate actual costs.
© The McGraw-Hill Companies, Inc., 2004
8-54
Intermediate Accounting, 3/e Update Edition