ANSWERS TO QUESTIONS - CHAPTER 8 1. 1.

First In, First Out - The inventory cost flow method that assumes that the first items purchased are the first items sold for the purpose of computing cost of goods sold and inventory.

2. Last In, First Out - The inventory cost flow method that assumes that the first items purchased are the last items sold for the purpose of computing cost of goods sold and inventory. 3. Weighted Average - The inventory cost flow method that allocates cost between cost of goods sold and inventory based on an average cost per unit. Specific Identification - The inventory cost flow method that assigns cost to cost of goods sold based on the specific cost of each unit sold.

4.

2.

One advantage of the specific identification method is that both the inventory account and cost of goods sold reflect the actual amounts on hand and sold. This method is usually required for high cost items such as automobiles, boats, etc. One disadvantage of this method is that recordkeeping can become burdensome for high-volume, lower-priced items. FIFO allocates the cost of the first units purchased to the first units sold; consequently, in a period of rising prices, this would produce a larger net income. This may be an advantage for the purpose of financial reporting if reporting a higher profit is desired. However, this is a disadvantage for tax reporting because a higher profit means paying more tax. FIFO also tends to best match physical flow for most products. LIFO allocates the cost of the last units purchased to the first units sold; consequently, in a period of rising prices, this would produce a smaller net income. This may be a disadvantage for the purpose of financial reporting if 8-1

3.

4.

reporting a higher profit is desired. However, for tax reporting, a lower profit means paying less tax. 5. In an inflationary period, i.e., a period where prices are consistently rising, FIFO will produce the largest amount of income. This is true because the items purchased first (and at the lowest cost) are the items that are deemed sold first (these are the items whose cost is charged to expense). The highest cost items remain in the asset account inventory. Since the lowest cost items have been expensed, net income will be larger than it would assuming a LIFO flow. In an inflationary period, FIFO will produce the largest amount of total assets. (Refer to the discussion for Question 5.) The unsold items, inventory, are the highest cost items. Consequently, assuming rising prices, FIFO flow produces a higher inventory amount than would be the case under a LIFO flow. Flow of costs refers to the assumption that is made for the purpose of determining the cost of inventory items that are sold when preparing financial statements. The cost flow assumption that a business makes may have nothing to do with the actual flow of inventory into and out of the business. The physical flow of goods refers to the actual timing of when goods are sold. For example, a grocery store may use a FIFO cost flow assumption for financial statement purposes and this may reflect the physical flow of some inventory items but not others. The grocer will put the oldest detergent on the shelf for the customer to purchase (FIFO) but may display the last produce purchased (the freshest) for the customer to buy. In a world where there is no income tax, the choice of cost flow method would not affect the statement of cash flows because it is simply allocating some of the cost of inventory purchased to expense and the remainder to assets. The statement of cash flows is affected when cash is received for goods sold and when cash is paid for goods purchased. However, most businesses do face income tax consequences. In that situation, the difference in tax paid 8-2

6.

7.

8.

based on each cost flow assumption would cause a difference in the cash flow statement. In a period of rising prices, LIFO would produce a smaller cash outflow for the payment of tax, because a smaller amount of income tax would be paid on a smaller amount of income.

8-3

9.

Key Company (first year of operations): Beginning inventory Merchandise purchased Cost of Goods Sold Ending Inventory 1,000 units @ 25 850 units @ 25 150 units @ 25 $ -0-

25,000 21,250 3,750

Cost of goods sold will be the same for all methods because all items were purchased for the same cost. Consequently, it will not make any difference whether the first unit sold is assumed to be the first or last purchased. Weighted average will also be the same. 10. The amount of cost of goods sold for Key Company will be different using different cost flow assumptions because the units purchased during the second year have a different cost than those purchased the previous year. Beginning inventory 150 units @ 25 Merchandise purchased1,500 units @ 27 Total 1,650 Units sold FIFO: Cost of Goods Sold LIFO Cost of Goods Sold Weighted Average: unit 1,500 150 units @ 25 1,350 units @ 27 1,500 1,500 units @ 27 $ 3,750 36,450 $40,200 $40,500 $40,500 $ 3,750 40,500 $44,250

Total Cost ÷ Total Units = Cost per

44,250 ÷ 1,650 = $26.82 per unit Cost of Goods Sold: 1,500 units @ 26.82 = $40,230

11. It may be advantageous to use FIFO for financial statement purposes because it produces the smallest cost of goods sold and consequently, the largest gross margin 8-4

and net income. It also produces the largest amount of assets. However, a larger net income produces a higher income tax expense, so LIFO would be more desirable strictly from an income tax perspective in that the cost of goods sold would be larger, and consequently the net income and income tax paid will be smaller. Since each cost flow method is desirable for a specific group of users, the cost flow assumptions chosen must be the best for the business overall. A part of that consideration is the ease of applying each method. 12. In an inflationary period, for a business subject to income tax, LIFO would produce the larger amount of cash flow because the smaller net income (larger cost of goods sold) would result in a smaller amount of income tax being paid. 13. A deflationary period, i.e., a period of falling prices, would produce results opposite of those for an inflationary period. FIFO would produce the smallest amount of net income, because the goods purchased first would cost more than the goods purchased last. This would cause a larger amount of cost to be expensed resulting in a lower net income. LIFO would produce the largest net income. 14. When using a perpetual inventory system, each item purchased is added to inventory and each item sold is taken out of inventory. When using the periodic inventory system, all items purchased are charged to a purchases account. At the end of the period, a physical count is made to determine the amount of goods in inventory. 15. "Lower of cost or market" is an accounting convention that helps to reduce overstating inventory (assets) when the market value of certain items has fallen below the original cost. It is a conservative accounting measure that helps to prevent any material misstatement of the asset inventory. 16. For merchandise that has declined in value, the "lower of cost or market" rule will cause a reduction in the asset account inventory and result in an overall reduction of 8-5

total assets. This causes more cost to be shifted to cost of goods sold, thus causing net income to be lower. 17. In certain situations it is not possible or practical to take a complete inventory. One such situation is when the inventory or part of it has been destroyed by some disaster or similar event. Another situation where it is not practical to take inventory is when monthly or quarterly financial statements are prepared when the periodic inventory method is used. It is not cost effective to physically count inventory of any size on a regular basis. In a third situation, when the periodic method is used, inventory may be estimated on a monthly or weekly basis to provide information for insurance coverage. 18. It is generally easier to manipulate net income when a periodic inventory system is used. There is no accounting for inventory at the time it is sold. There is very little control over the inventory (as far as the accounting records are concerned) except at the end of the year. The only measurement available is the amount of inventory still on hand. There is no control over the amount that was sold, damaged, or stolen. In addition, if the inventory is counted wrong or priced wrong, the amount of cost of goods sold will also be determined incorrectly. For a business owner wishing to manipulate profit, it is easy to either overstate or understate the amount of ending inventory. 19. Goods Available for Sale Sales Less: Estimated Gross Margin ($130,000 x .25) Cost of Goods Sold Estimated Ending Inventory 25,500 $123,000 $130,000 (32,500) (97,500) $

20. When using the periodic method, an overstated ending inventory at the end of 2001 will result in an understated cost of goods sold (expense). If cost of goods sold is understated, then net income will be overstated. Since the ending inventory used to compute cost of goods sold 8-6

is the same inventory that is listed as an asset on the balance sheet, assets will also be overstated for 2001. In addition, the ending inventory for 2001 is the beginning inventory for 2002. If the beginning inventory is overstated, the total cost of goods available for sale for 2002 will be overstated. Assuming the ending inventory is correct for 2002, cost of goods sold will then be overstated in 2002 because goods available for sale (more specifically, beginning inventory was overstated). The overstatement of cost of goods sold for 2002 will cause gross margin and net income to be understated in 2002. There is no effect on the 2002 balance sheet, assuming the 2002 ending inventory is correct. 21. The inventory turnover tells the user how many times average inventory has been sold during the year. 22. Discount merchandisers such as Wal-Mart and K-Mart should have a high inventory turnover. Specialty stores such as exclusive jewelers and antique shops will have a low inventory turnover. 23. Operating Cycle = average number of days to sell inventory + average number of days to collect receivables. 24. Historical cost information is used in financial statements because it is reliable and objective, whereas market value is often subjective and difficult to determine. 25. FASB requires market value information to be disclosed for certain types of investment securities and inventory. 26. Market value of marketable investment securities is easy to determine because the securities are traded daily in established markets. Some items of property, plant and equipment may be difficult to value at FMV. Such items may not have a ready market and accountants/management may not be able to agree on an appraised value. 27. The two primary types of investment securities are debt and equity securities. 8-7

28. A debt security is acquired by loaning assets to the investee. Examples include bonds, notes, certificates of deposit, and commercial paper. 29. An equity security is acquired when an investor gives assets or services to an investee in exchange for an ownership interest in the investee. Examples are common and preferred stock. 30. The primary securities market is made up of transactions directly between the investee and investors. The secondary securities market refers to securities exchanges between investors. 31. Marketable securities are those that are regularly traded in established secondary markets. 32. The three categories of investment securities are: Held-to-maturity: the investor has the intent and ability to hold the securities until maturity. Trading: securities that are bought and sold for the purpose of generating profits on the short-term appreciation of stock and/or bond prices. Available-for-sale: all marketable securities not properly classified as Held-to-Maturity or Trading. 33. The equity method must be used to account for investments in equity securities when the investor exercises significant influence (i.e., 20%-50% ownership) over the investee.

8-8

SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 8 EXERCISE 8-1A a. b. c. d. e. f. g. h. FIFO FIFO FIFO Weighted Average LIFO Weighted Average LIFO LIFO

8-9

EXERCISE 8-2A Tyler Co. First Purchase Second Purchase Total $3,000 4,000 $7,000 (a) FIFO Cost of Goods Sold Ending Inventory $3,000 4,000 (b) LIFO $4,000 3,000 (c) W. AVG. $3,500* 3,500*

*Average Cost per Unit: $3,000 + $4,000 = $7,000; $7,000 ÷ 2 = $3,500

8-10

EXERCISE 8-3A The Breckin Company Inventory Purchases Beginning Inventory First Purchase Second Purchase Goods Sale Available 10 0 15 0 20 0 for 45 0 @ @ @ $40 60 68 = = $ 4,000 9,000

= 13,600 $26,60 0

a. Cost of Goods Sold: FIFO Units @ @ @ Cost per Unit $40 60 68 Cost of Goods Sold = $ 4,000 = = 9,000 680 $13,680

From Beginning 100 Inventory From First Purchase 150 From Second Purchase 10 Total Units Sold 260

Ending Inventory: 190 units @ Second Purchase Cost of $68 = $12,920 b. Cost of Goods Sold: LIFO From Second Purchase From First Purchase Total Units Sold Units 200 60 260 @ @ Cost per Unit $68 60 Cost of Goods Sold = $13,600 = 3,600 $17,200

Ending Inventory: 190 units. 90 @ first purchase price $60 = $5,400 100 @ Beginning Inv. Cost of $40 = $4,000 c. $9,400 8-11

Weighted Average: Total Cost $26,600 Cost of Goods Sold Ending Inventory: ÷ ÷ Total Units 450 = Cost per Unit = $59.111 @ $59.11 = $15,368.89 1 @ $59.11 = $11,231.11 1

260 units 190 units

8-12

EXERCISE 8-4A a. (1) FIFO Porter Company $9,600

Sales (320 @ $30) Cost of Goods Sold: From Beginning 50 units @ = $ 500 Inv. $10 From Purchases 270 units @ = 4,050 $15 Gross Margin a. (2) LIFO Sales (320 @ $30) Cost of Goods Sold: From Purchases 275 units @ = $4,125 $15 From Beg. Inv. 45 units @ = 450 $10 Gross Margin a. (3) Weighted Average Sales (320 @ $30) Cost of Goods Sold: Average Cost per 320 Unit $14.23* Gross Margin @ = $4,554

(4,550) $5,050

$9,600

(4,575) $5,025

$9,600 (4,554) $5,046

*Total cost $4,625 ÷ Total units 325 = $14.23 Cost per unit

8-13

b. $25 ($5,050 − $5,025). The difference in net income would be the same as the difference in gross margin, assuming there are no income tax considerations.

8-14

EXERCISE 8-4A (cont.) c. FIFO Cash Flows From Operating Activities: Cash Inflow from Customers Cash Outflow for Inventory Net Cash Flow from Operating Act. $9,600 (4,625) $4,975 LIFO $9,600 (4,625) $4,975 W. Avg. $9,600 (4,625) $4,975

Net cash flow from operating activities will be the same for all three methods because the amount of cash from sales and the amount of cash paid for inventory is the same regardless of the method of cost flow assumed. If the company were subject to income tax, the amount of cash paid for tax expense would be different because the amount of taxable income would be different.

8-15

EXERCISE 8-5A McKee Sales Summary of Purchase Transactions 1/20 4/21 7/25 9/19 Purchased Units Purchased Units Purchased Units Purchased Units Available Sale a. (1) FIFO Ending Inventory From 9/19 Purchase From 7/25 Purchase Total Inventory a. (2) LIFO Units 75 25 @ @ Cost per Unit $18 $30 = $1,350 = 750 $2,100 for 450 200 100 75 825 @ $20 = @ @ @ 24 30 18 = = = $ 9,000 4,800 3,000 1,350 $18,15 0

Ending 100

Units

Cost per Unit @ $20 = $2,000 $2,000

Ending Inventory From 1/20 100 Purchase Total Inventory Ending 100

8-16

a. (3) Weighted Average Total Cost $18,150 ÷ ÷ Total Units = Cost per Unit 825 = $22 $2,200

Ending Inventory 100 units @ $22=

8-17

EXERCISE 8-5A (cont.) b. FIFO Sales (725 units @ $50) Cost of Goods Sold Cost of Goods Avail. for Sale* Less: Ending Inventory Cost of Goods Sold Gross Margin $18,150 (2,100) (16,050) $20,200 $36,250

LIFO Sales (725 units @ $50) Cost of Goods Sold Cost of Goods Avail. for Sale* Less: Ending Inventory Cost of Goods Sold Gross Margin $18,150 (2,000) (16,150) $20,100 $36,250

*This amount is computed in the Summary of Purchase Transactions at the beginning of the problem. Difference in Gross Margin: $20,200 − $20,100 = $100 Note to Instructor: Cost of goods sold can be computed on a units sold basis rather than subtracting ending inventory from goods available for sale.

8-18

EXERCISE 8-6A a. Foley Company Income Statements FIFO Sales $20) (3,400 @ $68,000

Cost of Goods Sold: From Beginning Inv. From 4/1 Purchase From 10/1 Purchase Cost of Goods Sold Gross Margin Operating Expenses Income Before Tax Income Tax Expense Net Income LIFO Sales $20) (3,400 @

500 units @ = $ 5,000 $10 2,500 units @ = 27,500 $11 400 units @ = 5,600 $14 (38,100) 29,900 (17,000) 12,900 (3,870) $ 9,030

(30%)

$68,000

Cost of Goods Sold: From 10/1 Purchase From 4/1 Purchase From Beginning Inv. Cost of Goods

800 units @ = $11,200 $14 2,500 units @ = 27,500 $11 100 units @ = 1,000 $10 (39,700) 8-19

Sold Gross Margin Operating Expenses Income Before Tax Income Tax Expense Net Income EXERCISE 8-6A (cont.) b. Income tax savings would be the difference between the tax using FIFO and the tax using LIFO, or $3,870 − $3,390 = $480. c. Foley Company Cash Flows from Operating Activities FIFO Cash Flows From Operating Activities: Cash Inflow from Customers Cash Outflow for Inventory* Cash Outflow for Operating Expenses Cash Outflow for Income Tax Expense Net Cash Flow from Operating Activities LIFO (30%) 28,300 (17,000) 11,300 (3,390) $ 7,910

$68,000 (38,700) (17,000) (3,870) $ 8,430

$68,000 (38,700) (17,000) (3,390) $ 8,910

*Computation of cash paid for inventory: 4/1 Purchase 10/1 Purchase 2,500 units @ $11 =$27,500 800 units @ 14 = 11,200 $38,700

8-20

d. More income tax must be paid on the higher amount of net income reported under FIFO.

8-21

EXERCISE 8-7A a.
Tiny Tots Company Effect of Events on Financial Statements Panel 1: FIFO Cost Flow Even t 1. 2. 3. 4. 5. Bal. Cash + Inv. = C. Stk. + NA NA NA NA NA NA Ret. Ear. Rev. − Exp. = Net Inc. Cash Flows 125,000 OA (35,000) OA (28,500) OA NA (32,200) OA 29,300 NC

125,000 +

NA =

(35,000) + 35,000 = (28,500) + 28,500 = + (44,500 = )1 (32,200) + NA =
2

+ 125,00 0 + NA + NA

125,00 − 0 NA − NA − NA − NA − 125,00 − 0

NA = 125,00 0 NA = NA NA = NA

NA

29,300

+ 19,000 =

+ (44,500 ) + (32,200 ) + 48,300

44,50 = (44,50 0 0) 32,20 = (32,20 0 0) 76,70 = 48,300 0

Panel 2: LIFO Cost Flow Even t 1. 2. 3. 4. 5. Cash + Inv. = C. Stk + NA NA NA NA NA Ret. Ear. Rev. − Exp. = Net Inc. Cash Flows 125,000 OA (35,000) OA (28,500) OA NA (31,600) OA

125,000 +

NA =

(35,000) + 35,000 = (28,500) + 28,500 = NA + (46,000 = )3 (31,600) + NA =
4

+ 125,00 0 + NA + NA

125,00 − 0 NA − NA − NA − NA −

NA = 125,00 0 NA = NA NA = NA

+ (46,000 ) + (31,600 )

46,00 = (46,00 0 0) 31,60 = (31,60 0 0)

8-22

Bal.

29,900 + 17,500 =

NA

+ 47,400

125,00 − 0

77,60 = 47,400 0

29,900

NC

1

Cost of Goods Sold -- FIFO: 4/2 200 units @ $175 =$35,000 9/1 50 units @ $190 = 9,500 Total $44,500 Income Tax Expense: ($125,000 − $44,500) x 40% = $32,200. $28,500 17,500 Cost of Goods Sold -- LIFO: 9/1 150 units @ $190 = 4/2 100 units @ $175 = Total $46,000 Income Tax Expense ($125,000 − $46,000) x 40% = $31,600.

2 3

4

8-23

EXERCISE 8-7A (cont.) b. c. d. Net Income assuming FIFO cost flow: $48,300 (see statements model above). Net Income assuming LIFO cost flow: $47,400 (see statements model above). LIFO produces a lower income tax of $600 ($32,200 − $31,600). This results because a larger amount of inventory is expensed resulting in a lower income before tax. The last purchase was bought at a higher price than the first purchase. The difference in cash flow from operating activities is caused by the difference in income tax paid of $600. LIFO will produce a larger cash flow because there was $600 less income tax paid.

e.

8-24

EXERCISE 8-8A a. Nikols Company - General Journal Date 1/1/04 Account Titles Merchandise Inventory (250 @ $10) Cash Cash (125 @ $18) Sales Revenue Cost of Goods Sold (125 @ $11) Merchandise Inventory Merchandise Inventory (400 @ $11) Cash Cash (500 @ $19) Sales Revenue Cost of Goods Sold* Merchandise Inventory Debit 2,500 2,500 2,250 2,250 1,375 1,375 4,400 4,400 9,500 9,500 5,250 5,250 = $ 550 2,500 2,200 Credit

4/1a 4/1b

8/1

12/1a 12/1b

*Cost of Goods Sold: 50 @ $11 250 @ $10 = 200 @ $11 = $5,250

b.

Ending Inventory: 200 units @ $11 = $2,200.

8-25

EXERCISE 8-9A a. Spring Hill, Inc.
Date 1/1
Beg.

Purchased Units Cost Total

Sold Units Cost

Total

Inventory Balance Units Cost Total 50 @ $20 = $1,000 50 @ $20 = $1,000 200 @ $24 = $4,800

Inv.

3/15 Pur. 5/30 Sold

200 @

$24 = $4,800 50 @ $20 = $1,000 120 $24 = $2,880 @

-080 @ $24 = $1,920 80 @ $24 = $1,920 275 @ $25 = $6,875

8/10 Pur 11/20 Sold

275 @

$25 = $6,875 80 @ $24 = $1,920 260 @ $25 = $6,500

-015 @ $25 = $375

Ending Inventory: 15 units @ $25 = $375 b. A problem arises when LIFO is applied to intermittent sales and purchase transactions. LIFO requires that the unit cost of the last purchase be applied to the first units sold. However, at the time of the first sale, that cost is not known. This problem is often overcome by recording only quantities of units sold on a perpetual basis. At the end of the accounting period, costs are then assigned perpetually to the units that have been sold.

8-26

EXERCISE 8-10A a. a. b. c. Cost Per Unit Auto Parts, Co. d. e. f. Unit Mkt. Lower Total Val. Cost/Mk Cost per t. Unit $3 4 7 4 $3 4 6 4 (b x c) $400 250 120 75 $845 h. Ind. Total Item Market Lower Cost/Mk t. (b x d) $300 200 140 60 $700 (b x e) $300 200 120 60 $680 g.

I Quanti tem ty

P D S J

100 50 20 15

$4 5 6 5

1. Ending inventory using the individual item method: $680 2. Ending inventory using the aggregate method: $700 b. Date 1. 2. Account Titles Cost of Goods Sold* Merchandise Inventory Cost of Goods Sold** Merchandise Inventory Debit 165 165 145 145 Credit

*$845 − $680 = $165 **$845 − $700 = $145

8-27

EXERCISE 8-11A a. a. Item b. Quantit y 200 250 175 c. Cost Per Unit $10 15 5 d. Market Per Unit e. Unit Lower Cost/Mkt. $9 14 5 f. Total Cost (b x c) $2,000 3,750 875 $6,625 g. Total Lower Cost/Mkt. (b x e) $1,800 3,500 875 $6,175

O J R Totals

$9 14 8

The inventory would be carried at $6,175, the lower of cost or market applied to individual inventory items. b. Under the periodic method, the amount of ending inventory would be shown at the lower of cost or market in the schedule of cost of goods sold. By lowering the ending inventory, cost of goods sold is increased. The loss is automatically included in cost of goods sold.

8-28

EXERCISE 8-12A Rick’s Fishing Supplies a. Gross Margin: Sales x Gross Margin % $550,000 x 20% = $110,000 b. Cost of Goods Sold: Sales x Cost of Goods Sold % $550,000 x 80% = $440,000 c. Computation of Ending Inventory: Beginning Inventory $100,000 Plus: Purchases 400,000 Goods Available for Sale 500,000 Less: Cost of Goods Sold (Est.) (440,000) Ending Inventory (Est.) $ 60,000 d. Lost Inventory: Estimated Ending Inventory $60,000 Less: Undamaged Inventory (8,000) Inventory Lost $52,000

EXERCISE 8-13A June 14 Inventory Account Balance Less: Cost of Unrecorded Sale Balance in the Warehouse Less: 5% Shrinkage Less: Amount of Inventory Showroom Inventory Lost in $164,000 (21,000) 143,000 (7,150) (37,500) $ 98,350

8-29

8-30

EXERCISE 8-14A Marshall Company The uncounted inventory will only affect The Marshall Company’s financial statements if the book amount of the inventory is actually written down to the counted amount. The perpetual system records the actual amount of goods as they are purchased and sold. However, if an adjustment is actually made on the books, the reduction in inventory would cause cost of goods sold to be overstated, gross margin and net income to be understated, and total assets and total stockholders’ equity to be understated.

EXERCISE 8-15A Tedall Company Item Number 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Year 2005 2005 2005 2005 2005 2005 2006 2006 2006 2006 2006 2006 Amount Affected Beginning Inventory Purchases Goods Available for Sale Cost of Goods Sold Gross Margin Net Income Beginning Inventory Purchases Goods Available for Sale Cost of Goods Sold Gross Margin Net Income NA NA NA Overstated Understated Understated Understated NA Understated Understated Overstated Overstated Effect

8-31

EXERCISE 8-16A Asset Buildings Available-for-Sale Securities Office Equipment Inventory Supplies Land Trading Securities Cash Held-to-Maturity Securities FMV X X X X X X X X X LCM HC/AC X

8-32

EXERCISE 8-17A a.
Type Held Trading Availabl e C + ash − − − Balance Sheet Inv. = Liab + S. Sec. . Equity + + + NA NA NA NA NA NA Income Statement R − E Net ev. xp. Inc. NA NA NA NA NA NA NA NA NA Stmt. of Cash Flows −IA −OA −IA

b. Martinez Brothers Computation of Net Income Classified as: Revenue Expenses Unrealized Loss Net Income Held-toMaturity $5,000 (1,500) -0$3,500 Trading $5,000 (1,500) (1,500) $2,000 Availabl e-forSale $5,000 (1,500) -0$3,500

8-33

EXERCISE 8-18A a.
Tony Electronics Horizontal Statements Models (1) Held-to-Maturity Balance Sheet Even t 1. 2. 3. 4. Tot. Inv. = Liab. + Sec. (150,000 + 150,00 = NA + ) 0 9,000 + NA = NA + 30,000 + (25,00 = NA 0) NA + NA = NA (111,000 + 125,00 = -0) 0 + Cash + Ret. Ear. NA 9,000 5,000 + + + + Unreal. Gain. NA NA NA NA -0Income Statement Rev./ Exp./ Gain − Loss = Net Inc. NA − 9,000 − 5,000 − NA − 14,000 − NA = -0- = -0- = NA 9,000 5,000 Statement of Cash Flows (150,000) IA 9,000 OA 30,000 IA NA (111,000) NC

+ NA + + 14,000 +

NA NA -0- = 14,000

(2) Trading Even t 1. 2. 3. 4. Tot. Cash + Inv. Sec. 150,00 0 NA (25,00 0) (25,00 0) 100,00 0 = Liab + . = NA + Unre Ret. + al. Ear. Gain NA + NA NA NA NA -0Rev./ Gain − NA − 9,000 − 5,000 − Exp./ Loss = Net Inc. NA = NA Cash Flow (150,000) OA 9,000 OA 30,000 OA NA (111,000) NC

(150,00 + 0) 9,000 + 30,000 + NA + (111,00 + 0)

= NA + 9,000 + = NA + 5,000 + = NA + (25,00 + 0) = -0- + (11,00 + 0)

NA = 9,000 NA = 5,000

NA − 25,000 = (25,000 ) 14,00 − 25,000 = (11,000 0 )

(3) Available-for-Sale

8-34

Even t 1. 2. 3. 4. Tot.

Cash

+

(150,00 + 0) 9,000 + 30,000 + NA + (111,00 + 0)

Inv. Sec. 150,00 0 NA (25,00 0) (25,00 0) 100,00 0

= Liab + . = NA +

Ret. + Ear. NA +

Unreal. Gain NA NA NA

Rev./ Gain NA 9,000 5,000 NA 14,000

Exp. / = − Loss − NA = − − − −

Net Inc. NA

Cash Flow (150,000) IA 9,000 OA 30,000 IA NA (111,000) NC

= NA + 9,000 + = NA + 5,000 + = NA +

NA = 9,000 NA = 5,000 NA = NA

NA + (25,000 ) = -0- + 14,000 + (25,000 )

-0- = 14,000

8-35

EXERCISE 8-18A (cont.) b. Held-to-Maturity $14,000 Trading $(11,000) Available-for-Sale $14,000 The amount of change in cash from these activities is the same for all three classifications ($111,000). Held-tomaturity and available-for-sale securities each had net cash inflows from operating activities of $9,000, while trading securities had a net cash outflow of $111,000 from operating activities.

c.

d. The amount of net income and the amount of cash flow from operating activities is different for those securities classified as trading from those classified as held-tomaturity or as available-for-sale. The difference is caused by the recognition of the unrealized loss on the income statement for trading securities and treating investments in trading securities as an operating activity rather than an investing activity. The gain on the sale increased net income by $5,000 in each case.

8-36

EXERCISE 8-19A Transactions are recorded in the accounting equation for the use of the instructor.
Assets Event
Beg. Bal. 1. Pur. Sec. 2. Inv. Rev. 3. Sold Sec 4. Pur. Sec. Totals 5. Mkt. Val. if HM 5. Mkt. Val. if TR 5. Mkt. Val. if AS

= Inv. Sec.

Stockholders’ Equity Ret. + Earn. -0-01,200 4,000 -05,200 -02,000 -0Unreal. Gain -0-0-0-0-0-0-0-02,000

Cash 80,000 (40,000 ) 1,200 16,000 (18,000 ) 39,200 -0-0-0-

+

= C. Stock + 80,000 -0-0-0-080,000 -0-0-0-

40,000 -0(12,000) 18,000 46,000 -02,000 2,000

8-37

EXERCISE 8-19A (cont.) Poort Inc. Financial Statements For Year Ending 2001 Classified as: Income Statements Investment Revenue Realized Gain Unrealized Gain Net Income Balance Sheets Assets Cash Investment Securities Total Assets Stockholders’ Equity Common Stock Retained Earnings Unrealized Gain Total Stockholders’ Equity Statements of Cash Flows Cash Flows From Operating Act.: Inflow from Invest. Revenue Outflow to Purchase Securities Inflow from Sale of Securities Net Cash Inflow from Oper. Act. Cash Flows From Investing Act.: Outflow to Purchase Securities Inflow from Sale of Securities $39,200 46,000 $85,200 $80,000 5,200 -0$85,200 $39,200 48,000 $87,200 $80,000 7,200 -0$87,200 $39,200 48,000 $87,200 $80,000 5,200 2,000 $87,200 $1,200 4,000 -0$5,200 $ 1,200 4,000 2,000 $7,200 $ 1,200 4,000 -0$5,200 Held Trading Availabl e

$

1,200 -0-01,200

$

1,200

(58,000) 16,000 (40,800)

$ 1,200 -0-01,200

(58,000) 16,000

-0-0-

(58,000) 16,000

8-38

Net Cash Investing Act.

Flow

from

(42,000) -0(40,800) 80,000 $39,200

-0-0(40,800) 80,000 $39,200

(42,000) -0(40,800) 80,000 $39,200

Cash Flows From Financing Act. Net Change in Cash Plus: Beginning Balance Ending Cash Balance Cash

8-39

EXERCISE 8-20A
Recognition of Unrealized Cash Flow Value Gains/Losses from Purchase Reported on Income Stmt. or Sale Balance Sheet Classified As

Investme Types of Types nt Securiti of Category es Revenu e

Held

Debt

Intere st

Amortized Cost

No

Investing Act. Operating Act. Investing Act.

Debt & Intere Trading Equity st & Market Value Div. Debt & Intere Availabl Equity st & Market Value e Div.

Yes

No

8-40

SOLUTIONS TO PROBLEMS - SERIES A - CHAPTER 8 PROBLEM 8-21A Sharp Photography Inc. Inventory Purchases Beginning Inventory First Purchase Second Purchase Total a. Cost of Goods Sold: FIFO Units @ @ @ Cost per Unit $110 85 100 Cost of Goods Sold = $16,500 = = 10,200 3,000 $29,700 15 0 12 0 20 0 47 0 @ @ @ $110 = $16,50 0 85 = 10,200 100 = 20,000 $46,70 0

From Beginning 150 Inventory From First Purchase 120 From Second Purchase 30 Total Units Sold 300 Ending Inventory: FIFO From Second Purchase Cost of Goods Sold: LIFO From Second Purchase From First Purchase Total Units Sold Ending Inventory:
8-41

Units 170 @

Cost per Unit 100

Ending Inventory = $17,000

Cost Units per Unit 200 @ $100 100 @ 85 300

Cost of Goods Sold = $20,000 = 8,500 $28,500

LIFO From Beginning Inventory From First Purchase Total Ending Inventory

150 20

@ @

110 85

= $16,500 = 1,700 $18,200

8-42

PROBLEM 8-21A a. (cont.) Weighted Average Total Cost $46,700 Weighted Average Cost of Goods Sold: 300 units Ending Inventory: b. Sharp Photography Inc. FIFO Sales (300 units @ $185) Cost of Goods Sold Gross Margin Operating Expenses Income Before Tax Income Tax (40%) Net Income $55,500 (29,700) 25,800 (12,000) 13,800 (5,520) $ 8,280 LIFO $55,500 (28,500) 27,000 (12,000) 15,000 (6,000) $ 9,000 Weighte d Average $55,500 (29,809) 25,691 (12,000) 13,691 (5,476) $ 8,215 170 units @ $99.36 2 @ $99.36 2 = $29,809 = $16,891 ÷ ÷ Total Units 470 = Cost per Unit

= $99.362

FIFO Income Tax Expense Net Income $5,520 8,280

LIFO $6,000 9,000

Weighte d Average $ 5,476 8,215

8-43

8-44

PROBLEM 8-21A (cont.) c. The Accounting Equation is provided for the use of the instructor. Assets Event FIFO Cost Flow Beginning Balance 1. First Purchase 2. Second Purchase 3a. Sale of Inventory 3b. Cost of Goods Sold 4. Paid Oper. Expenses 5. Paid Income Tax Totals LIFO Cost Flow Beginning Balance 1. First Purchase 2. Second Purchase 3a. Sale of Inventory 3b. Cost of Goods Sold 4. Paid Oper. Expenses 5. Paid Income Tax Totals Cash = Stockholders’ Equity Com Ret. Stock Earn. $14,300 $24,200 55,500 (29,700) (12,000)

Inventor = y

$22,000 $16,500 (10,200) 10,200 (20,000) 20,000 55,500 (29,700) (12,000)

(5,520) (5,520) $29,780 $17,000 = $14,300 $32,480 $22,000 $16,500 (10,200) 10,200 (20,000) 20,000 55,500 (28,500) (12,000) $14,300 $24,200 55,500 (28,500) (12,000)

(6,000) (6,000) $29,300 $18,200 = $14,300 $33,200 $14,300 $24,200 55,500

Weighted Average Beginning Balance $22,000 $16,500 1. First Purchase (10,200) 10,200 2. Second Purchase (20,000) 20,000 3a. Sale of 55,500
8-45

Inventory 3b. Cost of Goods (29,809) (29,809) Sold 4. Paid Oper. (12,000) (12,000) Expenses 5. Paid Income Tax (5,476) (5,476) Totals $29,824 $16,891 = $14,300 $32,415

8-46

PROBLEM 8-21A (cont.) c. Sharp Photography Inc. Financial Statements For Year Ended December 31, 2007 FIFO Income Statements Sales Cost of Goods Sold Gross Margin Operating Expenses Income Before Tax Income Tax Expense Net Income Balance Sheets Assets Cash Merchandise Inventory Total Assets Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity $29,780 17,000 $46,780 $14,300 32,480 $46,780 $29,300 18,200 $47,500 $14,300 33,200 $47,500 $29,824 16,891 $46,715 $14,300 32,415 $46,715 $55,500 (29,700) 25,800 (12,000) 13,800 (5,520) $ 8,280 $55,500 (28,500) 27,000 (12,000) 15,000 (6,000) $ 9,000 $55,500 (29,809) 25,691 (12,000) 13,691 (5,476) $ 8,215 LIFO Weight. Av.

8-47

PROBLEM 8-21A c. (cont.) Sharp Photography Inc. Statements of Cash Flows For the Year Ended December 31, 2007 FIFO Cash Flows From Operating. Act.: Cash Inflow from Customers Cash Outflow for Inventory Cash Outflow for Oper. Exp. Cash Outflow for Income Tax Net Cash Flow from Oper. Act. Cash Flows From Investing Act. Cash Flows From Financing Act. Net Change in Cash Plus: Beginning Balance Ending Cash Balance Cash LIFO Weight. Av.

$55,500 (30,200) (12,000) (5,520) 7,780 -0-07,780 22,000 $29,780

$55,500 (30,200) (12,000) (6,000) 7,300 -0-07,300 22,000 $29,300

$55,500 (30,200) (12,000) (5,476) 7,824 -0-07,824 22,000 $29,824

8-48

PROBLEM 8-22A Provided for the use of the instructor:
Milan, Inc. Sales and Purchase Transactions for 2006 Sales Price = Per Unit Purchases Cost Per Total Unit Cost of Goods Sold Cost Unit per Total s Unit Unit s 80 80 60 70 @$245 = $14,70 0 @$245 = $17,15 0 @$125 = $10,00 0 60 20 50 @$12 = 0 @$12 = 0 = @$12 5 $ 7,200 $ 2,400 $ 6,250 80 80 20 80 30 Inventory Cost per Total Unit @120 = $ 9,600 @$120 = $ 9,600 @$125 = $10,000 @$120 = $ 2,400 @$125 = $10,000 @$125 = $ 3,750

Date 1/1 3/5 4/10 6/19

Unit s

Total

Unit s

9/16 11/2 8 55 @$255 = $14,02 5

60

@$130 =

$ 7,800 30 25 @$12 = 5 = @$13 0 $ 3,750 $ 3,250

30 60

@$125 = $ 3,750 @$130 = $ 7,800

35

@$130 = $ 4,550

Total s

Sales

= $45,87 5

COGS = $22,85 0

End Inv.

$ 4,550

8-49

8-50

PROBLEM 8-22A (cont.) a. Milan, Inc. General Journal, 2006 Date 3/5 4/10 4/10 6/19 6/19 9/16 11/28 11/28 Account Titles Merchandise Inventory Cash Cash Sales Cost of Goods Sold* Merchandise Inventory Cash Sales Cost of Goods Sold* Merchandise Inventory Merchandise Inventory Cash Cash Sales Cost of Goods Sold* Merchandise Inventory Debit 10,000 10,000 14,700 14,700 7,200 7,200 17,150 17,150 8,650 8,650 7,800 7,800 14,025 14,025 7,000 7,000 Credit

*See schedule above for computation. b. Sales $45,875 Cost of Goods Sold (22,850) Gross Margin $23,025 c. Ending Inventory: $4,550 (See computation above)

8-51

PROBLEM 8-23A DOT Computer Repair Individual Item Lower of Cost or Market Unit Unit Item Quanti Cost Mark ty et D1 D2 D3 D4 60 30 44 40 $30 55 40 50 $35 50 55 35 Total Cost $1,80 0 1,650 1,760 2,000 $7,21 0 Total Marke t $2,10 0 1,500 2,420 1,400 $7,42 0
LCM Unit per Unit

Total $1,800 1,500 1,760 1,400 $6,460

s 60 30 44 40 @ $30 @ $50 @ $40 @ $35

a. b.

$6,460 Debit Credit Cost of Goods Sold (Inventory 750 Loss)* Merchandise Inventory 750 *$7,210 − $6,460 = $750

c. d. e.

$7,210 No entry; Cost is lower than market. Under the periodic system, the amount of ending inventory would be shown at the lower of cost or market in the schedule of cost of goods sold. By lowering the ending inventory, cost of goods sold is increased. Any loss is automatically included in cost of goods sold.

8-52

PROBLEM 8-24A a. 1. Estimated Gross Margin: Sales x Gross Margin %: $520,000 x .25 = $130,000 2. Estimated Cost of Goods Sold: Sales − Gross Margin: $520,000 − $130,000= $390,000 Or: Sales x Cost of Goods Sold %: $520,000 x 75% = $390,000 3. Estimated Inventory at September 21: Beginning Inventory $ 68,000 Plus: Purchases 350,000 Less: Cost of Goods Sold (390,000) Ending Inventory $ 28,000 b. Loss: Total Inventory $28,000 Less: Undamaged (8,000) Total Loss $20,000 Under the perpetual inventory system, if records are maintained accurately, the balance in the inventory account should be equal to the amount of the inventory on hand at the time of the loss. Any differences would be attributable to lost, stolen, or damaged goods.

c.

8-53

PROBLEM 8-25A Lexington Company 2004 Net Sales Cost of Goods Sold Gross Margin $140,000 (62,000) 78,000 2005 $200,00 0 (90,000) 110,000 Total $340,000 (152,000 ) 188,000

Gross Margin % Cost of Goods Sold %

$188,000 ÷ $340,00 = 0 152,000 ÷ 340,00 = 0

55% 45%

a.

Computation of Gross Margin: Sales $240,000 Less: Sales Discounts (10,000) Net Sales 230,000 x Gross Margin % 55% Gross Margin $126,500

b.

Computation of Ending Inventory: Beginning Inventory $ 60,000 Plus: Purchases 160,000 Plus: Transportation-In 4,000 Goods Available for Sale224,000 Less: Cost of Goods Sold (103,500)* Ending Inventory $120,500

*$230,000 x 45% = $103,500

8-54

PROBLEM 8-26A Error No.1 Sales, 2002 Ending Inventory, 12/31/02 Gross Margin, 2002 Beginning Inventory, 1/1/03 Cost of Goods Sold, 2002 Net Income, 2002 Retained Earnings, 12/31/02 Total Assets, 12/31/02 Amount Error NA NA $1,400 NA 1,400 NA NA NA of Effect NA NA − NA + NA NA NA

Error No. 2 Sales, 2002 Ending Inventory, 12/31/02 Gross Margin, 2002 Beginning Inventory, 1/1/03 Cost of Goods Sold, 2002 Net Income, 2002 Retained Earnings, 12/31/02 Total Assets, 12/31/02

Amount Error $2,400 1,344 1,056 1,344 1,344 1,056 1,056 1,056

of Effect − + − + − − − −

Error No. 3 Sales, 2002

Amount Error NA
8-55

of Effect NA

Ending Inventory, 12/31/02 Gross Margin, 2002 Beginning Inventory, 1/1/03 Cost of Goods Sold, 2002 Net Income, 2002 Retained Earnings, 12/31/02 Total Assets, 12/31/02

$1,200 1,200 1,200 1,200 1,200 1,200 1,200

− − − + − − −

8-56

PROBLEM 8-27A (a). Held-to-Maturity T-Accounts Cash 1. 20,000 3. 20,000 2. 60,000 4. 19,000
5.

Investment Sec. 3. 20,000 8. 5,000 6. 12,000
Bal.

Common Stock 1. 20,000
Bal.

20,000

400 6. 12,000 2,000

27,000 Dividends 7. 2,000 Bal.2,000 Service Revenue 2. 60,000
Bal.

8. 6,300 7. 9. 1,000 Bal.

34,700

60,000

Investment Income 5. 400 9. 1,000 Bal. 1,400 Gain on Sale of Invest.
8.

1,300 1,300

Bal.

Operating Expenses 4. 19,000
Bal.

19,000

8-57

PROBLEM 8-27A (cont.) (b). Trading T-Accounts Cash 1. 20,000 3. 20,000 2. 60,000 4. 19,000
5. 8.

Investment Sec. 3.20,000 8. 5,000 6.12,000
10.

Common Stock 1. 20,000
Bal.

20,000

400 6. 12,000 6,300 7. 2,000

13,000
Bal.

40,000

Dividends
7. 2,000 Bal.2,000

9. 1,000 Bal.

34,700

Service Revenue 2. 60,000
Bal.

60,000

Investment Income 5. 400 9. 1,000 Bal. 1,400 Gain on Sale of Invest. 8. 1,300 Bal. 1,300 Operating Expenses 4. 19,000
Bal.

19,000

(Income Account) Unrealized Gain/Loss 10.13,000
Bal. 8-58

13,000

8-59

PROBLEM 8-27A (cont.) (c). Available-for-Sale T-Accounts Cash
1. 20,000 3. 20,000 2. 60,000 4. 19,000 5. 8.

Investment Securities 3. 20,000 8. 5,000 6. 12,000
10.

Common Stock
1. 20,000 Bal.

20,000

400 6. 12,000 6,300 7. 2,000

13,000
Bal.

40,000

Dividends
7. 2,000 Bal.

9. 1,000 Bal.

34,700

2,000

(Equity Account) Unrealized Gain/Loss
10.

13,000 13,000

Bal.

Service Revenue 2. 60,000
Bal.

60,000

Investment Income 5. 400 9. 1,000 Bal. 1,400 Gain on Sale of Invest. 8. 1,300 Bal. 1,300

8-60

Operating Expenses 4. 19,000
Bal.

19,000

8-61

PROBLEM 8-27A (cont.) Best Answering Service Comparative Financial Statements For the Year Ended 2007 Investment Classified As Income Statements Services Revenue Operating Expenses Net Operating Income Investment Revenue Realized Gains Unrealized Gains Net Income Balance Sheets Assets Cash Investment Cost Investment Market Total Assets Stockholders’ Equity Common Stock Retained Earnings Unrealized Gain Total Stockholders’ Equity Securities Securities @ @ $34,70 0 27,000 -0$61,70 0 $20,00 0 41,700 -0$61,70
8-62

Securities

Held

Trading

Availabl e

$60,00 0 (19,00 0) 41,000 1,400 1,300 -0$43,70 0

$60,000 (19,000 ) 41,000 1,400 1,300 13,000 $56,700

$60,000 (19,000 ) 41,000 1,400 1,300 -0$43,700

$34,700 -040,000 $74,700

$34,700 -040,000 $74,700

$20,000 54,700 -0$74,700

$20,000 41,700 13,000 $74,700

0

8-63

PROBLEM 8-27A (cont.) Best Answering Service Comparative Financial Statements For the Year Ended 2007 Investment Classified as Securities Held Trading Availabl e

Statements of Cash Flows Cash Flows From Operating Act.: Cash Inflow from Customers Cash Inflow from Invest. Rev. Outflow for Expenses Outflow to Purchase Securities Inflow from Sale of Securities Net Cash Flow from Oper. Act. Cash Flows From Investing Act.: Outflow to Purchase Securities Inflow from Sale of Securities Net Cash Flow from Investing Act. Cash Flows From Financing Act.: Inflow from Stock Issue Outflow for Dividends Net Cash Flow from Financing Act. Net Change in Cash

$60,00 0 1,400 (19,00 0) -0-042,400

$60,000 1,400 (19,000 ) (32,000 ) 6,300 16,700

$60,00 0 1,400 (19,000 ) -0-042,400

(32,00 0) 6,300 (25,70 0)

-0-0-0-

(32,000 ) 6,300 (25,700 )

20,000 (2,000) 18,000 $34,70

20,000 (2,000) 18,000 $34,700

20,000 (2,000) 18,000 $34,70

8-64

Plus: Beginning Cash Balance Ending Cash Balance

0 -0$34,70 0

-0$34,700

0 -0$34,700

8-65

PROBLEM 8-28A
a. Even t 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Balance Sheet Asset = Liab. + S. s Equity + + +− − − NA − NA − − NA + NA NA NA NA NA NA NA NA + NA NA − − NA − NA − − Income Statement Rev. − Exp. = Net Inc. NA NA NA NA NA NA NA NA NA NA NA NA NA + NA NA + NA + + NA NA NA − NA NA − NA − − Stmt. of Cash Flow + FA NA − OA NA NA NA NA NA NA NA

b. The directional effect is the same for events 9 and 10. In both transactions, inventory was reduced and an expense was recorded that decreased stockholders’ equity. However, the amounts would be different during periods of changing prices.

8-66

SOLUTIONS TO EXERCISES - SERIES B - CHAPTER 8 EXERCISE 8-1B a. b. c. d. e. FIFO LIFO FIFO LIFO Weighted Average

8-67

EXERCISE 8-2B Spruell Co. First Purchase $ 750 Second Purchase 1,000 Total $1,750 (a) FIFO Cost of Goods Sold Ending Inventory $ 750 1,000 (b) LIFO $1,000 750 (c) W. AVG. $875* 875*

*Average Cost per Unit: $ 750 + $1,000 = $1,750; $1,750 ÷ 2 = $875

8-68

EXERCISE 8-3B The Perez Company Inventory Purchases Beginning Inventory First Purchase Second Purchase Goods Sale a. Cost of Goods Sold: FIFO Unit s Beginning 100 @ @ @ Unit Cost $40 50 60 Cost of Goods Sold $ 4,000 7,500 600 $12,100 Unit Cost $60 Ending Inventory = $11,400 Available 10 0 15 0 20 0 for 45 0 @ @ @ $40 50 60 = = $ 4,000 7,500

= 12,000 $23,50 0

From Inventory From First Purchase 150 From Second 10 Purchase Total Units Sold 260 Ending Inventory: FIFO From Second Purchase b. Cost of Goods Sold LIFO

= = =

Unit s 190 @

From Purchase From First Purchase Total Units Sold Ending Inventory LIFO

Unit s Second 200 @ 60 260 @

Unit Cost $60 50

= =

Cost of Goods Sold $12,000 3,000 $15,000

From Inventory From First Purchase

Unit s Beginning 100 @ 90 @

Unit Cost $40 50

Ending Inventory = = $4,000 4,500

8-69

Total Inventory c.

Ending 190

$8,500

Weighted Average: Total Cost $23,500 Cost of Goods Sold Ending Inventory: ÷ ÷ Total Units 450 = Cost per Unit = $52.222 @ $52.22 = $13,577.7 2 2 @ $52.22 = $9,922.18* 2

260 units 190 units

*.10 difference due to rounding

8-70

EXERCISE 8-4B a. (1) FIFO Parker Company $10,50 0

Sales (210 @ $50) Cost of Goods Sold: From Beginning 40 units @ = $ 800 Inv. $20 From Purchases 170 units @ = 4,250 $25 Gross Margin a. (2) LIFO Sales (210 @ $50) Cost of Goods Sold: From Purchases 200 units @ = $5,000 $25 From Beg. Inv. 10 units @ = 200 $20 Gross Margin a. (3) Weighted Average Sales (210 @ $50) Cost of Goods Sold: Average Cost per 210 Unit $24.1671 Gross Margin
1

( 5,050) $ 5,450

$10,50 0

(5,200) $ 5,300

$10,50 0 @ = $5,075
2

( 5,075) $ 5,425

Total cost ($800 + $5,000) $5,800 ÷ Total units 240 = $24.167 Cost per unit 2 Rounded to the nearest dollar.
8-71

b. The difference between net income using FIFO and LIFO is $150 ($5,450 − $5300). The difference between FIFO and Weighted Average is $25 ($5,450 − $5,425). The difference in the net incomes would be the same as the difference in gross margins, assuming there are no income tax considerations.

8-72

EXERCISE 8-4B (cont.) c. Ending Inventory FIFO LIFO Weighted Average

30 @ $25 30 @ $20 30 $24.167

= = @=

$750 600 725

8-73

EXERCISE 8-5B King Sales Summary of Purchase Transactions 1/20 4/21 7/25 9/19 Purchased Units Purchased Units Purchased Units Purchased Units Available Sale a. (1) FIFO Ending Inventory From 9/19 Purchase From 7/25 Purchase Total Inventory a. (2) LIFO for 450 200 100 75 825 @ @ @ @ $5 6 10 8 = = = = $2,250 1,200 1,000 600 $5,050

Units 75 25 @ @

Unit Cost $8 $10

Total $600 250 $850

Ending 100

Units @

Unit Cost $5

Total $500 $500

Ending Inventory From 1/20 100 Purchase Total Inventory Ending 100

a. (3) Weighted Average Total Cost ÷ Total Units
8-74

=

Cost per Unit

$5,050 Ending Inventory

÷

825

=

$6.12 $612

100 units @ $6.12 =

8-75

EXERCISE 8-5B (cont.) b. FIFO Sales (725 units @ $20) Cost of Goods Sold Cost of Goods Avail. for Sale* Less: Ending Inventory Cost of Goods Sold Gross Margin $5,050 (850) (4,200) $10,300 $14,500

LIFO Sales (725 units @ $20) Cost of Goods Sold Cost of Goods Avail. for Sale* Less: Ending Inventory Cost of Goods Sold Gross Margin $5,050 (500) (4,550) $ 9,950 $14,500

*This amount is computed in the Summary of Purchase Transactions at the beginning of the problem. Difference in Gross Margin: $10,300 − $9,950 = $350 Note to Instructor: Cost of goods sold can be computed on a units sold basis rather than subtracting ending inventory from goods available for sale.

8-76

EXERCISE 8-6B a. Market Company Income Statements FIFO Sales $40) (3,400 @ $136,00 0 500 units @ = $10,000 $20 2,500 units @ = 55,000 $22 400 units @ = 11,200 $28 (76,200) 59,800 (34,000) 25,800 (7,740) $ 18,060

Cost of Goods Sold: From Beginning Inv. From 4/1 Purchase From 10/1 Purchase Cost of Goods Sold Gross Margin Operating Expenses Income Before Tax Income Tax Expense Net Income LIFO Sales $40) (3,400 @

(30%)

$136,00 0 800 units @ = $22,400 $28 2,500 units @ = 55,000 $22 100 units @ = 2,000 $20
8-77

Cost of Goods Sold: From 10/1 Purchase From 4/1 Purchase From Beginning Inv.

Cost Sold

of

Goods

(79,400) 56,600 (34,000) 22,600 (6,780) $ 15,820

Gross Margin Operating Expenses Income Before Tax Income Tax Expense Net Income (30%)

EXERCISE 8-6B (cont.) b. Income tax paid using FIFO: $7,740 Income tax paid using LIFO: $6,780 c. Market Company Cash Flows from Operating Activities FIFO Cash Flows From Operating Activities: Cash Inflow from Customers Cash Outflow for Inventory* Cash Outflow for Operating Expense Cash Outflow for Income Tax Expense Net Cash Flow from Operating Activities LIFO

$136,00 0 (77,400) (34,000) (7,740) $ 16,860

$136,000 (77,400) (34,000) (6,780) $ 17,820

*Computation of cash paid for inventory: 4/1 Purchase 10/1 Purchase 2,500 units @ $22 =$55,000 800 units @ 28 = 22,400
8-78

$77,400 d. The difference in cash flow from operating activities between FIFO and LIFO is caused by the difference in income tax paid for the two methods. Taxable income is greater by using FIFO; consequently more income tax will be paid causing a greater cash outflow for tax expense.

8-79

EXERCISE 8-7B a
West Coast Company Effect of Events on Financial Statements Panel 1: FIFO Cost Flow Even t 1. 2. 3. 4. 5. Bal. Cash + Inv. = C. + Ret. Ear. Stk. NA + 250,000 NA + NA NA + NA NA + (88,750 ) NA + (64,500) NA + 96,750 Rev. 250,00 0 NA NA NA − − Exp. = Net Inc. Cash Flows 250,000 OA (70,000) OA (56,250) OA NA (64,500) OA 59,250 NC

250,000 +

NA =

NA = 250,000

(70,000) + 70,000 = (56,250) + 56,250 = NA + (88,750 = )1 (64,500) + NA =
2

59,250

+ 37,500 =

NA = NA − NA = NA − − 88,750 = (88,750 ) NA − 64,500 = (64,500 ) 250,00 − 153,25 = 96,750 0 0

Panel 2: LIFO Cost Flow Even t 1. 2. 3. 4. 5. Bal. Cash + Inv. = C. + Stk. Ret. Earn. Rev. 250,00 0 NA NA NA − − Exp. = Net Inc. Cash Flows 250,000 OA (70,000) OA (56,250) OA NA (63,500) OA 60,250 NC

250,000 +

NA =

NA + 250,000 NA + NA NA + NA NA + (91,250 ) NA + (63,500 ) NA + 95,250

NA = 250,000

(70,000) + 70,000 = (56,250) + 56,250 = NA + (91,250 = )3 (63,500) + NA =
4

60,250 + 35,000 =

NA = NA − NA = NA − − 91,250 = (91,250 ) NA − 63,500 = (63,500 ) 250,00 − 154,75 = 95,250 0 0

1

Cost of Goods Sold -- FIFO: 4/2

200 units @ $350 =$70,000 8-80

9/1 50 units @ $375 = Total $88,750
2 3

18,750

Income Tax Expense:

($250,000 − $88,750) x 40% = $64,500. $56,250 35,000

Cost of Goods Sold -- LIFO: 9/1 150 units @ $375 = 4/2 100 units @ $350 = Total $91,250 Income Tax Expense ($250,000 − $91,250) x 40% = $63,500.

4

8-81

EXERCISE 8-7B (cont.) b. c. d. Net Income assuming FIFO cost flow: $96,750 (see statements model above). Net Income assuming LIFO cost flow: $95,250 (see statements model above). LIFO produces an income tax that is $1,000 lower ($64,500 − $63,500) than FIFO. This results because a larger amount of inventory is expensed using LIFO. The last purchase was bought at a higher price than the first purchase. FIFO

e.

8-82

EXERCISE 8-8B a. Polo Company - General Journal Date 1/1/06 4/1a 4/1b Account Titles Inventory (250 @ $40) Cash Cash (125 @ $70) Sales Revenue Cost of Goods Sold (125 @ $34) Inventory Inventory (400 @ $44) Cash Cash (500 @ $76) Sales Revenue Cost of Goods Sold* Inventory Debit 10,000 10,000 8,750 8,750 4,250 4,250 17,600 17,600 38,000 38,000 20,500 20,500 = $ 1,700 10,000 8,800 Credit

8/1 12/1a 12/1b

*Cost of Goods Sold: 50 @ $34 250 @ $40 = 200 @ $44 = $20,500

b. Total Cost of Goods Sold: 4/1 $ 4,250 12/1 20,500 Total $24,750

8-83

EXERCISE 8-9B a.
Date 1/1
Beg.

Big Hill, Inc.
Purchased Units Cost Total Sold Units Cost Total Inventory Balance Units Cost Total 50 @ $30 = $1,500 50 @ $30 = $1,500 200 @ $35 = $7,000 50 @ $30 = $1,500 120 $35 = $4,200 @ 275 @ $40 = $11,00 0 $ 2,800 260 @ $40 = $10,40 0 80 @ $35 = -080 @ $35 = $2,800 80 @ $35 = $2,800 275 @ $40 =$11,000 -015 @ $40 = $600

Inv.

3/15 Pur. 5/30 Sold

200 @

$35 = $7,000

8/10 Pur 11/20 Sold

Ending Inventory: 15 units @ $40 = $600 b. A problem arises when Weighted Average is applied to intermittent sales and purchase transactions. Weighted Average requires that average cost be computed when each sale is made. This problem is often overcome by recording only quantities of units sold on a perpetual basis. At the end of the accounting period, costs are then assigned perpetually to the units that have been sold.

8-84

EXERCISE 8-10B a. a. b. c. Cost Per Unit Original Woodwork d. e. f. Unit Mkt. Lower Total Val. Cost/Mk Cost per t. Unit $ 12 16 26 22 $ 12 16 24 20 h. Ind. Total Item Market Lower Cost/Mk t. g.

I Quanti tem ty

P D S J

100 50 20 15

$ 16 18 24 20

(b x c) (b x d) (b x e) $1,600 $1,200 $1,200 900 800 800 480 520 480 300 330 300 $3,280 $2,850 $2,780

1. Ending inventory using the individual item method: $2,780 2. Ending Inventory using the aggregate method: $2,850 b. Date 1. 2. Account Titles Cost of Goods Sold* Inventory Cost of Goods Sold** Inventory Debit 500 500 430 430 Credit

*$3,280 − $2,780 = $500 **$3,280 − $2,850 = $430

8-85

EXERCISE 8-11B a. a. Item b. Quantit y 100 150 90 c. Cost Per Unit $40 60 20 d. Market Per Unit e. Unit Lower Cost/Mkt. $36 56 20 f. Total Cost (b x c) $ 4,000 9,000 1,800 $14,800 g. Total Lower Cost/Mkt. (b x e) $ 3,600 8,400 1,800 $13,800

B C D Totals

$36 56 30

The inventory would be carried at $13,800, the lower of cost or market applied to individual inventory items. b. Under the periodic method, the amount of ending inventory would be shown at the lower of cost or market in the schedule of cost of goods sold. By lowering the ending inventory, cost of goods sold is increased. The loss is automatically included in cost of goods sold.

8-86

EXERCISE 8-12B Deep Woods Hunting Goods a. Gross Margin: Sales x Gross Margin % $137,500 x 25% = $34,375 b. Cost of Goods Sold: Sales x Cost of Goods Sold % $137,500 x 75% = $103,125 c. Computation of Ending Inventory: Beginning Inventory $ 25,000 Plus: Purchases 100,000 Goods Available for Sale 125,000 Less: Cost of Goods Sold (Est.) (103,125) Ending Inventory (Est.) $ 21,875 d. Lost Inventory: Estimated Ending Inventory $21,875 Less: Undamaged Inventory (2,000) Inventory Lost $19,875

EXERCISE 8-13B June 14 Inventory Account Balance Less: Cost of Unrecorded Sale Balance in the Warehouse Less: 5% Shrinkage Less: Amount of Inventory Showroom Inventory Lost in $338,000 (42,000) 296,000 (14,800) (75,000) $206,200

8-87

8-88

EXERCISE 8-14B Short Company The uncounted inventory will only affect The Short Company’s balance sheet if the book amount of the inventory is actually written down to the counted amount. The perpetual system records the actual amount of goods as they are purchased and sold. However, if an adjustment is actually made on the books, the reduction in inventory would cause the inventory amount shown on the balance sheet to be understated.

EXERCISE 8-15B Tefall Company Item Number 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Year 2006 2006 2006 2006 2006 2006 2007 2007 2007 2007 2007 2007 Amount Affected Beginning Inventory Purchases Goods Available for Sale Cost of Goods Sold Gross Margin Net Income Beginning Inventory Purchases Goods Available for Sale Cost of Goods Sold Gross Margin Net Income NA NA NA Overstated Understated Understated Understated NA Understated Understated Overstated Overstated Effect

8-89

EXERCISE 8-16B Asset Inventory Prepaid Rent Cash Held-to-Maturity Securities Machinery Available-for-Sale Securities Certificate of Deposit Trading Securities FMV LCM X X X X X X X X X HC/AC

8-90

EXERCISE 8-17B a.
Type Held Trading Availabl e C + ash − − − Balance Sheet Inv. = L + S. Sec. iab. Equity + + + NA NA NA NA NA NA Income Statement Rev. − Exp. = Net Inc. NA NA NA NA NA NA NA NA NA Stmt. of Cash Flows −IA −OA −IA

b. Blass Brothers Computation of Net Income Classified as: Revenue Expenses Unrealized Gain Net Income Held-toMaturity $10,000 (4,000) -0$ 6,000 Trading $10,000 (4,000) 7,000 $13,000 Availabl e-forSale $10,000 (4,000) -0$ 6,000

8-91

EXERCISE 8-18B a.
Circuit Electronics Horizontal Statements Models
(1) Held-to-Maturity Balance Sheet Event 1. 2. 3. 4. Totals Inv. = Liab. + Sec. (75,000) + 75,000 = NA + 4,500 15,000 + NA + (12,500 ) NA + NA (55,500) + 62,500
1

Cash

+

Ret. Ear. NA

+ + + + + +

Unreal. Gain. NA NA NA NA -0-

Income Statement Rev./ Exp. Gain − / = Net Inc. Loss NA − NA = NA 4,500 − 2,500 − NA − 7,000 − -0- = 4,500 -0- = 2,500 NA = NA -0- = 7,000

Statement of Cash Flows (75,000) IA 4,500 OA 15,000 IA NA (55,500) NC

= NA = NA = = NA -0-

+ 4,500 + 2,500 + NA + 7,000

(2) Trading
Event 1. 2. 3. 4. Totals Inv. = Liab + Ret. Sec. . Ear. (75,000 + 75,000 = NA + NA ) 4,500 + NA = NA + 4,500 15,000 + (12,500 = NA + 2,500 ) NA + (12,500 = NA + (12,500 ) ) (55,500 + 50,000 = -0- + (5,500) ) Cash + + + + + + + Unreal. Gain NA NA NA NA -0Rev./ Gain − NA − 4,500 − 2,500 − Exp./ Loss = Net Inc. NA = NA = NA = NA 4,500 2,500 Cash Flow (75,000)OA 4,500 OA 15,000 OA NA (55,500)NC

NA − 12,500 = (12,500 ) 7,000 − 12,500 = (5,500)

(3) Available-for-Sale
Event Cash + Inv. = Liab. + Ret. Unreal. + Gain Rev./ Gain Exp. / = Net Inc. − Cash Flow

8-92

1. 2. 3. 4. Totals
1

Sec. (75,000 + 75,000 ) 4,500 + NA 15,000 + (12,500 ) NA + (12,500 ) (55,500 + 50,000 )

= = = = =

NA NA NA NA -0-

+

Ear. NA

+ + +

NA NA NA

NA 4,500 2,500 NA 7,000

Loss − NA = − − − −

NA

(75,000)IA 4,500 OA 15,000 IA NA (55,500)NC

+ 4,500 + 2,500 + NA

NA = 4,500 NA = 2,500 NA = NA

+ 7,000

+ (12,500 ) + (12,500 )

-0- = 7,000

Cash is negative because these transactions do not reflect any beginning balances.

8-93

EXERCISE 8-18B (cont.) b. (1) Held-to-Maturity (2) Trading (3) Available-for-Sale c. $7,000 $(5,500) $7,000

The amount of change in total cash from these activities is the same for all three classifications ($55,500). Heldto-maturity and available-for-sale securities each had a net cash inflow from operating activities of $4,500, while trading securities had a net cash outflow of $55,500 from operating activities.

d. (1) Held-to-Maturity $62,500 (2) Trading $50,000 (3) Available-for-Sale $50,000

8-94

EXERCISE 8-19B Transactions are recorded in the accounting equation for the use of the instructor.
Assets Event
Beg. Bal. 1. Pur. Sec. 2. Inv. Rev. 3. Sold Sec 4. Pur. Sec. Totals 5. Mkt. Val. if HM 5. Mkt. Val. if TR 5. Mkt. Val. if AS

= Inv. Sec.

Stockholders’ Equity Ret. + Earn. -0-0800 3,000 -03,800 -01,000 -0Unreal. Gain -0-0-0-0-0-0-0-01,000

Cash 60,000 (30,000 ) 800 10,000 (10,000 ) 30,800 -0-0-0-

+

= C. Stock + 60,000 -0-0-0-060,000 -0-0-0-

30,000 -0(7,000) 10,000 33,000 -01,000 1,000

8-95

EXERCISE 8-19B. (cont.) Deal Inc. Financial Statements For Year Ended 2002 Classified as: Income Statements Investment Revenue Realized Gain Unrealized Gain Net Income Balance Sheets Assets Cash Investment Securities Total Assets Stockholders’ Equity Common Stock Retained Earnings Unrealized Gain Total Stockholders’ Equity Statements of Cash Flows Cash Flows From Operating Act.: Inflow from Invest. Revenue Outflow to Purchase Securities Inflow from Sale of Securities Net Cash Inflow from Oper. Act. Cash Flows From Investing Act.: Outflow to Purchase Securities Inflow from Sale of Securities $30,800 33,000 $63,800 $60,000 3,800 -0$63,800 $30,800 34,000 $64,800 $60,000 4,800 -0$64,800 $30,800 34,000 $64,800 $60,000 3,800 1,000 $64,800 $ 800 3,000 -0$3,800 $ 800 3,000 1,000 $4,800 $ 800 3,000 -0$3,800 Held Trading Availabl e

$

800 -0-0800

$

800

$

800 -0-0800

(40,000) 10,000 (29,200)

(40,000) 10,000

-0-0-

(40,000) 10,000

8-96

Net Cash Investing Act.

Flow

from

(30,000) -0(29,200) 60,000 $30,800

-0-0(29,200) 60,000 $ 30,800

(30,000) -0(29,200) 60,000 $30,800

Cash Flows From Financing Act. Net Change in Cash Plus: Beginning Balance Ending Cash Balance Cash

8-97

EXERCISE 8-20B The three classifications of investment securities are: 1. Held-to-Maturity Securities: An example of held-tomaturity securities would be bonds that are intended to be held to their maturity date. 2. Trading Securities: An example of trading securities would more likely be stocks that are intended to be held a short time and are traded on a regular basis for the purpose of generating profit. 3. Available-for-Sale Securities: An example would be stocks and bonds that are neither trading nor held-tomaturity. The company may buy a stock with the intention of holding it until it appreciates and it may be sold within a short period of time or held for several years. Intent determines the classification.

8-98

SOLUTIONS TO PROBLEMS - SERIES B - CHAPTER 8 PROBLEM 8-21B Paul’s Bicycle Shop Inventory Purchases Beginning Inventory First Purchase Second Purchase Total 20 0 12 0 14 0 46 0 @ @ @ $280 = $56,000 300 330 = = 36,000 46,200 $138,200

a. Cost of Goods Sold: FIFO

From Inventory From First Purchase 120 From Second 80 Purchase Total Units Sold 400 Ending Inventory: FIFO From Purchase

Unit Unit s Cost Beginning 200 @ $280 @ @ 300 330

= = =

Cost of Goods Sold $ 56,000 36,000 26,400 $118,400

Unit s Second 60

Unit Cost @ $330

Ending Inventory = $19,800

Cost of Goods Sold: LIFO

From Purchase From First Purchase 120 From Beginning 140 Inventory

Unit Unit s Cost Second 140 @ $330 @ @ 300 280

= = =

Cost of Goods Sold $46,200 36,000 39,200

8-99

Total Units Sold

400

$121,400

Ending Inventory: 60 @ $280 = $16,800 LIFO Unit Unit s Cost From Beginning 60 $280 Inventory

=

Ending Inventory $16,800

8-100

PROBLEM 8-21B a. (cont.) Weighted Average Total Cost $138,200 ÷ ÷ Total Units 460 = Cost per Unit

= $300.435

Cost of Goods Sold: 400 units Ending Inventory: b. 60 units

@ $300.43 = $120,174 5 @ $300.43 = $18,026 5

Paul’s Bicycle Shop Computation of Net Income FIFO Sales (400 units @ $450) Cost of Goods Sold Gross Margin Salaries Expenses Income Before Tax Income Tax (25%) Net Income $180,00 0 (118,400 ) 61,600 (30,000) 31,600 (7,900) $23,700 LIFO $180,00 0 (121,40 0) 58,600 (30,000) 28,600 (7,150) $21,450 Weighte d Average $180,00 0 (120,17 4) 59,826 (30,000) 29,826 (7,457) $22,369

8-101

PROBLEM 8-21B (cont.) c. The Accounting Equation is provided for the use of the instructor. Event Assets Cash FIFO Cost Flow Beginning Balance $ 50,800 $56,000 1. First Purchase (36,000) 36,000 2. Second Purchase (46,200) 46,200 3a. Sale of 180,000 Inventory 3b. Cost of Goods (118,40 Sold 0) 4. Paid Sal. (30,000) Expense 5. Paid Income Tax (7,900) Totals $110,700 $19,800 LIFO Cost Flow Beginning Balance $50,800 $56,000 1. First Purchase (36,000) 36,000 2. Second Purchase (46,200) 46,200 3a. Sale of 180,000 Inventory 3b. Cost of Goods (121,40 Sold 0) 4. Paid Sal. (30,000) Expense 5. Paid Income Tax (7,150) Totals $111,450 $16,800 Weighted Average Beginning Balance $50,800 $56,000 1. First Purchase (36,000) 36,000 2. Second Purchase (46,200) 46,200 3a. Sale of 180,000
8-102

Stockholders’ Equity Inventor = C. Stock Ret. y Earn.

=

$43,000

$63,800 180,000 (118,400 ) (30,000)

$43,000 $43,000

(7,900) $87,500 $63,800 180,000 (121,400 ) (30,000)

$43,000 $43,000

(7,150) $85,250 $63,800 180,000

Inventory 3b. Cost of Goods (120,17 Sold 4) 4. Paid Sal. (30,000) Expense 5. Paid Income Tax (7,457) Totals $111,143 $18,026

(120,174 ) (30,000) $43,000 (7,457) $86,169

8-103

PROBLEM 8-21B (cont.) c. Paul’s Bicycle Shop Financial Statements For Year Ended December 31,2007 FIFO Income Statements Sales Cost of Goods Sold Gross Margin Salaries Expense Income Before Tax Income Tax Expense Net Income Balance Sheets Assets Cash Inventory Total Assets Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity $110,700 19,800 $130,500 $111,45 0 16,800 $128,25 0 $43,000 85,250 $128,25 0 $111,143 18,026 $129,169 $180,000 (118,400 ) 61,600 (30,000) 31,600 (7,900) $23,700 $180,00 0 (121,400 ) 58,600 (30,000) 28,600 (7,150) $21,450 $180,000 (120,174) 59,826 (30,000) 29,826 (7,457) $22,369 LIFO Weight. Av.

$43,000 87,500 $130,500

$43,000 86,169 $129,169

8-104

PROBLEM 8-21B c. (cont.) Paul’s Bicycle Shop Statements of Cash Flows For the Year Ended December 31, 2007 FIFO Cash Flows From Oper. Act.: Cash Inflow from Customers Cash Outflow for Inventory Cash Outflow for Sal. Exp. Cash Outflow for Income Tax Net Cash Flow from Oper. Act. Cash Flows From Investing Act. Cash Flows From Financing Act. Net Change in Cash Plus: Beginning Balance Ending Cash Balance Cash LIFO Weight. Av.

$180,000 (82,200) (30,000) (7,900) 59,900 -0-059,900 50,800 $110,700

$180,00 0 (82,200) (30,000) (7,150) 60,650 -0-060,650 50,800 $111,45 0

$180,000 (82,200) (30,000) (7,457) 60,343 -0-060,343 50,800 $111,143

8-105

PROBLEM 8-22B Provided for the use of the instructor: Fred’s Fireplaces
Sales and Purchase Transactions for 2008 Date
Units

Sales
Price Per Unit = Total Unit s

Purchases
Cost Per Unit Total

Cost of Goods Sold
Unit s Cost per Unit Total Unit s

Inventory
Cost per Unit Total

1/1 3/5 4/10 6/19 40 50 @$45 = $18,00 0 0 @$45 = $22,50 0 0 50 @$370 = $18,50 0 40 20 30 @$350 = $14,00 0 @$350 = @$370 = $ 7,000 $11,10 0

60 60 50 20 50 20

@$350 = $21,000 @$350 = $21,000 @$370 = $18,500 @$350 = $ 7,000 @$370 = $18,500 @$370 = $ 7,400

9/16 11/2 8 35 @$47 0 = $16,45 0

50

@$390 = $19,50 0 20 15 @$370 = @$390 = $ 7,400 5,85 0 $45,35 0

20 50

@$370 = $ 7,400 @$390 = $19,500

35

@$390 = $13,650

Total s

Sales

$56,95 0

COGS

End Inv.

$13,650

8-106

PROBLEM 8-22B (cont.) a. Fred’s Fireplaces General Journal, 2008 Date 3/5 4/10 4/10 6/19 6/19 9/16 11/28 11/28 Account Titles Inventory Cash Cash Sales Cost of Goods Sold* Inventory Cash Sales Cost of Goods Sold* Inventory Inventory Cash Cash Sales Cost of Goods Sold* Inventory Debit 18,500 18,500 18,000 18,000 14,000 14,000 22,500 22,500 18,100 18,100 19,500 19,500 16,450 16,450 13,250 13,250 Credit

*See previous schedule for computation. b. Sales $56,950 Cost of Goods Sold (45,350) Gross Margin $11,600 Ending Inventory $13,650 (See previous computation)

c.

8-107

PROBLEM 8-23B Ed’s Repair Service
Individual Item Lower of Cost or Market LCM Unit per Total s Unit 80 60 100 50 @ $80 @ $60 @ $130 @ $130 $ 6,400 3,600 13,000 6,500 $29,50 0

Item

Quantit y 80 60 100 50

Unit Cost $80 60 140 130

Unit Marke t $90 66 130 140

Total Cost

Total Market

P1 P2 P3 P4

$ $ 7,200 6,400 3,600 3,960 14,000 13,000 6,500 7,000 $30,50 $31,160 0

a. b.

$29,500 Debit Credit Cost of Goods Sold (Inventory 1,000 Loss)* Inventory 1,000 *($30,500 − $29,500)

c. d. e.

$30,500 No entry; cost is lower than market. Under the periodic system the amount of ending inventory would be shown at the lower of cost or market in the schedule of cost of goods sold. By lowering the ending inventory, cost of goods sold is increased. Any loss is automatically included in cost of goods sold.

8-108

PROBLEM 8-24B Hank’s Fun House a. 1.Estimated Gross Margin: Sales x Gross Margin %: $1,140,000 x .30 = $342,000 2. Estimated Cost of Goods Sold: Sales − Gross Margin: $1,140,000 − $342,000= $798,000 Or: Sales x Cost of Goods Sold %: $1,140,000 x 70% = $798,000 3. Estimated Inventory at October 6: Beginning Inventory $162,000 Plus: Purchases 680,000 Less: Cost of Goods Sold (798,000) Ending Inventory $ 44,000 b. Loss: Total Inventory $ 44,000 Less: Undamaged (20,000) Total Loss $ 24,000 Under the perpetual inventory system, if records are maintained accurately, the balance in the inventory account should be equal to the amount of the inventory on hand at the time of the loss. Any differences would be attributable to lost, stolen, or damaged goods.

c.

8-109

PROBLEM 8-25B Elle’s Eatery 2006 Net Sales Cost of Goods Sold Gross Margin $60,000 (31,000) $ 29,000 2007 $70,000 (36,500) $33,500 Total $130,000 (67,500) $ 62,500

Gross Margin % Cost of Goods Sold %

$62,500 $67,500

÷ $130,00 = 0 ÷ 130,000 =

48% 52%

a.

Computation of Gross Margin: Sales Less: Sales Discounts Net Sales x Gross Margin % Gross Margin $56,500 (2,500) 54,000 48% $25,920

b.

Computation of Ending Inventory: Beginning Inventory $12,500 Plus: Purchases 41,000 Plus: Transportation-In 2,000 Goods Available for Sale 55,500 Less: Cost of Goods Sold (28,080)* Ending Inventory $27,420

*$54,000 x 52% = $28,080

8-110

PROBLEM 8-26B Error No.1 Sales, 2006 Ending Inventory, 12/31/06 Gross Margin, 2006 Beginning Inventory, 1/1/07 Cost of Goods Sold, 2006 Net Income, 2006 Retained Earnings, 12/31/06 Total Assets, 12/31/06 Amount Error NA NA $2,000 NA 2,000 NA NA NA of Effect NA NA − NA + NA NA NA

Error No. 2 Sales, 2006 Ending Inventory, 12/31/06 Gross Margin, 2006 Beginning Inventory, 1/1/07 Cost of Goods Sold, 2006 Net Income, 2006 Retained Earnings, 12/31/06 Total Assets, 12/31/06

Amount Error $500 300 200 300 300 200 200 200

of Effect − + − + − − − −

Error No. 3 Sales, 2006

Amount Error NA
8-111

of Effect NA

Ending Inventory, 12/31/06 Gross Margin, 2006 Beginning Inventory, 1/1/07 Cost of Goods Sold, 2006 Net Income, 2006 Retained Earnings, 12/31/06 Total Assets, 12/31/06

$1,800 1,800 1,800 1,800 1,800 1,800 1,800

− − − + − − −

8-112

PROBLEM 8-27B (a). Held-to-Maturity T-Accounts Assets Cash 1. 15,000 3. 12,000 2. 50,000 4. 17,000
5.

=

Stockholders’ Equity Common Stock 1. 15,000
Bal.

Investment Sec. 3. 12,000 8. 6,000 6. 16,000
Bal.

15,000

400 6. 16,000 1,000

22,000 Dividends 7. 1,000 Bal.1,000 Service Revenue 2. 50,000
Bal.

8. 6,400 7. 9. 900 Bal.

26,700

50,000

Investment Income 5. 400 9. 900 Bal. 1,300 Gain on Sale of Invest. 8. 400 Bal. 400 Operating Expenses 4. 17,000
Bal.

17,000

8-113

8-114

PROBLEM 8-27B (cont.) (b). Trading T-Accounts Assets Cash 1. 15,000 3. 12,000 2. 50,000 4. 17,000
5. 8. 9. Bal.

=

Stockholders’ Equity Common Stock 1. 15,000
Bal.

Investment Sec. 3. 12,000 8. 6,000 6. 16,000
10.

15,000

400 6. 16,000 6,400 7. 900 1,000
Bal.

2,000 20,000 Dividends
7. 1,000 Bal.1,000

26,700

Service Revenue 2. 50,000
Bal.

50,000

Investment Income 5. 400 9. 900 Bal. 1,300 Gain on Sale of Invest. 8. 400 Bal. 400 Operating Expenses 4. 17,000
Bal.

17,000

8-115

(Income Account) Unrealized Gain/Loss 10. 2,000 Bal. 2,000

8-116

PROBLEM 8-27B (cont.) (c). Available-for-Sale T-Accounts Assets Cash
1. 15,000 3. 12,000 2. 50,000 4. 17,000 5.

=

Stockholders’ Equity Common Stock
1. 15,000 Bal.

Investment Securities 3. 12,000 8. 6,000 6. 16,000 10. 2,000
Bal.

15,000

400 6. 16,000 1,000

20,000 Dividends 7. 1,000 Bal.1,000 (Equity Account) Unrealized Gain/Loss 10. 2,000 Bal.2,000 Service Revenue 2. 50,000
Bal.

8. 6,400 7. 9. 900 Bal.

26,700

50,000

Investment Income 5. 400 9. 900 Bal. 1,300 Gain on Sale of Invest. 8. 400 Bal. 400
8-117

Operating Expenses 4. 17,000
Bal.

17,000

8-118

PROBLEM 8-27B (cont.) Brogan’s Trucking Company Comparative Financial Statements For the Year Ended 2007 Investment Classified As: Income Statements Services Revenue Operating Expenses Net Operating Income Investment Revenue Realized Gains Unrealized Loss Net Income Balance Sheets Assets Cash Investment Cost Investment Market Total Assets Stockholders’ Equity Common Stock Retained Earnings* Unrealized Loss Total Stockholders’ Equity Securities Securities @ @ $26,700 22,000 -0$48,700 $26,70 0 -020,000 $46,70 0 $15,00 0 31,700 -0$46,70 $26,70 0 -020,000 $46,70 0 $15,00 0 33,700 (2,000) $46,70 $50,000 (17,000 ) 33,000 1,300 400 -0$34,700 $50,00 0 (17,000 ) 33,000 1,300 400 (2,000) $32,70 0 $50,00 0 (17,000 ) 33,000 1,300 400 -0$34,70 0 Securities Held Trading Availab le

$15,000 33,700 -0$48,700
8-119

0
*Net Income above less $1,000 dividends

0

8-120

PROBLEM 8-27B (cont.) Brogan’s Trucking Company Comparative Financial Statements For the Year Ended 2007 Investment Classified As: Securities Held Trading Availabl e

Statements of Cash Flows Cash Flows From Operating Act.: Cash Inflow from Customers Cash Inflow from Invest. Rev. Outflow for Expenses Outflow to Purchase Securities Inflow from Sale of Securities Net Cash Flow from Oper. Act. Cash Flows From Investing Act.: Outflow to Purchase Securities Inflow from Sale of Securities Net Cash Flow from Investing Act. Cash Flows From Financing Act.: Inflow from Stock Issue Outflow for Dividends Net Cash Flow from Financing Act.

$50,00 0 1,300 (17,00 0) -0-034,300

$50,000 1,300 (17,000 ) (28,000 ) 6,400 12,700

$50,00 0 1,300 (17,000 ) -0-034,300

(28,00 0) 6,400 (21,60 0)

-0-0-0-

(28,000 ) 6,400 (21,600 )

15,000 (1,000) 14,000

15,000 (1,000) 14,000

15,000 (1,000) 14,000

8-121

Net Change in Cash Plus: Beginning Cash Balance Ending Cash Balance

26,700 -0$26,70 0

26,700 -0$26,700

26,700 -0$26,70 0

8-122

PROBLEM 8-28B a.
Even t Balance Sheet Asset = Liab. + S. s Equity 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. + +− +− + + NA − NA − − NA NA NA NA NA NA NA NA NA NA + NA NA + + NA − NA − − Income Statement Rev. − Exp. = NA NA NA + NA NA NA NA NA NA NA NA NA NA NA NA + NA + + Net Inc. NA NA NA + NA NA − NA − − Stmt. of Cash Flows + FA − IA − OA NA NA NA NA NA NA NA

b. The directional effect is the same for events 9 and 10. In both events, you are reducing inventory and recording an expense that reduces stockholders’ equity. However, the amounts would be different during periods of changing prices.

8-123

ATC 8-1 Financial Statement Analysis a. Inventory turnover:

$25,445 ÷ $400 = 63.61 times Average days to sell inventory: 365 days ÷ 63.6 = 5.7 days (Wow!)

b. FIFO. See Note 1 on page 31 of the annual report. c. Unlike most companies, including other direct marketers such as Land’s End, Dell does
not need to maintain significant quantities of “finished goods” inventory. Dell builds computers “to order”, so its inventory includes an inventory of parts. See Note 9 on page 42 of the annual report. Conversely, Land’s End must maintain many different sizes and colors of each of its clothing products, so it can fill customers’ orders on a timely basis. Additionally, Dell is famous for its very efficient “just-in-time” inventory system, which results in very low inventory levels.

8-124

ATC 8-2 a. Blue Bird Company Inventory Purchases Beginning Inventory First Purchase Second Purchase Total FIFO Cost of Goods Sold: FIFO From Beginning Inventory From Beginning Inventory From First Purchase From Second Purchase Total Units Sold Ending Inventory: LIFO Cost of Goods Sold: LIFO From Second Purchase From First Purchase From Beginning Inventory Total Units Sold Ending Inventory: Units 250 100 70 420 Cost per Unit $58 54 55 Cost of Goods Sold $14,500 5,400 3,850 $23,750 Units 100 70 100 150 420 Cost per Unit $50 55 54 58 Cost of Goods Sold $ 5,000 3,850 5,400 8,700 $22,950 100 70 100 250 520 @ @ @ @ $50 55 54 58 = = = = $ 5,000 3,850 5,400 14,500 $28,750

@ @ @ @

= = = =

100 units @ $58 = $5,800

@ @ @

= = =

100 units @ $50 = $5,000

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ATC 8-2 a. (cont.) Weighted Average Total Cost $28,750 Cost of Goods Sold Ending Inventory ÷ ÷ Total Units 520 @ @ = = $55.288 $55.288 Cost per Unit $55.288 = = $23,221 $5,529

420 units 100 units

Blue Bird Company Income Statements Sales (220 @$80; 200 @ $90) Cost of Goods Sold Gross Margin Operating Expenses Income Before Tax Income Tax (30%) Net Income FIFO $35,600 (22,950) 12,650 (3,200) 9,450 (2,835) $6,615 LIFO $35,600 (23,750) 11,850 (3,200) 8,650 (2,595) $6,055 Weighted Average $35,600 (23,221) 12,379 (3,200) 9,179 (2,754) $6,425

b. LIFO may be preferred for tax purposes in a period of rising prices because it will result in
the lowest net income and, consequently, the lowest amount of tax paid for the year. FIFO may be preferred for financial statement purposes because it will result in the higher net income in a period of rising prices. The higher net income is more favorable to stockholders. Because LIFO generally results in a deferral of the payment of income tax, if it is used for tax reporting, it must also be used for financial statement purposes to prevent abuse by taxpayers.

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ATC 8-3 Real World Case Note, all dollar amounts are in millions. a. Sales for 2000 x decrease in gross margin percentage (11.9% - 10.7%) Decrease in 2000's pretax earnings due to the lower gross margin b. Ending inventory for 2000 x Ford’s interest rate x increased portion of a year to sell inventory from 1999 to 2000 (22 days - 17 days) Increase in financing cost per inventory cycle x inventory cycles per year for 2000 (365/22) Decrease in 2000 pretax earnings due to increased financing cost resulting from longer time to sell inventory Decrease in 2000's pretax earnings due to the lower gross margin (see a. above) Decrease in 2000 pretax earnings due to increased financing cost resulting from longer time to sell inventory (see b. above) Total ÷ Decrease in pretax earnings from 1999 to 2000 Percentage of decrease in pretax earnings resulting from the lower gross margin percentage and the longer time to sell inventory $141,230.0 0.012 $ $ 1,694.8 7,514.0 0.075 5 ÷ 365 7.7 16.6 $ 127.8

c.

$

1,694.8 127.8 1,822.6 2,008.0 90.8%

÷

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ATC 8-4 Inventory turnover: $7,518,000 ÷ $289,000 = 26 inventory turnovers

365 ÷ 26 = 14 days to sell inventory The average days to sell inventory is 14 days. However, the average shelf life for the fruit sold is only 10 days. The inventory does not appear to be good collateral for the loan.

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ATC 8-5 a. First the company's gross margins must be calculated: Sales Cost of Goods Sold Gross Margin Gross margin %: Cosmos: Fantasy: Cosmos $2,000,000 (1,200,000) $ 800,000 Fantasy $2,000,000 (1,260,000) $ 740,000

$800,000 ÷ $2,000,000 = 40% $740,000 ÷ $2,000,000 = 37%

Cosmos appears to be charging more in relation to cost of goods sold. b. Inventory turnover ratios: Cosmos: $1,200,000 ÷ $240,000 = 5.0 times Fantasy: $1,260,000 ÷ $180,000 = 7.0 times Average days to sell inventory: Cosmos: 365 days ÷ 5.0 = 73 days Fantasy: 365 days ÷ 7.0 = 52 days Cosmos appears to incur the higher costs to finance inventory for two reasons: (1) it takes the longest time to sell its inventory, and (2) it has more inventory than Fantasy.

c. Other things being equal, this would indicate a company sells its product at a lower price.
The lower the price, the more quickly goods should sell. “Other things” are not equal in this problem. Fantasy is using LIFO while Cosmos is using FIFO. Assuming prices are rising, LIFO causes the gross margin percentage to be lower, due to the higher cost of goods sold. LIFO also causes ending inventory to appear to be lower. The higher cost of goods sold and the lower ending inventory resulting from LIFO both cause the inventory turnover ratio to be higher than if FIFO is being used. However, neither the lower gross margin percentage nor the higher inventory turnover ratio that results from using LIFO have any effect on cash flows, except for the related income tax effects.

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ATC 8-5 (cont.) d. First, calculate the accounts receivable turnover ratio: Cosmos: Fantasy: $2,000,000 ÷ $320,000 = 6.3 times $2,000,000 ÷ $320,000 = 6.3 times

Next, calculate the average days to collect accounts receivable: Both companies: 365 days ÷ 6.3 = 58 days

Finally, using the “average days to sell inventory” calculated in part b. and the “average days to collect accounts receivable,” calculated above, determine the length of the operating cycle. Cosmos Days to sell inventory (see b.) Days to collect receivables Operating cycle 73 58 131 Fantasy 52 58 110

The shorter a company’s operating cycle, the more quickly it gets its cash back and the more quickly this cash can be reinvested. The quicker money is reinvested, the more money can be made. As noted above in c., this is not entirely true if the shorter operating cycle results from using different inventory flow assumptions.

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ATC 8-6 a. The following amounts would be shown on the balance sheet at December 31, 2001: Assets: Investments Available for Sale Held-to-maturity Trading securities Stockholders’ Equity: Unrealized gains on investment securities (Available for Sale)

$19,978.5 $143.0 $16,535.7

$871.4 (951.3 − 79.9)

b. The memo should include an explanation of the difference in intent between available-forsale, held-to-maturity, and trading securities. Also the memo should include an explanation of how each is reported on the balance sheet.

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ATC 8-7 a. When the LIFO method is used, tax law requires companies to use the same cost flow method for financial reporting that they use for tax reporting. Consequently, if the company uses LIFO for tax purposes, then it is legally bound to use the same method in its financial statements. Accordingly, it would be illegal for Coolage to follow Bailey’s instructions. It is not unethical to report certain items one way on the tax return and a different way on the financial statements, so long as there is no legal requirement preventing it. Indeed, this is common business practice. The requirement for consistency between LIFO on the tax return and LIFO on the income statement is an exception to the general rule. Nevertheless, it would be illegal and unethical to violate the tax laws. The switch to FIFO would increase the amount of ending inventory reported on Far Eastern’s balance sheet. Assuming an inflationary economy, the first inventory purchased, which would be the lower cost inventory, would be the first inventory expensed when goods are sold under FIFO. This would leave the higher cost inventory in ending inventory which is the cost that would appear on the balance sheet. It would be unwise to pay $400,000 of additional taxes in order to increase the amount of reported net income by $800,000. Since LIFO reduces cash outflow for taxes, it increases the value of the company to its owners. The switch to FIFO would decrease the value of the company and thereby would act to deter rather than stimulate investment. According to accounting research, investors are not fooled by deceptive reporting practices. They make investment decisions on the basis of the economic consequences (i.e., cash consequences) rather than spurious values that may be reported in the financial statements.

b.

c.

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ATC 8-8 Using the EDGAR Database NOTE: This solution was accurate as of January 3, 2002. However, the EDGAR database is subject to update at any time, so this solution will likely be “dated” at the time you assign this case to your students.

These data are from the February 3, 2001 financial statements and dollar amounts are in thousands. a. b. c. Gap Company had 3,676 stores and total merchandise inventory of $1,904,153. The average inventory per store was $518. During its 2000 fiscal year, Gap opened 731 new stores and closed 73 existing stores, for a net increase of 658 stores. (See the “properties” section of MD&A) Quarter 1 2 3 4 Sales During Each Quarter $2,731,990 2,947,714 3,414,668 4,579,088

d.

Gap has higher sales during the third and fourth quarters due to Christmas sales. Yes, its inventory must also vary throughout the year to support the changing level of sales.

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