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Chapter 08 - Inventories: Measurement

Chapter 8
Question 8-1

Inventories: Measurement FOR REVIEW OF KEY QUESTIONS

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 (1) purchase of merchandise (2) sale of merchandise (3) return of merchandise (4) payment of freight debit inventory debit cost of goods sold; credit inventory credit inventory debit inventory Periodic System debit purchases no entry credit purchase returns 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 2011 and includes the shipment in its ending inventory. Bockner Company records the sale in 2011. Inventory shipped f.o.b. destination is included in the inventory of the seller until it reaches the purchasers location. Bockner would include the merchandise in its 2011 ending inventory and the sale/purchase would be recorded in 2012.

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Chapter 08 - Inventories: Measurement

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 cant 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 increase 2. Purchases increase Question 8-8 3. methods of assigning cost to ending inventory and cost of goods sold are (1) specific decrease FourEnding inventory 4. Purchase returnsfirst-out (FIFO),decrease identification, (2) first-in, (3) last-in, first-out (LIFO), and (4) average cost. 5. Freight-in increase 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, firstout (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.

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Chapter 08 - Inventories: Measurement

Answers to Questions (continued) 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 companys LIFO inventory balance could be based on unit costs actually incurred several years earlier. When inventory quantity declines during a period, then these outof-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
The gross profit, inventory turnover, and average days in inventory ratios are designed to monitor inventories. The gross profit ratio is calculated by dividing gross profit (net sales minus cost of goods sold) by net sales. Inventory turnover is calculated by dividing cost of goods sold by average inventory, and we compute average days in inventory by dividing the number of days in the period by the inventory turnover ratio.

Question 8-13
A LIFO inventory pool groups inventory units into pools based on physical similarities of the individual units. The average cost for all of a pools beginning inventory and for all of a pools 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 8-14
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.

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Chapter 08 - Inventories: Measurement

Answers to Questions (concluded) Question 8-15


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 layers base year cost measurement to layer year cost measurement using the layer years cost index and then sum the layers.

Question 8-16
The primary difference between U.S. GAAP and IFRS in the methods allowed to value inventory is that IFRS does not allow the use of the LIFO method.

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Chapter 08 - Inventories: Measurement

BRIEF EXERCISES
Brief Exercise 8-1
Beginning inventory$186,000 Plus: Purchases 945,000 Less: Cost of goods sold (982,000) Ending inventory $149,000

Brief Exercise 8-2

To record the purchase of inventory on account.

Inventory..................................................................... 845,000 ........................................................Accounts payable .......................................................................845,000

To record sales on account and cost of goods sold. Accounts receivable....................................................1,420,000 ..............................................................Sales revenue ....................................................................1,420,000 Cost of goods sold...................................................... 902,000 .....................................................................Inventory .......................................................................902,000

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Brief Exercise 8-3

Both shipments should be included in inventory. The goods shipped to a customer f.o.b. destination did not arrive at the customers location until after the fiscal year-end. They belong to Kelly until they arrive at the customers location. Title to the goods shipped from a supplier to Kelly on December 30, f.o.b. shipping point, changed hands on December 30.

Brief Exercise 8-4

Purchase price = 10 units x $25,000 = $250,000

December 28, 2011 Inventory..................................................................... 250,000 ........................................................Accounts payable .......................................................................250,000

January 6, 2012 Accounts payable........................................................ 250,000 ......................................................................Cash (99% x $250,000) .................................................................................... 247,500 .................................................................Inventory (1% x $250,000) .................................................................................... 2,500

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Chapter 08 - Inventories: Measurement

Brief Exercise 8-5


December 28, 2011 Inventory (99% x $250,000)............................................... 247,500 Accounts payable ....................................................... 247,500

January 6, 2012 Accounts payable........................................................ 247,500 ............................................................................Cash .......................................................................247,500 Cost of goods available for sale: Brief Exercise 8-6 Beginning inventory (200 x $25) $5,000 Purchases: 100 x $28 $2,800 200 x $30 6,000 8,800 Cost of goods available (500 units) $13,800 First-in, first-out (FIFO) Cost of goods available for sale (500 units) Less: Ending inventory (determined below) Cost of goods sold Cost of ending inventory: Date of purchase January 8 January 19 Total Average cost Cost of goods available for sale (500 units) Less: Ending inventory (determined below)
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$13,800 (8,100) $5,700

Units 75 200

Unit cost $28 30

Total cost $2,100 6,000 $8,100

$13,800 (7,590)

Chapter 08 - Inventories: Measurement

Cost of goods sold Cost of ending inventory: $13,800 Weighted-average unit cost = 500 units 275 units x $27.60 = $7,590 = $27.60

$6,210 *

* Alternatively, could be determined by multiplying the units sold by the average cost: 225 units x $27.60 = $6,210

Brief Exercise 8-7First-in, first-out (FIFO)


Cost of goods sold: Date of sale January 10 January 25 Total Units sold 125 (from Beg. Inv.) 75 (from Beg. Inv.) 25 (from 1/8 purchase) 225 Cost of Units Sold $25 25 28 Total Cost $3,125 1,875 700 $5,700

Ending inventory: Date of purchase Units January 8 75 January 19 200 Total

Unit cost $28 30

Total cost $2,100 6,000 $8,100

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Chapter 08 - Inventories: Measurement

Brief Exercise 8-7 (concluded) Average cost


Date Beginning inventory January 8 Available Purchased
200 @ $25 = $5,000

Sold

Balance
200 @ $25 $5,000

100 @ $28 $7,800 300 units

$2,800

= $26/unit

January 10 January 19 Available


200 @ $30 = $10,550 $28.133/unit 375 units = $6,000

125 @ $26 = $3,250 175 @ $26

$4,550

January 25
Total cost of goods sold

100 @ $28.133 = $2,813 275 @ $28.133 = $6,063

$7,737 Ending inventory

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Brief Exercise 8-8

Cost of goods available for sale: Beginning inventory (20,000 x $25) $ 2,400,000 2,900,000 375,000* $2,525,000

500,000 Purchases: 80,000 x $30 Cost of goods available (100,000 units) Less: Ending inventory (15,000 units) Cost of goods sold 15,000 units x $25 each = $375,000

Brief Exercise 8-9

64,000 units were sold.

Cost of goods sold without year-end purchase: Units purchased during the year: 60,000 x $18 $1,080,000 Plus units from beginning inventory: 4,000 x $15 60,000 Cost of goods sold 1,140,000 Cost of goods sold with year-end purchase: 64,000 units x $18 Difference 1,152,000 $ 12,000

Cost of goods sold would be $12,000 higher and income before income taxes $12,000 lower if the year-end purchase is made. If FIFO were used instead of LIFO, the year-end purchase would have no effect on income before income taxes. FIFO cost of goods sold with or without the purchase would consist of the 10,000 units from beginning inventory and 54,000 units purchased during the year at $18: 10,000 units x $15 Plus: 54,000 units x $18 Cost of goods sold $ 150,000 972,000 $1,122,000

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Chapter 08 - Inventories: Measurement

Brief Exercise 8-10

Units liquidated 5,000 Difference in cost ($30 25) Before tax LIFO liquidation profit $25,000 Tax effect ($25,000 x 40%) (10,000) LIFO liquidation profit $15,000

x $5

Brief Exercise 8-11

Cost of goods sold for the fiscal year ended February 28, 2009 would have been $78 million lower had SuperValue used FIFO for its LIFO inventory. While beginning inventory would have been $180 million higher, ending inventory also would have been higher by $258 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 the year are the same regardless of the inventory valuation method used. Cost of goods sold as reported Decrease if FIFO Cost of goods sold, FIFO instead of LIFO $34,451 million (78) million $34,373 million

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Chapter 08 - Inventories: Measurement

Brief Exercise 8-12

Average inventory = ($60,000 + 48,000) 2 = $54,000

Cost of goods sold Average inventory = Inventory turnover Cost of goods sold $54,000 = 5 Cost of goods sold = $54,000 x 5 Cost of goods sold = $270,000 Gross profit ratio = 40%, therefore cost percentage = 60% Sales x .60 = $270,000 Sales = $270,000 .60 = $450,000

Ending Inventory Brief Exercise 8-13Layers Date at Base Year Cost $1,400,000 1.00 12/31/11 $1,664,000 1.04 = $1,400,000 $1,400,000 (base) 1/1/11

at Base Year Cost

Inventory Layers Inventory Converted to Cost $1,400,000 x 1.00 =$1,400,000

Inventory DVL Cost $1,400,000

= $1,600,000 $1,400,000 (base) 200,000 (2011)

$1,400,000 x 1.00 = $1,400,000 200,000 x 1.04 = 208,000

$1,608,000

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Chapter 08 - Inventories: Measurement

EXERCISES
Exercise
1. To record the purchase of inventory on account and the payment 8-1of freight charges. 5,000

Inventory..................................................................... ........................................................Accounts payable ...........................................................................5,000 Inventory..................................................................... ............................................................................Cash ..............................................................................300

300

2.

To record purchase returns. Accounts payable........................................................ .....................................................................Inventory ..............................................................................600 600

3.

To record cash sales and cost of goods sold. Cash............................................................................ ..............................................................Sales revenue ...........................................................................5,200 Cost of goods sold...................................................... .....................................................................Inventory ...........................................................................2,800 5,200

2,800

Exercise

1. To record the purchase of inventory on account and the payment 8-2of freight charges.

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Chapter 08 - Inventories: Measurement

Purchases.................................................................... ........................................................Accounts payable ...........................................................................5,000 Freight-in..................................................................... ............................................................................Cash ..............................................................................300

5,000

300

2.

To record purchase returns. Accounts payable........................................................ ..........................................................Purchase returns ..............................................................................600 600

3.

To record cash sales. Cash............................................................................ ..............................................................Sales revenue ...........................................................................5,200 5,200

NO ENTRY IS MADE FOR THE COST OF GOODS SOLD.

Exercise 8-3Requirement 1
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

Beginning inventory $ 32,000 $240,000 (6,000) (10,000) 17,000

241,000 273,000 (40,000) $233,000

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Requirement 2 Cost of goods sold (above).......................................... 233,000 Inventory (ending)....................................................... 40,000 Purchase discounts...................................................... 6,000 Purchase returns.......................................................... 10,000 ...................................................Inventory (beginning) .........................................................................32,000 ....................................................................Purchases .......................................................................240,000 .....................................................................Freight-in .........................................................................17,000

Exercise 8-4

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Chapter 08 - Inventories: Measurement

PERPETUAL SYSTEM
($ in 000s) Purchases Inventory Accounts payable Freight Inventory Cash Returns Accounts payable Inventory Sales Accounts receivable Sales revenue Cost of goods sold Inventory End of period No entry 155 155 10 10 12 12 250 250 148 148

PERIODIC SYSTEM
Purchases Accounts payable Freight-in Cash Accounts payable Purchase returns Accounts receivable Sales revenue No entry 155 155 10 10 12 12 250 250

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

148 30 12 25 155 10 $25 $155 (12) 10 153 178 (30) $148

Exercise 8-5

249 (3) Cost of goods sold Ending inventory Cost of goods available for sale Purchases (gross)

2011 2012 Beginning inventory 225 627 621 249 (2) 225 876 846 (4) 630 610 (5)
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2013 275 (1) 584 (6) 216 800 585

Chapter 08 - Inventories: Measurement

Purchase discounts Purchase returns Freight-in

18 24 13

15 30 32

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 2011: (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 2012: (3) 2012 beginning inventory = 2011 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) 2013: (6) Cost of goods available for sale - Ending inventory = Cost of goods sold 800 - 216 = 584 = Cost of goods sold

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Chapter 08 - Inventories: Measurement

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

Inventory balance before additional transactions Exercise 8-6 $165,000 Add: Goods shipped to Kwok f.o.b. shipping point on Dec. 28 17,000 Goods shipped to customer f.o.b. destination on December 27 22,000 Correct inventory balance $204,000 Inventory balance before additional transactions Exercise 8-7 $210,000 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 (14,000) Correct inventory balance $181,000

Exercise 8-8
4. 5. 6. 7. 8. Excluded Included Excluded Included Included

1. Excluded 2. Included 3. Included

Exercise 8-9Requirement 1
Purchase price = 1,000 units x $50 = $50,000

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Chapter 08 - Inventories: Measurement

July 15, 2011 Purchases.................................................................... ........................................................Accounts payable .........................................................................50,000

50,000

July 23, 2011 Accounts payable........................................................ 50,000 ......................................................................Cash (98% x $50,000) .................................................................................... 49,000 ..................................................Purchase discounts (2% x $50,000) .................................................................................... 1,000

Requirement 2 August 15, 2011 Accounts payable........................................................ ............................................................................Cash .........................................................................50,000

50,000

Requirement 3 The 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 purchase discounts.

Exercise 8-10Requirement 1
July 15, 2011 Purchases (98% x $50,000)................................................ Accounts payable ....................................................... 49,000 49,000

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Chapter 08 - Inventories: Measurement

July 23, 2011 Accounts payable........................................................ ............................................................................Cash .........................................................................49,000

49,000

Requirement 2 August 15, 2011 Accounts payable........................................................ Interest expense.......................................................... ............................................................................Cash .........................................................................50,000

49,000 1,000

Requirement 3 The July 15 entry would include a debit to the inventory account instead of to purchases.

Exercise 8-11Requirement 1

Purchases: $500 x 70% = $350 per unit. 100 units x $350 = $35,000

November 17, 2011 Purchases.................................................................... ........................................................Accounts payable .........................................................................35,000

35,000

November 26, 2011 Accounts payable .......................................................

35,000

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Chapter 08 - Inventories: Measurement

..................................................Purchase discounts (2% x $35,000) .................................................................................... 700 ......................................................................Cash (98% x $35,000) .................................................................................... 34,300

Requirement 2 December 15, 2011 Accounts payable........................................................ ............................................................................Cash .........................................................................35,000

35,000

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Chapter 08 - Inventories: Measurement

Exercise 8-11 (concluded) Requirement 3 Requirement 1: November 17, 2011 Purchases (98% x $35,000)............................................ ........................................................Accounts payable .........................................................................34,300

34,300

November 26, 2011 Accounts payable........................................................ ............................................................................Cash .........................................................................34,300

34,300

Requirement 2: December 15, 2011 Accounts payable........................................................ Interest expense (2% x $35,000).................................... ............................................................................Cash .........................................................................35,000

34,300 700

Exercise 8-12

The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. Define the meaning of cost as it applies to the initial measurement of inventory. FASB ASC 33010301: InventoryOverallInitial Measurement.
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Chapter 08 - Inventories: Measurement

The primary basis of accounting for inventories is cost, which has been defined generally as the price paid or consideration given to acquire an asset. As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location. It is understood to mean acquisition and production cost, and its determination involves many considerations. 2. Indicate the circumstances when it is appropriate to initially measure agricultural inventory at fair value. FASB ASC 905330301: AgricultureInventoryInitial Measurement. Exceptional cases exist in which it is not practicable to determine an appropriate cost basis for products. A market basis is acceptable if the products meet all of the following criteria:

a. They have immediate marketability at quoted market prices that cannot be influenced by the producer. b. They have characteristics of unit interchangeability. c. They have relatively insignificant costs of disposal.

The accounting basis of those kinds of inventories shall be their realizable value, calculated on the basis of quoted market prices less estimated direct costs of disposal. An example is freshly dressed meats produced in meat packing operations.

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Exercise 8-12 (concluded) 3. What is a major objective of accounting for inventory? FASB ASC 33010101: InventoryOverallObjectives. A major objective of accounting for inventories is the proper determination of income through the process of matching appropriate costs against revenues. 4. Are abnormal freight charges included in the cost of inventory? FASB ASC 33010307: InventoryOverallInitial Measurement. Unallocated overheads shall be recognized as an expense in the period in which they are incurred. Other items such as abnormal freight, handling costs, and amounts of wasted materials (spoilage) require treatment as current period charges rather than as a portion of the inventory cost. Cost of goods available for sale: Exercise 8-13 Beginning inventory (2,000 x $6.10) $12,200 Purchases: 10,000 x $5.50 $55,000 6,000 x $5.00 30,000 85,000 Cost of goods available (18,000 units) $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 Cost of ending inventory: Date of purchase August 18 Units 3,000 Unit cost $5.00 Total cost $15,000 $97,200 (15,000) $82,200

Last-in, first-out (LIFO)


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Cost of goods available for sale (18,000 units) Less: Ending inventory (determined below) Cost of goods sold Cost of ending inventory: Date of purchase Beg. Inv. August 8 Units 2,000 1,000 Total Unit cost $6.10 5.50 Total cost $12,200 5,500 $17,700

$97,200 (17,700) $79,500

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Chapter 08 - Inventories: Measurement

Exercise 8-13 (concluded) Average cost Cost of goods available for sale (18,000 units) Less: Ending inventory (determined below) Cost of goods sold Cost of ending inventory: $97,200 Weighted-average unit cost = 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 First-in, first-out (FIFO) Cost of goods sold: Cost of Units Sold $6.10 5.50 5.50 5.00 Total Cost $12,200 33,000 22,000 15,000 $82,200 = $5.40 $97,200 (16,200) $81,000 *

Exercise 8-14
Date of sale Aug. 14 Aug. 25 Total

Units sold 2,000 (from Beg. Inv.) 6,000 (from 8/8 purchase) 4,000 (from 8/8 purchase) 3,000 (from 8/18 purchase) 15,000

Ending inventory = 3,000 units x $5.00 = $15,000

Last-in, first-out (LIFO)


Date Beginning inventory Purchased
2,000 @ $6.10 = $12,200

Sold

Balance
2,000 @ $6.10 $12,200

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Chapter 08 - Inventories: Measurement 10,000 @ $5.50 = $55,000 8,000 @ $ 5.50 = 6,000 @ $5.00 = $30,000 $44,000 2,000 @ $6.10 10,000 @ $5.50 2,000 @ $6.10 2,000 @ $5.50 2,000 @ $6.10 2,000 @ $5.50 6,000 @ $5.00 6,000 @ $5.00 = 1,000 @ $5.50 = Total cost of goods sold = $30,000 $ 5,500 $79,500 2,000 @ $6.10 1,000 @ $5.50

August 8 August 14 August 18

$67,200 $23,200 $53,200

August 25

$17,700 Ending inventory

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Exercise 8-14 (concluded) (Note: the perpetual inventory LIFO results in this exercise are the same as periodic LIFO results, 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 Available Purchased
2,000 @ $6.10 = $12,200

Sold

Balance
2,000 @ $6.10 $12,200

10,000 @ $5.50 = $67,200 12,000 units

$55,000

= $5.60/unit

August 14 August 18 Available August 25


Total cost of goods sold 6,000 @ $5.00 = $52,400 10,000 units = $5.24/unit $30,000

8,000 @ $5.60 =

$44,800 4,000 @ $5.60

$22,400

7,000 @ $5.24 = =

$36,680 3,000 @ $5.24 $81,480

$15,720 Ending inventory

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.

Exercise 8-15

Requirement 2 Cost of goods available for sale: Beginning inventory (600 x $80) Purchases:
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$ 48,000

Chapter 08 - Inventories: Measurement

1,000 x $ 95 $95,000 800 x $100 80,000 Cost of goods available (2,400 units) First-in, first-out (FIFO) Cost of goods available for sale (2,400 units) Less: Ending inventory (below) Cost of goods sold Cost of ending inventory: Date of purchase January 21 Units 800 Unit cost $100 Total cost $80,000

175,000 $223,000

$223,000 (80,000) $143,000

Last-in, first-out (LIFO) Cost of goods available for sale (2,400 units) Less: Ending inventory (below) Cost of goods sold Cost of ending inventory: Date of purchase Beg. Inv. January 15 Total Units 600 200 Unit cost $80 95 Total cost $48,000 19,000 $67,000 $223,000 (67,000) $156,000

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Exercise 8-16Requirement 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)

$ 50,000 117,200 $167,200 $167,200 (73,150) $ 94,050*

Cost of goods available for sale (16,000 units) Less: Ending inventory (below) Cost of goods sold Cost of ending inventory: $167,200 Weighted-average unit cost = 16,000 units 7,000 units x $10.45 = $73,150

= $10.45

* Alternatively, could be determined by multiplying the units sold by the average cost: 9,000 units x $10.45 = $94,050

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Exercise 8-16 (concluded) Requirement 2


Date
Beginning inventory September 7 Available

Purchased
5,000 @ $10.00 = $50,000

Sold

Balance
5,000 @ $10.00 $50,000

3,000 @ $10.40 = $81,200 8,000 units

$31,200

= $10.15/unit

September 10 September 25 Available


8,000 @ $10.75 = $126,600 12,000 units $86,000

4,000 @ $10.15 =

$40,600 4,000 @ $10.15

$40,600

= $10.55/unit

September 29
Total cost of goods sold

5,000 @ $10.55 = =

$52,750 7,000 @ $10.55 $93,350

$73,850 Ending inventory

Exercise 8-17Requirement 1

FIFO cost of goods sold: = $50,000 = 60,000 $110,000

10,000 units @ $5.00 + 10,000 units @ $6.00 (determined below) Requirement 2 LIFO cost of goods sold: 20,000 units @ $6.00 (determined below)

= $120,000

Calculations to determine cost per unit of year 2011 purchases:


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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 2011 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) $ 50,000 180,000 $230,000

Exercise 8-18Requirement 1
February 27, 2009
millions) ($ in

LIFO reserve ($29.6-27.2)............................................. ......................................................Cost of goods sold ..................................................................................2.4

2.4

Requirement 2 $2,236.7 + 2.4 = $2,239.1 millionRequirement 1 Cost of goods sold: Exercise 8-19 50,000 units x $8.50 = 4,000 units x $7.00 = $453,000

$425,000 28,000

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Chapter 08 - Inventories: Measurement

Requirement 2 When inventory quantity declines during a reporting period, liquidation of LIFO inventory layers carried at different 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 $6,000 [4,000 units liquidated x $1.50 ($8.50 current year cost per unit - $7 LIFO layer cost per unit)].

Exercise 8-20Requirement 2

The specific citation that describes the disclosure requirements that must be made by publicly traded companies for a LIFO liquidation is FASB ASC 33010S993: InventoryOverallSEC MaterialsLIFO Liquidations. Requirement 3 When a company using LIFO liquidates a substantial portion of its LIFO inventory and as a result includes a material amount of income in its income statement that otherwise would not have been recorded must disclose the amount of income realized as a result of the inventory liquidation. Such disclosure would be required in order to make the financial statements not misleading. Disclosure may be made either in a footnote or parenthetically on the face of the income statement.

Exercise 8-21
Gross profit ratio

($ in millions)

HOME DEPOT

LOWES 16,501 48,230 31,729 7,910 365 4.01 = 34.2% = 4.01 = 91 days

= 23,990 = 33.7% 71,288 = 47,298 = 4.22 11,202 = 365 4.22 = 86 days

Inventory turnover Average days in inventory

The gross profit ratios for the two companies are almost identical and similar to the industry average (33%). On average, Home Depot turns over its inventory five days faster than both Lowes and the industry average.
Ending

Exercise 8-22
8-33

Chapter 08 - Inventories: Measurement Ending Inventory at Base Year Cost $660,000 = $660,000 1.00 $690,000 = $663,462 1.04 $760,000 = $703,704 1.08 Inventory Layers at Base Year Cost $660,000 (base) Inventory Layers Converted to Cost $660,000 x 1.00 = $660,000 Inventory DVL Cost $660,000

Date 1/1/11

12/31/11

$660,000 (base) 3,462 (2011)

$660,000 x 1.00 = $660,000 3,462 x 1.04 = 3,600

663,600

12/31/12

$660,000 (base) 3,462 (2011) 40,242 (2012) Ending Inventory Inventory at Base Year Cost $200,000 (base)

$660,000 x 1.00 = $660,000 3,462 x 1.04 = 3,600 40,242 x 1.08 = 43,461 Inventory Layers Converted to Cost $200,000 x 1.00 = $200,000

Exercise 8-23Layers
Date at Base Year Cost 12/31/11 $200,000 = $200,000 1.00 $231,000 Index

707,061 Ending Inventory DVL Cost $200,000

12/31/12

= $220,000

Index = 1.05 $200,000 (base) 20,000 (2012) $200,000 x 1.00 = $200,000 20,000 x 1.05 = 21,000 221,000

12/31/13

$299,000 Index

= $260,000

Index = 1.15 $200,000 (base) 20,000 (2012) 40,000 (2013) $200,000 x 1.00 = $200,000 20,000 x 1.05 = 21,000 40,000 x 1.15 = 46,000

267,000

12/31/14

$300,000 Index = $250,000 Index = 1.20 $200,000 (base) 20,000 (2012) 30,000 (2013) $200,000 x 1.00 = $200,000 20,000 x 1.05 = 21,000 30,000 x 1.15 = 34,500

255,500

Exercise 8-24

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Chapter 08 - Inventories: Measurement

List A i l a c g h k e f 1. Perpetual inventory system 2. Periodic inventory system 3. F.o.b. shipping point 4. Gross method 5. Net method 6. Cost index 7. F.o.b. destination 8. FIFO 9. LIFO

List B 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 yearend 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.

b 10. Consignment j 11. Average cost d 12. IRS conformity rule

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CPA / CMA REVIEW QUESTIONS


CPA Exam Questions
1.

d.

2.

c. Under the net method, purchases are recorded net of the discount: $3,600 x 98% = $3,528 3. b. Average Cost = $4,950 / 140 units = $35.36 per unit Ending Inventory = $35.36 x 5 = $176.79 4. a. 5 units x $30 = $150 5. c. 5 units x $50 = $250 6. b. If the inventory balance was lower using FIFO than LIFO, then prices during the period were moving downward. By using FIFO during such a period, the higher priced items are sold first with lower-priced goods remaining in the ending inventory.
7. b. Inventory at base year cost $100,000 120,000 128,000 Layer at base Cost year cost Index 1.00 $20,000 1.05 8,000 1.10 Layer at current year cost $21,000 8,800 Ending Inventory $100,000 121,000 129,800

Date 1/1/11 12/31/11 12/31/12

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Chapter 08 - Inventories: Measurement

CMA Exam Questions


1. c. The company began March with 3,200 units in inventory at $64.30 each. The March 4 purchase added 3,400 additional units at $64.75 each. Under FIFO, the 3,600 units sold on March 14 were the oldest units. That sale eliminated all of the 3,200 units priced at $64.30 and 400 of the units priced at $64.75, leaving an inventory of 3,000 units at $64.75 prior to the March 25 purchase. On March 25, 3,500 units were acquired at $66. The 3,450 units sold on March 28 were the 3,000 remaining units priced at $64.75 and 450 units priced at $66. The ending inventory consists of 3,050 units at $66 each, or $201,300. The answer would have been the same under the periodic FIFO method. 2. a. The ending inventory consists of 3,050 units (beginning inventory plus purchases, minus sales). Under the periodic LIFO method, those units are valued at the oldest prices for the period, which is $64.30 of the beginning inventory. Multiplying $64.30 times 3,050 units produces a total inventory value of $196,115.
3. a.

Under the perpetual LIFO method, the company begins with 3,200 units at $64.30. Added to this is the March 4 purchase of 3,400 units at $64.75. The March 14 sale uses all of the March 4 purchase and 200 of the original inventory units. Thus, the firm is left with 3,000 units at $64.30. The March 25 purchase of 3,500 at $66 is added to the previous 3,000 units. The March 28 sale of 3,450 units comes entirely from the March 25 purchase, leaving just 50 of those units at $66 each. Thus, at the end of the month, the inventory consists of two layers: 3,000 units at $64.30 ($192,200), and 50 units at $66 ($3,300). Adding the two together produces a total ending inventory of $196,200.

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Chapter 08 - Inventories: Measurement

PROBLEMS
Problem 8-1Requirement 1
of freight charges. October 12, 2011 Purchases (98% x $22,000)............................................ .......................................................Accounts payable .........................................................................21,560 Freight-in..................................................................... ............................................................................Cash ..............................................................................500 a. To record the purchase of inventory on account and the payment

21,560

500

b.

To record purchase returns. October 18, 2011 Accounts payable........................................................ ..........................................................Purchase returns ...........................................................................3,000

3,000

c.

To record payment of accounts payable. October 31, 2011 Accounts payable........................................................ Interest expense.......................................................... ............................................................................Cash .........................................................................22,000

21,560 440

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Chapter 08 - Inventories: Measurement

Problem 8-1 (continued) d. To record sales on account. October, 2011 Accounts receivable.................................................... ..............................................................Sales revenue .........................................................................28,000 No entry is made for the cost of goods sold.

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 Adjusting entry: October 31, 2011 Cost of goods sold (above)........................................... Inventory (ending)........................................................ Purchase returns.......................................................... ....................................................Inventory (beginning) .........................................................................15,000 ....................................................................Purchases .........................................................................21,560 .....................................................................Freight-in ..............................................................................500 18,000 16,060 3,000 $15,000

19,060 34,060 (16,060) $18,000

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Chapter 08 - Inventories: Measurement

Problem 8-1 (concluded) Requirement 2 a. To record the purchase of inventory on account and the payment of freight charges. October 12, 2011 Inventory (98% x $22,000)............................................. .......................................................Accounts payable .........................................................................21,560 Inventory..................................................................... ............................................................................Cash ..............................................................................500

21,560

500

b.

To record purchase returns. October 18, 2011 Accounts payable........................................................ .....................................................................Inventory ...........................................................................3,000

3,000

c.

To record payment of accounts payable. October 31, 2011 Accounts payable........................................................ Interest expense.......................................................... ............................................................................Cash .........................................................................22,000

21,560 440

d.

To record sales on account. October, 2011

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Chapter 08 - Inventories: Measurement

Accounts receivable.................................................... ..............................................................Sales revenue .........................................................................28,000 Cost of goods sold...................................................... .....................................................................Inventory .........................................................................18,000

28,000

18,000

1. The transaction is not correctly accounted for. Inventory held on Problem 8-2 consignment by another company should be included in the inventory of the consignor. Rasul should include this merchandise in its 2011 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 2011 and include the merchandise in its 2011 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 2012, it should be included in Rasuls 2011 ending inventory. The sale should be recorded in 2012. 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 Rasuls location until 2012, it should not be included in Rasuls 2011 ending inventory. The purchase is correctly recorded in 2012. Accounts Problem 8-3 Inventory Payable Sales Initial amounts $1,250,000 $1,000,000 $9,000,000 Adjustments - increase (decrease): 1. (155,000) (155,000) NONE 2. (22,000) NONE NONE 3. NONE NONE 40,000 4. 210,000 NONE NONE 5. 25,000 25,000 NONE 6. 2,000 2,000 NONE 7. (5,300) (5,300) NONE Total adjustments 54,700 (133,300) 40,000
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Chapter 08 - Inventories: Measurement

Adjusted amounts

$1,304,700

$ 866,700

$9,040,000

Problem 8-4Requirement 1
$ 80,000 Net purchases: Purchases (50,000* units x $10.00) Less: Returns (1,000 units x $10.50) Less: Purchase discounts
($500,000 x 2%) Plus: Freight-in (50,000 units x $.50) Cost of goods available (59,000 units) Less: Ending inventory (below)

Beginning inventory (10,000 x $8.00) $500,000 (10,500) (10,000) 25,000 504,500 584,500 (121,200) $463,300

Cost of goods sold

* The 5,000 units purchased on December 28 are not included. The merchandise was shipped f.o.b. destination and did not arrive at Johnsons warehouse until 2012. Cost of ending inventory: Date of purchase Beg. Inv. 2011 Total Units 10,000 4,000 14,000 Unit cost Total cost $ 8.00 $ 80,000 10.30** 41,200 $121,200

**$10 x 98% = $9.80 + .50 in freight charges = $10.30 Requirement 2 Sales (45,000 units x $18.00) $810,000 Less: Cost of goods sold (above) $463,300 Other operating expenses 150,000 (613,300) Income before income taxes $196,700 Cost of goods available for sale for periodic system:

Problem 8-5

Beginning inventory (6,000 x $8.00)

48,000 Purchases: 5,000 x $ 9.00 $45,000 6,000 x $10.00 60,000 Cost of goods available (17,000 units)

105,000 $153,000

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Chapter 08 - Inventories: Measurement

1. FIFO, periodic system Cost of goods available for sale (17,000 units) Less: Ending inventory (determined below) Cost of goods sold Cost of ending inventory: Date of purchase Jan. 10 Jan. 18 Totals Units 2,000 6,000 8,000 Unit cost $ 9.00 10.00 Total cost $18,000 60,000 $78,000 $153,000 (78,000) $ 75,000

Alternatively, cost of goods sold can be determined by adding the cost of the 6,000 units in beginning inventory ($48,000) and the 3,000 units from the January 10 purchase ($27,000) = $75,000.

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Chapter 08 - Inventories: Measurement

Problem 8-5 (continued) 2. LIFO, periodic system Cost of goods available for sale (17,000 units) Less: Ending inventory (determined below) Cost of goods sold Cost of ending inventory: Date of purchase Beg. Inv. Jan. 10 Totals Units 6,000 2,000 8,000 Unit cost $8.00 9.00 Total cost $48,000 18,000 $66,000 $153,000 (66,000) $ 87,000

Alternatively, cost of goods sold can be determined by adding the cost of the 6,000 units from the January 18 purchase ($60,000) and the 3,000 units from the January 10 purchase ($27,000) = $87,000.

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Chapter 08 - Inventories: Measurement

Problem 8-5 (continued) 3. LIFO, perpetual system


Date Beginning inventory January 5 January 10 January 12 January 18
6,000 @ $10.00 = $60,000 5,000 @ $9.00 = $45,000 2,000 @ $9.00 =

Purchased
6,000 @ $8.00 = $48,000

Sold

Balance
6,000 @ $8.00 $48,000

3,000 @ $8.00 =

$24,000 3,000 @ $8.00 3,000 @ $8.00 5,000 @ $9.00 $18,000 3,000 @ $8.00 3,000 @ $9.00 3,000 @ $8.00 3,000 @ $9.00 6,000 @ $10.00

$24,000

$69,000 $51,000 $111,000

January 20

4,000 @ $10.00 =

$40,000 3,000 @ $8.00 3,000 @ $9.00 2,000 @ $10.00 $82,000

$71,000 Ending inventory

Total cost of goods sold

4. Average cost, periodic system Cost of goods available for sale (17,000 units) Less: Ending inventory (below) Cost of goods sold Cost of ending inventory: Weighted-average unit cost = 8,000 units x $9.00 = $72,000 Alternatively, cost of goods sold could be determined by multiplying the units sold by the average cost: 9,000 units x $9.00 = $81,000. $153,000 = $9.00 17,000 units $153,000 (72,000) $ 81,000

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Chapter 08 - Inventories: Measurement

Problem 8-5 (concluded) 5. Average cost, perpetual system


Date Beginning inventory January 5 January 10 Available
5,000 @ $9.00 = $69,000 8,000 units $45,000

Purchased
6,000 @ $8.00 = $48,000

Sold

Balance
6,000 @ $8.00 $48,000

3,000 @ $8.00 =

$24,000 3,000 @ $8.00

$24,000

= $8.625/unit

January 12 January 18 Available


6,000 @ $10.00 = $111,750 12,000 units $60,000

2,000 @ $8.625 =

$17,250 6,000 @ $8.625

$51,750

= $9.3125/unit

January 20

4,000 @ $9.3125 = $37,250 8,000 @ $9.3125

$74,500 Ending inventory

Total cost of goods sold

= $78,500

Problem 8-6Requirement 1

Cost of goods available for sale for periodic system: $20,000 54,000 85,000 $159,000

Purchases: 5,000 x $4.00 12,000 x $4.50 17,000 x $5.00 Cost of goods available (34,000 units) a. FIFO

Cost of goods available for sale (34,000 units)


8-46

$159,000

Chapter 08 - Inventories: Measurement

Less: Ending inventory (determined below) Cost of goods sold Cost of ending inventory: Date of purchase March 22 Units 14,000 Unit cost 5.00 Total cost 70,000

(70,000) $ 89,000

b. LIFO Cost of goods available for sale (34,000 units) Less: Ending inventory (determined below) Cost of goods sold Cost of ending inventory: Date of purchase Jan. 7 Feb. 16 Totals Units 5,000 9,000 14,000 Unit cost $4.00 4.50 Total cost $20,000 40,500 $60,500 $159,000 (60,500) $ 98,500

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Chapter 08 - Inventories: Measurement

Problem 8-6 (concluded) c. Average cost Cost of goods available for sale (34,000 units) Less: Ending inventory (below) Cost of goods sold Cost of ending inventory: Weighted-average unit cost = $159,000 = $4.6765 34,000 units $159,000 (65,471) $ 93,529*

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: LIFO: Average: $51,000* $140,000** = 36% $41,500* $140,000** = 30% $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.

Problem 8-7Requirement 1
$183,000 Purchases: 211 212 213 214 215 216 $63,000 63,000 64,500 66,000 69,000 70,500

Beginning inventory ($60,000 + 60,000 + 63,000)

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Chapter 08 - Inventories: Measurement

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 Requirement 2 Cost of goods available for sale Less: Ending inventory (below) Cost of goods sold Cost of ending inventory (3 autos): Car ID 219 218 217 Total Cost $ 75,000 72,300 72,000 $219,300

615,300 798,300

(210,000) $588,300

$798,300 (219,300) $579,000

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Chapter 08 - Inventories: Measurement

Problem 8-7 (concluded) Requirement 3 Cost of goods available for sale Less: Ending inventory (below) Cost of goods sold Cost of ending inventory (3 autos): Car ID 203 207 210 Total Requirement 4 Cost of goods available for sale (12 units) Less: Ending inventory (below) Cost of goods sold Cost of ending inventory: $798,300 Weighted-average unit cost = 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 = $66,525 $798,300 (199,575) $598,725* Cost $ 60,000 60,000 63,000 $183,000 $798,300 (183,000) $615,300

Problem 8-8Requirement 1

The note indicates that if the company had used FIFO, inventory would have been higher by $3,183 million and $2,617 million at the end of

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Chapter 08 - Inventories: Measurement

2008 and 2007, respectively. Therefore, 2008 cost of goods sold would have been lower (and income before tax higher) by $566 million ($3,183 - 2,617). The information provided also states that net income for 2008 would have been higher by $447 million if FIFO had been used. This means that the tax effect of the difference between LIFO and FIFO was $119 million ($566 - 447). The effective tax rate is therefore approximately 21% ($119 $566). Requirement 2 The information might be useful to a financial analyst interested in comparing Caterpillars performance with another company using the FIFO inventory method exclusively. Requirement 3 Retained earnings would have been higher by approximately $2,515 million [$3,183 million x (1 - .21)].

Problem 8-9Requirement 1
Purchases: 30,000 units @ $25 Cost of goods available for sale Less: Ending inventory (below) Cost of goods sold Cost of ending inventory: Date of purchase Units Beg. Inv. 10,000 Beg. Inv. 5,000 Totals 15,000

Beginning inventory 750,000 1,200,000 (250,000) $ 950,000

$ 450,000

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 2011 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

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Chapter 08 - Inventories: Measurement

Problem 8-10
2011:

Requirement 1

Cost of goods sold: 1,000 x $16 = $ 16,000 10,000 x $18 = 180,000 11,000 $196,000 1,500 x $16 = $ 24,000 13,000 x $18 = 234,000 14,500 $258,000 1,000 x $12 = $ 12,000 12,000 x $18 = 216,000 13,000 $228,000

2012:

2013:

Requirement 2 LIFO liquidation before-tax profit or loss: 2011: 1,000 units x $2 ($18 16) = 2012: 1,500 units x $2 ($18 16) = 2013: 1,000 units x $6 ($18 12) = Requirement 3 Disclosure note: During fiscal 2013, 2012, and 2011, inventory quantities in certain LIFO layers were reduced. These reductions resulted in a liquidation of LIFO inventory quantities carried at lower costs prevailing in prior years as compared with the cost of fiscal 2013, 2012, and 2011 purchases. As a result, cost of goods sold decreased by $6,000, $3,000, and $2,000 in fiscal 2013, 2012, and 2011, respectively, and net income increased by approximately $3,600, $1,800, and $1,200, respectively. $2,000 profit $3,000 profit $6,000 profit

Problem 8-11Requirement 1

Sales (27,000 units x $2,000) Less: Cost of goods sold (27,000 units x $1,000) Gross profit

$54,000,000 (27,000,000) $27,000,000

Gross profit ratio = $27,000,000 $54,000,000 = 50%

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Chapter 08 - Inventories: Measurement

Requirement 2 Sales (27,000 units x $2,000) Less: Cost of goods sold* Gross profit $54,000,000 (25,000,000) $29,000,000

Gross profit ratio = $29,000,000 $54,000,000 = 53.7% *Cost of goods sold: 15,000 units x $1,000 6,000 units x $ 900 4,000 units x $ 800 2,000 units x $ 700 27,000 units

= = = =

$15,000,000 5,400,000 3,200,000 1,400,000 $25,000,000

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Chapter 08 - Inventories: Measurement

Problem 8-11 (concluded) Requirement 3 The gross profit and gross profit ratio are higher applying the requirement 2 assumption of 15,000 units purchased because of the LIFO liquidation profit that results. When inventory quantity declines during a reporting period, LIFO inventory layers carried at costs prevailing in prior years are liquidated or assumed sold in the cost of goods sold calculation. This results in noncurrent costs being matched with current selling prices. If the company had purchased at least 27,000 units during 2007, there would be no LIFO liquidation. The profit difference ($2,000,000 in this case), if material, must be disclosed in a note. The difference can be arrived at by comparing the current replacement cost of $1,000 with each inventory layer from prior years that were included in this years cost of goods sold, as follows: 6,000 units x $100 ($1,000 900) 4,000 units x $200 ($1,000 800) 2,000 units x $300 ($1,000 700) Total LIFO liquidation profit Requirement 4 Sales (27,000 units x $2,000) Cost of goods sold: 5,000 units x $700 4,000 units x $800 6,000 units x $900 12,000 units x $1,000 27,000 units $ 600,000 800,000 600,000 $2,000,000 $54,000,000 $ 3,500,000 3,200,000 5,400,000 12,000,000 Gross profit =

24,100,000 $29,900,000

Gross profit ratio = $29,900,000 $54,000,000 = 55.4% If only 15,000 units are purchased, cost of goods sold, gross profit, and the gross profit ratio would be exactly the same as when 28,000 units are purchased. Requirement 5 The number of units purchased has no effect on FIFO cost of goods sold. When applying the first-in, first-out approach, beginning inventory costs are included in cost of goods sold first, regardless of the quantities of inventory purchased in the new reporting period.

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Chapter 08 - Inventories: Measurement

Problem 8-12Requirement 1
Allowance for uncollectible accounts Balance, beginning of year Add: Bad debt expense for 2011 Less: End-of-year balance Accounts receivable written off Requirement 2 Accounts receivable analysis: Balance, beginning of year ($583 + 7) Add: Credit sales Less: write-offs (from Requirement 1) Less: Balance end of year ($703 + 10) Cash collections $ 590 6,255 (5) (713) $6,127 $7 8 (10) $5

Requirement 3 Cost of goods sold for 2011 would have been $130 million lower had Inverness used the average cost method for its entire inventory. While beginning inventory would have been $350 million higher, ending inventory also would have been higher by $480 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 the year are the same regardless of the inventory valuation method used. Therefore, cost of goods sold would have been $5,060 ($5,190 130). Requirement 4 a. Receivables turnover ratio b. Inventory turnover ratio c. Gross profit ratio = = $6,255 ($703 + 583)/2 $5,190 ($880 + 808)/2 = = = 9.73 6.15 17%

= ($6,255- 5,190) $6,255

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Chapter 08 - Inventories: Measurement

Problem 8-12 (concluded) Requirement 5 If inventory costs are increasing, 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. The income generated by this liquidation is known as LIFO liquidation profit. The liquidation caused 2011 cost of goods sold to be lower by $9.23 million [$6 million (1 - .35)]

Problem 8-13Layers
Date 1/1/11 at Base Year Cost $400,000 1.00 12/31/11 $441,000 1.05 12/31/12 $487,200 1.12 12/31/13 $510,000 1.20 = $425,000 = $435,000 = $420,000 = $400,000

Ending Inventory Inventory at Base Year Cost $400,000 (base)

Inventory Layers Converted to Cost $400,000 x 1.00 = $400,000

Ending Inventory DVL Cost $400,000

$400,000 (base) 20,000 (2011) $400,000 (base) 20,000 (2011) 15,000 (2012) $400,000 (base) 20,000 (2011) 5,000 (2012) Ending Inventory at Base Year Cost $150,000 (base)

$400,000 x 1.00 = 20,000 x 1.05 = $400,000 x 1.00 = 20,000 x 1.05 = 15,000 x 1.12 = $400,000 x 1.00 = 20,000 x 1.05 = 5,000 x 1.12 = Inventory Layers

$400,000 21,000 $400,000 21,000 16,800 $400,000 21,000 5,600

421,000

437,800

426,600 Ending Inventory DVL Cost $150,000

Problem 8-14
Layers Date 1/1/11 Inventory at Base Year Cost $150,000 1.00 12/31/11 $200,000 1.08 12/31/12 $245,700 1.17 12/31/13 $235,980 1.14 = $210,000 = $185,185 = $150,000

Converted to Cost $150,000 x 1.00 = $150,000

$150,000 (base) 35,185 (2011) $150,000 (base) 35,185 (2011) 24,815 (2012) $150,000 (base) 35,185 (2011) 21,815 (2012)

$150,000 x 1.00 = 35,185 x 1.08 = $150,000 x 1.00 = 35,185 x 1.08 = 24,815 x 1.17 = $150,000 x 1.00 = 35,185 x 1.08 = 21,815 x 1.17 =

$150,000 38,000 $150,000 38,000 29,034 $150,000 38,000 25,524

188,000

217,034

= $207,000

213,524

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12/31/14

$228,800 1.10

= $208,000

$150,000 (base) 35,185 (2011) 21,815 (2012) 1,000 (2014)

$150,000 35,185 21,815 1,000

x 1.00 x 1.08 x 1.17 x 1.10

= = = =

$150,000 38,000 25,524 1,100

214,624

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Problem 8-15
Layers Date 1/1/11 Inventory at Base Year Cost $260,000 1.00 12/31/11 $340,000 1.02 12/31/12 $350,000 1.06 12/31/13 $400,000 1.07 12/31/14 $430,000 1.10 = $373,832 = $330,189 = $333,333 = $260,000

Ending Inventory at Base Year Cost $260,000 (base)

Inventory Layers Converted to Cost $260,000 x 1.00 = $260,000

Ending Inventory DVL Cost $260,000

$260,000 (base) 73,333 (2011) $260,000 (base) 70,189 (2011) $260,000 (base) 70,189 (2011) 43,643 (2013) $260,000 (base) 70,189 (2011) 43,643 (2013) 17,077 (2014)

$260,000 x 1.00 = 73,333 x 1.02 = $260,000 x 1.00 = 70,189 x 1.02 = $260,000 x 1.00 = 70,189 x 1.02 = 43,643 x 1.07 = $260,000 70,189 43,643 17,077 x 1.00 x 1.02 x 1.07 x 1.10 = = = =

$260,000 74,800 $260,000 71,593 $260,000 71,593 46,698 $260,000 71,593 46,698 18,785

334,800

331,593

378,291

= $390,909

397,076

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Problem 8-16
Layers Date 1/1/11 Inventory at Base Year Cost $84,000 1.00 12/31/11 $100,800 1.05 12/31/12 $136,800 1.14 12/31/13 $150,000 = $120,000 = $96,000 = $84,000

Ending Inventory at Base Year Cost $84,000 (base)

Inventory Layers Converted to Cost $84,000 x 1.00 = $84,000

Ending Inventory DVL Cost $84,000

$84,000 (base) 12,000 (2011) $84,000 (base) 12,000 (2011) 24,000 (2012) $84,000 (base) 12,000 (2011) 24,000 (2012) 5,000 (2013) $84,000 (base) 12,000 (2011) 24,000 (2012) 5,000 (2013) 3,000 (2014)

$84,000 12,000 $84,000 12,000 24,000 $84,000 12,000 24,000 5,000 $84,000 12,000 24,000 5,000 3,000(3)

x 1.00 = x 1.05 = x 1.00 = x 1.05 = x 1.14 = x 1.00 x 1.05 x 1.14 x 1.20 x 1.00 x 1.05 x 1.14 x 1.20 x 1.25 = = = = = = = = =

$84,000 12,600 84,000 12,600 27,360 $84,000 12,600 27,360 6,000 84,000 12,600 27,360 6,000 3,750(2)

96,600

123,960

= $125,000 1.20 (1)

129,960

12/31/14

$160,000(5) = $128,000(4) 1.25

133,710

(1) (2) (3) (4) (5)

$150,000 $125,000 = 1.20 (2013 cost index) $133,710 129,960 = $3,750 $3,750 1.25 = $3,000 $125,000 + 3,000 = $128,000 (2014 inventory at base-year cost) $128,000 x 1.25 = $160,000(2014 inventory at year-end costs)

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CASES
Advance warning of the company's impending Judgment Case 8-1bankruptcy 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-Go-Round'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.

Real World Case 8-2Requirement 1

Identifying items that should be included in inventory is difficult due to goods in transit, goods on consignment, and sales returns. Goods in transit. Inventory shipped f.o.b. shipping point is included in the purchasers inventory as soon as the merchandise is shipped. On the other hand, inventory shipped f.o.b. destination is included in the purchasers inventory only after it reaches the purchasers location. Goods on consignment. Goods held on consignment are included in the inventory of the consignor until sold by the consignee. Sales returns. When the right of return exists, a seller must be able to estimate those returns. As a result, a company includes in inventory the cost of merchandise it anticipates will be returned. Requirement 2 In addition to the direct acquisition costs such as the price paid and transportation costs to obtain inventory, the costs of unloading, unpacking, and preparing inventory for sale or raw materials for use, if material in amount, also should be included in the cost of inventory. Requirement 3 Sport Chalet considers cost to include the direct cost of merchandise and inbound freight, plus internal costs associated with merchandise procurement, storage and handling.

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1. a. The specific identification method requires each Judgment Case 8-3unit 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. Managements ability to manipulate cost of goods sold is minimized because once the inventory is in the retailers hands, Happlias 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 unit 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 2011 income statement should report in cost of goods sold all inventory costs related to units sold in 2011, 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.

Communication Case 8-4


ending inventory

Suggested Grading Concepts and Grading Scheme: Content (70%) 20 Describes the differential effect on

________

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.
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_______ 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

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LIFO produces a higher cost of goods sold, Communication Case 8-5lower taxable income and therefore lower income taxes currently payable than FIFO only in periods when the costs of the companys 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. At the end of a reporting period it is important to ensure Judgment Case 8-6that 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 buyers 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.

Ethics Case 8-7Requirement 1

Without purchase of the additional units: Sales (35,000 @ $60) $2,100,000 Cost of goods sold (35,000 x $30) (1,050,000) Gross profit $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 Due Jim Lester ($850,000 x 20%) = $170,000 $2,100,000 (1,250,000) $ 850,000

Requirement 2 Discussion should include these elements.

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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 2012, 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?

Real World Case 8-8Requirement 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 inventories valued using LIFO and inventory valued as if another method had been used. Kroger's note provides this supplemental information. Requirement 2 1/31/09 Ending Beginning Inventory Inventory
($ in millions)

Inventory as stated Add: Increase in LIFO inventory FIFO inventory balances

$4,859 800 $5,659

$4,849 604 $5,453

Requirement 3 Cost of goods sold for the fiscal year ended January 31, 2009 would have been $196 million lower had Kroger used FIFO for its entire inventory. While beginning inventory would have been $604 million higher, ending inventory also would have been higher by $800 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 the year are the same regardless of the inventory valuation method used.
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Requirement 3 Real World Case 8-9 The following is based on Whole Food's 2009 financial statements. Answers will vary depending on the financial statement dates chosen. a.Whole Foods uses the last-in, first-out (LIFO) method for approximately 93.6% of its inventories at the end of 2009 and 94% of its inventories at the end of 2008 and FIFO for the remainder. b. Assuming that current cost approximates FIFO cost, the inventory disclosure note indicates that, if FIFO had been used to value LIFO inventories, inventories would have been higher than reported by $27.1 million at the end of 2009 and $32.7 million at the end of 2008. Cost of goods sold for 2009 would have been $5.6 million higher ($32.7 27.1) had Whole Foods used FIFO. Beginning inventory would have been $32.7 million higher and ending inventory also would have been higher by $27.1 million. An increase in beginning inventory causes an increase in cost of goods sold, while an increase in ending inventory causes a decrease in cost of goods sold. Purchases for 2009 are the same regardless of the inventory valuation method used. c.Inventory turnover = cost of goods sold divided by average inventory
($ rounded to millions)

Inventory turnover = *($311 + 327) 2

$5,277 = 16.54 $319 *

The dollar-value LIFO inventory estimation Communication Case 8-10technique begins with the determination of the current years 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 years 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.

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The final step converts the layers identified to cost by multiplying the layers at base year cost by the layers cost index. The costs are totaled to obtain ending inventory at DVL cost.

Research Case 8-11Requirement 1

The FASBs codification citation that provides guidance for determining whether an arrangement involving the sale of inventory is in substance a financing arrangement is FASB ASC 47040052: DebtProduct Financing ArrangementsOverview and Background. Requirement 2 The FASBs codification citation that addresses the recognition of a product financing arrangement is FASB ASC 47040251: DebtProduct Financing ArrangementsRecognition Requirement 3 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 sponsors accounting policies applicable to other financing and holding costs. Notice that this is an example of substance (a loan) over form (a sale). Requirement 4 Journal entry to record the sale (cash receipt): Cash............................................................................ 160,000 ..................Liability product financing arrangement .......................................................................160,000

Journal entry to record the repurchase: Liability product financing arrangement ................. 160,000 Holding and financing costs* ..................................... 4,000

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............................................................................Cash .......................................................................164,000

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Research Case 8-11 (concluded) *The treatment of these costs depends on the accounting policies of the sponsor. For example, if these costs normally are expensed as period costs, then the debit in this case would be to an expense account (or accounts).

Analysis Case 8-12Requirement 1


($ in millions)

SAKS Gross profit ratio Inventory turnover Average days in inventory = = = 968 3,030 2,062 793 365 2.6 = 32% = 2.6 = 140 days

DILLARDS 2,003 6,831 4,828 1,576.5 365 3.06 = 29% = 3.06 = 119 days

The gross profit ratios for the two companies are similar, and both are higher than the industry average. The inventory turnover ratios for the two companies reveal that, on average, it takes Saks 21 more days to sell its inventory than Dillards. This could be a reflection of more higher end merchandise sold at Saks which would also explain the slightly higher gross profit ratio of 32% compared to 29% for Dillards. Saks turns its inventory over 6 days slower than the industry average, Dillards 15 days faster. 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. Per note 2, BA uses the average cost method to British Airways Case value its inventory. Under IFRS, the FIFO (first-in, firstout) method also can be used. However, the LIFO (last-in, first-out) method, which can be used under U.S. GAAP in addition to the average cost method and the FIFO method, is prohibited under IFRS.

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