Chapter 7

Reporting and Analyzing Inventory

Learning Objectives – coverage by question

Mini- Cases
Exercises Problems
Exercises and Projects

LO1 – Interpret disclosures of

information concerning operating
expenses, including 13 - 15, 17
manufacturing and retail
inventory costs.

LO2 – Account for inventory and cost

26, 27,
of goods sold using different costing 18 - 21, 23 33, 34, 36 37, 38
29 - 31
methods.

LO3 – Apply the lower of cost or net

realizable value rule to value 24 28
inventory.

LO4 – Evaluate how inventory

costing affects management
decisions and outsiders’ 18 26, 29 - 31 33, 34, 36 37, 38
interpretations of financial
statements.

LO5 – Define and interpret gross

profit margin and inventory turnover
ratios. Use inventory footnote 16, 22 25, 31, 32 33 - 35 37
information to make appropriate
adjustments to ratios.

LO6 – Appendix 7A: Analyze LIFO

liquidations and the impact they have 26, 29, 30 36 37
on the financial statements.

©Cambridge Business Publishers, 2020

Solutions Manual, Chapter 7 7-1
 QUESTIONS

Q7-1. When company A purchases inventory from company B, the buyer and seller
must agree on which firm is responsible for the transportation costs. The
terminology “freight on board shipping point” or FOB is used to indicate the
buyer assumes responsibility for the transportation cost once notice of delivery
to the shipper is received. In addition, the buyer assumes responsibility for any
delay or damage during transit.
When goods are shipped FOB, the seller normally can recognize revenue
unless the seller has not fulfilled all requirements of the purchase agreement.
An example is when an equipment installation and/or up-and-running properly
is part of that agreement.
Q7-2. If stable purchase prices prevail, the dollar amount of inventories (beginning or
ending) tends to be approximately the same under different inventory costing
methods and the choice of method does not materially affect net income. To see
this, remember that FIFO profits include holding gains on inventories. If the
inflation rate is low (or inventories turn quickly), there will be less holding
(inflationary) profit in inventory.
Q7-3. FIFO holding gains occur when the costs of earlier inventory acquisitions are
matched against current selling prices. Holding gains on inventories increase with
an increase in the inflation rate and a decrease in the inventory turnover rate.
Conversely, if the inflation rate is low or inventories turn quickly, there will be less
holding (inflationary) profit in inventory.
Q7-4. (a) Last-in, first-out, (b) Last-in, first-out, (c) First-in, first-out, (d) First-in, first-out,
(e) Last-in, first-out.
Q7-5. A significant tax benefit results from using LIFO when costs are consistently
rising. LIFO results in lower pretax income and, therefore, lower taxes payable,
than other inventory costing methods.
Q7-6. Kaiser Aluminum Corporation is using the lower of cost or market (LCM) rule.
When the replacement cost for inventory falls below its (FIFO or LIFO)
historical cost, the inventory must be written down to the lower replacement
costs (market value).
Q7-7. The various inventory costing methods would produce the same results (inventory
values and cost of goods sold) if prices were stable. The inventory costing
methods produce differing results when prices are changing.
Q7-8. Inventory “shrink” refers to the loss of inventory due to theft, spoilage, damage,
etc. Shrink costs are part of cost of goods sold but do not represent goods that
were actually sold.

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7-2 Financial Accounting, 6th Edition
Q7-9. The “LIFO reserve” is the difference between the cost of inventory determined
using the last-in, first-out (LIFO) method and the cost determined using another
method (either FIFO or average cost). Companies that report inventory cost
using the LIFO method must also report the LIFO reserve. This allows the
financial statement reader to convert from LIFO to another method for
comparison purposes.
The LIFO reserve represents the difference between the historical, LIFO cost of
inventory and its current cost. This disparity between the book value and the
current value represents a gain from holding the inventory that has not yet been
recognized in income or in equity ̶ an unrealized holding gain.
Q7-10. Because LIFO assigns the last units purchased during the year to cost of goods
sold (COGS), changing prices can make it difficult to forecast earnings.
Companies have discretion as to when and how much inventory they purchase
during an accounting period. LIFO is always applied on a periodic, annual basis,
so a purchase made during the final days of the year will end up in COGS and
affect current earnings. However, if that purchase is delayed until the first week of
the next year, it could be several years before those units are transferred to
COGS. Unlike other inventory methods, LIFO requires that the quantity and price
of inventory purchases be predicted to make accurate earnings forecasts.
Q7-11A. LIFO liquidation is involuntary when it is caused by events that are beyond
management’s control. Examples of such events include labor strikes, natural
disasters, or wars which could interrupt the delivery of inventory by suppliers or
shut down production facilities.
Q7-12A. In periods of rising prices, LIFO liquidation results in older, lower-cost goods being
expensed as cost of goods sold, yielding higher profits. This may be the result of
a management decision to reduce inventory levels for efficiency purposes.
However, it may also be an earnings management tactic. Management may be
trying to avoid violating bond covenants, or it may be trying to manipulate
management compensation. In any case, this practice is costly, in that the
additional profits lead to higher income taxes.

©Cambridge Business Publishers, 2020

Solutions Manual, Chapter 7 7-3
 MINI EXERCISES

M7-13. (15 minutes)

LO 1

The cost to be assigned to the inventory is $535 ($500 + $30 + $5).

+ Inventory (A) - - Accounts Payable (L) +

(a) 500 30 (b)
(b) 30 10 (c)
(d) 5 5 (d)

- Notes Payable (L) + + Interest Expense, Discounts Lost (E) -

500 (a) (c) 10

M7-14. (15 minutes)

LO 1

The only cost that should be included in inventory is the cost of merchandise to be sold.

M7-15. (20 minutes)

LO 1

RAW MATERIALS INVENTORY

Beginning inventory $ 0
Purchases + 84,000
Materials used - 63,000
Ending inventory $ 21,000

WORK IN PROCESS INVENTORY

Beginning inventory $ 0
Materials used + 63,000
Labor costs + 58,000
Overhead costs + 28,000
Cost of goods produced - 130,000
Ending inventory $ 19,000

FINISHED GOODS INVENTORY

Beginning inventory $ 0
Cost of goods produced + 130,000
Cost of goods sold - 95,000
Ending inventory $ 35,000

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7-4 Financial Accounting, 6th Edition
M7-16. (10 minutes)
LO 5

$76,450 - 25,354
2017: = 0.668
$76,450

$71,890 - 21,685
2016: = 0.698
$71,890

$70,074 - 21,536
2015: = 0.693
$70,074

M7-17. (15 minutes)

LO 1

a. Purchases are understated. If ending inventory is correctly valued, cost of goods

sold will also be understated and current income will be overstated. There would be
no effect in the following year.

If, however, ending inventory is understated (due to the mistakenly recorded

purchase) then there is no effect on income in either period.

b. Purchases are overstated. The effect on income, assuming normal inventory levels,
depends on the inventory costing system being used by the company. Assuming
rising prices, income would be reduced in the current year under LIFO or average
costing but unaffected under FIFO costing. Income in the following year would not
be affected. (The solution assumes the error is not discovered and corrected in the
current year.)

c. Shrink (part of cost of goods sold) is overstated and ending inventory is understated.
Consequently, current period income is understated. If the inventory is counted
correctly the following year, the error will reverse itself and income will be
overstated. This is an example of a “self-correcting” inventory error.

©Cambridge Business Publishers, 2020

Solutions Manual, Chapter 7 7-5
M7-18. (20 minutes)
LO 2, 4

a. Balance Sheet, December 2019

Assets
Cash $12,000
Inventory 50,000
Shareholders’ equity
Contributed capital $62,000

b. All monetary amounts in $ thousands.

Year 2020 2021 2022

Income statement:
Revenue 75 85 95
COGS-FIFO 50 60 70
Earnings before tax 25 25 25
Tax expense 10 10 10
Net income 15 15 15
Cash flows:
Receipts 75 85 95
Inventory purchases -60 -70 -80
Tax payments -10 -10 -10
Cash from 5 5 5
operations
Dividends -9 -9 -9
Cash from financing -9 -9 -9
Net change in cash -4 -4 -4
Balance sheet:
Assets
Cash 8 4 0
Inventory 60 70 80
Total 68 74 80
Shareholders’ equity
Contributed capital 62 62 62
Retained earnings 6 12 18
Total 68 74 80

Clearly there is a problem with this business model. The company is showing
profits, and assets and retained earnings are increasing. However, there is a cash
flow problem. The net change in cash every year is -$4 thousand and, by the end of
2022, the company would have a cash balance of zero. In 2023, it would not be
possible to replenish the inventory and to pay the dividend.

©Cambridge Business Publishers, 2020

7-6 Financial Accounting, 6th Edition
c. All monetary amounts in $ thousands.

Year 2020 2021 2022

Income statement:
Revenue 75 85 95
COGS-LIFO 60 70 80
Earnings before tax 15 15 15
Tax expense 6 6 6
Net income 9 9 9
Cash flows:
Receipts 75 85 95
Inventory purchases -60 -70 -80
Tax payments -6 -6 -6
Cash from operations 9 9 9
Dividends -9 -9 -9
Cash from financing -9 -9 -9
Net change in cash 0 0 0
Balance sheet:
Assets
Cash 12 12 12
Inventory 50 50 50
Total 62 62 62
Shareholders’ equity
Contributed capital 62 62 62
Retained earnings 0 0 0
Total 62 62 62

Interestingly, the use of LIFO reduces profits, and the company’s reported assets
(and net assets) are not growing like the FIFO case above. However, the cash flow
situation is improved. The company can pay the desired dividends and continue to
replace its inventory at the end of every year. The difference between LIFO and
FIFO is that FIFO profits include a gain from holding inventory while prices are
rising. When the company is taxed on that gain, it has less cash available to
maintain its physical assets (inventory). In essence, paying taxes based on FIFO
(when inventory costs are increasing) can cause a firm’s ability to stay in business to
be taxed away. LIFO profits exclude holding gains, so the company could continue
to stay in business. (The tax authorities will “catch up” when the business decides to
stop investing in inventory, and the LIFO liquidation profits get taxed.)

©Cambridge Business Publishers, 2020

Solutions Manual, Chapter 7 7-7
 M7-19. (20 minutes)
LO 2

a. FIFO cost of goods sold = 1,000 @ $100 + 700 @ $150 = $205,000

FIFO ending inventories = $400,000 - $205,000 = $195,000

b. LIFO cost of goods sold = 1,700 @ $150 = $255,000

LIFO ending inventories = $400,000 - $255,000 = $145,000

c. AC cost of goods sold = 1,700 @ $400,000/3,000 = $226,667

AC ending inventories = $400,000 – $226,667 = $173,333

M7-20. (15 minutes)

LO 2

a. $1,320,000 + purchases - $6,980,000 = $1,460,000; purchases = $7,120,000.

b.
1. Inventory (+A) 7,120,000
Cash or Accounts payable (-A or +L) 7,120,000

2. Cost of goods sold (+E, -SE) 6,980,000

Inventory (-A) 6,980,000

c.
+ Cash (A) - + Cost of Goods Sold (E) -
7,120,000 (1) (2) 6,980,000

+ Inventory (A) -
Balance 1,320,000
(1) 7,120,000
6,980,000 (2)
Balance 1,460,000

d.
Balance Sheet Income Statement
Cash Noncash Liabi- Contrib. Earned Net
Transaction + = + + Revenues - Expenses =
Asset Assets lities Capital Capital Income
a. Purchase -7,120,000 +7,120,000
inventory. Cash Inventory = - =

c. Cost of -6,980,000 -6,980,000 +6,980,000 -6,980,000

inventory Inventory = Retained - Cost of =
sold. Earnings Goods Sold

©Cambridge Business Publishers, 2020

7-8 Financial Accounting, 6th Edition
M7-21. (10 minutes)
LO 2

a. FIFO cost of goods sold = 400 @ $10 + 200 @ $12 = $6,400

FIFO ending inventories = $12,400 - $6,400 = $6,000

b. LIFO cost of goods sold = 600 @ $12 = $7,200

LIFO ending inventories = $12,400 - $7,200 = $5,200

c. AC cost of goods sold = 600 @ $12,400/1,100 = $6,764

AC ending inventories = $12,400 – $6,764 = $5,636

M7-22. (20 minutes)

LO 5

a.
Inventory Turnover-2017 Inventory Turnover-2016
Wal-Mart 373/[(43.8+43.0)/2] = 8.59 361/[(43.0+44.5)/2] = 8.25
Target 51.1/[(8.66+8.31)/2] = 6.07 49.1/[(8.31+8.60)/2] = 5.81

b. Wal-Mart’s inventory turnover rate is higher than Target’s. There can be several
reasons for this. Wal-Mart’s product lines may be oriented toward lower-
margin/higher-turnover goods (Wal-Mart does report a lower gross profit margin than
Target). Both companies had slight increases in turnover rates from 2016 to 2017.
At the end of 2017, both companies hold roughly the same, or slightly more,
inventory than in the prior year, possibly in anticipation of increased sales in 2018 (or
the addition of new products).

c. Inventory turns improve as the dollar volume of goods sold increases relative to the
dollar volume of goods on hand. Inventory reductions can be realized by reducing
the depth and breadth of product lines carried (e.g., not every style, size and color),
eliminating slow-moving product lines, working with suppliers to arrange for delivery
when needed rather than inventorying for a longer holding period, and marking down
goods for sale at the end of product seasons.

Retailers must balance the cost savings from inventory reductions against the
marketing implications of lower inventory levels on hand. It would be possible to
stock only those items that turn over very quickly, but those items may have low
margins. Or, there may be items that turn over slowly, but have sufficient margins to
make offering them attractive, even though it reduces inventory turnover. Whenever
ratios are used as incentive measures, it is important to recognize that they may
cause “cherry-picking” of only those activities that provide the highest ratio outcome.

©Cambridge Business Publishers, 2020

Solutions Manual, Chapter 7 7-9
 M7-23. (15 minutes)
LO 2

a. Cost of goods sold (+E, -SE) 142,790,00

0
Inventory (-A) 142,790,000

b.
+ Inventory - + Cost of Goods Sold -
Balance 25,790,000 (a) 142,790,000
142,790,000 (a)
(c) 140,560,000
Balance 23,560,000

c. Inventory (+A) 140,560,00

0
Cash or Accounts payable (-A or +L) 140,560,000

d. ($000)
Balance Sheet Income Statement
Cash Noncash Liabil- Contrib. Earned Net
Transaction + = + + Revenues - Expenses =
Asset Assets ities Capital Capital Income
c. Purchase -140,560 +140,560
inventory = - =
Cash Inventory
a. Cost of -142,790 -142,790 +142,790 -142,790
inventory sold Inventory = Retained - Cost of =
Earnings Goods Sold

M7-24. (10 minutes)

LO 3

a. (60 x $45) + (210 x $34) + (300 x $20) + (100 x $27) = $18,540

b. Cost: (60 x $45) + (210 x $38) + (300 x $22) + (100 x $27) = $19,980
Market: (60 x $48) + (210 x $34) + (300 x $20) + (100 x $32) = $19,220
Therefore, the ending inventory balance should be $19,220.

b.

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7-10 Financial Accounting, 6th Edition
 EXERCISES

E7-25. (45 minutes)

LO 5

a. Fiscal year 2015:

Gross profit margin = ($705 – $503) ÷ $705 = 28.7%

Inventory turnover ratio = $503 ÷ [($214 + $223) ÷ 2] = 2.30 times

Fiscal year 2016:

Gross profit margin = ($703 – $497) ÷ $703 = 29.3%

Inventory turnover ratio = $497 ÷ [($223 + $212) ÷ 2] = 2.29 times

b.
Gross
Fiscal Year Quarter Gross Profit Profit Margin
1 $ 27 21.3%
2 91 36.0%
2015
3 56 28.9%
4 28 21.5%
1 32 24.6%
2 90 35.7%
2016
3 55 28.7%
4 29 22.3%

The gross profit and gross profit margin numbers show that West Marine is
significantly more profitable in the second and third quarters. The revenues from
these quarters are 50% - 100% higher than the other quarters and the gross profit
from quarters two and three is sometimes more than three times that of quarters one
and four. Unlike many retailers, who make most of their sales and profits in the
fourth calendar quarter, West Marine must discount its prices and run promotions in
order to generate sales in the first and fourth quarters.

©Cambridge Business Publishers, 2020

Solutions Manual, Chapter 7 7-11
c. Inventory is lowest at the end of the fiscal year. At the end of the first quarter (end of
March), inventory has increased in anticipation of the busy second quarter, and
inventory stays high through the second quarter (end of June). By the end of
September (third quarter), inventory has declined, and it continues to decline
through the fourth quarter.

It is common for seasonal businesses to choose fiscal year-ends when inventories

(and other balances like receivables) are lower. But it can mean that annual ratios
(like those calculated in part a) do not reflect the inventory investment that was
necessary to generate the sales reported for the year. Understanding these
seasonal effects can be important for cash management over the year.

d. One approach to calculating an inventory turnover ratio is to use an “average of

averages” approach. For the first quarter of 2015, the average inventory was
($214 + $257) / 2 = $235.5. Follow the same process to determine the average
inventory for quarters two, three and four. Then average the averages. The effect
of this process is the following:

2015: Weighted average inventory = [214 + 2x(257 + 258 + 237) + 223)] / 8 = $242.6

2016: Weighted average inventory = [223 + 2x(269 + 254 + 232) + 212)] / 8 = $243.1

The weighted average inventory levels are greater than the simple annual averages
for both years because the fiscal year-end is set when inventory is predictably low.
When these inventory values are divided into annual cost of goods sold, the
inventory turnover ratios are lower than those calculated in part a.

Weighted average inventory turnover ratio:

2015: $503 / $242.6 = 2.07 times

2016: $497 / $243.1 = 2.04 times

©Cambridge Business Publishers, 2020

7-12 Financial Accounting, 6th Edition
E7-26.A (30 minutes)
LO 2, 4 6

Units Cost
Beginning Inventory 1,000 $ 20,000
Purchases: #1 1,800 39,600
#2 800 20,800
#3 1,200 34,800
Goods available for sale 4,800 $115,200

Units in ending inventory = 4,800 – 2,800 = 2,000

a. First-in, first-out

Units Cost Total

1,200 @ $29 = $34,800
800 @ $26 = 20,800
Ending Inventory 2,000 $55,600

Cost of goods available for sale $115,200

Less: Ending inventory 55,600
Cost of goods sold $ 59,600

b. Last-in, first-out

Units Cost Total

1,000 @ $20 = $20,000
1,000 @ $22 = 22,000
Ending inventory 2,000 $42,000

Cost of goods available for sale $115,200

Less: Ending inventory 42,000
Cost of goods sold $ 73,200

c. Average cost

$115,200/4,800 = $24 average unit cost

2,000 x $24 = $48,000 ending inventory
$115,200 - $48,000 = $67,200 cost of goods sold (or 2,800x$24)

©Cambridge Business Publishers, 2020

Solutions Manual, Chapter 7 7-13
d. 1. The first-in, first-out method in most circumstances represents physical flow. This
inventory system applies to perishables or to situations in which the earliest items
acquired are moved out first because of risk of deterioration or obsolescence.

2. Last-in, first-out results in the lowest inventory amount during periods of rising unit
costs, which in turn results in the lowest net income and the lowest income tax.

3. The first-in, first-out results in the lowest cost of goods sold in periods of rising
prices. This is the inventory method Chen should use to report the largest amount
of income. Of course, this assumes that prices will continue to rise. Companies
cannot change inventory costing methods without justification, and the change may
be prohibited by tax laws as well.

E7-27. (25 minutes)

LO 2

Units Cost Total

Beginning inventory 100 @ $46 = $ 4,600
Purchases: Purchase #1 650 @ 42 = 27,300
Purchase #2 550 @ 38 = 20,900
Purchase #3 200 @ 36 = 7,200
Cost of goods available for sale 1,500 $60,000

a. First-in, first-out
Units Cost Total
200 @ $36 = $ 7,200
150 @ 38 = 5,700
Ending inventory................................. 350 $12,900

Cost of goods available for sale.......... $60,000

Less: Ending inventory........................ 12,900
Cost of goods sold.............................. $47,100

b. Average cost
Cost of Goods Available for Sale/Total Units Available for Sale
= $60,000/1,500 = $40 Average Unit Cost

Ending Inventory = 350 units x $40 = $14,000

Cost of goods available for sale $60,000

Less: Ending inventory 14,000
Cost of goods sold $46,000

©Cambridge Business Publishers, 2020

7-14 Financial Accounting, 6th Edition
c. Last-in, first-out
Units Cost Total
100 @ $46 = $ 4,600
250 @ 42 = 10,500
Ending inventory 350 $15,100
Cost of goods available for sale $60,000
Less: Ending inventory 15,100
Cost of goods sold $44,900

E7-28. (20 minutes)

LO 3

a. 1. (70 x $190) + (45 x $268) + (20 x $350) + (120 x $60) + (80 x $88) + (50 x $126)
= $52,900.

2. Desks: (70 x $190) + (45 x $280) + (20 x $350) = $32,900

(70 x $210) + (45 x $268) + (20 x $360) = $33,960

Chairs: (120 x $60) + (80 x $95) + (50 x $130) = $21,300

(120 x $64) + (80 x $88) + (50 x $126) = $21,020

Therefore, inventory would be reported at $32,900 + $21,020 = $53,920.

3. (70 x $190) + (45 x $280) + (20 x $350) + (120 x $60) + (80 x $95) + (50 x $130)
= $54,200

(70 x $210) + (45 x $268) + (20 x $360) + (120 x $64) + (80 x $88) + (50 x $126)
= $54,980

Therefore, inventory would be reported at $54,200.

b. Applying the lower of cost or net realizable value (NRV) rule to individual items in
inventory results in the lowest inventory amount, the highest cost of goods sold and
the lowest net income. Under either of the other two methods, the inventory may be
valued at the higher of cost or NRV for some items in inventory.

©Cambridge Business Publishers, 2020

Solutions Manual, Chapter 7 7-15
E7-29.A (20 minutes)
LO 2, 4, 6

a. $13,042 million

b. $14,275 million

c. Pretax income has been reduced by $1,233 million cumulatively since GM adopted
LIFO inventory costing. This is because it has matched current inventory costs
against current selling prices, thus avoiding the recognition of holding gains that
would have resulted had FIFO inventory costing been used. If LIFO has put $1,233
million less into ending inventory than FIFO, it must have put $1,233 more into cost
of goods sold than FIFO.

d. Pretax income has been reduced by $1,233 million (see part c). Assuming a 35% tax
rate, taxes have been reduced by $1,233 x 0.35 = $431.6 million.
Cumulative taxes were decreased by the use of LIFO inventory costing.

e. During this period GM was experiencing declining earnings while inventory costs
were not keeping pace. Under these conditions, FIFO reporting mitigates the effect
on income.

E7-30.A (25 minutes)

LO 2, 4, 6

a. $6,149 million

b. $7,786 million. The FIFO inventory carrying amount is greater than the LIFO carrying
amount, which is common. It implies Deere’s current inventory costs are rising. We
cannot blindly assume that inventory costs always rise, however. When costs
decline as is true in the computer chip industry (generally not on LIFO) or in the past
year in the oil and gas industry (generally on LIFO), a lower FIFO carrying amount
can occur. However, if prices fall for so long and to such an extent that the FIFO
carrying amount is lower than the LIFO carrying amount the company would have to
consider switching off of LIFO onto FIFO.

c. Pretax income has been decreased by $1,637 million cumulatively since Deere
adopted LIFO inventory costing. This result occurs because higher current inventory
costs are matched against current selling prices, thus avoiding the recognition of
holding gains that would have resulted had FIFO inventory costing been used.

d. Pretax income has been decreased by $1,637 million (see part c). Assuming a 25%
tax rate, taxes have been decreased by $1,637 x 0.25 = $409.25 million.
Cumulative taxes have been decreased by use of LIFO inventory costing.

©Cambridge Business Publishers, 2020

7-16 Financial Accounting, 6th Edition
e. For 2018, the change in the LIFO reserve is an increase of $176 million. Pretax
income has been decreased by this amount, thus decreasing taxes by $176 million x
0.25 = $44 million.

Observation: If Deere’s inventory were at some future date to be more highly valued
under LIFO than under FIFO, the company could reduce its tax expense by
switching to FIFO costing. This is, however, unlikely for Deere or other industries
facing continued price increases or even essentially constant prices.

f. In 2016 and 2015, Deere liquidated some LIFO layers, meaning that it sold more
inventory than it bought (of a certain type) and thus older costs assigned previously
assigned to inventory are now assigned to cost of goods sold as that inventory is
sold. In periods of rising costs that means old, lower costs are assigned to cost of
goods sold and matched with revenues from the current period. As a result, higher
profits are recorded than would have been recorded if new inventory (purchased at
higher prices) would have been bought and assumed to have been sold. Companies
are required to disclose this when it happens because it shows a higher profit merely
for depleting inventory layers. Deere states that they recorded $4 million in pretax
profit attributable to such LIFO liquidations in 2016 ($22 million in 2015).

E7-31. (20 minutes)

LO 2, 4, 5

a. ($ millions)
$517 + Purchases - $10,633 = $471. Purchases = $10,587.

b.
($ millions) As reported (LIFO) Pro forma (FIFO)
Sales revenue $16,030 $16,030
Cost of goods sold 10,633 10,628
Gross profit $ 5,397 $ 5,402
$10,633 - ($47 - $42) = $10,628

c. As reported (LIFO): $5,397 / $16,030 = 33.67%

Pro forma (FIFO): $5,402 / $16,030 = 33.70%
The small differences between LIFO and FIFO reflect both the rate of price change
for Whole Foods’ inventories and the fact that its inventory moves through very
quickly (about 21 times per year).

©Cambridge Business Publishers, 2020

Solutions Manual, Chapter 7 7-17
E7-32. (30 minutes)
LO 5

a.
Tiffany Best Buy RH
2017 2016 2017 2016 2017 2016
Revenue $4,170 $4,002 $42,151 $39,403 $2,44 $2,135
0
COGS 1,565 1,512 32,275 29,963 1,591 1,455
Gross profit 2,605 2,490 9,876 9,440 849 680
Gross profit margin (GPM) 62.5% 62.2% 23.4% 24.0% 34.8% 31.9%

b.
Tiffany Best Buy RH
2017 2017 2017
COGS 1,565 32,275 1,591
Average inventory 2,206 5,036.5 639.5
Inventory turnover 0.71 6.41 2.49
Average inventory 2,206 5,036.5 639.5
Average daily COGS 4.29 88.42 4.36
AIDO 514.2 57.0 146.7

c. These three retailers offer very different products (jewelry, consumer electronics,
and furniture) and thus have different gross profit margins and inventory turnover
ratios.
All three have seen their gross profit margins improve slightly from 2016 to 2017.
Comparing the three retailers, each has ratios that are consistent with the type of
product they sell. Tiffany’s GPM is quite high, but its inventory turnover is very low.
This is representative of jewelry retailers. Best Buy, a “big box” store chain,
illustrates a more typical retail GPM and turnover. RH, which sells furniture, has
ratios between the jewelry retailer, Tiffany, and Best Buy. The comparison illustrates
that retailers of “big ticket” items tend to have inventory that turns slower but has
higher gross profit per dollar of sales.

©Cambridge Business Publishers, 2020

7-18 Financial Accounting, 6th Edition