CHAPTER 7
INVENTORIES
EYE OPENERS
1. TtThhee
inreitciaelivpinugrcrheapsoert
osrhdoeur ldanbde rtheecovnecnileddort’os
invoice before recording or paying for inven-
tory purchases. This procedure will verify
that the inventory received matches the type
and quantity of inventory ordered. It also ve-
rifies that the vendor’s invoice is charging
the company for the actual quantity of inven-
tory received at the agreed-upon price.
2. To protect inventory from customer theft,
retailers use two-way mirrors, cameras, se-
curity guards, locked display cabinets, and
inventory tags that set off an alarm if the in-
ventory is removed from the store.
3. Perpetual. The perpetual inventory system
provides the more effective means of con-
trolling inventories, since the inventory ac-
count is updated for each purchase and
sale. This also assists managers in deter-
mining when to reorder inventory items.
4. A physical inventory should be taken period-
ically to test the accuracy of the perpetual
records. In addition, a physical inventory will
identify inventory shortages or shrinkage.
5. No, they are not techniques for determining
physical quantities. The terms refer to cost
flow assumptions, which affect the determi-
nation of the cost prices assigned to items in
the inventory.
6. No, the term refers to the flow of costs rather
than the items remaining in the inventory.
The inventory cost is composed of the earli-
est acquisitions costs rather than the most
recent acquisitions costs.
7. a. LIFO c. LIFO
b. FIFO d. FIFO
8. FIFO
9. LIFO. In periods of rising prices, the use of
LIFO will result in the lowest net income and
thus the lowest income tax expense.
10. Yes. The inventory method may be changed
for a valid reason. The effect of any change
in method and the reason for the change
should be fully disclosed in the financial
statements for the period in which the
change occurred.
11. Net realizable value (estimated selling price
less any direct cost of disposition, such as
sales commissions).
12. By a notation next to “Merchandise invento-
ry” on the balance sheet or in a note to the
financial statements.
13. a. Gross profit for the year was unders-
tated by $12,750.
b. Merchandise inventory and owner’s eq-
uity were understated by $12,750.
14. Jaffe Company. Since the merchandise was
shipped FOB shipping point, title passed to
Jaffe Company when it was shipped and
should be reported in Jaffe Company’s fi-
nancial statements at December 31, the end
of the fiscal year.
15. Manufacturer’s; The manufacturer retains
tsitoleld
umnteilrct heangdoisoedsatartehesoelndd.
Tohf utsh,e ayneyaur nis- part of the
manufacturer’s (consignor’s) in- ventory,
even though the merchandise is in the hands
of the retailer (consignee).
457
 PRACTICE EXERCISES

PE 7–1A

Gross Profit Ending Inventory

a. First-in, first-out (FIFO) $23 ($53 – $30) $78 ($36 + $42)

b. Last-in, first-out (LIFO) $11 ($53 – $42) $66 ($30 + $36)

c. Average cost $17 ($53 – $36) $72 ($36 × 2)

PE 7–1B

Gross Profit Ending Inventory

a. First-in, first-out (FIFO) $45 ($125 – $80) $172 ($84 + $88)

b. Last-in, first-out (LIFO) $37 ($125 – $88) $164 ($80 + $84)

c. Average cost $41 ($125 – $84) $168 ($84 × 2)

PE 7–2A

a. Cost of merchandise sold (July 25):

10 units @ $8 $ 80
50 units @ $12 600
60 $680

b. Inventory, July 31:

$900 = 75 units × $12

PE 7–2B

a. Cost of merchandise sold (April 24):

12 units @ $70 $ 840

3 units @ $72 216
15 $1,056

b. Inventory, April 30:

$1,584 = 22 units × $72

458
PE 7–3A

a. Cost of merchandise sold (July 25):

$720 = (60 units × $12)

b. Inventory, July 31:

10 units @ $8 $ 80
65 units @ $12 780
75 $860

PE 7–3B

a. Cost of merchandise sold (April 24):

$1,080 = (15 units × $72)

b. Inventory, April 30:

12 units @ $70 $ 840

10 units @ $72 720
22 $1,560

PE 7–4A

a. First-in, first-out (FIFO) method: $2,786 = (10 units × $119) + (14 units × $114)

b. Last-in, first-out (LIFO) method: $2,766 = (5 units × $120) + (19 units × $114)

c. Average cost method: $2,760 (24 units × $115), where average cost = $115 =
$9,200/80 units

PE 7–4B

a. First-in, first-out (FIFO) method: $2,592 = 48 units × $54

b. Last-in, first-out (LIFO) method: $2,160 = 48 units × $45

c. Average cost method: $2,400 (48 units × $50), where average cost = $50 =
$11,250/225 units

459
PE 7–5A

A B C D E F G
1 Unit Unit Total
2 Inventory Cost Market Lower
3 Commodity Quantity Price Price Cost Market of C or M
4 Alpha 400 $ 6 $ 5 $2,400 $2,000 $2,000
5
Beta 350 12 14 4,200 4,900 4,200
6 Total $6,600 $6,900 $6,200

PE 7–5B

A B C D E F G
1 Unit Unit Total
2 Inventory Cost Market Lower
3 Commodity Quantity Price Price Cost Market of C or M
4 Widget 100 $30 $27 $3,000 $2,700 $2,700
5
Gidget 75 24 25 1,800 1,875 1,800
6 Total $4,800 $4,575 $4,500

PE 7–6A

Amount of Misstatement
Overstatement (Understatement)
Balance Sheet:
Merchandise inventory overstated ............... $16,000
Current assets overstated............................. 16,000
Total assets overstated ................................. 16,000
Owner’s equity overstated ............................ 16,000
Income Statement:
Cost of merchandise sold understated ........ $(16,000)
Gross profit overstated.................................. 16,000
Net income overstated................................... 16,000

460
PE 7–6B

Amount of Misstatement
Overstatement (Understatement)
Balance Sheet:
Merchandise inventory understated............. $(30,000)
Current assets understated .......................... (30,000)
Total assets understated............................... (30,000)
Owner’s equity understated.......................... (30,000)
Income Statement:
Cost of merchandise sold overstated .......... $ 30,000
Gross profit understated ............................... (30,000)
Net income understated ................................ (30,000)

461
 EXERCISES

Ex. 7–1

Switching to a perpetual inventory system will strengthen Hammer & Nails

Hard- ware’s internal controls over inventory, since the store managers will be
able to

k oe f egpootrda-
cskelolifnhgoitwemsucahndofexecaecshsitienmveinstorniehsaonfdp. oTohri-
seslhlionuglditeminsi.mize shortages

On the other hand, switching to a perpetual inventory system will not eliminate
the need to take a physical inventory count. A physical inventory must be taken
to verify the accuracy of the inventory records in a perpetual inventory system. In
addition, a physical inventory count is needed to detect shortages of inventory
due to damage or theft.

Ex. 7–2

a. Inappropriate. Good controls include a receiving report, prepared after all in-

vcvehenatstoerdy sihteomulsd roencleyivbed

rehcaovredebdeeandcopuanidtefdor anfdterinrsepcoecntceidlin.
gIntvhentroercyeivpiunrg- report, the initial purchase order, and the vendor’s
invoice.
b. Appropriate. The inventory tags will protect the inventory from customer
theft.
c. Inappropriate. The control of using security measures to protect the inventory
is violated if the stockroom is not locked.
462
Ex. 7–3

Portable Video CD Players

Purchases Cost of Merchandise Sold Inventory
Unit Total Unit Total Unit Total
Date Quantity Cost Cost Quantity Cost Cost Quantity Cost Cost
Apr. 1 50 35 1,750
5 40 35 1,400 10 35 350
14 60 36 2,160 10 35 350
60 36 2,160

21 1
225
05 35
5
66 39500 35 36 1,260
23 10 36 360 25 36 900
30 75 38 2,850 25 36 900
75 38 2,850
30 Balances 3,010 3,750

463

Ex. 7–4

Portable Video CD Players

Purchases Cost of Merchandise Sold Inventory
Unit Total Unit Total Unit Total
Date Quantity Cost Cost Quantity Cost Cost Quantity Cost Cost
Apr. 1 50 35 1,750
5 40 35 1,400 10 35 350
14 60 36 2,160 10 35 350
60 36 2,160
21 35 36 1,260 10 35 350
25 36 900
23 10 36 360 10 35 350
15 36 540
30 75 38 2,850 10 35 350
15 36 540
75 38 2,850
30 Balances 3,020 3,740
 464

Ex. 7–5

Cell Phones
Purchases Cost of Merchandise Sold Inventory
Unit Cost Total Unit Total UnitTotal
Date Quantity Cost Quantity Cost Cost QuantityCostCost
Mar. 1 1,000 40 40,000
5 500 42 21,000 1,000 40 40,000
500 42 21,000
8 500 42 21,000 800 40 32,000
200 40 8,000
14 600 40 24,000 200 40 8,000
20 450 44 19,800 200 40 8,000
450 44 19,800
31 300 44 13,200 200 40 8,000
150 44 6,600
31 Balances 66,200 14,600

465

Ex. 7–6

Cell Phones
Purchases Cost of Merchandise Sold Inventory
Unit Total Unit Total Unit Total
Date Quantity Cost Cost Quantity Cost Cost Quantity Cost Cost
Mar. 1 1,000 40 40,000
5 500 42 21,000 1,000 40 40,000
500 42 21,000
 8 700 40 28,000 300 40 12,000
500 42 21,000
14 300 40 12,000
300 42 12,600 200 42 8,400
20 450 44 19,800 200 42 8,400
450 44 19,800
31 200 42 8,400
100 44 4,400 350 44 15,400
31 Balances 65,400 15,400

466

Ex. 7–7

a. $19,200 ($80 × 240 units)

b. $18,650 [($75 × 30 units) + ($78 × 200 units) + ($80 × 10 units)] = $2,250 +
$15,600 + $800

Ex. 7–8

a. $8,124 (36 units at $165 plus 14 units at $156) = $5,940 + $2,184

b. $6,414 (27 units at $120 plus 23 units at $138) = $3,240 + $3,174
c. $7,350 (50 units at $147; $26,460/180 units =
$147) Cost of merchandise available for sale:
27 units at $120 ........................................................ $ 3,240
54 units at $138 ........................................................ 7,452
63 units at $156 ........................................................ 9,828
36 units at $165 ........................................................ 5,940
180 units (at average cost of $147) .......................... $26,460
 467

Ex. 7–9

Cost
Merchandise Merchandise
Inventory Method Inventory Sold
a. FIFO ..................... $2,508 $7,242
b. LIFO ..................... 2,160 7,590
c. Average cost 2,340 7,410
.......
Cost of merchandise available for sale:
42 units at $60 .......................................................... $2,520
58 units at $65 .......................................................... 3,770
20 units at $68 .......................................................... 1,360
30 units at $70 .......................................................... 2,100
150 units (at average cost of $65) ............................ $9,750
a. First-in, first-out:
Merchandise inventory:
30 units at $70 .......................................................... $2,100
6 units at $68 .......................................................... 408
36 units ..................................................................... $2,508
Merchandise sold:
$9,750 – $2,508 ......................................................... $7,242
b. Last-in, first-out:
Merchandise inventory:
36 units at $60 .......................................................... $2,160
Merchandise sold:
 $9,750 – $2,160 ......................................................... $7,590
c. Average cost:
Merchandise inventory:
36 units at $65 ($9,750/150 units) ........................... $2,340
Merchandise sold:
$7,410
$9,750 – $2,340 .........................................................

468

Ex. 7–10

1. a. FIFO inventory > (greater than) LIFO inventory

b. FIFO cost of goods sold < (less than) LIFO cost of goods sold
c. FIFO net income > (greater than) LIFO net income
d. FIFO income tax > (greater than) LIFO income tax

2. In periods of rising prices, the income shown on the company's tax return
would be lower than if FIFO were used; thus, there is a tax advantage of
using LIFO.

Note to InS tructorS :The federal tax laws require that if LIFO is used for tax pur-
poses, LIFO must also be used for financial reporting purposes. This is known as
the LIFO conformity rule. Thus, selecting LIFO for tax purposes means that the
company's reported income will also be lower than if FIFO had been used. Com-
panies using LIFO believe the tax advantages from using LIFO outweigh any
neg- ative impact of reporting a lower income to shareholders.

Ex. 7–11

A B C D E F G
1 Unit Unit Total
2 Inventory Cost Market Lower
3 Commodity Quantity Price Price Cost Market of C or M
4 Aquarius 20 $ 80 $ 92 $ 1,600 $ 1,840 $ 1,600
5 Capricorn 50 70 65 3,500 3,250 3,250
6
7 Leo 8 300 280 2,400 2,240 2,240
8 Scorpio 30 40 30 1,200 900 900
Taurus 100 90 94 9,000 9,400 9,000
9 Total $ 17,700 $ 17,630 $ 16,990

Ex. 7–12

The merchandise inventory would appear in the Current Assets section, as fol-
lows:
Merchandise inventory—at lower of cost (FIFO) or market.............$16,990
Alternatively, the details of the method of determining cost and the method of
valuation could be presented in a note.

469

Ex. 7–13

a. Balance Sheet
Merchandise inventory $9,400 ($325,000 – $315,600)
understated Current assets $9,400 ($325,000 – $315,600) understated
Total assets $9,400 ($325,000 – $315,600) understated
Owner’s equity $9,400 ($325,000 – $315,600) understated

b. Income Statement
Cost of merchandise sold $9,400 ($325,000 – $315,600)
overstated Gross profit $9,400 ($325,000 – $315,600) understated
Net income $9,400 ($325,000 – $315,600) understated

Ex. 7–14

a. Balance Sheet
Merchandise inventory $7,550 ($195,750 – $188,200)
overstated Current assets $7,550 ($195,750 – $188,200) overstated
Total assets $7,550 ($195,750 – $188,200) overstated
Owner’s equity $7,550 ($195,750 – $188,200) overstated

b. Income Statement
Cost of merchandise sold $7,550 ($195,750 – $188,200) understated
 Gross profit $7,550 ($195,750 – $188,200) overstated
Net income $7,550 ($195,750 – $188,200) overstated

Ex. 7–15

When an error is discovered affecting the prior period, it should be corrected. In

this case, the merchandise inventory account should be debited and the owner’s
capital account credited for $11,900.
Failure to correct the error for 2009 and purposely misstating the inventory and
the cost of merchandise sold in 2010 would cause the income statements for the
two years to not be comparable. The balance sheet at the end of 2010 would be
correct, however, since the 2009 inventory error reverses itself in 2010.

470

Appendix Ex. 7–16

$627,000 ($950,000 × 66%)

Appendix Ex. 7–17

$572,000 ($880,000 × 65%)

Appendix Ex. 7–18

$225,000 ($375,000 × 60%)

Appendix Ex. 7–19

A B C
1 Cost Retail
2 Merchandise inventory, April 1 $ 180,000 $ 300,000
3 Purchases in April (net) 1,200,000 2,000,000
4 Merchandise available for sale $ 1,380,000 $ 2,300,000
$1,380,000
5 Ratio of cost to retail price: = 60%
$2,300,000
6 Sales for April (net) 2,025,000
7 Merchandise inventory, April 30, at retail price $ 275,000

8 M e r c h a nd i s in ve n $ 165,000
a t e s t im a t ed co s t
t o ry , A p r il 30 ,
( $2 7 5 ,0 0 0 × 6 0%)
 471

Appendix Ex. 7–20

a.
A B C
1 Cost Retail
2 Merchandise inventory, January 1 $ 260,000
3 Purchases (net), January 1–October 11 1,900,000
4 Merchandise available for sale $ 2,160,000
5 Sales (net), January 1–October 11 $3,200,000
6 Less estimated gross profit ($3,200,000 × 40%) 1,280,000
7 Estimated cost of merchandise sold 1,920,000
8 Estimated merchandise inventory, October 11 $ 240,000

b. The gross profit method is useful for estimating inventories for monthly or
quarterly financial statements. It is also useful in estimating the cost of
mer- chandise destroyed by fire or other disasters.

Appendix Ex. 7–21

Merchandise available for sale .......................................................... $3,150,000

Less cost of merchandise sold [$4,800,000 × (100% – 40%)].......... 2,880,000
Estimated ending merchandise inventory ........................................ $ 270,000

Appendix Ex. 7–22

Merchandise available for sale .......................................................... $1,028,000
Less cost of merchandise sold [$1,500,000 × (100% – 38%)].......... 930,000
Estimated ending merchandise inventory ........................................ $ 98,000

472

Ex. 7–23

a. Apple: 63.1 {$13,717,000,000/[($270,000,000 + $165,000,000)/2]}

American Greetings: 4.0 {$826,791,000/[($187,817,000 +
$230,308,000)/2]}

b. Lower. Although American Greetings’ business is seasonal in nature, with

most of its revenue generated during the major holidays, much of its
nonholi- day inventory may turn over very slowly. Apple, on the other
hand, turns its inventory over very fast because it maintains a low
inventory, which allows it to respond quickly to customer needs.
Additionally, Apple’s computer prod- ucts can quickly become obsolete, so
it cannot risk building large invento- ries.

Ex. 7–24

a. Number of Days’ Sales in Inventory AverageInventory

=
Cost of Goods Sold/365

Kroger, $4,609 $4,486 / $4,547.5 33 days

2
$50,115/365 137.3

Safeway, $2,643 $2,766 / $2,704.5 34 days

2
 $28,604/365 78.4

Winn-Dixie, $523$798 / 2$660.5 45 days

$5,327/365 14.6
 Cost of Goods Sold
Inventory Turnover =
Average Inventory

Kroger,
$50,115
11.0
($4,609 $4,486)/2

Safeway, $28,604
10.6
($2,643 $2,766)/2
$5,327
Winn-Dixie, 8.1
($523 $798)/2

b. The number of days’ sales in inventory and inventory turnover ratios are rela-
tively consistent. Kroger has slightly better inventory ratios than does
Safe- way or Winn-Dixie.

473

Ex. 7–24 Concluded

c. If Safeway matched Kroger’s days’ sales in inventory, then its

hypothetical ending inventory would be determined as follows,
Average Inventory
Number of Days’ Sales in Inventory
= Cost of Goods Sold/365

33 days =
X
$28,604/365
X = 33 × ($28,604/365) = 33 × $78.4 per day

X = $2,587

Tenhcues,btehtewaedendi tihoen alctuaaslhafvloewragtheaitnwveonutlodryh

avned btehenhgyepnoethraeteicdalisavtheradgieffeinr - ventory, as follows:

Actual average inventory ......................... $ 2,705

million Hypothetical average inventory............... 2,587
Positive cash flow potential .................... $ 118 million
That is, a lower average inventory amount would have required less cash
than actually was required.
 474

PROBLEMS

Prob. 7–1A

1.
Purchases Cost of Merchandise Sold Inventory
Unit Cost Total Unit Total UnitTotal
Date Quantity Cost Quantity Cost Cost QuantityCostCost
Mar. 3 60 1,500 90,000
8 120 1,800 216,000 60 1,500 90,000
120 1,800 216,000
11 60 1,500 90,000 100 1,800 180,000
20 1,800 36,000
30 50 1,800 90,000 50 1,800 90,000
Apr. 8 100 2,000 200,000 50 1,800 90,000
100 2,000 200,000
10 50 1,800 90,000 90 2,000 180,000
10 2,000 20,000
19 30 2,000 60,000 60 2,000 120,000
28 100 2,200 220,000 60 2,000 120,000
100 2,200220,000
Continued

475
Prob. 7–1A Concluded

Purchases Cost of Merchandise Sold Inventory

Unit Total Unit Total Unit Total
Date Quantity Cost Cost Quantity Cost Cost Quantity Cost Cost
May 5 60 2,000 120,000
100 2,200 220,000
16 80 2,200 176,000 20 2,200 44,000
21 180 2,400 432,000 20 2,200 44,000
180 2,400 432,000

28 2 2 110 2,400 264,000

7 70 2, 400
4 4
16 8 ,000
31 Balances 894,000 264,000

2. Accounts Receivable...................................................... 2,307,500

Sales ........................................................................... 2,307,500
Cost of Merchandise Sold.............................................. 894,000
Merchandise Inventory.............................................. 894,000

3. $1,413,500 ($2,307,500 – $894,000)

4. $264,000 (110 units × $2,400)

476

Prob. 7–2A

1.
Purchases Cost of Merchandise Sold Inventory
Unit Total Unit Total Unit Total
Date Quantity Cost Cost Quantity Cost Cost Quantity Cost Cost
Mar. 3 60 1,500 90,000
8 120 1,800 216,000 60 1,500 90,000
120 1,800 216,000
11 80 1,800 144,000 60 1,500 90,000
40 1,800 72,000
30 40 1,800 72,000 50 1,500 75,000
10 1,500 15,000
Apr. 8 100 2,000 200,000 50 1,500 75,000
100 2,000 200,000
10 60 2,000 120,000 50 1,500 75,000

19 30 2,000 60,000 54 0 12 , 50 0 78 50 ,0 0
0 0
10 2,000 20,000
28 100 2,200 220,000 50 1,500 75,000
 10 2,000 20,000
100 2,200 220,000
Continued
 477

Prob. 7–2A Concluded

Purchases Cost of Merchandise Sold Inventory

Unit Total Unit Total Unit Total
Date Quantity Cost Cost Quantity Cost Cost Quantity Cost Cost
May 5 60 2,200 132,000 50 1,500 75,000
10 2,000 20,000

4 2 2 8 8
16 40 2,200 88,000 2 0 1 ,5 0 3 0 ,00
0 0
10 2,000 20,000
30 1,500 45,000
21 180 2,400 432,000 20 1,500 30,000
180 2,400 432,000
28 90 2,400 216,000 20 1,500 30,000
90 2,400 216,000
31 Balances 912,000 246,000

2. Total sales ....................................................................... $2,307,500

Total cost of merchandise sold .................................... 912,000
Gross profit .................................................................... $1,395,500

3. $246,000 = [(20 units × $1,500) + (90 units × $2,400)] = $30,000 + $216,000

478

Prob. 7–3A

1. First-In, First-Out Method

Model Quantity Unit Cost Total Cost

 12 222 2,664
C911 2 70 140
2 65 130
L100 4 317 1,268
N201 2 535 1,070
2 530 1,060
Q73 6 542 3,252
1 549 549
Z120 2 232 464
ZZRF 12 78 936
Total ................................................................. $ 15,583

2. Last-In, First-Out Method

Model Quantity Unit Cost Total Cost

BB900 27 $213 $ 5,751

3 215 645
C911 4 60 240
L100 4 305 1,220
N201 2 520 1,040
2 527 1,054
Q73 6 520 3,120
1 531 531
Z120 2 222 444
ZZRF 8 70 560
4 72 288
Total ................................................................. $ 14,893

479

Prob. 7–3A Concluded

3. Average Cost Method

Model Quantity Unit Cost* Total Cost