In Class Demo Questions - Solutions

ICDQ6-1

Aside from cars, which was the example given in the chapter, name products that would use
specific identification as the costing method. What must be true about those products?

INSTRUCTORS: It is not possible to predict what answers students will give.

NOTE: this question was developed to promote a discussion of when specific identification
should NOT be used (lower $ value, high volume) and why not (expensive and time consuming
method of tracking inventory so only makes sense when required or higher $ value, low
volume, like cars). If students given the example, say, of memory chips, they have serial
numbers so can be tracked but businesses who sell them do not use specific identification due
to the fact that the volume is high and the dollar value is low.

Be sure to encourage the discussion about WHY all items that CAN use specific identification
DON'T! The most common examples of businesses that use specific identification are expensive
jewellery stores, artwork, pianos, and automobiles.

What must be true about those products? They must have something which will identify them
that is unique, like a serial number on a GUN (which does use specific identification, by the way!)
ICDQ6-2

Retail stores that sell clothing always use the average cost method.

Considering how businesses choose between the methods, why does this make sense?

 Because customers choose the clothing they want, both the style and the size.

 There is no way for owners/managers to control what is chosen (by putting out the old inventory first).

 Therefore, the average cost method makes more sense as it more appropriately recognizes the physical flow
(random, in the control of customers)
ICDQ6-3

Date Purchases Cost of goods sold Inventory on hand

Quantity Unit Total Quantity Unit Total Quantity Unit Total
cost Cost cost Cost cost Cost

May 1, 30 95
Opening 2,850
May-05 25 100 2,500 30 95
25 100 5,350

May-12 30 95
4,050 1,300
12 100 13 100
May-19 40 105 4,200 13 100
5,500
40 105
May-22 13 100
5,185
37 105 3 105 315
May-25 30 110 3,300 3 105
3,615
30 110
Totals: 95 10,000 92 9,235

Check:
Availabl COGS +
e for Ending
sale: 125 units Inventory: 125 units
12,850 dollars 12,850 dollars

ICDQ6-3 continued
 Assets Liabilities Equity
Owner's
Capital Retained Earnings
Profit
Revenue Expenses

Sales Returns &

Sales Discounts

Freight Expense
Sales Revenue

Cost of goods
Allowances
Receivable

Inventory
Accounts

Accounts
Payable
Cash

sold
Openin n/a n/a 2,850 n/a n/a n/a n/a n/a n/a
g
May-05 -2,500 2,500
May-12 6720 6720
-4,050 4,050
May-19 -4,200 4,200
May-22 8500 8500
-5,185 5,185
May-25 -3,300 3,300

Total n/a 3,615 15,220 9,235

Analyze your inventory purchases and sales once you have completed the chart.
First, the cost of your inventory has continued to increase over the month.
What, if anything, might you do in response?
Second, do you feel that you have retained good control over inventory levels?
What about the inventory records would indicate that?

· Students might answer this in different ways.

· It appears as if you have retained good controls over the inventory levels and your levels
have stayed fairly steady of the period (end of period was 33, beginning of period was 30 units)

· Over time what you bought you sold.

· Your inventory level of that end of the month appear to be enough to cover early sales
in the following month, which is what you want so as to provide the necessary inventory
to your customers when needed.
 ICDQ6-4

Date Purchases Cost of goods sold Inventory on hand

Quantit Unit Total Quantity Unit Total Quantit Unit Total
y cost Cost cost Cost y cost Cost

Opening
30 12.00 360
Jun-06 20 11.50 230 30 12.00
590
20 11.50
Jun-09 100 11.00 1,100 30 12.00
20 11.50 1,690
100 11.00
Jun-14 30 12.00
20 11.50 1,250
60 11.00 40 11.00 440
Jun-18 150 10.00 1,500 40 11.00
1,940
150 10.00
Jun-22 40 11.00
940
50 10.00 100 10.00 1,000
Jun-28 45 10.00 450 55 10.00 550
Totals: 270 $2,830 245 $2,640

Check:
COGS +
Ending
Available Inventor
for sale: 300 units y 300 units
3,190 dollars 3,190 dollars
 ICDQ6-4 continued

Assets Liabilities Equity

Owner's
Capital Retained Earnings
Profit Dividends

Revenue Expenses

Cost of goods sold

Accounts Payable

Sales Returns &

Sales Discounts

Freight Expense
Sales Revenue

Allowances
Receivable

Inventory
Accounts
Cash

Opening 360
Jun-06 -230 230
Jun-09 -1,100 1,100
Jun-14 2200 2200
-1,250 1,250
Jun-18 -1,500 1,500
Jun-22 1710 1710
-940 940
Jun-28 855 855
-450 450

Total n/a 550 4,765 2,640

Analyze the cost of inventory over the month. What might cause the change in
costs that you see?
The price was decreasing throughout the period. It may be due to a change in the
exchange rate in your favour. Note that, after June 9, it may be due to finding a
new supplier.
Students may have other suggestions about why prices decreased. Be sure to
consider if their suggestions make sense.

At the end of the period the selling price dropped from $20 to $19. What might
be some reasons why a business might do this?
 Your costs are decreasing so you might want to pass that on to your
customers (goodwill gesture)
 If your costs are decreasing so are your competitor's costs. They might have
dropped their prices to generate greater sales and, unless you follow suit, you will
lose customers.
 Generally a drop in price is due to competition factors.
Assume that June 30 is the year end for this business and a physical count is
performed and there are only 47 units on hand. Why might the physical count be
different than what the perpetual inventory records show? What is the value of
the inventory that is missing? What, if anything, should the business do and why?
If an entry is required, provide it in the following chart.
Why might the physical count be different than the perpetual inventory records
show?
 Shrinkage, damages not reported, or human error. Note that obsolescence
is not likely since that would involve ALL of this type of inventory, not just a few
items.

What is the value of the inventory that is missing?

55 units in ending inventory according to the records less 47 units counted = 8
units missing * $10 each = $80

What, if anything, should the business do and why?

The inventory recorded on the books (55 units at $550) is incorrect. The
inventory does not have $550 as future benefit to the business. Because of that
the business must write off the value of the inventory which is gone ($80)
because that has become a cost of running a retail business where customers or
employees steal or mistakes are made.
An entry is required because the inventory must be written down to the future
value of the asset inventory.

Assets Liabilities + Equity

Owner's
+ Retained Earnings
Capital
Profit

Revenue Expenses
Goods Sold
Inventory

Inventory
Cost of

Losses
Cash

Openin 550 2,640

g
Adjust -80 80
 Total 470 2,640 80

ICDQ6-5

77,000 Unadjusted inventory

3,250 include as FOB shipping point as HBD is the buyer

3,200 include as FOB destination as HBD is the seller

83,450 Adjusted inventory

In addition, assume that HBS plans to ask the bank for a loan. Why would
having an accurate inventory value on the financial statements be important to
an external stakeholder such as the bank?

 The bank would want to know the value of the current assets as that value
is used to determine the business's ability pay off their short term liabilities.
 The bank may also want to know the value of the current assets as those
assets, including inventory, may be used as collateral for the loan.
NOTE: be sure to go over with students what collateral is - there are students
who may not know what that means and this is the opportunity to teach them
about securing a loan with current assets.