The Purchase and Sale of Inventory

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1 Chapter 5 The Purchase and Sale of Inventory LEARNING OBJECTIVES 1. Calculate and record the purchase and sale of inventory. 2. Explain the two methods of inventory record keeping. 3. Define and calculate inventory using the four major inventory cost flow assumptions and explain how these methods affect the financial statements. 4. Analyze transactions and prepare financial statements after the purchase and sale of inventory. 5. Explain the lower-of-cost-or-market rule for valuing inventory. 6. Define and calculate the gross profit ratio and the inventory turnover ratio. 7. Describe the risks associated with inventory and the controls that minimize those risks. 8. (Appendix 5A) Describe and calculate the effect of inventory errors on the financial statements. 9. (Appendix 5B) Estimate inventory using the gross profit method. Questions 1. Explain the terms FOB shipping point and FOB destination. What are the accounting and business implications of the shipping terms? Why is it important to know who owns goods during shipping? These terms describe who owns the goods that have been sold or purchased. Under FOB shipping point, the title to the goods passes to the buyer at the shipping point and the buyer is responsible for shipping costs. Under FOB destination, title to the goods passes at the time of delivery, and the seller is responsible for shipping costs. From a business standpoint, it is important to know if shipping is part of the cost of acquiring your inventory. From an accounting standpoint, it determines how the cost of the inventory is recorded. It will then have an effect on cost of goods sold and net income. 2. What is the difference between freight-in and freight-out? Freight-in is transportation costs paid on goods purchased and is included as part of the cost of the goods. Freight out is transportation costs paid on goods sold and is an operating expense. 3. What is the difference between a purchase return and a purchase allowance? What is the effect of purchase returns and allowances on the overall cost of inventory to the buyer? A purchase return is when goods previously purchased are returned to the seller. A purchase allowance is when the cost of damaged or defective goods is reduced, but the goods are retained by the purchaser. Purchases returns and allowances reduce the cost of inventory. 4. What is a purchase discount? What is the effect of a purchase discount on the overall cost of inventory to the buyer? A purchase discount is a reduction in the purchase price granted to a customer for prompt payment. A purchase discount reduces the cost of the inventory to the buyer. 208

2 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY Explain the terms of a purchase described as 2/15, n/30. Would you take advantage of this offer? Why or why not? 2/15, n/30 means that the purchasing company will receive a 2% discount if payment is made within 15 days of the invoice date. Otherwise the full amount is due within 30 days. You would definitely want to take advantage of this offer. If you didn t, you d be paying 2% interest to borrow the money for 15 days. That s an annual rate of 48%. 6. What is a contra-revenue account? Give two examples of contra-revenue accounts. A contra revenue account is an account with a debit balance in which reductions to revenue are recorded. A contra revenue account reduces revenue. Two examples are sales returns and allowances and sales discounts. 7. What is a sales discount? What is the effect of a sales discount on the total sales revenue of the seller? A sales discount is a reduction in the sales price for prompt payment. Sales discounts reduce sales revenue. 8. What is the difference between a periodic and perpetual inventory system? Under a perpetual system, record keeping is continuous. In other words, each time a sale is made, cost of goods sold and ending inventory are computed and recorded. Under a periodic system accounting records are only updated at the end of the accounting period. 9. What is inventory shrinkage? Inventory shrinkage is a reduction in the physical inventory due to causes other than sales. (Examples include damage, loss, and theft.) 10. What is the difference between the physical flow of inventory and the inventory cost flow? The physical flow of inventory refers to the actual physical movement of goods (i.e., which goods are actually sold). The inventory cost flow assumption refers to the flow of costs associated with the goods that pass through the company (i.e. determines which costs are assigned to goods sold). 11. What are the common cost flow methods for accounting for inventory? Describe the differences. *The specific identification method is used for large, luxury items that can be identified individually. Ending inventory is reported at the actual cost of each individual inventory item. Similarly, cost of goods sold is recorded at the actual cost of the individual items. * The weighted average cost method uses a weighted-average cost which is applied to all units in ending inventory and goods sold. * The FIFO method assigns the cost of the first goods purchased to the first goods sold. Ending inventory is determined from the most recent purchases. * The LIFO method assigns the cost of the most recent goods purchased to the first goods sold. Ending inventory reflects the cost of the earliest goods purchased. 12. If inventory costs are rising, which method (FIFO, LIFO, or weighted average cost) results in the highest net income? Explain your answer. If inventory costs are rising, FIFO results in the highest net income because the first purchases (lowest cost) are assumed to have been sold and these lower costs are assigned to cost of goods sold.

3 210 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL 13. If inventory costs are rising, which method (FIFO, LIFO, or weighted average cost) results in the lowest net income? Explain your answer. If inventory costs are rising, LIFO results in the lowest net income because the goods with the highest costs (most recent purchases) are assumed to have been sold and these higher costs are assigned to cost of goods sold. 14. Does LIFO or FIFO give the best most current balance sheet value for the ending inventory? Why? FIFO gives the most current balance sheet value for ending inventory because it assigns the cost of the last goods purchased to inventory on hand. LIFO, on the other hand, assigns the cost of the oldest goods to ending inventory. So FIFO is a better balance sheet value. 15. How do taxes affect the choice between LIFO and FIFO? In periods of rising prices, LIFO gives you a larger amount for cost of goods sold, which gives you a lower amount of net income. If net income is lower under LIFO, your taxes are lower. Conversely, in periods of declining prices, FIFO gives you a larger amount for cost of good sold, which would give you a lower net income, and your taxes are lower. Lower taxes mean higher cash flows (less cash for taxes). 16. Does the periodic or perpetual choice affect the choice of a cost flow (LIFO versus FIFO) method? Explain. No, each cost flow method can be used in conjunction with either periodic or perpetual systems. 17. What is the lower-of-cost-or-market rule and why is it necessary? Under the lower-of-cost-or-market rule, inventory must be recorded at the lower of the inventory s cost or market value. This rule prevents overstatement of inventory on the balance sheet. 18. What does the gross profit percentage measure? How is it calculated? The gross profit percentage measures the proportion of sales dollars remaining after paying for the goods sold. The gross profit percentage is calculated by dividing gross profit by net sales. 19. What does the inventory turnover ratio measure? What does average-days-in-inventory mean? The inventory turnover ratio is a measure of how quickly a firm is selling its inventory. It indicates the number of times the company turns over (sells and replaces) its inventory during the period. The average-days-in-inventory indicates the average number of days an item is held in inventory. 20. What are some of the risks associated with inventory? How do managers minimize these risks? The risks associated with inventory include loss by theft or damage and obsolescence. Damage and theft can be minimized with physical controls such as passwords and security locks. Risk of obsolescence can be minimized with rapid inventory turnover. Multiple-Choice Questions 1. When inventory is purchased, it is recorded as a(n) and when sold it becomes a(n). a. liability; withdrawal b. asset; expense c. liability; asset d. asset; contra-asset

4 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 211 Use the following information to answer questions 2 5: Inventory data for Newman & Frith Merchandisers, Inc., is provided here. Sales for the period were 2,800 units. Each sold for $8. The company maintains a periodic inventory system. Date Number of Units Unit Cost Total Cost January Beginning inventory 1,000 $3.00 $ 3,000 February Purchases 600 $3.50 $ 2,100 March Purchases 800 $4.00 $ 3,200 April Purchases 1,200 $4.25 $ 5,100 Totals 3,600 $13, Determine the ending inventory assuming the company uses the FIFO cost flow method. a. $3,400 b. $2,400 c. $9,200 d. $10, Determine the cost of goods sold assuming the company uses the FIFO cost flow method. a. $3,400 b. $10,000 c. $10,200 d. $2, Determine the ending inventory assuming the company uses the weighted average cost flow method. (Round average cost to two decimal places.) a. $2,300 b. $3,300 c. $9,800 d. $2, Determine the gross profit assuming the company uses the LIFO cost flow method. a. $11,400 b. $14,400 c. $22,400 d. $19, Using LIFO will produce a lower net income than using FIFO under which of the following conditions? a. Inventory costs are decreasing. b. Inventory costs are increasing. c. Inventory costs are not changing. d. Sales prices are decreasing. Use the following information to answer questions 7 10: Sales revenue $480,000 Cost of goods sold 300,000 Sales discounts 20,000 Sales returns and allowances 15,000 Operating expenses 85,000 Interest revenue 5, What is the net sales revenue? a. $400,000 b. $445,000 c. $415,000 d. $455, What is the gross profit? a. $145,000 b. $105,000 c. $140,000 d. $90,000

5 212 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL 9. What is the net income? a. $60,000 b. $65,000 c. $55,000 d. $180, What is the gross profit percentage? a % b % c % d % Short Exercises Set A SE5-1A. Calculate cost of inventory. (LO 1). Invoice price of goods is $5,000. Purchase terms are 2/10, n/30 and the invoice is paid in the week of receipt. The shipping terms are FOB shipping point, and the shipping costs amount to $200. What is the total cost of the inventory? SE5-2A. Record sale of merchandise inventory: perpetual inventory system. (LO 1, 2). Brenda Bailey s Textiles, Inc., uses a perpetual inventory system. Enter the following transaction into the accounting equation: In February, Brenda Bailey s sold $500,000 of merchandise on account with terms 2/10, n/30. The cost of the merchandise sold was $230,000. SE5-3A. Calculate gross profit and the gross profit ratio. (LO 1, 6). Using the information in SE5-2A, calculate the gross profit from the sale and the gross profit ratio. Assume that the customer does not pay within the discount period. SE5-4A. Calculate cost of goods sold and ending inventory: weighted average cost. (LO 3). Calculate the cost of goods sold and the cost of the ending inventory using the weighted average cost flow assumption. Assume periodic record keeping. Sales Beginning inventory Purchases 100 units at $15 per unit 90 units at $6 per unit 60 units at $9 per unit

6 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 213 SE5-5A. Calculate cost of goods sold and ending inventory: FIFO. (LO 3). Using the data from SE5-4A, calculate the cost of goods sold and the cost of the ending inventory using the FIFO periodic cost flow assumption.

7 214 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL SE5-6A. Calculate cost of goods sold and ending inventory: LIFO. (LO 3). Using the data from SE5-4A, calculate the cost of goods sold and the cost of the ending inventory using the LIFO periodic cost flow assumption. SE5-7A. Analyze the effect of the cost flow method on net income. (LO 3). Given the following information, calculate the amount by which net income would differ between FIFO and LIFO. Assume the periodic system. Beginning inventory Purchases Units sold 3,000 units at $100 per unit 8,000 units at $130 per unit 6,000 units at $225 per unit

8 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 215 SE5-8A. Analyze the effect of the cost flow method on gross profit. (LO 3, 4). Given the following information, calculate the amount by which gross profit would differ between FIFO and LIFO. Assume the periodic system. Beginning inventory Purchases Units sold 1,500 units at $55 per unit 2,750 units at $58 per unit 2,250 units at $99 per unit

9 216 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL SE5-9A. Apply the lower-of-cost-or-market rule. (LO 5). The following information pertains to item #007SS of inventory of Marine Aquatic Sales, Inc.: Per unit Cost $180 Replacement cost 181 Selling price 195 The physical inventory indicates 2,000 units of item #007SS on hand. What amount will be reported on the Marine Aquatic Sales, Inc. s balance sheet for this inventory item? SE5-10A. Calculate the gross profit ratio, inventory turnover ratio, and average days in inventory. (LO 6). Using the following information, calculate inventory turnover ratio, the average days in inventory, and the gross profit ratio for Barkley Company for the year ended December 31, (Round to two decimal places.) Sales $125,000 Cost of goods sold 75,000 Ending inventory, December 31, ,275 Ending inventory, December 31, ,750 Net income 26,500

10 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 217 Set B SE5-11B. Calculate cost of inventory. (LO 1). Invoice price of goods is $1,000. Purchase terms are 1/10, n/30 and the invoice is paid in the week of receipt. The shipping terms are FOB shipping point, and the shipping costs amount to $200. What is the total cost of the inventory? SE5-12B. Record sale of merchandise inventory: perpetual inventory system. (LO 1, 2). Sam s Supply, Inc., uses a perpetual inventory system. Enter the following transaction into the accounting equation: In February, Sam s sold $320,000 of merchandise on account with terms 3/10, n/30. The cost of the merchandise sold was $100,000. SE5-13B. Calculate gross profit and the gross profit ratio. (LO 1, 6). Using the information in SE5-12B, calculate the gross profit from the sale and the gross profit ratio. Assume the customer does not pay within the discount period.

11 218 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL SE5-14B. Calculate cost of goods sold and ending inventory: weighted average cost. (LO 3). Calculate the cost of goods sold and the cost of the ending inventory using the weighted average cost flow assumption. Assume periodic record keeping. Sales Beginning inventory Purchases 150 units at $5 per unit 100 units at $2 per unit 60 units at $3 per unit SE5-15B. Calculate cost of goods sold and ending inventory: FIFO. (LO 3). Using the data from SE5-14B, calculate the cost of goods sold and the cost of the ending inventory using the FIFO periodic cost flow assumption.

12 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 219 SE5-16B. Calculate cost of goods sold and ending inventory: LIFO. (LO 3). Using the data from SE5-14B, calculate the cost of goods sold and the cost of the ending inventory using the LIFO periodic cost flow assumption. SE5-17B. Analyze the effect of the cost flow method on net income. (LO 3). Given the following information, calculate the amount by which net income would differ between FIFO and LIFO. Assume the periodic system. Beginning inventory Purchases Units sold 2,000 units at $10 per unit 5,000 units at $12 per unit 6,500 units at $25 per unit

13 220 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL SE5-17B Solution continued: SE5-18B. Analyze the effect of the cost flow method on gross profit. (LO 3, 4). Given the following information, calculate the amount by which gross profit would differ between FIFO and LIFO. Assume the periodic system. Beginning inventory Purchases Units sold 500 units at $50 per unit 1,200 units at $48 per unit 900 units at $60 per unit

14 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 221 SE5-18B Solution continued: SE5-19B. Apply the lower-of-cost-or-market rule. (LO 5). The following information pertains to item #3801B of inventory of Parts- A-Plenty: Per unit Cost $180 Replacement cost 170 Selling price 195 The physical inventory indicates 1,000 units of item #3801B on hand. What amount will be reported on Parts-A-Plenty s balance sheet for this inventory item? SE5-20B. Calculate the gross profit ratio, inventory turnover ratio, and average days in inventory. (LO 6). Using the following information, calculate inventory turnover ratio, the average days in inventory, and the gross profit ratio for Howard Company for the year ended December 31, (Round to two decimal places.) Sales $225,000 Cost of goods sold 175,000 Ending inventory, December 31, ,275 Ending inventory, December 31, ,750 Net income 36,500

15 222 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL Exercises Set A E5-21A. Record merchandising transactions: perpetual inventory system. (LO 1, 2). Assume the following transactions for Clark s Appliances, Inc., took place during May. Clark s Appliances uses a perpetual inventory system. Enter each of the transactions into the accounting equation. May 2 Purchased refrigerators on account at a total cost of $500,000; terms 1/10, n/30 May 9 Paid freight of $800 on refrigerators purchased from GE May 16 Returned refrigerators to GE because they were damaged; received a credit of $5,000 from GE May 22 Sold refrigerators costing $100,000 for $180,000 to Pizzeria Number 1 on account, terms n/30 May 24 Gave a credit of $3,000 to Pizzeria Number 1 for the return of a refrigerator not ordered. Clark s cost was $1,200.

16 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 223 E5-22A. Record merchandising transactions: perpetual inventory system. (LO 1, 2). The Fedora Company had a beginning inventory balance of $25,750 and engaged in the following transactions during the month of June: June 2 Purchased $4,000 of merchandise inventory on account from Plumes, Inc., with terms 2/10, n/30 and FOB destination. Freight costs associated with this purchase were $225. June 4 Returned $400 of damaged merchandise to Plumes, Inc. June 6 Sold $7,000 of merchandise to Fancy Caps on account, terms 1/15, n/30 and FOB shipping point. Freight costs were $125. The cost of the inventory sold was $3,500. June 9 Paid the amount owed to Plumes, Inc. June 10 Granted Fancy Caps an allowance on the June 6 sale of $300 for minor damage found on several pieces of merchandise June 22 Received total payment owed from Fancy Caps June 24 Paid sales salaries of $1,850 June 25 Paid the rent on the showroom of $1,200 Enter each of the transactions for the Fedora Company into the accounting equation, assuming it uses a perpetual inventory system. Use the following data to answer the questions in E5-23A through E5-26A: Box Office Projectors began the month of August with three movie projectors in inventory, each unit costing $350. During August, eight additional projectors of the same model were purchased. August 11 Purchased four units at $400 each August 13 Sold five units at $425 each August 14 Purchased three units at $375 August 18 Sold two units at $425 each August 21 Sold three units at $425 each August 26 Purchased one unit at $380

17 224 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL E5-23A. Calculate cost of goods sold and ending inventory: periodic FIFO. (LO 3, 4). Assume Box Office uses a periodic recordkeeping system and the FIFO cost flow method. 1. Calculate the cost of goods sold that will appear on the income statement for the month of August. 2. Determine the cost of inventory that will appear on the balance sheet at the end of August. E5-24A. Calculate cost of goods sold and ending inventory: periodic LIFO. (LO 3, 4). Assume Box Office uses a periodic recordkeeping system and the LIFO cost flow method. 1. Calculate the cost of goods sold that will appear on the income statement for the month of August. 2. Determine the cost of inventory that will appear on the balance sheet at the end of August.

18 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 225 E5-25A. Calculate cost of goods sold and ending inventory: perpetual FIFO. (LO 3, 4). Assume Box Office uses a perpetual recordkeeping system and the FIFO cost flow method. 1. Calculate the cost of goods sold that will appear on the income statement for the month of August. 2. Determine the cost of inventory that will appear on the balance sheet at the end of August. E5-26A. Calculate cost of goods sold and ending inventory: perpetual LIFO. (LO 3, 4). Assume Box Office uses a perpetual recordkeeping system and the LIFO cost flow method. 1. Calculate the cost of goods sold that will appear on the income statement for the month of August. 2. Determine the cost of inventory that will appear on the balance sheet at the end of August.

19 226 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL E5-27A. Calculate cost of goods sold and ending inventory: periodic weighted average cost. (LO 3, 4). The Fancy Phones Company sells phones to business customers. The company began 2009 with 2,000 units of inventory on hand. These units cost $200 each. The following transactions related to the company s merchandise inventory occurred during the first quarter of 2009: All unit costs include the purchase price and freight charges paid by Fancy Phones. During the quarter ending March 31, 2009, sales totaled 2,500 units, leaving 950 units in ending inventory. Assume Fancy Phones uses a periodic record-keeping system and the weighted average cost flow method. 1. Calculate the cost of goods sold that will appear on Fancy Phone s income statement for the quarter ending March Determine the cost of inventory that will appear on Fancy Phone s balance sheet at the end of March. January 14 February 13 March 30 Total purchases Purchased 750 units for $225 each Purchased 500 units for $175 each Purchased 200 units for $205 each 1,450 units E5-28A. Calculate cost of goods sold and ending inventory: perpetual weighted average cost. (LO 3, 4). Speedy Wireless, Inc., sells netbooks. The company began the fourth quarter of the year on October 1, 2009, with 500 units of inventory on hand. These units cost $250 each. The following transactions related to the company s merchandise inventory occurred during the fourth quarter of 2009: October 3 November 5 November 29 December 1 December 24 Sold 400 units for $400 each Purchased 600 units for $275 each Sold 500 units for $425 each Purchased 700 units for $260 each Sold 600 units for $450 each All unit costs include the purchase price and freight charges paid by Speedy Wireless. Assume the company uses a perpetual record-keeping system and the weighted average cost flow method. 1. Calculate the cost of goods sold that will appear on the income statement for the quarter ending December 31, Determine the cost of inventory that will appear on the balance sheet at December 31, 2009.

20 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 227 E5-29A. Apply the lower-of-cost-or-market rule. (LO 5). Use the data provided to answer the question that follows: Ending inventory at cost, December 31, 2011 $ 17,095 Ending inventory at replacement cost, December 31, ,545 Cost of goods sold, balance at December 31, ,765 Sales revenue, balance at December 31, ,780 Cash, balance at December 31, ,340 What inventory amount will this firm report on its balance sheet at December 31, 2011? E5-30A. Apply the lower-of-cost-or-market rule. (LO 5). In each case, indicate the correct amount to be reported for the inventory on the year-end balance sheet. 1. Ending inventory at cost $125,000 Ending inventory at market $121, Ending inventory at cost $117,500 Ending inventory at market $120,250 E5-31A. Calculate gross profit and gross profit percentage: FIFO and LIFO. (LO 6). Given the following information, calculate the gross profit and gross profit ratio under (a) FIFO periodic and under (b) LIFO periodic: Sales Beginning inventory Purchases 250 units at $100 per unit 75 units at $75 per unit 300 units at $60 per unit

21 228 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL Set B E5-32B. Record merchandising transactions: perpetual inventory system. (LO 1, 2). Assume the following transactions for Jennifer s Fix-It-Up, Inc., took place during March. Jennifer s uses a perpetual inventory system. Enter each of the transactions into the accounting equation. March 3 Purchased televisions from Sanyo on account at a total cost of $650,000, terms 2/10, n/25 March 8 Paid freight of $1,000 on televisions purchased from Sanyo March 16 Returned televisions to Sanyo because they were damaged. Received a credit of $15,000 from Sanyo. March 22 Sold televisions costing $125,000 for $225,000 to Joe s Sports Bar & Grille on account, terms n/15 March 28 Gave a credit of $2,800 to Joe s Sports Bar & Grille for the return of a television not ordered. Jennifer s cost was $1,600.

22 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 229 E5-33B. Record merchandising transactions: perpetual inventory system. (LO 1, 2). Discount Wines, Inc., had a beginning inventory balance of $85,450 and engaged in the following transactions during the month of October: October 2 Purchased $15,000 of merchandise inventory on account from Joe s Winery with terms 2/10, n/30 and FOB destination. Freight costs for this purchase were $750. October 5 October 6 October 10 October 10 Returned $100 of damaged merchandise to Joe s Sold $18,000 of merchandise to Tasty Catering Service on account, terms 2/15, n/30 and FOB shipping point. Freight costs were $155. The cost of the inventory sold was $10,500. Paid the amount owed to Joe s Granted Tasty an allowance on the October 6 sale of $200 for some soured wine Received total payment owed from Tasty October 23 October 29 Paid sales salaries of $1,500 October 31 Paid the rent on the warehouse of $1,450 Enter each of the transactions for Discount Wines, Inc., into the accounting equation, assuming it uses a perpetual inventory system.

23 230 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL E5-34B. Calculate cost of goods sold and ending inventory: periodic weighted average cost. (LO 3, 4). Tom s Trampoline Company sells commercial-size trampolines. The company s most recent fiscal year began on August 1, 2009, and ended July 31, The company began the year with 500 units of inventory on hand. These units cost $500 each. The following transactions related to the company s merchandise inventory occurred during the first quarter of the year: August 14 September 12 October 20 Total purchases Purchased 200 units for $525 each Purchased 175 units for $490 each Purchased 100 units for $510 each 475 units During the quarter ending October 31, sales totaled 625 units. Assume the company uses a periodic record-keeping system and the weighted average cost flow method. 1. Calculate the cost of goods sold that will appear on the company s income statement for the quarter ending October Determine the cost of inventory that will appear on the company s balance sheet at the end of October. E5-35B. Calculate cost of goods sold and ending inventory: perpetual weighted average cost. (LO 3, 4). Bob s Barber Supplies sells hair clippers to local businesses. The company began the first quarter of the year January 1, 2009, with 1,000 units of inventory on hand. These units cost $50 each. The following transactions related to the company s merchandise inventory occurred during the first quarter of 2009: January 12 January 20 February 8 March 5 March 19 Sold 800 units for $75 each Purchased 500 units for $45 each Sold 400 units for $75 each Purchased 600 units for $60 each Sold 500 units for $75 each Assume the company uses a perpetual record-keeping system and the weighted average cost flow method. 1. Calculate the cost of goods sold that will appear on the income statement for the quarter ending March 31, Determine the cost of inventory that will appear on the balance sheet at the end of March.

24 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 231 Use the following data to answer E5-36B through E5-39B: Radio Tech Sales & Service, Inc., began the month of April with three top-of-the-line radios in inventory, Model # RD58V6Q; each unit cost $235. During April, nine additional radios of the same model were purchased. April 9 Purchased three units at $230 each April 11 Sold five units at $350 each April 17 Purchased two units at $195 each April 18 Sold one unit at $350 April 20 Sold two units at $350 each April 28 Purchased four units at $180 each

25 232 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL E5-36B. Calculate cost of goods sold and ending inventory: periodic FIFO. (LO 3, 4). Assume Radio Tech uses a periodic inventory system and the FIFO cost flow method. 1. Calculate the cost of goods sold that will appear on Radio Tech s income statement for the month of April. 2. Determine the cost of inventory that will appear on Radio Tech s balance sheet at the end of April. E5-37B. Calculate cost of goods sold and ending inventory: periodic LIFO. (LO 3, 4). Assume Radio Tech uses a periodic inventory system and the LIFO cost flow method. 1. Calculate the cost of goods sold that will appear on Radio Tech s income statement for the month of April. 2. Determine the cost of inventory that will appear on Radio Tech s balance sheet at the end of April.

26 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 233 E5-37B Solution continued: E5-38B. Calculate cost of goods sold and ending inventory: perpetual FIFO. (LO 3, 4). Assume Radio Tech uses a perpetual inventory system and the FIFO cost flow method. 1. Calculate the cost of goods sold that will appear on Radio Tech s income statement for the month of April. 2. Determine the cost of inventory that will appear on Radio Tech s balance sheet at the end of April. E5-39B. Calculate cost of goods sold and ending inventory: perpetual LIFO. (LO 3, 4). Assume Radio Tech uses a perpetual inventory system and the LIFO cost flow method. 1. Calculate the cost of goods sold that will appear on Radio Tech s income statement for the month of April. 2. Determine the cost of inventory that will appear on Radio Tech s balance sheet at the end of April.

27 234 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL E5-40B. Apply the lower-of-cost-or-market rule. (LO 5). Use the data provided to answer the question that follows: Ending inventory at cost, June 30, 2010 $ 25,180 Ending inventory at replacement cost, June 30, ,130 Cost of goods sold, balance at June 30, ,550 Sales revenue, balance at June 30, ,625 Cash, balance at June 30, ,515 ASB Hardware, Inc., uses a perpetual inventory system and the FIFO cost flow method to account for its inventory. What inventory amount will ASB Hardware report on its balance sheet at June 30, 2010? E5-41B. Apply the lower-of-cost-or-market rule. (LO 5). In each case, indicate the correct amount to be reported for the inventory on the year-end balance sheet. 1. Ending inventory at cost $275,000 Ending inventory at market $271, Ending inventory at cost $185,250 Ending inventory at market $187,550

28 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 235 E5-42B. Calculate gross profit and gross profit ratio: FIFO and LIFO. (LO 6). Given the following information, calculate the gross profit and gross profit ratio under (a) FIFO periodic and under (b) LIFO periodic: Sales Beginning inventory Purchases 300 units at $75 per unit 425 units at $40 per unit 100 units at $50 per unit Problems Set A P5-43A. Analyze purchases of merchandise inventory. (LO 1). Rondo s Sports Wear made the following purchases in June of the current year: June 7 June 15 June 25 Purchased $5,000 of merchandise, terms 5/15, n/60, FOB shipping point Purchased $2,500 of merchandise, terms 3/10, n/30, FOB shipping point Purchased $7,500 of merchandise, terms 2/10, n/30, FOB destination Requirements 1. For each of the purchases listed, how many days does the company have to take advantage of the purchase discount? 2. What is the amount of the cash discount allowed in each case? 3. Assume the freight charges are 10% of the gross sales price. What is the amount of freight that Rondo s must pay for each purchase? 4. What is the total cost of inventory for Rondo s for the month of June, assuming that all discounts were taken?

29 236 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL P5-44A. Analyze purchases of merchandise inventory. (LO 1) Carrie & Runnels Bikes Plus, Inc., made the following purchases in December of the current year: Requirements 1. For each purchase, by what date is the payment due, assuming the company takes advantage of the discount? 2. For each purchase, when is the payment due if the company does not take advantage of the discount? 3. In each case, what is the amount of the cash discount allowed? 4. Assume the freight charges are $365 on each purchase. For which purchase(s) is Bikes Plus responsible for the freight charges? 5. What is the total cost of inventory for Bikes Plus for the month of December, assuming that all discounts were taken? December 5 December 14 December 24 Purchased $2,600 of merchandise, terms 3/10, n/30, FOB destination Purchased $6,150 of merchandise, terms 1/10, n/60, FOB shipping point Purchased $8,375 of merchandise, terms 2/05, n/20, FOB destination

30 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 237 P5-44A Solution continued: P5-45A. Record merchandising transactions, prepare financial statements, and calculate gross profit ratio: perpetual inventory system. (LO 1, 2, 4, 6). At the beginning of February, Ace Distribution Company, Inc., started with a contribution of $10,000 cash in exchange for common stock from its shareholders. The company engaged in the following transactions during the month of February: February 2 Purchased merchandise on account from Enter Supply Co. for $7,100, terms 2/10, n/45 February 5 Sold merchandise on account to Exit Company for $6,000, terms 2/10, n/30 and FOB destination. The cost of the merchandise sold was $4,500. February 6 Paid $100 freight on the sale to Exit Company February 8 Received credit from Enter Supply Co. for merchandise returned for $500 February 10 Paid Enter Supply Co. in full February 12 Received payment from Exit Company for sale made on February 5 February 14 Purchased merchandise for cash for $5,200 February 16 Received refund from supplier for returned merchandise on February 14 cash purchase of $350 February 17 Purchased merchandise on account from Inware Distributors for $3,800, terms 1/10, n/30 February 18 February 21 Paid $250 freight on February 17 purchase Sold merchandise for cash for $10,350. The cost of the merchandise sold was $8,200. February 24 Purchased merchandise for cash for $2,300 February 25 Paid Inware Distributors for purchase on February 17 February 27 Gave refund of $200 to customer from February 21. The cost of the returned merchandise was $135. February 28 Sold merchandise of $3,000 on account with the terms 2/10, n/30. The merchandise cost $2,300. Requirements 1. Enter each transaction into the accounting equation, assuming Ace Distribution Company uses a perpetual inventory system. Start with the opening balances in cash and common stock described at the beginning of the problem. 2. Calculate the balance in the inventory account at the end of February. 3. Prepare a multistep income statement, the statement of changes in shareholders equity, and the statement of cash flows for the month of February. Prepare a balance sheet at February Calculate the gross profit ratio.

31 238

32 P5-45A Solution continued: CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 239

33 240 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL P5-45A Solution continued: P5-46A. Record merchandising transactions, prepare financial statements, and calculate gross profit ratio: perpetual inventory system. (LO 1, 2, 4, 6). The following transactions occurred during July 2010 at Tiny s Sports Shop: July 2 Purchased weights on credit from Barbells Company for $900, with terms 3/10, n/30 July 4 Paid freight of $75 on the July 2 purchase July 8 Sold merchandise to members on credit for $500, terms n/45. The merchandise sold cost $425. July 9 Received credit of $50 from Barbells for damaged goods that were returned July 11 Purchased workout equipment from Spinners for cash for $2,000 July 13 Paid Barbells Company in full July 15 Purchased gloves and workout belts from Get Pumped on credit for $1,000, terms 5/15, n/60 July 17 Received credit of $25 from Get Pumped for damaged merchandise July 19 Sold merchandise to members on account, $750, terms n/15. The cost of the merchandise sold was $250. July 20 Received $700 in cash payment on account from members July 23 Paid Get Pumped in full July 27 Granted an allowance of $50 to members for gear that didn t work properly July 29 Received $400 in cash payments on account from members July 31 Paid cash operating expenses of $500 for the month Requirements 1. Suppose Tiny s Sports Shop started the month with cash of $8,000, merchandise inventory of $2,000, and common stock of $10,000. Enter each transaction into the accounting equation, assuming Tiny s Sports Shop uses a perpetual inventory system. 2. Calculate the cost of goods sold for July and the ending balance in inventory. 3. Prepare the multistep income statement, and the statement of changes in shareholders equity for the month of July, and the balance sheet at July Calculate the gross profit ratio for Tiny s Sports Shop for July. Explain what the ratio measures.

34 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 241

35 242 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL P5-46A Solution continued: P5-47A. Analyze accounting methods and prepare corrected income statement. (LO 1, 2, 4). You are the accountant for Baldwin Company, and your assistant has prepared the following income statement for the year ended September 30, 2010: Baldwin Company Income Statement For the Year Ended September 30, 2010 Sales revenue Sales returns and allowances $ 22,500 Freight costs ,300 Net sales Expenses Cost of goods sold $540,000 Selling expenses ,000 Insurance expense ,000 Administrative expenses ,000 Dividends ,000 Total expenses Net income $850,000 (36,800) 813, ,000 $ 55,200 You have uncovered the following errors: a. Sales revenue includes $5,000 of items that have been back-ordered. (The items have not been delivered to the customers, and the customers have not been billed for the items.) b. Selling expenses include $250 of allowances that were given to customers who received damaged products. c. Insurance expense includes $100 worth of insurance that applies to d. Administrative expenses include a loan made to worker who had some serious financial trouble and needed $500 to pay a hospital bill. The worker plans to repay the money by the end of December. Requirements 1. Prepare a corrected multistep income statement for the year. Baldwin shows sales as the net amount only on its income statement. 2. Write a memo to your assistant explaining why each error you found is incorrect and what the correct accounting treatment should be.

36 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 243 P5-48A. Calculate cost of goods sold and ending inventory and analyze effect of each method on financial statements. (LO 3, 4). Jefferson Company had the following sales and purchases during 2011, its first year of business: January 5 Purchased 40 units at $100 each February 15 Sold 15 units at $150 each April 10 Sold 10 units at $150 each June 30 Purchased 30 units at $105 each August 15 Sold 25 units at $150 each November 28 Purchased 30 units at $110 each Requirements 1. Calculate the ending inventory, the cost of goods sold, and the gross profit for the December 31, 2011, financial statements under each of the following assumptions: a. FIFO periodic b. LIFO periodic c. Weighted average cost periodic 2. How will the differences between the methods affect the income statement for the year and balance sheet at December 31, 2011?

37 244 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL

38 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 245 P5-48A Solution continued: P5-49A. Calculate cost of goods sold and ending inventory; analyze effects of each method on financial statements; apply lower-ofcost-or-market rule; calculate inventory turnover ratio. (LO 3, 4, 5, 6). The following series of transactions occurred during 2009: January 1 Beginning inventory was 70 units at $10 each January 15 Purchased 100 units at $11 each February 4 Sold 60 units at $20 each March 10 Purchased 50 units at $12 each April 15 Sold 70 units at $20 each June 30 Purchased 100 units at $13 each August 4 Sold 110 units at $20 each October 1 Purchased 80 units at $14 each December 5 Sold 50 units at $21 each Requirements 1. Calculate the value of the ending inventory and cost of goods sold, assuming the company uses a periodic inventory system and the FIFO cost flow assumption. 2. Calculate the value of the ending inventory and cost of goods sold, assuming the company uses a periodic inventory system and the LIFO cost flow assumption. 3. Calculate the value of the ending inventory and cost of goods sold, assuming the company uses a periodic record-keeping system and the weighted average cost flow assumption. 4. Which of the three methods will result in the highest cost of goods sold for the year ended December 31, 2009? 5. Which of the three methods will provide the most current ending inventory value for the balance sheet at December 31, 2009? 6. How will the differences between the methods affect the income statement for the year and the balance sheet at year end? 7. Calculate the company s inventory turnover ratio and average days in inventory for the year for each method in items 1, 2, and At the end of the year, the current replacement cost of the inventory is $1,100. Indicate at what amount the company s inventory will be reported using the lower-of-cost-or-market rule for each method (FIFO, LIFO, and weighted average cost).

39 246 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL P5-49A Solution continued:

40 P5-49A Solution continued: CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 247

41 248 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL P5-50A. Calculate cost of goods sold, ending inventory, and inventory turnover ratio. (LO 3, 6). The following merchandise inventory transactions occurred during the month of May for the Super Stars, Inc.: May 1 May 9 May 15 May 21 May 29 Inventory on hand was 2,000 units at $10 each Sold 1,000 units at $15 each Purchased 1,500 units at $11 each Sold 1,250 units at $14 each Purchased 3,000 units at $9 each Requirements 1. Assume Super Stars uses a periodic record-keeping system and compute the cost of goods sold for the month ended May 31 and ending inventory at May 31 using each of the following cost flow methods: a. FIFO b. LIFO c. Weighted average cost 2. Using the information for item (1), calculate the inventory turnover ratio and average days in inventory for the month of May for each method. 3. Assume Super Stars uses the perpetual inventory system and compute the cost of goods sold for the month ended May 31 and ending inventory at May 31 using each of the following cost flow methods: a. FIFO b. LIFO

42 P5-50A Solution continued: CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 249

43 250 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL P5-51A. Analyze effect of cost flow method on financial statements and inventory turnover ratio. (LO 2, 4, 6). Green Bay Cheese Company is considering changing inventory cost flow methods. Green Bay s primary objective is to maximize profits. Currently, the firm uses weighted average cost. Data for 2011 are provided. Beginning inventory (10,000 units) $ 14,500 Purchases 60,000 units at $1.50 each $ 90,000 50,000 units at $1.60 each 80,000 70,000 units at $1.70 each 119,000 Sales 130,000 units at $3.00 each Operating expenses were $120,000 and the company s tax rate is 30%. Requirements 1. Prepare the multistep income statement for 2011 using each of the following methods: a. FIFO periodic b. LIFO periodic 2. Which method provides the more current balance sheet inventory balance at December 31, 2011? Explain your answer. 3. Which method provides the more current cost of goods sold for the year ended December 31, 2011? Explain your answer. 4. Which method provides the better inventory turnover ratio for the year? Explain your answer. 5. In order to meet its goal, what is your recommendation to Green Bay Cheese Company? Explain your answer.

44 P5-51A Solution continued: CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 251

45 252 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL P5-51A Solution continued: P5-52A. Calculate cost of goods sold and ending inventory; analyze effects of each method on financial statements; apply lowerof-cost-or-market rule; calculate inventory turnover ratio. (LO 3, 4, 5, 6). The following information is for Leo s Solar Supplies for the year ending December 31, At January 1, 2010: Cash amounted to $15,550. Beginning inventory was $20,000 (100 units at $200 each). Contributed capital was $19,000. Retained earnings was $16,550. Transactions during 2010: Purchased 250 units for cash at $225 each Purchased 100 more units for cash at $250 each Cash sales of 300 units at $400 each Paid $11,500 cash for operating expenses Paid cash for income tax at a rate of 30% of net income Requirements 1. Compute the cost of goods sold for the year and ending inventory at December 31, 2010, using each of the following cost flow methods: a. FIFO periodic b. LIFO periodic c. Weighted average cost periodic 2. For each method, prepare the balance sheet at December 31, 2010, a multistep income statement, statement of cash flows, and statement of changes in shareholders equity for Leo s for the year ended December 31, What is income before taxes and net income after taxes under each of the three inventory cost flow assumptions? What observations can you make about net income from the analysis of the three methods? 4. For each method, calculate the inventory turnover ratio and average days in inventory for the year ended December 31, At the end of the year, the current replacement cost of the inventory is $35,000. Indicate at what amount the company s inventory will be reported using the lower-of-cost-or-market rule for each method (FIFO, LIFO, and weighted average cost).

46 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 253

47 254 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL P5-52A Solution continued:

48 P5-52A Solution continued: CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 255

49 256 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL P5-52A Solution continued:

50 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 257 P5-52A Solution continued: P5-53A. Calculate the gross profit ratio and inventory turnover ratio. (LO 6). The following information is from the financial statements of Abby s International Pasta Corporation: For year ended June 30, 2011 June 30, 2010 June 30, 2009 (amounts in thousands) Sales $416,049 $429,813 $445,849 Cost of sales 92,488 98, ,632 Inventory 17,030 16,341 12,659 Requirements 1. Calculate the gross profit ratio for the last two years shown. 2. Calculate the inventory turnover ratio for the last two years shown. 3. What information do these comparisons provide?

51 258 FINANCIAL ACCOUNTING 3/E SOLUTIONS MANUAL Set B P5-54B. Analyze purchases of merchandise inventory. (LO 1). Deborah Hart s Professional Costumers, Inc., made the following purchases in November of the current year: November 7 November 12 November 16 Purchased $2,500 of merchandise, terms 3/15, n/20, FOB shipping point Purchased $4,300 of merchandise, terms 1/05, n/25, FOB destination Purchased $6,200 of merchandise, terms 2/10, n/40, FOB shipping point Requirements 1. For each of the listed purchases, how many days does the company have to take advantage of the purchase discount? 2. What is the amount of the cash discount allowed in each case? 3. Assume the freight charges are $115 on each purchase. What is the amount of freight that Professional Costumers must pay for each purchase? 4. What is the total cost of inventory for Professional Costumers for the month of November, assuming that all discounts were taken?

52 CHAPTER 5 THE PURCHASE AND SALE OF INVENTORY 259 P5-55B. Analyze purchases of merchandise inventory. (LO 1). Cynthia s Pet Supplies, Inc., made the following purchases in March of the current year: March 6 March 11 March 12 Purchased $3,500 of merchandise, terms 2/10, n/30, FOB shipping point Purchased $5,250 of merchandise, terms 3/10, n/30, FOB destination Purchased $4,000 of merchandise, terms 3/15, n/60, FOB shipping point Requirements 1. For each purchase, by what date is the payment due, assuming the company takes advantage of the discount? 2. For each purchase, when is the payment due if the company does not take advantage of the discount? 3. In each case, what is the amount of the cash discount allowed? 4. Assume the freight charges are $100 on each purchase. For which purchase(s) is Cynthia s responsible for the freight charges? 5. What is the total amount of inventory costs for the month of March, assuming that all discounts were taken?

Chapter 5. Accounting for merchandising operations. Appendix 5A: Periodic inventory system

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