CHAPTER 9. Inventories ASSIGNMENT CLASSIFICATION TABLE. Brief. B Problems. A Problems. 1. Describe the steps in determining inventory quantities.

Transcription

1 CHAPTER 9 Inventories ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises A Problems B Problems 1. Describe the steps in determining inventory quantities. 4, 5, 6, 7, 8, Prepare the entries for purchases and sales of inventory under a periodic inventory system. 3. Determine cost of goods sold under a periodic inventory system. 4. Identify the unique features of the income statement for a merchandising company using a periodic inventory system A 1B 2, 3 2, 3 2 1A, 2A 1B, 2B A, 2A 1B, 2B 5. Explain the basis of accounting for inventories and describe the inventory cost flow methods. 8, 9, 11, 12, 13, 14 5, 6, 7 5, 6, 7 3A, 4A 3B, 4B 6. Explain the financial statement and tax effects of each of the inventory cost flow methods. 7. Explain the lower of cost or market basis of accounting for inventories. 8. Indicate the effects of inventory errors on the financial statements. 15, 16, 21 6, 7 3A, 4A 3B, 4B 17, 18, ,

2 ASSIGNMENT CLASSIFICATION TABLE (Continued) Study Objectives Questions Brief Exercises Exercises A Problems B Problems *09. Compute and interpret the inventory turnover ratio *10. Describe the two methods of estimating inventories. 23, 24, 25, 26 11, 12 12, 13 5A, 6A 5B, 6B *11. Apply the inventory cost flow methods to perpetual inventory records. 27, A 7B *Note: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the *chapter. 9-2

3 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Journalize, post, and prepare trial balance and partial income statement. Simple A Prepare an income statement. Simple A 4A Determine cost of goods sold and ending inventory using FIFO, LIFO, and average cost with analysis. Compute ending inventory, prepare income statements and answer questions using FIFO and LIFO. Simple Moderate *5A Compute gross profit rate and inventory loss using the gross profit method. *6A Compute ending inventory using the retail inventory method. *7A Determine ending inventory under a perpetual inventory system. Moderate Moderate Moderate B Journalize, post, and prepare a trial balance and partial income statement. Simple B Prepare an income statement. Simple B 4B Determine cost of goods sold and ending inventory using FIFO, LIFO, and average cost. Compute ending inventory, prepare income statements and answer questions using FIFO and LIFO. Simple Moderate *5B Estimate inventory loss using the gross profit method. Moderate *6B Compute ending inventory and cost of inventory lost using the retail inventory method. *7B Determine ending inventory under a perpetual inventory system. Moderate Moderate

4 9-4 Correlation Chart between Bloom's Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems Study Objective Knowledge Comprehension Application Analysis Synthesis Evaluation *01. Describe the steps in determining inventory quantities. *02. Prepare the entries for purchases and sales of inventory under a periodic inventory system. *03. Determine cost of goods sold under a periodic inventory system. *04. Identify the unique features of the income statement for a merchandising company using a periodic inventory system. *05. Explain the basis of accounting for inventories and describe the inventory cost flow methods. *06. Explain the financial statement and tax effects of each of the inventory cost flow methods. *07. Explain the lower of cost or market basis of accounting for inventories. *08. Indicate the effects of inventory errors on the financial statements. *09. Compute and interpret the inventory turnover ratio. *10. Describe the two methods of estimating inventories. *11. Apply the inventory cost flow methods to perpetual inventory records. Broadening Your Perspective Q9-5 Q9-4 Q9-6 Q9-7 Q9-2 Q9-3 Q9-12 Q9-14 BE9-5 Q9-9 Q9-8 E9-4 BE9-4 Q9-1 BE9-1 E9-1 BE9-2 BE9-3 Q9-10 E9-3 P9-1A P9-1B Q9-9 Q9-11 Q9-13 Q9-15 Q9-16 Q9-21 Q9-17 Q9-18 Q9-23 Q9-24 Q9-27 Q9-28 Q9-8 BE9-6 BE9-7 E9-6 E9-7 P9-3A Q9-19 BE9-8 E9-8 BE9-9 BE9-11 Q9-25 Q9-26 BE9-12 BE9-13 E9-14 P9-7A P9-1A P9-1B E9-2 P9-1B P9-2A P9-1A P9-2B E9-5 E9-6 E9-7 P9-3B E9-12 P9-5B E9-13 P9-6B P9-5A P9-6A P9-7B P9-2A P9-2B P9-3A P9-4A P9-3B P9-4B P9-4A P9-4B Q9-20 BE9-9 Q9-22 BE9-10 E9-9 E9-10 Financial Reporting Real-World Focus Group Decision Case Communication Research Assign. Surfing the Net Ethics Case Comp. Analysis Interpreting Financial Sts. BLOOM'S TAXONOMY TABLE

5 ANSWERS TO QUESTIONS 01. July 24 Accounts Payable ($1,700 $200)... 1,500 Purchase Discounts ($1,500 X 2%) Cash ($1,500 $30)... 1, Accounts Added/Deducted Normal Balance Purchase Returns and Allowances Purchase Discounts Freight-in 03. (a) X = Purchase returns and allowances and Y = Purchase discounts, or vice versa. (b) X = Freight-in. (c) X = Cost of goods purchased. (d) X = Ending merchandise inventory. Deducted Deducted Added Credit Credit Debit 04. Agree. Effective inventory management is frequently the key to successful business operations. Management attempts to maintain sufficient quantities and types of goods to meet expected customer demand. It also seeks to avoid the cost of carrying inventories that are clearly in excess of anticipated sales. 05. Inventory items have two common characteristics: (1) they are owned by the company and (2) they are in a form ready for sale to customers in the ordinary course of business. 06. Taking a physical inventory involves actually counting, weighing or measuring each kind of inventory on hand. Retailers, such as a hardware store, generally have thousands of different items to count. This is normally done when the store is closed. Tom will probably count items, and mark the quantity, description, and inventory number on prenumbered inventory tags. 07. (a) (1) The goods will be included in Janine Company's inventory if the terms of sale are FOB destination. (2) They will be included in Laura Company's inventory if the terms of sale are FOB shipping point. (b) Janine Company should include goods shipped to a consignee in its inventory. Goods held by Janine Company on consignment should not be included in inventory. 08. Inventoriable costs are $3,020 (invoice cost $3,000 + freight charges $80 purchase discounts $60). The amount paid to negotiate the purchase is a buying cost that normally is not included in the cost of inventory because of the difficulty of allocating these costs. Buying costs are expensed in the year incurred. 09. The primary basis of accounting for inventories is cost in accordance with the cost principle. The major objective of accounting for inventories is the proper determination of net income in accordance with the matching principle. 10. There are three distinguishing features in the income statement of a merchandising company: (1) a sales revenues section, (2) a cost of goods sold section, and (3) gross profit. 9-5

6 Questions Chapter 9 (Continued) 11. Actual physical flow may be impractical because many items are indistinguishable from one another. Actual physical flow may be inappropriate because management may be able to manipulate net income through specific identification of items sold. 12. The major advantage of the specific identification method is that it tracks the actual physical flow of the goods available for sale. The major disadvantage is that management could manipulate net income. 13. No. Selection of an inventory costing method is a management decision. However, once a method has been chosen, it should be consistently applied. 14. (a) FIFO, (b) Average cost, (c) LIFO. 15. Jim Groat Company is using the FIFO method of inventory costing, and Greg Hanson Company is using the LIFO method. Under FIFO, the latest goods purchased remain in inventory. Thus, the inventory on the balance sheet should be close to current costs. The reverse is true of the LIFO method. Jim Groat Company will have the higher gross profit because cost of goods sold will include a higher proportion of goods purchased at earlier (lower) costs. 16. Char Lewis Company may experience severe cash shortages if this policy continues. All of its net income is being paid out as dividends, yet some of the earnings must be reinvested in inventory to maintain inventory levels. Some earnings must be reinvested because net income is computed with cost of goods sold based on older, lower costs while the inventory must be replaced at current, higher costs. Because of this factor, net income under FIFO is sometimes referred to as "phantom profits." 17. Bob should know the following: (a) A departure from the cost basis of accounting for inventories is justified when the utility (revenue-producing ability) of the goods is no longer as great as its cost. The writedown to market should be recognized in the period in which the price decline occurs. (b) Market means current replacement cost, not selling price. For a merchandising company, market is the cost at the present time from the usual suppliers in the usual quantities. 18. Hohenberger Music Center should report the CD players at $320 each for a total of $1,600. $320 is the current replacement cost under the lower of cost or market basis of accounting for inventories. A decline in replacement cost usually leads to a decline in the selling price of the item. Valuation at LCM is conservative. 19. The methods that may be used under LCM are (1) individual items, (2) major categories, and (3) total inventory. The individual items method produces the lowest inventory value. 20. (a) Elaine Stahl Company's 1998 net income will be understated $5,000; (b) 1999 net income will be overstated $5,000; and (c) the combined net income for the two years will be correct. 21. Maureen & Nathan Company should disclose (1) the major inventory classifications, (2) the basis of accounting (cost or lower of cost or market), and (3) the costing method (FIFO, LIFO, or average). 9-6

7 Questions Chapter 9 (Continued) *22. An inventory turnover ratio too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory outages may also cause customer ill will and result in lost future sales. *23. Inventories must be estimated when (1) management wants monthly or quarterly financial statements but a physical inventory is only taken annually and (2) a fire or other type of casualty makes it impossible to take a physical inventory. *24. In the gross profit method, the average is the gross profit rate, which is gross profit divided by net sales. The rate is often based on last year's actual rate. The gross profit rate is applied to net sales in using the gross profit method. In the retail inventory method, the average is the cost-to-retail ratio, which is the goods available for sale at cost divided by the goods available for sale at retail. The ratio is based on current year data and is applied to the ending inventory at retail. *25. The estimated cost of the ending inventory is $20,000: Net sales... $400,000 Less: Gross profit ($400,000 X 30%) ,000 Estimated cost of goods sold... $280,000 Cost of goods available for sale... $300,000 Less: Cost of goods sold ,000 Estimated cost of ending inventory... $020,000 *26. The estimated cost of the ending inventory is $21,000: Cost-to-retail ratio: Ending inventory at retail: $30,000 ($120,000 $90,000). Ending inventory at cost: $21,000 ($30,000 X 70%). *27. Disagree. The results under the FIFO method are the same but the results under the LIFO method are different. The reason is that the pool of inventoriable costs (cost of goods available for sale) is not the same. Under a periodic system, the pool of costs is the goods available for sale for the entire period, whereas under a perpetual system, the pool is the goods available for sale up to the date of sale. *28. In a periodic system, the average is a weighted average based on total goods available for sale for the period. In a perpetual system, the average is a moving average of goods available for sale after each purchase. 9-7

8 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 (a) Purchases ,000 Accounts Payable ,000 (b) Accounts Payable ,000 Purchase Returns and Allowances ,000 (c) Accounts Payable ($900,000 $130,000) ,000 Purchase Discounts ($770,000 X 2%)... 15,400 Cash ($770,000 $15,400) ,600 BRIEF EXERCISE 9-2 (a) Purchases... $440,000 Less: Purchase returns and allowances... $11,000 Purchase discounts , ,000 Net purchases... $421,000 (b) Net purchases... $421,000 Add: Freight-in ,000 Cost of goods purchased... $437,000 BRIEF EXERCISE 9-3 Net sales... $650,000 Beginning inventory... $060,000 Add: Cost of goods purchased* ,000 Cost of goods available for sale ,000 Ending inventory ,000 Cost of goods sold ,000 Gross profit... $243,000 *Information taken from Brief Exercise

9 BRIEF EXERCISE Ownership of the goods belongs to the consignor (Oriental Press). Thus, these goods should be included in Oriental Press' inventory. 2. The goods in transit should not be included in the inventory count because ownership by Oriental Press does not occur until the goods reach the buyer. 3. The goods being held belong to the customer. They should not be included in Oriental Press' inventory. 4. Ownership of these goods rests with the other company (the consignor). Thus, these goods should not be included in the physical inventory. BRIEF EXERCISE 9-5 The items that should be included in inventoriable costs are: (1) Freight-in (2) Purchase Returns and Allowances (3) Purchases (5) Purchase Discounts BRIEF EXERCISE 9-6 (1) The ending inventory under FIFO consists of 300 units at $ units at $7 for a total allocation of $3,100 ($2,400 + $700). (2) The ending inventory under LIFO consists of 300 units at $ units at $7 for a total allocation of $2,500 ($1,800 + $700). 9-9

10 BRIEF EXERCISE 9-7 Average unit cost is $7.00 computed as follows: 0,300 X $6 = $1,800 0,400 X $7 = 02,800 0,300 X $8 = 02,400 1,000 $7,000 $7,000 1,000 = $7.00. The cost of the ending inventory is $2,800 (400 X $7.00). BRIEF EXERCISE 9-8 Inventory Categories Cost Market LCM Cameras Camcorders VCRs Total valuation $12,000 9,000 14,000 $10,200 9,700 12,800 $10,200 9, ,800 $32,000 BRIEF EXERCISE 9-9 Inventory turnover ratio: = = 3.0 Days in inventory: = days BRIEF EXERCISE 9-10 The understatement of ending inventory caused cost of goods sold to be overstated $7,000 and net income to be understated $7,000. The correct net income for 1999 is $97,000 ($90,000 + $7,000). Total assets in the balance sheet will be understated by the amount that ending inventory is understated, $7,

11 *BRIEF EXERCISE 9-11 (1) Net sales $300,000 Less: Estimated gross profit (40% X $300,000) 0120,000 Estimated cost of goods sold $180,000 (2) Cost of goods available for sale $230,000 Less: Estimated cost of goods sold 0180,000 Estimated cost of ending inventory $050,000 *BRIEF EXERCISE 9-12 Goods available for sale Net sales Ending inventory at retail At Cost At Retail $35,000 $50, ,000 $20,000 Cost-to-retail ratio = ($35,000 $50,000) = 70% Estimated cost of ending inventory = ($20,000 X 70%) = $14,000 *BRIEF EXERCISE 9-13 (1) FIFO Method Product E2-D2 Date Purchases Sales Balance May 7 June 1 July 28 Aug. 27 $10) $500 $15) $450 $10) $300 $10) $15) $395 $10) $500 $10) $200 $10) $15) $650 $15) $

12 *BRIEF EXERCISE 9-13 (Continued) (2) LIFO Method Product E2-D2 Date Purchases Sales Balance May 7 June 1 July 28 Aug. 27 $10) $500 $15) $450 $10) $300 $15) $10) $480 $10) $500 $10) $200 $10) $15) $650 $10) $170 (3) Average Cost Product E2-D2 Date Purchases Sales Balance May 7 June 1 July 28 Aug. 27 *$ $10) $500 $15) $450 $10) $300 $13) $429 $10) $500 $10) $200 $13)* $650 $13) $

13 SOLUTIONS TO EXERCISES EXERCISE 9-1 (a) (1) April 5 Purchases... 18,000 Accounts Payable... 18,000 (2) April 6 Freight-in Cash (3) April 7 Equipment... 26,000 Accounts Payable... 26,000 (4) April 8 Accounts Payable... 3,000 Purchase Returns and Allowances... 3,000 (5) April 15 Accounts Payable... 15,000 ($18,000 $3,000) Purchase Discounts [($18,000 $3,000) X 2%] Cash ($15,000 $300)... 14,700 (b) May 4 Accounts Payable ($18,000 $3,000).. 15,000 Cash... 15,000 EXERCISE 9-2 Inventory, September 1, $017,200 Purchases... $142,400 Less: Purchase returns and allowances ,000 Net purchases ,400 Add: Freight-in ,000 Cost of goods purchased ,400 Cost of goods available for sale ,600 Inventory, August 31, ,000 Cost of goods sold... $134,

14 EXERCISE 9-3 MEXICO COMPANY Income Statement For the Month Ended January 31, 1999 Sales revenues Sales... $312,000 Less: Sales returns and allowances... $013,000 Sales discounts , ,000 Net sales ,000 Cost of goods sold Inventory, January ,000 Purchases... $200,000 Less: Purchase returns and allowances... $6,000 Purchase discounts.. 03, ,000 Net purchases ,000 Add: Freight-in ,000 Cost of goods purchased ,000 Cost of goods available for sale ,000 Inventory, January ,000 Cost of goods sold ,000 Gross profit ,000 Operating expenses Salary expense... 61,000 Rent expense... 19,000 Insurance expense... 12,000 Freight-out ,000 Total operating expense ,000 Net income... $014,

15 EXERCISE 9-4 Ending inventory physical count No effect title passes to purchaser upon shipment when terms are FOB shipping point No effect title does not transfer to Canada until goods are received Add to inventory: Title passed to Canada when goods were shipped Add to inventory: Title remains with Canada until purchaser receives goods The goods did not arrive prior to year-end. The goods, therefore, cannot be included in the inventory... Correct inventory... $297,000) 0) 0) 25,000) 40,000) 0044,000) ( $318,000 EXERCISE 9-5 FIFO Beginning inventory (30 X $8)... $240 Purchases May 15 (25 X $10)... $250 May 24 (35 X $13) Cost of goods available for sale Less: Ending inventory (12 X $13) Cost of goods sold... $789 Proof Date Units Unit Cost Total Cost 5/1 5/15 5/ $ $ $789 LIFO Cost of goods available for sale... $945 Less: Ending inventory (12 X $8) Cost of goods sold... $

16 EXERCISE 9-5 (Continued) Proof Date Units Unit Cost Total Cost 5/24 5/15 5/ $ $ $849 EXERCISE 9-6 (a) FIFO Beginning inventory (200 X $5)... $1,000 Purchases June 12 (300 X $6)... $1,800 June 23 (500 X $7)... 03,500 05,300 Cost of goods available for sale... 6,300 Less: Ending inventory (180 X $7)... 01,260 Cost of goods sold... $5,040 LIFO Cost of goods available for sale... $6,300 Less: Ending inventory (180 X $5) Cost of goods sold... $5,400 (b) (c) The FIFO method will produce the higher ending inventory because costs have been rising. Under this method, the earliest costs are assigned to cost of goods sold, and the latest costs remain in ending inventory. For Luxenburg Company, the ending inventory under FIFO is $1,260 (180 X $7) compared to $900 (180 X $5) under LIFO. The LIFO method will produce the higher cost of goods sold for Luxenburg Company. Under LIFO the most recent costs are charged to cost of goods sold and the earliest costs are included in the ending inventory. The cost of goods sold is $5,400 [$6,300 (180 X $5)] compared to $5,040 ($6,300 $1,260) under FIFO. 9-16

17 EXERCISE 9-7 (a) Cost of Goods Available for Sale $6,300 + Total Units Available for Sale 1,000 = Weighted Average Unit Cost $6.30 Ending inventory (180 X $6.30) $1,134 Cost of goods sold (820 X $6.30) 05,166 (b) (c) Ending inventory is lower than FIFO ($1,260) and higher than LIFO ($900). In contrast, cost of goods sold is higher than FIFO ($5,040) and lower than LIFO ($5,400). The average cost method uses a weighted average unit cost, not a simple average of unit costs. EXERCISE 9-8 Lower of Cost or Market by: Cost Market (a) Individual Items (b) Major Categories (c) Total Inventory Cameras Minolta Canon Total $0,850 01,050 01,900 $0,800 01,064 01,864 $0,800 01,050 $1,864 Light Meters Vivitar Kodak Total Total inventory 01,500 01,150 02,650 $4,550 01,320 01,350 02,670 $4,534 01,320 01,150 00,000 $4,320 02,650 $4,514 $4,

18 EXERCISE 9-9 Beginning inventory... Cost of goods purchased... Cost of goods available for sale... Corrected ending inventory... Cost of goods sold $020, , , ,000 a $144,000 $026, , , ,000 b $163,000 a $30,000 $4,000 = $26,000. b $35,000 + $3,000 = $38,000. EXERCISE 9-10 (a) Sales... Cost of goods sold Beginning inventory... Cost of goods purchased... Cost of goods available for sale... Ending inventory ($40,000 $6,000).. Cost of goods sold... Gross profit... $210, , , , , ,000 $039,000 $250, , , , , ,000 $066,000 (b) The cumulative effect on total gross profit for the two years is zero as shown below: Incorrect gross profits: $45,000 + $60,000 = $105,000 Correct gross profits: $39,000 + $66,000 = 0105,000 Difference $000,000 (c) Dear Mr./Ms. President: Because your ending inventory of December 31, 1999 was overstated by $6,000, this resulted in your net income for 1999 being overstated and for 2000 being understated by $6,000. In a periodic system, the cost of goods sold is calculated by deducting the cost of ending inventory from the total cost of goods you have available for sale in the period. Therefore, if this ending inventory figure is overstated, as it was in December 1999, then the cost of goods sold 9-18

19 EXERCISE 9-10 (Continued) is understated and therefore net income will be overstated by that amount. Consequently, this overstated ending inventory figure goes on to become the next period's beginning inventory amount and is a part of the total cost of goods available for sale. Therefore, the mistake repeats itself in the reverse. The error also affects the balance sheet at the end of The inventory reported in the balance sheet is overstated; therefore, total assets are overstated. The overstatement of the 1999 net income results in the capital account balance being overstated. The balance sheet at the end of 2000 is correct because the overstatement of the capital account at the end of 1999 is offset by the understatement of the 2000 net income and the inventory at the end of 2000 is correct. Thank you for allowing me to bring this to your attention. If you have any questions, please contact me at your convenience. Sincerely, EXERCISE 9-11 Inventory turnover ratio = 3.6 = 3.2 = 2.8 Days in inventory = days = days = days Gross profit rate =.25 =.30 =.34 The inventory turnover decreased by approximately 22% from 1997 to 1999 while the days in inventory increased by almost 29% over the same time period. Both of these changes would be considered negative in nature since it's better to have a higher inventory turnover ratio with a corresponding lower days in inventory. However, Wasicsko's gross profit rate increased by 36% from 1997 to 1999, which is a positive sign. 9-19

20 *EXERCISE 9-12 (a) Net sales ($51,000 $1,000)... $50,000 Less: Estimated gross profit (30% X $50,000) ,000 Estimated cost of goods sold... $35,000 Beginning inventory... $20,000 Cost of goods purchased ($28,200 $1,400 + $1,200) ,000 Cost of goods available for sale... 48,000 Less: Estimated cost of goods sold ,000 Estimated cost of merchandise lost... $13,000 (b) Net sales... $50,000 Less: Estimated gross profit (25% X $50,000) ,500 Estimated cost of goods sold... $37,500 Beginning inventory... $25,000 Cost of goods purchased ,000 Cost of goods available for sale... 53,000 Less: Estimated cost of goods sold ,500 Estimated cost of merchandise lost... $15,500 *EXERCISE 9-13 Beginning inventory Goods purchased Goods available for sale Net sales Ending inventory at retail Women's Department Men's Department Cost Retail Cost Retail $032, ,000 $180,000 $045, , , ,000 $040,000 $046, ,300 $183,750 $060, , , ,000 $050,000 Cost/retail ratio = 79% = 75% Estimated cost of ending inventory $40,000 X 79% = $31,600 $50,000 X 75% = $37,

21 *EXERCISE 9-14 (1) FIFO Date Purchases Sales Balance Jan $640) $3,840 $600) $1,200 $600) $640) $2,480 $600) $2,400 $600) 1,200 $600) $640) 5,040 $640) 2,560 (2) LIFO Date Purchases Sales Balance Jan $640) $3,840 $600) $1,200 $640) $2,560 $600) $2,400 $600) 1,200 $600) $640) 5,040 $600) $640) 2,480 (3) AVERAGE COST Date Purchases Sales Balance Jan $640) $3,840 *Average cost = $5,040 8 = $630 $600) $1,200 $630) $2,520 $600) $2,400 $600) 1,200 $630)* 5,040 $630) 2,

22 SOLUTIONS TO PROBLEMS PROBLEM 9-1A (a) General Journal Date Account Titles and Explanation Ref. Debit Credit Apr. 5 Purchases Accounts Payable ,600 1,600 7 Freight-in Cash ,080 0,080 9 Accounts Payable Purchase Returns and Allowances ,100 0, Accounts Receivable Sales ,900 0, Purchases Accounts Payable ,660 0, Accounts Payable ($1,600 $100) Purchase Discounts ($1,500 X 2%) Cash ,500 0,030 1, Accounts Payable Purchase Returns and Allowances ,060 0, Accounts Receivable Sales ,700 0, Accounts Payable ($660 $60) Purchase Discounts ($600 X 1%) Cash ,600 0,006 0,

23 PROBLEM 9-1A (Continued) Date Account Titles and Explanation Ref. Debit Credit Apr. 27 Sales Returns and Allowances 412 0,030 Accounts Receivable 112 0, Cash Sales ,600 0, Cash Accounts Receivable ,100 1,100 (b) Cash No. 101 Date Explanation Ref. Debit Credit Balance Apr Balance 0,600 1,100 0,080 1,470 0,594 2,500 2,420 0,950 0,356 0,956 2,056 Accounts Receivable No. 112 Date Explanation Ref. Debit Credit Balance Apr ,900 0,700 0,030 1,100 0,900 1,600 1,570 0,470 Merchandise Inventory No. 120 Date Explanation Ref. Debit Credit Balance Apr. 1 Balance 3,

24 PROBLEM 9-1A (Continued) Accounts Payable No. 201 Date Explanation Ref. Debit Credit Balance Apr ,100 1,500 0,060 0,600 1,600 0,660 1,600 1,500 2,160 0,660 0,600 0,000 C. Lopez, Capital No. 301 Date Explanation Ref. Debit Credit Balance Apr. 1 Balance 06,000 Sales No. 401 Date Explanation Ref. Debit Credit Balance Apr ,900 0,700 0,600 0,900 1,600 2,200 Sales Returns and Allowances No. 412 Date Explanation Ref. Debit Credit Balance Apr. 27 0,030 0,030 Purchases No. 510 Date Explanation Ref. Debit Credit Balance Apr ,600 0,660 1,600 2,

25 PROBLEM 9-1A (Continued) Purchase Returns and Allowances No. 512 Date Explanation Ref. Debit Credit Balance Apr Purchase Discounts No. 514 Date Explanation Ref. Debit Credit Balance Apr Freight-in No. 516 Date Explanation Ref. Debit Credit Balance Apr (c) CHI CHI'S PRO SHOP Trial Balance April 30, 1999 Cash... Accounts Receivable... Merchandise Inventory... Capital... Sales... Sales Returns and Allowances... Purchases... Purchase Returns and Allowances... Purchase Discounts... Freight-in... Debit $2,056 00,470 03,500 00,030 02,260 00,080 $8,396 Credit $6,000 02,200 00,160 00,036 00,000 $8,

26 PROBLEM 9-1A (Continued) (d) CHI CHI'S PRO SHOP Income Statement (Partial) For the Month Ended April 30, 1999 Sales revenues Sales... $2,200 Less: Sales returns and allowances... 00,030 Net sales... 2,170 Cost of goods sold Inventory, April 1... $3,500 Purchases... $2,260 Less: Purchase returns and allowances... $160 Purchase discounts ,196 Net purchases... 2,064 Add: Freight-in... 00,080 Cost of goods purchased... 02,144 Cost of goods available for sale... 5,644 Inventory, April ,200 Cost of goods sold... 01,444 Gross profit... $0,

27 PROBLEM 9-2A ASIAN DEPARTMENT STORE Income Statement For the Year Ended November 30, 1999 Sales revenues Sales $860,000 Less: Sales returns and allowances ,000 Net sales ,000 Cost of goods sold Inventory, Dec. 1, $034,360 Purchases... $640,000 Less: Purchase returns and allowances... $3,000 Purchase discounts.. 07, ,000 Net purchases ,000 Add: Freight-in ,060 Cost of goods purchased ,060 Cost of goods available for sale ,420 Inventory, Nov. 30, ,200 Cost of goods sold ,220 Gross profit 216,780 Operating expenses Selling expenses Salaries expense... 84,000 ($120,000 X 70%) Sales commissions expense... 12,000 Depreciation expense store equipment... 9,500 Delivery expense... 8,200 Insurance expense... 4,500 ($9,000 X 50%) Depreciation expense delivery equipment ,000 Total selling expenses ,

28 PROBLEM 9-2A (Continued) ASIAN DEPARTMENT STORE Income Statement (Continued) For the Year Ended November 30, 1999 Administrative expenses Salaries expense... 36,000 ($120,000 X 30%) Rent expense... 19,000 Utilities expense... 10,600 Insurance expense... 4,500 ($9,000 X 50%) Property tax expense ,500 Total administrative expenses ,600 Total operating expenses ,800 Net income... $020,

29 PROBLEM 9-3A (a) COST OF GOODS AVAILABLE FOR SALE Date Explanation Units Unit Cost Total Cost 1/1 3/15 7/20 9/4 12/2 Beginning inventory Purchase Purchase Purchase Purchase Total 0,100 0,300 0,200 0,300 0,100 1,000 $ $02, , , , ,000 $25,600 (b) (1) Ending Inventory Date 12/2 9/4 Units Unit Cost $ Total Cost $3,000 01,400 $4,400 FIFO (2) Cost of Goods Sold Cost of goods available for sale $25,600 Less: Ending inventory 004,400 Cost of goods sold $21,200 Date 1/1 3/15 7/20 9/4 Proof of Cost of Goods Sold Units Unit Cost $ Total Cost $02, , , ,000 $21,

30 PROBLEM 9-3A (Continued) (1) Ending Inventory Date 1/1 3/15 Units Unit Cost $ Total Cost $2,000 01,200 $3,200 LIFO (2) Cost of Goods Sold Cost of goods available for sale $25,600 Less: Ending inventory 003,200 Cost of goods sold $22,400 Date 12/2 9/4 7/20 3/15 Proof of Cost of Goods Sold Units Unit Cost $ Total Cost $03, , , ,000 $22,400 (1) Ending Inventory $25,600 1,000 = $25.60 Unit Total Units Cost Cost 150 $25.60 $3,840 Proof of Cost of Goods Sold 850 units X $25.60 = $21,760 AVERAGE COST (2) Cost of Goods Sold Cost of goods available for sale $25,600 Less: Ending inventory 003,840 Cost of goods sold $21,760 (c) (1) As shown in (b) above, FIFO produces the highest inventory amount, $4,400. (2) As shown in (b) above, LIFO produces the highest cost of goods sold, $22,

31 PROBLEM 9-4A (a) AFRICAN CO. Condensed Income Statements For the Year Ended December 31, 1999 Sales... Cost of goods sold Beginning inventory... Cost of goods purchased... Cost of goods available for sale... Ending inventory... Cost of goods sold... Gross profit... Operating expenses... Income before income taxes... Income tax expense (28%)... Net income... a $ $4.20 = $111,000. b $ $4.00 = $95,000. FIFO $665, , , , ,000 a 0384, , , , ,080 $115,920 LIFO $665, , , , ,000 b 0400, , , , ,600 $104,400 (b) Answers to questions: (1) The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchases. (2) The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. (3) The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. (4) There will be $4,480 additional cash available under LIFO because income taxes are $40,600 under LIFO and $45,080 under FIFO. 9-31

32 PROBLEM 9-4A (Continued) (5) The illusionary profit is $16,000 ($281,000 $265,000). Under LIFO, African Co. has recovered the current replacement cost of the units ($400,000), whereas under FIFO, it has only recovered the earlier costs ($384,000). This means that under FIFO, the company must reinvest $16,000 of the gross profit to replace the units used. (b) Answer in business-letter form: Dear African Co.: After preparing the comparative condensed income statements for 1999 under FIFO and LIFO methods, we have found the following: The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchases. This method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. There will be $4,480 additional cash available under LIFO because income taxes are $45,080 under LIFO and $40,600 under FIFO. There exists an illusionary profit under FIFO of $16,000 ($281,000 $265,000). Under LIFO, you have recovered the current replacement cost of the units ($400,000) whereas under FIFO you have only recovered the earlier costs ($384,000). This means that under FIFO, the company must reinvest $16,000 of the gross profit to replace the units used. Sincerely, 9-32

33 *PROBLEM 9-5A (a) Net sales Cost of goods sold Beginning inventory Purchases Less: Purchase returns and allowances Purchase discounts Add: Freight-in Cost of goods purchased Cost of goods available for sale Ending inventory Cost of goods sold Gross profit $022, ,975 (11,800) (8,577) 0004, , , ,100 November $400, ,000 $108,000 Gross profit rate = = 27% (b) Net sales... $300,000 Less: Estimated gross profit ,000 (27% x $300,000) Estimated cost of goods sold... $219,000 Beginning inventory... $029,100 Purchases... $236,000 Less: Purchase returns and allowances... $5,000 Purchase discounts... 06, ,000 Net purchases ,000 Freight-in ,700 Cost of goods purchased ,700 Cost of goods available for sale ,800 Less: Estimated cost of goods sold ,000 Estimated inventory lost in fire... $038,

34 *PROBLEM 9-6A (a) Hardcovers Paperbacks Cost Retail Cost Retail Beginning inventory Purchases Freight-in Purchase discounts Goods available for sale Net sales Ending inventory $0,260,000 01,180,000 00,005,000 00,015,000) ( $1,430,000 $0,400,000 1,800,000 00,000,000 2,200,000 01,810,000 $0,390,000 $065, , , ,000) ( $329,000 $090, , , , ,000 $107,000 Cost-to-retail ratio: Hardcovers ($1,430,000 $2,200,000) = 65%. Paperbacks ($329,000 $470,000) = 70%. Estimated inventory at cost: ($390,000 X 65%) = $253,500 Hardcovers. ($107,000 X 70%) = $74,900 Paperbacks. (b) Hardcovers $400,000 X 65% = $260,000 Paperbacks $100,000 X 70% = $70,

35 *PROBLEM 9-7A (a) (1) FIFO Date Purchases Sales Balance July $90) $450 $99) $396 $106) $318 $90) $270 $90) $99) $99) $106) $279 $403 $90) $450 $90) $180 $90) $99) $576 $99) $297 $99) $106) $615 $106) $212 (2) Average Cost Date Purchases Sales Balance July **$576 6=$96 **$606 6=$101 $90) $450 $99) $396 $106) $318 $90) $270 $96) $288 $101) $404 $90) $450 $90) $180 $96)* $576 $96) $288 $101)** $606 $101) $

36 *PROBLEM 9-7A (Continued) (3) LIFO Date Purchases Sales Balance July $90) $450 $99) $396 $106) $318 $90) $270 $99) $297 $106) $99)0 $417 $90) $450 $90) $180 $90) $99) $576 $90) $99) $279 $90) $99) $106) $597 $90) $180 (b) The highest ending inventory is $212 under the FIFO method. 9-36

37 PROBLEM 9-1B (a) General Journal Date Account Titles and Explanation Ref. Debit Credit Apr. 4 Purchases Accounts Payable Freight-in Cash Accounts Receivable Sales Accounts Payable Purchase Returns and Allowances Purchases Cash Accounts Payable ($640 $40) Purchase Discounts ($600 X 3%) Cash Purchases Accounts Payable Cash Purchase Returns and Allowances Freight-in Cash Accounts Receivable Sales Cash Accounts Receivable

38 PROBLEM 9-1B (Continued) Date Account Titles and Explanation Ref. Debit Credit Apr. 21 Accounts Payable Purchase Discounts ($700 X 2%) Cash Sales Returns and Allowances Accounts Receivable Accounts Receivable Sales Cash Accounts Receivable (b) Cash No. 101 Date Explanation Ref. Debit Credit Balance Apr Balance ,500 2,460 2,160 1,578 1,628 1,598 2,098 1,412 1,912 Accounts Receivable No. 112 Date Explanation Ref. Debit Credit Balance Apr ,900 1,700 1,200 1,170 2,070 1,

39 PROBLEM 9-1B (Continued) Merchandise Inventory No. 120 Date Explanation Ref. Debit Credit Balance Apr. 1 Balance 1,700 Accounts Payable No. 201 Date Explanation Ref. Debit Credit Balance Apr ,640 0,600 0,000 0,700 0,000 B. J. Evert, Capital No. 301 Date Explanation Ref. Debit Credit Balance Apr. 1 Balance 4,200 Sales No. 401 Date Explanation Ref. Debit Credit Balance Apr ,900 1,700 2,600 Sales Returns and Allowances No. 412 Date Explanation Ref. Debit Credit Balance Apr ,030 Purchases No. 510 Date Explanation Ref. Debit Credit Balance Apr ,640 0,940 1,

40 PROBLEM 9-1B (Continued) Purchase Returns and Allowances No. 512 Date Explanation Ref. Debit Credit Balance Apr Purchase Discounts No. 514 Date Explanation Ref. Debit Credit Balance Apr Freight-in No. 516 Date Explanation Ref. Debit Credit Balance Apr (c) B. J.'S TENNIS SHOP Trial Balance April 30, 1999 Cash... Accounts Receivable... Merchandise Inventory... Capital... Sales... Sales Returns and Allowances... Purchases... Purchase Returns and Allowances... Purchase Discounts... Freight-in... Debit $1,912 01,570 01,700 00,030 01,640 00,070 $6,922 Credit $4,200 02,600 00,090 00,032 00,000 $6,

41 PROBLEM 9-1B (Continued) (d) B. J.'S TENNIS SHOP Income Statement (Partial) For the Month Ended April 30, 1999 Sales revenues Sales... $2,600 Less: Sales returns and allowances... 00,030 Net sales... 2,570 Cost of goods sold Inventory, April 1... $1,700 Purchases... $1,640 Less: Purchase returns and allowances... $90 Purchase discounts ,122 Net purchases... 1,518 Add: Freight-in... 00,070 Cost of goods purchased... 01,588 Cost of goods available for sale... 3,288 Inventory, April ,800 Cost of goods sold... 01,488 Gross profit... $1,

42 PROBLEM 9-2B AUSTRIAN DEPARTMENT STORE Income Statement For the Year Ended December 31, 1999 Sales revenues Sales $618,000 Less: Sales returns and allowances ,000 Net sales ,000 Cost of goods sold Inventory, January 1... $040,500 Purchases... $462,000 Less: Purchase discounts.. $12,000 Purchase returns and allowances , ,400 Net purchases ,600 Add: Freight-in ,600 Cost of goods purchased ,200 Cost of goods available for sale ,700 Inventory, December ,000 Cost of goods sold ,700 Gross profit 197,300 Operating expenses Selling expenses Sales salaries expense... 74,000 Sales commissions expense... 14,500 Depreciation expense equipment... 13,300 Utilities expense ($11,000 X 60%)... 6,600 Insurance expense ($7,200 X 60%) ,320 Total selling expenses ,

43 PROBLEM 9-2B (Continued) AUSTRIAN DEPARTMENT STORE Income Statement (Continued) For the Year Ended December 31, 1999 Administrative expenses Office salaries expense.. 32,000 Depreciation expense building... 10,400 Property tax expense... 4,800 Utilities expense ($11,000 X 40%)... 4,400 Insurance expense ($7,200 X 40%) ,880 Total administrative expenses ,480 Total operating expenses ,200 Net income... $030,

44 PROBLEM 9-3B (a) COST OF GOODS AVAILABLE FOR SALE Date Explanation Units Unit Cost Total Cost 1/1 2/20 5/5 8/12 12/8 Beginning inventory Purchase Purchase Purchase Purchase Total 0,400 0,700 0,500 0,300 0,100 2,000 $ $03, , , , ,200 $19,000 (b) (1) Ending Inventory Date 12/8 8/12 5/5 Units Unit Cost $ Total Cost $1,200 03,300 00,500 $5,000 FIFO (2) Cost of Goods Sold Cost of goods available for sale $19,000 Less: Ending inventory 005,000 Cost of goods sold $14,000 Date 1/1 2/20 5/5 Proof of Cost of Goods Sold Units 0,400 0,700 0,450 1,550 Unit Cost $ Total Cost $03, , ,500 $14,

45 PROBLEM 9-3B (Continued) (1) Ending Inventory Date 1/1 2/20 Units Unit Cost $8 09 Total Cost $3,200 00,450 $3,650 LIFO (2) Cost of Goods Sold Cost of goods available for sale $19,000 Less: Ending inventory 003,650 Cost of goods sold $15,350 Date 12/8 8/12 5/5 2/20 Proof of Cost of Goods Sold Units 0,100 0,300 0,500 0,650 1,550 Unit Cost $ Total Cost $01, , , ,850 $15,350 (1) Ending Inventory $19,000 2,000 = $9.50 Unit Total Units Cost Cost 450 $9.50 $4,275 Proof of Cost of Goods Sold 1,550 X $9.50 = $14,725 AVERAGE COST (2) Cost of Goods Sold Cost of goods available for sale $19,000 Less: Ending inventory 004,275 Cost of goods sold $14,725 (c) (1) LIFO results in the lowest inventory amount for the balance sheet, $3,650. (2) FIFO results in the lowest cost of goods sold, $14,

46 PROBLEM 9-4B (a) INDIA CO. Condensed Income Statement For the Year Ended December 31, 1999 Sales... Cost of goods sold Beginning inventory... Cost of goods purchased... Cost of goods available for sale... Ending inventory... Cost of goods sold... Gross profit... Operating expenses... Income before income taxes... Income taxes (32%)... Net income... a 20,000 X $2.65 = $53,000. b $34,000 + (5,000 X $2.30) = $45,500. FIFO $865, , , , ,000 a 0559, , , , ,720 $107,780 LIFO $865, , , , ,500 b 0567, , , , ,320 $102,680 (b) (1) The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchases. (2) The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. (3) The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. (4) There will be $2,400 additional cash available under LIFO because income taxes are $48,320 under LIFO and $50,720 under FIFO. (5) Gross profit under the average cost method will be (a) lower than FIFO and (b) higher than LIFO. 9-46

47 *PROBLEM 9-5B (a) Net sales Cost of goods sold Beginning inventory Net purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Ending inventory Cost of goods sold Gross profit $016, , , , , ,400 February $270, ,800 $070,200 Gross profit rate = = 26% (b) Net sales... $260,000 Less: Estimated gross profit ,600 (26% X $260,000) Estimated cost of goods sold... $192,400 Beginning inventory... $020,400 Net purchases... $191,000 Add: Freight-in ,000 Cost of goods purchased ,000 Cost of goods available for sale ,400 Less: Estimated cost of goods sold ,400 Estimated total cost of ending inventory... 23,000 Less: Inventory not lost (20% X $23,000) ,600 Estimated inventory lost in fire... $018,400 (80% X $23,000) 9-47

48 *PROBLEM 9-6B (a) Beginning inventory Purchases Purchase returns Purchase discounts Freight-in Goods available for sale Net sales Ending inventory at retail Sporting Goods Jewelry and Cosmetics Cost Retail Cost Retail $047, , ,000) ( 0015,360) ( 0006,000 $682,000 $0,074,000 01,066,000 00,040,000) ( 00,000,000 01,100,000 01,020,000) ( $0.080,000 $036, , ,000) ( 0009,440) ( 0008,000 $756,000 $0,062,000 01,158,000 00,020,000) ( 00,000,000 01,200,000 01,160,000) ( $0,040,000 Cost-to-retail ratio: Sporting Goods ($682,000 $1,100,000) = 62%. Jewelry and Cosmetics ($756,000 $1,200,000) = 63%. Estimated ending inventory at cost: ($80,000 X 62%) = $49,600 Sporting Goods. ($40,000 X 63%) = $25,200 Jewelry and Cosmetics. (b) Sporting Goods $75,000 X 60% = $45,000 Jewelry and Cosmetics $44,000 X 65% = $28,

49 *PROBLEM 9-7B (a) (1) FIFO Date Purchases Sales Balance May $150) $1,050 $170) $1,360 $180) $0,900 $150) $750 $150) $170) $810 $170) $680 $170) $180) $530 $150) $1,050 $150) $0,300 $150) $170) $1,660 $170) $0,850 $170) $180) $1,750 $170) $180) $1,070 $180) $0,540 (2) AVERAGE COST Date Purchases Sales Balance May $150) $1,050 $170) $1,360 $180) $0,900 **Average cost = $1, **$1, $150) $750 $166) $830 $173) $692 $173) $519 $150) $1,050 $150) $0,300 $166)* $1,660 $166) $0,830 $173)** $1,730 $173) $1,038 $173) $0,

50 *PROBLEM 9-7B (Continued) (3) LIFO Date Purchases Sales Balance May $150) $1,050 $170) $1,360 $180) $0,900 $150) $750 $170) $850 $180) $720 $180) $170) $520 $150) $1,050 $150) $0,300 $150) $170) $1,660 $150) $170) $0,810 $150) $170) $1,710 $180) $150) $170) $180) $0,990 $150) $170) $0,470 (b) (1) The highest ending inventory is $540 under the FIFO method. (2) The lowest ending inventory is $470 under the LIFO method. 9-50

51 BYP 9-1 FINANCIAL REPORTING PROBLEM December 31, 1997 December 31, 1996 (a) Inventories $434.3 million $424.9 million (b) Dollar change in inventories between 1996 and 1997: $434.3 $424.9 = $9.4 million increase Percent change in inventories between 1996 and 1997: 9.4 $424.9 = 2.2% increase 1997 inventory as a percent of current assets: $434.3 $1,467.7 = 29.6% (c) Inventories are valued at the lower of cost or market using the average cost method (per Note 1 on Accounting Principles). (d) Kellogg Company (in millions) Cost of Goods Sold $3,270.1 $3,122.9 $3, cost of goods sold as a percent of sales: $3,270.1 $6,830.1 = 47.9% 9-51

52 BYP 9-2 COMPARATIVE ANALYSIS PROBLEM (a) 1. Inventory turnover: Kellogg: $3,270.1 = 7.6 times General Mills: $2,328.4 = 6.1 times 2. Average days to sell inventory: Kellogg: = 48 days General Mills: = 60 days (b) Kellogg's turnover of 7.6 times is slightly greater than General Mills' 6.1 times resulting in average days to sell of 48 versus 60. Thus, Kellogg's inventory control is more effective. 9-52

53 BYP 9-3 RESEARCH ASSIGNMENT (a) (b) (c) (d) CompUSA estimated a retail value of $7.6 million, while one bidder predicted a selling price less than $1 million. The computers experienced an excessively high failure rate, leading to speculation that the units would sell for the value of the parts. The sealed-bid auction had two major rules: (1) all of the units were to be sold together for cash, and (2) the buyer had to haul the units away. The answer depends on the students' opinions. 9-53

54 BYP 9-4 INTERPRETING FINANCIAL STATEMENTS NIKE/REEBOK (a) (b) (c) (d) Both companies have international sales; thus, they must move their goods around the world. Styles are often cultural, so what sells in one country may not in another. Because fads in their industry change quickly, both must manage inventory carefully. If a fad is really hot, you must make sure you have enough inventory before people's interest in the product fades. But you don't want to get stuck with a lot of excess inventory. The best approach is to have very efficient inventory production and distribution systems that allow you to respond to changes in demand very quickly. Reebok uses FIFO, Nike uses LIFO for US operations and FIFO for international. Nike probably uses LIFO for US operations to minimize its US taxes. Many foreign countries do not allow the use of LIFO though, so for its international operations it uses FIFO. Under the usual circumstances, where prices are rising, FIFO will result in higher reported profits and higher ending inventories than does LIFO. The format used by Nike is the approach used by manufacturers. It allows the financial statement reader to see how much inventory is in each stage of production inventory. This can be useful. For example, if the company is planning to step up production, we would expect to see raw materials increase, or if it is planning a slow-down in production, we would expect to see raw materials decline. Both Nike and Reebok hire contractors to do much of their production (as evidenced by the minor amounts of raw materials and work-in-process reported by Nike and by the fact that Reebok reports that "substantially all" of its inventory is finished goods. Thus, in this case it is not surprising that Reebok did not provide this information, and probably was not necessary that Nike did. Inventory turnover is calculated as (cost of goods sold/average inventory). Average days in inventory is simply 365 days divided by the inventory turnover ratio. This is calculated for each of these companies as follows: 9-54