Chapter 8 Inventories: Measurement

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1 Chapter 8 Inventories: Measurement QUESTIONS FOR REVIEW OF KEY TOPICS Question 8 1 Inventory for a manufacturing company consists of (1) raw materials, (2) work in process, and (3) finished goods. Raw materials represent the cost, primarily purchase price plus freight charges, of goods purchased from suppliers that will become part of the finished product. Work-in-process inventory represents the products that are not yet complete in the manufacturing process. The cost of work in process includes the cost of raw materials used in production, the cost of labor that can be directly traced to the goods in process, and an allocated portion of other manufacturing costs, called manufacturing overhead. When the manufacturing process is completed, these costs that have been accumulated in work in process are transferred to finished goods. Question 8 2 Beginning inventory plus net purchases for the period equals cost of goods available for sale. The main difference between a perpetual and a periodic system is that the periodic system allocates cost of goods available for sale to ending inventory and cost of goods sold only at the end of the period. The perpetual system accomplishes this allocation by decreasing inventory and increasing cost of goods sold each time goods are sold. Question 8 3 Perpetual System Periodic System (1) Purchase of merchandise debit inventory debit purchases (2) Sale of merchandise debit cost of goods sold; credit inventory no entry (3) Return of merchandise credit inventory credit purchase returns (4) Payment of freight debit inventory debit freight-in Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

2 Answers to Questions (continued) Question 8 4 Inventory shipped f.o.b. shipping point is included in the inventory of the purchaser when the merchandise reaches the common carrier. Laetner Corporation records the purchase in 2018 and includes the shipment in its ending inventory. Bockner Company records the sale in Inventory shipped f.o.b. destination is included in the inventory of the seller until it reaches the purchaser s location. Bockner would include the merchandise in its 2018 ending inventory and the sale/purchase would be recorded in Question 8 5 A consignment is an arrangement under which goods are physically transferred to another company (the consignee), but the transferor (consignor) retains legal title. If the consignee can t find a buyer, the goods are returned to the consignor. Goods held on consignment are included in the inventory of the consignor until sold by the consignee. Question 8 6 By the gross method, purchase discounts not taken are viewed as part of inventory cost. By the net method, purchase discounts not taken are considered interest expense because they are viewed as compensation to the seller for providing financing to the buyer. Question Beginning inventory increase 2. Purchases increase 3. Ending inventory decrease 4. Purchase returns decrease 5. Freight-in increase 8 2 Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

3 Answers to Questions (continued) Question 8 8 Four methods of assigning cost to ending inventory and cost of goods sold are (1) specific identification, (2) first-in, first-out (FIFO), (3) last-in, first-out (LIFO), and (4) average cost. The specific identification method requires each unit sold during the period or each unit on hand at the end of the period to be traced through the system and matched with its actual cost. First-in, first-out (FIFO) assumes that units sold are the first units purchased. The last-in, first-out (LIFO) method assumes that the units sold are the most recent units purchased. The average cost method assumes that cost of goods sold and ending inventory consist of a mixture of all the goods available for sale. The average unit cost applied to goods sold or ending inventory is an average unit cost weighted by the number of units acquired at the various unit prices. Question 8 9 When costs are declining, LIFO will result in a lower cost of goods sold and higher income than FIFO. This is because LIFO will include in cost of goods sold the most recently purchased lower-cost merchandise. LIFO also will provide a higher ending inventory in the balance sheet. Question 8 10 Proponents of LIFO argue that it provides a better match of revenues and expenses because cost of goods sold includes the costs of the most recent purchases. These are matched with sales that reflect a current selling price. On the other hand, inventory costs in the balance sheet generally are out of date because they are derived from old purchase transactions. It is conceivable that a company s LIFO inventory balance could be based on unit costs actually incurred several years earlier. When inventory quantity declines during a period, then these out-of-date inventory layers will be liquidated and cost of goods sold will match noncurrent costs with current selling prices. Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

4 Answers to Questions (continued) Question 8 11 Many companies choose the LIFO inventory method to reduce income taxes in periods when prices are rising. In periods of rising prices, LIFO results in a higher cost of goods sold and therefore a lower net income than the other methods. The companies income tax returns will report lower taxable incomes using LIFO and lower taxes will be paid currently. If a company uses LIFO to measure its taxable income, IRS regulations require that LIFO also be used to measure income reported to investors and creditors. Question 8 12 The gross profit, inventory turnover, and average days in inventory ratios are designed to monitor inventories. The gross profit ratio is calculated by dividing gross profit (net sales minus cost of goods sold) by net sales. Inventory turnover is calculated by dividing cost of goods sold by average inventory, and we compute average days in inventory by dividing the number of days in the period by the inventory turnover ratio. Question 8 13 A LIFO inventory pool groups inventory units into pools based on physical similarities of the individual units. The average cost for all of a pool s beginning inventory and for all of a pool s purchases during the period is used instead of individual unit costs. If the quantity of ending inventory for the pool increases, then ending inventory will consist of the beginning inventory plus a layer added during the period at the average acquisition cost for the pool. Question 8 14 The dollar-value LIFO method has important advantages. First, it simplifies the recordkeeping procedures compared to unit LIFO because no information is needed about unit flows. Second, it minimizes the probability of the liquidation of LIFO inventory layers, even more so than the use of pools alone, through the aggregation of many types of inventory into larger pools. In addition, firms that do not replace units sold with new units of the same kind can use the method. 8 4 Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

5 Answers to Questions (concluded) Question 8 15 After determining ending inventory at year-end cost, the following steps remain: 1. Convert ending inventory valued at year-end cost to base year cost. 2. Identify the layers in ending inventory with the years they were created. 3. Convert each layer s base year cost measurement to layer year cost measurement using the layer year s cost index and then sum the layers. Question 8 16 The primary difference between U.S. GAAP and IFRS in the methods allowed to value inventory is that IFRS does not allow the use of the LIFO method. Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

6 BRIEF EXERCISES Brief Exercise 8 1 Beginning inventory $186,000 Plus: Purchases 945,000 Less: Cost of goods sold (982,000) Ending inventory $149,000 Brief Exercise 8 2 To record the purchase of inventory on account. Inventory ,000 Accounts payable ,000 To record sales on account and cost of goods sold. Accounts receivable... 1,420,000 Sales revenue... 1,420,000 Cost of goods sold ,000 Inventory , Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

7 Brief Exercise 8 3 Both shipments should be included in inventory. The goods shipped to a customer f.o.b. destination did not arrive at the customer s location until after the fiscal year-end. They belong to Kelly until they arrive at the customer s location. Title to the goods shipped from a supplier to Kelly on December 30, f.o.b. shipping point, changed hands on December 30. Brief Exercise 8 4 Purchase price = 10 units x $25,000 = $250,000 December 28, 2018 Inventory ,000 Accounts payable ,000 January 6, 2019 Accounts payable ,000 Cash (99% x $250,000) ,500 Inventory (1% x $250,000)... 2,500 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

8 Brief Exercise 8 5 December 28, 2018 Inventory (99% x $250,000) ,500 Accounts payable ,500 January 6, 2019 Accounts payable ,500 Cash , Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

9 Brief Exercise 8 6 Cost of goods available for sale: Beginning inventory (200 x $25) $5,000 Purchases: 100 x $28 $2, x $30 6,000 8,800 Cost of goods available (500 units) $13,800 First-in, first-out (FIFO) Cost of goods available for sale (500 units) $13,800 Less: Ending inventory (determined below) (8,100) Cost of goods sold $5,700 Cost of ending inventory: Date of purchase Units Unit cost Total cost January 8 75 $28 $2,100 January ,000 Total $8,100 Average cost Cost of goods available for sale (500 units) $13,800 Less: Ending inventory (determined below) (7,590) Cost of goods sold $6,210 * Cost of ending inventory: $13,800 Weighted-average unit cost = = $ units 275 units x $27.60 = $7,590 * Alternatively, could be determined by multiplying the units sold by the average cost: 225 units x $27.60 = $6,210 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

10 Brief Exercise 8 7 First-in, first-out (FIFO) Cost of goods sold: Date of Cost of Sale Units Sold Units Sold Total Cost January (from Beg. Inv.) $25 $3,125 January (from Beg. Inv.) 25 1, (from 1/8 purchase) Total 225 $5,700 Ending inventory: Date of Purchase Units Unit Cost Total Cost January 8 75 $28 $2,100 January ,000 Total $8, Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

11 Brief Exercise 8 7 (concluded) Average cost Date Purchased Sold Balance Beginning inventory January 8 $25 = $5,000 $25 $5,000 $28 = $2,800 Available $7, units = $26/unit January 10 $26 = $3,250 $26 $4,550 January 19 $30 = $6,000 Available $10, units = $28.133/unit January 25 $ = $2,813 $ $7,737 Ending inventory Total cost of goods sold = $6,063 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

12 Brief Exercise 8 8 Cost of goods available for sale: Beginning inventory (20,000 x $25) $ 500,000 Purchases: 80,000 x $30 2,400,000 Cost of goods available (100,000 units) 2,900,000 Less: Ending inventory (15,000 units) 375,000* Cost of goods sold $2,525,000 *15,000 units x $25 each = $375,000 Brief Exercise ,000 units were sold. Cost of goods sold without year-end purchase: Units purchased during the year: 60,000 x $18 $1,080,000 Plus units from beginning inventory: 4,000 x $15 60,000 Cost of goods sold 1,140,000 Cost of goods sold with year-end purchase: 64,000 units x $18 1,152,000 Difference $ 12,000 Cost of goods sold would be $12,000 higher and income before income taxes $12,000 lower if the year-end purchase is made. If FIFO were used instead of LIFO, the year-end purchase would have no effect on income before income taxes. FIFO cost of goods sold with or without the purchase would consist of the 10,000 units from beginning inventory and 54,000 units purchased during the year at $18: 10,000 units x $15 $ 150,000 Plus: 54,000 units x $18 972,000 Cost of goods sold $1,122, Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

13 Brief Exercise 8 10 Units liquidated 5,000 Difference in cost ($30 25) x $5 Before-tax LIFO liquidation profit $25,000 Tax effect ($25,000 x 40%) (10,000) LIFO liquidation profit $15,000 Brief Exercise 8 11 Cost of goods sold for the year ended August 31, 2015, would have been $200 million lower had Walgreens used FIFO for its LIFO inventory. While beginning inventory would have been $2,300 million higher, ending inventory also would have been higher by $2,500 million. An increase in beginning inventory causes an increase in cost of goods sold, but an increase in ending inventory causes a decrease in cost of goods sold. Purchases for the year are the same regardless of the inventory valuation method used. Cost of goods sold as reported (LIFO) Decrease if FIFO Cost of goods sold, FIFO instead of LIFO $76,520 million (200) million $76,320 million Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

14 Brief Exercise 8 13 Ending Inventory Inventory Layers Inventory Layers Inventory Date at Base Year Cost at Base Year Cost Converted to Cost DVL Cost 1/1/2018 $1,400,000 = $1,400,000 $1,400,000 (base) $1,400,000 x 1.00 =$1,400,000 $1,400, /31/2018 $1,664,000 = $1,600,000 $1,400,000 (base) $1,400,000 x 1.00 = $1,400, ,000 (2018) 200,000 x 1.04 = 208,000 $1,608, Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

15 EXERCISES Exercise To record the purchase of inventory on account and the payment of freight charges. Inventory... 5,000 Accounts payable... 5,000 Inventory Cash To record purchase returns. Accounts payable Inventory To record cash sales and cost of goods sold. Cash... 5,200 Sales revenue... 5,200 Cost of goods sold... 2,800 Inventory... 2,800 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

16 Exercise To record the purchase of inventory on account and the payment of freight charges. Purchases... 5,000 Accounts payable... 5,000 Freight-in Cash To record purchase returns. Accounts payable Purchase returns To record cash sales. Cash... 5,200 Sales revenue... 5,200 NO ENTRY IS MADE FOR THE COST OF GOODS SOLD Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

17 Exercise 8 3 Requirement 1 Beginning inventory $ 32,000 Plus net purchases: Purchases $240,000 Less: Purchase discounts (6,000) Less: Purchases returns (10,000) Plus: Freight-in 17, ,000 Cost of goods available for sale 273,000 Less: Ending inventory (40,000) Cost of goods sold $233,000 Requirement 2 Cost of goods sold (above) ,000 Inventory (ending)... 40,000 Purchase discounts... 6,000 Purchase returns... 10,000 Inventory (beginning)... 32,000 Purchases ,000 Freight-in... 17,000 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

18 Exercise Beginning inventory 275 (1) 249 (3) 225 Cost of goods sold (6) Ending inventory 249 (2) Cost of goods available for sale (4) 800 Purchases (gross) (5) 585 Purchase discounts (7) Purchase returns Freight-in Net purchases = Purchases (gross) Purchase returns Purchase discounts + Freight-in Beginning inventory + Net purchases = Cost of goods available for sale Cost of goods available for sale Ending inventory = Cost of goods sold 2018: (1) Cost of goods available for sale Net purchases = Beginning inventory 876 ( ) = 275 = Beginning inventory (2) Cost of goods available for sale Cost of goods sold = Ending inventory = 249 = Ending inventory 2019: (3) 2019 beginning inventory = 2018 ending inventory = 249 (4) Cost of goods sold + Ending inventory = Cost of goods available for sale = 846 = Cost of goods available for sale (5) Cost of goods available for sale Beginning inventory = Net purchases = 597 = Net purchases Net purchases + Purchases discounts + Purchase returns Freight-in = Purchases(gross) = 610 = Purchases (gross) 2020: (6) Cost of goods available for sale Ending inventory = Cost of goods sold = 584 = Cost of goods sold 8 18 Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

19 Exercise 8 5 (concluded) (7) Cost of goods available for sale Beginning inventory = Net purchases = 575 = Net purchases Purchases (gross) Purchase returns + Freight-in Net purchases = Purchase discounts = 12 = Purchase discounts Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

20 Exercise 8 6 Inventory balance before additional transactions $165,000 Add: 2. Goods shipped to Kwok f.o.b. shipping point on Dec , Goods shipped to customer f.o.b. destination on December 27 22,000 Correct inventory balance $204,000 Exercise 8 7 Inventory balance before additional transactions $210,000 Add: 4. Merchandise on consignment with Joclyn Corp. 15,000 Deduct: 1. Merchandise shipped to Raymond f.o.b. destination on December 26 (30,000) 2. Merchandise held on consignment from the Harrison Company (14,000) Correct inventory balance $181,000 Exercise Excluded 2. Included 3. Included 4. Excluded 5. Included 6. Excluded 7. Included 8 20 Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

21 Exercise 8 11 Requirement 1 Purchases: $500 x 70% = $350 per unit. 100 units x $350 = $35,000 November 17, 2018 Purchases... 35,000 Accounts payable... 35,000 November 26, 2018 Accounts payable... 35,000 Purchase discounts (2% x $35,000) Cash (98% x $35,000)... 34,300 Requirement 2 December 15, 2018 Accounts payable... 35,000 Cash... 35,000 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

22 Exercise 8 11 (concluded) Requirement 3 Requirement 1: November 17, 2018 Purchases (98% x $35,000)... 34,300 Accounts payable... 34,300 November 26, 2018 Accounts payable... 34,300 Cash... 34,300 Requirement 2: December 15, 2018 Accounts payable... 34,300 Interest expense (2% x $35,000) Cash... 35, Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

23 Exercise 8 13 Cost of goods available for sale: Beginning inventory (2,000 x $6.10) $12,200 Purchases: 10,000 x $5.50 $55,000 6,000 x $ ,000 85,000 Cost of goods available (18,000 units) $97,200 First-in, first-out (FIFO) Cost of goods available for sale (18,000 units) $97,200 Less: Ending inventory (determined below) (15,000) Cost of goods sold $82,200 Cost of ending inventory: Date of purchase Units Unit cost Total cost August 18 3,000 $5.00 $15,000 Last-in, first-out (LIFO) Cost of goods available for sale (18,000 units) $97,200 Less: Ending inventory (determined below) (17,700) Cost of goods sold $79,500 Cost of ending inventory: Date of purchase Units Unit cost Total cost Beg. Inv. 2,000 $6.10 $12,200 August 8 1, ,500 Total $17,700 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

24 Exercise 8 13 (concluded) Average cost Cost of goods available for sale (18,000 units) $97,200 Less: Ending inventory (determined below) (16,200) Cost of goods sold $81,000 * Cost of ending inventory: $97,200 Weighted-average unit cost = = $ ,000 units 3,000 units x $5.40 = $16,200 * Alternatively, could be determined by multiplying the units sold by the average cost: 15,000 units x $5.40 = $81, Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

25 Exercise 8 14 First-in, first-out (FIFO) Cost of goods sold: Date of Cost of Sale Units Sold Units Sold Total Cost Aug. 14 2,000 (from Beg. Inv.) $6.10 $12,200 6,000 (from 8/8 purchase) ,000 Aug. 25 4,000 (from 8/8 purchase) ,000 3,000 (from 8/18 purchase) ,000 Total 15,000 $82,200 Ending inventory = 3,000 units x $5.00 = $15,000 Last-in, first-out (LIFO) Date Purchased Sold Balance Beginning inventory $6.10 = $12,200 $6.10 $12,200 August 8 $5.50 = $55,000 $6.10 $5.50 $67,200 August 14 $ 5.50 = $44,000 $6.10 $5.50 $23,200 August 18 $5.00 = $30,000 $6.10 $5.50 $53,200 $5.00 August 25 $5.00 = $30,000 $5.50 = $ 5,500 Total cost of goods sold = $79,500 $6.10 $5.50 $17,700 Ending inventory Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

26 Exercise 8 14 (concluded) (Note: the perpetual inventory LIFO results in this exercise are the same as periodic LIFO results, due to the timing of sales and purchases. The same LIFO layers are on hand at the end of the period under each method. This is unusual. LIFO perpetual and LIFO periodic normally produce different results for ending inventory and cost of goods sold.) Average cost Date Purchased Sold Balance Beginning inventory August 8 $6.10 = $12,200 $6.10 $12,200 $5.50 = $55,000 Available $67,200 12,000 units = $5.60/unit August 14 $5.60 = $44,800 $5.60 $22,400 August 18 $5.00 = $30,000 Available $52,400 10,000 units = $5.24/unit August 25 $5.24 = $36,680 $5.24 $15,720 Ending inventory Total cost of goods sold = $81, Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

27 Exercise 8 16 Requirement 1 Cost of goods available for sale: Beginning inventory (5,000 x $10.00) $ 50,000 Purchases: 3,000 x $10.40 $31,200 8,000 x $ , ,200 Cost of goods available (16,000 units) $167,200 Cost of goods available for sale (16,000 units) $167,200 Less: Ending inventory (below) (73,150) Cost of goods sold $ 94,050* Cost of ending inventory: $167,200 Weighted-average unit cost = = $ ,000 units 7,000 units x $10.45 = $73,150 * Alternatively, could be determined by multiplying the units sold by the average cost: 9,000 units x $10.45 = $94,050 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

28 Exercise 8 16 (concluded) Requirement 2 Date Purchased Sold Balance Beginning inventory September 7 $10.00 = $50,000 $10.00 $50,000 $10.40 = $31,200 Available $81,200 8,000 units = $10.15/unit September 10 $10.15 = $40,600 $10.15 $40,600 September 25 $10.75 = $86,000 Available $126,600 12,000 units = $10.55/unit September 29 $10.55 = $52,750 $10.55 $73,850 Ending inventory Total cost of goods sold = $93, Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

29 Exercise 8 18 Requirement 1 January 31, 2016 LIFO reserve ($18,093 $13,655)... 4,438 Cost of goods sold... 4,438 ($ in thousands) Requirement 2 $209,826 + $4,438 = $214,264 thousand cost of goods sold under FIFO. Cost of goods sold is provided as $209,826 (thousand) on a LIFO basis. To convert LIFO to FIFO, the adjustment in Requirement 1 converting FIFO to LIFO is reversed and cost of goods sold is thereby increased by $4,438. Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

30 Exercise 8 19 Requirement 1 Cost of goods sold: 50,000 units x $8.50 = $425,000 4,000 units x $7.00 = 28,000 $453,000 Requirement 2 When inventory quantity declines during a reporting period, liquidation of LIFO inventory layers carried at different costs prevailing in prior year s results in noncurrent costs being matched with current selling prices. If the resulting effect on income is material, it must be disclosed. In this case, the effect of the LIFO layer liquidation is to increase income (ignoring taxes) by $6,000 [4,000 units liquidated x $1.50 ($8.50 current year cost per unit $7 LIFO layer cost per unit)] Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

31 Exercise 8 24 Ending Ending Inventory Inventory Layers Inventory Layers Inventory Date at Base Year Cost at Base Year Cost Converted to Cost DVL Cost 12/31/2018 $200,000 = $200,000 $200,000 (base) $200,000 x 1.00 = $200,000 $200, /31/2019 $231,000 = $220,000 Index = 1.05 Index $200,000 (base) $200,000 x 1.00 = $200,000 20,000 (2019) 20,000 x 1.05 = 21, ,000 12/31/2020 $299,000 = $260,000 Index = 1.15 Index $200,000 (base) $200,000 x 1.00 = $200,000 20,000 (2019) 20,000 x 1.05 = 21,000 40,000 (2020) 40,000 x 1.15 = 46, ,000 12/31/2021 $300,000 = $250,000 Index = 1.20 Index $200,000 (base) $200,000 x 1.00 = $200,000 20,000 (2019) 20,000 x 1.05 = 21,000 30,000 (2020) 30,000 x 1.15 = 34, ,500 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

32 Exercise 8 25 Set the base year, 1/1/2018, equal to Cost index in layer year: = 1.10 Ending Inventory Inventory Layers Inventory Layers Inventory Date at Base Year Cost at Base Year Cost Converted to Cost DVL Cost 1/1/2018 $720,000 = $720,000 $720,000 (base) $720,000 x 1.00 = $720,000 $720, /31/2018 $880,000 = $800,000 $720,000 (base) $720,000 x 1.00 = $720, ,000 (2018) 80,000 x 1.10 = 88, , Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

33 Exercise 8 26 List A List B i 1. Perpetual inventory a. Legal title passes when goods are system delivered to common carrier. l 2. Periodic inventory system b. Goods are transferred to another company but title remains with transferor. a 3. F.o.b. shipping point c. Purchase discounts not taken are included in inventory cost. c 4. Gross method d. If LIFO is used for taxes, it must be used for financial reporting. g 5. Net method e. Assumes items sold are those acquired first. h 6. Cost index f. Assumes items sold are those acquired last. k 7. F.o.b. destination g. Purchase discounts not taken are considered interest expense. e 8. FIFO h. Used to convert ending inventory at yearend cost to base year cost. f 9. LIFO i. Continuously records changes in inventory. b 10. Consignment j. Items sold come from a mixture of goods acquired during the period. j 11. Average cost k. Legal title passes when goods arrive at location. d 12. IRS conformity rule l. Adjusts inventory at the end of the period. Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

34 PROBLEMS 8 34 Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

35 Problem The transaction is not correctly accounted for. Inventory held on consignment by another company should be included in the inventory of the consignor. Rasul should include this merchandise in its 2018 ending inventory. 2. The transaction is not correctly accounted for. Legal title to merchandise shipped f.o.b. shipping point changes hands when the goods are shipped. Rasul should record the purchase and corresponding account payable in 2018 and include the merchandise in its 2018 ending inventory. 3. The transaction is not correctly accounted for. Since the merchandise was shipped f.o.b. destination and did not arrive at the customer's location until 2019, it should be included in Rasul s 2018 ending inventory. The sale should be recorded in The transaction is correctly accounted for. Merchandise held on consignment from another company belongs to the consignor and should be excluded from the inventory of the consignee. 5. The transaction is correctly accounted for. Since the merchandise was shipped f.o.b. destination and did not arrive at Rasul s location until 2019, it should not be included in Rasul s 2018 ending inventory. The purchase is correctly recorded in Problem 8 3 Accounts Inventory Payable Sales Initial amounts $1,250,000 $1,000,000 $9,000,000 Adjustments - increase (decrease): 1. (155,000) (155,000) NONE 2. (22,000) NONE NONE 3. NONE NONE 40, ,000 NONE NONE 5. 25,000 25,000 NONE 6. 2,000 2,000 NONE 7. (5,300) (5,300) NONE Total adjustments 54,700 (133,300) 40,000 Adjusted amounts $1,304,700 $ 866,700 $9,040,000 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

36 Problem 8 8 Requirement 1 The note indicates that if the company had used FIFO, inventory would have been higher by $2,498 million and $2,430 million at the end of 2015 and 2014, respectively. The increase in the difference between LIFO and FIFO means there was an increase in the LIFO reserve in The increase in the LIFO reserve increased cost of goods sold by $68 million under LIFO. Therefore, we subtract this amount from LIFO cost of goods sold to determine FIFO cost of goods sold of $33,674 million ($33,742 million $68 million). Requirement 2 Because cost of goods sold would have been lower by $68 million if FIFO had been used, income before taxes would have been higher by $68 million. Requirement 3 The information might be useful to a financial analyst interested in comparing Caterpillar s performance with another company using the FIFO inventory method exclusively Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

37 Problem 8 11 Requirement 1 Sales (27,000 units x $2,000) $54,000,000 Less: Cost of goods sold (27,000 units x $1,000) (27,000,000) Gross profit $27,000,000 Gross profit ratio = $27,000,000 $54,000,000 = 50% Requirement 2 Sales (27,000 units x $2,000) $54,000,000 Less: Cost of goods sold* (25,000,000) Gross profit $29,000,000 Gross profit ratio = $29,000,000 $54,000,000 = 53.7% *Cost of goods sold: 15,000 units x $1,000 = $15,000,000 6,000 units x $ 900 = 5,400,000 4,000 units x $ 800 = 3,200,000 2,000 units x $ 700 = 1,400,000 27,000 units $25,000,000 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

38 Problem 8 11 (concluded) Requirement 3 The gross profit and gross profit ratio are higher applying the requirement 2 assumption of 15,000 units purchased because of the LIFO liquidation profit that results. When inventory quantity declines during a reporting period, LIFO inventory layers carried at costs prevailing in prior years are liquidated or assumed sold in the cost of goods sold calculation. This results in noncurrent costs being matched with current selling prices. If the company had purchased at least 27,000 units during 2019, there would be no LIFO liquidation. The profit difference ($2,000,000 in this case), if material, must be disclosed in a note. The difference can be arrived at by comparing the current replacement cost of $1,000 with each inventory layer from prior years that was included in this year s cost of goods sold, as follows: 6,000 units x $100 ($1, ) $ 600,000 4,000 units x $200 ($1, ) 800,000 2,000 units x $300 ($1, ) 600,000 Total LIFO liquidation profit $2,000,000 Requirement 4 Sales (27,000 units x $2,000) $54,000,000 Cost of goods sold: 5,000 units x $700 $ 3,500,000 4,000 units x $800 3,200,000 6,000 units x $900 5,400,000 12,000 units x $1,000 12,000,000 24,100,000 27,000 units Gross profit = $29,900,000 Gross profit ratio = $29,900,000 $54,000,000 = 55.4% If only 15,000 units are purchased, cost of goods sold, gross profit, and the gross profit ratio would be exactly the same as when 28,000 units are purchased. Requirement 5 The number of units purchased has no effect on FIFO cost of goods sold. When applying the first-in, first-out approach, beginning inventory costs are included in cost of goods sold first, regardless of the quantities of inventory purchased in the new reporting period Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

39 Problem 8 12 Requirement 1 Allowance for uncollectible accounts Balance, beginning of year $7 Add: Bad debt expense for Less: End-of-year balance (10) Accounts receivable written off $ 5 Requirement 2 Accounts receivable analysis: Balance, beginning of year ($ ) $ 590 Add: Credit sales 6,255 Less: write-offs (from Requirement 1) (5) Less: Balance end of year ($ ) (713) Cash collections $6,127 Requirement 3 Cost of goods sold for 2018 would have been $130 million lower had Inverness used the average cost method for its entire inventory. While beginning inventory would have been $350 million higher, ending inventory also would have been higher by $480 million. An increase in beginning inventory causes an increase in cost of goods sold, but an increase in ending inventory causes a decrease in cost of goods sold. Purchases for the year are the same regardless of the inventory valuation method used. Therefore, cost of goods sold would have been $5,060 ($5, ). Requirement 4 a. Receivables turnover ratio = $6,255 = 9.73 times ($ )/2 b. Inventory turnover ratio = $5,190 = 6.15 times ($ )/2 c. Gross profit ratio = ($6,255 5,190) = 17% $6,255 Solutions Manual, Vol.1, Chapter Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

40 Problem 8 12 (concluded) Requirement 5 If inventory costs are increasing, when inventory quantity declines during a period, liquidation of LIFO inventory layers carried at lower costs prevailing in prior year s results in noncurrent costs being matched with current selling prices. The income generated by this liquidation is known as LIFO liquidation profit. The liquidation caused 2018 cost of goods sold to be lower by $9.23 million [$6 million (1.35)] Problem 8 16 Ending Ending Inventory Inventory Layers Inventory Layers Inventory Date at Base Year Cost at Base Year Cost Converted to Cost DVL Cost 1/1/2018 $84, = $84,000 $84,000 (base) $84,000 x 1.00 = $84,000 $84,000 12/31/2018 $100,800 = $96,000 $84,000 (base) $84,000 x 1.00 = $84, ,000 (2018) 12,000 x 1.05 = 12,600 96,600 12/31/2019 $136,800 = $120,000 $84,000 (base) $84,000 x 1.00 = 84, ,000 (2018) 12,000 x 1.05 = 12,600 24,000 (2019) 24,000 x 1.14 = 27, ,960 12/31/2020 $150,000 = $125,000 $84,000 (base) $84,000 x 1.00 = $84, (1) 12,000 (2018) 12,000 x 1.05 = 12,600 24,000 (2019) 24,000 x 1.14 = 27,360 5,000 (2020) 5,000 x 1.20 = 6, ,960 12/31/2021 $160,000(5) = $128,000(4) $84,000 (base) $84,000 x 1.00 = 84, ,000 (2018) 12,000 x 1.05 = 12,600 24,000 (2019) 24,000 x 1.14 = 27,360 5,000 (2020) 5,000 x 1.20 = 6,000 3,000 (2021) 3,000(3) x 1.25 = 3,750(2) 133,710 (1) $150,000 $125,000 = 1.20 (2020 cost index) (2) $133, ,960 = $3,750 (3) $3, = $3,000 (4) $125, ,000 = $128,000 (2021inventory at base-year cost) (5) $128,000 x 1.25 = $160,000 (2021inventory at year-end costs) 8 40 Intermediate Accounting, 9e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of