CHAPTER 6 Inventory Costing ANSWERS TO QUESTIONS

CHAPTER 6 Inventory Costing ANSWERS TO QUESTIONS 1. Taking a physical inventory involves counting, weighing or measuring each kind of inventory on hand. This is normally done when the store is closed. Tom will probably count items, and mark the quantity, description, location and inventory number on prenumbered inventory tags. Retailers, such as a hardware store, generally have thousands of different items to count. Later, unit costs will likely be applied to the inventory quantities using either specific identification or a cost formula. Many businesses also use electronic devices, such as hand-held scanners. Information on the scanners can be uploaded to the perpetual inventory system to partially automate taking an inventory. 2. Goods in transit at year end should be included in the inventory of the company (buyer or seller) that has ownership of the goods. This is determined by the terms of sale and is evidenced by the free on board terms. When the terms are FOB (free on board) shipping point, ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. When the terms are FOB destination, ownership of the goods remains with the seller until the goods reach the buyer. The transfer of ownership also means that the sales revenue is recorded at that point. 3. Consigned goods are goods held on a company s premises (the consignee), but belong to someone else (the consignor). The consignee agrees to sell the goods for a fee but never takes ownership of the goods even though the goods are physically located on the consignee s premises. Therefore, the consignor, not the consignee, owns the goods and should include them in inventory. 4. (1) include. (2) do not include. (3) include (it is assumed legal ownership remains with the store). 5. Actual physical flow may be impractical because many items are indistinguishable from one another. And, even if the items are individually identifiable, it may be too costly and too complex to track the physical flow of each inventory item. Actual physical flow may also be inappropriate because management may be able to manipulate profit through specific identification of items sold. 6. Specific identification is appropriate when goods are uniquely identifiable or Solutions Manual 6-1 Chapter 6

produced for a specific purpose, for example, automobiles. GAAP does not allow companies to use specific identification when goods are interchangeable. Solutions Manual 6-2 Chapter 6

QUESTIONS (Continued) 7. Specific identification tracks the actual physical flow of goods in the system and matches the cost of a particular item of inventory against its sale price. Each good is uniquely identifiable and can be traced back to its purchase cost, for example, automobiles. This gives the specific identification method the advantage of producing financial results that are more accurate. Specific identification may be more expensive to operate since each item must be tracked individually in the accounting system. The FIFO cost formula assumes that the first goods purchased are the first goods sold. The average cost formula determines the cost using a weighted average of the cost of the items purchased. Both the FIFO and the average cost formulas assume a flow of goods that may not exactly match the actual flow of physical goods. These cost formula can be used in both a periodic and perpetual inventory systems, whereas the specific identification method can only be used in a perpetual system. This has the advantage of making the bookkeeping simpler and less expensive. An example of merchandise that would be valued using the FIFO basis is electronic products, whereas merchandise such as clothing might be valued on an average basis. 8. The average cost per unit is calculated by dividing the cost of goods available for sale by the units available for sale at the date of each purchase. This means that every purchase of product will change the average cost per unit. Sales of product mean that items of inventory are removed from the cost pool at the average cost. This does not change the average cost. 9. (a) Cash: No effect. The cash impact of the purchase and sale is the same regardless of which inventory cost formula is chosen. The inventory cost formula simply allocates the cost of goods available for sale between cost of goods sold and ending inventory. (b) Ending inventory: In a period of rising prices, FIFO will produce a higher ending inventory as inventory is determined using the most recent (higher) prices; Average will produce a lower ending inventory as ending inventory is calculated at an average of all the inventory available for sale during the accounting period. (c) Cost of goods sold: The cost of goods sold effect is opposite to that of ending inventory. Hence, cost of goods sold will be lower under FIFO and higher under average cost. (d) Profit: Because of the effect on the cost of goods sold, profit will be higher under FIFO and lower under average cost. Solutions Manual 6-3 Chapter 6

QUESTIONS (Continued) 10. The average cost formula results in more recent costs being reflected in cost of goods sold. This better matches current costs with current revenues and provides a better income statement valuation. The FIFO cost formula provides the better balance sheet valuation because the cost of older items is transferred to cost of goods sold. This leaves the more recently purchased items in ending inventory, which better reflects replacement cost. 11. (a) Choose a method that corresponds as closely as possible to the physical flow of goods. (b) Report an inventory cost on the balance sheet that is close to the inventory s recent costs. (c) Use the same method for all inventories having a similar nature and use in the company. 12. (a) Mila Company's 2013 profit will be understated (O) $5,000. Beginning inventory Sales + Purchases Cost of goods sold U $5,000 = Cost of goods available for sale = Gross profit/profit O $5,000 Ending inventory O $5,000 = Cost of goods sold U $5,000 (b) Mila s 2014profit will be overstated (U) $5,000 since the ending inventory of 2013 becomes the beginning inventory of 2014. Beginning inventory O $5,000 Sales + Purchases Cost of goods sold O $5,000 = Cost of goods = Gross profit/profit U $5,000 available for sale O $5,000 Ending inventory 0000000 = Cost of goods sold O $5,000 (c) The combined profit for the two years will be correct because the errors offset each other (O $5,000 in 2013 and U $5,000 in 2014). 13. It is necessary to correct the error because users of the financial statements look at the results for individual years and also look at any trends. Solutions Manual 6-4 Chapter 6

QUESTIONS (Continued) 14. Lucy 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 write down to net realizable value should be recognized in the period in which the decline in utility occurs. It is not appropriate to use the cost basis to value inventory when the current value of the inventory is less than the cost price (that is, when the value of the inventory has dropped below cost price). (b) Net realizable value means the estimated selling price less any estimated costs required to complete the sale. 15. Net realizable value is the selling price of an inventory item, less any estimated costs required to make the item saleable. 16. No. Net realizable value is usually higher than cost because this is the nature of selling merchandise inventory for a profit. The recognition of the gain occurs when the inventory is sold, in accordance with revenue recognition criteria. 17. An inventory turnover ratio that is too high may be caused by sales opportunities being lost because of inventory shortages, which can also lead to customer ill will and result in lost future sales. An inventory turnover ratio that is too low may be caused by excess inventory which is not being sold and which may be obsolete, resulting in the company spending too much to carry its inventory. 18. A decrease in the days sales in inventory ratio from one year to the next would usually be seen as an improvement in the company s efficiency in managing inventory. It means that less inventory is being held relative to sales. 19. There are no significant differences in the valuation and reporting of inventory between IFRS and ASPE. *20. It is necessary to calculate cost of goods available for sale in a periodic inventory system because we wait until the end of the period to allocate the amount to ending inventory and cost of goods sold. *21. No, he is not correct. The FIFO cost formula assumes that the goods that were purchased the earliest are the first ones to be sold. The cost of the oldest units is used first to calculate cost of goods sold, not ending inventory. Solutions Manual 6-5 Chapter 6

QUESTIONS (Continued) *22. In a periodic system, the average is a weighted average calculated at the end of the period based on total goods available for sale for the entire period. In a perpetual system, the average is calculated after each purchase (goods available for sale in dollars goods available for sale in units). A new average must be calculated with each purchase and thus the average becomes a moving average. *23. Inventories must be estimated when (1) a company uses the periodic inventory system and management wants interim (monthly or quarterly) financial statements but a physical inventory is only taken annually, or (2) a fire or other type of casualty makes it impossible to take a physical inventory. An estimate of the inventory can also help to test the reasonableness of the actual inventory when a physical count is done. *24. Disagree. A company s gross profit margin does not necessarily remain constant from year to year. Gross profit can change due to changes in merchandising policies or in market conditions. The accuracy of the method is also affected by the mix of products sold during the year and whether the method is applied to a product line, a department, or the company as a whole. The year-end inventory count also serves internal control purposes. It helps management examine the presence of merchandise and its physical condition. *25. The gross profit method uses an average gross profit margin based on previous year s results and applies it to net sales to estimate the cost of goods sold. The estimated cost of goods is subtracted from the goods available for sale to arrive at the estimated ending inventory. The retail inventory method calculates an average cost-to-retail percentage. This percentage is determined by dividing goods available for sale at cost, by goods available for sale at retail. This ratio is then applied to the ending inventory at retail to estimate the ending inventory at cost. The retail inventory method approximates results that would have occurred had the average cost formula been used. *26. The retail inventory method is an averaging technique and may produce an incorrect inventory valuation if the blend of inventory items in ending inventory is not the same as in cost of goods available for sale. It produces an estimate of ending inventory based on the average cost formula and would not be appropriate if the company is using a FIFO approach. Solutions Manual 6-6 Chapter 6

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 6-1 (a) (b) (c) Ownership of the goods belongs to the consignor (Helgeson). Thus, these goods should be included in Helgeson s inventory. The goods in transit should not be included in inventory as title remains with the seller until the goods reach the buyer (Helgeson). The goods being held belong to the customer. They should not be included in Helgeson s inventory. (d) Ownership of these goods rests with the other company (the consignor). These goods should not be included in Helgeson s inventory. (e) The goods in transit to a customer should not be included in inventory as title passes to the buyer when the public carrier accepts the goods from the seller. BRIEF EXERCISE 6-2 The correct cost of inventory is: Total cost per inventory count $55,500 (a) Merchandise on hold for customers 0 (b) Inventory held for alterations (1,200) (c) Inventory held on consignment (4,250) (d) Goods shipped FOB shipping point prior to Dec. 31 2,875 Freight on inventory purchase 310 (e) Goods shipped FOB destination prior to Dec. 31 0 Freight on inventory purchase 0 Correct inventory cost at December 31 $53,235 Solutions Manual 6-7 Chapter 6

BRIEF EXERCISE 6-3 Cost of Goods Sold Painting Total Cost 3 $3,000 4 4,000 Total $7,000 Ending Inventory Painting Total Cost 1 $1,000 2 2,000 Total $3,000 BRIEF EXERCISE 6-4 (a) 2 FIFO (b) 2 FIFO (c) 1 Specific identification (d) 3 Average (e) 3 Average (f) 3 Average (g) 1 Specific identification (h) 1 Specific identification Solutions Manual 6-8 Chapter 6

BRIEF EXERCISE 6-5 PURCHASES COST OF GOODS SOLD BALANCE Date Units Cost Total Units Cost Total Units Cost Total June 1 200 $25.00 $5,000.00 7 400 $22.00 $8,800.00 (a) (b) 200 400 $25.00 $22.00 (c) 13,800.00 18 (d) (e) 200 150 $25.00 $22.00 8,300.00 (f) 250 (g) $22.00 (h) 5,500.00 26 350 $20.00 7,000.00 (i) (j) 250 350 $22.00 $20.00 (k) 12,500.00 Solutions Manual 6-9 Chapter 6

BRIEF EXERCISE 6-6 PURCHASES COST OF GOODS SOLD BALANCE Date Units Cost Total Units Cost Total Units Cost Total June 200 $25.00 $5,000.00 1 7 400 $22.00 $8,800.00 (a) 600 (b) $23.00 (c) 13,800.00 18 350 (d) $23.00 (e) 8,050.00 (f) 250 (g) $23.00 (h) 5,750.00 26 350 $20.00 7,000.00 (i) 600 (j) $21.25 (k) 12,750.00 (a) 600 = 200 + 400 (b) ($5,000.00 + $8,800.00) (200 + 400) (c) $13,800.00 = $5,000.00 + $8,800.00 (d) see (b) above (e) $8,050.00 = 350 $23.00 (f) 250 = 600 350 (g) see (b) above (h) $5,750.00 = 250 $23.00 (i) 600 = 250 + 350 (j) $21.25 = ($5,750.00 + $7,000.00) (250 + 350) (k) $12,750.00 = 600 $21.25 Solutions Manual 6-10 Chapter 6

BRIEF EXERCISE 6-7 (a) FIFO Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Nov. 1 10 $5.00 $50 4 20 $5.50 $110 10 5.00 20 7 20 6.00 120 10 20 20 5.50 160 5.00 5.50 6.00 280 10 10 $5.00 50 20 5.50 20 6.00 230 12 20 5.50 10 6.00 170 10 6.00 60 Total 40 $230 40 $220 10 $60 Check: $50 + $230 $220 = $60 (b) Average Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Nov. 1 10 $5.000 $50 4 20 $5.50 $110 30 5.333 160 7 20 6.00 120 50 5.600 280 10 10 $5.600 $ 56 40 5.600 224 12 30 5.600 168 10 5.600 56 Total 40 $230 40 $224 10 $56 Check: $50 + $230 $224 = $56 Recap: FIFO Average Cost of goods sold $220 $224 Ending inventory 60 56 Goods available for sale $280 $280 Solutions Manual 6-11 Chapter 6

BRIEF EXERCISE 6-8 (a) FIFO Date Account Titles and Explanation Debit Credit Nov. 4 Inventory (20 $5.50)... 110 Accounts Payable... 110 Nov. 12 Accounts Receivable... 240 Sales (30 $8.00)... 240 Cost of Goods Sold... 170 Inventory ([20 $5.50] + [10 $6.00]) 170 (b) Average Date Account Titles and Explanation Debit Credit Nov. 4 Inventory (20 $5.50)... 110 Accounts Payable... 110 Nov. 12 Accounts Receivable... 240 Sales (30 $8.00)... 240 Cost of Goods Sold... 168 Inventory (30 $5.60)... 168 BRIEF EXERCISE 6-9 (a) FIFO (b) Average cost (c) Average cost (d) FIFO Solutions Manual 6-12 Chapter 6

BRIEF EXERCISE 6-10 (a) Average cost gives the higher inventory valuation when prices are falling. This is because the cost of the units are a blend of older and newer items. Under the FIFO system, ending inventory is composed of newer items purchased at a lower cost. (b) FIFO gives the higher cost of goods sold amount. This is because the cost of the units purchased earlier, at a higher cost, are assumed to have been sold first and are allocated to cost of goods sold. (c) The selection of a cost formula does not affect cash flow. The cost formula is a method of allocating costs to cost of goods sold and ending inventory. It does not involve the inflow or outflow of cash. (d) In selecting a cost formula, the company should consider their type of inventory and its actual physical flow. While it is not essential to match the actual physical flow to the cost formula, it does give the company an indication as to its flow of costs throughout the period. The company should also consider the method that will report inventory on the balance sheet that is close to the inventory s recent costs. Solutions Manual 6-13 Chapter 6

BRIEF EXERCISE 6-11 2013 Assets = Liabilities + Owner s Equity 2013 No Effect No Effect No Effect 2014 No Effect No Effect No Effect Beginning inventory O $23,000 Sales + Purchases - Cost of goods sold O $23,000 Cost of goods available for sale O $23,000 Gross profit/profit U $23,000 - Ending inventory Cost of goods sold O $23,000 Note that the inventory error first occurred in 2012 and that 2012 profit and owner s equity would be overstated by $23,000. The 2013 profit is understated $23,000. This error is added to the prior year s overstatement of $23,000, and the two errors cancel out. Owner s equity at the end of 2013 is correct. The ending inventory is also correct at the end of 2013. 2014 Since the 2013 error reverses the impact of an error originally occurring in 2012, there would be no impact on the 2014 financial statements. 2014 profit, owner s equity and ending inventory would all be correctly stated (assuming no new errors have occurred). Solutions Manual 6-14 Chapter 6

BRIEF EXERCISE 6-12 (a) The understatement of ending inventory caused cost of goods sold to be overstated by $7,000 and profit to be understated by $7,000. The correct profit for 2013 is $97,000 ($90,000 + $7,000). Beginning inventory Sales + Purchases - Cost of goods sold O $7,000 Cost of goods available for sale Gross profit / Profit U $7,000 - Ending inventory U $7,000 Cost of goods sold O $7,000 (b) Total assets and owner s equity in the balance sheet will both be understated by the amount that ending inventory is understated, $7,000. If profit is understated, then owner s equity is also understated as profit is a component of owner s equity. Using the accounting equation: A = L + OE U$7,000 = U$7,000 (c) The error arising in 2013, if left uncorrected, will flow through in 2014. The 2013 error will affect the 2014 beginning inventory by an understatement of $7,000. This causes cost of goods sold to be understated $7,000 and profit to be overstated $7,000. Beginning inventory U $7,000 Sales + Purchases - Cost of goods sold U $7,000 Cost of goods Gross profit / Profit available for sale O $7,000 - Ending inventory Cost of goods sold U $7,000 Total assets and owner s equity in the balance sheet will both be correct since 2014 ending inventory is correct. The 2013 error causes an understatement of 2013 profit of $7,000 and an overstatement of 2014 profit of $7,000, causing the total profit for the two-year period to be correct. This causes owner s capital in 2014 to be correctly stated. Solutions Manual 6-15 Chapter 6

EXERCISE 6-1 SOLUTIONS TO EXERCISES 1. Do not include in inventory Shippers does not own items held on consignment for another company. 2. Include in inventory Shippers still owns the items as they were only shipped on consignment. 3. Include in inventory Because the shipping terms are FOB destination, Shippers owns the goods until they arrive at the customer s premises. 4. Do not include in inventory Shipping terms FOB shipping point means that ownership transferred at the time of shipping and therefore, the customer owns the goods in transit. 5. Do not include in inventory Shipping terms FOB destination means that Shippers does not own the items until they reach them. 6. Include in inventory Because the shipping terms are FOB shipping point, Shippers owns the goods in transit. 7. Include in inventory Because the shipping terms are FOB shipping point, ownership has transferred to Shippers and Shipper pays the freight charges. 8. Do not include in inventory Because freight costs paid by the seller are freight-out or delivery expense they are included in operating expenses, not as part of the cost of inventory. 9. Do not include in inventory record as supplies on the balance sheet. Solutions Manual 6-16 Chapter 6

EXERCISE 6-2 Ending inventory physical count... $281,000 Adjustments: 1. Add to inventory: Title passed to Moghul when goods were shipped... 95,000 2. Add to inventory: Title remains with Moghul until buyer receives goods... 35,000 3. No effect: Title passes to purchaser upon shipment when terms are FOB shipping point... 0 4. Add to inventory: Consignor (Moghul) own goods 30,500 5. Add to inventory: Title passed to Moghul when goods were shipped... 28,000 6. No effect: Title does not transfer to Moghul until goods are received... 0 $469,500 Solutions Manual 6-17 Chapter 6

EXERCISE 6-3 (a) Paul s Paintings should use the specific identification instead of one of the cost formulas. Specific identification is required when a company sells items that are not interchangeable. In the case of paintings, these items are not interchangeable. Each painting, along with its cost, is identifiable from the name of the artist. (b) Painting Cost Cost of Goods Sold Ending Inventory 1 $1,000 $1,000 2 800 $800 3 1,100 1,100 4 700 700 5 1,200 1,200 $4,800 $2,200 $2,600 (c) Date Account Titles and Explanation Debit Credit Dec. 22 Cash or Accounts Receivable... 5,000 Sales ($2,500 2)... 5,000 Cost of Goods Sold... 2,200 Merchandise Inventory... 2,200 ($1,000 + $1,200) Solutions Manual 6-18 Chapter 6

EXERCISE 6-4 (a) FIFO Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total May 1 400 $4.00 $1,600 3 300 $4.00 $1,200 100 4.00 400 4 1,300 $4.10 5,330 100 4.00 1,300 14 700 $4.40 3,080 100 1,300 700 4.10 5,730 4.00 4.10 4.40 8,810 16 100 4.00 400 4.10 900 4.10 4,090 700 4.40 4,720 18 400 4.10 1,640 700 4.40 3,080 29 500 4.75 2,375 700 4.40 500 4.75 5,455 Total 2,500 $10,785 1,700 $6,930 1,200 $5,455 Check: $1,600 + $10,785 $6,930 = $5,455 Solutions Manual 6-19 Chapter 6 2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited.

EXERCISE 6-4 (Continued) (b) Date Account Titles and Explanation Debit Credit May 3 Accounts Receivable... 2,100 Sales (300 $7.00)... 2,100 Cost of Goods Sold... 1,200 Inventory (300 $4.00)... 1,200 4 Inventory (1,300 $4.10)... 5,330 Accounts Payable... 5,330 16 Accounts Receivable... 7,000 Sales (1,000 $7.00)... 7,000 Cost of Goods Sold... 4,090 Inventory... 4,090 [(100 $4.00) + (900 $4.10)] (c) Sales ($2,100 + $7,000 + [400 $7.50]) $12,100 Cost of goods sold 6,930 Gross profit $5,170 Solutions Manual 6-20 Chapter 6

EXERCISE 6-5 (a) Average Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Jan. 1 1,000 $12.000 $12,000 Feb. 15 2,000 $18.00 $36,000 3,000 (1) 16.000 48,000 Apr. 24 2,500 16.000 40,000 500 16.000 8,000 Jun. 6 3,500 23.00 80,500 4,000 (2) 22.125 88,500 Oct. 18 2,000 22.125 44,250 2,000 22.125 44,250 Dec. 4 1,400 26.00 36,400 5 0 3 50 3,400 (3) 23.721 80,650 Total 6,900 $152,900 4,500 $84,250 3,400 $80,650 Check: $12,000 + $152,900 $84,250 = $80,650 (1) ($12,000 + $36,000) (1,000 + 2,000) (2) ($8,000 + $80,500) (500 + 3,500) (3) ($44,250 + $36,400) (2,000 + 1,400) Solutions Manual 6-21 Chapter 6

EXERCISE 6-5 (Continued) (b) Date Account Titles and Explanation Debit Credit June 6 Inventory (3,500 $23)... 80,500 Accounts Payable... 80,500 Oct. 18 Accounts Receivable... 66,000 Sales (2,000 $33)... 66,000 Cost of Goods Sold... 44,250 Inventory (2,000 $22.125)... 44,250 (c) Sales ([2,500 $30] + $66,000) $141,000 Cost of goods sold 84,250 Gross profit $56,750 Solutions Manual 6-22 Chapter 6

EXERCISE 6-6 (a) (1) FIFO Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total July 1 150 $5 $ 750 July 12 230 $6 $1,380 150 5 230 6 2,130 July 15 150 $5 100 6 $1,350 130 6 780 July 16 490 7 3,430 130 6 490 7 4,210 July 23 175 8 1,400 130 490 6 7 175 8 5,610 July 27 130 6 50 7 350 35 0 440 7 3,860 175 8 1,750 Total 895 $6,210 820 $5,210 225 $1,750 Check: $750 + $6,210 $5,210 = $1,750 (2) Average Purchases Cost of Goods Sold Balance July 1 150 $5.000 $ 750 July 12 230 $6 $1,380 380 5.605 2,130 July 15 250 $5.605 $1,401 130 5.605 729 July 16 490 7 3,430 620 6.708 4,159 July 23 175 8 1,400 795 6.993 5,559 July 27 570 6.993 3,986 225 6.993 1,573 Total 895 $6,210 820 $5,387 225 $1,573 Check: $750 + $6,210 $5,387 = $1,573 Solutions Manual 6-23 Chapter 6

EXERCISE 6-6 (Continued) (b) Cost of Goods Sold Ending Inventory FIFO Perpetual $5,210 $1,750 Average Perpetual $5,387 $1,573 The FIFO cost formula will produce the higher ending inventory because costs have been rising. Under this formula, the earliest costs are assigned to cost of goods sold, and the latest costs remain in ending inventory. For Dene Company, the ending inventory under FIFO is $1,750 compared to $1,573 under average cost. (c) The average cost formula will produce the higher cost of goods sold for Dene Company. Under the average cost formula some of the most recent costs are averaged into cost of goods sold, and the earliest costs are averaged into the ending inventory. The cost of goods sold is $5,387 compared to $5,210 under FIFO. Solutions Manual 6-24 Chapter 6

EXERCISE 6-7 (a) (1) FIFO Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total May 1 350 $8 $2,800 May 4 480 $7 $3,360 350 8 480 7 6,160 May 11 350 $8 160 7 $3,920 320 7 2,240 May 12 (10) 7 (70) 330 7 2,310 May 17 150 6 900 330 7 150 6 3,210 May 22 475 5 2,375 330 150 7 6 475 5 5,585 May 29 330 150 7 6 200 5 _4,210 275 5 _1,375 Total 1,105 $6,635 1,180 $8,060 275 $1,375 Check: $2,800 + $6,635 $8,060 = $1,375 (2) Average Purchases Cost of Goods Sold Balance May 1 350 $8.000 $2,800 May 4 480 $7 $3,360 830 7.422 6,160 May 11 510 $7.422 $3,785 320 7.422 2,375 May 12 (10) 7.422 (74) 330 7.422 2,449 May 17 150 6 900 480 6.977 3,349 May 22 475 5 2,375 955 5.994 5,724 May 29 _680 5.994 _4,076 275 5.994 _1,648 Total 1,105 $6,635 1,180 $7,787 275 $1,648 Check: $2,800 + $6,635 $7,787 = $1,648 Solutions Manual 6-25 Chapter 6

EXERCISE 6-7 (Continued) (b) FIFO Average Sales ($15 1,180) $17,700 $17,700 Cost of goods sold 8,060 7,787 Gross profit $ 9,640 $ 9,913 Gross profit is different under the two methods because a different flow of goods is assumed. Under the FIFO method, the earliest costs are assigned to cost of goods sold. Since product costs are decreasing, this means that older, higher costs are flowing to cost of goods sold. Under the average method, the older, higher costs are averaged into cost of goods sold with newer, lower costs, producing a lower amount than the FIFO method. (c) The choice of inventory cost formula does not affect cash flow. It is an allocation of costs between inventory and cost of goods sold. Solutions Manual 6-26 Chapter 6

EXERCISE 6-8 (a) 2014 2013 Ending inventory, incorrect $30,000 $30,000 Error $4,000 U $5,500 O Ending inventory, correct $34,000 $24,500 Cost of goods sold, incorrect $170,000 $175,000 Error beginning inventory 2013 $5,500 O Error ending inventory 2013 $5,500 U Error ending inventory 2014 $4,000 O Cost of goods sold, correct $160,500 $180,500 (b) In 2013 profit is overstated by $5,500, the amount of the error in ending inventory. This error flows through to owner s equity in 2013 to produce an overstatement of $5,500. In 2014 both errors have an impact. The net effect is an understatement of profit by $9,500. This is a result of the $5,500 overstatement of the beginning inventory plus $4,000 understatement of ending inventory. Owner s equity in 2014 would show only an understatement of $4,000. The $5,500 overstatement of 2013 would be offset by the $5,500 understatement in profit caused by the impact on beginning inventory in 2014. (c) It is important that Glacier Fishing Gear correct these errors because users of the financial statements look at the results for individual years and also look at any trends. Solutions Manual 6-27 Chapter 6

EXERCISE 6-9 (a) MARRAKESH COMPANY Income Statement (Partial) December 31 2014 2013 Sales... $500,000 $500,000 Cost of goods sold*... 430,000 390,000 Gross profit... $ 70,000 $110,000 * Cost of goods sold (2013) = $410,000 $20,000 = $390,000 Cost of goods sold (2014) = $410,000 + $20,000 = $430,000 (b) The cumulative effect on total gross profit for the two years is zero, as shown below: 2014 2013 Incorrect gross profits: $90,000 + $90,000 = $180,000 Correct gross profits: $70,000 + $110,000 = 180,000 Difference $ 0 (c) 2014 2013 Original $90,000 $500,000 $90,000 $500,000 = 18% = 18% Corrected $70,000 $500,000 $110,000 $500,000 = 14% = 22% Solutions Manual 6-28 Chapter 6

SOLUTIONS TO PROBLEMS PROBLEM 6-1A (a) 1. Include the unsold portion of $510 ($875 $365) in Kananaskis inventory. Title passes to the buyer on sale. 2. Exclude the items from Kananaskis inventory. These goods have been sold. 3. Exclude the items from Kananaskis inventory. These goods are owned by Craft Producers. 4. Title to the goods does not transfer to the customer until March 3. Include the $950 in ending inventory. 5. Kananaskis owns the goods once they are shipped on February 26. Include inventory of $405 ($375 + $30). 6. Include $630 in inventory. These goods have not yet been sold. 7. Title of the goods does not transfer to Kananaskis until March 2. Exclude this amount from the February 28 inventory. 8. The sale will be recorded on February 26. The goods should be excluded from Kananaskis inventory at the end of February. (b) $65,000 Original Feb. 28 inventory valuation +510 1. +950 4. +405 5. +630 6. $67,495 Revised Feb. 28 inventory valuation Solutions Manual 6-29 Chapter 6

PROBLEM 6-1A (Continued) Taking It Further The accountant would consider overlooking item 4. A sale to a customer has taken place but the legal ownership of the merchandise is transferred after year end. Recording this transaction in February will increase profit and increase the accountant s bonus. Intentionally not correcting this error would be unethical. Solutions Manual 6-30 Chapter 6

PROBLEM 6-2A (a) Cost of goods sold Ending inventory Model Serial # Cost/ Unit Sales price/ Unit Model Serial # Cost/ Unit Nov. 8 Corolla C81362 $20,000 $22,000 Corolla C63825 $15,000 Camry G62313 26,000 28,000 Tundra F1883 22,000 18 Camry G71891 25,000 27,000 Camry G71811 27,000 Venza X3892 27,000 31,000 Venza X4212 28,000 Tundra F1921 25,000 29,000 Venza X4214 31,000 $123,000 $137,000 Tundra F2182 23,000 Camry G72166 30,000 $176,000 (b) Gross profit = $137,000 $123,000 = $14,000 Taking It Further: EastPoint Toyota should use the specific identification method because the vehicles are large dollar value items that are specifically identifiable and they are not interchangeable. Solutions Manual 6-31 Chapter 6

(a) PROBLEM 6-3A Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Nov. 1 60 $50 $3,000 9 100 $46 $4,600 60 50 100 46 7,600 15 60 $50 60 46 $5,760 40 46 1,840 16 (5) 46 (230) 45 46 2,070 22 150 44 6,600 45 46 150 44 8,670 29 45 46 115 44 7,130 35 44 1,540 30 45 42 1,890 35 44 45 42 3,430 Total 295 $13,090 275 $12,660 80 $3,430 Check: $3,000 + $13,090 $12,660 = $3,430 (b) Nov. 22 Merchandise Inventory... 6,600 Accounts Payable (150 $44)... 6,600 29 Accounts Receivable... 9,600 Sales (160 $60)... 9,600 Cost of Goods Sold... 7,130 Inventory [(45 $46) + (115 $44)] 7,130 Solutions Manual 6-32 Chapter 6

PROBLEM 6-3A (Continued) (c) Sales ([120 $66] + $9,600) $17,520 Less: Sales returns and allowances (5 $66) (330) Net sales 17,190 Cost of goods sold 12,660 Gross profit $ 4,530 (d) The entry to record the adjustment would be: Cost of Goods Sold (2 $44)... 88 Merchandise Inventory... 88 Revised gross profit would be: $4,530 $88 = $4,442 (e) The merchandise inventory on the balance sheet would be overstated by $88, as well as the owner s capital account by the same amount. On the income statement, the cost of goods sold would be understated by $88. This would lead to an overstatement of gross profit by $88 and of profit by $88. Taking It Further: The FIFO cost formula produces more meaningful inventory amounts for the balance sheet because the units are costed at the most recent purchase prices. These prices approximate replacement cost, which is the most relevant value for decision making. The FIFO cost formula is more likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. Solutions Manual 6-33 Chapter 6

PROBLEM 6-4A (a) Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Nov. 1 60 $50.00 $3,000 9 100 $46 $4,600 160 47.50 7,600 15 120 $47.50 $5,700 40 47.50 1,900 16 (5) 47.50 (238) 45 47.50 2,138 22 150 44 6,600 195 44.81 8,738 29 160 44.81 7,170 35 44.81 1,568 30 45 42 1,890 80 43.23 3,458 Total 295 $13,090 275 $12,632 80 $3,458 (b) Check: $3,000 + $13,090 $12,632 = $3,458 Nov. 15 Accounts Receivable... 7,920 Sales (120 $66)... 7,920 Cost of Goods Sold... 5,700 Inventory (120 $47.50)... 5,700 16 Sales Returns and Allowances... 330 Accounts Receivable (5 $66)... 330 Inventory... 238 Cost of Goods Sold (5 $47.50)... 238 Solutions Manual 6-34 Chapter 6

PROBLEM 6-4A (Continued) (c) Before making the change to the FIFO cost formula, the company must consider if the FIFO formula would result in more relevant information in the financial statements. Orhas the physical flow of inventory has changed from average flow to FIFO? Comparison FIFO Average Ending Inventory Cost of Goods Sold Ending Inventory Cost of Goods Sold $3,430 $12,660 $3,458 $12,632 If prices continue to fall, the FIFO cost formula will continue to yield lower ending inventory and higher cost of goods sold than the average cost formula. Taking It Further: In selecting a cost formula, management should consider their circumstances the type of inventory and the flow of costs throughout the period. Management should also consider their financial reporting objectives. In the final determination, however, management should select the cost formula that will provide the most relevant financial information for decision-making. Solutions Manual 6-35 Chapter 6

(a) (1) FIFO PROBLEM 6-5A Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total June 1 5 $105 $525 4 2 $105 $210 3 105 315 18 5 $115 $575 3 105 5 115 890 30 3 105 3 115 660 2 115 230 July 5 5 120 600 2 115 5 120 830 12 2 115 1 120 350 4 120 480 25 2 120 240 2 120 240 Total 10 $1,175 13 $1,460 2 $240 Check: $525 + $1,175 $1,460 = $240 (2) Average Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total June 1 5 $105.00 $525 4 2 $105.00 $210 3 105.00 315 18 5 $115 $ 575 8 111.25 890 30 6 111.25 668 2 111.25 223 July 5 5 120 600 7 117.50 823 12 3 117.50 353 4 117.50 470 25 2 117.50 235 2 117.50 235 Total 10 $1,175 13 $1,465 2 $235 Check: $525 + $1,175 $1,465 = $235 Solutions Manual 6-36 Chapter 6

PROBLEM 6-5A (Continued) (b) FIFO Average Sales*... $3,105 $3,105 Cost of goods sold... 1,460 1,465 Gross profit... $1,645 $1,640 * Sales = (2 $210) + (6 $235) + (3 $255) + (2 $255) (c) The choice of inventory cost formula does not affect cash flow. It is an allocation of costs between inventory and cost of goods sold. Taking It Further: In selecting a cost formula, management should consider their circumstances the type of inventory and the flow of costs throughout the period. In the final determination, however, management should select the cost formula that best approximates the physical flow of goods or represents recent costs on the balance sheet. Solutions Manual 6-37 Chapter 6

PROBLEM 6-6A (a) Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total July 1 25 $10.00 $250 5 55 $9 $495 80 9.31 745 8 70 $9.31 $652 10 9.31 93 10 (15) 9.31 (140) 25 9.31 233 15 50 8 400 75 8.44 633 16 (10) 8 (80) 65 8.51 553 20 55 8.51 468 10 8.51 85 25 10 7 70 20 7.75 155 Total 105 $885 110 $980 20 $155 Check: $250 + $885 $980 = $155 GENERAL JOURNAL Date Account Titles and Explanation Debit Credit July 5 Merchandise Inventory (55 $9).. 495 Cash... 495 8 Cash (70 $15)... 1,050 Sales... 1,050 Cost of Goods Sold (70 $9.31).. 652 Merchandise Inventory... 652 10 Sales Returns and Allowances (15 $15)... 225 Cash... 225 Merchandise Inventory (15 $9.31) 140 Cost of Goods Sold... 140 Solutions Manual 6-38 Chapter 6

PROBLEM 6-6A (Continued) (a) (Continued) 15 Merchandise Inventory (50 $8).. 400 Cash... 400 16 Cash (10 $8)... 80 Merchandise Inventory... 80 20 Cash (55 $12)... 660 Sales... 660 Cost of Goods Sold (55 $8.51).. 468 Merchandise Inventory... 468 25 Merchandise Inventory (10 $7).. 70 Cash... 70 (b) The ending inventory is 20 units $7.75 = $155 (c) Since cost is less than net realizable value, no entry is required to adjust the amount to lower of cost and net realizable value. Cost: 20 $7.75 = $155 Net realizable value: 20 $8 = $160 (d) The ending inventory should be valued at $155, the lower of cost and net realizable value. The cost of goods sold is $980 ($652 $140 + $468). Taking It Further: If Amelia had used FIFO instead of average, the cost of the ending inventory on July 31 would be calculated as follows: (10 units $7) + (10 units $8) = $150 The FIFO cost is lower than net realizable value, so no adjustment is required. The inventory will be presented on the balance sheet at its cost basis of $150. Solutions Manual 6-39 Chapter 6

PROBLEM 6-7A (a) Year Ended December 31, 2012 Total Assets Owner's Equity Cost of goods sold Profit As reported $ 850,000 $ 650,000 $ 500,000 $ 70,000 Impact of Dec.31/2012 Inventory overstatement O 20,000 O 20,000 U 20,000 O 20,000 Correct amount $ 830,000 $ 630,000 $ 520,000 $ 50,000 Year Ended December 31, 2013 Total Assets Owner's Equity Cost of goods sold Profit As reported $ 900,000 $ 700,000 $ 550,000 $80,000 Impact of Dec.31/2012 Inventory overstatement NE NE O 20,000 U 20,000 Impact of Dec.31/2013 Inventory understatement U 32,000 U 32,000 O 32,000 U 32,000 Correct amount $ 932,000 $ 732,000 $ 498,000 $ 132,000 Year Ended December 31, 2014 Total Assets Owner's Equity Cost of goods sold Profit As reported $ 925,000 $ 750,000 $ 550,000 $90,000 Impact of Dec.31/2013 Inventory understatement NE NE U 32,000 O 32,000 Correct amount $ 925,000 $ 750,000 $ 582,000 $ 58,000 Solutions Manual 6-40 Chapter 6

PROBLEM 6-7A (Continued) (b) The errors in calculating the company s ending inventory will not have an impact on the company s cash account. The cash balances will be correctly stated at December 31, 2012, 2013 and 2014. Taking It Further: Part (a) shows that even though inventory and owner s equity are correct, the income statement shows the impact of the 2013 error on cost of goods sold and profit. In addition, comparative amounts for 2013 and 2012 would show incorrect amounts for inventory, owner s equity, cost of goods sold and profit. These errors impact trend and profitability analyses and would need to be corrected. Solutions Manual 6-41 Chapter 6