Suggested Solutions Chapter 19 Discussion Questions

4.

Critically examine the following statement: During times of high inflation, the LIFO cost assumption should be permitted in financial statements because it allows the entity to show a more up-to-date profit figure. During times of inflation, the use of a LIFO cost assumption tends to cause cost of sales to reflect the most recent (higher) purchase prices. Hence, the cost of sales calculation will be a close approximation of the current cost of goods at the time of the sale, thereby producing a more up-to-date gross profit figure when deducted from current sales for the period. This applies only if inventories are not run down but are maintained at a reasonably constant level or gradually increased during the year. However, if inventories are run down at any stage during the period, very old, out-of-date cost prices will then be placed automatically into the cost of sales figure under LIFO, and the statement does not hold true.

8.

Why is the lower of cost and net realisable value rule required by accounting standards? Is it permissible to revalue inventories upwards? If so, when? Are there any limits to revaluation? The lower of cost and net realisable value rule is used in order to ensure that inventory is not overvalued. Based on the qualitative characteristic of faithful representation, it is considered suitable that if inventory cost is below net realisable value, the most faithfully representative valuation is cost, and if net realisable value is less than cost, the most faithfully representative valuation is net realisable value. Inventory cannot be valued at more that the entity would obtain from its sale. It is not permissible to revalue inventory upwards, above cost. For inventory valued at net realisable value, if this value rises and the circumstances for the original write-down no longer exist, the standard permits a reversal of the write-down, but only if the reversal does not exceed the original cost. Cost is the maximum value permitted to be placed on inventories. See IAS 2/AASB 102, as discussed in learning objective 5 of this chapter of the text.

Exercise 19.2

Inventory cost flow methods periodic inventory system

GO LTD

Required: Determine the cost of sales for the month under each of the following cost flow assumptions, based on the periodic inventory system: 1. 2. FIFO weighted average.

1.

Cost of sales FIFO: From inventory, 1 June From purchase of 3 June From purchase of 15 June 8 000 units @ 7 000 units @ 9 000 units @ 24 000 units $18.00 $19.00 $20.00 $144 000 133 000 180 000 $457 000

2.

Cost of sales weighted average: Average cost per unit Cost of sales $832 000 42 000 = 19.81 24 000 @ $19.81 = $475 440

Exercise 19.5

Inventory cost methods perpetual inventory system

OPEN LTD

Required: Determine the cost of the ending inventory and the cost of sales, using the following three methods. 1. 2. the moving average; round unit cost to the nearest cent. specific identification; assume that the ending inventory on 31 May consisted of 13 units from the beginning inventory, 24 units from the 3 May purchase, and the remainder from the 12 May purchase. FIFO.

3.

1.

Moving average method

Purchases Date
1/5 3/5 10/5 12/5 17/5 25/5

Sales Total Cost

$630 110 $6.53 $7.41 $7.41 $718.30 592.80 $222.30 $1 533.40 720 80 30

Balance Total Cost Units

80

Explanation
Beg. Invent. Purchases Sales Purchases Sales Sales

Units

Unit Cost
$7.00 8.00

Unit

Unit Cost

Unit Cost
$6.00 6.53 6.53 7.41 7.41 7.41

Total Cost
$480.00 1 110.00 391.70 1 111.70 518.90 $296.60

90 90

170 60 150 70 40

Ending inventory $296.60 Cost of sales $1 533.40

2.

Specific identification

Ending inventory: 13 units @ $6.00 24 units @ $7.00 3 units @ $8.00 40 units $78.00 168.00 24.00 $270.00

Cost of sales 67 units @ $6.00 66 units @ $7.00 87 units @ $8.00 220 units $402.00 462.00 696.00 $1 560.00

2.

FIFO method

Purchases Date 1/5 3/5 10/5 Explanation Beg. invent. Purchases Sales 90 $7.00 $630 80 30 12/5 17/5 Purchases Sales 90 $8.00 $720 60 20 25/5 Sales 30 Units Unit Cost Total Cost Units

Sales Unit Cost Total Cost Units 80 80 90 $6.0 0 $7.0 0 $480.00 $210.00 60 60 90 $7.0 0 $8.0 0 $8.0 0 $420.00 $160.00 $240.00 70 40

Balance Unit Cost $6.00 $6.00 $7.00 1 110 Total Cost $480

$7.00 $7.00 $8.00

420

1 140

$8.00 $8.00

560 320

$1 510.00

Ending inventory $320.00 Cost of sales $1 510.00

Exercise 19.12

Retail inventory and gross profit methods

Part A CLOSED LTD Required: A. Calculate estimated cost of the inventory at 30 April 2013 using the retail inventory method. B. What key assumptions underlie the validity of this estimate of inventory cost? A. Cost Inventory, 1 April 2013 Net purchases Total merchandise available Cost-to-retail percentage: $316 000/$494 000 = 64% Less: Sales during period Estimated ending inventory at retail prices Applicable cost percentage Estimated ending inventory at cost, 30 April $100 000 216 000 316 000 Selling Price $170 000 324 000 494 000

390 000 $104 000 64% $66 560

B.

The accuracy of the retail method depends upon the assumption that the ending inventory contains the same relative proportions of goods at various mark-ups as the goods available for sale.

Part B DOLLY LTD Required: Determine the amount of Dolly Ltds claim for the inventory loss. Beginning inventory Net purchases Cost of goods available for sale Net sales Estimated gross profit (40%) Estimated cost of sales Estimated inventory lost by fire $320 000 904 800 1 224 800 $1 022 000 (408 800) 613 200 $611 600

Problem 19.8

Cost of sales FIFO and moving average SAMMYS STATIONERY

Required: A. Calculate the cost of inventory on hand at 31 December 2013 and the cost of sales for the year ended 31 December 2013, assuming: the FIFO cost flow assumption the moving average cost flow assumption (round average unit costs to the nearest cent, and total cost amounts to the nearest dollar). B. Prepare the income statement to gross profit for the year ended 31 December 2013, assuming: the FIFO cost flow assumption the moving average cost flow assumption

A. FIFO Cost assumption: perpetual

Product Purchases Date 1/1 6/1 5/2 17/3 24/4 4/5 26/6 11/8 19/8 11/9 6/10 11/12 Explanatio n Balance Purchases Sales Purchases Purch retns Sales Purchases Sales Sales retns Sales Purchases Sales 500 8.00 4 000 3100 7.50 23 250 $74 817 8400 7 50 63 000 620 1180 (20) 3500 $7.35 $7 50 $7.50 $7.50 4 557 8 850 (150) 26 250 7220 7240 3740 3740 500 640 500 $7.50 $7 50 $7.50 $7.50 8.00 7.50 8 00 8 800 32 250 54 150 54 300 28 050 1100 (80) 7.35 7.35 8 085 (588) 300 400 $7.05 $7.35 2 115 2 940 620 620 8400 $7.35 $7.35 $7.50 67 557 4 557 400 $7.05 $2 820 900 100 $7.00 $ 7.05 $6 300 705 300 300 1100 300 1020 $7.05 $7.05 $7.35 $7.05 $7.35 9 612 10 200 2 115 Unit Unit Cost Total Cost Unit FIFO Method Sales Unit Cost Total Cost Unit 900 900 400 Balance Unit Cost $7.00 $7.00 $7.05 9 120 Total Cost $6 300

Moving average method: Perpetual

Purchases Date 1/1 6/1 5/2 17/3 24/4 4/5 26/6 11/8 19/8 11/9 6/10 11/12 Explanatio n Beg. invent. Purchase Sales Purchase Purchase Retn Sale Purchase Sale Sale return Sale Purchase Sale 500 8.00 4 000 3 100 $7.55 23 390 $75 016 8400 7.50 63 000 1800 (20) 3 500 $7.48 $7.48 $7.48 13 472 (150) 26 195 1100 (80) $7.35 $7.35 8 085 (588) 700 $7.27 5 089 400 $7.05 $2 820 1000 $7.02 $7020 Units Unit Cost Total Cost Units Sales Unit Cost Total Cost Units 900 1300 300 1400 1320 620 9 020 7 220 7 240 3 740 4 240 1 140 Balance Unit Cost $7.00 $7.02 $7.02 $7.28 $7.27 $7.27 $7.48 $7.48 $7.48 $7.48 $7 55 $7.55 Total Cost $6 300 9 120 2 100 10 185 9 597 4 508 67 508 54 036 54 186 27 991 31 991 8 601

B. FIFO SAMMYS STATIONERY Income Statement for the year ended 31 December 2013 INCOME Sales* Less: Sales Returns and allowances Net sales Less: Cost of sales GROSS PROFIT $137 820 (265) 137 555 74 817 $62 738

Sales = 1 000 x $12 + 700 x $12.10 + 1800 x $13.25 + 3 500 x 13.50 + 3100 x $15 = $137 820

MOVING AVERAGE SAMMYS STATIONERY Income Statement for the year ended 31 December 2013 INCOME Sales* Less: Sales Returns and allowances Net sales Less: Cost of sales GROSS PROFIT $137 820 (265) 137 555 75 016 $62 539

Problem 19.9

Cost of sales periodic inventory system WELSH AND BROWN

Required: A. Prepare an income statement up to gross profit for December using each of the following costing methods: 1. specific identification, assuming that 300 units were sold from the beginning inventory and 400 units were sold from the first purchase 2. FIFO 3. LIFO 4. weighted average. B. Which cost flow method resulted in the highest gross profit on sales? the highest ending inventory? Explain why your results differ. C. Prepare an income statement to gross profit for December using the FIFO and LIFO costing methods and assuming the 23 December purchase had not been made. D. Management of Welsh and Brown is expecting the unit cost to increase to $6.00 early in the next period. In anticipation of the price increase, assume that a purchase of 600 additional units was made on 29 December at a unit cost of $5.80. Prepare an income statement to gross profit for December using the FIFO and LIFO costing methods. E. Compare your results obtained in requirements A, C and D. Explain why your results are or are not the same. A. WELSH AND BROWN Income Statements for the month ended 31 December Specific identification Sales revenue Cost of sales: Beginning inventory Purchases Goods available for sale Less: Ending inventory Cost of sales Inventory loss* GROSS PROFIT * assuming from last purchase 2 000 4 920 6 920 3 300 3 620 56 $2 624 $2 657 $2 387 $2 519 2 000 4 920 6 920 3 277 3 643 2 000 4 920 6 920 3 007 3 913 2 000 4 920 6 920 3 139 3 781 $6 300 FIFO $6 300 LIFO $6 300 Weighted average $6 300

Specific identification: 100 x $5.00 = $ 500 500 x $5.60 = 2 800 $3 300 FIFO: 500 x $5.60 =$2 800 90 x $5.30 = 477

LIFO: 400 x $5.00 = 190 x $5.30 = $2 000 1 007 $3 007 Weighted average: $6 920 1 300 = $5.32 $5.32 x 590 = $3 139

$3 277

B. FIFO produced the highest gross profit. FIFO produced the highest ending inventory value. When unit costs change, the cost of sales and ending inventory amounts will vary depending on the cost flow method used. In other words, the four cost flow methods are based on different assumptions as to which unit cost is to be included in cost of sales.

C. and D. Assume for part C. that the ending inventory physical count was 90 units rather than 590 units. Assume for part D. that the ending inventory physical count was 1190 units rather than 590 units. WELSH AND BROWN Income Statements for the month ended 31 December C. FIFO INCOME: Sales Cost of sales: Beginning inventory Purchases Goods available for sale Less: ending inventory Cost of sales GROSS PROFIT 2 000 2 120 4 120 477 3 643 $2 657 2 000 2 120 4 120 450 3 670 $2 630 2 000 8 400 10 400 6 757 3 643 $2 657 2 000 8 400 10 400 6 304 4 096 $2 204 $6 300 LIFO $6 300 FIFO $6 300 D. LIFO $6 300

Ending Inventory Requirement C. FIFO: 90 x $5.30 = $477 600 500 90 Requirement D. x x x $5.80 5.60 5.30 = = = $3 480 2 800 477 $6 757

LIFO:

90

$5.00

$450

400 400 390

x x x

$5.00 5.30 5.60

= = =

$2 000 2 120 2 184 $6 304

Purchases (Requirement D) 10/12 23/12 29/12 600 x $5.80 = 2 120 2 800 3 480 8 400

E.

The FIFO results are the same because it is assumed that the first units purchased are the first ones sold. On the other hand, LIFO results are affected by purchases made or not made at the end of the period because the last units purchased are assumed to be the first units sold.