Exercise 8.6 Inventory Write-Downs L.O.

3
Late in the year, Software City began carrying WordCrafter, a new word processing software program. At December 31, Software Citys perpetual inventory records included the following cost layers in its inventory of WordCrafter programs: Purchase Date Nov. 14 Dec. 12 Total available for sale at Dec. 31 Quantity 8 20 Unit Cost $400 310 Total Cost $ 3,200 6,200

28

9,400

a. At December 31, Software City takes a physical inventory and finds that all 28 units of Word-Crafter are on hand. However, the current replacement cost (wholesale price) of this product is only $250 per unit. a-1 Prepare the entries to record this write-down of the inventory to the lower-of-cost-or-market at December 31. (Company policy is to charge LCM adjustments of less than $2,000 to Cost of Goods Sold and larger amounts to a separate loss account.) (Omit the "$" sign in your response.) General Journal 1. Loss from write-down of inventory Inventory Debit
2,400 5% 2,400 5%

Credit

a-2 Prepare the entries to the cash sale of 15 WordCrafter programs on January 9, at a retail price of $350 each. Assume that Software City uses the FIFO flow assumption. (Omit the "$" sign in your response.) General Journal 2. Cash Sales Cost of goods sold Inventory
3,750 5% 3,750 5%

Debit
5,250 5%

Credit

5,250 5%

b. Now assume that the current replacement cost of the WordCrafter programs is $405 each. A physical inventory finds only 25 of these programs on hand at December 31. (For this part, return to the original information and ignore what you did in part a.) b-1 Prepare the journal entry to record the shrinkage loss assuming that Software City uses the FIFO flow assumption. (Omit the "$" sign in your response.) General Journal 1. Cost of goods sold Inventory Debit
1,200 5% 1,200 5%

Credit

b-2 Prepare the journal entry to record the shrinkage loss assuming that Software City uses the LIFO flow assumption. (Omit the "$" sign in your response.) General Journal 2. Cost of goods sold Inventory Debit
930 5% 930 5%

Credit

Explanation: a-1

To write down the inventory of 28 units of WordCrafter to the lower-of-cost-or-market Cost Replacement cost (28 units @ $250) Reduction in carrying value $ 9,400 7,000

2,400

a-2

To recognize the sales revenue from the sale of 15 WordCrafter programs @ $350, cash. To record cost of 15 WordCrafter programs sold on January 9 using the FIFO flow assumption. (All units are carried in inventory at $250 following the year-end reduction to the lower-of-cost-or-market.)
b-1

To record shrinkage loss of 3 units of WordCrafter software using the FIFO flow assumption (3 units @ $400). b-2 To record shrinkage loss of 3 units of WordCrafter software using the LIFO flow assumption (3 units @ $310).

Problem 8.6A Effects of Inventory Errors on Earnings L.O. 5

The owners of Hexagon Health Foods are offering the business for sale. The partial income statements of the business for the three years of its existence are summarized below. Net sales Cost of goods sold Gross profit on sales Gross profit percent age $ 2011 875,000 481,250 $ 2010 840,000 487,200 $ 2009 820,000 480,000

393,750 45%

352,800 42%

340,000 41 %

In negotiations with prospective buyers of the business, the owners of Hexagon are calling attention to the rising trends of the gross profit and the gross profit percentage as very favorable elements. Assume that you are retained by a prospective purchaser of the business to make an investigation of the fairness and reliability of the enterprise's accounting records and financial statements. You find everything in order except for the following: (1) An arithmetic error in the computation of inventory at the end of 2009 had caused a $40,000 understatement in that inventory, and (2) a duplication of figures in the computation of inventory at the end of 2011 had caused an overstatement of $81,750 in that inventory. The company uses the periodic inventory system, and these errors had not been brought to light prior to your investigation. a. Prepare a revised three-year partial income statement summary. (Input all amounts in positive values. Round your percentage answers to the nearest whole number. Omit the "$" and "%" signs in your response.) 2011 Net sales Cost of goods sold Gross profit on sales $
875,000 5% 563,000 5%

2010 $
840,000 5% 527,200 5%

2009 $ $ $
820,000 5% 440,000 5%

312,000 5%

312,800 5%

380,000 5%

Gross profit percentage

36 5%

37 5%

46 5%

Explanation: Cost of Goods Sold:

2009: $480,000 $40,000 = $440,000 2010: $487,200 + $40,000 = $527,200 2011: $481,250 + $81,750 = $563,000

Problem 9.1A Determining the Cost of Plant Assets L.O. 1-3

Wilmet College recently purchased new computing equipment for its library. The following information refers to the purchase and installation of this equipment: 1. The list price of the equipment was $275,000; however, Wilmet College qualified for an "education discount" of $25,000. It paid $50,000 cash for the equipment, and issued a three-month, 9 percent note payable for the remaining balance. The note, plus accrued interest charges of $4,500, was paid promptly at the maturity date. 2. In addition to the amounts described in 1, Wilmet paid sales taxes of $15,000 at the date of purchase. 3. Freight charges for delivery of the equipment totaled $1,000. 4. Installation costs related to the equipment amounted to $5,000. 5. During installation, one of the computer terminals was accidentally damaged by a library employee. It cost the college $500 to repair this damage. 6. As soon as the computers were installed, the college paid $4,000 to print admissions brochures featuring the library's new, state-of-the-art computing facilities. c. Compute the total cost debited to the college's Computing Equipment account. (Omit the "$" sign in your response.) Total cost of the equipment
271,000 5%

d. Prepare a journal entry at the end of the current year to record depreciation on the computing equipment. Wilmet College will depreciate this equipment by the straight-line method (half-year convention) over an estimated useful life of five years. Assume a zero residual value. (Omit the "$" sign in your response.) Date Dec. 31 General Journal Depreciation expense: Computing equip. Accumulated depreciation: Computing equip. Debit
27,100 5% 27,100 5%

Credit

Explanation: c. Expenditures that should be debited to the Computing Equipment account:

Purchase price Sales tax Freight charges Installation charges Total cost of the equipment

250000 15000 1000 5000 271,000

d.

To record depreciation of computing equipment in the year of acquisition ($271,000 cost 5 years) 1/2 = $27,100.

Problem 9.4A Disposal of Plant Assets L.O. 5

During the current year, Ramirez Developers disposed of plant assets in the following transactions: Feb. 10 Office equipment costing $26,000 was given to a scrap dealer at no charge. At the date of disposal, accumulated depreciation on the office equipment amounted to $25,800. Apr. 1 Ramirez sold land and a building to Claypool Associates for $900,000, receiving $100,000 cash and a five-year, 9 percent note receivable for the remaining balance. Ramirez's records showed the following amounts: Land, $50,000; Building, $550,000; Accumulated Depreciation: Building (at the date of disposal), $250,000. Aug. 15 Ramirez traded in an old truck for a new one. The old truck had cost $26,000, and its accumulated depreciation amounted to $18,000. The list price of the new truck was $39,000, but Ramirez received a $10,000 trade-in allowance for the old truck and paid only $29,000 in cash. Ramirez includes trucks in its Vehicles account. Oct. 1 Ramirez traded in its old computer system as part of the purchase of a new system. The old system had cost $15,000, and its accumulated depreciation amounted to $11,000. The new computer's list price was $8,000. Ramirez accepted a trade-in allowance of $500 for the old computer system, paying $1,500 down in cash and issuing a one-year, 8 percent note payable for the $6,000 balance owed. a. Prepare journal entries to record each of the disposal transactions. Assume that depreciation expense on each asset has been recorded up to the date of disposal. Thus, you need not update the accumulated depreciation figures stated in the problem. (Omit the "$" sign in your response.) Date Feb. 10 General Journal Loss on disposal of plant assets Accumulated depreciation: Office equipment Office equipment Apr. 1 Cash Notes receivable Accumulated depreciation: Building Land Building Gain on sale of plant assets Aug. 15 Vehicles (new truck) Accumulated depreciation: Vehicles (old truck) Vehicles (old truck) Gain on disposal of plant assets Cash Oct. 1 Office equipment (new computer) Loss on trade-in of plant assets Accumulated depreciation: Office equip. (old computer) Office equipment (old computer) Cash
8,000 3,500 11,000 15,000 1,500 39,000 18,000 26,000 2,000 29,000 100,000 800,000 250,000 50,000 550,000 550,000

Debit
200 5% 25,800

Credit

26,000 5%

Notes payable

6,000

Explanation: a.

Sold land and building for a $100,000 cash down-payment and a 5-year, 9% note for the balance. Aug.15 To record trade-in of old truck on new; trade-in allowance exceeded book value by $2,000. Oct. 1 Acquired new computer system by trading in old computer, paying part cash, and issuing a 1year, 8% note payable. Recognized loss equal to book value of old computer ($4,000) minus trade-in allowance ($500). Apr. 1