Chap 006

Chapter 6
Inventories and Cost of Sales

QUESTIONS
1.
(a) FIFO: The first (earliest) items purchased in inventory are assumed to be the first
items sold. (b) LIFO: The last (most recent) items purchased in inventory are
assumed to be the first items sold.
2.
Merchandise inventory is disclosed on the balance sheet as a current asset. It is

also sometimes reported in the income statement as part of the calculation of cost
of goods sold.
3.
Incidental costs sometimes are ignored in computing the cost of inventory because
the expense of tracking such costs on a precise basis can outweigh the benefits
gained from the increased accuracy. The principle of materiality permits such
practices when the effects on the financial statements are not significant (that is,
when such practices do not impact business decisions).
4.
LIFO will result in the lower cost of goods sold when costs are declining.
5.
The full-disclosure principle requires that the nature of the accounting change, the
justification for the change, and the effect of the change on net income be disclosed
in the notes or in the body of a company's financial statements.
6.
No; changing the inventory method each period would violate the accounting
principle of consistency.
7.
No; the consistency principle does not preclude changes in accounting methods
from ever being made. Instead, a change from one acceptable method to another is
allowed if the company justifies the change as an improvement in financial
reporting.
8.
Many people make important business decisions based on period-to-period

fluctuations in a company's financial numbers, including gross profit and net
income. As such, inventory errorswhich can substantially impact gross profit, net
income, current assets, and cost of salesshould not be permitted to cause such
fluctuations and impair business decisions. (Note: Since such errors are selfcorrecting, they will distort net income in only two consecutive accounting periods
the period of the error and the next period.)
9.
An inventory error that causes an understatement (or overstatement) for net income
in one accounting period, if not corrected, will cause an overstatement (or
understatement) in the next. Since an understatement (overstatement) of one period
offsets the overstatement (understatement) in the next, such errors are said to
correct themselves.
Solutions Manual, Chapter 6
McGraw-Hill Companies, Inc., 2005

71
10. Market usually means replacement cost of inventory when applied in the LCM.
11. The principle of conservatism guides preparers of accounting reports to select the
less optimistic estimate in uncertain situations where two estimates of amounts are
about equally likely. Users of information must also be cognizant of the potential
conservatism in accounting reports when making business decisions.
12. Factors that contribute to inventory shrinkage are breakage, loss, deterioration,
decay, and theft.
13.A Accounts that are used only in a periodic inventory system include Purchases,
Purchase Discounts, Purchase Returns and Allowances, and Transportation-In.
14.B For interim reporting, companies can estimate costs of goods sold and ending
inventory by either the retail inventory method or the gross profit method.
15. Inventory as a percent of current assets on February 2, 2003 is ($ in thousands):
$24,365 / $141,128 = 17.3%.
16. Cost of goods available for sale equals ending inventory plus cost of sales. As of
December 28, 2002 this is computed as:
Ending Inventory of $6,777,152 + Cost of Sales of $111,187,357 = $117,964,509
17. Merchandise inventory comprises 10.6% ($218,156 / $2,066,586) of HarleyDavidsons current assets as of December 31, 2002, and 10.9% ($181,115 /
$1,665,264) of its current assets as of December 31, 2001. ($ in thousands)
QUICK STUDIES
Quick Study 6-1 (25 minutes)
(a) FIFO
Date
Goods Purchased
Cost of Goods Sold
Inventory Balance
12/ 7
10 @ $ 6 = $ 60
10 @ $ 6
= $ 60
12/14
20 @ $12 = $240
10 @ $ 6
20 @ $12
= $300
15 @ $12
= $180
15 @ $12
15 @ $14
= $390
12/15
12/21
10 @ $ 6 = $120
5 @ $12
15 @ $14 = $210
____
$120

72
Fundamental Accounting Principles, 17th Edition
Quick Study 6-1 (continued)

(b) LIFO
Date
Goods Purchased
Cost of Goods Sold
Inventory Balance
12/7
10 @ $ 6 = $ 60
10 @ $ 6
= $ 60
12/14
20 @ $12 = $240
10 @ $ 6
20 @ $12
= $300
10 @ $ 6
5 @ $12
= $120
10 @ $ 6
5 @ $12
15 @ $14
= $330
12/15
12/21
15 @ $12 = $180
15 @ $14 = $210
____
$180
(c) Weighted Average

Date
Goods Purchased
12/7
10 @ $6 = $60
12/14
20 @ $12 = $240
Cost of Goods Sold
12/15
12/21
Inventory Balance
10 @ $6
= $ 60
10 @ $6
20 @ $12
(avg cost is $10)
15 @ $10 =$150
15 @ $10
____
$150
15 @ $10
15 @ $14
(avg cost is $12)
15 @ $14 = $210
= $300
= $150
= $360
(d) Ending inventory under specific identification:

(2 units x $6) + (13 units x $12) + (15 units x $14) = $378.
Beginning inventory.....................................
Plus:
1st week purchase........................................
2nd week purchase.......................................
3rd week purchase.......................................
4th week purchase........................................
Units Available for sale.................................
Cost of Goods Available for Sale................
10 units @ $50
$ 500
10 units @ $51
10 units @ $52
10 units @ $55
10 units @ $60
50 units
510
520
550
600
$2,680

73

(a) FIFO
Date
1/1
1/9
1/25
Goods Purchased
Cost of Goods Sold
75 @ $3.20
100 @ $3.35
1/26
310 @ $3.00 = $ 930

35 @ $3.20 =
112
$1,042
Inventory Balance
310 @ $3.00
=
310 @ $3.00
=
75 @ $3.20
310 @ $3.00
75 @ $3.20
=
100 @ $3.35
40 @ $3.20
=
100 @ $3.35
$ 930
$1,170
$1,505
$ 463
(b) LIFO
Date
1/1
1/9
1/25
Goods Purchased
Cost of Goods Sold
75 @ $3.20
100 @ $3.35
1/26
100 @ $3.35 = $ 335

75 @ $3.20 =
240
170 @ $3.00 =
510
$1,085
Inventory Balance
310 @ $3.00
= $ 930
310 @ $3.00
= $1,170
75 @ $3.20
310 @ $3.00
75 @ $3.20
= $1,505
100 @ $3.35
140 @ $3.00
= $ 420
(c) Weighted Average

Date
1/1
1/9
1/25
Goods Purchased
Cost of Goods Sold
75 @ $3.20
100 @ $3.35
1/26

74
345 @ $3.10 = $1,070
Inventory Balance
310 @ $3.00
= $ 930
310 @ $3.00
75 @ $3.20
= $1,170
(avg. cost is $3.04)
310 @ $3.00
75 @ $3.20
= $1,505
100 @ $3.35
140 @ $3.10
= $ 434
Quick Study 6-3 (continued)

Alternate solution format:
(a) FIFO:
100 @ $3.35 =
40 @ $3.20 =
140
$ 335
128
$ 463 Ending inventory cost
(b) LIFO:
140 @ $3.00 =
(c) Weighted average:

310 @ $3.00 =
75 @ $3.20 =
100 @ $3.35 =
485
$ 930
240
335
$1,505 Cost of goods available for sale
$1,505/485 = $3.10 weighted average cost per unit

140 units @ $3.10 =

1.
2.
3.
4.
5.
Specific identification
LIFO
LIFO
LIFO
FIFO

1. The title will pass at destination which is China Companys receiving
dock. Jolie should show the $850 in its inventory at year-end as Jolie
retains title until the goods reach China Company.
2. The consignor is Jolie Company. The consignee is China Company. The
consignor, Jolie Company, should include any unsold and consigned
goods in its inventory.

75

Units in ending inventory
Units stored in basement............................
Less damaged (unsalable) units.................
Plus units in transit......................................
Plus units on consignment.........................
Total units in ending inventory...................
1,500 units
(30)
250
70
1,790 units

Cost..............................................................
Plus
Transportation-in.....................................
Import duties............................................
Insurance..................................................
Inventory Cost..........................................
$3,000
150
200
50
$3,400
The $25 advertising cost and the $250 cost for sales staff salaries are
included in operating expensesnot part of inventory costs. Those two
costs are not necessary to get the vehicle in a place and condition for sale.

Cost of inventory (estates contents)
Price............................................................. $37,500
Transportation-in........................................
1,200
Insurance on shipment..............................
150
Cleaning and refurbishing.........................
490
Total cost of inventory............................... $39,340

Per Unit
Total
Inventory Items Units Cost Market
Cost
Mountain bikes
9 $360
$330 $ 3,240
Skateboards
12
210
270
2,520
Gliders
25
480
420 12,000
$17,760
Total
Market
$ 2,970
3,240
10,500
$16,710
LCM applied to:

Items
Whole
$ 2,970
2,520
10,500
______
$15,990
$16,710
a. LCM for inventory as a whole...................................................

76
$16,710
b. LCM applied to each product ...................................................
$15,990

77

a.
b.
c.
d.
e.
Overstates 2005 cost of goods sold.

Understates 2005 gross profit.
Understates 2005 net income.
Overstates 2006 net income.
The understated 2005 net income and the overstated 2006 net income
combine to yield a correct total income for the two-year period.
f. The 2005 error will not affect years after 2006.
Inventory turnover
= Cost of goods sold/Average merchandise inventory

= $1,600,000 / [($200,000 + $230,000)/2 ] = 7.44 times
Days sales in inventory = Ending Inventory/Costs of goods sold x 365

= ($230,000 / $1,600,000) x 365 = 52.47 days
Quick Study 6-12A (15 minutes)

Ending
Inventory
a. FIFO
(15 x $12) + (15 X $14)...................................
(10 x $6) + (5 x $12).........................................
$390
b. LIFO
(10 x $6) + (20 x $12).......................................
(15 x $14) ........................................................
$300
c. Weighted Average ($510/ 45 = $11.33 cost per unit)

(30 x $11.33)...................................................
(15 x $11.33)...................................................
$340
d. Specific Identification
(2 x $6) + (13 x $12) + (15 x $14)....................
(8 x $6) + (7 x $12)...........................................
$378

78
Cost of
Goods Sold
$120
$210
$170
$132
Quick Study 6-13A (15 minutes)

Ending
Inventory
a. FIFO
(40 x $3.20) + (100 X $3.35)..............................
(310 x $3.00) + (35 x $3.20)...............................
$463
b. LIFO
(140 x $3.00).......................................................
(100 x $3.35) + (75 x $3.20) + (170 x $3.00).....
$420
Cost of
Goods Sold
$1,042
$1,085
c. Weighted Average ($1,505/ 485 = $3.10* cost per unit)

(140 x $3.10)...................................................... $434
(345 x $3.10)......................................................
$1,071*
*rounded
Quick Study 6-14B (15 minutes)

Goods available for sale
Inventory, January 1.......................................................................
$180,000
Cost of goods purchased (net).....................................................
342,000
Goods available for sale (at cost).................................................
522,000
Net sales at retail.............................................................................. $675,000
Estimated cost of goods sold [$675,000 x (1 - 42%)]..........................
(391,500)
Estimated September 5 inventory destroyed................................
$130,500

79
EXERCISES
Exercise 6-1 (30 minutes)
a. Specific identification
Ending inventory: 400 units from July 28 plus 100 units from
December 19.
Computations:
Ending
Inventory
(400 x $5.00) + (100 x $4.10)..........................
$2,410
Cost of
Goods Sold
$6,380 - $2,410 ...............................................
$3,970
b. Weighted average perpetual

Date
Goods Purchased
Cost of Goods Sold
Inventory Balance
1/1
1/10
3/7
70 @ $ 6.00 = $ 420
200 @ $5.50
3/15
120 @ $6.00
= $ 720
50 @ $6.00
= $ 300
50 @ $6.00
200 @ $5.50
125 @ $5.60 = $ 700
125 @ $5.60
7/28
500 @ $5.00
125 @ $5.60
500 @ $5.00
10/3
375 @ $4.40
125 @ $5.60
500 @ $5.00
375 @ $4.40
10/5
12/19
600 @ $4.85 = $2,910

100 @ $4.10
_____
$4,030

80
400 @ $4.85
400 @ $4.85
100 @ $4.10
= $1,400
= $ 700
= $3,200
= $4,850
= $1,940
= $2,350
Exercise 6-1 (Continued)

c. FIFO Perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
1/10
3/7
70 @ $6.00
= $ 420
200 @ $5.50
3/15
50 @ $6.00
75 @ $5.50
= $ 712*
Inventory Balance
120 @ $6.00
= $ 720
50 @ $6.00
= $ 300
50 @ $6.00
200 @ $5.50
= $1,400
125 @ $5.50
= $ 688*
7/28
500 @ $5.00
125 @ $5.50
500 @ $5.00
= $3,188
10/3
375 @ $4.40
125 @ $5.50
500 @ $5.00
375 @ $4.40
= $4,838
10/5
12/19
125 @ $5.50
475 @ $5.00
= $3,063*
100 @ $4.10
_____
$4.195
25 @ $5.00
375 @ $4.40
25 @ $5.00
375 @ $4.40
100 @ $4.10
= $1,775
= $2,185
* rounded to the nearest dollar

81

d. LIFO Perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
1/10
3/7
70 @ $6.00
10/3
125 @ $5.50
=$
687*
500 @ $5.00
375 @ $4.40
10/5
12/19
420
200 @ $5.50
3/15
7/28
=$
375 @ $4.40 = $ 2,775

225 @ $5.00
100 @ $4.10
______
$ 3,882
Inventory Balance
120 @ $6.00
= $ 720
50 @ $6.00
= $ 300
50 @ $6.00
200 @ $5.50
= $1,400
50 @ $6.00
75 @ $5.50
= $ 713*
50 @ $6.00
75 @ $5.50
500 @ $5.00
= $3,213*
50 @ $6.00
75 @ $5.50
500 @ $5.00
375 @ $4.40
= $4,863*
50 @ $6.00
75 @ $5.50
275 @ $5.00
= $2,088*
50 @ $6.00
75 @ $5.50
275 @ $5.00
100 @ $4.10
$2,498
* rounded to the nearest dollar

82

Alternate Solution Format for FIFO and LIFO Perpetual:
Ending
Computations:
Inventory
c. FIFO
(100 x $4.10) + (375 x $4.40)+(25 x $5.00).......................
$2,185
(70 x $6.00) + (50 X $6.00) + (75 x $5.50) +
(125 x $5.50)+ (475 x $5.00)........................................
d. LIFO:
(50 x $6.00) + (75 x $5.50) + (275 x $5.00) +
(100 x $4.10).................................................................
Cost of
Goods Sold
$4,195
$2,498
(70 x $6.00) + (125 x $5.50) + (375 x $4.40) +

(225 x $5.00).................................................................
$3,882

LAKIA CORPORATION
Income Statements
For Year ended December 31, 2005
Specific
Identification
Sales......................................$11,925
Weighted
Average
FIFO
LIFO
$11,925
$11,925
$11,925
4,030
7,895
1,250
6,645
1,994*
$ 4,651
4,195
7,730
1,250
6,480
1,944
$ 4,536
3,882
8,043
1,250
6,793
2,038*
$ 4,755
(795 units x $15 price)
Cost of goods sold...............

Gross profit...........................
Expenses...............................
Income before taxes.............
3,940
7,985
1,250
6,735
Income tax expense (30%)......... 2,021*
Net income............................$ 4,714
* Rounded to the nearest dollar.
1. LIFO method results in the highest net income of $4,755.

2. Weighted average net income of $4,651 falls between the FIFO net
income ($4,536) and the LIFO net income ($4,755).
3. If costs were rising instead of declining, then the FIFO method would
yield the highest net income.

83

a. FIFO Perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
100 @ $10
1/10
3/14
90 @ $10 = $ 900
250 @ $15 = $ 3,750
3/15
7/30
10 @ $10
130 @ $15 = $2,050
400 @ $20 = $ 8,000
10/5
10/26
Inventory Balance
120 @ $15
180 @ $20 = $5,400
600 @ $25 = $15,000
_____
$8,350
10 @ $10
= $ 1,000
=$
100
10 @ $10
250 @ $15
= $ 3,850
120 @ $15
= $ 1,800
120 @ $15
400 @ $20
= $ 9,800
220 @ $20
= $ 4,400
220 @ $20
600 @ $25
= $19,400
b. LIFO Perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
100 @ $10
1/10
3/14
90 @ $10 = $ 900
250 @ $15 = $ 3,750
3/15
140 @ $15 = $2,100
7/30
400 @ $20 = $ 8,000
10/5
300 @ $20 = $6,000
10/26
Inventory Balance
600 @ $25 = $15,000

_____
$9,000

84
10 @ $10
= $ 1,000
= $
100
10 @ $10
250 @ $15
= $ 3,850
10 @ $10
110 @ $15
= $ 1,750
10 @ $10
110 @ $15
400 @ $20
= $ 9,750
10 @ $10
110 @ $15
100 @ $20
= $ 3,750
10 @ $10
110 @ $15
100 @ $20
600 @ $25
= $ 18,750
Exercise 6-3 (Concluded)

Alternate Solution Format
Ending
Inventory
a. FIFO:
(600 x $25) + (220 x $20)................................................
(90 x $10) + (10 x $10) + (130 x $15) +
(120 x $15)+ (180 x $20)..................................................
b. LIFO:
(10 x $10) + (110 x $15) + (100 x $20) + (600 x $25).....
(90 x $10) + (140 x $15) + (300 x $20)............................
Cost of
Goods Sold
$19,400
$8,350
$18,750
$9,000
FIFO Gross Margin

Sales revenue (530 units sold x $40 selling price).................
Less: FIFO cost of goods sold................................................
Gross margin.............................................................................
$21,200
8,350
$12,850
LIFO Gross Margin

Sales revenue (530 units sold x $40 selling price).................
Less: LIFO cost of goods sold................................................
Gross margin.............................................................................
$21,200
9,000
$12,200

a. Specific identification methodCost of goods sold
Cost of goods available for sale.............................................
Ending inventory under specific identification
3/14 purchase (200 @ $15) ...............................................
$ 3,000
7/30 purchase ( 20 @ $20)................................................ 400
10/26 purchase (600 @ $25)................................................
15,000
Total ending inventory under specific identification..........
Cost of goods sold under specific identification................
$27,750
18,400
$ 9,350
b. Specific identification methodGross margin

Sales revenue (530 units sold x $40 selling price)................
Less: Specific identification cost of goods sold..................
Gross margin............................................................................
$21,200
9,350
$11,850

85

Inventory Items
Unit
Helmets........... 22
Bats.................. 15
Shoes............... 36
Uniforms.......... 40
Per Unit
Cost Market
$50
78
95
36
$54
72
91
36
Total
Cost
$1,100
1,170
3,420
1,440
$7,130
Total
Market
$1,188
1,080
3,276
1,440
$6,984
LCM applied to:

Products
Whole
$1,100
1,080
3,276
1,440
$6,896
a.
Lower of cost or market of inventory as a whole = $6,984
b.
Lower of cost or market of inventory by product = $6,896
$6,984

1. Gross profit = $900,000 - $500,000 = $400,000 (for each year)
2.
Year 2004
$900,000
Year 2005
$900,000
Year 2006
$900,000
Sales..............................
Cost of goods sold
Beginning inventory..... $200,000
$180,000
$200,000
Cost of purchases........ 500,000
500,000
500,000
Good available for sale..... 700,000
680,000
700,000
Ending inventory.......... 180,000
200,000
200,000
Cost of goods sold.......
520,000
480,000
500,000
Gross profit....................
$380,000
$420,000
$400,000

2004 Inventory turnover
2004 Days' Sales in Inventory
$426,650/[($91,500 + $86,750)/2]
= 4.8 times
$86,750/$426,650 x 365 days = 74.2 days
2005 Inventory turnover
2005 Days' Sales in Inventory
$643,825/[($86,750 + $96,400)/2]
= 7.0 times
$96,400/$643,825 x 365 days = 54.7 days

86
Analysis comment: It appears that during a period of increasing sales, Ryder

has been efficient in controlling its amount of inventory. Specifically inventory
turnover increased by 2.2 times (7.0 - 4.8) from 2004 to 2005. In addition, days'
sales in inventory decreased by 19.5 days (74.2 - 54.7).

87

1. a. LIFO ratio computations
LIFO current ratio (2005) = $210/$190 = 1.1
LIFO inventory turnover (2005) = $730/ [($150+$100)/2] = 5.8
LIFO days sales in inventory (2005) = ($150/$730) x 365 = 75 days
b. FIFO ratio computations
FIFO current ratio (2005) = $280/$190 = 1.5
FIFO inventory turnover (2005) = $685/ [($220+$125)/2] = 4.0
FIFO days sales in inventory (2005) = ($220/$685) x 365 = 117.2 days
2. The use of LIFO versus FIFO for Checkers markedly impacts the ratios
computed. Specifically, LIFO makes Checkers appear worse in
comparison to FIFO numbers on the current ratio (1.1 vs. 1.5) but better
on inventory turnover (5.8 vs. 4.0) and days sales in inventory (75 vs.
117.2). These results can be generalized. That is, when costs are rising
and quantities are stable or rising, the FIFO inventory exceeds LIFO
inventory. This suggests that (relative to FIFO) the LIFO current ratio is
understated, the LIFO inventory turnover is overstated, and the days
sales in inventory is understated. Overall, users prefer the FIFO
numbers for these ratios because they are considered more
representative of current replacement costs for inventory.

88
Exercise 6-9A (20 minutes)

Cost of goods available for sale
= (120 x $6.00) + (200 x $5.50) + (500 x $5.00)

+ (375 x $4.40) + (100 x $4.10)
= $6,380
Ending
Inventory
Cost of
Goods Sold
a. Specific Identification
(400 x $5.00) + (100 x $4.10)...................................... $2,410
$6,380 - $2,410 ..........................................................
$3,970
b. Weighted Average
($6,380 / 1295 units = $4.927* average cost per unit)
500 x $4.927................................................................ $2,463*

795 x $4.927................................................................
$3,917*
c. FIFO
(100 x $4.10) + (375 x $4.40 )+ (25 x $5.00).............. $2,185
(70 x $6.00) + (50 x $6.00) + (75 x $5.50) +
(125 x $5.50)+ (475 x $5.00).....................................
$4,195
d. LIFO
(120 x $6.00) + (200 x $5.50) + (180 x $5.00)............ $2,720
(100 x $4.10) +(375 x $4.40) + (125 x $5.00) +
(125 x $5.00) + (70 x $5.00).....................................
$3,660
*rounded

89

Cost of goods available for sale = (100 x $10) + (250 x $15) + (400 x $20)
+ (600 x $25)
= $27,750
Ending
Cost of
Inventory Goods Sold
a. FIFO
(600 x $25) + (220 x $20)............................................ $19,400
(90 x $10) + (10 x $10) + (130 x $15) +
(120 x $15)+ (180 x $20)...........................................
$8,350
b. LIFO
(100 x $10) + (250 x $15) + (400 x $20) + (70 x $25).... $14,500
530 x $25....................................................................
$13,250
c.
FIFO Gross Margin
Sales revenue (530 units sold x $40 selling price)................. $21,200
Less: FIFO cost of goods sold................................................
8,350
Gross margin............................................................................. $12,850
LIFO Gross Margin
Sales revenue (530 units sold x $40 selling price)................. $21,200
Less: LIFO cost of goods sold................................................ 13,250
Gross margin............................................................................. $ 7,950

90

Ending
Inventory
(100 x $2.90) + (100 x$2.80) + (100 x $2.50)........
$7,706 - $820..........................................................
b. Weighted average ($7,706/3,000 = $2.57*)
$2.57 x 300.............................................................
$7,706 - $771..........................................................
c. FIFO
(300 x $2.90) ..........................................................
(200 x $2.00) + (440 x $2.25) + (1,080 x $2.50) +
(960 x $2.80) + (20 x 2.90)...............................
d. LIFO
(200 x $2.00) + (100 x $2.25).................................
(320 x $2.90) + (960 x $2.80) + (1,080 x $2.50) +
(340 x $2.25)......................................................
Cost of
Goods Sold
$820
$6,886
771
6,935
870
6,836
625
7,081
*rounded
Income effect: FIFO provides the lowest cost of goods sold, the highest
gross profit, and the highest net income.
Ending
Inventory
(100 x $2.00) + (100 x $2.30) + (100 x $2.50).......
$7,550 - $680..........................................................
b. Weighted average ($7,550/3,030 = $2.49*)
$2.49 x 300.............................................................
$7,550 - $747..........................................................
c. FIFO
(250 x $2.00) + (50 x $2.30)...................................
(280 x $3.00) + (600 x $2.80) + (800 x $2.50) +
(1,050 x $2.30)..................................................
d. LIFO
(280 x $3.00) + (20 x $2.80)...................................
(250 x $2.00) + (1,100 x $2.30) + (800 x $2.50) +
(580 x $2.80).....................................................
Cost of
Goods Sold
$680
$6,870
747
6,803
615
6,935
896
6,654
*rounded
Income effect: FIFO provides the highest cost of goods sold, the lowest
gross profit, and the lowest net income.

91
Exercise 6-13B (20 minutes)

At Cost
At Retail

Beginning inventory................................................... $31,900
Cost of goods purchased........................................... 57,810
Goods available for sale............................................. $89,710
Deduct net sales at retail...............................................
Ending inventory at retail..............................................
$ 64,200
98,400
162,600
130,000
$ 32,600
Cost ratio: ($89,710/$162,600) = 0.55...............................

Ending inventory at cost ($32,600 x 55%)................... $17,930
Exercise 6-14B (20 minutes)

Inventory, January 1......................................................
$ 450,000
*
Net cost of goods purchased ......................................1,604,500
Goods available for sale...............................................2,054,500
Less estimated cost of goods sold
Net sales.........................................................................
$2,000,000
Estimated cost of goods sold
[$2,000,000 x (1 30%)]............................................
(1,400,000)
Estimated March 31 inventory.........................................
$ 654,500
*
$1,590,000 - $23,100 + $37,600 = $1,604,500

92
PROBLEM SET A
Problem 6-1A (40 minutes)
1. Calculate cost of goods available for sale and units available for sale
Beginning inventory............................ 600 units @ $44
Feb. 10
200 units @ $40
Mar. 13.................................................. 100 units @ $20
Aug. 21.................................................. 160 units @ $60
Sept. 5.................................................. 280 units @ $48
Units available......................................1,340 units
$26,400
8,000
2,000
9,600
13,440
$59,440
2. Units in ending inventory

Units available (from part 1)............................
1,340
Less: Units sold (400+200)..............................
600
Ending Inventory (units)..................................
740

93
Problem 6-1A (Continued)

3a. FIFO perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
2/10
3/13
200 @ $40 = $ 8,000

100 @ $20 = $ 2,000
9/5
600 @ $44
= $26,400
600 @ $44
200 @ $40
= $34,400
600 @ $44
200 @ $40
100 @ $20
3/15
8/21
Inventory Balance
400 @ $44 = $17,600
160 @ $60 = $ 9,600
200 @ $44
200 @ $40
100 @ $20
200 @ $44
200 @ $40
100 @ $20
160 @ $60
280 @ $48 = $13,440
200 @ $44
200 @ $40
100 @ $20
160 @ $60
280 @ $48
9/10
200 @ $44 = $ 8,800

______
$26,400
FIFO Alternate Solution Format

Less: Cost of sales
400 @ $44
$17,600
200 @ $44
8,800
Total cost of goods sold

Ending Inventory
200 @ $40
100 @ $20
160 @ $60
280 @ $48
= $36,400
= $18,800
= $28,400
= $41,840
= $33,040
$59,440
26,400
$33,040
Proof of Ending Inventory

200
100
160
280
Ending Inventory................. 740

94
@ $40
@ 20
@ 60
@ 48
units
$ 8,000
2,000
9,600
13,440
$33,040

3b. LIFO perpetual
Date
Goods Purchased
Cost of Goods Sold
Inventory Balance
1/1
2/10
3/13
200 @ $40 = $ 8,000

100 @ $20 = $ 2,000
3/15
8/21
9/5
100 @ $20
200 @ $40
100 @ $44
280 @ $48 = $13,440
200 @ $48
= $26,400
600 @ $44
200 @ $40
= $34,400
600 @ $44
200 @ $40
100 @ $20
= $36,400
500 @ $44
= $22,000
500 @ $44
160 @ $60
= $31,600
= $14,400
160 @ $60 = $ 9,600
9/10
600 @ $44
= $ 9,600
______
$24,000
500 @ $44
160 @ $60
280 @ $48
= $45,040
500 @ $44
160 @ $60
80 @ $48
= $35,440
LIFO alternate solution format

Less: Cost of sales
100 @ $20
200 @ 40
100 @ 44
200 @ 48
Cost of Goods Sold
Ending Inventory
$59,440
$ 2,000
8,000
4,400
9,600
24,000
$35,440
Ending Inventory
500 @ $44
160 @ 60
80 @ 48
740 units
$22,000
9,600
3,840
$35,440

95

3c. Specific Identification
Cost of goods available for sale..............

Less: Cost of Goods Sold
500 @ $44..................................... $22,000
100 @ $20..................................... 2,000
Total cost of goods sold...........................
Ending Inventory.......................................
$59,440
24,000
$35.440
Ending Inventory.
100 @ $44
200 @
40
160 @
60
280 @
48
740 units
$ 4,400
8,000
9,600
13,440
$35,440
3d. Weighted Average

Date
Goods Purchased
Cost of Goods Sold
1/1
Inventory Balance
600 @ $44.00
= $26,400
2/10
200 @ $40 = $ 8,000
600 @ $44.00
= $34,400
200 @ $40.00
3/13
100 @ $20 = $ 2,000
600 @ $44.00
200 @ $40.00
= $36,400
100 @ $20.00
(avg. cost is $40.44*)
3/15
400 @ $40.44 = $16,176
500 @ $40.44
= $20,220
8/21
160 @ $60 = $ 9,600
500 @ $40.44
= $29,820
160 @ $60.00
9/5
280 @ $48 = $13,440
660 @ $45.18
280 @ $48.00
= $43,259**
9/10
200 @ $46.02 = $ 9,204

$25,380
740 @ $46.02
= $34,055***
* rounded to nearest cent

** rounded to nearest dollar
*** Total cost of goods sold plus ending inventory = $25,380 + $34,055 = $59,435 (the $5
difference from cost of goods available for sale of $59,440 is due to rounding)
96
Problem 6-1A (Concluded)

4.
FIFO
Sales (600 x $75)..................... $45,000

Less: Cost of goods sold....... 26,400
Gross profit............................. $18,600
LIFO
Specific
Identification
Weighted
Average
$45,000
24,000
$21,000
$45,000
24,000
$21,000
$45,000
25,380
$19,620
5. Parkers manager would likely prefer the LIFO method or the Specific
Identification method since these methods gross profit is the largest at
$21,000. This would give the manager his/her highest bonus based on
gross profit. It is only by coincidence that the LIFO and Specific
Identification method have the same cost of goods sold and gross
profit. This would not necessarily be the case.

97

Part 1
(a)
Cost of goods sold:
Reported
Adjustments: 12/31/2004 error.......
2004
$ 715,000
- 66,000
12/31/2005 error.......
Corrected.....................................
$ 649,000
(b)
Net income:
Reported.......................................
2004
$ 220,000
+ 66,000
12/31/2005 error.......
Corrected.....................................
$ 286,000
(c)
Total current assets:
Reported.......................................
2004
$1,155,000
+ 66,000
12/31/2005 error.......
Corrected.....................................
(d)
Equity:
Reported
12/31/2005 error.......
Corrected.....................................
$1,221,000
2004
$1,287,000
+ 66,000
_________
$1,353,000
2005
$ 847,000
+ 66,000
+ 30,000
$ 943,000
2006
$ 770,000
2005
$ 275,000
- 66,000
- 30,000
$ 179,000
2006
$ 231,000
2005
$1,265,000
2006
$1,100,000
- 30,000
$1,235,000
$1,100,000
2005
$1,430,000
2006
$1,232,000
- 30,000
$1,400,000
$1,232,000
- 30,000
$ 740,000
+ 30,000
$ 261,000
Part 2
Total net income for the combined three-year period is not affected by the
errors. This is because these errors are "self-correcting"that is, each
overstatement (or understatement) of net income is offset by a matching
understatement (or overstatement) in the following year.
Part 3
The understatement of inventory by $66,000 results in an overstatement of cost of
goods sold by that same amount. The $66,000 overstatement of cost of goods
sold results in an understatement of gross profit by the same amount. This
understatement of gross profit carries through to an understatement of net

98
income. Since the understated net income is closed to equity, the final equity
figure is understated by the amount of the inventory understatement.

99

Inventory Items
Unit
s
Audio equipment
Receivers...............335
CD players.............250
DVD players...........316
Speakers................194
Subtotal.................
Video equipment
Televisions.............470
VCRs.....................281
Video cameras.......202
Subtotal.................
Per Unit
Cost Market
Total
Cost
$ 90
111
86
52
$ 98 $ 30,150
100
27,750
95
27,176
41
10,088
95,164
150
93
310
125
84
322
70,500
26,133
62,620
159,253
Total
Market
LCM applied to:

Items
Categorie
Whole
s
$ 32,830 $ 30,150
25,000
25,000
30,020
27,176
7,954
7,954
95,804
$ 95,164
58,750
23,604
65,044
147,398
58,750
23,604
62,620
147,398
Car audio equipment

DVD radios.............175
CD radios...............160
70
97
Subtotal.................
Total........................
84
105
12,250
14,700
12,250
15,520
16,800
15,520
27,770
31,500 _______
27,770
$282,187 $274,702 $263,024 $270,332 $274,702
a. Lower of cost or market for the inventory as a whole
= $274,702
b. Lower of cost or market for the inventory by major category =

$95,164 + $147,398 + $27,770 = $270,332
c. Lower of cost or market for inventory applied separately

100
= $263,024
Problem 6-4AA (25 minutes)

Part 1
Number and total cost of units available for sale:
20,000 units in beginning inventory @ $15........................... $ 300,000
28,000 units purchased @ $18................................................
504,000
30,000 units purchased @ $22................................................
660,000
20,000 units purchased @ $24................................................
480,000
33,000 units purchased @ $27................................................
891,000
131,000 units available for sale ............................................... $2,835,000
Part 2
a. FIFO periodic
Total cost of 131,000 units available for sale........................
Less ending inventory on a FIFO basis
33,000 units @ $27................................................................
$891,000
2,000 units @ $24................................................................
48,000
Cost of units sold.....................................................................
$2,835,000
939,000
$1,896,000
b. LIFO periodic
Less ending inventory on a LIFO basis
20,000 beginning inventory units @ $15.............................
$300,000
15,000 units @ $18................................................................
270,000
$2,835,000
570,000
$2,265,000
c. Weighted average periodic

Less ending inventory at weighted average
($2,835,000/131,000) x 35,000..............................................
*
$2,835,000
757,443
$2,077,557
Amount can slightly vary due to differences in rounding.

101
*
*

Part 1
TRUE BLUE CORP.
Income Statements Comparing FIFO, LIFO, and Weighted Average
For Year Ended December 31, 2005
LIFO
Weighted
Average
Sales
$247,500
Cost of goods sold
Inventory, Dec. 31, 2004.............................. 10,800
Cost of purchases....................................... 123,500
Cost of goods available for sale................ 134,300
Inventory, Dec. 31, 2005................................ 22,000
Cost of goods sold...................................... 112,300
Gross profit.................................................... 135,200
$247,500
$247,500
10,800
123,500
134,300
18,400
115,900
131,600
10,800
123,500
134,300
20,662 *
113,638 *
133,862 *
Expenses........................................................ 33,000
Income before taxes...................................... 102,200
Income taxes expense.................................. 30,660
Net income.....................................................$ 71,540
33,000
98,600
29,580
$ 69,020
33,000
100,862 *
30,259 *
$ 70,603 *
FIFO
$ 10,800
LIFO
$ 10,800
Weighted
Average
$ 10,800
123,500
123,500
123,500
FIFO
*Amounts can slightly vary due to differences in rounding.
Supporting calculations:
Dec. 31, 2004, inventory (600 x $18)...................
Purchases
1,500 x $19 = $28,500
700 x $20 = 14,000
400 x $21 = 8,400
3,300 x $22 = 72,600
Dec. 31, 2005, inventory (6,500 - 5,500 = 1,000 units)

FIFO: 1,000 x $22 = $22,000
LIFO:
600 x $18 = $10,800
400 x $19 = $ 7,600
W.A.:
($134,300/6,500) x 1,000
22,000
18,400
20,662*

102
Problem 6-5AA (Concluded)

Part 2
If True Blue, Corp. had been experiencing declining costs in the acquisition
of inventory, we would observe the opposite results in our comparisons.
Specifically, LIFO would have resulted in a higher ending inventory, lower
cost of goods sold, higher gross profit, and higher net income. FIFO would
have resulted in a lower ending inventory, higher cost of goods sold, lower
gross profit, and lower net income.
Part 3
Advantages:
LIFO: Given the cost trends in the problem, the advantage of using LIFO is
that the lower net income will result in a lower tax obligation (tax deferral).
Also, LIFO is likely to better match current costs against revenues.
FIFO: The advantage of using FIFO is that the inventory figure reported on
the balance sheet is likely similar to the current replacement cost.
Disadvantages:
LIFO: Given the cost trends in the problem, the disadvantage of using LIFO
is that the inventory figure, which is also reported on the income
statement, will likely be understated in comparison to the current
replacement costs.
FIFO: The disadvantage of using FIFO is that it will produce a greater tax
obligation for the current period as a result of a higher reported net
income.

103

Part 1
NILSON COMPANY
Estimated Inventory
December 31
Beginning inventory............................................
Cost of goods purchased...................................
Goods available for sale.....................................
At Cost
At Retail
$ 471,350
3,276,030
$3,747,380
$ 927,150
6,279,350
$7,206,500
Sales.......................................................................
Less: Sales returns...............................................
Net sales.................................................................
$5,495,700
(44,600)
$5,451,100
Ending inventory at retail ($7,206,500 - $5,451,100)
$1,755,400
Cost-to-retail ratio: $3,747,380/$7,206,500 = 0.52 or 52%

Ending inventory at cost ($1,755,400 x 52%).................
$ 912,808
Part 2
NILSON COMPANY
Inventory Shortage
December 31
At Cost
Estimated inventory (from part 1).............................
$ 912,808
Physical inventory:.................................................... 871,416 *
Inventory shortage.....................................................
$ 41,392
At Retail
$ 1,755,400
1,675,800
$
79,600
* $871,416 = $1,675,800 (given) x 52% (from part 1).

104
Problem 6-7AB (25 minutes)

WAYMAN COMPANY
Estimated Inventory at March 31
Inventory, January 1..............................................$ 300,260
Cost of goods purchased...................................... 939,050
Goods available for sale........................................ 1,239,310
Sales........................................................................
Less sales returns.................................................
Net sales.................................................................
[$1,181,700 x (1 35%)].................................... (768,105)
Estimated March 31 inventory.................................$ 471,205
$1,191,150
(9,450)
$1,181.700

105
PROBLEM SET B
Problem 6-1B (40 minutes)
1. Calculate cost of goods available for sale and units available for sale:
Beginning inventory............................ 600 units @ $55 =
Jan. 10................................................... 450 units @ $56 =
Feb. 13................................................... 200 units @ $57 =
July 21................................................... 230 units @ $58 =
Aug. 5................................................... 345 units @ $59 =
Units available......................................1,825 units
Cost of goods available for sale.........
$ 33,000
25,200
11,400
13,340
20,355
$103,295
2. Units in ending inventory:

Units available (from part 1)....................
1,825
Less: Units sold (given)...........................
765
Ending Inventory......................................
1,060

106
Problem 6-1B (Continued)

3a. FIFO perpetual
Date
Goods Purchased
Cost of Goods Sold
Inventory Balance
1/1
600 @ $55
= $33,000
1/10
450 @ $56 = $25,200
600 @ $55
450 @ $56
2/13
200 @ $57 = $11,400
600 @ $55
450 @ $56
200 @ $57
= $69,600
170 @ $55
450 @ $56
200 @ $57
= $45,950
2/15
7/21
8/5
430 @ $55 = $23,650
230 @ $58 = $13,340
170 @ $55
450 @ $56
200 @ $57
230 @ $58
345 @ $59 = $20,355
170 @ $55
450 @ $56
200 @ $57
230 @ $58
345 @ $59
8/10
170 @ $55
165 @ $56 = $18,590
285 @ $56
200 @ $57
230 @ $58
345 @ $59
______
$42,240
= $58,200
= $59,290
= $79,645
= $61,055
Alternate FIFO solution format

Cost of goods available for sale........................
430 @ $55...........................................................
$23,650
170 @ 55...........................................................
9,350
165 @ 56...........................................................
9,240
765
Total cost of goods sold.....................................
Ending Inventory.................................................
$103,295
42,240
$ 61,055
Ending Inventory
285 @ $56
200 @ 57
230 @ 58
345 @ 59
1,060 units
$ 15,960
11,400
13,340
20,355
$ 61,055
107

3b. LIFO perpetual
Date
Goods Purchased
Cost of Goods Sold
1/1
Inventory Balance
600 @ $55
1/10
450 @ $56 = $25,200
600 @ $55
450 @ $56
2/13
200 @ $57 = $11,400
600 @ $55
450 @ $56
200 @ $57
2/15
7/21
8/5
200 @ $57
230 @ $56 = $24,280
230 @ $58 = $13,340
600 @ $55
220 @ $56
230 @ $58
345 @ $59 = $20,355
8/10
600 @ $55
220 @ $56
600 @ $55
220 @ $56
230 @ $58
345 @ $59
335 @ $59 = $19,765
______
$44,045
600 @ $55
220 @ $56
230 @ $58
10 @ $59
= $33,000
= $58,200
= $69,600
= $45,320
= $58,660
= $79,015
= $59,250
Alternate LIFO solution format

Cost of goods available for sale........................
200 @ $57...........................................................
$11,400
230 @ 56...........................................................
12,880
335 @ 59...........................................................
19,765
765
Cost of Goods Sold............................................
Ending Inventory.................................................
$103,295
44,045
$ 59,250
Ending inventory...

108
600 @ $55
220 @ 56
230 @ 58
10 @ 59
1,060 units
$ 33,000
12,320
13,340
590
$ 59,250

3c. Specific Identification
Cost of goods available for sale........
600 @ $55.............................................
$33,000
165 @ $57.............................................
9,405
765 ........................................................
Cost of Goods Sold.............................
Ending inventory.................................
$103,295
42,405
$ 60,890

450 @ $56
35 @ 57
230 @ 58
345 @ 59
Ending inventory................. 1,060 Units
$25,200
1,995
13,340
20,355
$60,890
3d. Weighted Average

Date
Goods Purchased
Cost of Goods Sold
1/1
Inventory Balance
600 @ $55.00
= $33,000
1/10
450 @ $56 = $25,200
600 @ $55.00
= $58,200
450 @ $56.00
2/13
200 @ $57 = $11,400
600 @ $55.00
450 @ $56.00
= $69,600
200 @ $57.00
2/15
430@ $55.68 = $23,942**
820 @ $55.68
= $45,658**
7/21
230 @ $58 = $13,340
820 @ $55.68
= $58,998**
230 @ $58.00
8/5
345 @ $59 = $20,355
820 @ $55.68
230 @ $58.00
= $79,353**
345 @ $59.00
8/10
335@ $56.88 = $19,055**

$42,997
1,060@ $56.88
= $60,293**
* rounded to nearest cent

** rounded to nearest dollar

109
Note: Total cost of goods sold plus ending inventory = $42,997 + $60,293 = $103,290. The
$5 difference from the cost of goods available for sale of $103,295 is due to rounding.

110
Problem 6-1B (Concluded)

4.
FIFO
Specific
Identification
LIFO
$68,850 $68,850
Sales (765 x $90)..........................
Less: Cost of goods sold............ 42,240 44,045
Gross profit...................................
$26,610 $24,805
Weighted
Average
$68,850
$68,850
42,405
$26,445
42,997
$25,853
5. The manager of Venus Company likely will prefer the FIFO method
because it would yield the largest gross profit. This would give the
manager his/her highest bonus based on gross profit.

111

Part 1
(a)
Cost of goods sold:
Reported....................................
Adjustments: 12/31/2004 error
12/31/2005 error
Corrected..................................
(b)
Net income:
Reported....................................
12/31/2005 error
Corrected..................................
(c)
Total current assets:
Reported....................................
12/31/2005 error
Corrected..................................
2004
$ 205,200
+ 17,000
________
$ 222,200
2005
$ 212,800
- 17,000
- 25,000
$ 170,800
2006
$ 196,030
2004
$ 174,800
- 17,000
________
$ 157,800
2005
$ 211,270
+ 17,000
+ 25,000
$ 253,270
2006
$ 183,910
2004
$ 266,000
- 17,000
________
$ 249,000
2005
$ 276,500
2006
$ 262,950
+ 25,000
$ 301,500
________
$ 262,950
2005
$ 316,000
2006
$ 336,000
+ 25,000
$ 341,000
________
$ 336,000
(d)
Equity:
2004
Reported............................................ $ 304,000
- 17,000
12/31/2005 error
________
Corrected.......................................... $ 287,000
+ 25,000
$ 221,030
- 25,000
$ 158,910
Part 2
Total net income for the combined three-year period is not affected by the errors.
This is because these errors are "self-correcting"that is, each overstatement (or
understatement) of net income is offset by a matching understatement (or
overstatement) in the following year.
Part 3
The overstatement of inventory by $17,000 results in an understatement of cost of
goods sold by that same amount. The $17,000 understatement of cost of goods
sold results in an overstatement of gross profit by the same amount. This
112
overstatement of gross profit carries through to an overstatement of net income.

Since the overstated net income is closed to equity, the final equity figure is
overstated by the amount of the inventory overstatement.

113

Inventory Items
Unit
s
Per Unit
Cost Market
Total
Cost
Total
Market
Items
LCM applied to:

Categories
Whole
Office furniture
Desks....................436
$261
Credenzas..............295
227
Chairs....................587
49
Bookshelves..........321
93
$305
256
43
82
Subtotal.................
$113,796 $132,980
66,965
75,520
28,763
25,241
29,853
26,322
239,377
260,063
$113,796
66,965
25,241
26,322
$239,377
Filing cabinets
Two-drawer............214
Four-drawer...........398
Lateral....................175
Subtotal.................
81
135
104
70
122
118
17,334
53,730
18,200
89,264
14,980
48,556
20,650
84,186
14,980
48,556
18,200
84,186
Office equipment
Fax machine..........430
Copiers..................545
Telephones............352
168
317
125
Subtotal.................
Total........................
200
288
117
72,240
86,000
72,240
172,765
156,960
156,960
44,000
41,184
41,184
289,005
284,144 _______
284,144 _______
$617,646 $628,393 $584,444 $607,707 $617,646
a. Lower of cost or market for the inventory as a whole
= $617,646
b. Lower of cost or market for the inventory by major category =

$239,377 + $84,186 + $284,144 = $607,707
c. Lower of cost or market for inventory applied separately

114
= $584,444
Problem 6-4BA (25 minutes)

Part 1
Number and total cost of units available for sale
6,300 units in beginning inventory @ $35.............................
10,500 units purchased @ $33..................................................
13,000 units purchased @ $32..................................................
12,000 units purchased @ $29..................................................
15,500 units purchased @ $26..................................................
57,300 units available for sale..................................................
$ 220,500
346,500
416,000
348,000
403,000
$1,734,000
0
Part 2
a. FIFO periodic
Total cost of 57,300 units available for sale.......
Less ending inventory on a FIFO basis
15,500 units @ $26.............................................
1,000 units @ $29.............................................
Cost of units sold.................................................
$1,734,000
$403,000
29,000
432,000
$1,302,000
b. LIFO periodic
Less ending inventory on a LIFO basis
6,300 beg. inv. units @ $35...............................
10,200 units @ $33...............................................
$1,734,000
$220,500
336,600
557,100
$1,176,900
c. Weighted average periodic

Less ending inventory at weighted average cost
($1,734,000/57,300) x 16,500 units....................
$1,734,000
499,319*
$1,234,681*
*Amount can slightly vary due to differences in rounding.

115
Problem 6-5BA (30 minutes)

Part 1
RIKKERS CORP.
Income Statements Comparing FIFO, LIFO, and Weighted Average
For Year Ended December 31, 2005
FIFO
LIFO
Weighted
Average
Sales
$245,000 $245,000
Cost of goods sold
Inventory, Dec. 31, 2004..............................
42,920
42,920
Cost of purchases....................................... 161,900
161,900
Cost of goods available for sale................ 204,820
204,820
Inventory, Dec. 31, 2005..............................
54,560
48,820
Cost of goods sold...................................... 150,260
156,000
Gross profit....................................................
94,740
89,000
$245,000
Expenses........................................................
35,000
Income before taxes......................................
59,740
Income taxes expense..................................
14,935
Net income..................................................... $ 44,805 $
35,000
56,692 *
14,173 *
$ 42,519 *
35,000
54,000
13,500
40,500
42,920
161,900
204,820
51,512 *
153,308 *
91,692 *
Supporting calculations:
Dec. 31, 2004, inventory (740 x $58)...................
Purchases
700 x $59 = $41,300
600 x $61 = 36,600
500 x $64 = 32,000
800 x $65 = 52,000
Dec. 31, 2005, inventory
FIFO:
800 x $65 = $52,000
40 x $64 =
2,560
LIFO:
W.A.:
FIFO
$ 42,920
LIFO
$ 42,920
Weighted
Average
$ 42,920
$161,900
$161,900
$161,900
$ 54,560
740 x $58 = $42,920

100 x $59 =
5,900
$ 48,820
($204,820/3,340) x 840
$ 51,512*

116
Problem 6-5BA (Concluded)

Part 2
If Rikkers Corp. had been experiencing decreasing costs in the acquisition
of inventory, we would observe the opposite results in our comparisons.
Specifically, LIFO would have resulted in a higher ending inventory, lower
cost of goods sold, higher gross profit, and higher net income. FIFO would
have resulted in a lower ending inventory, higher cost of goods sold, lower
gross profit, and lower net income.
Part 3
Advantages:
LIFO: Assuming a trend of increasing costs, the advantage of using LIFO is
that the lower net income will result in a lower tax obligation (tax deferral).
Also, LIFO is likely to better match current costs against revenues.
FIFO: The advantage of using FIFO is that the inventory figure reported on
the balance sheet is likely similar to the current replacement cost.
Disadvantages:
LIFO: Assuming a trend of increasing costs, the disadvantage of using
LIFO is the inventory figure, which is also reported on the income
statement, will likely be understated in comparison to the current
replacement costs.
FIFO: The disadvantage of using FIFO is that it will produce a greater tax
obligation for the current period as a result of a higher reported net
income.

117
Problem 6-6BB (25 minutes)

Part 1
ALAINA CO.
Estimated Inventory
December 31
Goods available for sale:
Beginning inventory..............................................
Cost of goods purchased.....................................
Goods available for sale.......................................
At Cost
At Retail
$ 81,670
492,250
$573,920
$114,610
751,730
$866,340
Sales
Less: Sales returns..................................................
Net sales...................................................................
$786,120
(4,480)
$781,640
Ending inventory at retail ($866,340 - $781,640)...
$ 84,700
Cost ratio: $573,920/$866,340 = 0.66 or 66%

Ending inventory at cost ($84,700 x 66%).....................
$ 55,902
Part 2
ALAINA CO.
Inventory Shortage
December 31
At Cost
Estimated inventory (from part 1)............................. $55,902
Physical inventory..................................................... 51,843 *
Inventory shortage..................................................... $ 4,059
At Retail
$84,700
78,550
$ 6,150
* $51,843 = $78,550 (given) x 66% (from part 1).

118
Problem 6-7BB (25 minutes)

ERNST EQUIPMENT CO.
Estimated Inventory at March 31
At Cost
Inventory, January 1........................................
Cost of goods purchased...............................
Goods available for sale.................................
Sales.................................................................
Less sales returns...........................................
Net sales...........................................................
[$3,636,050 x (1 - 30%)]..............................
Estimated March 31 inventory..........................
At Retail
$ 752,880
2,159,630
2,912,510
$3,710,250
(74,200)
$3,636,050
(2,545,235)
$ 367,275
SERIAL PROBLEM
Serial Problem, Success Systems (20 minutes)
1. Ratio computations for the three months ended March 31, 2005:
Inventory Turnover
= Cost of Goods Sold / Average Inventory

= $14,052 / [($0 + $704)/2]
= 40 times (Since this is the first period of carrying
inventory, it is acceptable to substitute ending inventory for
average inventory. This would yield a turnover of 20 times.)
Days Sales in Inventory = (Ending Inventory/Cost of Goods Sold) x 365

= ($704 / $14,052) x 365 = 18.3 days
2. Success Systems outperforms its competitors on both ratios. Its inventory
turnover is 40 (or 20) times versus competitors 10 times. Also, its days
sales in inventory is 18.3 days versus competitors 29 days. Thus, Success
Systems appears to be successfully managing its inventory.

119
Reporting in Action BTN
6-1
($ thousands)
1. Ending inventories at February 2, 2003, were $24,365. Ending

inventories at February 3, 2002, were $16,159.
2.
2003:
$24,365
$410,487
= 0.059 or 5.9%
2002:
$16,159
$255,376
= 0.063 or 6.3%
3. Krispy Kreme reports 14 different types of assets on its balance sheet.

Inventory is the fifth largest asset behind property and equipment ,
accounts receivable, cash and cash equivalents, and intangible assets
at both February 2, 2003, and at February 3, 2002.
4. As stated in the summary of significant accounting policies (Note 2),
Krispy Kreme uses the FIFO method of inventory costing for
inventories. Its inventories are stated at the lower of average cost
(FIFO) or market.
5. a. Inventory turnover =
Cost of sales
Average inventory
$16,159 + 24,365
2
Average inventory =
= $20,262
$ 381,489
Inventory turnover = $ 20,262
= 18.8 times
b. Days sales in inventory =
=
Ending inventory
Cost of sales
$24,365
$381,489
x 365
x 365 = 23.3 days
6. Solution depends on the financial statement information obtained.

120
Comparative Analysis
BTN 6-2
($ thousands)
1. Inventory turnover =
Cost of sales
Average inventory
Krispy Kreme current year

$381,489
($24,365 + $16,159)/2
Inventory turnover =
= 18.8 times
Krispy Kreme one year prior

$316,946
($16,159 + $12,031)/2
= 22.5 times
Tastykake current year

$111,187
($6,777 + $8,412)/2
= 14.6 times
Tastykake one year prior

2. Days sales in inventory =
$103,297
($8,412 + $5,930)/2
= 14.4 times
Ending Inventory x 365

Costs of Goods Sold
Current year Krispy Kremes days sales in inventory

$24,365
$381,489 x 365
= 23.3 days
One year prior Krispy Kremes days sales in inventory

$16,159
$316,946 x 365
= 18.6 days
Two years priorKrispy Kremes days sales in inventory

$12,031
$250,690 x 365
= 17.5 days

121
Comparative Analysis (Concluded)

2. Continued
Current year Tastykakes days sales in inventory
$6,777
$111,187
x 365
= 22.2 days
One year prior Tastykakes days sales in inventory

$8,412
$103,297
x 365
= 29.7 days
Two years priorTastykakes days sales in inventory

$ 5,930
$105,036
x 365
= 20.6 days
3. For two of the three years Krispy Kreme manages its inventory more
efficiently than Tastykake. For the current (prior) year(s), Krispy Kreme
holds 23.3 (18.6 and 17.5) days of sales in inventory and turns its
inventory 18.8 (22.5) times. For the current (prior) year(s), Tastykake
holds 22.2 (29.7 and 20.6) days of sales in inventory and only turns its
inventory 14.6 (14.4) times.

122
Ethics Challenge
BTN 6-3
1. Profit Margin: In an economic environment of rising costs, the use of

FIFO results in a lower cost of goods sold than LIFO. If cost of goods
sold is lower, then net income will be higher. A higher net income will
improve the profit margin ratio, which is calculated as net income
divided by net sales.
Current Ratio: With rising costs, FIFO results in the most recent, higher
costs being reflected in ending inventory. This means that the balance
sheet FIFO inventory figure will be larger than under LIFO. In the
numerator of the current ratio, inventory is included as part of the
current asset total. A larger inventory from FIFO, therefore, results in a
larger numerator and therefore a larger current ratio than under LIFO.
2. First, it is true that managers have discretion in choosing an inventory
costing method. It appears, however, that Golf Aways owner does not
understand that changing methods can only be done very selectively
over time. A change in method must be justified by management for
improving the financial reporting of the company.
Second, the consistency principle does not allow frequent changes in
inventory costing methods by management. If Golf Aways owner can
justify the method change as improving the financial reports of the
company, then the owners action is ethical. However, the owner must
realize that changing methods can only be an infrequent occurrence
given that consistency in financial reporting is required.
Third, the full disclosure principle requires the owner to disclose to the
bank that the company has implemented a change in inventory costing
method from LIFO to FIFO.
Finally, if LIFO is currently being used for tax reporting, then the tax
reporting method must also change due to the LIFO Conformity Rule
which demands that if LIFO is used for tax reporting, it must be used
for financial reporting.

123
Communicating in Practice
BTN 6-4
[Note: An acceptable memorandum format should be used.]
The body of the memo should recommend use of the LIFO method. The
memo should explain that this would allow for the matching of the most
recent (higher) costs against revenue through cost of goods sold. It
should further explain that this would result in a lower net income and,
therefore, lower tax. The justification for this method is a better matching
of current costs against revenue to more fairly reflect the results of
operation. A statement could be made that the actual physical flow of
goods does not dictate the inventory method a business uses.
Taking It to the Net
BTN 6-5
1. One especially popular product with college students that Oakley sells
is Oakley sunglasses.
2. The summary of significant accounting policies states that Oakley
reports inventory at the lower of cost to purchase and/or manufacture
or the current estimated market value.
3. Oakleys gross margin for 2002 is ($ in thousands)
Sales
Cost of sales......................................
Gross margin.....................................
$489,552
(211,962)
$277,590
Gross margin ratio is: $277,590 / $489,552 = 0.567 or 56.7%

4. 2002 Inventory turnover*
=
$211,962 / [($87,007+$77,270)/2] = 2.6 times
2002 Days sales in inventory*
=
($87,007 / $211,962) x 365 = 150 days
* $ thousands

124
Teamwork in Action
BTN 6-6
Concepts and procedures to illustrate in expert presentation:

Specific Identification Expert:
(a) and (b) Concept:
Purchases are always recorded at the actual specific costs. The specific
identification cost flow assumption requires units sold be assigned their
actual cost. Total cost of goods sold is tallied based on these individual
cost assignments. The new inventory balance is perpetually determined to
be the amount after sales at actual cost is deducted.
(a) and (b) Procedures:
Date
Goods Purchased
Cost of Goods Sold
Jan. 1
50 @ $10 = $ 500
Jan.10
Jan.14
Inventory Balance
30 @ $10 = $ 300
150 @ $12 = $1,800
Feb.15
20 @ $10 =
20 @ $10 =
150 @ $12 =
100 @ $ 12 = $1,200
$ 200
$
200
1,800
$2,000
20 @ $10 = $
200
50 @ $12 =
600
$ 800
Apr.30
200 @ $15 = $3,000
20 @ $10 =
50 @ $12 =
200 @ $15 =
Sept 26
300 @ $20 = $6,000
20
50
200
300
@
@
@
@
$10 = $
$12 =
$15 =
$20 =
$9,800
20
50
100
50
@
@
@
@
$10=
$12 =
$15 =
$20 =
Oct. 5
100 @ $ 15 = $1,500
250 @ $ 20 = $5,000
_____
$8,000
200
600
3,000
$3,800
200
600
3,000
6,000
200
600
1,500
1,000
$3,300

125
Teamwork in Action (Continued)

LIFO Expert:
Purchases are always recorded at actual costs. The LIFO cost flow
assumption requires (i) units sold be assigned the most recent costtotal
cost of goods sold is tallied based on these individual cost assignments,
and (ii) that the inventory balance be perpetually determined to be the
amount after goods sold (using the most recent costs) are deducted.
Date
Goods Purchased
Cost of Goods Sold
Jan. 1
Jan.10
Jan.14
30 @ $10 = $
300
150 @ $12 = $1,800
Feb.15
Inventory Balance
50 @ $10 =
500
20 @ $10 =
200
20 @ $10 =
150 @ $12 =
100 @ $12 = $ 1,200
20 @ $10 =
50 @ $12 =
$ 200
1,800
$ 2,000
$
$
Apr.30
200 @ $15 = $3,000
20 @ $10 =
50 @ $12 =
200 @ $15 =
Sept 26
300 @ $20 = $6,000
20
50
200
300
$10 =
$12 =
$15 =
$20 =
$
20 @ $10 =
50 @ $12 =
150 @ $15 =
Oct. 5

126
300 @ $20 = $ 6,000

50 @ $15 = $ 750
______
$ 8,250
@
@
@
@
200
600
800
200
600
3,000
$ 3,800
200
600
3,000
6,000
9,800
200
600
2,250
$ 3,050

FIFO Expert:
Purchases are always recorded at actual costs. The FIFO cost flow
assumption requires units sold be assigned the first (earliest) cost of
purchases. Total cost of goods sold is tallied based on these individual
cost assignments. The inventory balance is perpetually determined to be
the amount after deducting goods sold using the earliest costs.
Date
Goods Purchased
Cost of Goods Sold
Inventory Balance
Jan. 1
Jan.10
Jan.14
30 @ $10 = $
300
150 @ $12 = $1,800
Feb.15
50 @ $10 = $
500
20 @ $10 = $
200
20 @ $10 = $ 200
150 @ $12 = 1,800
$ 2,000
20 @ $ 10 = $ 200
80 @ $ 12 =
960
70 @ $12 = $
840
Apr.30
200 @ $15 = $3,000
70 @ $12 = $ 840
200 @ $15 = 3,000
$ 3,840
Sept 26
300 @ $20 = $6,000
70 @ $12 = $ 840
200 @ $15 = 3,000
300 @ $20 = 6,000
$ 9,840
Oct. 5
70 @ $12 = $ 840
200 @ 15 = 3,000
80 @ 20 = 1,600
______
$ 6,900
220 @ $20 = $ 4,400

______
$ 4,400

127

Weighted Average Expert:
Purchases are always recorded at actual costs. The Weighted Average
cost flow assumption requires units sold be assigned a cost based on
running weighted average cost per unit in the inventory balance. This
requires the computation of a new weighted average cost per unit after
each purchase. The total cost of goods sold is tallied based on cost
assignments. The new inventory balance is perpetually determined to be
the residual amount after goods sold are deducted using this weighted
average cost.
Date
Goods Purchased
Cost of Goods Sold
Jan. 1
Jan.10
Jan.14
30 @ $10
= $ 300
150 @ $12 = $1,800
Inventory Balance
50 @ $10
= $ 500
20 @ $10
= $ 200
170 @ $11.7647 = $2,000

(200 +1,800) / (20+150)
Feb.15
Apr.30
100 @ $11.7647 = $1,176*

200 @ $15 = $3,000
70 @ $11.7647 = $ 824*
270 @ $14.163* = $3,824*
(824+3,000) / (70 +200)
Sept 26
300 @ $20 = $6,000
570 @ $17.24*
= $9,824*
(3,824 +6,000) / (270 +300)
Oct. 5
* rounded
350 @ $17.24
= $6,034
_____
$7,510
220 @ $17.24*
=
$3,790**
** adjusted for rounding

128
Teamwork in Action (Concluded)

(c) Cost Flow versus Actual Physical Flow
Typical comments experts may express in response to (c):
Physical flow of goods can be affected by the type of products in

inventory and/or the way inventory is stored and/or displayed.
Actual physical flow of goods is not relevant in selecting an acceptable

method of accounting for inventory. Any one of the four methods is
acceptable. The method chosen should be consistently applied.
More Specific Expert Comments to (c):
Specific Identification--Always reflects the actual cost flow. Electronic
scanning has increased the ability to use this method in businesses that sell
homogeneous goods.
FIFO--Most businesses try to move their older or earlier acquired inventory
first, particularly if they sell perishable goods. Therefore, FIFO will frequently
reflect the physical flow of goods.
LIFO--Few actually sell their most recently acquired inventory first. This
could follow actual physical flow if inventory is stocked in a manner that
requires accessing most recent cost first.
Weighted Average--This cost is rarely the actual cost flow. This would require
the mixing or combining of units on hand. This is possible for inventory such
as oil but it still unlikely that the actual blending would be as complete as the
averaging of costs.
(d) Impact of Methods
Typical comments experts may express in response to (d):
In a period of rising prices LIFO will generally result in the highest cost of
goods sold and therefore the lowest net income and lowest tax. However,
LIFO must be used for financial reporting if it is used for tax purposes.
In a period of rising prices FIFO will generally result in the lowest cost of
goods sold and therefore the highest net income and highest tax.
Weighted Average will usually result in a reported net income and tax
consequences somewhere in between LIFO and FIFO.
Specific Identification will result in a cost of goods sold, net income and tax
expense dependent on whether the actual cost of units sold were the higher
or lower priced items.
(e) Valuation
Typical comments experts may express in response to (e):
FIFO tends to value ending inventory closest to replacement cost whereas
LIFO does not. Weighted average tends to value inventory between old and
new market values, and specific identification depends on whether the items
remaining in inventory have costs similar to current replacement costs.

129
Business Week Activity
BTN 6-7
1. Apple has a 2.5% share of the U.S. market for digital music players.
2. Toshiba with Mobilphile, and SONICblue.
3. Toshibas Mobilphile has a removable hard drive. Toshiba could
choose to ship players and different size removable drives separately
to stores. The separate shipment would allow retailers to meet
customer demand for product specifications quite efficiently onsite.
This flexibility will hold down inventory costs as retailers will not be
stocking players with drives of certain sizes that consumers do not
demand. In contrast, iPods hard drives are not removable and a
retailer might not be fortunate enough to stock the size iPod that is
most in demand by consumers.
4. Unit sales of the iPod are forecast to grow from 1 million in 2002 to 9
million in 2006.
Entrepreneurial Decision
BTN 6-8
Part 1
(a) Under current conditions, the inventory turnover is 2.1. This is
computed as its cost of sales of $1,050,000 divided by its average
merchandise inventory of $500,000. Also, days sales in inventory is 174
days. This is computed as its ending inventory of $500,000 divided by
its cost of sales of $1,050,000, and then this result is multiplied by 365.*
*Ratio definitions:
Days sales in inventory =
Cost of goods sold

Average inventory
Ending inventory
Cost of goods sold x 365
(b) Under the proposal, its inventory turnover would be 8.4. This is
computed as its cost of sales of $1,050,000 divided by its average
proposed merchandise inventory of $125,000. Also, its days sales in
inventory under the proposal is 43 days. This is computed as its
proposed ending inventory of $125,000 divided by its cost of sales of
$1,050,000, and then this result is multiplied by 365.
130
Entrepreneurial Decision (Concluded)

Part 2
Beckers proposal would yield a much improved inventory turnover of
8.4 vis--vis the current turnover of 2.1. On the downside, its days sales
in inventory would dramatically decline from 174 days to 43 days.
Assuming an inventory buffer of 43 days is sufficient, then Becker
should implement this proposal.
We need to recognize that the major concern with this proposal is with
the companys confidence in both maintaining its current sales level and
with not losing or alienating its current and future customers due to
delays in acquiring merchandise. Assuming the companys predictions
are reasonable, we need to focus on the customer concern. That is, we
need to be certain that Becker can continue to satisfactorily serve
customers with a 43-day buffer in inventory. If not, then current and
future sales could suffer to an extent that would outweigh the benefit of
slashing inventory.
Hitting the Road
BTN 6-9
There is no formal solution for this field activity. The required solution
does allow students to see the relevance of studying merchandise
activities and inventory accounting.

131
Global Decision
1. Inventory turnover =
BTN 6-10
Cost of sales
Average inventory
Current year Grupo Bimbo (pesos millions):

19,156
(905 + 767) / 2
= 22.9 times
One year prior Grupo Bimbo (pesos millions):

15,708
(767 + 725) / 2
Days sales in inventory =
= 21.1 times
Ending Inventory x 365

Costs of Goods Sold
Current year Grupo Bimbos days sales in inventory (pesos millions):

905
19,156 x 365
= 17.2 days
One year priorGrupo Bimbos days sales in inventory (pesos millions):

767
15,708 x 365
Company
= 17.8 days
Inventory Turnover
Current Prior Year
Days Sales in Inventory

Current
Prior Year
Grupo Bimbo......................................22.9
21.1
17.2
17.8
Krispy Kreme......................................18.8
22.5
23.3
18.6
Tastykake............................................14.6
14.4
22.2
29.7
Note: Computations for Krispy Kreme and Tastykake are in BTN 6-2.
2. In the current year Grupo Bimbo manages its inventory more efficiently
than Krispy Kreme or Tastykake. Its inventory turnover is higher and
its days sales in inventory are less than both Krispy Kreme and
Tastykake.
132

Chap 006

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chap 006

Uploaded by

Copyright:

Available Formats

Chapter 6

Inventories and Cost of Sales

Merchandise inventory is disclosed on the balance sheet as a current asset. It is

Many people make important business decisions based on period-to-period

Solutions Manual, Chapter 6

McGraw-Hill Companies, Inc., 2005

Cost of Goods Sold

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Quick Study 6-1 (continued)

Cost of Goods Sold

(c) Weighted Average

Cost of Goods Sold

(d) Ending inventory under specific identification:

Solutions Manual, Chapter 6

McGraw-Hill Companies, Inc., 2005

Quick Study 6-3 (25 minutes)

Cost of Goods Sold

310 @ $3.00 = $ 930

Cost of Goods Sold

100 @ $3.35 = $ 335

(c) Weighted Average

Cost of Goods Sold

McGraw-Hill Companies, Inc., 2005

345 @ $3.10 = $1,070

Fundamental Accounting Principles, 17th Edition

Quick Study 6-3 (continued)

$ 420 Ending inventory cost

(c) Weighted average:

$1,505/485 = $3.10 weighted average cost per unit

$ 434 Ending inventory cost

Quick Study 6-4 (10 minutes)

Quick Study 6-5 (10 minutes)

Solutions Manual, Chapter 6

McGraw-Hill Companies, Inc., 2005

Quick Study 6-6 (10 minutes)

Quick Study 6-7 (5 minutes)

Quick Study 6-8 (10 minutes)

Quick Study 6-9 (20 minutes)

LCM applied to:

a. LCM for inventory as a whole...................................................

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

b. LCM applied to each product ...................................................

Solutions Manual, Chapter 6

McGraw-Hill Companies, Inc., 2005

Quick Study 6-10 (15 minutes)

Overstates 2005 cost of goods sold.

= Cost of goods sold/Average merchandise inventory

Days sales in inventory = Ending Inventory/Costs of goods sold x 365

Quick Study 6-12A (15 minutes)

c. Weighted Average ($510/ 45 = $11.33 cost per unit)

McGraw-Hill Companies, Inc., 2005

Fundamental Accounting Principles, 17th Edition

Quick Study 6-13A (15 minutes)

c. Weighted Average ($1,505/ 485 = $3.10* cost per unit)

Quick Study 6-14B (15 minutes)

Solutions Manual, Chapter 6

McGraw-Hill Companies, Inc., 2005

(400 x $5.00) + (100 x $4.10)..........................

$6,380 - $2,410 ...............................................

b. Weighted average perpetual

Cost of Goods Sold

600 @ $4.85 = $2,910