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6.12: Solutions

  • Page ID
    33003
  • Discussion Questions

      1. The amount of inventory on hand is important to management for two reasons. First, management wants to ensure there is ample inventory to meet all customers' orders. Second, because the cost of carrying inventory (for instance, rental of warehouse space, insurance) can be quite high, management wants to keep the inventory as low as possible.
      2. Investors and creditors are concerned with the inventory because inventory is a large asset. They will want to assess its current amount and trends compared to other years and competitors' levels to help determine the financial strength of the company before investing or lending money, or for use as collateral, for instance.
    1. Accountants must ensure the inventory is not obsolete or unsalable and that it is properly counted and valued, using an acceptable inventory cost flow assumption that is applied consistently from year to year.
    2. The laid-down cost of inventory is the invoice price of the goods less purchase discounts, plus transportation-in, insurance while in transit, and any other expenditure made by the purchaser to get the merchandise to the place of business and ready for sale.
    3. Flow of goods is the physical movement of the goods themselves as they enter the firm and are sold, especially when dealing with similar items, while the flow of costs is the costs assigned to the flow of goods in the firm using specific identification, FIFO, or average cost bases.

      GAAP does not require that the flow of costs basis be similar to the physical flow of goods, except when individual units of inventory can be identified by, for example, serial numbers. However, it does require that once the cost basis is selected, that it be followed consistently from period to period.

    4. Two factors are considered in costing inventory: the quantity and the assigned value per unit. Assigning the value is often the more difficult aspect, as this involves tracking the laid-down costs of many items. Physical quantities can be tracked by computerised accounting systems and verified or determined by physical count at year-end.
    5. Consistency in inventory costing is necessary for comparing a company's performance from year to year. GAAP does allow a company to change its inventory valuation method; however, the company must restate inventory and cost of goods sold effects on prior years using the new method. In practise this change is rarely made.
    6. If the ending inventory is overstated at the end of 2018, then cost of goods sold is understated; therefore, the 2018 net income is overstated by $5,000. In 2019, the opening inventory would be overstated and cost of goods sold would be overstated; therefore, the net income would be understated by $5,000.
    7. Inventory should be valued at less than cost when the lower of cost and net realisable value (LCNRV) principle is applied, perhaps due to factors such as physical deterioration, obsolescence, or changes in price levels.
    8. The primary reason for the use of the LCNRV method of inventory valuation is to prevent overstatement. If the likely value of inventory has declined below cost, it is prudent to recognize the loss immediately, rather than when the goods are eventually sold. Net realisable value is the expected selling cost of inventory, less any applicable costs related to the sale.
    9. When inventory is valued at LCNRV, cost refers to the laid-down cost.
    10. The inventory cost flow assumptions permissible under GAAP are specific identification, FIFO or average cost.
    11. Estimating inventory is useful for two reasons:
      1. It is useful for inventory control. When a total inventory amount is calculated under a periodic inventory system through physical count and valuation, an estimate can help check the accuracy.
      2. It is useful for the preparation of interim financial statements. Under a periodic inventory system, inventory on hand at any point in time is not readily available. To take a physical count often would be costly and inconvenient. An estimate offers a way of determining a company's inventory at any point in time in a cost-effective manner.
    12. Under the gross profit method, the percentage of profit remaining after accounting for cost of goods sold (the gross profit percentage) is assumed to remain the same from year to year. By applying the rate to sales, gross profit and then cost of goods sold can be estimated. Opening inventory and purchases will be known from the accounting records, so cost of goods available for sale can be determined. The difference between the cost of goods sold and cost of goods available for sale is the ending inventory amount.

      Under the retail inventory method, mark-up on goods purchases then sold is considered to be constant. Both cost and selling prices of goods acquired are then valued at retail by using the mark-up amount. From this, the ending inventory at retail is calculated. By applying the cost percentage (costs of goods available for sale divided by retail costs of goods available for sale) to the retail ending inventory, its value at cost can be calculated.

      1. Example – gross profit method:
        Sales $100
        Cost of Goods Sold:

        Opening Inventory (from records)

        80

        Purchases (from records)

        70

        Cost of Goods Available for Sale

        150

        Ending Inventory

        (a)?

        (b)?

        Gross Profit $(c)?

        If the gross profit percentage average is 25%, the following can be estimated:

        (c) Gross profit = 25% of $100 = $25
        (b) Cost of goods sold = $100 − $25 (c) = $75
        (a) Ending inventory = $150 − $75 (b) = $75

        Ending inventory (a) would be $75.

      2. Example – retail inventory method; assumed mark-up = 200%:
        At Retail At Cost
        Sales $500 $500
        Cost of Goods Sold:

        Opening Inventory (records)

        $(b)

        $80

        Purchases (records)

        (b)

        300

        Cost of Goods Available for Sale

        (c)

        380

        Ending Inventory

        (d)?

        (e)?

        Cost of Goods Sold (a)? (f)?
        Gross Profit (same as Sales) $-0- (g)?
        (a) Cost of Goods restated at retail to equal sales = $500
        (b) Opening Inventory and Purchases re-stated at retail = $300 × 200% = $600;
        = 80 × 200% = 160
        (c) Cost of Goods Available at retail = $600 (b) + 160 (b)
        = $760
        (d) Ending Inventory at retail = $760 (c) − 500 (a)

        = Cost of Goods Available at retail − Cost of Goods Sold at retail

        = $260

        (e) Inventory at cost = Inventory at retail/200% = $260 (c)/200%
        = $130
        (f) Cost of Goods Sold at cost = $380 − 130(e) = $250
        (e) Gross Profit at cost = $500 − $250(e) = $250
    13. The gross profit method is particularly useful in cases where goods have been stolen or lost in a fire; in such cases it is not possible to determine the balance in the ending inventory by a physical count when the periodic inventory system is used.
    14. The retail inventory method assumes an average inventory cost flow assumption because the cost percentage used to calculate ending inventory and cost of goods sold is based on a constant mark-up.

    Exercises

    EXERCISE 6–1

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    EXERCISE 6–2

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    EXERCISE 6–3

    Weighted Average (per unit costs must be rounded to two decimal places)

    Purchased (Sold) Balance
    Date Units Unit Cost COGS Units Unit Cost Total Cost
    Jan. 1 Opening Inventory 2,000 $0.50 $1,000
    5 Sales #1 (1,200) × $0.50 ($600) 800 400
    6 Purchase #1 1,000 × 2.00 1,800 1.33\(^{1}\) 2,400
    10 Purchase #2 500 × 1.00 2,300 1.26\(^{2}\) 2,900
    16 Sale #2 (2,000) × 1.26 = (2,520) 300 380
    21 Purchase #3 1,000 × 2.50 1,300 2.22\(^{3}\) $2,880

    \(^{1}\)[$400 + (1,000 × $2)]/(800 + 1,000) = $1.33/unit (rounded)

    \(^{2}\)[$2,400 + (500 × 1)]/(1,800 + 500) = $1.26/unit (rounded)

    \(^{3}\)[$380 + (1,000 × 2.50)]/(300 + 1,000) = $2.22/unit (rounded)

    1. The entry for the January 5 sale:
      General Journal
      Date Account/Explanation F Debit Credit
      Jan. 5 Accounts Receivable 6,000
      Sales 6,000
      Cost of Goods Sold 600
      Merchandise Inventory 600
      To record Jan. 5 sales: 1,200 units × $5.00/unit selling price = $6,000.
    2. The entry for the January 16 sale:
      General Journal
      Date Account/Explanation F Debit Credit
      Jan. 16 Accounts Receivable 12,000
      Sales 12,000
      Cost of Goods Sold 2,520
      Merchandise Inventory 2,520
      To record Jan. 16 sales: 2,000 units × $6.00/unit selling price = $12,000.
    3. Per the above table, there are 1,300 units on hand @ $2.22 (rounded), for a total ending inventory cost of $2,880. Be careful to note that the total ending inventory cost of $2,880 is NOT calculated as 1,300 units × the average unit cost of $2.22. The $2,880 is calculated as the inventory balance of $380 on January 16 plus the January 21 purchase of $2,500.

    EXERCISE 6–4

    N/E = No Effect; O = Overstated; U = Understated

    2016 Statements 2017 Statements
    Errors Opening Invent. Ending Invent. 2016 Total Assets 2016 Net Income Opening Invent. Ending Invent. 2017 Total Assets 2017 Net Income
    1. Goods purchased in 2016 were included in the December 31, 2016 inventory, but the transaction was not recorded until early 2017. N/E U U U U N/E N/E O
    2. Goods purchased in 2017 were included in December 31, 2016 inventory, and the transaction was recorded in 2016. N/E O O O O N/E N/E U

    EXERCISE 6–5

      1. Ending inventory for 2021 was understated by $2,000. Thus, cost of goods sold should have been $18,000 and gross profit, $12,000. Because of this mistake, the 2022 opening inventory was also understated by $2,000, causing cost of goods sold to be understated by $2,000 and gross profit overstated by $2,000; gross profit in 2022 should have been $15,000. There is no impact on 2023 as a result of the error.
      2. The 2023 ending inventory was overstated by $5,000. Thus, cost of goods sold should have been $30,000 and gross profit, $20,000. This error does not impact 2021 or 2022.
    1. For 2021, the merchandise inventory on the balance sheet was understated by $2,000. Thus, the total assets were $2,000 less than they should have been. For 2022, there is no effect on the balance sheet, as the error is in opening inventory. For 2023, the ending inventory in the balance sheet is overstated by $5,000, which means that total assets were overstated by $5,000.

    EXERCISE 6–6

    1. LCNRV on a unit-by-unit basis: (2 × $50) + (3 × $75) + (4 × $20) = $405

      Therefore, LCNRV = $405 on a unit-by-unit basis.

    2. LCNRV on a group inventory basis: Total cost of the group: (2 × $50) + (3 × $150) + (4 × $25) = $650 Total NRV of the group: (2 × $60) + (3 × $75) + (4 × $20) = $425

      Therefore, LCNRV = $425 on a group inventory basis.

    EXERCISE 6–7

    1. Estimated amount of inventory lost in the fire:
      Sales $300,000 100%
      Cost of Goods Sold:
      Opening Inventory $80,000
      Purchases 150,000
      Cost of Goods Available 230,000
      Ending Inventory (estimated) (iii)
      Cost of Goods Sold (ii) 65%
      Gross Profit (i) 35%
      (i) Gross Profit = 35% of Sales
      = 35% × $300,000
      = $105,000
      (ii) Cost of Goods Sold = Sales − Gross Profit
      = $300,000 − 105,000
      = $195,000
      (iii) Estimated Ending Inventory = Cost of Goods Available − Total Cost of Goods Sold
      = $230,000 − 195,000
      = $35,000
    2. Balton lost about $35,000 of inventory in the fire and is claiming $45,000. This does not appear reasonable.

    EXERCISE 6–8

    1. Merchandise inventory turnover for each of the years 2022 to 2025:
      2025 2024 2023 2022 2021
      Cost of Goods Sold 370,000 400,000 420,000 440,000 450,000
      Merchandise Inventory 120,000 111,250 88,750 111,250 88,750
      Merchandise Inventory Turnover 3.2 4 4.2 4.4
    2. The change in Able Corp.'s Merchandise Inventory Turnover ratio is unfavourable because inventory is being sold at a slower rate from 2022 to 2025, from 4.4 times per year in 2022 to 3.2 times per year in 2025.

    Problems

    PROBLEM 6–1

    1. Weighted Average Cost Flow Assumption:
      Product A
      Purchased (Sold) Balance
      Date Units Unit Cost COGS Units Unit Cost Total Cost
      Jan. 1 Opening Inventory 4,000 × $11.90 = $47,600
      Jan. 7 Purchase #1 8,000 × $12.00 12,000 × 11.97\(^{1}\) = 143,600
      Mar. 30 Sale #1 (9,000) × 11.97 = ($107,730) 3,000 × = 35,870
      May 10 Purchase #2 12,000 × 12.10 15,000 × 12.07\(^{2}\) = 181,070
      Jul. 4 Sale #2 (14,000) × 12.07 = (168,980) 1,000 × = $12,090

      \(^{1}\)[$47,600 + (8,000 × $12)]/(4,000 + 8,000) = $11.97/unit (rounded)

      \(^{2}\)[$35,870 + (12,000 × $12.10)]/(3,000 + 12,000) = $12.07/unit (rounded)

      Product B
      Purchased (Sold) Balance
      Date Units Unit Cost COGS Units Unit Cost Total Cost
      Jan. 1 Opening Inventory 2,000 × $13.26 = $26,520
      Jan. 13 Purchase #1 5,000 × $13.81 7,000 × 13.65\(^{3}\) = 95,570
      Jul. 15 Sale #1 (1,000) × 13.65 = ($13,650) 6,000 × = 81,920
      May 10 Purchase #2 7,000 × 14.21 13,000 × 13.95\(^{4}\) = 181,390
      Dec. 14 Sale #2 (8,000) × 13.95 = (111,600) 5,000 × = $69,790

      \(^{3}\)[$26,520 + (5,000 × $13.81)]/(2,000 + 5,000) = $13.65/unit (rounded)

      \(^{4}\)[$81,920 + (7,000 × $14.21)]/(6,000 + 7,000) = $13.95/unit (rounded)

    2. Total ending inventory at December 31, 2020:
      Product A $12,090
      Product B 69,790

      Total

      $81,880

    3. Gross profit percentage earned:
      Product A Product B
      Mar. 30 Sale 144,000 Jul. 15 Sale 20,000
      Jul. 04 Sale 238,000 Dec. 14 Sale 168,000
      Total Sales 382,000 Total Sales 188,000

      COGS 276,710 COGS 125,250
      Gross Profit 105,290 Gross Profit 62,750

      Gross Profit %

      27.56

      Gross Profit %

      33.38

    PROBLEM 6–2

    1. Inventory Record – FIFO
      Purchases/Shipping costs/ Purchase returns, discounts and allowances Cost of Goods Sold/ Returns to Inventory Balance in Inventory
      Date Description Units Cost/Unit Total Units Cost/Unit Total Units Cost/Unit Total
      Jan 1 Inventory, opening 500 $ 10 5,000
      4 Sale of 100 units @ $20 100 $ 10 1,000 400 $ 10 4,000
      400 $ 10 4,000
      6 Purchase 200 $ 11 2,200 200 $ 11 2,200
      400 $ 10 4,000
      8 Purchase return (from Jan 6 purchase) (10) $ 11 (110) 190 $ 11 2,090
      9 Sale of 200 unit @ $22 200 $ 10 2,000 200 $ 10 2,000
      190 $ 11 2,090
      10 Sales return from customer from Jan 4 sale (15) $10 (150) 215 $ 10 2,150
      (returned to inventory) 190 $ 11 2,090
      15 Sale of 150 units @ $23 150 $ 10 1,500 65 $ 10 650
      190 $ 11 2,090
      65 $ 10 650
      190 $ 11 2,090
      17 Purchase 300 $ 9 2,700 300 $ 9 2,700
      19 Sales return from customer from Jan 15 sale (beyond repair, disposed) no entry disposed 65 $ 10 650
      190 $ 11 2,090
      300 $ 9 2,700
      20 Sale of 400 units @ $21 65 $ 10 650 0 $ 10
      190 $ 11 2,090 0 $ 11
      145 $ 9 1,305 155 $ 9 1,395
      Total 835 8,395 155 $ 9 1,395
    2. Sales:
      Sale of 100 units @ $20 $ 2,000.00
      Sale of 200 unit @ $22 $ 4,400.00
      Sales return of 15 units @ $20 $ (300.00)
      Sale of 150 units @ $23 $ 3,450.00
      Sales return of 2 units @ $20 $ (40.00)
      Sale of 400 units @ $21 $ 8,400.00
      Total sales $ 17,910.00
      Cost of goods sold $ 8,395.00
      Gross profit $ 9,515.00
      Gross profit % 53.13%
    3. Ending inventory balance, Jan 20, 2016: $1,395.00

    PROBLEM 6–3

    1. Weighted Average Cost
      Purchases/Shipping costs/Purchase returns, discounts and allowances Cost of Goods Sold/Returns to Inventory Balance in Inventory
      Date Description Units Cost/Unit Total Units Cost/Unit Total Units Cost/Unit Total
      Feb 1 Opening inventory 75 $ 12.00 900
      5 Sale 70 $12.00 840 5 $ 12.00 60
      7 Purchase 300 $ 11.00 3,300 305 $ 11.02 3,360
      12 Sale 180 $11.02 1,984 125 $ 11.01 1,376
      14 Purchase return from Feb 7 (10) $ 11.00 (110) 115 $ 11.01 1,266
      17 Sale 100 $11.01 1,101 15 $ 11.00 165
      19 Purchase 400 $ 9.00 3,600 415 $ 9.07 3,765
      23 Sale 80 $ 9.07 726 335 $ 9.07 3,039
      Total 430 4,651 335 $ 9.07 3,039
    2. Sales:
      430 units × $24 $ 10,320
      Cost of goods sold $ 4,651
      Gross profit $ 5,669
      Gross profit % 54.93%
    3. Ending inventory balance, Jan 20, 2016: $1,395

    PROBLEM 6–4

    2015

    If ending inventory was overstated by $45,000, then COGS is understated causing net income to be overstated. This will cause equity to also be overstated.

    COGS Net Income Total Assets Equity
    Unadjusted balance $ 500,000 $ 250,000 $ 1,500,000 $ 1,400,000
    Correction 45,000 (45,000) (45,000) (45,000)
    Corrected balance $ 545,000 $ 205,000 $ 1,455,000 $ 1,355,000

    2016

    If ending inventory was overstated by $45,000 in 2015, then opening inventory will also be overstated in 2016. This will cause COGS to be overstated in 2016 causing net income to be understated. Since equity was overstated in 2015, this overstatement for 2016 will cancel out the previous year's error and equity will no longer contain any errors.

    COGS Net Income Total Assets Equity
    Unadjusted balance $ 660,000 $ 350,000 $ 1,400,000 $ 1,300,000
    Correction (45,000) 45,000 0 0
    Corrected balance $ 615,000 $ 395,000 $ 1,400,000 $ 1,300,000

    PROBLEM 6–5

    2015

    If ending inventory was understated by $30,000, then COGS is overstated causing net income to be understated. This will cause equity and total assets to also be understated.

    COGS Net Income Total Assets Equity
    Unadjusted balance $ 500,000 $ 250,000 $ 1,500,000 $ 1,400,000
    Correction (30,000) 30,000 30,000 30,000
    Corrected balance $ 470,000 $ 280,000 $ 1,530,000 $ 1,430,000

    2016

    If ending inventory was understated by $30,000 in 2015, then opening inventory will also be understated in 2016. This will cause COGS to be understated in 2016 causing net income to be overstated. Since equity was overstated in 2015, this understatement for 2016 will cancel out the previous year's error and equity will no longer contain any errors. There are no errors in the ending inventory for 2016, so there are no mis-statements for assets.

    COGS Net Income Total Assets Equity
    Unadjusted balance $ 660,000 $ 350,000 $ 1,400,000 $ 1,300,000
    Correction 30,000 (30,000) 0 0
    Corrected balance $ 690,000 $ 320,000 $ 1,400,000 $ 1,300,000

    PROBLEM 6–6

    1. LCNRV LCNRV
      Ceramic Wall Tiles: # of Units Cost/Unit NRV/Unit Total Cost Total NRV by Group by Product

      White

      1,025

      $ 5.00

      $ 6.00

      $ 5,125.00

      $ 6,150.00

      5,125

      Black

      875

      4.50

      4.25

      3,937.50

      3,718.75

      3,719

      Slate

      645

      7.00

      7.11

      4,515.00

      4,585.95

      4,515

      Beige

      325

      2.00

      2.25

      650.00

      731.25

      650

      14,227.50 15,185.95 $ 14,228
      Marble Flooring:

      Cordoba

      10,000

      9.25

      9.35

      92,500.00

      93,500.00

      92,500

      Carrerra

      12,000

      10.50

      10.50

      126,000.00

      126,000.00

      126,000

      Maricha

      8,000

      11.50

      11.45

      92,000.00

      91,600.00

      91,600

      310,500.00 311,100.00 310,500
      Shower Waterproofing:

      Novo

      10,035

      9.85

      9.50

      98,844.75

      95,332.50

      95,333

      Deetra

      15,000

      6.75

      7.15

      101,250.00

      107,250.00

      101,250

      200,094.75 202,582.50 200,095
      Totals $ 524,822.25 $ 524,822 $ 520,692
    2. No entry required by group.

      By individual product:

      General Journal
      Date Account/Explanation F Debit Credit
      Cost of goods sold 4,130
      Merchandise inventory 4,130
      ($524,822−520,692)

    PROBLEM 6–7

    1. Goods available for sale:
      Inventory, opening balance $ 420,364
      Purchases 1,323,280
      Purchase returns (18,270)
      Transportation-in 9,660 1,314,670
      Goods available for sale: $1,735,034
      Sales 1,667,610
      Sales returns (13,230)
      Net sales 1,654,380
      Estimated COGS
      ($1,654,380 × (1 − 34%)) (1,091,891)
      Estimated March 31, 2017 inventory $ 643,143
    2. Varane Ltd.

      Income Statement

      for the First Quarter ending March 31, 2017

      Sales $ 1,667,610
      Less: Sales returns and allowances 13,230
      Net sales 1,654,380
      Cost of goods sold 1,091,891
      Gross profit from sales 562,489 34%
      Operating expenses
      Total operating expenses 130,500
      Income before tax 431,989
      Income tax expense 129,597
      Net income $ 302,392

    PROBLEM 6–8

    1. At Cost At Retail
      Goods available for sale:
      Inventory, opening balance $ 659,890 $ 1,298,010
      Purchases 4,660,362 8,958,180
      Purchase returns (73,920) (167,090)
      Goods available for sale: $ 5,246,332 $ 10,089,100
      Sales $ 7,693,980
      Sales returns (62,440) $ 7,631,540
      Ending inventory at retail $ 2,457,560
      Ratio of Cost to retail ($5,246,332÷$10,089,100)×100 52.00%
      Ending inventory at cost $ 1,277,931
    2. Ceabane Ltd.

      Income Statement

      for the Six Months ending June 30, 2017

      Sales $ 7,693,980
      Less: Sales returns and allowances 62,440
      Net sales 7,631,540
      Cost of goods sold\(^{*}\) 3,968,401
      Gross profit from sales 3,663,139
      Operating expenses
      Total operating expenses 1,500,000
      Income before tax 2,163,139
      Income tax expense 648,942
      Net income $ 1,514,197

      \(^{*}\) $5,246,332−1,277,931=3,968,401

    PROBLEM 6–9

    1. Ending inventory for 2016 was overstated by $2,000. Thus, cost of goods sold should have been $2,000 higher, or $22,000 and gross profit $2,000 lower, or $28,000. Because of this mistake, the 2017 opening inventory was also overstated by $2,000, causing cost of goods sold to be overstated by $2,000 and gross profit to be understated by $2,000. Gross profit should have been $29,000.
    2. 2016 total and net assets were overstated by $2,000. 2017 total assets and net assets were correct.

    PROBLEM 6–10

    2017 2018
    Cost Market Unit Basis (LCNRV) Cost Market Unit Basis (LCNRV)
    Product X $14,000 $15,000 $14,000 $15,000 $16,000 $15,000
    Product Y 12,500 12,000 12,000 12,000 11,500 11,500
    Product Z 11,000 11,500 11,000 10,500 10,000 10,000

    Total

    $37,500

    $38,500

    $37,000

    $37,500

    $37,500

    $36,500

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