311solution8-03

© The McGraw-Hill Companies, Inc., 2004Solutions Manual, Vol.1, Chapter 8 8-1

Question 8-1

Question 8-2

Question 8-3Perpetual System Periodic System

(1) purchase of merchandise debit inventory debit purchases

(2) sale of merchandise debit cost of goods sold;credit inventory no entry

(3) return of merchandise credit inventory credit purchase returns

Question 8-4Inventory shipped f.o.b. shipping point is included in the inventory of the purchaser when the

merchandise reaches the common carrier. Laetner Corporation records the purchase in 2003 andincludes the shipment in its ending inventory. Bockner Company records the sale in 2003. Inventoryshipped f.o.b. destination is included in the inventory of the seller until it reaches the purchaser’slocation. Bockner would include the merchandise in its 2003 ending inventory and the sale/purchasewould be recorded in 2004.

Chapter 8 Inventories: Measurement

QUESTIONS FOR REVIEW OF KEY TOPICS

Inventory for a manufacturing company consists of (1) raw materials, (2) work in process, and (3)finished goods. Raw materials represent the cost, primarily purchase price plus freight charges, ofgoods purchased from other manufacturers that will become part of the finished product. Work-in-process inventory represents the products that are not yet complete. The cost of work in processincludes the cost of raw materials used in production, the cost of labor that can be directly traced to thegoods in process, and an allocated portion of other manufacturing costs, called manufacturing overhead.When the manufacturing process is completed, these costs that have been accumulated in work inprocess are transferred to finished goods.

Beginning inventory plus net purchases for the period equals cost of goods available for sale. Themain difference between a perpetual and a periodic system is that the periodic system allocates cost ofgoods available for sale to ending inventory and cost of goods sold only at the end of the period. Theperpetual system accomplishes this allocation by decreasing inventory and increasing cost of goods soldeach time goods are sold.

(4) payment of freight debit inventory debit freight-in


Answers to Questions (continued)

Question 8-5

Question 8-6

Question 8-7

Question 8-8

Question 8-9

A consignment is an arrangement under which goods are physically transferred to anothercompany (the consignee), but the transferor (consignor) retains legal title. If the consignee can’t find abuyer, the goods are returned to the consignor. Goods held on consignment are included in theinventory of the consignor until sold by the consignee.

By the gross method purchase discounts not taken are viewed as part of inventory cost. By the netmethod purchase discounts not taken are considered interest expense, because they are viewed ascompensation to the seller for providing financing to the buyer.

1. Beginning inventory — increase2. Purchases — increase3. Ending inventory — decrease4. Purchase returns — decrease5. Freight-in — increase

Four methods of assigning cost to ending inventory and cost of goods sold are (1) specificidentification, (2) first-in, first-out (FIFO), (3) last-in, first-out (LIFO), and (4) average cost. Thespecific identification method requires each unit sold during the period or each unit on hand at the endof the period to be traced through the system and matched with its actual cost. First-in, first-out (FIFO)assumes that units sold are the first units acquired. The last-in, first-out (LIFO) method assumes that theunits sold are the most recent units purchased. The average cost method assumes that cost of goods soldand ending inventory consist of a mixture of all the goods available for sale. The average unit costapplied to goods sold or ending inventory is an average unit cost weighted by the number of unitsacquired at the various unit prices.

When costs are declining, LIFO will result in a lower cost of goods sold and higher income thanFIFO. This is because LIFO will include in cost of goods sold the most recently purchased lower costmerchandise. LIFO also will provide a higher ending inventory in the balance sheet.


Answers to Questions (concluded)

Question 8-10

Question 8-11

Question 8-12

Question 8-13

Question 8-14

Proponents of LIFO argue that it provides a better match of revenues and expenses because cost ofgoods sold includes the costs of the most recent purchases. These are matched with sales that reflect acurrent selling price. On the other hand, inventory costs in the balance sheet generally are out of datebecause they are derived from old purchase transactions. It is conceivable that a company’s LIFOinventory balance could be based on unit costs actually incurred several years earlier. When inventoryquantity declines during a period, then these out-of-date inventory layers will be liquidated and cost ofgoods sold will match noncurrent costs with current selling prices.

Many companies choose the LIFO inventory method to reduce income taxes in periods whenprices are rising. In periods of rising prices, LIFO results in a higher cost of goods sold and therefore alower net income than the other methods. The companies’ income tax returns will report lower taxableincomes using LIFO and lower taxes will be paid currently. If a company uses LIFO to measure itstaxable income, IRS regulations require that LIFO also be used to measure income reported to investorsand creditors.

A LIFO inventory pool groups inventory units into pools based on physical similarities of theindividual units. The average cost for all of a pool’s beginning inventory and for all of a pool’spurchases during the period is used instead of individual unit costs. If the quantity of ending inventoryfor the pool increases, then ending inventory will consist of the beginning inventory plus a layer addedduring the period at the average acquisition cost for the pool.

The dollar-value LIFO method has important advantages. First, it simplifies the recordkeepingprocedures compared to unit LIFO because no information is needed about unit flows. Second, itminimizes the probability of the liquidation of LIFO inventory layers, even more so than the use ofpools alone, through the aggregation of many types of inventory into larger pools. In addition, firmsthat do not replace units sold with new units of the same kind can use the method.

After determining ending inventory at year-end cost, the following steps remain:

1. Convert ending inventory valued at year-end cost to base year cost.2. Identify the layers in ending inventory with the years they were created.3. Convert each layer’s base year cost measurement to layer year cost measurement using the

layer year’s cost index and then sum the layers.


Exercise 8-11. To record the purchase of inventory on account and the payment of freight charges.

Inventory........................................................................................ 4,000Accounts payable ...................................................................... 4,000

Inventory........................................................................................ 300Cash........................................................................................... 300

2. To record purchase returns.

Accounts payable........................................................................... 600Inventory ................................................................................... 600

3. To record cash sales and cost of goods sold.

Cash ............................................................................................... 5,000Sales revenue ............................................................................ 5,000

Cost of goods sold ......................................................................... 2,800Inventory ................................................................................... 2,800

EXERCISES


Exercise 8-21. To record the purchase of inventory on account and the payment of freight charges.

Purchases ....................................................................................... 4,000Accounts payable ...................................................................... 4,000

Freight-in ....................................................................................... 300Cash........................................................................................... 300

2. To record purchase returns.

Accounts payable........................................................................... 600Purchase returns ........................................................................ 600

3. To record cash sales.

Cash ............................................................................................... 5,000Sales revenue ............................................................................ 5,000

NO ENTRY IS MADE FOR THE COST OF GOODS SOLD.

Exercise 8-3

Requirement 1Beginning inventory $ 32,000Plus net purchases:

Purchases $230,000Less: Purchase discounts (6,000)Less: Purchases returns (8,000)Plus: Freight-in 16,000 232,000

Cost of goods available for sale 264,000Less: Ending inventory (40,000)Cost of goods sold $224,000


Requirement 2

Cost of goods sold (above)............................................................ 224,000Inventory (ending) ........................................................................ 40,000Purchase discounts......................................................................... 6,000Purchase returns............................................................................. 8,000

Inventory (beginning) .............................................................. 32,000Purchases .................................................................................. 230,000Freight-in .................................................................................. 16,000

Exercise 8-8

Requirement 1Purchase price = 100 units x $500 = $50,000 x .70 = $35,000

November 17, 2003Purchases ....................................................................................... 35,000

Accounts payable ...................................................................... 35,000

November 26, 2003Accounts payable .......................................................................... 35,000

Purchase discounts (2% x $35,000).......................................... 700Cash (98% x $35,000) .............................................................. 34,300

Requirement 2

November 17, 2003Purchases ....................................................................................... 35,000



Exercise 8-8 (concluded)

December 15, 2003Accounts payable........................................................................... 35,000

Cash........................................................................................... 35,000

Requirement 3

Requirement 1:

November 17, 2003Purchases (98% x $35,000) ........................................................... 34,300


November 26, 2003Accounts payable........................................................................... 34,300

Cash........................................................................................... 34,300

Requirement 2:

November 17, 2003Purchases (98% x $35,000) ........................................................... 34,300


December 15, 2003Accounts payable........................................................................... 34,300Interest expense (2% x $35,000) ................................................... 700

Cash........................................................................................... 35,000


Exercise 8-10Inventory balance before additional transactions $220,000Add: Merchandise on consignment with Joclyn Corp. 15,000Deduct: Merchandise shipped to Raymond f.o.b. destination on December 26 (30,000) Merchandise held on consignment from the Harrison Company (12,000) Correct inventory balance $193,000

Exercise 8-11Cost of goods available for sale:Beginning inventory (2,000 x $6.10) $12,200Purchases:

10,000 x $5.50 $55,000 6,000 x $5.00 30,000 85,000

Cost of goods available (18,000 units) $97,200

First-in, first-out (FIFO)

Cost of goods available for sale (18,000 units) $97,200 Less: Ending inventory (determined below) (15,000) Cost of goods sold $82,200

Cost of ending inventory:

Date ofpurchase Units Unit cost Total costAugust 18 3,000 $5.00 $15,000

Last-in, first-out (LIFO)

Cost of goods available for sale (18,000 units) $97,200 Less: Ending inventory (determined below) (17,700) Cost of goods sold $79,500


Date ofpurchase Units Unit cost Total costBI 2,000 $6.10 $12,200August 8 1,000 5.50 5,500

Total $17,700



Average cost

Cost of goods available for sale (18,000 units) $97,200 Less: Ending inventory (determined below) (16,200) Cost of goods sold $81,000 *

Cost of ending inventory: $97,200

Weighted-average unit cost = = $5.40 18,000 units

3,000 units x $5.40 = $16,200

* Alternatively, could be determined by multiplying the units sold by the average cost: 15,000 units x $5.40 = $81,000

Exercise 8-12First-in, first-out (FIFO)

Cost of goods sold:

Date of Cost of sale Units sold Units Sold Total Cost

Aug. 14 2,000 (from BI) $6.10 $12,200 6,000 (from 8/8 purchase) 5.50 33,000Aug. 25 4,000 (from 8/8 purchase) 5.50 22,000 3,000 (from 8/18 purchase) 5.00 15,000 Total 15,000 $82,200

Ending inventory = 3,000 units x $5.00 = $15,000


Last-in, first-out (LIFO)Date Purchased Sold Balance

Beginninginventory

2,000 @ $6.10 =$12,200

2,000 @ $6.10$12,200

August 8 10,000 @ $5.50 =$55,000

2,000 @ $6.1010,000 @ $5.50$67,200

August 14 8,000 @ $ 5.50 =$44,000

2,000 @ $6.10 2,000 @ $5.50$23,200

August 18 6,000 @ $5.00 =$30,000

2,000 @ $6.10 2,000 @ $5.50$53,200 6,000 @ $5.00

August 25 6,000 @ $5.00 =$30,000

1,000 @ $5.50 = $5,500

2,000 @ $6.10 1,000 @ $5.50$17,700

Endinginventory

Total cost of goods sold = $79,500



(Note: the perpetual inventory LIFO results are the same as periodic LIFO results would be, due tothe timing of sales and purchases. The same LIFO layers are on hand at the end of the period undereach method. This is unusual. LIFO perpetual and LIFO periodic normally produce different results forending inventory and cost of goods sold.)

Average costDate Purchased Sold Balance

Beginninginventory

2,000 @ $6.10 =$12,200

2,000 @ $6.10$12,200

August 8 10,000 @ $5.50 =$55,000

$67,200 =$5.60/unit12,000 units

August 14 8,000 @ $5.60 =$44,800

4,000 @ $5.60$22,400

August 18 6,000 @ $5.00 =$30,000

$52,400 =$5.24/unit10,000 units

August 25 7,000 @ $5.24 =$36,680

3,000 @ $5.24$15,720

Endinginventory



Exercise 8-14

Requirement 1Cost of goods available for sale:Beginning inventory (5,000 x $10.00) $ 50,000Purchases:

3,000 x $10.40 $31,2008,000 x $10.75 86,000 117,200

Cost of goods available (16,000 units) $167,200

Cost of goods available for sale (16,000 units) $167,200 Less: Ending inventory (below) (73,150) Cost of goods sold $ 94,050*


$167,200Weighted-average unit cost = = $10.45

16,000 units

7,000 units x $10.45 = $73,150

* Alternatively, could be determined by multiplying the units sold by the average cost: 9,000 units x $10.45 = $94,050



Requirement 2

Date Purchased Sold Balance

Beginninginventory

5,000 @ $10.00 =$50,000

5,000 @ $10.00$50,000

September 7 3,000 @ $10.40 =$31,200

$81,200 =$10.15/unit8,000 units

September10

4,000 @ $10.15 =$40,600

4,000 @ $10.15$40,600

September25

8,000 @ $10.75 =$86,000

$126,600 =$10.55/unit12,000 units

September29

5,000 @ $10.55 =$52,750

7,000 @ $10.55$73,850

Ending inventory



Exercise 8-17

Requirement 1Cost of goods sold:50,000 units x $9 = $450,000 6,000 units x $7 = 42,000

$492,000

Requirement 2When inventory quantity declines during a period, liquidation of LIFO inventory layers carried at

lower costs prevailing in prior years results in noncurrent costs being matched with current sellingprices. If the resulting effect on income is material, it must be disclosed. In this case, the effect of theLIFO layer liquidation is to increase income (ignoring taxes) by $12,000 [6,000 units liquidated x $2($9 current year cost per unit - $7 LIFO layer cost per unit)].

Exercise 8-18

MAYTAG WHIRLPOOL

Gross profit ratio = 1,146 = 27% 2,487 = 24% 4,248 10,325

Inventory turnover = 3,102 = 7.63 7,838 = 7.18 406.5 1,092

Average days = 365 = 48 days 365 = 51 days in inventory 7.63 7.18

Maytag's gross profit ratio (27%) is slightly higher than Whirlpool's (24%). Maytag’s turnoverratio also is higher (7.63 compared to 7.18).


Exercise 8-20Ending

Ending Inventory Inventory Layers Inventory Layers Inventory Date at Base Year Cost at Base Year Cost Converted to Cost DVL Cost

12/31/03 $200,000 = $200,000 $200,000 (base) $200,000 x 1.00 = $200,000 $200,000 1.00

12/31/04 $231,000 = $220,000 Index = 1.05 Index

$200,000 (base) $200,000 x 1.00 = $200,000 20,000 (2004) 20,000 x 1.05 = 21,000 221,000

12/31/05 $299,000 = $260,000 Index = 1.15 Index

$200,000 (base) $200,000 x 1.00 = $200,000 20,000 (2004) 20,000 x 1.05 = 21,000 40,000 (2005) 40,000 x 1.15 = 46,000 267,000

12/31/06 $300,000 = $250,000 Index = 1.20 Index

$200,000 (base) $200,000 x 1.00 = $200,000 20,000 (2004) 20,000 x 1.05 = 21,000 30,000 (2005) 30,000 x 1.15 = 34,500 255,500


Exercise 8-22

List A List B

i 1. Perpetual inventory system a. Legal title passes when goods are delivered to common carrier.

l 2. Periodic inventory system b. Goods are transferred to another company but title remains with transferor.

a 3. F.o.b. shipping point c. Purchase discounts not taken are included in inventory cost.

c 4. Gross method d. If LIFO is used for taxes, it must be used for financial reporting.

g 5. Net method e. Items sold are those acquired first. h 6. Cost index f. Items sold are those acquired last. k 7. F.o.b. destination g. Purchase discounts not taken are considered interest

expense. e 8. FIFO h. Used to convert ending inventory at year-end cost to

base year cost. f 9. LIFO i. Continuously records changes in inventory. b 10. Consignment j. Items sold come from a mixture of goods acquired

during the period. j 11. Average cost k. Legal title passes when goods arrive at location. d 12. IRS conformity rule l. Adjusts inventory at the end of the period.

Problem 8-4

Requirement 1Beginning inventory (10,000 x $8.00) $ 80,000Net purchases:

Purchases (50,000* units x $10.00) $500,000Less: Returns (1,000 units x $10.50) (10,500)Less: Purchase discounts ($500,000 x 60% x 2%) (6,000)Plus: Freight-in (50,000 units x $.50) 25,000 508,500

Cost of goods available (59,000 units) 588,500Less: Ending inventory (below) (122,000)Cost of goods sold $466,500

* The 5,000 units purchased on December 28 are not included. The merchandise was shippedf.o.b. destination and did not arrive at Johnson’s warehouse until 2004.



Date ofpurchase Units Unit cost Total costBI 10,000 $ 8.00 $ 80,0002003 4,000 10.50** 42,000

Total 14,000 $122,000

** Includes freight charge of $.50 per unit.

Requirement 2Sales (45,000 units x $18.00) $810,000Less: Cost of goods sold (above) $466,500 Other operating expenses 150,000 (616,500)Income before income taxes $193,500

Problem 8-10Ending

Ending Inventory Inventory Layers Inventory Layers Inventory Date at Base Year Cost at Base Year Cost Converted to Cost DVL Cost

1/1/03 $400,000 = $400,000 $400,000(base) $400,000 x 1.00 = $400,000 $400,000 1.00

12/31/03 $441,000 = $420,000 $400,000 (base) $400,000 x 1.00 = $400,000 1.05 20,000 (2003) 20,000 x 1.05 = 21,000 421,000

12/31/04 $487,200 = $435,000 $400,000 (base) $400,000 x 1.00 = $400,000 1.12 20,000 (2003) 20,000 x 1.05 = 21,000

15,000 (2004) 15,000 x 1.12 = 16,800 437,800

12/31/05 $510,000 = $425,000 $400,000 (base) $400,000 x 1.00 = $400,000 1.20 20,000 (2003) 20,000 x 1.05 = 21,000

5,000 (2004) 5,000 x 1.12 = 5,600 426,600

Judgment Case 8-1Advance warning of the company's impending bankruptcy existed at the date of the financial

statements. As a rule, inventories should rise in tandem with sales. If inventories rise faster, it may be


because the goods simply aren't selling. This is particularly true of companies in faddish or seasonalbusinesses — Merry-Go-Round's world.

The company's report showed that inventories on January 30 were $82.2 million, up 37 percentfrom $60 million a year earlier. That's well above the 15 percent sales growth in the same period, to$877.5 million from $761.2 million. This alone should have been a major cause for concern. Itindicated the company's goods simply weren't selling as rapidly as it expected, causing its inventories tobulge. The increase in receivables from $6,195 to over $6 million should also have been cause forconcern.

Judgment Case 8-5At the end of a reporting period it is important to ensure that a proper inventory cutoff is made. A

proper cutoff involves the determination of the ownership of goods that are in transit between thecompany and its customers as well as the company and its suppliers. If the shipment is made f.o.b.shipping point, then ownership is transferred to the buyer when the goods reach the common carrier. Ifthe shipment is made f.o.b. destination, then ownership is transferred to the buyer when the goods arriveat the buyer’s location.

In this case, John is incorrect if the goods were shipped f.o.b. destination. If so, even though thecompany is not in physical possession of the goods, they should be included in ending inventorybecause the shipment had not reached the buyer's location by the end of the reporting period.


Ethics Case 8-6

Requirement 1Without purchase of the additional units:Sales (35,000 @ $60) $2,100,000Cost of goods sold (35,000 x $30) (1,050,000)Gross profit $1,050,000

Due Jim Lester ($1,050,000 x 20%) = $210,000

With purchase of the additional units:Sales $2,100,000Cost of goods sold: 20,000 x $40 $800,000 15,000 x $30 450,000 (1,250,000)Gross profit $ 850,000

Due Jim Lester ($850,000 x 20%) = $170,000

Requirement 2Discussion should include these elements.

Facts:If Moncrief purchases the additional units at year end under a periodic LIFO inventory system, the

transaction results in a reduced payment to Jim Lester, reduced profits to shareholders, and reducedincome tax payments to government entities. By purchasing the additional units of Zelenex, Moncriefreduces Jim Lester's payment by $40,000 ($210,000 - $170,000) and decreases gross profit by $200,000($1,050,000 - $850,000). The net effect on before-tax income is a decrease of $160,000 ($200,000 -$40,000). Since Moncrief does not intend to sell the units until 2004, the only logical reason forpurchasing more costly inventory at year-end is profit manipulation.

Ethical Dilemma:Should Moncrief exercise its right to purchase inventory at will, resulting in a reduction in net

income, or recognize the rights of Jim Lester to receive profit for the sale of his product, shareholders'rights to have their investment appreciate through positive earnings, and government entities' rights tocollect tax on economic net income?

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