Chapter 08 Solution of fundamental of financial accouting by EDMONDS (4th edition)

ANSWERS TO QUESTIONS - CHAPTER 8

1. 1. First In, First Out - The inventory cost flow method that assumes that the first items purchased are the first items sold for the purpose of computing cost of goods sold and inventory.

2. Last In, First Out - The inventory cost flow method that assumes that the first items purchased are the last items sold for the purpose of computing cost of goods sold and inventory.

3. Weighted Average - The inventory cost flow method that allocates cost between cost of goods sold and inventory based on an average cost per unit.

4. Specific Identification - The inventory cost flow method that assigns cost to cost of goods sold based on the specific cost of each unit sold.

2. One advantage of the specific identification method is that both the inventory account and cost of goods sold reflect the actual amounts on hand and sold. This method is usually required for high cost items such as automobiles, boats, etc. One disadvantage of this method is that recordkeeping can become burdensome for high-volume, lower-priced items.

3. FIFO allocates the cost of the first units purchased to the first units sold; consequently, in a period of rising prices, this would produce a larger net income. This may be an advantage for the purpose of financial reporting if reporting a higher profit is desired. However, this is a disadvantage for tax reporting because a higher profit means paying more tax. FIFO also tends to best match physical flow for most products.

4. LIFO allocates the cost of the last units purchased to the first units sold; consequently, in a period of rising prices, this would produce a smaller net income. This may be a disadvantage for the purpose of financial reporting if

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reporting a higher profit is desired. However, for tax reporting, a lower profit means paying less tax.

5. In an inflationary period, i.e., a period where prices are consistently rising, FIFO will produce the largest amount of income. This is true because the items purchased first (and at the lowest cost) are the items that are deemed sold first (these are the items whose cost is charged to expense). The highest cost items remain in the asset account inventory. Since the lowest cost items have been expensed, net income will be larger than it would assuming a LIFO flow.

6. In an inflationary period, FIFO will produce the largest amount of total assets. (Refer to the discussion for Question 5.) The unsold items, inventory, are the highest cost items. Consequently, assuming rising prices, FIFO flow produces a higher inventory amount than would be the case under a LIFO flow.

7. Flow of costs refers to the assumption that is made for the purpose of determining the cost of inventory items that are sold when preparing financial statements. The cost flow assumption that a business makes may have nothing to do with the actual flow of inventory into and out of the business. The physical flow of goods refers to the actual timing of when goods are sold. For example, a grocery store may use a FIFO cost flow assumption for financial statement purposes and this may reflect the physical flow of some inventory items but not others. The grocer will put the oldest detergent on the shelf for the customer to purchase (FIFO) but may display the last produce purchased (the freshest) for the customer to buy.

8. In a world where there is no income tax, the choice of cost flow method would not affect the statement of cash flows because it is simply allocating some of the cost of inventory purchased to expense and the remainder to assets. The statement of cash flows is affected when cash is received for goods sold and when cash is paid for goods purchased. However, most businesses do face income tax consequences. In that situation, the difference in tax paid

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based on each cost flow assumption would cause a difference in the cash flow statement. In a period of rising prices, LIFO would produce a smaller cash outflow for the payment of tax, because a smaller amount of income tax would be paid on a smaller amount of income.

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9. Key Company (first year of operations):

Beginning inventory $ -0-

Merchandise purchased 1,000 units @ 25 25,000

Cost of Goods Sold 850 units @ 25 21,250

Ending Inventory 150 units @ 25 3,750

Cost of goods sold will be the same for all methods because all items were purchased for the same cost. Consequently, it will not make any difference whether the first unit sold is assumed to be the first or last purchased. Weighted average will also be the same.

10. The amount of cost of goods sold for Key Company will be different using different cost flow assumptions because the units purchased during the second year have a different cost than those purchased the previous year.

Beginning inventory 150 units @ 25 $ 3,750Merchandise purchased1,500 units @ 27 40,500Total 1,650 $44,250

Units sold 1,500

FIFO: 150 units @ 25 $ 3,7501,350 units @ 27 36,450

Cost of Goods Sold 1,500 $40,200

LIFO 1,500 units @ 27 $40,500Cost of Goods Sold $40,500

Weighted Average: Total Cost Total Units = Cost per unit

44,250 1,650 = $26.82 per unitCost of Goods Sold: 1,500 units @ 26.82 = $40,230

11. It may be advantageous to use FIFO for financial statement purposes because it produces the smallest cost of goods sold and consequently, the largest gross margin

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and net income. It also produces the largest amount of assets. However, a larger net income produces a higher income tax expense, so LIFO would be more desirable strictly from an income tax perspective in that the cost of goods sold would be larger, and consequently the net income and income tax paid will be smaller. Since each cost flow method is desirable for a specific group of users, the cost flow assumptions chosen must be the best for the business overall. A part of that consideration is the ease of applying each method.

12. In an inflationary period, for a business subject to income tax, LIFO would produce the larger amount of cash flow because the smaller net income (larger cost of goods sold) would result in a smaller amount of income tax being paid.

13. A deflationary period, i.e., a period of falling prices, would produce results opposite of those for an inflationary period. FIFO would produce the smallest amount of net income, because the goods purchased first would cost more than the goods purchased last. This would cause a larger amount of cost to be expensed resulting in a lower net income. LIFO would produce the largest net income.

14. When using a perpetual inventory system, each item purchased is added to inventory and each item sold is taken out of inventory. When using the periodic inventory system, all items purchased are charged to a purchases account. At the end of the period, a physical count is made to determine the amount of goods in inventory.

15. "Lower of cost or market" is an accounting convention that helps to reduce overstating inventory (assets) when the market value of certain items has fallen below the original cost. It is a conservative accounting measure that helps to prevent any material misstatement of the asset inventory.

16. For merchandise that has declined in value, the "lower of cost or market" rule will cause a reduction in the asset account inventory and result in an overall reduction of

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total assets. This causes more cost to be shifted to cost of goods sold, thus causing net income to be lower.

17. In certain situations it is not possible or practical to take a complete inventory. One such situation is when the inventory or part of it has been destroyed by some disaster or similar event. Another situation where it is not practical to take inventory is when monthly or quarterly financial statements are prepared when the periodic inventory method is used. It is not cost effective to physically count inventory of any size on a regular basis. In a third situation, when the periodic method is used, inventory may be estimated on a monthly or weekly basis to provide information for insurance coverage.

18. It is generally easier to manipulate net income when a periodic inventory system is used. There is no accounting for inventory at the time it is sold. There is very little control over the inventory (as far as the accounting records are concerned) except at the end of the year. The only measurement available is the amount of inventory still on hand. There is no control over the amount that was sold, damaged, or stolen. In addition, if the inventory is counted wrong or priced wrong, the amount of cost of goods sold will also be determined incorrectly. For a business owner wishing to manipulate profit, it is easy to either overstate or understate the amount of ending inventory.

19. Goods Available for Sale $123,000Sales $130,000Less: Estimated GrossMargin ($130,000 x .25) (32,500) Cost of Goods Sold (97,500) Estimated Ending Inventory $

25,500

20. When using the periodic method, an overstated ending inventory at the end of 2001 will result in an understated cost of goods sold (expense). If cost of goods sold is understated, then net income will be overstated. Since the ending inventory used to compute cost of goods sold

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is the same inventory that is listed as an asset on the balance sheet, assets will also be overstated for 2001. In addition, the ending inventory for 2001 is the beginning inventory for 2002. If the beginning inventory is overstated, the total cost of goods available for sale for 2002 will be overstated. Assuming the ending inventory is correct for 2002, cost of goods sold will then be overstated in 2002 because goods available for sale (more specifically, beginning inventory was overstated). The overstatement of cost of goods sold for 2002 will cause gross margin and net income to be understated in 2002. There is no effect on the 2002 balance sheet, assuming the 2002 ending inventory is correct.

21. The inventory turnover tells the user how many times average inventory has been sold during the year.

22. Discount merchandisers such as Wal-Mart and K-Mart should have a high inventory turnover.Specialty stores such as exclusive jewelers and antique shops will have a low inventory turnover.

23. Operating Cycle = average number of days to sell inventory + average number of days to collect receivables.

24. Historical cost information is used in financial statements because it is reliable and objective, whereas market value is often subjective and difficult to determine.

25. FASB requires market value information to be disclosed for certain types of investment securities and inventory.

26. Market value of marketable investment securities is easy to determine because the securities are traded daily in established markets.

Some items of property, plant and equipment may be difficult to value at FMV. Such items may not have a ready market and accountants/management may not be able to agree on an appraised value.

27. The two primary types of investment securities are debt and equity securities.

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28. A debt security is acquired by loaning assets to the investee. Examples include bonds, notes, certificates of deposit, and commercial paper.

29. An equity security is acquired when an investor gives assets or services to an investee in exchange for an ownership interest in the investee. Examples are common and preferred stock.

30. The primary securities market is made up of transactions directly between the investee and investors. The secondary securities market refers to securities exchanges between investors.

31. Marketable securities are those that are regularly traded in established secondary markets.

32. The three categories of investment securities are:Held-to-maturity: the investor has the intent and ability to hold the securities until maturity.

Trading: securities that are bought and sold for the purpose of generating profits on the short-term appreciation of stock and/or bond prices.

Available-for-sale: all marketable securities not properly classified as Held-to-Maturity or Trading.

33. The equity method must be used to account for investments in equity securities when the investor exercises significant influence (i.e., 20%-50% ownership) over the investee.

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SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 8

EXERCISE 8-1A

a. FIFO

b. FIFO

c. FIFO

d. Weighted Average

e. LIFO

f. Weighted Average

g. LIFO

h. LIFO

8-9

EXERCISE 8-2A

Tyler Co.First Purchase $3,000Second Purchase 4,000Total $7,000

(a) (b) (c)FIFO LIFO W. AVG.

Cost of Goods Sold $3,000 $4,000 $3,500*

Ending Inventory 4,000 3,000 3,500*

*Average Cost per Unit: $3,000 + $4,000 = $7,000;$7,000 2 = $3,500

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EXERCISE 8-3AThe Breckin CompanyInventory Purchases

Beginning Inventory 100

@ $40 = $ 4,000

First Purchase 150

@ 60 = 9,000

Second Purchase 200

@ 68 = 13,600

Goods Available for Sale

450

$26,600

a. Cost of Goods Sold:

FIFO UnitsCost per Unit

Cost of Goods Sold

From Beginning Inventory

100 @ $40 = $ 4,000

From First Purchase 150 @ 60 = 9,000From Second Purchase 10 @ 68 = 680Total Units Sold 260 $13,680

Ending Inventory: 190 units @ Second Purchase Cost of $68 =

$12,920

b. Cost of Goods Sold:

LIFO UnitsCost per Unit

Cost of Goods Sold

From Second Purchase 200 @ $68 = $13,600From First Purchase 60 @ 60 = 3,600Total Units Sold 260 $17,200

Ending Inventory: 190 units. 90 @ first purchase price $60 = $5,400 100 @ Beginning Inv. Cost of $40 =

$4,000c. $9,400

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Weighted Average:

Total Cost Total Units

= Cost per Unit

$26,600 450 = $59.111

Cost of Goods Sold 260 units

@ $59.111

= $15,368.89

Ending Inventory: 190 units

@ $59.111

= $11,231.11

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EXERCISE 8-4A

a. (1) Porter CompanyFIFO

Sales (320 @ $30) $9,600

Cost of Goods Sold:From Beginning

Inv. 50 units @ $10

= $ 500

From Purchases 270 units @ $15

= 4,050 (4,550)

Gross Margin $5,050

a. (2)LIFO

Sales (320 @ $30) $9,600

Cost of Goods Sold:From Purchases 275 units @

$15= $4,125

From Beg. Inv. 45 units @ $10

= 450 (4,575)

Gross Margin $5,025

a. (3)Weighted Average

Sales (320 @ $30) $9,600

Cost of Goods Sold:Average Cost per

Unit320 @ $14.23*

= $4,554 (4,554)

Gross Margin $5,046

*Total cost $4,625 Total units 325 = $14.23 Cost per unit

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b. $25 ($5,050 $5,025). The difference in net income would be the same as the difference in gross margin, assuming there are no income tax considerations.

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EXERCISE 8-4A (cont.)

c.FIFO LIFO W. Avg.

Cash Flows From Operating Activities:

Cash Inflow from Customers $9,600 $9,600 $9,600Cash Outflow for Inventory (4,625) (4,625) (4,625)

Net Cash Flow from Operating Act.

$4,975 $4,975 $4,975

Net cash flow from operating activities will be the same for all three methods because the amount of cash from sales and the amount of cash paid for inventory is the same regardless of the method of cost flow assumed. If the company were subject to income tax, the amount of cash paid for tax expense would be different because the amount of taxable income would be different.

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EXERCISE 8-5A

McKee SalesSummary of Purchase Transactions

1/20 Purchased Units

450 @ $20 = $ 9,000


200 @ 24 = 4,800


100 @ 30 = 3,000


75 @ 18 = 1,350

Available for Sale

825 $18,150

a. (1)


Ending InventoryFrom 9/19

Purchase75 @ $18 = $1,350

From 7/25 Purchase

25 @ $30 = 750

Total Ending Inventory

100 $2,100

a. (2)LIFO Units Cost

per Unit


Purchase100 @ $20 = $2,000


100 $2,000

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Total Cost Total Units = Cost per Unit

$18,150 825 = $22

Ending Inventory 100 units @ $22= $2,200

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b.FIFO

Sales (725 units @ $50) $36,250

Cost of Goods SoldCost of Goods Avail. for

Sale*$18,150

Less: Ending Inventory (2,100)Cost of Goods Sold (16,050)

Gross Margin $20,200

LIFO

Sales (725 units @ $50) $36,250


Sale*$18,150

Less: Ending Inventory (2,000)Cost of Goods Sold (16,150)


*This amount is computed in the Summary of Purchase Transactions at the beginning of the problem.

Difference in Gross Margin: $20,200 $20,100 = $100

Note to Instructor: Cost of goods sold can be computed on a units sold basis rather than subtracting ending inventory from goods available for sale.

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EXERCISE 8-6A

a.Foley Company

Income Statements

FIFO

Sales (3,400 @ $20)

$68,000


Inv. 500 units @ $10

= $ 5,000

From 4/1 Purchase

2,500 units @ $11

= 27,500

From 10/1 Purchase

400 units @ $14

= 5,600

Cost of Goods Sold

(38,100)

Gross Margin 29,900

Operating Expenses

(17,000)

Income Before Tax 12,900Income Tax Expense

(30%) (3,870)

Net Income $ 9,030

LIFO

Sales (3,400 @ $20)

$68,000

Cost of Goods Sold:From 10/1

Purchase 800 units @ $14

= $11,200

From 4/1 Purchase

2,500 units @ $11

= 27,500

From Beginning Inv.

100 units @ $10

= 1,000

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Cost of Goods Sold

(39,700)

Gross Margin 28,300

Operating Expenses

(17,000)


(30%) (3,390)

Net Income $ 7,910


b. Income tax savings would be the difference between the tax using FIFO and the tax using LIFO, or $3,870 $3,390 = $480.

c.Foley Company

Cash Flows from Operating Activities

FIFO LIFO


Cash Inflow from Customers $68,000 $68,000Cash Outflow for Inventory* (38,700) (38,700)Cash Outflow for Operating

Expenses(17,000) (17,000)

Cash Outflow for Income Tax Expense

(3,870) (3,390)

Net Cash Flow from Operating Activities

$ 8,430 $ 8,910

*Computation of cash paid for inventory:

4/1 Purchase 2,500 units @ $11 =$27,50010/1 Purchase 800 units @ 14 = 11,200

$38,700

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d. More income tax must be paid on the higher amount of net income reported under FIFO.

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EXERCISE 8-7A a.Tiny Tots Company

Effect of Events on Financial Statements

Panel 1: FIFO Cost Flow

Event

Cash + Inv. = C. Stk. + Ret. Ear.

Rev. Exp. = Net Inc.

Cash Flows

1. 125,000 + NA = NA + 125,000

125,000

NA = 125,000

125,000OA

2. (35,000) + 35,000 = NA + NA NA NA = NA (35,000)OA

3. (28,500) + 28,500 = NA + NA NA NA = NA (28,500)OA

4. NA + (44,500)1

= NA + (44,500)

NA 44,500

= (44,500)

NA

5. (32,200)2

+ NA = NA + (32,200)

NA 32,200

= (32,200)

(32,200)OA

Bal. 29,300 + 19,000 = NA + 48,300 125,000

76,700

= 48,300 29,300 NC

Panel 2: LIFO Cost Flow

Event

Cash + Inv. = C. Stk + Ret. Ear.


Cash Flows

1. 125,000 + NA = NA + 125,000

125,000

NA = 125,000

125,000OA

2. (35,000) + 35,000 = NA + NA NA NA = NA (35,000)OA

3. (28,500) + 28,500 = NA + NA NA NA = NA (28,500)OA

4. NA + (46,000)3

= NA + (46,000)

NA 46,000

= (46,000)

NA

5. (31,600)4

+ NA = NA + (31,600)

NA 31,600

= (31,600)

(31,600)OA

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Bal. 29,900 + 17,500 = NA + 47,400 125,000

77,600

= 47,400 29,900 NC

1Cost of Goods Sold -- FIFO: 4/2 200 units @ $175 =$35,0009/1 50 units @ $190 = 9,500 Total $44,500

2Income Tax Expense: ($125,000 $44,500) x 40% = $32,200.3Cost of Goods Sold -- LIFO: 9/1 150 units @ $190 = $28,500

4/2 100 units @ $175 = 17,500 Total $46,000

4Income Tax Expense ($125,000 $46,000) x 40% = $31,600.

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b. Net Income assuming FIFO cost flow: $48,300 (see statements model above).

c. Net Income assuming LIFO cost flow: $47,400 (see statements model above).

d. LIFO produces a lower income tax of $600 ($32,200 $31,600). This results because a larger amount of inventory is expensed resulting in a lower income before tax. The last purchase was bought at a higher price than the first purchase.

e. The difference in cash flow from operating activities is caused by the difference in income tax paid of $600. LIFO will produce a larger cash flow because there was $600 less income tax paid.

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EXERCISE 8-8A

a.Nikols Company - General Journal

Date Account Titles Debit Credit

1/1/04 Merchandise Inventory (250 @ $10)

2,500

Cash 2,500

4/1a Cash (125 @ $18) 2,250Sales Revenue 2,250

4/1b Cost of Goods Sold (125 @ $11)

1,375

Merchandise Inventory 1,375

8/1 Merchandise Inventory (400 @ $11)

4,400

Cash 4,400


12/1b Cost of Goods Sold* 5,250Merchandise Inventory 5,250

*Cost of Goods Sold: 50 @ $11 = $ 550250 @ $10 = 2,500200 @ $11 = 2,200

$5,250

b. Ending Inventory: 200 units @ $11 = $2,200.

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EXERCISE 8-9A

a. Spring Hill, Inc.

Date Purchased Sold Inventory BalanceUnits Cost Total Units Cost Total Units Cost Total

1/1 Beg. Inv.

50 @ $20 = $1,000

3/15 Pur. 200 @

$24 =$4,800 50 @200 @

$20$24

==

$1,000$4,800

5/30 Sold 50 @120

@

$20$24

==

$1,000$2,880 80 @ $24 =

-0-$1,920

8/10 Pur 275 @

$25 =$6,87580 @

275 @$24$25

==

$1,920$6,875

11/20 Sold

80 @ $24 = $1,920 -0-

260 @ $25 = $6,500 15 @ $25 = $375

Ending Inventory: 15 units @ $25 = $375

b. A problem arises when LIFO is applied to intermittent sales and purchase transactions. LIFO requires that the unit cost of the last purchase be applied to the first units sold. However, at the time of the first sale, that cost is not known. This problem is often overcome by recording only quantities of units sold on a perpetual basis. At the end of the accounting period, costs are then assigned perpetually to the units that have been sold.

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EXERCISE 8-10Aa.

Auto Parts, Co.a. b. c. d. e. f. g. h.

Item

Quantity

Cost Per Unit

Mkt. Val.per Unit

Unit LowerCost/Mkt.

Total Cost

Total Market

Ind. Item

Lower Cost/Mkt.

(b x c) (b x d) (b x e)P 100 $4 $3 $3 $400 $300 $300D 50 5 4 4 250 200 200S 20 6 7 6 120 140 120J 15 5 4 4 75 60 60

$845 $700 $680

1. Ending inventory using the individual item method: $6802. Ending inventory using the aggregate method: $700

b.


1. Cost of Goods Sold* 165Merchandise Inventory 165

2. Cost of Goods Sold** 145Merchandise Inventory 145

*$845 $680 = $165**$845 $700 = $145

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EXERCISE 8-11A

a.a. b. c. d. e. f. g.

Item Quantity

Cost Per Unit

Market Per Unit

Unit Lower

Cost/Mkt.

Total Cost

Total Lower

Cost/Mkt.

(b x c) (b x e)O 200 $10 $ 9 $ 9 $2,000 $1,800J 250 15 14 14 3,750 3,500R 175 5 8 5 875 875

Totals

$6,625 $6,175

The inventory would be carried at $6,175, the lower of cost or market applied to individual inventory items.

b. Under the periodic method, the amount of ending inventory would be shown at the lower of cost or market in the schedule of cost of goods sold. By lowering the ending inventory, cost of goods sold is increased. The loss is automatically included in cost of goods sold.

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EXERCISE 8-12A Rick’s Fishing Supplies

a. Gross Margin: Sales x Gross Margin % $550,000 x 20% = $110,000

b. Cost of Goods Sold: Sales x Cost of Goods Sold % $550,000 x 80% = $440,000

c. Computation of Ending Inventory:

Beginning Inventory $100,000Plus: Purchases 400,000Goods Available for Sale 500,000Less: Cost of Goods Sold (Est.) (440,000 ) Ending Inventory (Est.) $ 60,000

d. Lost Inventory: Estimated Ending Inventory $60,000Less: Undamaged Inventory (8,000 ) Inventory Lost $52,000

EXERCISE 8-13A

June 14 Inventory Account Balance

$164,000

Less: Cost of Unrecorded Sale (21,000)Balance in the Warehouse 143,000

Less: 5% Shrinkage (7,150)Less: Amount of Inventory in Showroom

(37,500)

Inventory Lost $ 98,350

8-29

EXERCISE 8-14A

Marshall Company

The uncounted inventory will only affect The Marshall Company’s financial statements if the book amount of the inventory is actually written down to the counted amount. The perpetual system records the actual amount of goods as they are purchased and sold. However, if an adjustment is actually made on the books, the reduction in inventory would cause cost of goods sold to be overstated, gross margin and net income to be understated, and total assets and total stockholders’ equity to be understated.

EXERCISE 8-15A

Tedall Company

Item Number

Year Amount Affected Effect

1. 2005 Beginning Inventory NA2. 2005 Purchases NA3. 2005 Goods Available for

SaleNA

4. 2005 Cost of Goods Sold Overstated5. 2005 Gross Margin Understate

d6. 2005 Net Income Understate

d7. 2006 Beginning Inventory Understate

d8. 2006 Purchases NA9. 2006 Goods Available for

SaleUnderstated

10. 2006 Cost of Goods Sold Understate

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d11. 2006 Gross Margin Overstated12. 2006 Net Income Overstated

8-32

EXERCISE 8-16A

Asset FMV LCM HC/AC

Buildings XAvailable-for-Sale Securities

X

Office Equipment XInventory XSupplies XLand XTrading Securities XCash X XHeld-to-Maturity Securities

X

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EXERCISE 8-17A

a.

Balance Sheet Income Statement Stmt. ofType Cas

h+ Inv.

Sec.= Liab

.+ S.

EquityRev

. Exp

.Net Inc.

Cash Flows

Held + NA NA NA NA NA IATrading + NA NA NA NA NA OAAvailable

+ NA NA NA NA NA IA

b.

Martinez BrothersComputation of Net Income

Classified as:Held-to-Maturity Trading

Available-for-Sale

Revenue $5,000 $5,000 $5,000

Expenses (1,500) (1,500) (1,500)

Unrealized Loss -0- (1,500) -0-

Net Income $3,500 $2,000 $3,500

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EXERCISE 8-18A a. Tony ElectronicsHorizontal Statements Models

(1) Held-to-MaturityBalance Sheet Income Statement Statement

Event

Cash + Inv. Sec.

= Liab. + Ret. Ear.

+Unreal. Gain.

Rev./Gain

Exp./Loss = Net Inc.

ofCash Flows

1. (150,000)

+ 150,000

= NA + NA + NA NA NA = NA (150,000)IA

2. 9,000 + NA = NA + 9,000 + NA 9,000 -0- = 9,000 9,000OA

3. 30,000 + (25,000)

= NA + 5,000 + NA 5,000 -0- = 5,000 30,000 IA

4. NA + NA = NA + NA + NA NA NA NA NATot. (111,000

)+ 125,00

0= -0- + 14,000 + -0- 14,000 -0- = 14,000 (111,000)

NC

(2) Trading

Event

Cash + Inv. Sec.

= Liab.

+ Ret. Ear.

+Unreal.

Gain

Rev./Gain

Exp./Loss = Net Inc. Cash Flow

1. (150,000)

+ 150,000

= NA + NA + NA NA NA = NA (150,000)OA

2. 9,000 + NA = NA + 9,000 + NA 9,000 NA = 9,000 9,000 OA3. 30,000 + (25,00

0)= NA + 5,000 + NA 5,000 NA = 5,000 30,000 OA

4. NA + (25,000)

= NA + (25,000)

+ NA NA 25,000 = (25,000)

NA

Tot. (111,000)

+ 100,000

= -0- + (11,000)

+ -0- 14,000

25,000 = (11,000)

(111,000)NC

(3) Available-for-Sale

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Event

Cash + Inv. Sec.

= Liab.

+ Ret. Ear.

+Unreal.

GainRev./Gain

Exp./

Loss= Net

Inc.Cash Flow

1. (150,000)

+ 150,000

= NA + NA + NA NA NA = NA (150,000) IA

2. 9,000 + NA = NA + 9,000 + NA 9,000 NA = 9,000 9,000 OA3. 30,000 + (25,00

0)= NA + 5,000 + NA 5,000 NA = 5,000 30,000 IA

4. NA + (25,000)

= NA + NA + (25,000)

NA NA = NA NA

Tot. (111,000)

+ 100,000

= -0- + 14,000 + (25,000)

14,000 -0- = 14,000 (111,000)NC

8-36


b. Held-to-Maturity $14,000Trading $(11,000)Available-for-Sale $14,000

c. The amount of change in cash from these activities is the same for all three classifications ($111,000). Held-to-maturity and available-for-sale securities each had net cash inflows from operating activities of $9,000, while trading securities had a net cash outflow of $111,000 from operating activities.

d. The amount of net income and the amount of cash flow from operating activities is different for those securities classified as trading from those classified as held-to-maturity or as available-for-sale. The difference is caused by the recognition of the unrealized loss on the income statement for trading securities and treating investments in trading securities as an operating activity rather than an investing activity. The gain on the sale increased net income by $5,000 in each case.

8-37

EXERCISE 8-19A

Transactions are recorded in the accounting equation for the use of the instructor.

Assets = Stockholders’ Equity

Event Cash + Inv. Sec.

= C. Stock + Ret. Earn.

+ Unreal. Gain

Beg. Bal. 80,000 80,000 -0- -0-1. Pur. Sec. (40,000

)40,000 -0- -0- -0-

2. Inv. Rev. 1,200 -0- -0- 1,200 -0-3. Sold Sec 16,000 (12,000) -0- 4,000 -0-4. Pur. Sec. (18,000

)18,000 -0- -0- -0-

Totals 39,200 46,000 80,000 5,200 -0-5. Mkt. Val. if HM

-0- -0- -0- -0- -0-

5. Mkt. Val. if TR

-0- 2,000 -0- 2,000 -0-

5. Mkt. Val. if AS

-0- 2,000 -0- -0- 2,000

8-38

EXERCISE 8-19A (cont.)Poort Inc.

Financial Statements For Year Ending 2001

Classified as: Held Trading Available

Income Statements

Investment Revenue $1,200 $ 1,200 $ 1,200Realized Gain 4,000 4,000 4,000Unrealized Gain -0- 2,000 -0-

Net Income $5,200 $7,200 $5,200

Balance Sheets

AssetsCash $39,200 $39,200 $39,200Investment Securities 46,000 48,000 48,000

Total Assets $85,200 $87,200 $87,200

Stockholders’ EquityCommon Stock $80,000 $80,000 $80,000Retained Earnings 5,200 7,200 5,200Unrealized Gain -0- -0- 2,000

Total Stockholders’ Equity $85,200 $87,200 $87,200

Statements of Cash Flows

Cash Flows From Operating Act.:

Inflow from Invest. Revenue

$ 1,200 $ 1,200 $ 1,200

Outflow to Purchase Securities

-0- (58,000) -0-

Inflow from Sale of Securities

-0- 16,000 -0-

Net Cash Inflow from Oper. Act.

1,200 (40,800) 1,200

Cash Flows From Investing Act.:


(58,000) -0- (58,000)

Inflow from Sale of 16,000 -0- 16,000

8-39

SecuritiesNet Cash Flow from Investing Act.

(42,000) -0- (42,000)

Cash Flows From Financing Act.

-0- -0- -0-

Net Change in Cash (40,800) (40,800) (40,800)Plus: Beginning Cash Balance

80,000 80,000 80,000

Ending Cash Balance $39,200 $39,200 $39,200

8-40

EXERCISE 8-20A

Investment

Category

Types of Securiti

es

Types of

Revenue

Value Reported on

Balance Sheet

Recognition of Unrealized Gains/Losses Income Stmt.

Cash Flow from

Purchase or Sale

Classified As

Held Debt Interest

Amortized Cost

No Investing Act.

TradingDebt & Equity

Interest & Div.

Market Value

Yes Operating Act.

Available

Debt & Equity

Interest & Div.

Market Value

No Investing Act.

8-41

SOLUTIONS TO PROBLEMS - SERIES A - CHAPTER 8

PROBLEM 8-21ASharp Photography Inc.

Inventory Purchases


@ $110 = $16,500

First Purchase 120

@ 85 = 10,200

Second Purchase 200

@ 100 = 20,000

Total 470

$46,700

a. Cost of Goods Sold:


Cost of Goods Sold


150 @ $110 = $16,500

From First Purchase 120 @ 85 = 10,200From Second Purchase 30 @ 100 = 3,000Total Units Sold 300 $29,700

Ending Inventory:


Ending Inventor

yFrom Second Purchase 170 @ 100 = $17,000

Cost of Goods Sold:

LIFO UnitsCost per Unit

Cost of Goods Sold

From Second Purchase 200 @ $100 = $20,000From First Purchase 100 @ 85 = 8,500Total Units Sold 300 $28,500

8-42

Ending Inventory:LIFOFrom Beginning Inventory

150 @ 110 = $16,500

From First Purchase 20 @ 85 = 1,700Total Ending Inventory $18,200

8-43

PROBLEM 8-21A a. (cont.)

Weighted Average


= Cost per Unit

$46,700 470 = $99.362

Weighted Average

Cost of Goods Sold: 300 units

@ $99.362

= $29,809


@ $99.362

= $16,891

b.

Sharp Photography Inc.

FIFO LIFOWeighte

dAverage

Sales (300 units @ $185) $55,500 $55,500 $55,500Cost of Goods Sold (29,700) (28,500) (29,809)Gross Margin 25,800 27,000 25,691Operating Expenses (12,000) (12,000) (12,000)Income Before Tax 13,800 15,000 13,691Income Tax (40%) (5,520) (6,000) (5,476)Net Income $ 8,280 $ 9,000 $ 8,215

FIFO LIFOWeighte

dAverage

Income Tax Expense $5,520 $6,000 $ 5,476

8-44

Net Income 8,280 9,000 8,215

8-45

PROBLEM 8-21A (cont.)

c. The Accounting Equation is provided for the use of the instructor.


Event Cash Inventory

= Com Stock

Ret. Earn.

FIFO Cost FlowBeginning Balance $22,000 $16,500 $14,300 $24,2001. First Purchase (10,200) 10,2002. Second Purchase (20,000) 20,0003a. Sale of Inventory

55,500 55,500

3b. Cost of Goods Sold

(29,700) (29,700)

4. Paid Oper. Expenses

(12,000) (12,000)

5. Paid Income Tax (5,520) (5,520)Totals $29,780 $17,000 = $14,300 $32,480

LIFO Cost FlowBeginning Balance $22,000 $16,500 $14,300 $24,2001. First Purchase (10,200) 10,2002. Second Purchase (20,000) 20,0003a. Sale of Inventory

55,500 55,500


(28,500) (28,500)


(12,000) (12,000)


Weighted AverageBeginning Balance $22,000 $16,500 $14,300 $24,2001. First Purchase (10,200) 10,2002. Second Purchase (20,000) 20,000

8-46

3a. Sale of Inventory

55,500 55,500


(29,809) (29,809)


(12,000) (12,000)


8-47

PROBLEM 8-21A (cont.) c.

Sharp Photography Inc.Financial Statements

For Year Ended December 31, 2007

FIFO LIFO Weight. Av.

Income Statements

Sales $55,500 $55,500 $55,500Cost of Goods Sold (29,700) (28,500) (29,809)Gross Margin 25,800 27,000 25,691

Operating Expenses (12,000) (12,000) (12,000)Income Before Tax 13,800 15,000 13,691Income Tax Expense (5,520) (6,000) (5,476)

Net Income $ 8,280 $ 9,000 $ 8,215

Balance Sheets

AssetsCash $29,780 $29,300 $29,824Merchandise Inventory 17,000 18,200 16,891

Total Assets $46,780 $47,500 $46,715

Stockholders’ EquityCommon Stock $14,300 $14,300 $14,300Retained Earnings 32,480 33,200 32,415


8-48

PROBLEM 8-21A c. (cont.)

Sharp Photography Inc.Statements of Cash Flows

For the Year Ended December 31, 2007


Cash Flows From Operating. Act.:

Cash Inflow from Customers

$55,500 $55,500 $55,500

Cash Outflow for Inventory

(30,200) (30,200) (30,200)

Cash Outflow for Oper. Exp.

(12,000) (12,000) (12,000)

Cash Outflow for Income Tax

(5,520) (6,000) (5,476)

Net Cash Flow from Oper. Act.

7,780 7,300 7,824

Cash Flows From Investing Act.

-0- -0- -0-


-0- -0- -0-

Net Change in Cash 7,780 7,300 7,824Plus: Beginning Cash Balance

22,000 22,000 22,000

Ending Cash Balance $29,780 $29,300 $29,824

8-49

PROBLEM 8-22A Provided for the use of the instructor:

Milan, Inc.Sales and Purchase Transactions for 2006

Sales Purchases Cost of Goods Sold Inventory

Date Units

Price Per Unit

=Total Unit

s

Cost Per Unit

Total Units

Cost per Unit

TotalUnit

sCost per Unit

Total

1/1 80 @120 = $ 9,600

3/5 80 @$125 = $10,000

8080

@$120@$125

==

$ 9,600$10,000

4/10 60 @$245 = $14,700

60 @$120

= $ 7,200

2080

@$120@$125

==

$ 2,400$10,000

6/19 70 @$245 = $17,150

2050

@$120

@$125

==

$ 2,400

$ 6,250

30 @$125 = $ 3,750

9/16 60 @$130 = $ 7,800

3060

@$125@$130

==

$ 3,750$ 7,800

11/28

55 @$255 = $14,025

3025

@$125

@$130

==

$ 3,750

$ 3,250

35 @$130 = $ 4,550

Totals

Sales = $45,875

COGS = $22,850

End Inv.

$ 4,550

8-50

PROBLEM 8-22A (cont.)a.

Milan, Inc.General Journal, 2006


3/5 Merchandise Inventory 10,000Cash 10,000

4/10 Cash 14,700Sales 14,700

4/10 Cost of Goods Sold* 7,200Merchandise Inventory 7,200

6/19 Cash 17,150Sales 17,150


9/16 Merchandise Inventory 7,800Cash 7,800

11/28 Cash 14,025Sales 14,025


*See schedule above for computation.

b. Sales $45,875Cost of Goods Sold (22,850 ) Gross Margin $23,025

c. Ending Inventory: $4,550 (See computation above)

8-52

PROBLEM 8-23A

DOT Computer Repair

Individual Item Lower of Cost or

Market

Item Quantity

Unit Cost

Unit Mark

et

Total Cost

Total Marke

tUnit

s

LCM per Unit Total

D1 60 $30 $35 $1,800

$2,100

60 @ $30 $1,800

D2 30 55 50 1,650 1,500 30 @ $50 1,500D3 44 40 55 1,760 2,420 44 @ $40 1,760D4 40 50 35 2,000 1,400 40 @ $35 1,400

$7,210

$7,420

$6,460

a. $6,460

b.Debit Credi

tCost of Goods Sold (Inventory Loss)*

750

Merchandise Inventory 750

*$7,210 $6,460 = $750

c. $7,210

d. No entry; Cost is lower than market.

e. Under the periodic system, the amount of ending inventory would be shown at the lower of cost or market in the schedule of cost of goods sold. By lowering the ending inventory, cost of goods sold is increased. Any loss is automatically included in cost of goods sold.

8-53

PROBLEM 8-24A

a. 1. Estimated Gross Margin:

Sales x Gross Margin %: $520,000 x .25 = $130,000

2. Estimated Cost of Goods Sold:

Sales Gross Margin: $520,000 $130,000= $390,000Or:Sales x Cost of Goods Sold %: $520,000 x 75% =

$390,000

3. Estimated Inventory at September 21:

Beginning Inventory $ 68,000Plus: Purchases 350,000Less: Cost of Goods Sold (390,000)Ending Inventory $ 28,000

b. Loss: Total Inventory $28,000Less: Undamaged (8,000) Total Loss $20,000

c. Under the perpetual inventory system, if records are maintained accurately, the balance in the inventory account should be equal to the amount of the inventory on hand at the time of the loss. Any differences would be attributable to lost, stolen, or damaged goods.

8-54

PROBLEM 8-25A

Lexington Company

2004 2005 Total

Net Sales $140,000 $200,000

$340,000

Cost of Goods Sold (62,000) (90,000) (152,000)

Gross Margin 78,000 110,000 188,000

Gross Margin % $188,000 $340,000

= 55%

Cost of Goods Sold %

152,000 340,000

= 45%

a. Computation of Gross Margin:

Sales $240,000Less: Sales Discounts (10,000)Net Sales 230,000x Gross Margin % 55%Gross Margin $126,500

b. Computation of Ending Inventory:

Beginning Inventory $ 60,000Plus: Purchases 160,000Plus: Transportation-In 4,000Goods Available for Sale224,000Less: Cost of Goods Sold (103,500)*

Ending Inventory $120,500

*$230,000 x 45% = $103,500

8-55

PROBLEM 8-26A

Error No.1 Amount of Error

Effect

Sales, 2002 NA NAEnding Inventory, 12/31/02

NA NA

Gross Margin, 2002 $1,400 Beginning Inventory, 1/1/03

NA NA

Cost of Goods Sold, 2002

1,400 +

Net Income, 2002 NA NARetained Earnings, 12/31/02

NA NA

Total Assets, 12/31/02 NA NA

Error No. 2 Amount of Error

Effect

Sales, 2002 $2,400 Ending Inventory, 12/31/02

1,344 +

Gross Margin, 2002 1,056 Beginning Inventory, 1/1/03

1,344 +


1,344

Net Income, 2002 1,056 Retained Earnings, 12/31/02

1,056

Total Assets, 12/31/02 1,056


Effect

8-57


$1,200


1,200


1,200 +


1,200

Total Assets, 12/31/02 1,200

8-58

PROBLEM 8-27A

(a). Held-to-Maturity

T-Accounts

Cash Investment Sec. Common Stock1. 20,000 3. 20,000 3. 20,000 8.5,000 1. 20,0002. 60,000 4. 19,000 6. 12,000 Bal.

20,0005. 400 6. 12,000 Bal.

27,0008. 6,300 7. 2,000 Dividends9. 1,000 7. 2,000Bal.

34,700Bal.2,000

Service Revenue2. 60,000Bal.60,000

Investment Income5. 4009. 1,000Bal. 1,400

Gain on Sale of Invest.

8.1,300Bal.1,300

Operating Expenses

4. 19,000Bal.

19,000

8-59


(b). Trading

T-Accounts

Cash Investment Sec. Common Stock1. 20,000 3. 20,000 3.20,000 8.5,000 1. 20,0002. 60,000 4. 19,000 6.12,000 Bal.

20,0005. 400 6. 12,000 10.

13,0008. 6,300 7. 2,000 Bal.

40,000Dividends

9. 1,000 7. 2,000Bal.

34,700Bal.2,000


Investment Income5. 4009. 1,000Bal. 1,400


8. 1,300Bal. 1,300

Operating Expenses

4. 19,000Bal.

19,000

(Income Account)Unrealized Gain/Loss

8-60

10.13,000Bal.13,000

8-61


(c). Available-for-Sale

T-Accounts

Cash Investment Securities

Common Stock

1. 20,000 3. 20,000 3. 20,000 8. 5,000 1. 20,0002. 60,000 4. 19,000 6. 12,000 Bal.

20,0005. 400 6. 12,000 10.

13,0008. 6,300 7. 2,000 Bal.

40,000Dividends

9. 1,000 7. 2,000Bal.

34,700Bal.

2,000

(Equity Account)Unrealized Gain/Loss

10.13,000Bal.13,000


Investment Income

5. 4009. 1,000Bal. 1,400


8. 1,300Bal. 1,300

8-62

Operating Expenses

4. 19,000Bal.

19,000

8-63


Best Answering ServiceComparative Financial Statements

For the Year Ended 2007

Investment Securities Classified As

Held Trading Available

Income Statements

Services Revenue $60,000

$60,000 $60,000

Operating Expenses (19,000)

(19,000)

(19,000)

Net Operating Income 41,000 41,000 41,000

Investment Revenue 1,400 1,400 1,400Realized Gains 1,300 1,300 1,300Unrealized Gains -0- 13,000 -0-

Net Income $43,700

$56,700 $43,700

Balance Sheets

AssetsCash $34,70

0$34,700 $34,700

Investment Securities @ Cost

27,000 -0- -0-

Investment Securities @ Market

-0- 40,000 40,000

Total Assets $61,700

$74,700 $74,700

Stockholders’ EquityCommon Stock $20,00

0$20,000 $20,000

Retained Earnings 41,700 54,700 41,700Unrealized Gain -0- -0- 13,000

8-64

Total Stockholders’ Equity $61,700

$74,700 $74,700

8-65


Best Answering ServiceComparative Financial Statements


Investment Securities Classified as





$60,000

$60,000 $60,000

Cash Inflow from Invest. Rev.

1,400 1,400 1,400

Outflow for Expenses (19,000)

(19,000)

(19,000)


-0- (32,000)

-0-


-0- 6,300 -0-


42,400 16,700 42,400



(32,000)

-0- (32,000)


6,300 -0- 6,300

Net Cash Flow from Investing Act.

(25,700)

-0- (25,700)

Cash Flows From Financing Act.:

Inflow from Stock Issue 20,000 20,000 20,000Outflow for Dividends (2,000) (2,000) (2,000)

Net Cash Flow from Financing Act.

18,000 18,000 18,000

Net Change in Cash $34,70 $34,700 $34,70

8-66

0 0Plus: Beginning Cash Balance -0- -0- -0-Ending Cash Balance $34,70

0$34,700 $34,700

8-67

PROBLEM 8-28A

a.Balance Sheet Income Statement Stmt. of

Event

Assets

= Liab. + S. Equity


Cash Flow

1. + NA + NA NA NA + FA2. + + NA NA NA NA NA3. + NA NA NA NA NA OA4. NA NA + NA5. NA NA NA NA NA6. NA NA NA NA NA NA NA7. NA NA + NA8. NA NA NA NA NA NA NA 9. NA NA + NA

10. NA NA + NA

b. The directional effect is the same for events 9 and 10. In both transactions, inventory was reduced and an expense was recorded that decreased stockholders’ equity. However, the amounts would be different during periods of changing prices.

8-68

SOLUTIONS TO EXERCISES - SERIES B - CHAPTER 8

EXERCISE 8-1B

a. FIFO

b. LIFO

c. FIFO

d. LIFO

e. Weighted Average

8-69

EXERCISE 8-2B

Spruell Co.First Purchase $ 750Second Purchase 1,000Total $1,750

(a) (b) (c)FIFO LIFO W. AVG.

Cost of Goods Sold $ 750 $1,000 $875*

Ending Inventory 1,000 750 875*

*Average Cost per Unit: $ 750 + $1,000 = $1,750;$1,750 2 = $875

8-70

EXERCISE 8-3BThe Perez Company Inventory Purchases


@ $40 = $ 4,000

First Purchase 150

@ 50 = 7,500

Second Purchase 200

@ 60 = 12,000

Goods Available for Sale

450

$23,500

a.Cost of Goods Sold:

FIFO Units

Unit Cost

Cost of Goods Sold


100 @ $40 = $ 4,000

From First Purchase 150 @ 50 = 7,500From Second Purchase

10 @ 60 = 600

Total Units Sold 260 $12,100

Ending Inventory: FIFO Unit

sUnit Cost

Ending Inventory

From Second Purchase

190 @ $60 = $11,400

b. Cost of Goods SoldLIFO Unit

sUnit Cost

Cost of Goods Sold


200 @ $60 = $12,000

From First Purchase 60 @ 50 = 3,000Total Units Sold 260 $15,000

Ending InventoryLIFO Unit

sUnit Cost

Ending Inventory


100 @ $40 = $4,000

8-71

From First Purchase 90 @ 50 = 4,500Total Ending Inventory

190 $8,500

c.

Weighted Average:


= Cost per Unit

$23,500 450 = $52.222

Cost of Goods Sold 260 units

@ $52.222

= $13,577.72


@ $52.222

= $9,922.18*

*.10 difference due to rounding

8-72

EXERCISE 8-4B

a. (1) Parker CompanyFIFO

Sales (210 @ $50) $10,500


Inv. 40 units @ $20

= $ 800

From Purchases 170 units @ $25

= 4,250 ( 5,050)

Gross Margin $ 5,450

a. (2)LIFO

Sales (210 @ $50) $10,500

Cost of Goods Sold:From Purchases 200 units @

$25= $5,000

From Beg. Inv. 10 units @ $20

= 200 (5,200)



Sales (210 @ $50) $10,500

Cost of Goods Sold:Average Cost per

Unit210 @ $24.1671

= $5,0752

( 5,075)


1Total cost ($800 + $5,000) $5,800 Total units 240 = $24.167 Cost per unit

8-73

2Rounded to the nearest dollar.

b. The difference between net income using FIFO and LIFO is $150 ($5,450 $5300). The difference between FIFO and Weighted Average is $25 ($5,450 $5,425). The difference in the net incomes would be the same as the difference in gross margins, assuming there are no income tax considerations.

8-74

EXERCISE 8-4B (cont.)

c.Ending InventoryFIFO 30 @ $25 = $750LIFO 30 @ $20 = 600Weighted Average

30 @ $24.167

= 725

8-75

EXERCISE 8-5B

King SalesSummary of Purchase Transactions


450 @ $5 = $2,250


200 @ 6 = 1,200


100 @ 10 = 1,000


75 @ 8 = 600

Available for Sale

825 $5,050

a. (1)FIFO Units Unit Cost Total


Purchase75 @ $8 $600

From 7/25 Purchase

25 @ $10 250


100 $850

a. (2)LIFO Units Unit Cost Total


Purchase100 @ $5 $500


100 $500


8-76

Total Cost Total Units = Cost per Unit$5,050 825 = $6.12

Ending Inventory 100 units @ $6.12 = $612

8-77


b.FIFO

Sales (725 units @ $20) $14,500


Sale*$5,050

Less: Ending Inventory (850)Cost of Goods Sold (4,200)


LIFO

Sales (725 units @ $20) $14,500


Sale*$5,050

Less: Ending Inventory (500)Cost of Goods Sold (4,550)


*This amount is computed in the Summary of Purchase Transactions at the beginning of the problem.

Difference in Gross Margin: $10,300 $9,950 = $350

Note to Instructor: Cost of goods sold can be computed on a units sold basis rather than subtracting ending inventory from goods available for sale.

8-78

EXERCISE 8-6B

a.Market Company

Income Statements

FIFO

Sales (3,400 @ $40)

$136,000


Inv. 500 units @ $20

= $10,000

From 4/1 Purchase

2,500 units @ $22

= 55,000

From 10/1 Purchase

400 units @ $28

= 11,200

Cost of Goods Sold

(76,200)

Gross Margin 59,800

Operating Expenses

(34,000)


(30%) (7,740)

Net Income $ 18,060

LIFO

Sales (3,400 @ $40)

$136,000

Cost of Goods Sold:From 10/1

Purchase 800 units @ $28

= $22,400

From 4/1 Purchase

2,500 units @ $22

= 55,000

From Beginning Inv.

100 units @ $20

= 2,000

8-79

Cost of Goods Sold

(79,400)

Gross Margin 56,600

Operating Expenses

(34,000)


(30%) (6,780)

Net Income $ 15,820


b. Income tax paid using FIFO: $7,740Income tax paid using LIFO: $6,780

c.Market Company

Cash Flows from Operating Activities

FIFO LIFO


Cash Inflow from Customers $136,000

$136,000

Cash Outflow for Inventory* (77,400) (77,400)Cash Outflow for Operating

Expense(34,000) (34,000)

Cash Outflow for Income Tax Expense

(7,740) (6,780)

Net Cash Flow from Operating Activities

$ 16,860

$ 17,820

*Computation of cash paid for inventory:

4/1 Purchase 2,500 units @ $22 =$55,000

8-80

10/1 Purchase 800 units @ 28 = 22,400$77,400

d. The difference in cash flow from operating activities between FIFO and LIFO is caused by the difference in income tax paid for the two methods. Taxable income is greater by using FIFO; consequently more income tax will be paid causing a greater cash outflow for tax expense.

8-81

EXERCISE 8-7B aWest Coast Company

Effect of Events on Financial Statements

Panel 1: FIFO Cost Flow

Event

Cash + Inv. = C. Stk.

+ Ret. Ear.

Rev. Exp. = Net Inc. Cash Flows

1. 250,000 + NA = NA + 250,000 250,000

NA = 250,000 250,000 OA

2. (70,000) + 70,000 = NA + NA NA NA = NA (70,000) OA3. (56,250) + 56,250 = NA + NA NA NA = NA (56,250) OA4. NA + (88,750

)1= NA + (88,750

)NA 88,750 = (88,750

)NA

5. (64,500)2

+ NA = NA + (64,500) NA 64,500 = (64,500)

(64,500) OA

Bal. 59,250 + 37,500 = NA + 96,750 250,000

153,250

= 96,750 59,250 NC

Panel 2: LIFO Cost Flow

Event

Cash + Inv. = C. Stk.

+ Ret. Earn.

Rev. Exp. = Net Inc. Cash Flows

1. 250,000 + NA = NA + 250,000 250,000

NA = 250,000 250,000 OA

2. (70,000) + 70,000 = NA + NA NA NA = NA (70,000) OA3. (56,250) + 56,250 = NA + NA NA NA = NA (56,250) OA4. NA + (91,250

)3= NA + (91,250

)NA 91,250 = (91,250

)NA

5. (63,500)4

+ NA = NA + (63,500)

NA 63,500 = (63,500)

(63,500) OA

Bal. 60,250 + 35,000 = NA + 95,250 250,000

154,750

= 95,250 60,250 NC

1Cost of Goods Sold -- FIFO: 4/2 200 units @ $350 =$70,000

8-82

9/1 50 units @ $375 = 18,750 Total $88,750

2Income Tax Expense: ($250,000 $88,750) x 40% = $64,500.3Cost of Goods Sold -- LIFO: 9/1 150 units @ $375 = $56,250

4/2 100 units @ $350 = 35,000 Total $91,250

4Income Tax Expense ($250,000 $91,250) x 40% = $63,500.

8-83


b. Net Income assuming FIFO cost flow: $96,750 (see statements model above).

c. Net Income assuming LIFO cost flow: $95,250 (see statements model above).

d. LIFO produces an income tax that is $1,000 lower ($64,500 $63,500) than FIFO. This results because a larger amount of inventory is expensed using LIFO. The last purchase was bought at a higher price than the first purchase.

e. FIFO

8-84

EXERCISE 8-8B

a.Polo Company - General Journal


1/1/06 Inventory (250 @ $40) 10,000Cash 10,000


4/1b Cost of Goods Sold (125 @ $34)

4,250

Inventory 4,250

8/1 Inventory (400 @ $44) 17,600Cash 17,600


12/1b Cost of Goods Sold* 20,500Inventory 20,500

*Cost of Goods Sold: 50 @ $34 = $ 1,700250 @ $40 = 10,000200 @ $44 = 8,800

$20,500

b. Total Cost of Goods Sold:4/1 $ 4,25012/1 20,500

Total $24,750

8-85

EXERCISE 8-9B

a. Big Hill, Inc.Date Purchased Sold Inventory Balance

Units Cost Total Units Cost Total Units Cost Total

1/1 Beg. Inv.

50 @ $30 = $1,500

3/15 Pur. 200 @

$35 =$7,000 50 @200 @

$30$35

==

$1,500$7,000

5/30 Sold 50 @120

@

$30$35

==

$1,500$4,200 80 @ $35 =

-0-$2,800

8/10 Pur 275 @

$40 =$11,000

80 @275 @

$35$40

==

$2,800$11,00

0

11/20 Sold

80 @ $35 = $ 2,800

-0-

260 @ $40 = $10,400

15 @ $40 = $600

Ending Inventory: 15 units @ $40 = $600

b. A problem arises when Weighted Average is applied to intermittent sales and purchase transactions. Weighted Average requires that average cost be computed when each sale is made. This problem is often overcome by recording only quantities of units sold on a perpetual basis. At the end of the accounting period, costs are then assigned perpetually to the units that have been sold.

8-86

EXERCISE 8-10Ba.

Original Woodworka. b. c. d. e. f. g. h.

Item

Quantity

Cost Per Unit

Mkt. Val.per Unit

Unit LowerCost/Mkt.

Total Cost

Total Market

Ind. Item

Lower Cost/Mkt.

(b x c) (b x d) (b x e)P 100 $ 16 $ 12 $ 12 $1,600 $1,200 $1,200D 50 18 16 16 900 800 800S 20 24 26 24 480 520 480J 15 20 22 20 300 330 300

$3,280 $2,850 $2,780

1. Ending inventory using the individual item method: $2,7802. Ending Inventory using the aggregate method: $2,850

b.


1. Cost of Goods Sold* 500Inventory 500

2. Cost of Goods Sold** 430Inventory 430

*$3,280 $2,780 = $500**$3,280 $2,850 = $430

8-87

EXERCISE 8-11B

a.a. b. c. d. e. f. g.

Item Quantity

Cost Per Unit

Market Per Unit

Unit Lower

Cost/Mkt.

Total Cost

Total Lower

Cost/Mkt.

(b x c) (b x e)B 100 $40 $36 $36 $ 4,000 $ 3,600C 150 60 56 56 9,000 8,400D 90 20 30 20 1,800 1,800

Totals

$14,800 $13,800

The inventory would be carried at $13,800, the lower of cost or market applied to individual inventory items.

b. Under the periodic method, the amount of ending inventory would be shown at the lower of cost or market in the schedule of cost of goods sold. By lowering the ending inventory, cost of goods sold is increased. The loss is automatically included in cost of goods sold.

8-88

EXERCISE 8-12B Deep Woods Hunting Goods

a. Gross Margin: Sales x Gross Margin % $137,500 x 25% = $34,375

b. Cost of Goods Sold: Sales x Cost of Goods Sold % $137,500 x 75% = $103,125

c. Computation of Ending Inventory:

Beginning Inventory $ 25,000Plus: Purchases 100,000Goods Available for Sale 125,000Less: Cost of Goods Sold (Est.) (103,125 ) Ending Inventory (Est.) $ 21,875

d. Lost Inventory: Estimated Ending Inventory $21,875Less: Undamaged Inventory (2,000 ) Inventory Lost $19,875

EXERCISE 8-13B

June 14 Inventory Account Balance

$338,000

Less: Cost of Unrecorded Sale (42,000)Balance in the Warehouse 296,000

Less: 5% Shrinkage (14,800)Less: Amount of Inventory in Showroom

(75,000)

Inventory Lost $206,200

8-89

EXERCISE 8-14B

Short Company

The uncounted inventory will only affect The Short Company’s balance sheet if the book amount of the inventory is actually written down to the counted amount. The perpetual system records the actual amount of goods as they are purchased and sold. However, if an adjustment is actually made on the books, the reduction in inventory would cause the inventory amount shown on the balance sheet to be understated.

EXERCISE 8-15B

Tefall Company

Item Number

Year Amount Affected Effect

1. 2006 Beginning Inventory NA2. 2006 Purchases NA3. 2006 Goods Available for

SaleNA

4. 2006 Cost of Goods Sold Overstated5. 2006 Gross Margin Understate

d6. 2006 Net Income Understate

d7. 2007 Beginning Inventory Understate

d8. 2007 Purchases NA9. 2007 Goods Available for

SaleUnderstated

10. 2007 Cost of Goods Sold Understated

11. 2007 Gross Margin Overstated12. 2007 Net Income Overstated

8-91

EXERCISE 8-16B

Asset FMV LCM HC/AC

Inventory XPrepaid Rent XCash X XHeld-to-Maturity Securities

X

Machinery XAvailable-for-Sale Securities

X

Certificate of Deposit XTrading Securities X

8-93

EXERCISE 8-17B

a.

Balance Sheet Income Statement Stmt. ofType Cas

h+ Inv.

Sec.= Lia

b.+ S.

EquityRev. Exp. = Net

Inc.Cash Flows

Held + NA NA NA NA NA IATrading + NA NA NA NA NA OAAvailable

+ NA NA NA NA NA IA

b.

Blass BrothersComputation of Net Income

Classified as:Held-to-Maturity Trading

Available-for-Sale

Revenue $10,000 $10,000 $10,000

Expenses (4,000) (4,000) (4,000)

Unrealized Gain -0- 7,000 -0-

Net Income $ 6,000 $13,000 $ 6,000

8-94

EXERCISE 8-18B a.Circuit Electronics

Horizontal Statements Models

(1) Held-to-MaturityBalance Sheet Income Statement Statement


= Liab. + Ret. Ear.

+Unreal. Gain.

Rev./Gain

Exp./

Loss= Net Inc.

ofCash Flows

1. (75,000) + 75,000 = NA + NA + NA NA NA = NA (75,000)IA

2. 4,500 + NA = NA + 4,500 + NA 4,500 -0- = 4,500 4,500OA

3. 15,000 + (12,500)

= NA + 2,500 + NA 2,500 -0- = 2,500 15,000 IA

4. NA + NA = NA + NA + NA NA NA = NA NATotals (55,500)

1+ 62,500 = -0- + 7,000 + -0- 7,000 -0- = 7,000 (55,500)

NC

(2) Trading


= Liab.

+ Ret. Ear.

+Unreal.

GainRev./Gain

Exp./Loss = Net Inc. Cash Flow

1. (75,000)

+ 75,000 = NA + NA + NA NA NA = NA (75,000)OA

2. 4,500 + NA = NA + 4,500 + NA 4,500 NA = 4,500 4,500 OA3. 15,000 + (12,500

)= NA + 2,500 + NA 2,500 NA = 2,500 15,000 OA

4. NA + (12,500)

= NA + (12,500)

+ NA NA 12,500 = (12,500)

NA

Totals (55,500)

+ 50,000 = -0- + (5,500) + -0- 7,000 12,500 = (5,500) (55,500)NC

(3) Available-for-Sale

Unreal. Rev./ Exp.

8-95


= Liab. + Ret. Ear.

+ Gain Gain /Loss

= Net Inc. Cash Flow

1. (75,000)

+ 75,000 = NA + NA + NA NA NA = NA (75,000)IA

2. 4,500 + NA = NA + 4,500 + NA 4,500 NA = 4,500 4,500 OA3. 15,000 + (12,500

)= NA + 2,500 + NA 2,500 NA = 2,500 15,000 IA

4. NA + (12,500)

= NA + NA + (12,500)

NA NA = NA NA

Totals (55,500)

+ 50,000 = -0- + 7,000 + (12,500)

7,000 -0- = 7,000 (55,500)NC

1Cash is negative because these transactions do not reflect any beginning balances.

8-96


b. (1) Held-to-Maturity $7,000(2) Trading $(5,500)(3) Available-for-Sale $7,000

c. The amount of change in total cash from these activities is the same for all three classifications ($55,500). Held-to-maturity and available-for-sale securities each had a net cash inflow from operating activities of $4,500, while trading securities had a net cash outflow of $55,500 from operating activities.

d. (1) Held-to-Maturity $62,500(2) Trading $50,000(3) Available-for-Sale $50,000

8-97

EXERCISE 8-19B

Transactions are recorded in the accounting equation for the use of the instructor.



= C. Stock + Ret. Earn.

+ Unreal. Gain

Beg. Bal. 60,000 60,000 -0- -0-1. Pur. Sec. (30,000

)30,000 -0- -0- -0-

2. Inv. Rev. 800 -0- -0- 800 -0-3. Sold Sec 10,000 (7,000) -0- 3,000 -0-4. Pur. Sec. (10,000

)10,000 -0- -0- -0-

Totals 30,800 33,000 60,000 3,800 -0-5. Mkt. Val. if HM

-0- -0- -0- -0- -0-

5. Mkt. Val. if TR

-0- 1,000 -0- 1,000 -0-

5. Mkt. Val. if AS

-0- 1,000 -0- -0- 1,000

8-98

EXERCISE 8-19B. (cont.)Deal Inc.

Financial Statements For Year Ended 2002

Classified as: Held Trading Available

Income Statements

Investment Revenue $ 800 $ 800 $ 800Realized Gain 3,000 3,000 3,000Unrealized Gain -0- 1,000 -0-

Net Income $3,800 $4,800 $3,800

Balance Sheets

AssetsCash $30,800 $30,800 $30,800Investment Securities 33,000 34,000 34,000

Total Assets $63,800 $64,800 $64,800

Stockholders’ EquityCommon Stock $60,000 $60,000 $60,000Retained Earnings 3,800 4,800 3,800Unrealized Gain -0- -0- 1,000




Inflow from Invest. Revenue

$ 800 $ 800 $ 800


-0- (40,000) -0-


-0- 10,000 -0-

Net Cash Inflow from Oper. Act.

800 (29,200) 800



(40,000) -0- (40,000)

Inflow from Sale of 10,000 -0- 10,000

8-99

SecuritiesNet Cash Flow from Investing Act.

(30,000) -0- (30,000)


-0- -0- -0-

Net Change in Cash (29,200) (29,200) (29,200)Plus: Beginning Cash Balance

60,000 60,000 60,000

Ending Cash Balance $30,800 $ 30,800 $30,800

8-100

EXERCISE 8-20B

The three classifications of investment securities are:

1. Held-to-Maturity Securities: An example of held-to-maturity securities would be bonds that are intended to be held to their maturity date.

2. Trading Securities: An example of trading securities would more likely be stocks that are intended to be held a short time and are traded on a regular basis for the purpose of generating profit.

3. Available-for-Sale Securities: An example would be stocks and bonds that are neither trading nor held-to-maturity. The company may buy a stock with the intention of holding it until it appreciates and it may be sold within a short period of time or held for several years. Intent determines the classification.

8-101

SOLUTIONS TO PROBLEMS - SERIES B - CHAPTER 8

PROBLEM 8-21B

Paul’s Bicycle ShopInventory Purchases


@ $280 = $56,000

First Purchase 120

@ 300 = 36,000

Second Purchase 140

@ 330 = 46,200

Total 460

$138,200

a. Cost of Goods Sold:FIFO Unit

sUnit Cost

Cost of Goods Sold


200 @ $280 = $ 56,000

From First Purchase 120 @ 300 = 36,000From Second Purchase

80 @ 330 = 26,400

Total Units Sold 400 $118,400

Ending Inventory: FIFO Unit

sUnit Cost

Ending Inventory


60 @ $330 = $19,800

Cost of Goods Sold:LIFO Unit

sUnit Cost

Cost of Goods Sold


140 @ $330 = $46,200

From First Purchase 120 @ 300 = 36,000From Beginning 140 @ 280 = 39,200

8-102

InventoryTotal Units Sold 400 $121,400

Ending Inventory: 60 @ $280 = $16,800LIFO Unit

sUnit Cost

Ending Inventory


60 $280 = $16,800

8-103

PROBLEM 8-21B a. (cont.)

Weighted Average


= Cost per Unit

$138,200 460 = $300.435

Cost of Goods Sold: 400 units

@ $300.435

= $120,174

Ending Inventory: 60 units @ $300.435

= $18,026

b.Paul’s Bicycle Shop

Computation of Net Income

FIFO LIFOWeighte

dAverage

Sales (400 units @ $450) $180,000

$180,000

$180,000

Cost of Goods Sold (118,400)

(121,400)

(120,174)

Gross Margin 61,600 58,600 59,826Salaries Expenses (30,000) (30,000) (30,000)Income Before Tax 31,600 28,600 29,826Income Tax (25%) (7,900) (7,150) (7,457)Net Income $23,700 $21,450 $22,369

8-104

PROBLEM 8-21B (cont.)

c. The Accounting Equation is provided for the use of the instructor.

Event Assets = Stockholders’ Equity

Cash Inventory

= C. Stock Ret. Earn.

FIFO Cost Flow

Beginning Balance $ 50,800 $56,000 $43,000 $63,8001. First Purchase (36,000) 36,0002. Second Purchase (46,200) 46,2003a. Sale of Inventory

180,000 180,000


(118,400)

(118,400)

4. Paid Sal. Expense

(30,000) (30,000)

5. Paid Income Tax (7,900) (7,900)Totals $110,700 $19,800 $43,000 $87,500

LIFO Cost FlowBeginning Balance $50,800 $56,000 $43,000 $63,8001. First Purchase (36,000) 36,0002. Second Purchase (46,200) 46,2003a. Sale of Inventory

180,000 180,000


(121,400)

(121,400)


(30,000) (30,000)


Weighted AverageBeginning Balance $50,800 $56,000 $43,000 $63,8001. First Purchase (36,000) 36,0002. Second Purchase (46,200) 46,200

8-105

3a. Sale of Inventory

180,000 180,000


(120,174)

(120,174)


(30,000) (30,000)


8-106

PROBLEM 8-21B (cont.) c.

Paul’s Bicycle ShopFinancial Statements

For Year Ended December 31,2007


Income Statements

Sales $180,000 $180,000

$180,000

Cost of Goods Sold (118,400)

(121,400)

(120,174)

Gross Margin 61,600 58,600 59,826

Salaries Expense (30,000) (30,000) (30,000)Income Before Tax 31,600 28,600 29,826Income Tax Expense (7,900) (7,150) (7,457)

Net Income $23,700 $21,450 $22,369

Balance Sheets

AssetsCash $110,700 $111,45

0$111,143

Inventory 19,800 16,800 18,026Total Assets $130,500 $128,25

0$129,169

Stockholders’ EquityCommon Stock $43,000 $43,000 $43,000Retained Earnings 87,500 85,250 86,169

Total Stockholders’ Equity $130,500 $128,250

$129,169

8-107

PROBLEM 8-21B c. (cont.)

Paul’s Bicycle ShopStatements of Cash Flows

For the Year Ended December 31, 2007


Cash Flows From Oper. Act.:


$180,000 $180,000

$180,000

Cash Outflow for Inventory

(82,200) (82,200) (82,200)

Cash Outflow for Sal. Exp.

(30,000) (30,000) (30,000)

Cash Outflow for Income Tax

(7,900) (7,150) (7,457)


59,900 60,650 60,343

Cash Flows From Investing Act.

-0- -0- -0-


-0- -0- -0-

Net Change in Cash 59,900 60,650 60,343Plus: Beginning Cash Balance

50,800 50,800 50,800

Ending Cash Balance $110,700 $111,450

$111,143

8-108

PROBLEM 8-22BProvided for the use of the instructor:

Fred’s FireplacesSales and Purchase Transactions for 2008

Date Sales Purchases Cost of Goods Sold Inventory

UnitsPrice Per Unit

= Total Units

Cost Per Unit

Total Units

Cost per Unit

Total Units

Cost per Unit

Total

1/1 60 @$350 = $21,000

3/5 50 @$370 = $18,500

6050

@$350@$370

==

$21,000$18,500

4/10 40 @$450

= $18,000

40 @$350 = $14,000

2050

@$350@$370

==

$ 7,000$18,500

6/19 50 @$450

= $22,500

2030

@$350@$370

==

$ 7,000

$11,100

20 @$370 = $ 7,400

9/16 50 @$390 = $19,500

2050

@$370@$390

==

$ 7,400$19,500

11/28

35 @$470

= $16,450

2015

@$370@$390

==

$ 7,400

5,850

35 @$390 = $13,650

Totals

Sales $56,95 0

COGS $45,35 0

End Inv.

$13,650

8-109

PROBLEM 8-22B (cont.)a.

Fred’s FireplacesGeneral Journal, 2008


3/5 Inventory 18,500Cash 18,500

4/10 Cash 18,000Sales 18,000

4/10 Cost of Goods Sold* 14,000Inventory 14,000

6/19 Cash 22,500Sales 22,500


9/16 Inventory 19,500Cash 19,500

11/28 Cash 16,450Sales 16,450


*See previous schedule for computation.

b. Sales $56,950Cost of Goods Sold (45,350 ) Gross Margin $11,600

c. Ending Inventory $13,650 (See previous computation)

8-111

PROBLEM 8-23B

Ed’s Repair Service

Individual Item Lower of Cost or Market

Item Quantity

Unit Cost

Unit Marke

t

Total Cost

Total Market Unit

s

LCM per Unit

Total

P1 80 $80 $90 $ 6,400

$ 7,200 80 @ $80 $ 6,400

P2 60 60 66 3,600 3,960 60 @ $60 3,600

P3 100 140 130 14,000 13,000 100 @ $130 13,000

P4 50 130 140 6,500 7,000 50 @ $130 6,500

$30,500

$31,160 $29,500

a. $29,500

b.Debit Credi

tCost of Goods Sold (Inventory Loss)*

1,000

Inventory 1,000

*($30,500 $29,500)

c. $30,500

d. No entry; cost is lower than market.

e. Under the periodic system the amount of ending inventory would be shown at the lower of cost or market in the schedule of cost of goods sold. By lowering the ending inventory, cost of goods sold is increased. Any loss is automatically included in cost of goods sold.

8-112

PROBLEM 8-24B

Hank’s Fun House

a. 1.Estimated Gross Margin:

Sales x Gross Margin %: $1,140,000 x .30 = $342,000

2. Estimated Cost of Goods Sold:

Sales Gross Margin: $1,140,000 $342,000= $798,000Or:Sales x Cost of Goods Sold %: $1,140,000 x 70% =

$798,000

3. Estimated Inventory at October 6:

Beginning Inventory $162,000Plus: Purchases 680,000Less: Cost of Goods Sold (798,000)Ending Inventory $ 44,000

b. Loss: Total Inventory $ 44,000Less: Undamaged (20,000)Total Loss $ 24,000

c. Under the perpetual inventory system, if records are maintained accurately, the balance in the inventory account should be equal to the amount of the inventory on hand at the time of the loss. Any differences would be attributable to lost, stolen, or damaged goods.

8-113

PROBLEM 8-25B

Elle’s Eatery

2006 2007 Total

Net Sales $60,000 $70,000 $130,000Cost of Goods Sold (31,000) (36,500) (67,500)Gross Margin $

29,000$33,500 $ 62,500

Gross Margin % $62,500 $130,000

= 48%

Cost of Goods Sold %

$67,500 130,000 = 52%

a. Computation of Gross Margin:

Sales $56,500Less: Sales Discounts (2,500)Net Sales 54,000x Gross Margin % 48%Gross Margin $25,920

b. Computation of Ending Inventory:

Beginning Inventory $12,500Plus: Purchases 41,000Plus: Transportation-In 2,000Goods Available for Sale 55,500Less: Cost of Goods Sold (28,080 ) *

Ending Inventory $27,420

*$54,000 x 52% = $28,080

8-114

PROBLEM 8-26B

Error No.1 Amount of Error

Effect


NA NA

Gross Margin, 2006 $2,000 Beginning Inventory, 1/1/07

NA NA


2,000 +

Net Income, 2006 NA NARetained Earnings, 12/31/06

NA NA

Total Assets, 12/31/06 NA NA


Effect

Sales, 2006 $500 Ending Inventory, 12/31/06

300 +

Gross Margin, 2006 200 Beginning Inventory, 1/1/07

300 +


300

Net Income, 2006 200 Retained Earnings, 12/31/06

200

Total Assets, 12/31/06 200


Effect

8-115


$1,800


1,800


1,800 +


1,800

Total Assets, 12/31/06 1,800

8-116

PROBLEM 8-27B

(a). Held-to-Maturity

T-Accounts


Cash Investment Sec. Common Stock1. 15,000 3. 12,000 3. 12,000 8. 6,000 1. 15,0002. 50,000 4. 17,000 6. 16,000 Bal.

15,0005. 400 6. 16,000 Bal.

22,0008. 6,400 7. 1,000 Dividends9. 900 7. 1,000Bal.

26,700Bal.1,000


Investment Income5. 4009. 900Bal. 1,300


8. 400Bal. 400

Operating Expenses

4. 17,000Bal.

17,000

8-117


(b). Trading

T-Accounts


Cash Investment Sec. Common Stock1. 15,000 3. 12,000 3. 12,000 8.6,000 1. 15,0002. 50,000 4. 17,000 6. 16,000 Bal.

15,0005. 400 6. 16,000 10.

2,0008. 6,400 7. 1,000 Bal.

20,000Dividends

9. 900 7. 1,000Bal.

26,700Bal.1,000




8. 400Bal. 400

Operating Expenses

4. 17,000Bal.

17,000

8-119

(Income Account)Unrealized Gain/Loss

10. 2,000Bal. 2,000

8-120


(c). Available-for-Sale

T-Accounts


Cash Investment Securities

Common Stock

1. 15,000 3. 12,000 3.12,000 8. 6,000 1. 15,0002. 50,000 4. 17,000 6.16,000 10.

2,000Bal.15,000

5. 400 6. 16,000 Bal.20,000

8. 6,400 7. 1,000 Dividends9. 900 7. 1,000Bal.

26,700Bal.1,000

(Equity Account)Unrealized Gain/Loss

10.2,000Bal.2,000




8. 400Bal. 400

8-121

Operating Expenses

4. 17,000Bal.

17,000

8-122


Brogan’s Trucking CompanyComparative Financial Statements


Investment Securities Classified As:

Held Trading

Available

Income Statements

Services Revenue $50,000 $50,000

$50,000

Operating Expenses (17,000)

(17,000)

(17,000)

Net Operating Income 33,000 33,000 33,000

Investment Revenue 1,300 1,300 1,300Realized Gains 400 400 400Unrealized Loss -0- (2,000) -0-

Net Income $34,700 $32,700

$34,700

Balance Sheets

AssetsCash $26,700 $26,70

0$26,70

0Investment Securities @

Cost22,000 -0- -0-

Investment Securities @ Market

-0- 20,000 20,000

Total Assets $48,700 $46,700

$46,700

Stockholders’ EquityCommon Stock $15,000 $15,00

0$15,00

0Retained Earnings* 33,700 31,700 33,700Unrealized Loss -0- -0- (2,000)

8-123

Total Stockholders’ Equity $48,700 $46,700

$46,700

*Net Income above less $1,000 dividends

8-124


Brogan’s Trucking CompanyComparative Financial Statements


Investment Securities Classified As:





$50,000

$50,000 $50,000

Cash Inflow from Invest. Rev.

1,300 1,300 1,300

Outflow for Expenses (17,000)

(17,000)

(17,000)


-0- (28,000)

-0-


-0- 6,400 -0-


34,300 12,700 34,300



(28,000)

-0- (28,000)


6,400 -0- 6,400

Net Cash Flow from Investing Act.

(21,600)

-0- (21,600)

Cash Flows From Financing Act.:

Inflow from Stock Issue 15,000 15,000 15,000Outflow for Dividends (1,000) (1,000) (1,000)

Net Cash Flow from Financing Act.

14,000 14,000 14,000

8-125

Net Change in Cash 26,700 26,700 26,700Plus: Beginning Cash Balance -0- -0- -0-Ending Cash Balance $26,70

0$26,700 $26,70

0

8-126

PROBLEM 8-28B

a.Even

tBalance Sheet Income Statement Stmt. of

Assets

= Liab. + S. Equity


Cash Flows

1. + NA + NA NA NA + FA2. + NA NA NA NA NA IA3. + NA NA NA NA NA OA4. + NA + + NA + NA5. + NA + NA NA NA NA6. NA NA NA NA NA NA NA7. NA NA + NA8. NA NA NA NA NA NA NA9. NA NA + NA

10. NA NA + NA

b. The directional effect is the same for events 9 and 10. In both events, you are reducing inventory and recording an expense that reduces stockholders’ equity. However, the amounts would be different during periods of changing prices.

8-127

ATC 8-1Financial Statement Analysis

a. Inventory turnover:

$25,445 ÷ $400 = 63.61 times

Average days to sell inventory:

365 days ÷ 63.6 = 5.7 days (Wow!)

b. FIFO. See Note 1 on page 31 of the annual report.

c. Unlike most companies, including other direct marketers such as Land’s End, Dell does not need to maintain significant quantities of “finished goods” inventory. Dell builds computers “to order”, so its inventory includes an inventory of parts. See Note 9 on page 42 of the annual report. Conversely, Land’s End must maintain many different sizes and colors of each of its clothing products, so it can fill customers’ orders on a timely basis. Additionally, Dell is famous for its very efficient “just-in-time” inventory system, which results in very low inventory levels.

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ATC 8-2a.

Blue Bird CompanyInventory Purchases

Beginning Inventory 100 @ $50 = $ 5,000 70 @ 55 = 3,850

First Purchase 100 @ 54 = 5,400Second Purchase 250 @ 58 = 14,500Total 520 $28,750

FIFOCost of Goods Sold:

FIFO UnitsCost per

UnitCost of Goods

SoldFrom Beginning Inventory 100 @ $50 = $ 5,000From Beginning Inventory 70 @ 55 = 3,850From First Purchase 100 @ 54 = 5,400From Second Purchase 150 @ 58 = 8,700Total Units Sold 420 $22,950

Ending Inventory: 100 units @ $58 = $5,800

LIFOCost of Goods Sold:

LIFO UnitsCost per

UnitCost of Goods

SoldFrom Second Purchase 250 @ $58 = $14,500From First Purchase 100 @ 54 = 5,400From Beginning Inventory 70 @ 55 = 3,850Total Units Sold 420 $23,750

Ending Inventory: 100 units @ $50 = $5,000

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ATC 8-2 a. (cont.)

Weighted Average

Total Cost Total Units = Cost per Unit$28,750 520 = $55.288

Cost of Goods Sold 420 units @ $55.288 = $23,221

Ending Inventory 100 units @ $55.288 = $5,529

Blue Bird Company

Income Statements FIFO LIFOWeightedAverage

Sales (220 @$80; 200 @ $90) $35,600 $35,600 $35,600Cost of Goods Sold (22,950) (23,750) (23,221)Gross Margin 12,650 11,850 12,379Operating Expenses (3,200) (3,200) (3,200)Income Before Tax 9,450 8,650 9,179Income Tax (30%) (2,835) (2,595) (2,754)Net Income $6,615 $6,055 $6,425

b. LIFO may be preferred for tax purposes in a period of rising prices because it will result in the lowest net income and, consequently, the lowest amount of tax paid for the year. FIFO may be preferred for financial statement purposes because it will result in the higher net income in a period of rising prices. The higher net income is more favorable to stockholders. Because LIFO generally results in a deferral of the payment of income tax, if it is used for tax reporting, it must also be used for financial statement purposes to prevent abuse by taxpayers.

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ATC 8-3

Real World Case

Note, all dollar amounts are in millions.a. Sales for 2000 $141,230.0 x decrease in gross margin percentage (11.9% - 10.7%) 0.012 Decrease in 2000's pretax earnings due

to the lower gross margin $ 1,694.8

b. Ending inventory for 2000 $ 7,514.0 x Ford’s interest rate 0.075 x increased portion of a year to sell inventory from 1999 to 2000 (22 days - 17 days) 5 ÷ 365 Increase in financing cost per inventory cycle 7.7 x inventory cycles per year for 2000 (365/22) 16.6

Decrease in 2000 pretax earnings due to increased financing cost resulting from longer time to sell inventory $ 127.8

c. Decrease in 2000's pretax earnings due to the lower gross margin (see a. above) $ 1,694.8

Decrease in 2000 pretax earnings due to increased financing cost resulting from longer time to sell inventory (see b. above) 127.8

Total 1,822.6÷ Decrease in pretax earnings from 1999 to 2000 ÷ 2,008.0

Percentage of decrease in pretax earnings resulting from the lower gross margin percentage and the longer time to sell

inventory 90.8%

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ATC 8-4

Inventory turnover: $7,518,000 $289,000 = 26 inventory turnovers

365 26 = 14 days to sell inventory

The average days to sell inventory is 14 days. However, the average shelf life for the fruit sold is only 10 days. The inventory does not appear to be good collateral for the loan.

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ATC 8-5

a. First the company's gross margins must be calculated:

Cosmos FantasySales $2,000,000 $2,000,000Cost of Goods Sold (1,200,000) (1,260,000)Gross Margin $ 800,000 $ 740,000

Gross margin %:Cosmos: $800,000 ÷ $2,000,000 = 40%Fantasy: $740,000 ÷ $2,000,000 = 37%

Cosmos appears to be charging more in relation to cost of goods sold.

b. Inventory turnover ratios:Cosmos: $1,200,000 ÷ $240,000 = 5.0 timesFantasy: $1,260,000 ÷ $180,000 = 7.0 times

Average days to sell inventory:Cosmos: 365 days ÷ 5.0 = 73 daysFantasy: 365 days ÷ 7.0 = 52 days

Cosmos appears to incur the higher costs to finance inventory for two reasons: (1) it takes the longest time to sell its inventory, and (2) it has more inventory than Fantasy.

c. Other things being equal, this would indicate a company sells its product at a lower price. The lower the price, the more quickly goods should sell. “Other things” are not equal in this problem. Fantasy is using LIFO while Cosmos is using FIFO. Assuming prices are rising, LIFO causes the gross margin percentage to be lower, due to the higher cost of goods sold. LIFO also causes ending inventory to appear to be lower. The higher cost of goods sold and the lower ending inventory resulting from LIFO both cause the inventory turnover ratio to be higher than if FIFO is being used. However, neither the lower gross margin percentage nor the higher inventory turnover ratio that results from using LIFO have any effect on cash flows, except for the related income tax effects.

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ATC 8-5 (cont.)

d. First, calculate the accounts receivable turnover ratio:

Cosmos: $2,000,000 ÷ $320,000 = 6.3 timesFantasy: $2,000,000 ÷ $320,000 = 6.3 times

Next, calculate the average days to collect accounts receivable:

Both companies: 365 days ÷ 6.3 = 58 days

Finally, using the “average days to sell inventory” calculated in part b. and the “average days to collect accounts receivable,” calculated above, determine the length of the operating cycle.

Cosmos Fantasy

Days to sell inventory (see b.) 73 52Days to collect receivables 58 58Operating cycle 131 110

The shorter a company’s operating cycle, the more quickly it gets its cash back and the more quickly this cash can be reinvested. The quicker money is reinvested, the more money can be made. As noted above in c., this is not entirely true if the shorter operating cycle results from using different inventory flow assumptions.

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ATC 8-6

a.The following amounts would be shown on the balance sheet at December 31, 2001:

Assets:InvestmentsAvailable for Sale $19,978.5

Held-to-maturity $143.0

Trading securities $16,535.7

Stockholders’ Equity:Unrealized gains on investment securities(Available for Sale) $871.4 (951.3 79.9)

b. The memo should include an explanation of the difference in intent between available-for-sale, held-to-maturity, and trading securities. Also the memo should include an explanation of how each is reported on the balance sheet.

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ATC 8-7

a. When the LIFO method is used, tax law requires companies to use the same cost flow method for financial reporting that they use for tax reporting. Consequently, if the company uses LIFO for tax purposes, then it is legally bound to use the same method in its financial statements. Accordingly, it would be illegal for Coolage to follow Bailey’s instructions. It is not unethical to report certain items one way on the tax return and a different way on the financial statements, so long as there is no legal requirement preventing it. Indeed, this is common business practice. The requirement for consistency between LIFO on the tax return and LIFO on the income statement is an exception to the general rule. Nevertheless, it would be illegal and unethical to violate the tax laws.

b. The switch to FIFO would increase the amount of ending inventory reported on Far Eastern’s balance sheet. Assuming an inflationary economy, the first inventory purchased, which would be the lower cost inventory, would be the first inventory expensed when goods are sold under FIFO. This would leave the higher cost inventory in ending inventory which is the cost that would appear on the balance sheet.

c. It would be unwise to pay $400,000 of additional taxes in order to increase the amount of reported net income by $800,000. Since LIFO reduces cash outflow for taxes, it increases the value of the company to its owners. The switch to FIFO would decrease the value of the company and thereby would act to deter rather than stimulate investment. According to accounting research, investors are not fooled by deceptive reporting practices. They make investment decisions on the basis of the economic consequences (i.e., cash consequences) rather than spurious values that may be reported in the financial statements.

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ATC 8-8Using the EDGAR Database

NOTE: This solution was accurate as of January 3, 2002. However, the EDGAR database is subject to update at any time, so this solution will likely be “dated” at the time you assign this case to your students.

These data are from the February 3, 2001 financial statements and dollar amounts are in thousands.

a. Gap Company had 3,676 stores and total merchandise inventory of $1,904,153. The average inventory per store was $518.

b. During its 2000 fiscal year, Gap opened 731 new stores and closed 73 existing stores, for a net increase of 658 stores. (See the “properties” section of MD&A)

c. Quarter Sales During Each Quarter 1 $2,731,990 2 2,947,714 3 3,414,668 4 4,579,088

d. Gap has higher sales during the third and fourth quarters due to Christmas sales. Yes, its inventory must also vary throughout the year to support the changing level of sales.

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Chapter 08 Solution of fundamental of financial accouting by EDMONDS (4th edition)

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