Solution manual intermediate accounting 9e by nicolai ch07

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER INVENTORIES: COST MEASUREMENT AND FLOW ASSUMPTIONS CONTENT ANALYSIS OF EXERCISES AND PROBLEMS Number Content Time Range (minutes) E7-1 Inventory Manufacturing company Computation of ending account balances 5-10 E7-2 Goods in Transit FOB destination FOB shipping point Items included as inventory, cost assigned 5-10 E7-3 Items in Inventory Determine if numerous items should be included in inventory 5-10 E7-4 Inventory Valuation Journal entries to record a rebate Effect on inventory valuation 5-10 E7-5 Discounts Gross price and net price methods Journal entries 5-15 E7-6 Discounts Gross price and net price methods Journal entries 5-15 E7-7 Inventory Methods Periodic system Cost of goods sold and ending inventory under FIFO, LIFO, and average cost 10-15 E7-8 Inventory Methods Perpetual system Cost of goods sold and ending inventory under FIFO, LIFO, and average cost 10-15 E7-9 (AICPA adapted) Inventory Methods Periodic system Ending inventory under FIFO, LIFO, and weighted average 15-20 E7-10 LIFO Perpetual and periodic systems Ending inventory, cost of goods sold 10-15 E7-11 Dollar-Value LIFO Determination of ending inventory at end of one year 10-15 E7-12 Dollar-Value LIFO Determination of ending inventory for four years 10-20 E7-13 (AICPA adapted) Dollar-Value LIFO Computation of yearend inventory for three years 10-20 E7-14 (AICPA adapted) Dollar-Value LIFO Computation of yearend inventory for three years 10-20 7-1 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Number Content Time Range (minutes) E7-15 Inventory Pools Dollar-value LIFO Computation of ending inventory 20-30 E7-16 Use of Different Methods FIFO used internally, LIFO used externally Journal entries to convert accounts Comparative balance sheet disclosure Difference in cost of goods sold 10-20 E7-17 Interim Financial Reports LIFO Accounting for inventory liquidation in different quarters Worksheet entry 10-20 E7-18 (Appendix) Exchange Gains and Losses Record journal entries for acquisition and payment 5-10 E7-19 (Appendix) Exchange Gains and Losses Record journal entries for sale and collection 5-10 P7-1 Items in Inventory Analyze several transactions to determine if included in inventory 10-15 P7-2 Valuation of Inventory Adjustment of ending inventory value to account for transactions not considered 20-30 P7-3 Cost of Sales FIFO, LIFO, and average cost Ending inventory, cost of goods sold (in units and dollars) 20-30 P7-4 Discounts Gross price and net price methods Income determination, journal entries 20-30 P7-5 Inventory Methods FIFO, LIFO, and average cost under periodic and perpetual systems Cost of goods sold, ending inventory Reconcile LIFO periodic and LIFO perpetual 25-35 P7-6 Inventory Methods FIFO, LIFO, and average cost under periodic and perpetual systems Cost of goods sold, ending inventory Reconcile LIFO periodic and LIFO perpetual Inventory turnover ratio and related issues 30-40 P7-7 Inventory Methods FIFO, LIFO, and average cost Periodic Gross profit determination Return on assets and related issues 30-45 P7-8 (AICPA adapted) LIFO and Inventory Pools Computation of ending inventories and cost of goods sold 30-40 P7-9 Dollar-Value LIFO Determination of year-end inventory for five years Prepare disclosures 45-60 P7-10 Dollar-Value LIFO Determination of year-end inventory for five years 45-60 P7-11 Dollar-Value LIFO and Inventory Pools Computation of ending inventory one pool and three pools 30-40 P7-12 Comprehensive: Dollar-Value LIFO Two pools Compute cost indexes Determine year-end inventory for years 45-60 7-2 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Number Content Time Range (minutes) P7-13 (AICPA adapted) Double-Extension: Dollar Value LIFO Multiple-pools Compute internal conversion cost indexes Compute year-end inventory for years 45-60 P7-14 LIFO Liquidation Profit Unit sales exceed unit purchases Computation of LIFO liquidation profit Determine effect on income taxes of additional purchases and use of LIFO Prepare disclosures 40-60 P7-15 Comprehensive Determination of ending inventory Cost of goods sold from purchases, from beginning inventory 30-45 P7-16 (AICPA adapted) Inventory Valuation FIFO, perpetual Early year-end physical count Inventory value determination 30-45 P7-17 AICPA adapted) Comprehensive: Inventory Adjustments Preparation of schedule of adjustments to compute ending inventory, accounts payable, and sales 25-35 ANSWERS TO QUESTIONS Q7-1 A merchandising company acquires goods for resale and does not alter their physical form, so it needs only one type of inventory account, usually called Merchandise Inventory A manufacturing company does change the physical form of the goods, and typically uses three inventory accounts in the financial statements to reflect the stage of completion The three accounts are usually called: (1) Raw Materials Inventory; (2) Goods in Process Inventory; and (3) Finished Goods Inventory Both types of companies may use more accounts internally Q7-2 Raw materials inventory includes the tangible goods acquired for direct use in the production process Goods (or work) in process inventory includes the products that have started in the manufacturing process but have not yet been completed The cost includes three components: Raw materials that have entered into the production process, Direct labor, which is the cost of the labor used directly in the manufacture of the product, Manufacturing (or factory) overhead, which includes the costs other than raw materials and direct labor that are associated with the production of the product These costs include variable manufacturing overhead, such as supplies and some indirect labor, and fixed manufacturing overhead, such as insurance, utilities, and depreciation on the assets used in the production process Finished goods inventory includes the same three cost components as the goods in process inventory combined into a single cost per unit for all the completed units 7-3 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q7-3 Under a perpetual inventory system, a company maintains a continuous record of inventory on hand It records every purchase and use of each item of inventory in detailed subsidiary records, sometimes in units only and sometimes with costs attached A company maintains an Inventory account and a Cost of Goods Sold account as summary accounts on a current basis, so inventory and cost of goods sold are continually known Under a periodic inventory system, a company periodically determines its inventory quantity and cost by a physical count of the goods on hand It typically does not debit the costs of purchases to an inventory account, but to an account entitled Purchases A company determines its cost of goods sold by adding the purchases for the period to beginning inventory (which is the ending inventory from the previous period) and subtracting ending inventory, which it calculates from an actual physical count at the end of the period Use of the perpetual system does not eliminate the need for taking a physical inventory count A physical count is taken periodically to confirm the balances in the perpetual records Q7-4 The general rule for determining whether a company includes an item in inventory is to include all items that are under the economic control of the company, regardless of their location or legal ownership Goods in transit shipped F.O.B destination are included in the inventory of the seller until they are received by the buyer, and are included in the inventory of the buyer when they are actually received Goods in transit shipped F.O.B shipping point are no longer included in the seller's inventory, and are included in the inventory of the buyer Goods on consignment, plus the handling and shipping costs incurred in delivery to the consignee, are included at cost in the inventory of the consignor, since the consignor retains economic control Q7-5 a Goods in transit purchased F.O.B shipping point for which the invoice has been received are included in the Raw Materials Inventory account since they are in transit and economic control has been transferred b Raw materials are included in the Raw Materials Inventory account c Since the consignor retains ownership (and control) of goods out on consignment, these are included in its Consignment-Out Inventory account d Since economic control of goods shipped F.O.B destination does not transfer to the purchaser until the goods are actually received, these are included in the inventory of the seller while in transit e Manufacturing supplies may be included in Raw Materials Inventory, but could also be isolated in a separate account entitled Manufacturing Supplies, Factory Supplies, or Indirect Materials a Sales commission are not included in the determination of inventory cost b A supervisor's salary, if directly related to the production of inventory, is included in the determination of inventory cost Q7-6 7-4 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q7-6 (continued) Q7-7 c Freight-in charges are included in inventory cost, unless they are the result of shipping errors, such as sending merchandise to the wrong warehouse and having it sent back Freight-out charges are included in selling costs d Indirect factory production labor, such as the salaries of machine maintenance personnel, is included in inventory cost if it can be allocated in a reasonable manner e Storage costs are included in inventory cost f The salaries of corporate executives are a period expense and are not included in the determination of inventory cost Standard costs are only acceptable for financial reporting purposes if adjusted for cost variances that occur during the period A company can account for standard cost variances in two different ways: it can expense them in the period, or it can allocate them between cost of goods sold and ending inventory Note to Instructor The following comments are not required or discussed in the chapter but may be useful for class discussion The advantages of expensing the variances as period expenses are that it is very simple and it avoids any arbitrary allocation to individual units of favorable or unfavorable variances The advantages of allocating the variances between ending inventory and cost of goods sold on the basis of relative total costs is that it spreads the cost variances evenly over all units produced Note that it is also possible to allocate the variances to the units in ending inventory, but this alternative has little support Q7-8 Under variable, or direct, costing only the variable costs incurred in production are included in inventory cost All fixed costs are treated as a period expense and are not allocated to inventory items Under absorption, or full, costing fixed manufacturing overhead costs are allocated to inventories and are expensed through the sale of inventory items Only the absorption, or full, costing method is acceptable for financial reporting purposes Q7-9 The gross price method, in which purchases are recorded at their gross price and discounts are only recorded when they are taken, is the easiest of the two methods to use It results in an Accounts Payable balance that reflects the maximum liability resulting from the purchase It has the disadvantage of hiding inefficiencies in the payment of Accounts Payable because discounts available but not taken are not known Also, inconsistent costing of inventories occurs when discounts taken are treated as a reduction in inventory cost Discounts lost, which result from inefficiencies in payment or poor cash flow control and add no value to inventory, are included in the cost of inventory under the gross price method The net price method isolates the discounts lost, thereby highlighting inefficiencies It also states the inventory at the cost management should expect to pay; that is, the invoice price less all available discounts The net price method has the disadvantage of possibly understating Accounts Payable, since some discounts may be lost, thus causing Accounts Payable to be higher However, proper adjusting entries will ensure that the correct liability appears on the financial statements 7-5 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q7-10 Generally accepted accounting principles require that an inventory cost flow assumption be systematic, based on cost, and match costs as expenses against revenues appropriately The assumed flow of costs does not represent the actual physical flow of goods The LIFO method matches the most recent costs with revenues, and thereby excludes some of the holding gain from gross profit (income) since the most recent costs are closer to replacement cost The LIFO method also results in lower gross profit (income) under conditions of rising costs, which produces the benefit of reduced cash payments for income taxes LIFO may only be used for tax purposes if it is used for financial accounting purposes, and management may not want to show a lower gross profit (income) on financial statements When a company using LIFO liquidates inventory during a period (sells some, or all, of the beginning inventory, which is valued at the costs of previous periods), costs of goods that may be carried at extremely old and unrealistically low costs are matched against current selling prices This matching produces a higher gross profit (income) that may be considered unrealistic The LIFO method enables management to manipulate profit by delaying purchases or liquidating inventory Alternatively, management may manipulate profit by avoiding a liquidation of inventory through a purchase at the end of the period The FIFO and average cost methods not produce unusual results when inventory liquidation occurs, nor are they susceptible to profit manipulation by management The LIFO ending inventory value bears little or no relationship to the costs of the current period, and therefore is not relevant LIFO is not allowed in most other countries because LIFO is not permitted to be used for income tax purposes in those countries Therefore there has been no incentive to allow its use for financial reporting Q7-11 During a period of rising costs, the LIFO cost flow assumption results in a lower gross profit (income) as compared with the FIFO method The cost of goods sold amount is higher under the LIFO method because the most recent costs are higher than the earliest costs During a period of falling costs, just the opposite is true The most recent costs in inventory (used in LIFO) would be less than the earliest costs (used in FIFO), causing a company's cost of goods sold to be lower and gross profit (income) to be higher under the LIFO cost flow assumption Q7-12 Under the LIFO method, the most recent costs are included in cost of goods sold, while earlier costs remain in inventory This results in the matching of the most recently incurred costs with current revenues in the determination of gross profit (income) and an inventory valuation at the earliest costs A company's ending inventory differs between a perpetual and a periodic LIFO system because of the difference in the assumptions about the timing of the sales Under the periodic method, cost of goods sold is determined at the end of the period, and therefore includes the costs of the latest purchases of the period Under the perpetual method, cost of goods sold is determined at each sale, and therefore includes the costs of the most recent purchase(s) at that time 7-6 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q7-13 When a company using the LIFO method sells more units than it has acquired during the period (liquidates inventory), the cost of units which were purchased in previous periods are brought into cost of goods sold Assuming inflation exists, these units have lower costs attached to them with the result that gross profit (income) is higher An extreme case of liquidation profits will result if there is a liquidation of inventory down to the base Inventory liquidation is an issue only with the LIFO method There is a build-up of layers in inventory that contain unit costs dating back many years Manipulation of profits can be achieved through intentional inventory liquidation under the LIFO method This is accomplished by delaying purchases until after the close of the reporting period, thereby matching costs of past periods against current revenues Q7-14 A holding gain is the difference between the historical cost and the replacement cost of the units sold It is not real income since it cannot be distributed to the owners without leaving the company worse off In a company that plans to continue as a going concern, inventory must be maintained Units sold are replaced with units acquired at current costs, so holding gains must be reinvested in inventory Since the FIFO method matches the earliest costs against current revenues, there is likely to be a substantial amount of holding gains included in gross profit (income) Since the LIFO method matches the most recent costs against current revenues, there are fewer holding gains included in gross profit (income) When inventory liquidation occurs, however, the opposite is true: there will be more holding gains included in gross profit (income) resulting from the liquidated inventory under the LIFO method than under the FIFO method Q7-15 The dollar value LIFO method simplifies some of the technical problems and recordkeeping detail involved in the LIFO method First, the inventory is grouped into pools of similar items The current cost of each inventory pool as of the end of the year is determined, and this amount is converted into base-year costs by using a cost index to eliminate the effects of cost changes This converted ending inventory amount at base-year costs is compared with the beginning inventory at base-year costs to determine whether there has been a real increase or decrease in the physical quantity of the inventory If there is an increase, it is converted back to the current year costs to determine the cost of the layer added If there is a decrease at base-year costs, the decrease is converted to the costs of the most recently added layer(s) of inventory Dollar value LIFO has several advantages as compared with the simple LIFO method First, it eliminates the necessity for detailed record-keeping of the flow of physical quantities and unit costs on a LIFO basis Second, it eliminates the effects of fluctuations in similar inventory items that may cause the LIFO base of one inventory item to be effectively eliminated, thus negating the advantages of LIFO Finally, strict application of the LIFO method requires that a new LIFO base be started for each new inventory item With the rate of technological development that exists in many industries the advantages of LIFO would be lost, but the inventory pools of the dollar value LIFO method eliminate the need for establishing new bases for each new inventory item 7-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q7-16 The double-extension and link-chain methods are used when a company computes an internal cost index Typically, each index is prepared using a sample of the total inventory Under the double-extension method, the ending inventory is priced at current year costs and at base year costs, and the cost index is computed as follows: Cost Index Sample of Ending Inventory at Current - Year Cost x 100 Sample of Ending Inventory at Base Year Costs This method should be used by companies which have little change in the types of their inventory items Under the link-chain method, the sample of ending inventory is priced at current cost at the end of the current year and at the beginning of the current year The current year cumulative index is computed as follows: Cost Index Previous Sample of Ending Inventory at Ending Year Cost x Year Cost Sample of Ending Inventory at Previous Year Current Costs Index This method should be used by companies which have frequent changes in the types of their inventory items Q7-17 In a period of rising costs, cost of goods sold is higher and ending inventory is lower under LIFO than under FIFO As a result, net income is usually lower when a company switches to LIFO from FIFO Working capital (current assets minus current liabilities) is also less when a company switches to the LIFO method because of the valuation of ending inventory, a current asset, at lower costs If the effect on prior periods is determinable, it is included in net income in the year of the change as a cumulative effect change If the effect of the change on the results of prior periods is not determinable, only disclosure of the effect on the current period is required Q7-18 The impact of LIFO inventory liquidation on a company's interim financial statements is addressed in APB Opinion No 28, which states that interim financial statements not give effect to the inventory liquidation if there is expected to be no inventory liquidation by the end of the annual period Thus, when a company incurs an inventory liquidation at the end of an interim reporting period, it must forecast its yearend physical quantities in inventory If it is forecasted that there will be no inventory liquidation at the end of the year, the quantity of the base that has been liquidated during the interim period is valued at its replacement cost instead of its LIFO historical cost for financial reporting purposes Q7-19 An exchange gain or loss is caused by a change in the exchange rate between the date of a purchase or sale on credit and the date of the payment or receipt An exchange gain occurs when the exchange rate declines (increases) between the date a company records a payable (receivable) and the date of the cash payment (receipt) An exchange loss occurs when the exchange rate increases (declines) between the date a company records a payable (receivable) and the date of the cash payment (receipt) 7-8 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANSWERS TO CASES C7-1 (AICPA adapted solution) a Inventories are unexpired costs and represent future benefits to the owner A statement of financial position includes a listing of unexpired costs and future benefits as the owner's assets at a specific point in time Because inventories are assets owned at the specific point in time for which a statement of financial position is prepared, they are included in order that the owner's financial position is presented fairly b Beginning and ending inventories are included in the computation of net income only for the purpose of arriving at the cost of goods sold during the period of time covered by the statement Goods included in the beginning inventory that are no longer on hand are expired costs matched against revenues earned during the period Goods included in the ending inventory are unexpired costs carried forward to a future period Financial accounting has as its goal the proper reporting of financial transactions and events in accordance with generally accepted accounting principles Income tax accounting has as its goal the reporting of taxable transactions and events in conformity with income tax laws and regulations While the primary purpose of an income tax is the production of tax revenues to finance the operations of government, income tax laws and regulations are often produced by various forces The income tax may be used as a tool of fiscal policy to stimulate or to decelerate the economy Some income tax laws may be passed because of political pressures brought to bear by individuals or industries When the purposes of financial accounting and income tax accounting differ, it is often desirable to report transactions or events differently and to employ income tax allocation in financial statement reporting to achieve simultaneously the conflicting goals of financial accounting and income tax accounting FIFO and LIFO are inventory costing methods employed to measure the flow of cost FIFO matches the first cost incurred with the first revenue produced whereas LIFO matches the most recent cost incurred with the first revenue produced after the cost is incurred (This, of course, assumes that a perpetual inventory system is in use and may not be precisely true if a periodic inventory system is employed.) If prices are changing, different costs are matched with revenue for the same quantity sold, depending upon whether the LIFO or FIFO system is in use In a period of rising prices, FIFO tends to value inventories at approximate market value in the balance sheet and LIFO tends to match approximately the current replacement cost of an item with the revenue produced The advantages of the dollar value LIFO method result from the use of a cost index and inventory pools The dollar value LIFO method requires less detailed record-keeping, because it is not necessary to record continuously the value of each item in inventory, or to record the liquidations of LIFO layers as they occur The method also maintains some of the advantages of LIFO when fluctuations in the levels of inventory of similar items occur The use of a pool evens the fluctuations in the levels of individual items and only accounts for the liquidation of a LIFO layer when the quantity of inventory in the total pool declines The dollar value LIFO method also helps maintain the advantages of LIFO when technological change occurs New products can be added to the pool and obsolete items removed from the pool so that a new LIFO base is not required when a more technologically advanced product replaces an existing product 7-9 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com C7-2 (AICPA adapted solution) a When using LIFO, the most recently incurred costs are included in cost of goods sold on the earnings statement, and the earlier costs are included in the inventory reported on the statement of financial position When using FIFO, the earlier costs are included in cost of goods sold on the earnings statement, and the later, more current costs are included in the inventory on the statement of financial position If all prices remain constant and inventory quantities remain constant, there will be no effect upon net earnings or working capital resulting from the use of LIFO rather than FIFO If prices are rising and inventory quantities remain constant or increase, LIFO will produce a larger cost of goods sold and a smaller net earnings than FIFO The change from FIFO to LIFO would thus reduce net earnings Likewise, rising prices yield a lower LIFO inventory cost on the statement of financial position than the corresponding FIFO inventory cost Therefore, the change to LIFO would reduce working capital If prices are falling and inventory quantities remain constant or increase, LIFO would produce a smaller cost of goods sold and, therefore, a larger net earnings than FIFO The change to LIFO thus would increase net earnings Likewise, falling prices yield a higher LIFO inventory cost on the statement of financial position than the corresponding FIFO inventory cost Therefore, the change to LIFO would increase working capital If inventory quantities decrease, the relative effects of using LIFO rather than FIFO cannot be determined without giving consideration to the direction of price changes and the magnitude of the inventory change a The use of FIFO as an inventory method results in recognizing all elements of earnings at the time of sale Holding gains (or losses) are combined with the operating (trading) earnings and are not separately identified Holding gains arise from holding inventory during periods of rising prices Operating earnings result from selling a product at a price above current cost Under FIFO, the operating cycle is viewed as cash to merchandise and back to cash again; therefore, reported earnings are net of goods (actually) sold An assumed FIFO cost flow generally is a good approximation of specific identification for most goods in most industries According to FIFO proponents, FIFO generally matches the actual cost of the (actual) goods sold with the revenue produced Because FIFO ignores the cost of the replacement of the inventory at possible higher prices (in a period of rising prices), it includes a "paper" profit that is not really available for distribution to owners because it is needed to replace inventory The use of LIFO as an inventory method matches the most recently incurred costs with the revenue produced It, therefore, largely excludes holding gains from the reported earnings if inventory quantity remains constant or increases Reported earnings from the period are more likely to include a deduction for goods sold in an amount that approximates more closely the higher cost required to replace inventory (during periods of rising prices) and, thereby, represent the distributable earnings accruing to the owners under the going-concern concept The operating cycle is viewed as 7-10 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-9 (continued) Note to Instructor: Other disclosure formats are acceptable: 2006 $78,000 (19,444) $58,556 Inventory at current cost Less: LIFO reservea Inventory at LIFO 2005 $73,000 (13,729) $59,271 The company had a LIFO liquidation profit (state reason, such as a decline in the physical size of inventory or falling costs) of $840b and $3,088c in 2006 and 2005, respectively The company would use current cost internally because it uses dollar-value LIFO and an internally generated cost index aThe difference between inventory at current cost and at LIFO b$622 x 135/100, rounded c$2,470 x 125/100, rounded 7-56 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-10 Date Increase Ending Increase (Decrease) Inventory Base Year Inventory (Decrease) Relevant at at x Cost Index = at at x Cost Index = Relevant Current Current Base-Year Base-Year Base-Year Current Costs Cost Index Cost Cost Cost Index Costs 01/01/03 $ 8,000 12/31/03 $10,800 x 7-57 12/31/04 11,500 x 12/31/05 14,000 x 12/31/06 10,500 x 100 120 100 130 100 145 100 125 x $1,000 x = 9,000 = 8,846 (154) x = 9,655 809 x (809) x = 120 100 120 100 145 100 145 100 = = $ 1,200 9,200 = (185) 9,015 = 1,173* 10,188 = (1,173)* 8,400 $ 8,000 8,480 (446) *Rounded down Ending Inventory at LIFO X 120 100 = (535)* Layers in LIFO Ending Inventory $8,000 8,000 ($8,000@100) 1,200 ($1,000@120) 8,000 ($8,000@100) 1,015 ($ 846@120) 8,000 ($8,000@100) 1,015 ($ 846@120) 1,173 ($ 809@145) 8,000 ($8,000@100) 480 ($ 400@120) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-11 Ending inventory (in units): X: 30,000 + 110,000 - 90,000 = 50,000 Y: 10,000 + 100,000 - 85,000 = 25,000 Z: 25,000 + 75,000 - 70,000 = 30,000 Cost index (50,000 x $4.75) (50,000 x $4.25) $237,500 $212,500 (25,000 x $3.75) (25,000 x $3.50) $93,750 $87,500 (30,000 x $2.10) x 100 (30,000 x $2.00) $63,000 x 100 $60,000 $394,250 x 100 $360,000 = 109.5139 Ending inventory at base 100 x 394,250 109.5139 year costs = $360,000 (rounded) Increase in inventory at base-year costs = $360,000 (rounded) - $212,500 = $147,500 Layer increase at current-year costs = $ 147,500 x 109.5139 100 = $161,533 (rounded) Total LIFO ending inventory cost = $212,500 + $161,533 = $374,033 Cost index of X = (50,000 x $4.75) x 100 (50,000 x $4.25) 237,500 $212,500 x 100 111.7647 7-58 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-11 (continued) (continued) Ending inventory of X at base-year costs = 100 x $237,500 111.7647 = $212,500 (rounded) Increase in X inventory at base-year costs = $212,500 - $127,500 = $ 85,000 Layer increase at current-year costs = $85,000 x 111.7647 100 = $95,000 (rounded) Total X LIFO ending inventory cost = $127,500 + $95,000 = $222,500 Cost index of Y = = (25,000 x $3.75) x 100 (25,000 x $3.50) $93,750 x 100 $87,500 = 107.1429 Ending inventory of Y at base-year costs = 100 x $93,750 107.1429 = $87,500 (rounded) Increase in Y inventory at base-year costs = $87,500 - $35,000 = $52,500 Layer increase at current-year costs = $52,500 x 107.1429 100 = $56,250 (rounded) 7-59 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-11 (continued) (continued) Total Y LIFO ending inventory cost = $35,000 + $56,250 = $91,250 Cost index of Z = = (30,000 x $2.10) x 100 (30,000 x $2.00) $63,000 x 100 $60,000 = 105 Ending inventory of Z at base-year costs = 100 x $63,00 105 = $60,000 Increase in Z inventory at base-year costs = $60,000 - $50,000 = $10,000 Layer increase at current-year costs = $ 10,000 x 105 100 = $10,500 Total Z LIFO ending inventory cost = $50,000 + $10,500 = $60,500 Total LIFO ending inventory cost: $222,500 (Inventory X pool) 91,250 (Inventory Y pool) 60,500 (Inventory Z pool) $374,250 7-60 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-12 Cost Indexes (2003 = 100) (30,000 x $11) (30,000 x $10) Pool 2004: = $330,000 $300,000 = $618,000 x 100 $540,000 (12,000 x $24) x 100 (12,000 x $20) $288,000 x 100 $240,000 = 114.4444 (40,000 x $12) (40,000 x $10) 2005: = $480,000 $400,000 = $788,000 x 100 $680,000 (14,000 x $22) x 100 (14,000 x $20) $308,000 x 100 $280,000 = 115.8824 (45,000 x $12) (45,000 x $10) 2006: = $540,000 $450,000 = $865,000 x 100 $710,000 (13,000 x $25) x 100 (13,000 x $20) $335,000 x 100 $260,000 = 121.8310 7-61 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-12 (continued) (continued) (50,000 x $7) (50,000 x $5) Pool 2004: = $350,000 $250,000 = $548,000 x 100 $426,000 (22,000 x $9) x 100 (22,000 x $8) $198,000 x 100 $176,000 = 128.6385 (46,000 x $6) (46,000 x $5) 2005: = $276,000 $230,000 = $436,000 x 100 $390,000 (20,000 x $8) x 100 (20,000 x $8) $160,000 x 100 $160,000 = 111.7949 (60,000 x $7) (60,000 x $5) 2006: = $420,000 $300,000 = $620,000 x 100 $500,000 (25,000 x $8) x 100 (25,000 x $8) $200,000 x 100 $200,000 = 124 Total ending inventory cost*: 2003: $400,000 + $360,000 = $ 760,000 2004: $560,222 + $444,901 = $1,005,123 2005: $722,457 + $398,591 = $1,121,048 2006: $759,006 + $534,991 = $1,293,997 *See next page for computations 7-62 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Pool 1: 7-63 Pool 2: Increase Increase (Decrease) Base Year Inventory (Decrease) Relevant at Ending x Cost Index = at at x Cost Index = Relevant Inventory Current Base-Year Base-Year Base-Year Current at Cost Index Cost Cost Cost Index Costs LIFO 01/01/04 $400,000 12/31/04 $618,800 X 12/31/05 788,000 x 12/31/06 865,000 x 100 114.444 100 115.8824 100 121.8310 = 540,000 $140,000 x = 680,000 140,000 x = 710,000 30,000 x 01/01/04 114.4444 100 115.8824 100 121.8310 100 = $162,222 560,222 = 162,235 722,457 = 36,549 759,006 $360,000 12/31/04 $548,000 x 12/31/05 436,000 x 12/31/06 620,000 x *Rounded $400,000 100 128.6385 100 111.7949 100 124 $360,000 = 426,000 66,000 x = 390,000 (36,000) x = 500,000 110,000 x 128.6385 100 128.6385 100 124 100 = 84,901 444,901 = (46,310) 398,591 = 136,400 534,991 P7-12 (continued) (continued) Date Ending Inventory at Current Costs To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-13 (AICPA adapted solution) LUCAS DISTRIBUTORS, INC Computation of Internal Conversion Cost Index For Inventory Pool No Double Extension Method December 31, 2004 December 31, 2005 Current inventory at current year cost Product A 17,000 x $35 = $595,000 Product B 9,000 x $28 = 252,000 $847,000 13,000 x $40 = $520,000 10,000 x $32 = 320,000 $840,000 Current inventory at base cost Product A 17,000 x $30 = $510,000 Product B 9,000 x $25 = 225,000 $735,000 13,000 x $30 = $390,000 10,000 x $25 = 250,000 $640,000 Conversion cost index $847,000 $735,000 = 1.15 $840,000 $640,000 = 1.31 LUCAS DISTRIBUTORS, INC Computation of Inventory Amounts Under Dollar Value LIFO Method For Inventory Pool No At December 31, 2004 and 2005 December 31, 2004 Base inventory 2004 layer ($735,000 - $560,000) Total Current Conversion inventory cost at base cost index $560,000 1.00 175,000 1.15a a $735,000 Inventory at LIFO cost $560,000 201,250 $761,250 December 31, 2005 Base inventory 2004 layer (remaining) 2005 layer Total $560,000 80,000b $640,000a $560,000 92,000 $652,000 aSee 1.00 1.15a 1.31a Computation of Internal Conversion Cost Index, above 7-64 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-13 (continued) (continued) bAfter liquidation of $95,000 at base cost: Product A (4,000 x $30) $120,000 Product B (1,000 x $25) (25,000) Net $ 95,000 P7-14 Note Although it is not required, it is helpful to compare the inventory amounts under FIFO and LIFO Inventory, December 31, 2004: FIFO 6,000 units at $8 = $48,000 LIFO 2,000 units at $5 = $10,000 3,000 units at $6 = 18,000 1,000 units at $8 = 8,000 $36,000 LIFO liquidation in units = 22,000 - 19,000 = LIFO liquidation profit = 3,000 1,000 ($10 - $8) + 2,000 ($10 - $6) = $10,000 LIFO liquidation profit after tax = $10,000 x 0.70 = $ 7,000 Note to Instructor: Other disclosure formats are acceptable: 2005 $30,000b (14,000) $16,000c Inventory at FIFO Less: LIFO reservea Inventory at LIFO 7-65 2004 $48,000 (12,000) $36,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-14 (continued) (continued) In 2005, the company experienced an unexpected increase in demand for our products that caused a decline in the physical size of the inventory The resulting liquidation of LIFO layers caused a LIFO liquidation profit that increased net income by $7,000 aThe difference between inventory at FIFO and at LIFO b[(6,000 c2,000 in beginning inventory - (22,000 - 19,000)], or 3,000 units @ $10 units @ $5 + 1,000 units @ $6 Purchase of an additional 7,000 units avoids the LIFO liquidation profit and therefore saves income taxes on that amount Income taxes saved = $10,000 x 0.30 = $ 3,000 The income tax savings over the 4-year period are equal to the difference in the inventory values times the income tax rate Inventory December 31, 2005: Units: 6,000 + (19,000 + 7,000) - 22,000 = 10,000 FIFO 10,000 units at $10 = $100,000 LIFO 6,000 units $36,000 (see above) 4,000 units at $10 = $40,000 $76,000 Income taxes saved = ($100,000 - $76,000) x 0.30 = $ 7,200 7-66 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-15 MARINO COMPANY Schedule for Computation of Ending Inventory Beginning inventory $100,000 Purchases Less: Purchases returns $300,000 (4,000) $296,000 Less: Purchases discounts taken ($296,000 x 0.02 x 0.80) Net purchases (4,736) $291,264 Sales = $640,000 Cost of goods sold = $640,000 = $320,000 Note to Instructor: Purchases in transit are not included in net purchases because they are being shipped FOB destination, so title has not passed Sales allowances are ignored because no inventory is returned and the sales price is twice the cost of sales Beginning Inventory + Purchases (net) - Cost of Goods Sold = Ending Inventory $100,000 + $291,264 $320,000 = $71,264 Under the LIFO periodic cost flow assumption, the net purchases for the period will first be included in cost of goods sold $291,264 x = $582,528 (sales from net purchases of period) ($640,000 - $582,528) = $57,472 (sales from beginning inventory) $57,472 = $28,736 (cost of sales from beginning inventory) Cost of sales from purchases Cost of sales from beginning inventory Total cost of goods sold 7-67 $291,264 28,736 $320,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-16 (AICPA adapted solution) Note to Instructor: Requirement of this problem requires an elementary knowledge of "inventory errors," discussed in Chapter Inventory per books Understatement per client's computations Physical inventory, per client Add: Footing and extension errors Total Less: Pricing errors Obsolete inventory Corrected physical inventory at November 30, 2004 Corrected physical inventory at November 30 Less: Direct labor included Overhead included (200% of direct labor) Inventory of materials at November 30 Add: Purchases Total material available Deduct: Cost of sales Less: Labor $13,800 Overhead (200% of direct labor) 27,600 Total Scrap loss on new product Total Less: Obsolete items included in cost of sales Materials inventory at December 31 Add: Direct labor in inventory Overhead (200% of direct labor) Inventory at December 31, 2004 aDirect labor in inventory at November 30 Additional direct labor costs incurred in December Total Less: Charges to cost of sales in December Direct labor in inventory at December 31, 2004 7-68 $ 2,200 250 $60,570 3,000 $63,570 150 $63,720 (2,450) $61,270 $10,000 20,000 $68,600 $57,700 (30,000) $27,700 24,700 $52,400 (41,400) $27,200 800 $28,000 (250) $ 8,300a 16,600 (27,750) $24,650 24,900 $49,550 $10,000 12,100 $22,100 (13,800) $ 8,300 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P7-17 (AICPA adapted solution) Inventory Initial amounts Adjustments: Increase (decrease) ($265,000 x 2%) Total adjustments Adjusted amounts Accounts Payable Sales $1,250,000 $1,000,000 $9,000,000 (155,000) (22,000) None 210,000 25,000 2,000 (5,300) 54,700 $1,304,700 (155,000) None None None 25,000 2,000 (5,300) (133,300) $ 866,700 None None 40,000 None None None None 40,000 $9,040,000 7-69 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 7-70 ... machine purchased during the year by $25, thereby reducing the cost of the ending inventory by the number of washing machines purchased this year and not sold multiplied by $25 per unit The rebate has... passed because of political pressures brought to bear by individuals or industries When the purposes of financial accounting and income tax accounting differ, it is often desirable to report transactions... period Financial accounting has as its goal the proper reporting of financial transactions and events in accordance with generally accepted accounting principles Income tax accounting has as