Solution manual intermediate accounting 9e by nicolai ch08

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER INVENTORIES: SPECIAL VALUATION PROBLEMS CONTENT ANALYSIS OF EXERCISES AND PROBLEMS Number Content Time Range (minutes) E8-1 Lower of Cost or Market Determination of inventory value 5-10 E8-2 Lower of Cost or Market Inventory value determination for five cases 5-10 E8-3 Lower of Cost or Market Individual items, groups of items, entire inventory Value determination 5-15 E8-4 Lower of Cost or Market Allowance method, periodic system Journal entries to record correct inventory value 5-15 E8-5 Purchase Commitment Loss Journal entries to record transactions 5-10 E8-6 Estimation of Fire Loss Determination of inventory value immediately prior to fire 5-15 E8-7 (AICPA adapted) Gross Profit Method Determination of estimated loss on inventory from fire 5-15 E8-8 Gross Profit Determination of price and cost changes, gross profit changes 5-15 E8-9 Gross Profit Percentage Based on net sales, based on cost of goods sold 5-10 E8-10 Retail Inventory Method Average cost, FIFO, lower of cost or market, LIFO Computation of ending inventory 10-15 E8-11 (AICPA adapted) Retail Inventory Method Lower of cost or market Computation of ending inventory 10-15 E8-12 Retail Inventory Method Average cost, FIFO, lower of cost or market, LIFO Computation of ending inventory 10-20 E8-13 Dollar-Value LIFO Retail Determination of the cost of inventory for one year 10-20 E8-14 Dollar-Value LIFO Retail Determination of the cost of inventory for one year 10-20 8-1 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Number Content Time Range (minutes) E8-15 (AICPA adapted) Dollar-Value LIFO Retail Determination of the cost of inventory for one year E8-16 Errors Impact of misstated purchases and ending inventory on the income statement and balance sheet E8-17 (AICPA adapted) Errors Discovery of prior year inventory valuation error Determination of correct net income 10-15 P8-1 Lower of Cost or Market Individual items, inventory as whole Inventory value computation 15-20 P8-2 Lower of Cost or Market Allowance and direct methods, periodic and perpetual systems Journal entries 15-20 P8-3 Lower of Cost or Market Interim financial statement disclosure P8-4 Lower of Cost or Market Allowance and direct methods, journal entries, financial statements P8-5 Gross Profit Determination of gross profit as a percentage of net sales 7-10 P8-6 Estimation of Theft Loss Computation of inventory lost 7-10 P8-7 Estimation of Fire Loss Computation of inventory lost Interim financial reporting 10-15 P8-8 Estimation of Flood Loss Determination of goods in process and raw materials inventory value destroyed 10-20 P8-9 (AICPA adapted) Estimation of Flood Loss Determination of work in process inventory loss in flood 10-20 P8-10 Retail Inventory Method Average cost, FIFO, lower of cost or market, LIFO Ending inventory value computation 20-30 P8-11 Comprehensive: Retail Inventory Method Average cost, FIFO, lower of cost or market, LIFO Ending inventory value computation 20-30 P8-12 (AICPA adapted) Retail Inventory Method Lower of average cost or market Includes estimated normal shrinkage 15-20 P8-13 Retail Inventory and Dollar-Value Methods Retail inventory method using lower of cost or market Dollar-value retail LIFO method Determination of inventory value 20-30 P8-14 Dollar-Value LIFO Retail Determination of cost of ending inventory for three years 30-40 P8-15 Dollar-Value LIFO Retail Computation of cost of ending inventory for four years 30-40 8-2 10-15 5-10 7-10 20-25 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Number Content Time Range (minutes) P8-16 Dollar-Value LIFO Retail and Fire Loss Computation of cost of inventory destroyed by fire 20-30 P8-17 Errors Impact of errors on inventory and net income 20-30 P8-18 (AICPA adapted) Comprehensive: Inventory Adjustments Prepare schedule to adjust inventory, accounts payable, and net sales for various items 40-60 ANSWERS TO QUESTIONS Q8-1 Cost is the cost incurred to purchase or manufacture the inventory Market value of inventory is defined as the current cost of replacing the inventory by either purchasing or manufacturing it Q8-2 The upper constraint on market value is the net realizable value, which is the estimated selling price less reasonably predictable cost of completion and disposal The upper constraint is used to ensure that if a decline in the value of the inventory occurs, the full amount of the decline is recognized at that time, therefore preventing the recognition of further losses in the future The lower constraint is the net realizable value less a normal profit margin This lower constraint assures that the inventory is not written down too far, which would result in a higher loss at the time of write-down and a higher profit in the future at the time the inventory is sold Q8-3 A company may apply the lower of cost or market method to inventory in three ways: It may be applied to (1) each individual inventory item, (2) each major category of inventory, or (3) the total inventory Q8-4 There are several arguments against the lower of cost or market rule First, the rule is a departure from the principle of historical cost Second, the rule is inconsistent, because losses are recognized from holding the inventory while gains are not Finally, the recognition of a loss violates the revenue recognition principle Since the earning process has not been completed, it may be argued that no loss should be recognized Q8-5 A company recognizes anticipated price declines as losses on certain purchase commitments If a company has entered into a noncancellable purchase commitment at a fixed price and subsequently the market price declines, the company reports a loss in the period that the decline occurs Q8-6 A company discloses an unconditional purchase obligation made at a definite price in a note to its financial statements When a company has an unconditional purchase obligation to acquire inventory at a fixed price and the market price is less than the fixed price, it recognizes a loss in the period in which the decline occurs, and writes down the inventory The "sale" under a product financing agreement is similar to borrowing cash with the inventory being used as collateral Thus, a company records the proceeds received as a liability 8-3 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q8-7 One exception to historical cost valuation of inventory is the lower of cost or market rule It is applied when the market value of inventory has declined below its original cost Another exception is the valuation of inventory at current market value even when it is above cost This method is only allowed in specific industries when it is highly certain that the goods can be sold at current market prices Q8-8 The gross profit method of inventory estimation would be useful in the following situations: At an interim date, the gross profit method is acceptable for estimating inventory rather than taking a physical count, as long as the method is disclosed It can be used to check on the reasonableness of the inventory value developed from a physical inventory or a perpetual inventory system Also, the auditor can take a physical count before the end of the year, and then estimate the ending inventory If inventory has been lost, stolen, or destroyed, or if inventory records are destroyed a company can estimate inventory on hand before the loss and be able to determine the amount of the loss If a company wishes to prepare budgets for upcoming periods, the gross profit method can be used to estimate inventories and cost of sales Q8-9 The underlying assumption of the gross profit method is that the rate of gross profit in the current period is not materially different from the rate in prior periods If the costs of inventory or the selling price have gone up or down in the current period and thus changed the gross profit rate, the prior percentage should be modified to reflect the change so that a better estimate of inventory can be made In addition, a separate rate may be used for each type of product sold Finally, an average rate for several past periods may be used to average out period to period fluctuation Q8-10 To provide valid results for inventory estimation using the retail inventory method, there should be a consistent, observable pattern between the cost of purchases and selling prices Q8-11 A markup is the original amount added to the cost of inventory to establish the first selling price An additional markup is an increase above the original selling price A markup cancellation is a reduction in the additional markup, but it cannot reduce the price below the original selling price A net markup is the aggregate of all additional markups less markup cancellations A markdown is a decrease that reduces the price below the original selling price A markdown cancellation is an increase in the selling price once it has been reduced by a markdown but it cannot be greater than the markdown A net markdown is the total markdowns less any markdown cancellations Q8-12 Under the FIFO cost flow assumption, the beginning inventory is not used in computing the cost-to-retail ratio for the period The ratio for the period includes both net markups and markdowns This method separately values the beginning inventory and the current purchases and retains the FIFO flow assumption 8-4 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q8-12 (continued) For average cost, the cost-to-retail ratio is computed using beginning inventory and net markups and net markdowns The use of beginning inventory, net markups, and net markdowns tends to average out fluctuations in costs The LIFO method calculates a separate ratio for each layer in the beginning inventory and for current purchases including both net markups and net markdowns This creates an estimate for the separate layers, which are then handled the same way as regular LIFO inventory The lower of average cost or market method uses the cost and retail value of the beginning inventory and net markups in the computation of the cost-to-retail ratio The inclusion of net markups but not net markdowns has the effect of lowering the cost-to-retail ratio and thus lowering the estimated inventory value below cost (however, not exactly to market) Q8-13 For the lower of average cost or market retail inventory method actually to produce an inventory valuation equal to the lower of cost or market, one of two conditions must exist: Markups and markdowns not exist at the same time; that is, there are either markups or markdowns, but not both All marked-down items have been sold in the current period Q8-14 First, it must be remembered that the retail inventory method is an estimate of inventory and thus discrepancies are likely to occur One cause may be inventory breakage or theft that would not be reflected in the cost-to-retail ratio, but does affect actual physical inventory Another reason for the discrepancy may be that one or more of the assumptions of the retail inventory method are not true For example, one such assumption is that items are homogeneous, or at least remain in relatively the same proportion in cost of goods available and ending inventory If this is not true in a particular period, the retail inventory value will be different than the actual physical inventory valuation Q8-15 O = Overstated; U = Understated; CY = Current Year; SY = Succeeding Year (a) CY Net Income: Balance Sheet: Beginning inventory Purchases Ending inventory Cost of goods sold Net income Earnings per share Ending inventory Accounts payable Retained earnings (b) SY O O U O O O O O U U (c) CY SY CY U O U O O O U U U U U O U U (d) SY U O CY U U O U U U U These effects assume that errors are corrected by the end of the following year 8-5 SY U O O To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANSWERS TO CASES C8-1 (AICPA adapted solution) The retail inventory method can be employed to estimate retail, wholesale, and manufacturing finished goods inventories The valuation of inventory under this method is arrived at by reducing the ending inventory at retail to an estimate of the lower of cost or market The retail value of ending inventory can be computed by (1) taking a physical inventory, or by (2) subtracting net sales plus net markdowns from the total retail value of merchandise available for sale (that is, the sum of beginning inventory at retail, net purchases at retail, and net markups) The reduction of ending inventory at retail to an estimate of the lower of cost or market is accomplished by applying to it an estimated cost ratio arrived at by dividing the retail value of merchandise available for sale as computed in (2) above into the cost of merchandise available for sale (that is, the sum of beginning inventory, net purchases, and other inventoriable costs) Since the retail method is based on an estimated cost ratio involving total merchandise available during the period, its validity depends on the underlying assumption that the merchandise in ending inventory is a representative mixture of all merchandise handled If this condition does not exist, the cost ratio may not be appropriate for the merchandise in ending inventory and can result in significant error Where there are a number of inventory subdivisions for which differing rates of markon are maintained, there is no assurance that the ending inventory mix will be representative of the total merchandise handled during the period In such cases, accurate results can be obtained by subclassifications by rate of markon Seasonal variations in the rate of markon will nullify the ending inventory "representative mix" assumption Since the estimated cost ratio is based on total merchandise handled during the period, the same rate of markon should prevail throughout the period Because of seasonal variations, it may be necessary to use data for the last months, quarter, or month to compute a cost ratio that is appropriate for ending inventory Material quantities of special sale merchandise handled during the period may also bias the result of this method because merchandise data included in arriving at the estimated cost ratio may not be proportionately represented in ending inventory This condition may be avoided by accumulating special sale merchandise data in separate accounts Distortion of the ending inventory approximation under this method is often caused by an inadequate system of inventory control Adequate accounting controls are necessary for the accurate accumulation of the data needed to arrive at a valid cost ratio Physical controls are equally important because, for interim purposes, this method is usually applied without taking a physical inventory 8-6 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com C8-1 (continued) The advantages of using the retail method as compared with cost methods include the following: a Approximate inventory values can be determined without maintaining perpetual inventory records b The preparation of interim financial statements is facilitated c Losses due to fire or other casualty are readily determined d Clerical work in pricing the physical inventory is reduced e The cost of merchandise can be kept confidential in intracompany transfers The treatments to be accorded net markups and net markdowns must be considered in light of their effects on the estimated cost ratio If both net markups and net markdowns are used in arriving at the cost ratio, ending inventory will be converted to an estimated average cost figure Excluding net markdowns will result in the inventory being stated at an estimate of the lower of cost or market The lower cost ratio arrived at by excluding net markdowns permits the pricing of inventory at an amount that reflects its current utility The assumption is that net markdowns represent a loss of utility that should be recognized in the period of markdown Ending inventory is therefore valued on the basis of its revenue-producing potential and may be expected to produce a normal gross profit if sold at prevailing retail prices in the next period C8-2 (AICPA adapted solution) THE SHELLY CORPORATION Computation of Gross Profit Ratio Sales Cost of goods sold Inventory, July 1, 2003 Purchases Purchases Adjustments Shipments received in May but recorded in June Unsalable shipments, no credit memos received at May 31, 2004 Deposit with vendor, recorded as purchase Adjusted purchases to May 31, 2004 Goods available for sale Physical inventory, May 31, 2004 Cost of goods sold Gross profit Gross profit ratio $840,000 $ 87,500 675,000 7,500 (1,000) (2,000) 679,500 767,000 (95,000) (672,000) $168,000 20% 8-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com C8-2 (continued) Computation of Cost of Goods Sold During June 2004 Sales for year ended June 30, 2004 Less sale of rain-damaged shipment Net sales Less sales for 11 months ended May 31, 2004 Net sales for June 2004 Less estimated gross profit at 20% Cost of goods sold during June $960,000 (10,000) 950,000 (840,000) 110,000 ( 22,000) $ 88,000 Computation of Inventory at June 30, 2004, by the Gross Profit Method Inventory, May 31, 2004 Purchases to June 30, 2004 per general ledger Adjustments Unsalable shipments, no credit memos received at June 30, 2004 Deposit made with vendor and charged to purchases in April, 2004; product was shipped in July, 2004 Cost of rain-damaged shipment Adjusted purchases to June 30, 2004 Less adjusted purchases to May 31, 2004 (from schedule 1) Adjusted purchases for June Goods available for sale during June Less cost of goods sold during June (from schedule 2) Inventory at June 30, 2004 $ 95,000 800,000 (1,500) (2,000) (10,000) 786,500 (679,500) 107,000 202,000 (88,000) $114,000 C8-3 (AICPA adapted solution) a b For its 2005 models, Blaedon should include in inventory carrying amounts all necessary and reasonable costs These costs may include design costs, purchase price from contractors, freight-in, and warehousing costs Blaedon's 2004 model inventory should be assigned a carrying amount equal to its net realizable value, which is its current list price reduced by both its disposition costs and two-thirds of the difference between the $40 allowance given and the carrying amount assigned to trade-ins The trade-ins' carrying amount should equal the $25 average net realizable value less the profit margin, if any, assigned Using FIFO, Blaedon would assign the earliest lawnmower costs to cost of goods sold With rising costs, this would result in matching old, relatively low inventory costs against current revenues Net income would be higher than that reported using certain other inventory methods 8-8 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com C8-3 (continued) b (continued) Blaedon would assign the latest costs to ending inventory Normally, the carrying amount of Blaedon's FIFO ending inventory would approximate replacement cost at December 31, 2004 Retained earnings would be higher than that reported using certain other inventory methods C8-4 (AICPA adapted solution) If the terms of the purchase are FOB shipping point (manufacturer's plant), Retail, Inc., includes in its inventory goods purchased from its suppliers when the goods are shipped For accounting purposes, title is presumed to pass at that time Freight-in expenditures are considered an inventoriable cost because they are part of the price paid or the consideration given to acquire an asset Because the cooking utensils were purchased three times during the current year, each time at a higher price than previously, Retail, Inc.'s ending inventory would be lower and the cost of goods sold would be higher using the weighted-average cost method instead of the FIFO method Because Retail, Inc., calculates the estimated cost of its ending inventory using the conventional (lower-of-cost-or-market) retail inventory method, net markdowns are excluded from the computation of the cost ratio and included in the computation of the ending inventory at retail Net markdowns are excluded in order to approximate a lowerof-cost-or-market valuation Excluding net markdowns from the computation of the cost ratio reduces the cost ratio, which in turn reduces the estimated cost of the ending inventory Products on consignment represent inventories owned by Retail, Inc., which are physically transferred to The Mall Space Company Retail, Inc., retains title to the goods until their sale by The Mall Space Company The goods consigned are still included by Retail, Inc., in the inventory section of its balance sheet Retail, Inc., reclassifies the inventory from regular inventory to consigned inventory The Mall Space Company, on the other hand, reports neither inventory nor a liability in its balance sheet C8-5 (AICPA adapted solution) (a) Diane's inventoriable cost includes all costs incurred to get the lighting fixtures ready for sale to the customer It includes not only the purchase price of the fixtures but also the other associated costs incurred on the fixtures up to the time they are ready for sale to the customer, for example, transportation in (b) No, administration costs are assumed to expire with the passage of time and not to attach to the product Furthermore, administrative costs not relate directly to inventories, but are incurred for the benefit of all functions of the business (a) The lower of cost or market rule is used for valuing inventories because of the concept of balance sheet conservatism and because the decline in the utility of the inventories below its cost is recognized as a loss in the current period 8-9 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com C8-5 (continued) (continued) (b) The net realizable value less a normal profit margin is used to value the inventories because market cannot be less than net realizable value less a normal profit margin To carry the inventories at net realizable value less a normal profit margin provides a means of measuring residual usefulness of an inventory expenditure Diane's beginning inventories at cost and at retail are included in the calculation of the cost ratio Net markdowns are excluded from the calculation of the cost ratio This procedure reduces the cost ratio because there is a larger denominator for the cost ratio calculation Thus the concept of balance sheet conservatism is being followed C8-6 (AICPA adapted solution) Purchases from various suppliers are generally included in Caddell's inventory when Caddell receives the goods For accounting purposes, in the absence of other information, title to goods purchased FOB destination is assumed to pass when the goods are received Caddell should account for the warehousing costs as an additional cost of inventory Theoretically, warehousing is a cost of readying the goods for sale and should be included in inventory cost (a) The advantages of using the dollar value LIFO inventory cost flow method are to reduce the cost of accounting for inventory according to the LIFO method and to minimize the probability of unintentional liquidation of LIFO inventory (b) The calculation of dollar value LIFO is based on dollars of inventory, a specific price index for each year, and broad inventory pools, whereas the conventional quantity of goods method is applied to individual units of each separate product The inventory layers are identified with the price index for the year in which the layer was added Caddell should account for the inventories consigned to Reed Company as part of inventory Caddell retains title to the goods until their sale by Reed; therefore the earnings process has not been completed In applying the lower of cost or market method, market does not exceed the ceiling or fall below the floor The ceiling is equal to the net realizable value, i.e., estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal The floor is equal to the net realizable value reduced by an allowance for an approximately normal profit margin C8-7 (AICPA adapted solution) The insurance costs on the raw materials while they were in transit from the supplier should be accounted for as part of inventory Theoretically, insurance cost on raw materials in transit is a cost associated with readying the goods for sale 8-10 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-7 (continued) Cost of goods salvaged = $4,700 x (1 - 0.40) = $2,820 Inventory lost in the fire: Cost of goods available for sale and on hand Less: Cost of goods sold Cost of goods salvaged Inventory lost $402,400 (345,840) (2,820) $ 53,740 When a company uses the periodic inventory method, it is estimating the ending inventory and cost of goods sold in its interim financial reports (unless it took a physical inventory) Therefore, you might be concerned about the accuracy of the reported amounts The gross profit method assumes that the gross profit percentage from the previous period(s) is applicable to the current period Using this percentage assumes that there has not been any change in the relationship between gross profit and net sales, due to, for example, cost or productivity changes Also, if the company uses a single gross profit percentage, it is assuming that inventories across departments are held in the same proportion P8-8 LRT COMPANY Computation of Value of Inventory Lost February 17, 2004 Sales Less: Gross profit (40%) Cost of goods sold Finished goods, February 17 Cost of goods available for sale Less: Finished goods, December 31, 2003 Cost of goods manufactured and completed $ 50,000 (20,000) $ 30,000 79,000 $109,000 (72,000) $ 37,000 Raw materials, December 31, 2003 Raw materials purchases Raw materials available for production Raw materials before flood Raw materials used Direct labor Manufacturing overhead cost Goods in process, December 31, 2003 Cost of production Less: Cost of goods completed (from above) Goods in process inventory lost in flood $ 70,000 20,000 $ 90,000 (70,000) ($35,000 $ 20,000 30,000 15,000 80,000 $145,000 (37,000) $108,000 8-34 ½) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-8 (continued) Total value of inventory destroyed by flood = Raw materials lost + Goods in process lost = ($70,000 - $35,000) + $108,000 = $143,000 P8-9 (AICPA adapted solution) PADWAY CORPORATION Computation of Value of Work-in-Process Inventory Lost June 30, 2004 Sales Less: Gross profit (25%) Cost of goods sold Add: Finished goods, June 30, 2004 Cost of goods available for sale Less: Finished goods, January 1, 2004 Cost of goods manufactured and completed $340,000 (85,000) $255,000 119,000 $374,000 (140,000) $234,000 Raw materials, January 1, 2004 Purchases Raw materials available Raw materials, June 30, 2004 Raw materials used Direct labor $ 80,000 Manufacturing overhead 40,000 Work-in-process, January 1, 2004 100,000 Cost of production Less: Cost of goods manufactured and completed Work-in-process inventory lost $ 30,000 115,000 $145,000 (62,000) $ 83,000 8-35 220,000 $303,000 (234,000) $ 69,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-10 Cost $140,000 (3,000) (5,000) 20,000 Purchases Less: Purchases discounts taken Purchases returns Freight-in Net markups ($50,000 - $10,000) Net markdowns ($15,000 - $3,000) Cost-to-retail ratio: $152,000 $210,000 $152,000 $181,000 $255,000 29,000 $181,000 $ 44,888 Cost $ 29,000 140,000 (3,000) (5,000) 20,000 Beginning inventory Purchases Less: Purchases discounts taken Purchases returns Freight-in Net markups Net markdowns Goods available for sale Cost-to-retail ratio: (8,000) 40,000 (12,000) $210,000 0.724 Beginning inventory Goods available for sale Less: Sales Employee discounts Ending inventory at retail Ending inventory at cost ($62,000 x 0.724) Retail $190,000 $181,000 45,000 $255,000 (190,000) (3,000) $ 62,000 Retail $ 45,000 190,000 (8,000) 40,000 (12,000) $255,000 0.710 Less: Sales and employee discounts Ending inventory at retail Ending inventory at cost ($62,000 x 0.710) 8-36 $ 44,020 (193,000) $ 62,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-10 (continued) Beginning inventory Cost-to-retail ratio: $29,000 $45,000 $152,000 $210,000 $190,000 (8,000) 40,000 (12,000) $210,000 0.724 $181,000 $255,000 (193,000) $ 62,000 $ 41,308 Cost $ 29,000 140,000 (3,000) (5,000) 20,000 Beginning inventory Purchases Less: Purchases discounts taken Purchases returns Freight-in Net markups $181,000 Cost-to-retail ratio: $267,000 $140,000 (3,000) (5,000) 20,000 $152,000 Goods available for sale Less: Sales and employee discounts Ending inventory at retail Ending inventory at cost $45,000 x 0.644 = $29,000a $17,000 x 0.724 = $12,308 aAdjusted for rounding error to original cost Retail $ 45,000 0.644 Purchases Less: Purchases discounts taken Purchases returns Freight-in Net markups Net markdowns Cost-to-retail ratio: Cost $ 29,000 $181,000 Retail $ 45,000 190,000 (8,000) 40,000 $267,000 0.678 Less: Sales and employee discounts Net markdowns Ending inventory at retail Ending inventory at LCM ($62,000 x 0.678) 8-37 $ 42,036 (193,000) (12,000) $ 62,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-11 Purchases Less: Purchases discounts taken Freight-in Net markups ($60,000 - $12,000) Net markdowns ($15,000 - $4,000) Cost-to-retail ratio: $330,000 $637,000 Cost Retail $320,000 (6,000) 16,000 $600,000 $330,000 48,000 (11,000) $637,000 0.518 Beginning inventory Goods available for sale Less: Net sales ($610,000 - $30,000)a Ending inventory at retail Ending inventory at cost ($237,000 x 0.518) 100,000 $430,000 $122,766 180,000 $817,000 (580,000) $237,000 aNote: Sales discounts are ignored because they are considered to be financing items and not part of the original markup Cost Beginning inventory Purchases Less: Purchases discounts taken Freight-in Net markups Net markdowns Cost-to-retail ratio: $430,000 $817,000 $100,000 320,000 (6,000) 16,000 $430,000 Retail $180,000 600,000 48,000 (11,000) $817,000 0.526 Less: Net sales ($610,000 - $30,000) Ending inventory at retail Ending inventory at cost ($237,000 x 0.526) 8-38 $124,662 (580,000) $237,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-11 (continued) Beginning inventory Cost-to-retail ratio: $100,000 $180,000 $330,000 $637,000 $100,000 $180,000 $320,000 (6,000) 16,000 $600,000 $330,000 48,000 (11,000) $637,000 0.518 Goods available for sale Less: Net sales ($610,000 - $30,000) Ending inventory at retail Ending inventory at cost ($180,000 x 0.556) ($ 57,000 x 0.518) aAdjusted Retail 0.556 Purchases Less: Purchases discounts taken Freight-in Net markups Net markdowns Cost-to-retail ratio: Cost $430,000 $100,000a 29,526 $129,526 $817,000 (580,000) $237,000 for rounding error to original cost Cost Beginning inventory Purchases Less: Purchases discounts taken Freight-in Net markups Cost-to-retail ratio: $430,000 $82,000 $100,000 320,000 (6,000) 16,000 $430,000 Retail $180,000 600,000 48,000 $828,000 0.519 Less: Net sales ($610,000 - $30,000) Net markdowns Ending inventory at retail Ending inventory at cost ($237,000 x 0.519) 8-39 $123,003 (580,000) (11,000) $237,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-12 (AICPA adapted solution) RED DEPARTMENT STORE Computation of Estimated Inventory Using Retail Inventory Method December 31, 2004 Inventory at January 1, 2004 Purchases Freight in Net markups ($60,000 - $10,000) Goods available for sale Cost ratio ($309,600 $720,000) = 0.43 Less: Sales Net markdowns ($25,000 - $5,000) Estimated normal shrinkage (2% x $600,000) Estimated inventory at retail at December 31, 2004 Estimated inventory at December 31, 2004, lower of cost or market ($88,000 x 0.43) Cost $ 32,000 270,000 7,600 $309,600 Retail $ 80,000 590,000 50,000 $720,000 (600,000) (20,000) (12,000) $ 88,000 $ 37,840 P8-13 Beginning inventory Net purchases ($75,000 - $2,000; $180,000 - $5,000) Net markups ($3,000 - $1,000) Cost-to-retail ratio: $98,000 $237,000 Cost $ 25,000 Retail $ 60,000 73,000 175,000 2,000 $237,000 $ 98,000 0.414 Less: Net sales ($210,000 - $5,000) Net markdowns ($7,000 - $2,000) Ending inventory at retail Ending inventory at cost ($27,000 x 0.414) 8-40 $ 11,178 (205,000) (5,000) $ 27,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-13(continued) Ending inventory at retail: $80,000 Ending inventory at retail in base-year prices: $80,000 1.05 = $76,190 Beginning inventory at retail in base-year prices: $60,000 Increase in inventory at retail in base-year prices: $16,190 Increase in inventory at retail in current-year prices: $16,190x1.05=$17,000 Increase in inventory at cost in current-year prices: $17,000 x 0.50 = $8,500 Ending inventory at cost base: $25,000 addition: 8,500 Ending inventory, total cost $33,500 P8-14 2004 Beginning inventory Cost-to-retail ratio: $ 50,000 $100,000 $200,000 $143,000 $420,000 20,000 (10,000) $430,000 0.465 $250,000 Ending inventory at retail at base-year prices: 100 108 $200,000 $200,000 Goods available for sale Less: Sales Ending inventory at retail $130,000 x Retail $100,000 0.50 Purchases Net markups Net markdowns Cost-to-retail ratio: Cost $ 50,000 $120,370 Inventory change at retail at base-year prices: $120,370 - $100,000 = $20,370 8-41 $530,000 (400,000) $130,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-14(continued) Change at relevant current costs: $20,370 x 108 x 0.465 100 $10,230 Ending inventory at cost: Base-year layer 2004 layer $50,000 10,230 $60,230 2005 Beginning inventory Purchases Net markups Net markdowns Cost $ 60,230 Retail $130,000 $250,000 $550,000 30,000 (40,000) $540,000 $250,000 $250,000 Cost-to-retail ratio: $540,000 0.463 Goods available for sale Less: Sales Ending inventory at retail $310,230 Ending inventory at retail at base-year prices: $70,000 x 100 115 $60,870 Inventory change at retail at base-year prices: $ 60,870 - $120,370 = $(59,500) Change at relevant current costs: $(20,370) x 108 x 0.465 100 (39,130) 100 x x 0.50 $(59,500 100 $(10,230) (all of 2004 layer) (19,565) (from base $(29,795) 8-42 year layer) $670,000 (600,000) $ 70,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-14 (continued) Ending inventory at cost: $60,230 - $29,795 = $30,435 (remaining base-year layer) 2006 Beginning inventory Purchases Net markups Net markdowns Cost-to-retail ratio: $240,000 $490,000 91,667 $ 91,667 - $ 60,870 = $30,797 Change at relevant current costs: 120 x 0.49 100 $18,109 Ending inventory at cost: Base layer 2006 layer $500,000 10,000 (20,000) $490,000 $270,435 Inventory change at retail at base-year prices: $30,797 x $240,000 0.49 Ending inventory at retail at base-year prices: 100 120 Retail $ 70,000 $240,000 Goods available for sale Less: Sales Ending inventory at retail $100,000 x Cost $ 30,435 $30,435 18,109 $48,544 8-43 $560,000 (450,000) $110,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Beginning inventory $ 40,000 Cost-to-retail ration: $ 80,000 85,500 Cost-to-retail ration: $190,000 8-44 130,000 x 9,849 x 12,333 x Cost $ 33,333 $270,000 (200,000) $ 70,000 92,000 0.40 $125,333 2004 Retail $ 70,000 Cost $ 39,999 230,000 117,600 2005 Retail $ 90,000 Cost $ 44,963 280,000 147,200 2006 Retail $110,000 $117,600 $280,000 $300,000 (210,000) $ 90,000 0.42 $157,599 $147,200 $320,000 $370,000 (260,000) $110,000 0.46 $192,163 $430,000 (300,000) $130,000 81,818 110 100 91,667 120 100 100 320,000 66,667 100 125 Inventory change at retail at base-year prices: $ 66,667 - $80,000 81,818 - 66,667 91,667 - 81,818 104,000 - 91,667 Change at retail at relevant current prices: 15,151 x $ 125,500 105 170,000 x $ 13,333 x $230,000 100 90,000 x 190,000 $ 92,000 0.45 Goods available for sale Sales Ending inventory at retail Ending inventory at retail at base-year prices: $ 70,000 x Retail $ 80,000 0.59 Purchases $ 85,000 2003 104,000 (13,333) 15,151 9,849 12,333 (13,333) 100 110 16,666 100 120 11,819 100 125 100 Change at relevant current costs: $(13,333) x 0.50 16,666 x 0.40 11,819 x 0.42 15,416 x 0.46 Year-end LIFO inventory Base-year layer ($40,000 - $6,667) Layer added in 2004 Layer added in 2005 Layer added in 2006 Ending inventory 15,416 (6,667) 6,666 4,964 33,333 33,333 6,666 33,333 6,666 4,964 $ 33,333 $ 39,999 $ 44,963 7,091 33,333 6,666 4,964 7,091 $ 52,054 P18-15 Cost $ 40,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-16 2004 Beginning inventory Cost-to-retail ratio: $40,000 $90,000 Retail $ 90,000 $100,000 $210,000 20,000 (40,000) $190,000 0.444 Purchases Net markups Net markdowns Cost-to-retail ratio: Cost $ 40,000 $100,000 $100,000 $190,000 0.526 Goods available for sale Less: Sales Ending inventory at retail $140,000 Ending inventory at retail at base-year prices: $80,000 x 100 106 $75,472 Inventory change at retail at base-year prices: $75,472 - $90,000 = $(14,528) Change at relevant current costs: $(14,528) x 100 X 0.444 100 $(6,450) (from base year layer) Ending inventory at cost: $40,000 - $6,450 = $33,550 (remaining base-year layer) 8-45 $280,000 (200,000) $ 80,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-16 (continued) 2005 Beginning inventory Purchases Net markups Net markdowns Cost-to-retail ratio: Cost $ 33,550 Retail $ 80,000 $160,000 $350,000 40,000 (70,000) $320,000 $160,000 $160,000 $320,000 0.50 Goods available for sale Less: Sales Ending inventory at retail $193,550 $400,000 (280,000) $120,000 Ending inventory at retail at base-year prices: $12,000 x 100 110 $109,091 Inventory change at retail at base-year prices: $109,091 - $75,472 = $33,619 Change at relevant current costs: $33,619 x 110 X 0.50 100 $18,490 Ending inventory (September 7, 2005) at cost: Base-year layer 2005 layer $33,550 18,490 $52,040 Inventory lost in the fire: Purchases in transit Undamaged goods salvaged ($10,000 x 0.50) Inventory after the fire Inventory before the fire (from above) Inventory lost 8-46 $ 8,000 5,000 $13,000 $52,040 $39,040 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-17 Current year: Ending inventory is correctly stated Net income is overstated by $17,500 because purchases are understated and, therefore, cost of goods sold is understated Following year: Since the purchase is recorded in the Purchases account in this year, net income is understated by $17,500, because cost of goods sold is overstated Current year: Ending inventory is understated by $4,300 Net income is understated by $4,300, because cost of goods sold is overstated Following year: Beginning inventory is understated by $4,300, so cost of goods sold will be understated by $4,300 causing net income to be overstated by $4,300 Current and following year: The results for both years will be the same as in Merchandise for which a purchase has been recorded are excluded from ending inventory in current year Current year: Ending inventory is understated Net income is correct because the errors in purchases and ending inventory offset each other Following year: The net income is correct because the errors would again offset each other Current year: Ending inventory is overstated Net income is overstated because cost of goods sold is understated Following year: Beginning inventory is overstated, which causes cost of goods sold to be overstated and net income to be understated 8-45 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P8-18 (AICPA adapted solution) LAYNE CORPORATION Adjustments to Initial Amounts As of December 31, 2004 Initial amounts Inventory $1,750,000 Accounts Payable $1,200,000 Adjustments [Increase (decrease)] Total adjustments Adjusted amounts None $ 50,000 20,000 26,000 25,000 30,000 None 2,000 $ 153,000 $1,903,000 None $ 50,000 None None None None 60,000 4,000 $ 114,000 $1,314,000 8-48 Net Sales $8,500,000 $ (35,000) None None (40,000) None None None None $ (75,000) $8,425,000 ... corrected by the end of the following year 8-5 SY U O O To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANSWERS TO CASES C8-1 (AICPA adapted solution) ... arrived at by reducing the ending inventory at retail to an estimate of the lower of cost or market The retail value of ending inventory can be computed by (1) taking a physical inventory, or by (2)... declined by 5%, the sales revenue at the same selling price would be $285,000 ($300,000 x 0.95) Therefore, the selling price increased by 3.9% ($296,000 $285,000 = 1.039) If volume decline by 5%,