Solutions manual intermediate accounting 18e by stice and stice ch09

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER QUESTIONS Four questions associated with accounting for inventory are as follows: When is inventory considered to have been purchased? Similarly, when is inventory considered to have been sold? Which costs are considered to be part of the cost of inventory, and which are simply business expenses for that period? How should total inventory cost be divided between the inventory that was sold (cost of goods sold) and the inventory that remains (ending inventory)? Vehicles are classified as inventory on the balance sheets of companies that sell vehicles in the normal course of business However, for a firm that uses vehicles but does not sell them, such as a delivery service business, the vehicles would be shown as property, plant, and equipment instead of as inventory Direct materials are applied directly to the manufacturing process and become part of the finished product Indirect materials are auxiliary materials, or materials that are not incorporated directly into the finished product They include such items as oil, fuels, and cleaning supplies They may also include materials of minor significance that are embodied in the final product but are too immaterial to account for as direct materials (a) The three cost elements found in work in process and finished goods are direct materials, direct labor, and manufacturing overhead (b) Manufacturing overhead is composed of all manufacturing costs other than direct materials and direct labor It includes indirect labor, indirect materials, depreciation, repairs, insurance, taxes, and the portion of managerial costs identified with production efforts The general rule of thumb is that inventoryrelated costs incurred inside the factory wall are allocated to the cost of inventory, and costs incurred outside the factory wall (e.g., 10 301 in the finished goods warehouse) are expensed as incurred Computers are characteristic of perpetual inventory systems The recordkeeping requirements of a perpetual system are greater than those for a periodic system, so a computer can greatly aid in managing the data In fact, periodic systems can be operated with just an old-fashioned cash register The decrease in computing costs over the past 20 years has greatly increased the use of perpetual systems The inventory system must be cost effective That is, cost vs benefit must be considered Also, it should provide effective control over the use and management of the asset The perpetual inventory system, because it is more costly to maintain and implement, should be used for items of relatively high unit value and for which management of the asset’s use is desired Therefore, items (a), (b), and (d) would most likely use the perpetual method However, with information technology constantly bringing down the cost of perpetual inventory systems, it is possible that a perpetual system is used in all the cases When a perpetual inventory system is used, the company knows how much inventory should be on hand at any point in time Comparing the inventory records to the result of a physical count allows the company to compute the amount of inventory shrinkage (a) Merchandise in transit is legally reported as inventory by the seller if it was shipped FOB destination (b) Merchandise in transit is legally reported as inventory by the buyer if it was shipped FOB shipping point or if it was shipped FOB destination and received before the year-end but not yet unloaded or moved into the inventory storage area (a) Consigned goods should be included in the inventory of the shipper/consignor, not in the inventory of the dealer holding the goods The consigned inventory should be reported in the shipper's inventory at the sum of its cost and the To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 302 Chapter handling and shipping costs incurred in the transfer to the dealer (b) Inventory sold under an installment sale may continue to be shown in the inventory of the seller because the seller retains title to the goods If the seller reports the inventory, it should be reduced by the buyer’s equity in the inventory as established by collections However, in the usual case when the possibilities of returns and defaults are very low, the seller, anticipating completion of the contract and the ultimate passing of title, recognizes the transaction as a regular sale and removes the goods from reported inventory at the time of the sale 11 The substance of an inventory sale accompanied by a repurchase agreement is that the inventory is being used as collateral for a loan Accordingly, the inventory continues to be reported as part of the seller’s inventory The proceeds from the ―sale‖ are reported as a loan A note describes the repurchase agreement 12 An activity-based cost (ABC) system is one in which overhead costs are allocated to inventory based on clearly identified cost drivers, which are characteristics of the production process known to create overhead costs 13 (a) Cash discounts may be accounted for under the gross method or the net method Under the gross method, purchases of merchandise are recorded at the gross amount of the invoice and discounts taken at the time of payment are recognized in a contra purchases account Under the net method, purchases of merchandise are recorded at the net amount of the invoice and any discounts not taken are recognized as an expense of the period (b) The net method of accounting for purchases is strongly preferred By separately reporting purchase discounts lost, the failure of a company to take advantage of cash discounts is highlighted It is normally considered advantageous for a company to take the purchase discount Failure to so is considered a lapse in efficient financial management of a company 14 Although the specific identification method may be considered a highly satisfactory approach in matching costs with revenues, it is often difficult or even impossible to apply If there are many items in the inventory with acquisition occurring at different times and at different prices, cost identification procedures may be very slow, burdensome, and costly When the units are in effect identical, the specific identification method opens the door to possible profit manipulation through the choice of specific units for sale 15 The average cost method of inventory valuation has the advantage of evening out the fluctuations of inventory pricing and generally is easier to apply than either the FIFO or LIFO method As prices vary, the average price used to cost inventory sold is automatically adjusted Because the cost of purchases during a period is usually several times more than the value of the opening inventory, the price used is heavily influenced by current costs 16 For most businesses, a FIFO assumption better matches the physical flow of goods A LIFO physical flow would mean that the oldest inventory would never be recycled but instead would stay in the company for years On the other hand, a LIFO assumption better matches current costs with current revenues because cost of goods sold is computed based on the costs of the most recently acquired inventory 17 Computation of average cost and LIFO under a perpetual system is complicated because the average cost of units available for sale changes every time a purchase is made, and the identification of the ―last in‖ units also changes with every purchase 18 (a) A new LIFO layer is created in each year in which the number of units purchased or manufactured exceeds the number of units sold As long as inventory continues to grow, a new LIFO layer is created each year and the old LIFO layers remain untouched (b) LIFO reserve is the difference between the LIFO ending inventory amount and the amount obtained using another inventory valuation method (such as FIFO or average cost) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 19 (a) The LIFO conformity rule requires companies using the LIFO method for tax reporting to also use it for financial reporting (b) In 1981, the IRS relaxed the LIFO conformity rule by permitting companies to use non-LIFO disclosures as long as they are not presented on the face of the income statement and to apply LIFO differently for book purposes than for tax purposes 20 In periods of increasing prices, FIFO historical cost flow will reflect the greatest dollar value of ending inventory because the historical unit cost assigned to the asset reflects the most recent unit price LIFO inventory will reflect the oldest relevant unit costs, thereby causing the highest cost of goods sold Even though the quantity of inventory does not change, the dollar value of the asset will change when using FIFO because the beginning inventory reflects the most recent unit prices for the prior year and the current year’s ending inventory reflects the most recent unit prices for the current year LIFO inventory value would not change since there has been no change in LIFO quantities and layers LIFO will result in higher cost of goods sold and lower payment of income taxes 21 The primary reason for using LIFO is to decrease income taxes paid during times of inflation For firms with small inventory levels or with flat or decreasing inventory costs, LIFO gives little, if any, tax benefit Such firms are unlikely to use LIFO 22 Under IAS 2, LIFO is not currently an acceptable inventory valuation method 23 The lower-of-cost-or-market rule is an application of the general valuation concept for inventories that they should not be valued at a price that would exceed the net realizable values If market is defined as replacement cost and there is no evaluation of net realizable value, the resulting valuation using the lower-of-cost-or-market concept could be ultraconservative On the other hand, if a decline in value has occurred, such decline should be reflected in the year the loss 303 occurred Similar arguments could be presented for recording gains in value if they occur 24 Movement in replacement cost (entry cost) may not result in immediate movement in sales price (exit value) If sales price does not change, no downward adjustment to cost is justified Thus, the floor limitation prevents charging a loss in one period to obtain a higher than normal profit in a subsequent period On the other hand, sales price may decline and replacement cost may not Thus, the net realizable value for an item might fall below replacement cost This decline should be recognized in the period when the loss occurs, not in a subsequent period when the sale takes place 25 Application of the lower-of-cost-or-market method to individual inventory items results in a lower inventory value When LCM is applied to the inventory as a whole, the increased market value of some inventory items offsets decreases in the value of other items 26 The value assigned to inventory can be very important in determining how profits and losses are allocated among different reporting units within the business A manager wants any inventory he or she receives from another department to be transferred at the lowest possible value When transferred inventory is reported at a low value, higher profits are recognized on the subsequent sale of the item Reported profits of a department may be used in the evaluation and bonus computation for the manager of the department 27 Under IAS 2, the rule governing inventory write-downs can best be labeled ―lower of cost or net realizable value.‖ Also, inventory write-downs can be reversed if inventory selling prices subsequently recover 28 In developing a reliable gross profit percentage, reference is made to the historical percentage, with adjustments for changes in current circumstances For example, the historical gross profit percentage would be adjusted if the pricing strategy has changed (e.g., because of increased competition), if the sales mix has changed, or if a different inventory valuation method has been adopted (e.g., a switch from FIFO to LIFO) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 304 Chapter 29 (1) Effect on Statements of Current Period (2) Effect on Statements of Succeeding Period (a) Ending inventory overstated because of a miscount Net income is overstated by the amount of the error Current assets and owners’ equity are overstated by the amount of the error Net income is understated by the amount of the error No effect on the balance sheet (b) Failure to record purchase of merchandise on account, and the merchandise purchased was not recognized in recording ending inventory No effect on net income, although both ending inventory and purchases are understated by the amount of the omission Both current assets and current liabilities are understated by the amount of the omission No effect on net income because the understatement in the beginning inventory is counterbalanced by the overstatement of purchases No effect on the balance sheet (c) Ending inventory understated because of a miscount Net income is understated by the amount of the error Current assets and owners’ equity are understated by the amount of the error Net income is overstated by the amount of the error No effect on the balance sheet Nature of Error 30 Generally, a higher inventory turnover ratio is a sign of a company that is managing its inventory more efficiently Therefore, Company B, with an inventory turnover ratio of 10.0 times, is managing its inventory more efficiently than Company A, with a ratio of 8.0 times However, as illustrated in the chapter, inventory turnover ratios for companies that not use the same inventory valuation method cannot be compared For example, comparison of the ratios for Companies A and B would not be valid if one company used FIFO and the other used LIFO FIFO assumption is made, the cost percentage used to convert ending inventory at retail into cost is the cost percentage for the purchases If a LIFO assumption is made, the conversion from retail to cost is done by first using the cost percentage applicable to beginning inventory and then applying the purchases cost percentage to the new LIFO layer, if any ‡ 33 a When using the retail inventory method to estimate average cost, markdowns are included in the computation of the cost percentage ‡ 31 The retail inventory method is more flexible than the gross profit method in that it allows estimates to be based on FIFO, LIFO, or average cost assumptions and even permits estimation of lower-of-cost-or-market values The retail inventory method also offers the advantage that when a physical inventory is actually taken for financial statement purposes, the inventory can be taken at retail and then converted to cost without reference to individual costs and invoices, thus saving time and expense ‡ 32 FIFO and LIFO assumptions can be incorporated into the retail inventory method by computing a different cost percentage for beginning inventory and for purchases If a b When using the retail inventory method to estimate lower of cost or market, markdowns are excluded from the computation of the cost percentage However, markdowns are included in the computation of ending inventory at retail ‡ 34 The purpose of forming LIFO pools is to simplify the LIFO calculations, so simplification should be a major factor In addition, all items in the pool should have some similarity, such as being in the same product line Finally, a company should carefully consider potential income tax effects when forming LIFO pools ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 305 ‡ 35 Dollar-value LIFO has the advantage of using dollar values identified with the inventory rather than physical units, and therefore the LIFO inventory valuation process is simplified Dollar-value LIFO makes the clerical routine less tedious and costly and permits the use of the LIFO valuation method in situations where it would not be feasible to use the unit method ‡ 36 Indexes are used to adjust current prices to a base-year period This adjustment is necessary to identify incremental layers If there is a new layer, another index must be used to adjust the incremental layer to current-year prices The incremental layer may be computed using beginning-of-year prices, average prices, or end-of-year prices ‡ 37 When using dollar-value LIFO, a new LIFO layer can be valued using a year-end price index, a first purchase price index, or an average price index Use of a first purchase price index is most consistent with the LIFO assumption ‡ 38 a When computing the cost percentage for the dollar-value LIFO retail method, beginning inventory values are ignored Any new inventory layer is converted from retail to cost using the cost percentage applicable to current year purchases b Both markdowns and markups are included in the retail number used to compute the cost percentage for use with the dollar-value LIFO retail method ‡ 39 No journal entry is made when a purchase commitment is originally entered into A purchase commitment is not an inventory purchase but a commitment to purchase inventory in the future This type of contract is an exchange of promises about future actions and is known as an executory contract ‡ 40 No, all transactions with foreign companies are not classified as foreign currency transactions The currency specified by the invoice determines if a transaction is a foreign currency transaction For example, if an invoice is denominated in U.S dollars, then—for a U.S company—the transaction is a domestic transaction regardless of to whom the merchandise is sold ‡ 41 The FASB requires an adjustment on the balance sheet date to ensure that gains and losses from exchange rate changes are included in the period in which the changes took place ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 306 Chapter PRACTICE EXERCISES PRACTICE 9–1 PERPETUAL AND PERIODIC JOURNAL ENTRIES Periodic: Purchases Accounts Payable 3,000 Accounts Receivable Sales 11,200 Cash Accounts Receivable 9,750 3,000 11,200 9,750 Perpetual: Inventory Accounts Payable 3,000 Accounts Receivable Sales 11,200 Cost of Goods Sold Inventory 4,500 Cash Accounts Receivable 9,750 PRACTICE 9–2 3,000 11,200 4,500 9,750 PERPETUAL AND PERIODIC COMPUTATIONS Beginning inventory Plus: Purchases Cost of goods available for sale Less: Ending inventory Cost of goods sold $220,000 720,000 $940,000 145,000 $795,000 Beginning inventory Plus: Purchases Cost of goods available for sale Less: Preliminary cost of goods sold Ending inventory, predicted Less: Ending inventory, actual Cost of missing inventory $220,000 720,000 $940,000 710,000 $230,000 145,000 $ 85,000 Cost of Goods Sold (or Inventory Shrinkage Expense) Inventory 85,000 85,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter PRACTICE 9–3 307 GOODS IN TRANSIT AND ON CONSIGNMENT Before adjustment Consignment Sold, FOB destination Purchased, FOB shipping point Sold, FOB shipping point Adjusted total PRACTICE 9–4 $ 225,000 no adjustment needed, correctly excluded + $20,000 + $30,000 no adjustment needed, correctly excluded $ 275,000 SCHEDULE OF COST OF GOODS MANUFACTURED Direct materials: Beginning raw materials inventory Plus: Purchases of raw materials Less: Ending raw materials inventory Raw materials used in production $ 40,000 230,000 (34,000) $ 236,000 Direct labor Manufacturing overhead: Depreciation on factory building Factory supervisor’s salary Indirect labor Total manufacturing overhead 198,000 $ 32,000 56,000 36,000 124,000 Total manufacturing costs Plus: Beginning work-in-process inventory Less: Ending work-in-process inventory Cost of goods manufactured PRACTICE 9–5 $ 558,000 76,000 (100,000) $ 534,000 ACCOUNTING FOR PURCHASE DISCOUNTS Net method, paid within discount period Inventory Accounts Payable 490,000 Accounts Payable Cash 490,000 490,000 490,000 Net method, paid after discount period Inventory Accounts Payable 490,000 Accounts Payable Discounts Lost Cash 490,000 10,000 490,000 500,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 308 Chapter PRACTICE 9–5 (Concluded) Gross method, paid within discount period Inventory Accounts Payable 500,000 Accounts Payable Inventory Cash 500,000 500,000 10,000 490,000 Gross method, paid after discount period Inventory Accounts Payable 500,000 Accounts Payable Cash 500,000 PRACTICE 9–6 500,000 500,000 INVENTORY VALUATION: FIFO, LIFO, AND AVERAGE Units 300 Beginning inventory Purchases: March 23 September 16 Cost per Unit $17.50 900 1,200 2,400 18.00 18.25 Total Cost $ 5,250 16,200 21,900 $43,350 Units remaining: 400, meaning that 2,000 (2,400 – 400) units were sold Cost of Goods Sold a 300 900 800 b $17.50 18.00 18.25 Total = $ 5,250 = 16,200 = 14,600 = $36,050 400 $18.25 = $7,300 $18.25 = $21,900 18.00 = 14,400 Total = $36,300 300 100 $17.50 = $5,250 18.00 = 1,800 Total = $7,050 400 $18.0625 = $7,225 LIFO 1,200 800 c Ending Inventory FIFO Average Cost $43,350/2,400 units = $18.0625 2,000 $18.0625 = $36,125 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter PRACTICE 9–7 309 INVENTORY VALUATION: COMPLICATIONS WITH A PERPETUAL SYSTEM Cost of Goods Sold Ending Inventory January 16 (100 units) 100 $17.50 = $ 1,750 200 $17.50 = $3,500 July 15 (600 units) 200 400 $17.50 = $ 3,500 18.00 = 7,200 500 $18.00 = $9,000 November (1,300 units) 500 800 $18.00 = $ 9,000 18.25 = 14,600 400 $18.25 = $7,300 a FIFO Total = $36,050 Total = $7,300 b LIFO January 16 (100 units) 100 $17.50 = $ 1,750 200 $17.50 = $3,500 July 15 (600 units) 600 $18.00 = $10,800 200 300 $17.50 = $3,500 18.00 = 5,400 November (1,300 units) 1,200 100 $18.25 = $21,900 18.00 = 1,800 200 200 $17.50 = $3,500 18.00 = 3,600 Total = $36,250 Total = $7,100 c Average Cost January 16 (100 units) 100 $17.50 = $ 1,750 200 900 1,100 $17.50 = $ 3,500 18.00 = 16,200 $19,700 200 $17.50 = $3,500 July 15 (600 units) $19,700/1,100 = $17.909 per unit 600 $17.909 = $10,745 500 1,200 1,700 $17.909 = $ 8,955 18.25 = 21,900 $30,855 500 $17.909 = $8,955 400 $18.150 = $7,260 November (1,300 units) $30,855/1,700 = $18.150 per unit 1,300 $18.150 = $23,595 Total = $36,090 Total = $7,260 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 310 Chapter PRACTICE 9–8 LIFO LAYERS Year Units Purchased 100 Cost per Unit $2.50 Units Sold 80 Year 160 $3.00 130 20 30 $2.50 = $50 $3.00 = 90 Year 180 $3.40 180 20 30 $2.50 = $50 $3.00 = 90 20 30 60 $2.50 = $ 50 $3.00 = 90 $4.00 = 240 Total = $380 Ending Inventory 20 $2.50 = $50 Note: No new LIFO layer was created in this year Year 260 PRACTICE 9–9 $4.00 200 LIFO RESERVE AND LIFO LIQUIDATION LIFO reserve: Difference between LIFO ending inventory and ending inventory computed using FIFO (which approximates current replacement cost) FIFO ending inventory (110 $4.00) LIFO ending inventory (see Practice 9–8 solution) LIFO reserve Cost of goods sold in Year 4: 200 units sold $440 380 $ 60 $4.00 = $800 Cost of goods sold in Year if the number of units purchased had been 150: Purchases during the year: 150 units $4.00 Beginning LIFO inventory of 50 units Total cost of goods sold $600 140 $740 It can be seen that dipping into the LIFO layers, as in (3), increases reported profit as the old LIFO layers, with lower costs, are assumed to be sold To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 366 9–80 Chapter (Concluded) (e) Purchases 1,175 Retained Earnings To correct the purchases account for 2013 Merchandise shipped FOB destination was not included in the 2012 inventory, but the purchase was recorded in 2012 instead of 2013 (f) Retained Earnings Purchases To reduce the purchases account for merchandise included in the 2012 ending inventory but not included in purchases until 2013 (g) Sales Merchandise Inventory Retained Earnings To reduce sales in 2013 for goods completed and segregated for customer in 2012, and to correct beginning inventory 9–81 Inventory—beginning Inventory—end Average inventory Cost of goods sold Inventory turnover Number of days’ sales in inventory 2013 $2,700 $3,000 $2,850 $41,200 14.46 25.2 1,175 835 835 1,825 1,350 475 2012 2011 $2,200 $1,800 $2,700 $2,200 $2,450 $2,000 $34,900 $26,500 14.24 13.25 25.6 27.5 The increasing inventory turnover and its related decreasing number of days’ sales in inventory indicates that Whittier has been able to increase its sales (doubled over the three years) without a correspondingly large increase in the inventory balance Because sales are increasing rapidly, Whittier must evaluate its inventory position carefully to balance inventory efficiency and customer satisfaction with an adequate supply of goods No indication of a problem is apparent in the data provided in the problem To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 9–82 367 ‡ Bergman Company Inventory Pools: Product 400 Unit Units Cost Beginning inventory 950 @ $11.50 Purchases: January 1,000 @ $12.00 February 1,500 @ $12.50 March 1,200 @ $12.25 Total units available 4,650 Less 1st quarter sales 2,850 Ending inventory units 1,800 Product 401 Unit Units Cost 155 @ $24.00 Product 402 Unit Units Cost 3,760 @ $5.00 500 @ $25.00 250 @ $26.00 5,000 @ $5.30 4,850 @ $5.38 3,500 @ $5.45 17,110 10,750 6,360 905 775 130 Computation of ending inventory values: Product 400 Product 401 Product 402 Beginning inventory 950 @ $11.50 = $10,925 130 @ $24 = $3,120 3,760 @ $5.00 = $18,800 Incremental layer 850 @ $12.28 = 10,438 0 2,600 @ $5.37 = 13,962 Ending inventory 1,800 $21,363 130 $3,120 6,360 $32,762 Purchases during the quarter: 1,000 @ $12.00 = $ 12,000 1,500 @ $12.50 = 18,750 1,200 @ $12.25 = 14,700 3,700 $ 45,450 Average value for computing incremental layer: $45,450 3,700 = $12.28 per unit $71,668 13,350 = $5.37 per unit Purchases during the quarter: 5,000 @ $5.30 = $ 26,500 4,850 @ $5.38 = 26,093 3,500 @ $5.45 = 19,075 13,350 $ 71,668 Average value for computing incremental layer: ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 368 Chapter 9–83.‡ Inventory at Year-End Inventory at Year-End Price Base-Year Date Prices Index Prices Dec 31, 2008 $32,400 ÷ 1.00 = $32,400 Layers $32,400 Incremental Layer Dollar-Value Index LIFO Cost 1.00 = $32,400 Dec 31, 2009 $43,100 ÷ 1.16 = $37,155 $32,400 4,755 $37,155 1.00 = 1.16 = $32,400 5,516 $37,916 Dec 31, 2010 $61,300 ÷ 1.34 = $45,746 $32,400 4,755 8,591 $45,746 1.00 = 1.16 = 1.34 = $32,400 5,516 11,512 $49,428 Dec 31, 2011 $52,900 ÷ 1.20 = $44,083 $32,400 4,755 6,928 $44,083 1.00 = 1.16 = 1.34 = $32,400 5,516 9,284 $47,200 Dec 31, 2012 $79,700 ÷ 1.68 = $47,440 $32,400 4,755 6,928 3,357 $47,440 1.00 1.16 1.34 1.68 = = = = $32,400 5,516 9,284 5,640 $52,840 Dec 31, 2013 $70,800 ÷ 2.10 = $33,714 $32,400 1,314 $33,714 1.00 = 1.16 = $32,400 1,524 $33,924 ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 9–84 369 ‡ Date Jan 1, 2010 Inventory at Year-End End-of-Year Price Retail Prices Index $235,000 ÷ 1.00 Dec 31, 2010 $280,000 Dec 31, 2011 $250,830 Dec 31, 2012 $258,875 Dec 31, 2013 $296,375 Inventory at Base-Year Retail Prices = $235,000 ‡ Incremental Dollar-Value Cost LIFO Retail Percentage Cost 0.63 = $ 148,050 ÷ 1.12 = $250,000 $235,000 15,000 $250,000 1.00 1.12 0.63 0.62 = = $ 148,050 10,416 $ 158,466 ÷ 1.08 = $232,250 $232,250 1.00 0.63 = $ 146,318 ÷ 1.09 = $237,500 $232,250 5,250 $237,500 1.00 1.09 0.63 0.58 = = $ 146,318 3,319 $ 149,637 ÷ 1.12 = $264,621 $232,250 5,250 27,121 $264,621 1.00 1.09 1.12 0.63 0.58 0.63 = = = $ 146,318 3,319 19,137 $ 168,774 $235,000 + $635,000 – $590,000 = $280,000 $393,700 ÷ $635,000 = 0.62 $280,000 + $550,000 – $579,170 = $250,830 $250,830 + $650,000 – $641,955 = $258,875 $377,000 ÷ $650,000 = 0.58 $258,875 + $800,000 – $762,500 = $296,375 $504,000 ÷ $800,000 = 0.63 Layers $235,000 Incremental Layer Index 1.00 Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 370 Chapter 9–85 ‡ No entry is made on the purchase commitment date The purchase commitment is an executory contract—an exchange of promises of future action 2013 Dec 31 Loss on Purchase Commitments Estimated Loss on Purchase Commitments [$150,000 – (3,000 $40)] 30,000 30,000 Estimated Loss on Purchase Commitments is a liability account 2014 Mar 23 Estimated Loss on Purchase Commitments Purchases Gain on Purchase Commitments Accounts Payable 30,000 150,000 30,000 150,000 When the value of inventory to be purchased under a purchase commitment recovers after a loss has been recognized, a gain is recognized to the extent that it offsets a previously recognized loss In this example, the gain is not the entire $42,000 ($162,000 – $120,000) increase in value since December 31; only the $30,000 amount that offsets the previously recognized $30,000 loss is recognized in 2014 ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 9–86 371 ‡ Date of original transaction: Goldstar Co., Ltd.: Inventory (or Purchases) Accounts Payable (fc) *(5,000 100,000 won) $0.00103 = $515,000 Lockner Inc.: Accounts Receivable Sales *(2,000 $135) = $270,000 515,000* 515,000 270,000* 270,000 Geopacific, Inc.: Accounts Receivable (fc) 323,232* Sales 323,232 *(2,400 148 Canadian dollars) = 355,200 $0.910 = $323,232 Printco: Inventory (or Purchases) Accounts Payable (fc) *(1,000 45,000 yen) = 45,000,000 $0.0075 = $337,500 337,500* 337,500 Adjustment on the balance sheet date: Goldstar Co., Ltd.: Exchange Loss Accounts Payable (fc) *($0.00112 – $0.00103) 500,000,000 won = $45,000 loss 45,000* 45,000 Lockner Inc.: Because this transaction is denominated in U.S dollars, it is classified as a domestic transaction even though it involves a foreign company As a result, there is no exchange gain or loss Geopacific, Inc.: Accounts Receivable (fc) Exchange Gain *($0.935 – $0.910) 355,200 Canadian dollars = $8,880 gain Printco: Accounts Payable (fc) Exchange Gain *($0.0075 – $0.0069) 45,000,000 yen = $27,000 gain ‡ Relates to Expanded Material 8,880 8,880* 27,000 27,000* To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 372 Chapter 9–86 ‡ (Concluded) Date of payment/receipt: Goldstar Co., Ltd.: Accounts Payable (fc) 560,000 Exchange Loss 15,000* Cash 575,000 *500,000,000 won $0.00115 – ($515,000 + $45,000) = $15,000 loss Lockner Inc.: Cash Accounts Receivable 270,000 270,000 Geopacific, Inc.: Cash 321,456 Exchange Loss 10,656* Accounts Receivable (fc) 332,112 *355,200 Canadian dollars $0.905 – ($323,232 + $8,880) = $10,656 loss Printco: Accounts Payable (fc) 310,500 Exchange Loss 18,000* Cash 328,500 *45,000,000 yen $0.0073 – ($337,500 – $27,000) = $18,000 loss ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 373 CASES Discussion Case 9–87 This case describes a situation that occurs frequently in an economy such as ours The chapter discusses some advantages and disadvantages of LIFO These could be emphasized in a discussion of the case As long as the prognosis is for continued inflation, and the company growth pattern is strong, a definite tax advantage exists by using LIFO Most companies maintain a separate average or FIFO system for internal bookkeeping purposes It is interesting to let class members vote their preference on this case after the class discussion It tends to demonstrate how accountants can honestly have different opinions based on the same facts Discussion Case 9–88 This case provides data for computing income and inventory values under various inventory systems Both the sales price and the cost of the inventory are rising The January purchase cost is $93 per unit, and the March 27 purchase cost is $99 per unit 400 units were on hand at the end of the period and 775 had been sold If the cost continues to increase, the LIFO periodic method will result in a lower net income than will the LIFO perpetual or the FIFO inventory method This will result in lower income taxes Net income computations for the four possibilities mentioned in the case are shown below The FIFO perpetual and periodic methods produce the same results Condensed Income Statement For Quarter Ended March 31, 2013 Periodic FlFO LlFO Sales $110,700* $110,700 † Cost of goods sold 73,600 75,475** Gross profit $ 37,100 $ 35,225 Operating expenses 25,300 25,300 Net income $ 11,800 $ 9,925 Perpetual FlFO LlFO $110,700 $110,700 † § 73,600 74,725 $ 37,100 $ 35,975 25,300 25,300 $ 11,800 $ 10,675 COMPUTATIONS: * Jan 200 units Feb 225 Mar 350 775 units $140 = 142 = 145 = $ 28,000 31,950 50,750 $110,700 † Cost of goods sold: Oldest purchase Next oldest Next oldest Next oldest 250 units 100 400 25 775 units $93 = $ 23,250 95 = 9,500 96 = 38,400 98 = 2,450 $ 73,600 225 units 200 350 775 units $99 = $22,275 98 = 19,600 96 = 33,600 $75,475 ** Cost of goods sold: Most recent purchase Next most recent purchase Next most recent purchase To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 374 Chapter Discussion Case 9–88 (Concluded) § Beginning inventory Purchases Ending inventory (given in problem) Cost of goods sold $ 113,025 (38,300) $ 74,725 The decision to change from LIFO to FIFO depends on the objectives of management and the stockholders If these groups want to show higher net income, then either of the FIFO methods could be used If they want to reduce cash outflows for income taxes, then the LIFO method is preferred The perpetual inventory system has the advantage of disclosing the inventory balance at any time When combined with a physical count, it permits management to evaluate its controls through determination of a shrinkage amount However, perpetual systems require more recordkeeping and thus cost more than a periodic inventory system There is no one best answer to this case Students should be encouraged to explore the advantages and disadvantages of each method in supporting their answers Discussion Case 9–89 A hybrid FIFO/LIFO system potentially offers the best of all possible worlds As outlined in Exhibit 9–15 in the text, LIFO normally results in a better matching of current costs and current revenues on the income statement In addition, use of LIFO excludes inventory holding gains and losses from the computation of gross profit On the other hand, for the balance sheet, FIFO yields a valuation that more closely approximates current replacement cost Use of LIFO for the income statement and FIFO for the balance sheet would result in a cost allocation discrepancy equal in amount to the LIFO reserve In essence, the FIFO inventory valuation on the balance sheet includes inventory holding gains, but the LIFO gross profit on the income statement excludes those holding gains A possible way to handle this discrepancy is to create a separate equity account, equal in amount to the LIFO reserve, called Unrecognized Inventory Holding Gains and Losses This equity account would normally have a credit balance (unrecognized inventory holding gain), reflecting the fact that FIFO ending inventory is typically greater than LIFO ending inventory The probability of this type of hybrid system being used in the United States in the near future is low However, if the Unrecognized Inventory Holding Gains and Losses are viewed as part of accumulated other comprehensive income, this hybrid system would fit exactly into the existing accounting model Discussion Case 9–90 This case examines the implications of changing prices on financial accounting measures It illustrates that in periods of rising prices, a portion of the profits from the sale of inventory must be used to replenish inventory levels While financial accounting and tax accounting compare the cost of a particular item with its subsequent sales price, they not account for the fact that to maintain inventory levels, some accounting profits must be reinvested into new inventory Sales (3 @ $2,600) FIFO cost of goods sold (3 @ $1,200) FIFO gross profit Income tax (40%) Net income $ 7,800 3,600 $ 4,200 1,680 $ 2,520 Sales (3 @ $2,600) Replacement cost (3 @ $2,300) Replacement cost gross profit Less taxes paid Net cash flow from sale $ 7,800 6,900 $ 900 1,680 $ (780) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 375 Discussion Case 9–91 This case is designed to illustrate how replacement cost must be modified in certain situations to reflect the net realizable value of the inventory The controller is correct in his understanding that GAAP requires a lower-of-cost-or-market approach However, he has failed to consider that GAAP also establishes a floor and a ceiling that are related to the sales price and limit the use of replacement cost In this case, it appears that the replacement cost will be lower than the floor because the selling price of the inventory item has not declined This would mean that an inventory loss has really not occurred, and the ending inventory can continue to be valued at its purchase cost The case discussion might point out that this pricing condition may be only temporary and that competition normally results in sales prices that reflect the purchase costs of the inventory items Discussion Case 9–92 Inventory obsolescence in a company such as Bright-Lite Shirt is a critical issue Too many ―obsolete‖ shirts and the gross margin on successful sales is reduced precariously low Because the shirts are purchased ―blank,‖ it is possible to defer imprinting the shirts until orders have been received or it is clear that the particular design will continue to well The delay to print the shirts will not usually be a critical factor as long as imprinting turnaround time can be controlled The shirt inventory should be reported at the lower of cost or market Often, the inventory can be moved at reduced prices At any given time, the inventory should be valued considering its current resale price The president must balance the desire of the marketing manager to satisfy all customers with the desire of the controller to maximize profits and satisfy the company's auditors Discussion Case 9–93 This case presents a situation in which a gross profit computation might be useful By estimating the store’s volume of activity and using either an industry gross profit average or one determined by examining records of surrounding stores, a rudimentary income statement can be prepared The fairness of such an approach might be questionable; however, the owners have a legal responsibility to keep records to present to the IRS when requested Failure to so leaves them with little recourse to whatever approach the IRS auditor might use Students should learn through this case discussion how important financial records are and that the situation described is not as far-fetched as it might seem Discussion Case 9–94 ‡ The principal risk in making purchase commitments is that the price of the commodity being purchased declines after the commitment is made, resulting in a loss to the purchaser, as compared to what would have been the result if no purchase commitment had been made GAAP generally requires recognition of market declines when they occur but defers recognition of market increases until the business event has been completed This has been recognized as a conservative measure that anticipates losses but defers gains Firms may reduce their risk from changing prices by entering into a hedging arrangement At the same time a purchaser enters into a purchase commitment, a future sales commitment can be made that protects the purchase price If prices fall, the excess cost can be recovered from the future sales commitment Some individuals make their profit by trying to outguess the market This is viewed as being speculative, and if this is not the goal of the purchaser, hedging may be used to avoid speculation gains or losses ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 376 Chapter Discussion Case 9–95‡ This case requires students to examine those factors that affect the risks associated with exchange rate changes and how those risks can be controlled Smith & Sons is exposed to exchange rate changes because the transactions are denominated in a foreign currency If the transactions were denominated in dollars, the exchange risks would fall to Matsutoshi Corp Thus, one method for reducing foreign exchange risks is to have the transactions denominated in Smith & Sons' local currency A second factor influencing exchange risk is time It is only because exchange rates change over time that a risk exists If the exchange rates were fixed and not allowed to vary, there would be no gain or loss on foreign transactions A method for eliminating the time factor is to pay for the inventory immediately A third option for reducing the risks associated with exchange rate changes is to hedge Hedging involves making a contract with a foreign currency broker to buy or sell (depending on whether the original transaction results in a receivable or a payable) foreign currency in the future For a fee, a foreign currency broker assumes all the risks associated with exchange rate changes Case 9–96 In its note on significant accounting policies, Disney states: "Carrying amounts of merchandise, materials, and supplies inventories are generally determined on a moving average cost basis and are stated at the lower of cost or market." In the statement of cash flows, inventories are shown as a reduction of $117 million in cash from operating activities Therefore, inventories must have increased during the year This is verified by looking at the balance sheet—inventories increased from $1,124 million to $1,271 million The discrepancy in amount is most likely a result of acquisition or disposal of subsidiaries during the year Disney does not disclose its costs and expenses by functional category (e.g., cost of goods sold, salaries, etc.) Instead, Disney lists all operating costs and expenses together In the notes, Disney presents information by business segment This presentation makes it impossible to analyze individual expense categories such as cost of goods sold However, the presentation does emphasize the distinct nature of the different types of businesses in which Disney has operations The best of all possible worlds would be a 2-way expense categorization—by business segment and by functional category within each business segment Case 9–97 Computation of gross profit percentage for Circle K’s gasoline and merchandise is as follows (amounts are in millions): Gasoline Merchandise Sales $1,562.5 $1,710.3 Cost of goods sold 1,372.1 1,192.6 Gross profit $ 190.4 $ 517.7 Gross profit percentage: Gross profit Sales $190.4 $517.7 $1,562.5 $1,710.3 = 12.2% = 30.3% Because the gross profit percentage on merchandise is so high compared to that on gasoline, Circle K would have wished that all customers would pay for their gas inside the store to increase the chance that they would have bought some merchandise ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter Case 9–97 377 (Concluded) Computation of inventory turnover is as follows: Gasoline Cost of goods sold Ending inventory Merchandise $1,372.1 $26.6 $1,192.6 $93.9 = 51.6 times = 12.7 times Computation of number of days’ sales in ending inventory is as follows: 365 Inventory turnover Gasoline Merchandise 365 51.6 365 12.7 = 7.1 days = 28.7 days Gasoline is much more costly to store than is merchandise The storage facilities are costly (underground tanks), the potential for disaster is higher (accidents or expensive cleanup of leaky tanks), and the gasoline itself degrades if it is stored for a long time Gross profit percentage: Gasoline Merchandise Overall 1993 1988 9.9% 31.6 20.9 10.6% 37.5 27.6 The more current set of numbers from 1993 is likely to yield a better estimate of 1994 gross profit percentage Two factors caused Circle K’s overall gross profit percentage to decrease from 1988 to 1993 First, the gross profit percentages on the individual products, gasoline and merchandise, declined Second, the sales mix changed In 1993, more gasoline was sold, in proportion to merchandise sold, than in 1988 Because gasoline has a lower gross profit percentage, this change in the sales mix lowered the overall gross profit percentage The 1994 sales mix and gross profit percentages on the individual products are more likely to be closer to 1993 levels than to 1988 levels Total sales Estimated cost of goods sold (79.1%) Estimated gross profit (20.9%) 1994 $3,272.8 2,588.8 $ 684.0 Beginning inventory + Purchases = Cost of goods available for sale – Cost of goods sold (estimated) = Ending inventory (estimated) $ 131.2 2,554.0 $2,685.2 2,588.8 $ 96.4 Actual ending inventory for 1994 for Circle K was $120.5 million The underestimate results from the fact that actual gross profit percentage for Circle K for 1994 was 21.6% instead of the estimated 20.9% A better estimate could be generated if we had separate 1993 inventory and 1994 purchases data for gasoline and merchandise To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 378 Chapter Case 9–98 Computation of cost of goods manufactured: Finished goods inventory, beginning + Cost of goods manufactured = Subtotal – Finished goods inventory, ending = Cost of goods sold Cost of goods manufactured = $11,859 Computation of total manufacturing costs: Work-in-process inventory, beginning + Total manufacturing costs = Subtotal – Work-in-process inventory, ending = Cost of goods manufactured Total manufacturing costs = $11,823 $ 1,505 ? $ ? 1,255 $ 12,109 $ 851 ? $ ? 815 $ 11,859 Computation of number of days’ sales in inventory is as follows: Average inventory Average daily cost of goods sold a Total inventory ($3,013 + $2,639)/2 $12,109/365 = 85.2 days b Finished goods ($1,505 + $1,255)/2 $12,109/365 = 41.6 days The number of days’ sales in average finished goods inventory (41.6 days) is a more meaningful number The comparison between finished goods and cost of goods sold is a natural one, and the ratio computation produces exactly what it claims to produce—the average number of days' sales that are stored in the form of finished goods inventory The number of days' sales in average total inventory (85.2 days) has no intuitive meaning Raw materials inventory is not available for sale nor is work-in-process inventory This ratio only serves to show the general level of inventory (compared to prior years); it has no natural interpretation like that for the finished goods ratio Case 9–99 Ford Ending LIFO inventory Ending FIFO inventory $5,450 ($5,450 $798) Caterpillar 87.2% $6,360 ($6,360 67.9% $3,003) For Ford, LIFO and FIFO inventories are fairly close to one another on a percentage basis On the other hand, for Caterpillar the LIFO inventory amount is just 67.9% of what would be reported under FIFO To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter Case 9–99 379 (Concluded) For Caterpillar: Beginning inventory + Purchases (same under LIFO and FIFO) = Cost of goods available for sale – Ending inventory = Cost of goods sold LIFO $ 8,781 21,465 $30,246 6,360 $23,886 FIFO $(8,781 + 3,183) 21,465 $ 33,429 (6,360 + 3,003) $ 24,066 The size of the LIFO reserve is a function of how long a company has used LIFO, how much of its inventories are under LIFO, and the rate of inflation in inventory costs in the company’s industry The LIFO reserve becomes large when there are many old LIFO layers containing old costs Caterpillar has used LIFO for a long time and uses it for 70% of its inventory (compared to 28% for Ford) Conversion of financial statement data from LIFO to FIFO is usually fairly easy because all that is needed is the LIFO reserve, and this can be approximated using the current value of the inventory Conversion from FIFO to LIFO is quite difficult, if not impossible The LIFO inventory balance is impacted by the entire history of the company’s inventory transactions, back to the beginning of time LIFO layers should exist for each year in which purchases have exceeded sales Some of those layers would have been liquidated in subsequent years The valuation of each layer depends on the inventory costs in the year the layer was created In short, retroactive conversion from FIFO to LIFO is very difficult Case 9–100 ExxonMobil uses LIFO for most of its inventories The reported LIFO cost of inventory can be substantially less than current replacement cost if old LIFO layers were established when costs were lower For ExxonMobil, the LIFO reserve (difference between LIFO cost and current replacement cost) was $6.7 billion for 2000 and $4.2 billion for 2001 Even though replacement cost of inventory decreased substantially in 2001 because of a decline in oil prices, the LIFO cost of inventory was still lower than replacement cost Thus, no lower-of-cost-or-market adjustment was needed Case 9–101 To: Controller, Duo-Therm Company From: Assistant Controller RE: Just-in-Time Inventory A just-in-time (JIT) inventory system will reduce our inventory storage and carrying costs, but it will also dramatically increase the amount we pay in income taxes As you know, we have been using LIFO for the past 25 years During that time, we have been consistently growing As a result, we have established many old LIFO layers that are carried in inventory at old costs If we implement a JIT inventory system, we will liquidate these LIFO layers and the old low costs will flow into cost of goods sold, increasing our reported gross profit Because of the LIFO conformity rule, we use LIFO for both book and income tax purposes Accordingly, the increased gross profit will lead to increased income tax payments As the board of directors considers adopting a JIT inventory system, yo u should advise them of the income tax consequences The tax costs should be factored into the decision of whether to implement a JIT system If you wish, I will provide detailed computations and estimates to serve as background material for your presentation to the board To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 380 Chapter Case 9–102 Clearly, you have stumbled upon a ploy to increase Lam Tin’s reported profit in order to boost the acquisition price to be paid by Kwun Tong The dilemma is deciding what you should with your information Let's take the questions in reverse order Should you talk with the negotiation team from Kwun Tong? Probably not This attempt to manipulate reported profits is part of Lam Tin’s bargaining strategy, and Kwun Tong should already be aware that such manipulations are possible To inject yourself into the complex negotiations is probably not a good idea Should you talk with Lam Tin’s independent auditor? Maybe, depending on what the vice president of finance says This is a matter that is best kept inside the company if possible It may be that the vice president is just brainstorming about possibilities and hasn't yet decided to insist that you curtail year-end purchases in order to liquidate LIFO layers Talking to the external auditor is something that should wait until after you have spoken with the vice president And if you disclose this LIFO liquidation manipulation attempt to the auditors, rest assured that you also will probably have to find work somewhere else Should you talk with Lam Tin’s vice president of finance? Absolutely You owe it to the vice president to tell her what your suspicions are and to tell her that you have extreme ethical reservations about the plan Your best strategy is to acknowledge the attractiveness of the plan, but you should also point out that if the manipulation is discovered before the deal is sealed with Kwun Tong, the scandal could sink the entire deal In addition, if the manipulation is discovered after the deal is sealed, the vice president and everyone else aware of the manipulation are vulnerable to a lawsuit Finally, you should help the vice president of finance come up with practical reasons for scuttling the plan For example, you might point out how costly the plan is, both in terms of extra income taxes and extra purchase costs Give the vice president of finance every opportunity to back away from this sleazy LIFO manipulation without losing face Case 9–103 Solutions to this problem can be found on the Instructor’s Resource CD-ROM or downloaded from the Web at www.cengage.com/accounting/stice ... merchandise on account, and the merchandise purchased was not recognized in recording ending inventory No effect on net income, although both ending inventory and purchases are understated by the... inventory Cost of goods sold Net income overstated by $2,200 correct overstated by $2,200 understated by $450 overstated by $2,650 understated by $2,650 Correct net income: $3,000 + $2,650 = $5,650...To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 302 Chapter handling and shipping costs incurred in the transfer to the dealer