Questions

➢  Why is proper inventory valuation so important?

➢  Why does an understated ending inventory understate net income for the period by the same amount?

➢  Why does an error in ending inventory affect two accounting periods?

➢  What is the meaning of taking a physical inventory?

➢  What is the accountant’s responsibility regarding taking a physical inventory?

➢  Which cost elements are included in inventory? What practical problems arise by including the costs of such elements?

➢  Which accounts that are used under periodic inventory procedure are not used under perpetual inventory procedure?

➢  What entries are necessary under perpetual inventory procedure when goods are sold?

➢  Why is there closer control over inventory under perpetual inventory procedure than under periodic inventory procedure?

➢  Why is perpetual inventory procedure being used increasingly in business?

➢  What is the cost flow assumption? What is meant by the physical flow of goods? Does a relationship between cost flows and the physical flow of goods exist, or should such a relationship exist?

➢  Indicate how a company can manipulate its net income if it uses LIFO. Is the same opportunity available under FIFO? Why or why not?

➢  What are the main advantages of using FIFO and LIFO?

➢  Which inventory method is the correct one? Can a company change inventory methods?

➢  Why are ending inventory and cost of goods sold the same under FIFO perpetual and FIFO periodic?

➢  Would you agree with the following statement? Reducing the amount of taxes payable currently is a valid objective of business management and, since LIFO results in such a reduction, all businesses should use LIFO.

➢  What is net realizable value, and how is it used?

➢  Why is it acceptable accounting practice to recognize a loss by writing down an item in inventory to market, but unacceptable to recognize a gain by writing up an inventory item?

➢  Under what conditions would the gross margin method of computing an estimated inventory yield approximately correct amounts?

➢  What are the main reasons for estimating ending inventory?

➢  Should a company rely exclusively on the gross margin method to determine the ending inventory and cost of goods sold for the end-of-year financial statements?

➢  How can the retail method be used to estimate inventory?

➢  The Limited Based on the notes to the financial statements of The Limited contained in the Annual Report Appendix, what inventory methods were used?

Exercises

Exercise A Crocker Company reported annual net income as follows:

2008	$484,480
2009	487,680
2010	409,984

Analysis of its inventories revealed the following incorrect inventory amounts and these correct amounts:

	Incorrect Inventory Amount	Correct inventory amount
2008 December 31	$ 76,800	$89,600
2009 December 31	86,400	77,600

Compute the annual net income for each of the three years assuming the correct inventories had been used.

Exercise B Slate Truck Company manufactures trucks and identifies each truck with a unique serial plate. On December 31, a customer ordered 5 trucks from the company, which currently has 20 trucks in its inventory. Ten of these trucks cost $20,000 each, and the other 10 cost $25,000 each. If Slate wished to minimize its net income, which trucks would it ship? By how much could Slate reduce net income by selecting units from one group versus the other group?

Exercise C Miami Discount Company inventory records show:

		Unit	Total
	Units	Cost	Cost
Beginning inventory	3,000	$38.00	$114,000
Purchases:
February 14	900	39.00	35,100
March 18	2,400	40.00	96,000
July 21	1,800	40.30	72,540
September 27	1,800	40.60	73,080
November 27	600	41.00	24,600
Sales:
April 15	2,800
August 20	2,000
October 3	1,500

The December 31 inventory was 4,200 units. Miami Discount Company uses perpetual inventory procedure. Present a schedule showing the measurement of the ending inventory using FIFO perpetual inventory procedure.

Exercise D Using the data in the previous exercise for Miami Discount Company, present a schedule showing the measurement of the ending inventory using LIFO perpetual inventory procedure.

Exercise E London Company had a beginning inventory of 160 units at $24 (total = $3,840) and the following inventory transactions during the year:

January 8, sold 40 units.

January 11, purchased 80 units at $30.00.

January 15, purchased 80 units at $32.00.

January 22, sold 80 units.

Using the preceding information, price the ending inventory at its weighted-average cost, assuming perpetual inventory procedure.

Exercise F Kettle Company made the following purchases of Product A in its first year of operations:

	Units		Unit Cost
January 2	1,400	@	$7.40
March 31	1,200	@	7.00
July 5	2,400	@	7.60
November 1	1,800	@	8.00

The ending inventory that year consisted of 2,400 units. Kettle uses periodic inventory procedure.

1. Compute the cost of the ending inventory using each of the following methods: (1) FIFO, (2) LIFO, and (3) weighted-average.
2. Which method would yield the highest amount of gross margin? Explain why it does.

Exercise G The following are selected transactions and other data of the Custer Company:

Purchased 20 units at $360 per unit on account on 2010 September 18.

Sold 6 units on account for $576 per unit on 2010 September 20.

Discovered a shortage of $2,640 at year-end after a physical inventory.

Prepare journal entries for these transactions using FIFO perpetual inventory procedure. Assume the beginning inventory consists of 20 units at $336 per unit.

Exercise H Following are selected transactions of Gamble Company:

Purchased 100 units of merchandise at $240 each; terms 2/10, n/30.

Paid the invoice in transaction 1 within the discount period.

Sold 80 units at $384 each for cash.

Purchased 100 units at $360; terms 2/10, n/30.

Paid the invoice in transaction 4 within the discount period.

Sold 60 units at $552 each for cash.

Prepare journal entries for the six preceding items. Assume Gamble uses FIFO perpetual inventory procedure.

Exercise I Wells Company had the following transactions during February:

Purchased 135 units at $65 on account.

Sold 108 units at $90 on account.

Purchased 170 units at $75 on account.

Sold 122 units at $95 on account.

Sold 67 units at $100 on account.

The beginning inventory consisted of 67 units purchased at a cost of $55.

Prepare the journal entries relating to inventory for these five transactions, assuming Wells accounts for inventory using perpetual inventory procedure and the LIFO inventory method. Do not record the entries for sales.

Exercise J Following are inventory data for Kintech Company:

January 1 inventory on hand, 400 units at $28.80.

January sales were 80 units.

February sales totaled 120 units.

March 1, purchased 200 units at $30.24.

Sales for March through August were 160 units.

September 1, purchased 40 units at $33.12.

September through December sales were 180 units.

Exercise K A company purchased 1,000 units of a product at $12.00 and 2,000 units at $13.20. It sold all of these units at $18.00 each at a time when the current cost to replace the units sold was $13.80. Compute the amount of gross margin under FIFO that LIFO supporters would call inventory, or paper, profits.

Exercise L Clayton Company’s inventory was 12,000 units with a cost of $160 each on 2010 January 1. During 2010, numerous units were purchased and sold. Also during 2010, the purchase price of this product fell steadily until at year-end it was $120. The inventory at year-end was 18,000 units. State which method of inventory measurement, LIFO or FIFO, would have resulted in higher reported net income, and explain briefly.

Exercise M Levi Motor Company owns a luxury automobile that it has used as a demonstrator for eight months. The auto has a list or sticker price of $85,000 and cost Levi $75,000. At the end of the fiscal year, the auto is on hand and has an expected selling price of $80,000. Costs expected to be incurred to sell the auto include tune-up and maintenance costs of $3,000, advertising of $1,000, and a commission of 5 per cent of the selling price to the employee selling the auto. Compute the amount at which the auto should be carried in inventory.

Exercise N Pure Sound Systems used one sound system as a floor model. It cost $3,600 and had an original selling price of $4,800. After six months, the sound system was damaged and replaced by a newer model. The sound system had an estimated selling price of $2,880, but when the company performed $480 in repairs, it could be sold for $3,840. Prepare the journal entry, if any, that must be made on Pure Sound’s books to record the decline in market value.

Exercise O Your assistant has compiled the following data:

	Quantity	Unit	Unit	Total	Total
Item	(units)	Cost	Market	Cost	Market
A	300	$ 57.60	$ 55.20	$17,280	$16,560
B	300	28.80	33.60	8,640	10,080
C	900	21.60	21.60	19,440	19,440
D	500	12.00	13.20	6,000	6,600

Calculate the dollar amount of the ending inventory using the LCM method, applied on an item-by-item basis, and the amount of the decline from cost to lower-of-cost-or-market.

Exercise P Use the data in the previous exercise to compute the cost of the ending inventory using the LCM method applied to the total inventory.

Exercise Q Tilley-Mill Company takes a physical inventory at the end of each calendar-year accounting period to establish the ending inventory amount for financial statement purposes. Its financial statements for the past few years indicate an average gross margin on net sales of 25 per cent. On July 18, a fire destroyed the entire store building and its contents. The records in a fireproof vault were intact. Through July 17, these records show:

Merchandise inventory, January 1 $672,000

Merchandise purchases $9,408,000

Purchase returns $134,400

Transportation-in $504,000

Sales $14,336,000

Sales returns $672,000

The company was fully covered by insurance and asks you to determine the amount of its claim for loss of merchandise.

Exercise R Ryan Company takes a physical inventory at the end of each calendar-year accounting period. Its financial statements for the past few years indicate an average gross margin on net sales of 30 per cent.

On June 12, a fire destroyed the entire store building and the inventory. The records in a fireproof vault were intact. Through June 11, these records show:

Merchandise inventory, January 1	$120,000
Merchandise purchases	$3,000,000
Purchase returns	$36,000
Transportation -in	$204,000
Sales	$3,720,000

The company was fully covered by insurance and asks you to determine the amount of its claim for loss of merchandise.

Exercise S Victoria Falls Company, Inc., records show the following account balances for the year ending 2010 December 31:

	Cost	Retail
Beginning inventory	$42,000	$57,500
Purchases	25000	37500
Transportation-in	500
Sales		52500

Using these data, compute the estimated cost of ending inventory using the retail method of inventory valuation.

Problems

Problem A Kelley Company reported net income of $358,050 for 2009, $371,400 for 2010, and $325,800 for 2011, using the incorrect inventory amounts shown for 2009 December 31, and 2010. Recently, Kelley corrected the inventory amounts for those dates. Kelley used the correct 2011 December 31, inventory amount in calculating 2011 net income.

	Incorrect	Correct
2009 December 31	$72,600	$86,200
2010 December 31	84000	70200

Prepare a schedule that shows: (a) the reported net income for each year, (b) the amount of correction needed for each year, and (c) the correct net income for each year.

Problem B An examination of the financial records of Lanal Company on 2009 December 31, disclosed the following with regard to merchandise inventory for 2009 and prior years:

2005 December 31, inventory was correct.

2006 December 31, inventory was overstated $200,000.

2007 December 31, inventory was overstated $100,000.

2081 December 31, inventory was understated $220,000.

2009 December 31, inventory was correct.

The reported net income for each year was:

2006	$384,000
2007	544,000
2008	670,000
2009	846,000

9. Prepare a schedule of corrected net income for each of the four years, 2006-2009.
10. What error(s) would have been included in each December 31 balance sheet? Assume each year’s error is independent of the other years’ errors.
11. Comment on the implications of your corrected net income as contrasted with reported net income.

Problem C Brett Company sells personal computers and uses the specific identification method to account for its inventory. On 2010 November 30, the company had 46 Orange III personal computers on hand that were acquired on the following dates and at these stated costs:

	Units		Unit cost
July 3	10	@	$10,080
September 10	20	@	$ 9,600
November 29	16	@	$10,700

Brett sold 36 Orange III computers at $12,720 each in December. There were no purchases of this model in December.

1. Compute the gross margin on December sales of Orange III computers assuming the company shipped those units that would maximize reported gross margin.
2. Repeat part (a) assuming the company shipped those units that would minimize reported gross margin for December.
3. In view of your answers to parts (a) and (b), what would be your reaction to an assertion that the specific identification method should not be considered an acceptable method for costing inventory?

Problem D The inventory records of Thimble Company show the following:

March 1 Beginning inventory consists of 10 units costing $40 per unit.

3 Sold 5 units at $94 per unit.

10 Purchased 16 units at $48 per unit.

12 Sold 8 units at $96 per unit.

20 Sold 7 units at $96 per unit.

25 Purchased 16 units at $50 per unit.

31 Sold 8 units at $96 per unit.

Assume all purchases and sales are made on credit.

Using FIFO perpetual inventory procedure, prepare the appropriate journal entries for March.

Problem E The following purchases and sales for Ripple Company are for April 2010. There was no inventory on April 1.

	Purchases			Sales
			Unit
	Units		Cost		Units
April 3	3,200	@	$33.00	April 6	1,500
April 10	1,600	@	34.00	April 12	1,400
April 22	2,000	@	35.00	April 25	2,300
April 28	1,800	@	36.00

1. Compute the ending inventory as of 2010 April 30, using perpetual inventory procedure, under each of the following methods: (1) FIFO, (2) LIFO, and (3) weighted-average (carry unit cost to four decimal places and round total cost to nearest dollar).
2. Repeat a using periodic inventory procedure.

Problem F Refer to the data in problem E

1. Using LIFO perpetual inventory procedure, prepare the journal entries for the purchases and sales (Cost of Goods Sold entry only).
2. Repeat (a) using LIFO periodic inventory procedure, including closing entries. (Note: You may want to refer to the Appendix in Chapter 6 for this part.)

Problem G The following data relate to the beginning inventory, purchases, and sales of Braxton Company for the year 2010:

			Unit
	Units		Cost
Merchandise Inventory, January 1	1,400	@	$5.04
Purchases:
February 2	1,000	@	4.80
April 5	2,000	@	3.60
June 15	1,200	@	3.00
September 30	1,400	@	2.88
November 28	1,800	@	4.20
Sales:
March 10	900
May 15	1,800
July 6	800
August 23	600
December 22	2,500

1. Assuming use of perpetual inventory procedure, compute the ending inventory and cost of goods sold under each of the following methods: (1) FIFO, (2) LIFO, and (3) weighted-average (carry unit cost to four decimal places and round total cost to nearest dollar).
2. Repeat (a) assuming use of periodic inventory procedure.

Problem H Welch Company accounts for a product it sells using LIFO periodic inventory procedure. Product data for the year ended 2009 December 31, are shown below. Merchandise inventory on January 1 was 3,000 units at $14.40 each.

	Purchases				Sales
			Unit				Unit
	Units		Cost		Units		Co st
January 5	6,000	@	$18.00	January 10	4,000	@	$28.80
March 31	18,000	@	21.60	April 2	15,000	@	32.40
August 12	12,000	@	27.00	August 22	16,000	@	36.00
December 26	6,000	@	28.80	December 24	3,000	@	39.60

9. Compute the gross margin earned on sales of this product for 2009.
10. Repeat part (a) assuming that the December 26 purchase was made in January 2010.
11. Recompute the gross margin assuming that 10,000 rather than 6,000 units were purchased on December 26 at the same cost per unit.
12. Solve parts (a), (b), and (c) using the FIFO method.

Problem I The accountant for Gentry Company prepared the following schedule of the company’s inventory at 2009 December 31, and used the LCM method applied to total inventory in determining cost of goods sold:

		Unit	Unit
Item	Quantity	Cost	Market
Q	4,200	$7.20	$7.20
R	2,400	6.00	5.76
S	5,400	4.80	4.56
T	4,800	4.20	4.32

1. State whether this approach is an acceptable method of inventory measurement and show the calculations used to determine the amounts.
2. Compute the amount of the ending inventory using the LCM method on an item-by-item basis.
3. State the effect on net income in 2009 if the method in (b) was used rather than the method referred to in (a).

Problem J As part of a loan agreement with a local bank, Brazos Company must present quarterly and cumulative income statements for the year 2009. The company uses periodic inventory procedure and marks its merchandise to sell at a price yielding a gross margin of 30 per cent. Selected data for the first six months of 2009 are as follows:

	First	Second
	Quarter	Quarter
Sales	$248,000	$256,000
Purchases	160,000	184,000
Purchase returns and allowances	9,600	11,200
Purchase discounts	3,200	3,520
Sales returns and allowances	8,000	4,800
Transportation-in	8,000	8,320
Miscellaneous selling expenses	25,600	24,000
Miscellaneous administrative expenses	9,600	8,000

The cost of the physical inventory taken 2008 December 31, was $30,400.

9. Indicate how income statements can be prepared without taking a physical inventory at the end of each of the first two quarters of 2009.
10. Prepare income statements for the first quarter, the second quarter, and the first six months of 2009.

Cobb Company records show the following information for 2010:

	Cost	Retail
Sales		$350,400
Purchases	$2/0,000	420,000
Transportation-in	26,280	—
Merchandise inventory,
January 1	12,000	1/,400
Purchase returns	15,120	18,600

Compute the estimated year-end inventory balance at cost using the retail method of estimating inventory.

Alternate problems

Alternate problem A Harris Company reported net income of $312,000 for 2009, $324,000 for 2010, and $348,000

Recently Harris corrected these inventory amounts. Harris used the correct 2011 December 31, inventory amount in calculating 2011 net income.