# CHAPTER 6

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"CHAPTER 6"

```					                                                CHAPTER 6
Inventory Costing

ASSIGNMENT CLASSIFICATION TABLE

Brief                      Problems   Problems
Study Objectives                             Questions         Exercises   Exercises          Set A      Set B

1. Describe the steps in determining     1, 2, 3, 4        1, 2            1            1              1
inventory quantities.

2. Prepare the entries for purchases     6, 8              3               2, 10        2, 8, *9       2, 8, *9
and sales of inventory under a
periodic inventory system.

3. Determine the cost of goods sold      5, 7, 8           4, 5            3, 4         2              2
under a periodic inventory system.

4. Identify the unique features of the   9                 5, 6            5            2, 3           2, 3
income statement for a
merchandising company using a
periodic inventory system.

5. Explain the basis of accounting for   10, 11, 12        7               6, 7, 8, 9   4, 5, 8, *9    4, 5, 8, *9
inventories and use the inventory
cost flow methods.

6. Demonstrate the effects on the        13, 14            8               8, 9, 10     4, 5, 6, *10   4, 5, 6
financial statements of each of the
inventory cost flow methods.

7. Determine the effects of inventory    15                9, 10           11, 12       6, 7           6, 7
errors on the financial statements.

8. Explain and use the lower of cost     16, 17, 18        11              13           8              8
and market basis of accounting for
inventories.

*9. Apply the inventory cost flow         *19               *12, *13        *14          *9, *10        *9, *10
methods to perpetual inventory
records (Appendix 6A).

*10. Use the two methods of estimating    *20, *21, *22     *14, *15        *15, *16     *11, *12       *11, *12
inventories (Appendix 6B).

6-1
ASSIGNMENT CHARACTERISTIC TABLE

Problem                                                                     Difficulty        Time
Number    Description                                                        Level       Allotted min.)

1A      Determine items and amounts to be recorded in inventory.          Moderate        25-30

2A      Journalize, post, and prepare trial balance and partial income     Simple         30-40
statement.

3A      Prepare a multiple-step income and closing entries.                Simple         15-20

4A      Determine cost of goods sold and ending inventory, using           Simple         20-30
periodic FIFO, weighted average, and LIFO. Answer questions

5A      Calculate ending inventory using FIFO and weighted average        Moderate        20-35
periodic inventory methods, prepare income statements, and

6A      Indicate effect of errors and identify cost flow assumptions.     Moderate        20-25

7A      Illustrate impact of inventory error.                              Simple         15-20

8A      Prepare journal entries for purchaser and seller using weighted   Moderate        25-30
average cost. Apply lower of cost and market.

*9A     Calculate and journalize FIFO transactions in perpetual and       Moderate        25-35
periodic inventory systems.

*10A     Calculate cost of goods and inventory using perpetual inventory   Moderate        20-30
system with FIFO and moving average cost. Answer questions

*11A     Estimate inventory loss using gross profit method.                Moderate        15-20

*12A     Estimate ending inventory using retail method.                    Moderate        15-20

1B      Determine items and amounts to be recorded in inventory.          Moderate        25-30

2B      Journalize, post, and prepare trial balance and partial income     Simple         30-40
statement.

3B      Prepare a multiple-step income statement and closing entries.      Simple         15-20

4B      Determine cost of goods sold and ending inventory using            Simple         20-30
periodic FIFO, weighted average, and LIFO. Answer questions

5B      Calculate ending inventory using FIFO and LIFO periodic           Moderate        20-35
inventory methods, prepare income statements, and answer
questions.

6B      Indicate effect of errors and identify cost flow assumptions.     Moderate        20-25

7B      Illustrate impact of inventory error.                              Simple         15-20

6-2
Problem                                                                     Difficulty        Time
Number    Description                                                        Level       Allotted min.)

8B      Prepare journal entries for purchaser and seller using FIFO       Moderate        25-30
periodic method. Apply lower of cost and market.

*9B     Calculate and journalize average cost transactions in perpetual   Moderate        25-35
and periodic inventory systems.

*10B     Calculate ending inventory and gross profit using perpetual       Moderate        20-30
inventory system with FIFO costing.

*11B     Estimate inventory loss using gross profit method.                Moderate        15-20

*12B     Estimate ending inventory using retail method.                    Moderate        15-20

6-3
BLOOM’S TAXONOMY TABLE
Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Material

Study Objective       Knowledge      Comprehension          Application           Analysis        Synthesis   Evaluation
1. Describe the steps     Q6-2           Q6-1               BE6-2                  E6-1
in determining         BE6-1          Q6-3                                      P6-1A
inventory                             Q6-4                                      P6-1B
quantities.

2. Prepare the entries                   Q6-6               BE6-3     *P6-9A       E6-10
for purchases and                     Q6-8               E6-2      P6-2B
sales of inventory                                       P6-2A     P6-8B
under a periodic                                         P6-8A     *P6-9B
inventory system.

3. Determine the cost     Q6-7           Q6-5               BE6-4                  E6-4
of goods sold                         Q6-8               BE6-5
under a periodic                                         E6-3
inventory system.                                        P6-2A
P6-2B
4. Identify the unique                   Q6-9               BE6-5     P6-2B
features of the                                          BE6-6     P6-3B
income statement                                         E6-5
for a                                                    P6-2A
P6-3A
merchandising
company using a
periodic inventory
system.

5. Explain the basis of   Q6-11          Q6-10              BE6-7      P6-8A       E6-6
accounting for         Q6-12                             E6-7       *P6-9A      P6-4A
inventories and use                                      E6-8       P6-8B       P6-5A
the inventory cost                                       E6-9       *P6-9B      P6-4B
P6-5B
flow methods.

6. Demonstrate the                       Q6-13              E6-8                   BE6-       P6-6A
effects on the                        Q6-14              E6-9                   8          P6-4B
financial                                                *P6-10A                E6-        P6-5B
statements of each                                                              10         P6-6B
P6-
of the inventory                                                                4A
cost flow methods.                                                              P6-
5A
7. Determine the                         Q6-15              BE6-9                  P6-6A              E6-12
effects of inventory                                     BE6-10                 P6-7A
errors on the                                            E6-11                  P6-6B
financial                                                                       P6-7B
statements.

8. Explain and use        Q6-18          Q6-16              Q6-17
the lower of cost                                        BE6-11
and market basis                                         E6-13
of accounting for                                        P6-8A
P6-8B
inventories.

6-4
Study Objective        Knowledge   Comprehension       Application       Analysis   Synthesis   Evaluation
*9. Apply the inventory   *Q6-19                       *BE6-12 *P6-10A
cost flow methods                                  *BE6-13 *P6-9B
to perpetual                                       *E6-14    *P6-10B
inventory records                                  *P6-9A
(Appendix 6A).

*10. Use the two          *Q6-20                       *Q6-21    *E6-16
methods of                                         *Q6-22    *P6-11A
estimating                                         *BE6-14   *P6-12A
inventories                                        *BE6-15   *P6-11B
*E6-15    *P6-12B
(Appendix 6B).

Perspective                                                                BYP6-2
BYP6-3
BYP6-4
BYP6-6

6-5
01. Agree. Effective inventory management is frequently the key to
successful business operations. Management attempts to maintain
sufficient quantities and types of goods to meet expected customer
demand. It also seeks to avoid the cost of carrying inventories that
are clearly in excess of anticipated sales.

02. Inventory items have two common characteristics: (1) they are owned
by the company and (2) they are in a form ready for sale to customers
in the ordinary course of business.

03. Taking a physical inventory involves counting, weighing or measuring
each kind of inventory on hand. This is normally done when the store
is closed. Tom will probably count items, and mark the quantity,
description, and inventory number on prenumbered inventory tags.
Retailers, such as a hardware store, generally have thousands of
different items to count. Later, unit costs will likely be applied to the
inventory quantities using either specific identification or an assumed
cost flow method.

04. (a) (1) The goods will be included in Janine Company's inventory if
the terms of sale are FOB destination.
(2) They will be included in Laura Corporation's inventory if the
terms of sale are FOB shipping point.

(b) Janine Company should include goods shipped to a consignee in
its inventory. Goods held by Janine Company on consignment
should not be included in its inventory.

5.   Account                     (a) Added or Deducted (b) Normal Balance
Purchase returns
and allowances             Deducted                     Credit

Purchases – Purchase returns and allowances = Net purchases +
Freight in = Cost of goods purchased

6-6
Questions Chapter 6 (Continued)

6.   Recording sales in either system requires an entry to record the
revenue generated by the transaction (e.g., Dr. Cash or Accounts
Receivable; Cr. Sales). Under the perpetual inventory system, a
second entry is made to record the cost of the sale (e.g., Dr. Cost of
Goods Sold; Cr. Merchandise Inventory). Under a periodic system the
cost of goods sold is not determined until the end of the accounting
period. At that time, it is not recorded but rather is a calculation
detailed within the income statement.

7.   (1)   Purchase returns and allowances
(2)   Freight in
(3)   Cost of goods purchased
(4)   Ending inventory

8.   Under a periodic inventory system, cost of goods sold is determined
at the end of an accounting period. Under a perpetual inventory
system, the cost of goods sold is determined throughout the period
as each sale takes place.

9.   The distinguishing feature is that cost of goods sold is detailed, rather
than shown as one amount. These details consist of:

Beginning inventory
+ Cost of goods purchased
+ Purchases
- Purchase returns and allowances
= Net purchases
+ Freight in
= Cost of goods purchased
= Goods available for sale
- Ending inventory
= Cost of goods sold

10. Actual physical flow may be impractical because many items are
indistinguishable from one another. And, even if the items are
individually identifiable, it may be too costly and too complex to track
the physical flow of each inventory item. Actual physical flow may
also be inappropriate because management may be able to
manipulate net income through specific identification of items sold.

6-7
Questions Chapter 6 (Continued)

11. An advantage of the specific identification method is that it tracks the
actual physical flow of the goods available for sale. A disadvantage is
that management could manipulate net income by directing the flow
of items and hence costs.

12. (a) FIFO
(b) FIFO
(c) Average cost

13. Plato Company is using the FIFO method of inventory costing. York
Company is using the LIFO or average cost flow method. Under FIFO,
the latest goods purchased remain in inventory. Thus, the inventory
on the balance sheet should be close to current costs. The reverse is
true of the LIFO cost flow method and average cost falls somewhere
in between the FIFO and LIFO results.

Plato Company will probably have the higher gross profit, because
cost of goods sold will include a higher proportion of goods
purchased at earlier (lower) costs.

14. No. Selection of an inventory costing method is a management
decision. The accountants may provide input for management
consideration, but the decision is that of the management. Once a
method has been chosen, it should be used consistently.

15. (a) Mila Company's 2002 net income will be understated \$5,000.

BI + CGP – EI = CGS                Sales – CGS = NI
-U=O                           -O=U

(b) Mila’s 2003 net income will be overstated \$5,000 since the ending
inventory of 2002 becomes the beginning inventory of 2003.

BI + CGP – EI = CGS                Sales – CGS = NI
U             =U                         -U=O

(c) The combined net income for the two years will be correct
because the errors offset each other (U\$5,000 in 2002 and O\$5,000
in 2003).

6-8
Questions Chapter 6 (Continued)

16. Lucy should know the following:

(a) A departure from the cost basis of accounting for inventories is
justified when the utility (revenue-producing ability) of the goods
is no longer as great as its cost. The writedown to market should
be recognized in the period in which the price decline occurs.
(b) Market can mean current replacement cost (cost to replace) or the
net realizable value (selling price less any costs required to make
the goods ready for sale) of the goods. The net realizable value is
more commonly used.

17. Rock Music Centre should report the five CD players at \$320 each, for
a total of \$1,600. \$320 is the estimated net realizable value (NRV)
under the lower of cost and market basis of accounting for
inventories. NRV represents the net revenue which can be expected
from the sale of the goods, and therefore constitutes a logical
maximum on the value of the items.

18.   Maureen & Nathan Company should disclose (1) the major inventory
classifications, (2) the basis of accounting (cost or lower of cost and
market), and (3) the costing method used (specific identification,
FIFO, average cost, or LIFO).

*19. In a periodic system, the average is a weighted average based on
total goods available for sale at the end of the period. In a perpetual
system, the average is calculated the same (GAS \$ ÷ GAS units) but
it becomes a moving average as the weighted average is recalculated
after each purchase.

*20. Inventories must be estimated when (1) management wants interim
(monthly or quarterly) financial statements but a physical inventory is
only taken annually, or (2) a fire or other type of casualty makes it
impossible to take a physical inventory.

6-9
Questions Chapter 6 (Continued)

*21. The estimated cost of the ending inventory is \$20,000:

Net sales ...........................................................................   \$400,000
Less: Gross profit (\$400,000 X 30%) ..............................                       120,000
Estimated cost of goods sold .........................................                  \$280,000

Cost of goods available for sale .....................................                  \$300,000
Less: Cost of goods sold ...............................................                 280,000
Estimated cost of ending inventory ................................                     \$ 20,000

*22. The estimated cost of the ending inventory is \$21,000:

Cost-to-retail ratio:                     \$84,000  \$120,000 = 70%

Ending inventory at retail: \$120,000 – \$100,000 = \$20,000

Ending inventory at cost:                 \$20,000 X 70% = \$14,000

6-10
SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 6-1

1.   Ownership of the goods belongs to the consignor (Helgeson). Thus,
these goods should be included in Helgeson’s inventory.

2.   The goods in transit should not be included in the inventory count be-
cause ownership by Helgeson does not occur until the goods reach
its warehouse.

3.   The goods being held belong to the customer. They should not be in-
cluded in Helgeson’s inventory.

4.   Ownership of these goods rests with the other company (the
consignor). These goods should not be included in Helgeson’s
inventory.

5.   The goods in transit to a customer should be included in inventory as
title does not pass to the customer until they reach the destination.

BRIEF EXERCISE 6-2

Inventoriable costs are \$3,070 (invoice cost \$3,000 + freight charges \$70).
The amount paid to negotiate the purchase is a buying cost that normally
is not included in the cost of inventory because of the difficulty of
allocating these costs, or other employee-related costs (e.g., wages),
directly to the product Buying costs such as these are usually expensed in
the year incurred.

6-11
BRIEF EXERCISE 6-3

(a) March 2             Purchases ............................... 900,000
Accounts Payable ............                               900,000

(b) March 6             Accounts Payable ................... 130,000
Purchases Returns and
Allowances...................                             130,000

(c) March 29            Accounts Payable ................... 770,000
Cash (\$900,000 - \$130,000)                                  770,000

(2) Seller Company

(a) March 2             Accounts Receivable .............. 900,000
Sales .................................                     900,000

(b) March 6             Sales Returns and Allowances 130,000
Accounts Receivable .......                                130,000

(c) March 29            Cash (\$900,000 - \$130,000)..... 770,000
Accounts Receivable .......                                 770,000

BRIEF EXERCISE 6-4

Purchases ..........................................................................   \$400,000
Less: Purchase returns and allowances ........................                           11,000
Net purchases ...................................................................       389,000
Cost of goods purchased .................................................              \$405,000

6-12
BRIEF EXERCISE 6-5

Net sales ...........................................................                 \$630,000
Beginning inventory ........................................                 \$ 60,000
Less: Purchase returns and allowances .......                         11,000
Net purchases .................................................. 389,000
Cost of goods purchased ................................                      405,000
Cost of goods available for sale .....................                       465,000
Less: Ending inventory ...................................                     90,000
Cost of goods sold ..........................................                       0 375,000
Gross profit ......................................................                   \$255,000

BRIEF EXERCISE 6-6

Dec. 31 Sales ............................................................   630,000
Merchandise Inventory (December 31) ......                            90,000
Purchase Returns and Allowances............                           11,000
Capital...................................................                 731,000

Dec. 31 Capital ..........................................................   476,000
Merchandise Inventory (January 1) ....                                      60,000
Purchases ............................................                     400,000
Freight In ..............................................                   16,000

6-13
BRIEF EXERCISE 6-7

Goods available for sale (GAS):

Units      Dollars
P     300 X \$6 = \$1,800
P     400 X \$7 = 2,800
P     300 X \$8 = 2,400
GAS 1,000        \$7,000
-EI   400
CGS   600

(a) FIFO

CGS:     300 x \$6 = \$1,800
300 x \$7 = 2,100
600      = \$3,900

EI:      300 x \$8 = \$2,400
100 x \$7 =    700
400      = \$3,100

Check: CGS + EI = GAS
\$3,900 + \$3,100 = \$7,000

(b) Weighted Average Cost

Weighted average unit cost: \$7,000  1,000 = \$7

CGS:     600 x \$7 = \$4,200

EI:      400 x \$7 = \$2,800

Check: CGS + EI = GAS
\$4,200 + \$2,800 = \$7,000

6-14
BRIEF EXERCISE 6-7 (Continued)

(c) LIFO

CGS:     300 x \$8 = \$2,400
300 x \$7 = 2,100
600      = \$4,500

EI:      300 x \$6 = \$1,800
100 x \$7 =    700
400      = \$2,500

Check: CGS + EI = GAS
\$4,500 + \$2,500 = \$7,000

BRIEF EXERCISE 6-8

(a) LIFO gives the highest inventory valuation when prices are falling.
This is because the cost of the units purchased earlier, at a higher
cost, are assumed to be still in inventory.

(b) FIFO gives the highest cost of goods sold amount. This is because the
cost of the units purchased earlier, at a higher cost, are assumed to
have been sold first and are allocated to cost of goods sold.

(c) In selecting a cost flow method, the company should consider their
type of inventory and its actual physical flow. While it is not essential
to match the actual physical flow to the assumed cost flow method, it
does give the company an indication as to its flow of costs throughout
the period. What is important is choosing a method that best matches
these costs to the revenue they generate.

6-15
BRIEF EXERCISE 6-9

BI + CGP = GAS – EI      = CGS
- U\$7,000 = O\$7,000

Sales – CGS     = NI
- O\$7,000 = U\$7,000

The understatement of ending inventory caused cost of goods sold to be
overstated \$7,000 and net income to be understated \$7,000. The correct
net income for 2002 is \$97,000 (\$90,000 + \$7,000).

A       = L + OE
U\$7,000 =     U\$7,000

Total assets and owner’s equity in the balance sheet will both be
understated by the amount that ending inventory is understated, \$7,000.
Remember that if net income is understated, then owner’s equity is also
understated as net income is a component of owner’s equity. Check your
work by ensuring that the accounting equation balances.

6-16
BRIEF EXERCISE 6-10

Assets =       Liabilities +     Owner’s Equity

2002     U\$25,000      No Effect        U\$25,000

2003     No Effect     No Effect        No Effect

2002
BI + CGP = GAS – EI       = CGS
- U\$25,000 = O\$25,000

Sales – CGS      = NI
- O\$25,000 = U\$25,000

Note that if Net Income is understated \$25,000, then Owner’s Equity is also
understated \$25,000.

2003
BI + CGP = GAS      – EI = CGS
U\$25,000 = U\$25,000      = U\$25,000

Sales – CGS      = NI
- U\$25,000 = O\$25,000

Note that if net income is overstated \$25,000 and added to the prior year’s
understatement of \$25,000, that the two errors cancel out. The Owner’s
Equity at the end of the period is correct. The ending inventory is also
correct at the end of 2003.

6-17
BRIEF EXERCISE 6-11

Inventory Categories                 Cost                 Market       LCM

Cameras                             \$12,000               \$11,200
Camcorders                            9,000                 9,500
VCRs                                 14,000                12,800
Total valuation                  \$35,000               \$33,500     \$33,500

*BRIEF EXERCISE 6-12

(a) March 2    Merchandise Inventory ..........             900,000
Accounts Payable ...........                         900,000

(b) March 6    Accounts Payable ..................          130,000
Merchandise Inventory ...                            130,000

(c) March 29   Accounts Payable ..................          770,000
Cash .................................               770,000

(2) Seller Company

(a) March 2    Accounts Receivable .............            900,000
Sales ................................               900,000

Cost of Goods Sold ...............           620,689
Merchandise Inventory ...                           620,689
(\$900,000 ÷ 1.45 = \$620,689)

(b) March 6    Sales Returns and Allowances 130,000
Accounts Receivable .......                         130,000

Merchandise Inventory ...........             89,655
Cost of Goods Sold .........                         89,655
(\$130,000 ÷ 1.45 = \$89,655)

(c) March 29   Cash......................................... 770,000
Accounts Receivable .......                          770,000

6-18
*BRIEF EXERCISE 6-13

(a) FIFO

Date          Purchased                Sold               Balance
May 5      (50 X \$10)   \$500                          (50 X \$10)   \$500

June 1                         (30 X \$10)      \$300   (20 X \$10)   \$200

July 29    (25 X \$12)   \$300                          (20 X \$10)
(25 X \$12)   \$500

Aug. 27                        (20 X \$10)
(15 X \$12)      \$380   (10 X \$12)   \$120

Cost of goods sold = \$300 + \$380 = \$680
Ending inventory = \$120
Check: CGS + EI =GAS; \$680 + \$120 = \$800

(b) Moving Average

Date          Purchased                Sold               Balance
May 5      (50 X \$10)   \$500                          (50 X \$10)   \$500

June 1                         (30 X \$10)      \$300   (20 X \$10)   \$200

July 29    (25 X \$12)   \$300                          (20 X \$10)
(25 X \$12)    \$500
Average \$500 ÷ 45
= \$11.11
Aug. 27                        (35 X \$11.11) \$389     (10 X \$11.11) \$111

Cost of goods sold = \$300 + \$389 = \$689
Ending inventory = \$111
Check: CGS + EI =GAS; \$689 + \$111 = \$800

6-19
*BRIEF EXERCISE 6-13

(c) LIFO

Date          Purchased                   Sold                  Balance
May 5      (50 X \$10)   \$500                                (50 X \$10)   \$500

June 1                            (30 X \$10)      \$300      (20 X \$10)   \$200

July 29    (25 X \$12)   \$300                                (20 X \$10)
(25 X \$12)   \$500

Aug. 27                           (25 X \$12)
(10 X \$10)      \$400      (10 X \$10)   \$100

Cost of goods sold = \$300 + \$400 = \$700
Ending inventory = \$100
Check: CGS + EI =GAS; \$700 + \$100 = \$800

Recap:
Moving
FIFO       Average            LIFO
CGS          \$680        \$689              \$700
EI            120         111               100
GAS          \$800        \$800              \$800

6-20
*BRIEF EXERCISE 6-14

Net sales ...................................................................................      \$350,000
Less: Estimated gross profit (40% X \$350,000) ....................                                  140,000
Estimated cost of goods sold .................................................                     \$210,000

Cost of goods available for sale .............................................                     \$310,000
Less: Estimated cost of goods sold ......................................                           210,000
Estimated cost of ending inventory .......................................                         \$100,000

*BRIEF EXERCISE 6-15
At Cost                  At Retail
Goods available for sale                                        \$35,000               \$50,000
Net sales                                                                              40,000
Ending inventory at retail                                                            \$10,000

Cost-to-retail ratio = \$35,000 ÷ \$50,000 = 70%

Estimated cost of ending inventory = \$10,000 X 70% = \$7,000

6-21
SOLUTIONS TO EXERCISES

EXERCISE 6-1

Ending inventory——physical count .............................................                     \$297,000
1. No effect: Title passes to purchaser upon shipment
when terms are FOB shipping point ....................................                             0
2. No effect: Title does not transfer to Novotna until
3. Add to inventory: Title passed to Novotna when
goods were shipped ..............................................................              25,000
4. Add to inventory: Title remains with Novotna until
5. No effect: Title does not transfer to Novotna until goods
Correct inventory ..............................................................................   \$362,000

6-22
EXERCISE 6-2

(1)   Olaf Company

April 5    Purchases ..............................................      18,000
Accounts Payable .............................                       18,000

April 6    Freight In ................................................     900
Cash ...................................................              900

April 7    Equipment ..............................................      26,000
Accounts Payable .............................                       26,000

April 8    Accounts Payable ..................................            3,000
Purchase Returns and Allowances..                                     3,000

April 30   Accounts Payable (\$18,000 – \$3,000) ...                       15,000
Cash ...................................................             15,000

(2)   DeVito Company

April 5    Accounts Receivable ............................              18,000
Sales ..................................................             18,000

April 8    Sales Returns and Allowances .............                     3,000
Accounts Receivables ......................                           3,000

April 30   Cash (\$18,000 – \$3,000).........................              15,000
Accounts Receivable ........................                         15,000

Note: Transactions #2 and #3 do not affect the DeVito Company.

6-23
EXERCISE 6-3

LEBLANC COMPANY
Income Statement (Partial)
For the Year Ended August 31, 2003

Cost of goods sold:
Inventory, September 1, 2002 .........................                          \$017,200
Purchases ........................................................   \$142,400
Less: Purchase returns and allowances ......                            2,000
Net purchases .................................................       140,400
Cost of goods purchased ...............................                           144,400
Cost of goods available for sale .....................                            161,600
Inventory, August 31, 2003 .............................                         0 26,000
Cost of goods sold ..........................................                    \$135,600

6-24
EXERCISE 6-4

Co. 1                  Co. 2              Co. 3                   Co. 4
BI                       \$ 250               \$ 120                \$1,000             (j) \$ 2,960
+P              \$1,500                        \$1,080         (g) \$7,500              \$44,590
- PR&A               40                   (d)     60                290            (k) 260
= NP          (a) 1,460                        1,020              7,210                44,330
+ FI                110                    (e) 210            (h)   730                 2,240
= CGP + CGP (b) 1,570 (b) 1,570                1,230 1,230        7,940      7,940 (l) 46,570 (l) 46,570
= CGAS               1,820                      1,350             (i) 8,940                 49,530
- EI                   310                    (f) 100                 1,450                  6,230
=CGS             (c) 1,510                      1,250                 7,490                 43,300

Supporting Detail:

(a) \$1,460 (\$1,500 - \$40)                        (g) \$7,500 (\$290 + \$7,210)
(b) \$1,570 (\$1,460 + \$110)                       (h) \$730 (\$7,940 - \$7,210)
(c) \$1,510 (\$1,820 - \$310)                       (i) \$8,940 (\$1,000 + \$7,940)
(d) \$60 (\$1,080 - \$1,020)                        (j) \$2,960 (\$49,530 - \$46,570 from (l))
(e) \$210 (\$1,230 - \$1,020)                       (k) \$260 (\$44,590 - \$44,330)
(f) \$100 (\$1,350 - \$1,250)                       (l) \$46,570 (\$44,330 + \$2,240)

6-25
EXERCISE 6-5

(a)
OKANAGAN COMPANY
Income Statement
For the Year Ended January 31, 2003

Sales revenues
Sales ...........................................................................   \$312,000
Less: Sales returns and allowances .........................                          13,000
Net sales .........................................................................              \$299,000
Cost of goods sold
Inventory, February 1, 2002 .......................................                 \$ 42,000
Purchases .................................................. \$200,000
Less: Purchase returns and allowances .                                  6,000
Net purchases ........................................... 194,000
Cost of goods purchased ..........................................                   204,000
Cost of goods available for sale ...............................                     246,000
Inventory, January 31, 2003.......................................                    63,000
Cost of goods sold ........................................................                       183,000
Gross profit ....................................................................                 116,000
Operating expenses
Salary expense ...........................................................          \$ 61,000
Rent expense ..............................................................           20,000
Insurance expense .....................................................               12,000
Freight out ..................................................................         7,000
Total operating expenses ....................................                               100,000
Net income .....................................................................                 \$ 16,000

6-26
EXERCISE 6-5 (Continued)

(b)

Jan. 31    Sales ...............................................................   312,000
Merchandise Inventory (Jan. 31, 2003) .........                          63,000
Purchase Returns and Allowances...............                            6,000
Capital .....................................................                 381,000

Capital .............................................................   365,000
Merchandise Inventory (Feb. 1, 2002) ...                                       42,000
Purchases ...............................................                     200,000
Freight In ................................................                    10,000
Salary Expense ......................................                          61,000
Rent Expense .........................................                         20,000
Insurance Expense ................................                             12,000
Freight Out..............................................                       7,000
Sales Returns and Allowances .............                                     13,000

EXERCISE 6-6

(a) FIFO

Cost of Goods Sold: (#1012) \$500 + (#1045) \$450 = \$950

(b) It could choose to sell specific units purchased at specific costs if it
wished to impact income selectively. If it wished to minimize net
income, it would choose to sell the units purchased at higher costs.
In this case, the cost of goods sold would be \$950 [(#1012) \$500 +
(#1045) \$450]. If it wished to minimize net income, it would choose to
sell the units purchased at lower costs. In this case, the cost of
goods sold would be \$850 [(#1045) \$450 + (#1056) \$400].

(c) I recommend Discount uses the FIFO method. FIFO provides a more
relevant balance sheet valuation for decision making (closer to
replacement cost) and reduces the opportunity to manipulate net
income.

Note to Instructor: This answer may vary depending on the method
the student chooses.

6-27
EXERCISE 6-7

(a)
FIFO

Cost of Goods Sold:
Date          Units            Unit Cost   Total Cost
5/1            30               \$08             \$240
5/15           25               010             0250
5/24           15               012              180
70                               \$670
Ending Inventory:
Date          Units            Unit Cost   Total Cost
5/24           20               \$12             \$240

Proof:
CGS + EI = GAS
\$670 + \$240 = \$910

(b)
WEIGHTED AVERAGE

\$910 ÷ 90 = \$10.11 average unit cost

Cost of Goods Sold:
70 x \$10.11 = \$708 (rounded)

Ending Inventory:
20 x \$10.11 = \$202 (rounded)

Proof:
CGS + EI = GAS
\$708 + \$202 = \$910

6-28
EXERCISE 6-8

Beginning inventory (200 X \$5) .........................................         \$1,000
Purchases: June 12 (300 X \$6) ........................................... \$1,800
June 23 (500 X \$7)........................................... 03,500 5,300
Cost of goods available for sale (1,000 units) ..................                 6,300
Less: Ending inventory (180 units)
Cost of goods sold (820 units)

(a)
(1) FIFO

Cost of Goods Sold:
Date             Units           Unit Cost           Total Cost
6/1               200                 \$5                   \$1,000
6/12              300                  6                    1,800
6/23              320                  7                    2,240
820                                      \$5,040
Ending Inventory:
Date             Units           Unit Cost           Total Cost
6/23              180                 \$7                   \$1,260

Proof: CGS    + EI     = GAS
\$5,040 + \$1,260 = \$6,300
(2) LIFO

Cost of Goods Sold:
Date             Units           Unit Cost           Total Cost
6/23                 500              \$7                   \$3,500
6/12                 300               6                    1,800
6/1                   20               5                      100
820                                   \$5,400
Ending Inventory:
Date             Units           Unit Cost           Total Cost
6/1               180                 \$5                     \$900

Proof: CGS + EI = GAS
\$5,400 + \$900 = \$6,300
6-29
EXERCISE 6-8 (Continued)

(b) The FIFO method will produce the higher ending inventory because
costs have been rising. Under this method, the earliest costs are as-
signed to cost of goods sold, and the latest costs remain in ending
inventory. For Dene Company, the ending inventory under FIFO is
\$1,260 compared to \$900 under LIFO.

(c) The LIFO method will produce the higher cost of goods sold for
Dene Company. Under LIFO, the most recent costs are charged to
cost of goods sold, and the earliest costs are included in the ending
inventory. The cost of goods sold is \$5,400 compared to \$5,040
under FIFO.

6-30
EXERCISE 6-9

(a)

Cost of Goods                Total Units            Weighted Average
Available for Sale    ÷    Available for Sale   =        Unit Cost
\$6,300                      1,000                    \$6.30

Ending Inventory:
180 X \$6.30 = \$1,134

Cost of Goods Sold:
820 X \$6.30 = \$5,166

Proof: CGS + EI       = GAS
\$5,166 + \$1,134 = \$6,300

(b) Ending inventory is lower than FIFO (\$1,260) and higher than LIFO
(\$900). In contrast, cost of goods sold is higher than FIFO (\$5,040)
and lower than LIFO (\$5,400). When prices are changing, the
average cost method will always produce this type of result. That is,
average results will fall somewhere between those of FIFO and
LIFO.

(c) The average cost method uses a weighted average unit cost, not a
simple average of unit costs (\$5 + \$6 + \$7 = \$18 ÷ 3 = \$6).

6-31
EXERCISE 6-10

(a)   Periodic Inventory Method

Purchases (100 x \$10) ........................................          1,000
Accounts Payable ......................................                    1,000

Accounts Receivable (70 x \$15).........................                 1,050
Sales ...........................................................           1,050

Perpetual Inventory Method

Merchandise Inventory (100 x \$10) ....................                  1,000
Accounts Payable ......................................                     1,000

Accounts Receivable (70 x \$15).........................                 1,050
Sales ...........................................................           1,050

Cost of Goods Sold (70 x \$10) ...........................                700
Merchandise Inventory..............................                         700

(b)   1. FIFO
2. LIFO
3. Specific Identification
4. LIFO

6-32
EXERCISE 6-11

SELES HARDWARE
Income Statement (Partial)
2002         2003
Beginning inventory ..............................................                   \$020,000     \$025,000
Cost of goods purchased......................................                         150,000      175,000
Cost of goods available for sale ...........................                         0170,000     0200,000
a           b
Corrected ending inventory ..................................                        0025,000     0 39,000
Cost of goods sold ................................................                  \$145,000     \$161,000

a
\$30,000 – \$5,000 = \$25,000
b
\$35,000 + \$4,000 = \$39,000

EXERCISE 6-12

(a)
BRASCAN COMPANY
Income Statement (Partial)
2002        2003
Sales.....................................................................     \$210,000    \$250,000
Cost of goods sold
Beginning inventory ....................................                   0032,000    0037,000
Cost of goods purchased............................                        0173,000    0202,000
Cost of goods available for sale .................                         0205,000    0239,000
Ending inventory (\$40,000 – \$3,000)...........                             0037,000    0052,000
Cost of goods sold ...............................                  0168,000    0187,000

Gross profit..........................................................         \$ 42,000    \$ 63,000

6-33
EXERCISE 6-12 (Continued)

(b) The cumulative effect on total gross profit for the two years is zero,
as shown below:

Incorrect gross profits: \$45,000 + \$60,000 =        \$105,000
Correct gross profits:   \$42,000 + \$63,000 =         105,000
Difference                                          \$      0

(c) Dear Mr./Ms. President:

Because your ending inventory of December 31, 2002 was
overstated by \$3,000, your net income for 2002 was overstated and
net income for 2003 was understated by \$3,000.

In a periodic system, the cost of goods sold is calculated by
deducting the cost of ending inventory from the total cost of goods
you have available for sale in the period. Therefore, if this ending
inventory figure is overstated, as it was in December 2002, the cost
of goods sold is understated and therefore net income will be
overstated by that amount.

Consequently, this overstated ending inventory figure goes on to
become the next period’s beginning inventory amount and is a part
of the total cost of goods available for sale. Therefore, the mistake
repeats itself in the reverse.

Although the cumulative effect of the error over the combined two
year period is nil, the effect on each individual year’s income
statement is significant. For example, the gross profit margin
before correction was 21.4% (\$45,000 ÷ \$210,000) in 2002 and
increased 2.6% to 24.0% (\$60,000 ÷ \$250,000) in 2003. After the
error is corrected, the gross profit margin for 2002 is 20.0%
(\$42,000 ÷ \$210,000) and the increase is 5.2% to 25.2% (\$63,000 ÷
\$250,000) in 2003.

Thank you for allowing me to bring this to your attention. If you

Sincerely,

6-34
EXERCISE 6-13

Cost      Market        LCM
Cameras
Minolta             \$ 875      \$ 800
Canon                1,050      1,064
Total              1,925      1,864

Light Meters
Vivitar              1,500     1,428
Kodak                1,150     1,350
Total             2,650     2,778

Total inventory       \$4,575     \$4,642       \$4,575

Since the market value of the total inventory is higher than its cost, the
lower of cost and market value is the inventory’s cost, \$4,575.

6-35
*EXERCISE 6-14

(1)                                        FIFO
Date               Purchased                  Sold                  Balance

Jan. 1                                                         (4 X \$600)    \$2,400

8                       (2 X \$600)        \$1,200   (2 X \$600)     1,200

10                                                     (2 X \$600)
(6 X \$700) \$4,200                              (6 X \$700)     5,400

15
(2 X \$600)
(2 X \$700)        \$2,600   (4 X \$700)     2,800

Cost of goods sold: \$1,200 + \$2,600 = \$3,800
Ending inventory: \$2,800
Proof: CGS + EI       = GAS
\$3,800 + \$2,800 = \$6,600

(2)
MOVING AVERAGE COST

Date           Purchased                 Sold                   Balance

Jan. 1                                                        (4 X \$600)    \$2,400

8                       (2 X \$600)    \$1,200       (2 X \$600)     1,200

10                                                     (8 X \$675)*    5,400
(6 X \$700) \$4,200
15                          (4 X \$675)    \$2,700       (4 X \$675)     2,700

*Average unit cost = \$5,400 ÷ 8 = \$675

Cost of goods sold: \$1,200 + \$2,700 = \$3,900
Ending inventory: \$2,700
Proof: CGS + EI       = GAS
\$3,900 + \$2,700 = \$6,600

6-36
*EXERCISE 6-15

Net sales (\$51,000 – \$1,000) ..............................................................         \$50,000
Less: Estimated gross profit (30% X \$50,000) ................................                       015,000
Estimated cost of goods sold ...........................................................            \$35,000

Beginning inventory ..........................................................................      \$25,000
Cost of goods purchased (\$28,200 – \$1,400 + \$1,200) ....................                            028,000
Cost of goods available for sale .......................................................             53,000
Less: Estimated cost of goods sold ................................................                 035,000
Estimated cost of merchandise lost .................................................                \$18,000

*EXERCISE 6-16

Women's                               Men's
Department                           Department
Cost              Retail             Cost              Retail
Beginning inventory                       \$032,000         \$045,000           \$046,450            \$060,000
Goods purchased                           0148,000         0 180,000          0137,300              185,000
Goods available for sale                  \$180,000           225,000          \$183,750             245,000
Net sales                                                  0 185,000                                195,000
Ending inventory at retail                                  \$ 40,000                               \$ 50,000

Cost to retail ratio                      \$180,000 = 80%                      \$183,750 = 75%
\$225,000                            \$245,000

Estimated cost of
ending inventory                          \$40,000 X 80%                       \$50,000 X 75%
= \$32,000                           = \$37,500

6-37
SOLUTIONS TO PROBLEMS

PROBLEM 6-1A

1.   Title to the goods does not transfer to the customer until March 2.
Include the \$800 in ending inventory.

2.   Kananaskis owns the goods once they are shipped on February
26. Include inventory of \$375.

3.   Include \$500 in inventory.

4.   Exclude the items from Kananaskis’ inventory.

5.   Title of the goods does not transfer to Kananaskis until March 2.
Exclude this amount from the February 28 inventory.

6.   The sale will be recorded on February 26. The goods should be
excluded from Kananaskis’ inventory at the end of February.

6-38
PROBLEM 6-2A

(a)
GENERAL JOURNAL                                                        J1
Date        Account Titles and Explanation                                            Debit   Credit

Apr.    5   Purchases .........................................................       1,600
Accounts Payable .....................................                        1,600

7   Freight In...........................................................       80
Cash ...........................................................                 80

9   Accounts Payable ............................................              100
Purchase Returns and Allowances..........                                        100

10   Accounts Receivable .......................................                900
Sales ..........................................................                 900

12   Purchases .........................................................        660
Accounts Payable .....................................                          660

14   Accounts Payable (\$1,600  \$100) ..................                       1,500
Cash ...........................................................               1,500

17   Accounts Payable ............................................               60
Purchase Returns and Allowances..........                                         60

20   Accounts Receivable .......................................                700
Sales ..........................................................                 700

21   Accounts Payable (\$660  \$60) .......................                      600
Cash ...........................................................                 600

27   Sales Returns and Allowances .......................                        30
Accounts Receivable ................................                             30

30   Cash ..................................................................    600
Sales ..........................................................                 600

30   Cash ..................................................................   1,100
Accounts Receivable ................................                           1,100

6-39
PROBLEM 6-2A (Continued)

(b)
Cash
Date        Explanation             Ref.       Debit    Credit    Balance
Apr.    1   Balance                                               2,500
7                           J1                       80    2,420
14                           J1                    1,500      920
21                           J1                      600      320
30                           J1            600                920
30                           J1          1,100              2,020

Accounts Receivable
Date        Explanation             Ref.       Debit    Credit    Balance
Apr. 10                             J1            900                900
20                             J1            700              1,600
27                             J1                       30    1,570
30                             J1                    1,100      470

Merchandise Inventory
Date        Explanation             Ref.       Debit    Credit    Balance
Apr.    1   Balance                                               3,500

Accounts Payable
Date        Explanation             Ref.       Debit    Credit    Balance
Apr.    5                           J1                    1,600    1,600
9                           J1            100              1,500
12                           J1                     660     2,160
14                           J1          1,500                660
17                           J1             60                600
21                           J1            600                  0

6-40
PROBLEM 6-2A (Continued)

(b) (Continued)

Kane, Capital
Date         Explanation            Ref.      Debit     Credit    Balance
Apr.   1     Balance                                              6,000

Sales
Date         Explanation            Ref.      Debit     Credit    Balance
Apr. 10                             J1                      900      900
20                             J1                      700    1,600
30                             J1                      600    2,200

Sales Returns and Allowances
Date         Explanation            Ref.      Debit     Credit    Balance
Apr. 27                             J1            30                  30
Purchases
Date         Explanation            Ref.      Debit     Credit    Balance
Apr.    5                           J1          1,600              1,600
12                           J1            660              2,260

Purchase Returns and Allowances
Date         Explanation            Ref.      Debit     Credit    Balance
Apr.    9                           J1                      100      100
17                           J1                       60      160

Freight In
Date         Explanation            Ref.      Debit     Credit    Balance
Apr.   7                            J1            80                  80

6-41
PROBLEM 6-2A (Continued)

(c)
KANE’S PRO SHOP
Trial Balance
April 30, 2003

Debit    Credit
Cash ..............................................................................   \$2,020
Accounts Receivable ...................................................                  470
Merchandise Inventory ................................................                 3,500
Kane, Capital ................................................................                  \$6,000
Sales .............................................................................              2,200
Sales Returns and Allowances ...................................                          30
Purchases ....................................................................         2,260
Purchase Returns and Allowances ............................                                      160
Freight In ......................................................................         80
Totals .....................................................................      \$8,360    \$8,360

(d)
KANE’S PRO SHOP
Income Statement (Partial)
For the Month Ended April 30, 2003

Sales revenues
Sales .........................................................         \$2,200
Less: Sales returns and allowances ....                                     30
Net sales ..................................................                                  \$2,170
Cost of goods sold
Inventory, April 1 .....................................                            \$3,500
Purchases ................................................              \$2,260
Less: Purchase returns and allowances                                      160
Net purchases..........................................                  2,100
Cost of goods purchased .......................                                      2,180
Cost of goods available for sale .............                                       5,680
Inventory, April 30 ...................................                              4,200
Cost of goods sold.............................                                             1,480
Gross profit ...................................................                                 \$ 690

6-42
PROBLEM 6-3A

(a)
METRO DEPARTMENT STORE
Income Statement
For the Year Ended November 30, 2003

Sales revenues
Sales ..........................................................................          \$848,000
Less: Sales returns and allowances .....................                                    10,000
Net sales ...................................................................              838,000
Cost of goods sold
Inventory, Dec. 1, 2002 ..............................                           \$ 34,360
Purchases .................................................. \$630,000
Less: Purchase returns
and allowances .........................                  3,000
Net purchases............................................ 627,000
Cost of goods purchased .........................                                 632,060
Cost of goods available for sale ...............                                  666,420
Inventory, Nov. 30, 2003 ............................                              36,200
Cost of goods sold...............................                                       630,220
Gross profit .....................................................                            207,780
Operating expenses
Salaries expense .................................................... \$140,000
Utilities expense .....................................................           19,600
Sales commissions expense .................................                       12,000
Amortization expensebuilding .............................                        9,500
Insurance expense .................................................                9,000
Delivery expense ....................................................              8,200
Amortization expensedelivery equipment ..........                                 4,000
Property tax expense .............................................                 3,500
Total operating expenses ...............................                             205,800
Net income .....................................................................             \$ 1,980

6-43
PROBLEM 6-3A (Continued)

(b)

Nov. 30   Sales .............................................................   848,000
Merchandise Inventory (Nov. 30, 2003) ......                           36,200
Purchase Returns and Allowances ............                            3,000
Hachey, Capital .......................................                       887,200

Hachey, Capital ............................................   885,220
Merchandise Inventory (Dec. 1, 2002)....                                       34,360
Purchases ...............................................                     630,000
Freight In .................................................                    5,060
Salaries Expense ....................................                         140,000
Utilities Expense .....................................                        19,600
Sales Commissions Expense ................                                     12,000
Amortization Expense-Building .............                                     9,500
Insurance Expense ................................                              9,000
Delivery Expense ....................................                           8,200
Amortization Expense-Delivery Equipment                                         4,000
Property Tax Expense ............................                               3,500
Sales Returns and Allowances ..............                                    10,000

Hachey, Capital ............................................           12,000
Hachey, Drawings ...................................                           12,000

Net income: \$887,200 - \$885,220 = \$1,980

Ending capital balance: \$220,200 + \$887,200 - \$885,220 - \$12,000 =
\$210,180

6-44
PROBLEM 6-4A

(a)               COST OF GOODS AVAILABLE FOR SALE

Date        Explanation             Units   Unit Cost   Total Cost
Jan. 1      Beginning inventory       100    \$20         \$ 2,000
Mar. 15     Purchase                  300     24           7,200
July 20     Purchase                  200     25           5,000
Sept. 4     Purchase                  300     28           8,400
Dec. 2      Purchase                  100     30           3,000
Total                   1,000                \$25,600

(b)                                 FIFO

(1)     Ending Inventory
Unit  Total
Date      Units Cost      Cost
Sept.   4   150    \$ 28 \$4,200
Dec.    2   100      30   3,000
250*         \$7,200

*1,000 – 750 = 250

(2)   Cost of Goods Sold
Unit    Total
Date     Units Cost      Cost
Jan.  1    100   \$ 20 \$ 2,000
Mar. 15    300     24     7,200
July 20    200     25     5,000
Sept. 4    150     28     4,200
750         \$18,400

Check: EI     + CGS     = GAS
\$7,200 + \$18,400 = \$25,600

6-45
PROBLEM 6-4A (Continued)

(b) (Continued)

WEIGHTED AVERAGE COST

Weighted average unit cost: \$25,600  1,000 = \$25.60

(1)     Ending Inventory
Unit       Total
Units        Cost         Cost
250        \$25.60        \$6,400

(2)   Cost of Goods Sold
Unit        Total
Units        Cost        Cost
750        \$25.60      \$19,200

Check: EI     + CGS     = GAS
\$6,400 + \$19,200 = \$25,600

LIFO

(1)      Ending Inventory
Unit  Total
Date       Units Cost      Cost
Jan.     1   100    \$ 20 \$2,000
Mar.    15   150      24   3,600
250          \$5,600

(2)       Cost of Goods Sold
Unit   Total
Date        Units Cost     Cost
Mar.    15   150    \$ 24 \$ 3,600
July    20   200      25    5,000
Sept.    4   300      28    8,400
Dec.     2   100      30    3,000
750         \$20,000

Check: EI     + CGS     = GAS
\$5,600 + \$20,000 = \$25,600

6-46
PROBLEM 6-4A (Continued)

(c) FIFO produces the highest inventory cost for the balance sheet,
\$7,200. LIFO produces the highest cost of goods sold for the income
statement, \$20,000.

(d) The choice of inventory cost method does not affect cash flow. It is
an allocation of costs between inventory and cost of goods sold.

6-47
PROBLEM 6-5A

(a)                                 RÉAL NOVELTY
Condensed Income Statements
For the Year Ended December 31, 2003

Weighted
FIFO           Average

Sales ........................................................ \$865,000    \$865,000
Cost of goods sold
Beginning inventory ........................                 34,000      34,000
Cost of goods purchased................                     591,500     591,500
Cost of goods available for sale .....                      625,500     625,500
Ending inventory .............................               55,000a     51,000b
Cost of goods sold ..........................               570,500     574,500
Gross profit .............................................      294,500     290,500
Operating expenses................................              147,000     147,000
Net income .............................................. \$147,500         \$143,500
a
20,000 x \$2.75 = \$55,000
b
[(\$34,000 + \$591,500) ÷ (15,000 + 230,000) = \$2.55]
20,000 x \$2.55 = \$51,000

6-48
PROBLEM 6-5A (Continued)

I would like to bring the following inventory related points to your
attention to assist you in making a choice between the FIFO and
weighted average cost flow assumptions:

1.   Gross profit under the weighted average cost flow assumption
will be lower than the gross profit reported under the FIFO cost
flow assumption. Costs are rising, and in such instances, FIFO
will always result in the higher gross profit.

2.   The choice of inventory cost flow assumption will impact the
balance sheet (through inventory) and income statement
(through cost of goods sold) of the company. It will not impact
the company’s cash flow. While purchases and sales have a
cash effect, the choice of cost flow assumption does not affect
cash as it only allocates costs between inventory and cost of
goods sold.

3.   In selecting a cost flow assumption management should
consider their circumstances—the type of inventory and the
flow of costs throughout the period. Management should select
the method that will best match their costs with their revenues.

The FIFO cost flow assumption produces the more meaningful
inventory amount for the balance sheet because the units are
costed at the most recent purchases. The FIFO method is most
likely to approximate actual physical flow because the oldest
goods are usually sold first to minimize spoilage and
obsolescence.

The weighted average cost flow assumption produces the more
meaningful gross profit / net income because the cost of more
recent purchases are matched against sales. At least, more so
than occurs with FIFO, which matches the cost of the earliest
purchases against sales revenue. Average also smoothes
these costs, using an average of all costs during the period
rather than matching the cost of any specific time period.

Sincerely,
6-49
PROBLEM 6-6A

(a)   1.   Cost of goods sold 2002          Overstated
2.   Cost of goods sold 2003          Understated
3.   Net income 2002                  Understated
4.   Net income 2003                  Overstated
5.   Combined net income              No effect

2002:      BI + P - EI = CGS
-U =O

Sales - CGS = NI
-O =U

2003:      BI + P - EI = CGS
U           =U

Sales - CGS = NI
-U    =O

(b)   1.   LIFO
2.   LIFO
3.   FIFO
4.   Average cost

6-50
PROBLEM 6-7A
(a) (incorrect)
ALYSSA COMPANY
Income Statement
For the Year Ended July 31

2002            2003
Sales                                         \$300,000       \$320,000
Cost of goods sold
Beginning inventory                            30,000         22,000
Purchases                                     200,000        240,000
Cost of goods available for sale             230,000        262,000
Ending inventory                               22,000         31,000
Cost of goods sold                            208,000        231,000
Gross profit                                     92,000         89,000
Operating expenses                               60,000         64,000
Net income                                     \$ 32,000       \$ 25,000

(correct)
ALYSSA COMPANY
Income Statement
For the Year Ended July 31

2002            2003
Sales                                         \$300,000       \$320,000
Cost of goods sold
Beginning inventory                            30,000         27,000
Purchases                                     200,000        240,000
Cost of goods available for sale             230,000        267,000
Ending inventory                               27,000         31,000
Cost of goods sold                            203,000        236,000
Gross profit                                     97,000         84,000
Operating expenses                             60,000         64,000
Net income                                     \$ 37,000       \$ 20,000

(b)   The impact of this error on owner’s equity at July 31, 2003 is zero.
The error in the 2002 is offset by the error in 2003. The total income
for the two years is \$57,000 in both the incorrect and correct
income statements.

6-51
PROBLEM 6-8A
(a) Amelia Company—Purchaser

GENERAL JOURNAL
Date        Account Titles and Explanation                                            Debit   Credit

July    5   Purchases .........................................................        540
Cash ...........................................................                540

8   Cash ..................................................................    495
Sales ..........................................................                 495

10   Sales Returns ...................................................          110
Cash ...........................................................                110

15   Purchases .........................................................        200
Cash ...........................................................                200

16   Accounts Payable ............................................               40
Purchase Returns and Allowances..........                                         40

20   Cash ..................................................................    540
Sales ..........................................................                 540

25   Purchases .........................................................         65
Cash ...........................................................                 65

6-52
PROBLEM 6-8A (Continued)

(b) Karina Company—Seller

GENERAL JOURNAL
Date            Account Titles and Explanation                                            Debit   Credit

July        5   Cash ..................................................................    540
Sales ..........................................................                  540

15    Cash ..................................................................    200
Sales ..........................................................                  200

16    Sales Returns and Allowances .......................                        40
Cash ...........................................................                     40

25    Cash ..................................................................     65
Sales ..........................................................                      65

(c)                    COST OF GOODS AVAILABLE FOR SALE

Date             Explanation                          Units          Unit Cost       Total Cost
July 1           Beginning inventory                    25           \$10.00            \$ 250
July 5           Purchase                               60             9.00               540
July 15          Purchase                               25             8.00               200
July 16          Purchase return                        (5)            8.00                (40)
July 25          Purchase                               10             6.50                 65
Total                                 115                             \$1,015

Weighted average unit cost = \$1,015 ÷ 115 = \$8.83

Ending inventory = 201 x \$8.83 = \$176.60
1
115 – 45 + 10 - 60 = 20

(d) Ending inventory:

Cost: 20 x \$8.83 = \$176.60
Market: 20 x \$7 = \$140

The ending inventory should be valued at \$140, the lower of cost
and market.
6-53
*PROBLEM 6-9A

(a)
FIFO—Perpetual
Date        Purchases            Sales                      Balance
9/1                                                     (26 @ \$97) \$2,522
9/5                           (12 @ \$97)   \$1,164       (14 @ \$97) \$1,358
9/12     (45 @ \$102) \$4,590                             (14 @ \$97)
(45 @ \$102) \$5,948
9/16                          (14 @ \$97)
(36 @ \$102) \$5,030        ( 9 @ \$102) \$918
9/19     (28 @ \$104) \$2,912                             ( 9 @ \$102)
(28 @ \$104) \$3,830
9/22                          ( 9 @ \$102)
(23 @ \$104) \$3,310        ( 5 @ \$104) \$520
9/26     (40 @ \$105) \$4,200                             ( 5 @ \$104)
(40 @ \$105) \$4,720

Cost of goods sold: \$1,164 + \$5,030 + \$3,310 = \$9,504

Ending inventory: \$4,720

Check: CGS + EI        = GAS
\$9,504 + \$4,720 = \$14,224

Note to Instructor: Remind students that the sales price is not relevant
when recording cost of goods sold or inventory. Only the cost is
relevant in this case.

6-54
PROBLEM 6-9A (Continued)

(b)
FIFO—Periodic

Cost of Goods Sold (12 + 50 + 32 = 94 units)
Date       Units         Unit Cost     Total Cost
Sept. 1       26             \$ 97             \$2,522
12        45              102              4,590
19        23              104              2,392
94                              \$9,504
Ending Inventory (45 units)
Date          Units         Unit Cost     Total Cost
Sept. 26         40                \$105          \$4,200
19          5                 104             520
45                              \$4,720

Proof: CGS    + EI     = GAS
\$9,504 + \$4,720 = \$14,224

Note: FIFO periodic yields exactly the same results as does FIFO
perpetual.

6-55
*PROBLEM 6-9A (Continued)

(c)

Sept.    5 Cash................................................   2,388
Sales ..........................................             2,388

Cost of Goods Sold .......................           1,164
Merchandise Inventory.............                         1,164

12 Merchandise Inventory ..................               4,590
Cash...........................................              4,590

16 Cash................................................   9,950
Sales ..........................................             9,950

Cost of Goods Sold .......................           5,030
Merchandise Inventory.............                         5,030

19 Merchandise Inventory ..................               2,912
Cash...........................................              2,912

22 Cash................................................   6,688
Sales ..........................................             6,688

Cost of Goods Sold .......................           3,310
Merchandise Inventory.............                         3,310

26 Merchandise Inventory ..................               4,200
Cash...........................................              4,200

6-56
*PROBLEM 6-9A (Continued)

(d)

Sept.    5 Cash................................................   2,388
Sales ..........................................             2,388

12 Purchases ......................................       4,590
Cash...........................................              4,590

16 Cash................................................   9,950
Sales ..........................................             9,950

19 Purchases ......................................       2,912
Cash...........................................              2,912

22 Cash................................................   6,688
Sales ..........................................             6,688

26 Purchases ......................................       4,200
Cash...........................................              4,200

6-57
*PROBLEM 6-10A

(a)

(1)                                    FIFO

Date           Purchased                 Sold          Balance
May 1          (7
1 X \$150) \$1,050                       (7 X \$150) \$1,050
4
4    8                    (5 X \$150) \$750   (2 X \$150) \$0,300

8    (8
12 X \$170) \$1,360                       (2 X \$150)
(8 X \$170) \$1,660
15
12                            (2 X \$150)
20                    (3 X \$170) \$810   (5 X \$170) \$ 850

15       (5
25 X \$180) \$900                         (5 X \$170)
(5 X \$180) \$1,750

20                            (4 X \$170) \$680   (1 X \$170)
(5 X \$180) \$1,070
25                            (1 X \$170)
(1 X \$180) \$350   (4 X \$180) \$0,720

Cost of goods sold: \$750 + \$810 + \$680 + \$350 = \$2,590

Ending inventory: \$720

Check: CGS    + EI = GAS
\$2,590 + \$720 = \$3,310

6-58
*PROBLEM 6-10A (Continued)

(2)
MOVING AVERAGE COST

Date             Purchased              Sold              Balance
May 1         (7 X \$150) \$1,050                      (07 X \$150) \$1,050

4                        (5 X \$150) \$750    (02 X \$150)     \$300

8    (8 X \$170) \$1,360                      (10 X \$166)* \$1,660

12                         (5 X \$166) \$830    (05 X \$166)     \$830

15     (5 X \$180)   \$900                      (10 X \$173)**\$1,730

20    1                    (4 X \$173) \$692    (06 X \$173) \$1,038

25     4                   (2 X \$173) \$346    (04 X \$173)     \$692
25

*Average cost = (\$300 + \$1,360)  (2 + 8) = \$1,660  10 = \$166
** Average cost = (\$830 + \$900)  (5 + 5) = \$1,730  10 = \$173

Cost of goods sold: \$750 + \$830 + \$692 + \$346 = \$2,618

Ending inventory: \$692

Check: CGS    + EI = GAS
\$2,618 + \$692 = \$3,310

(b) (1) The FIFO method produces the higher ending inventory valuation
(\$720 versus \$692).

(2) The FIFO method also produces the higher net income. Its cost
of goods sold is lower (\$2,590 versus \$2,618) than the moving
average cost method. A lower cost of goods sold results in a
higher net income.

6-59
*PROBLEM 6-11A

(a)
November
Net sales ...........................................................                      \$500,000
Cost of goods sold ..........................................
Beginning inventory .................................                       \$ 22,100
Purchases .................................................         \$314,975
Less: Purchase returns & allowances ...                               11,800
Net purchases ...........................................            303,175
Cost of goods purchased ........................                            0307,577
Cost of goods available for sale ..............                              329,677
Ending inventory ......................................                       31,100
Cost of goods sold ...................................                                  298,577
Gross profit ......................................................                        \$201,423

Gross profit margin = \$201,423 = 40.3%
\$500,000
(b)
December
Net sales.........................................................                       \$400,000
Less: Estimated gross profit
(40.3% x \$400,000) ...........................                                    161,200
Estimated cost of goods sold .......................                                     \$238,800

Beginning inventory ......................................                               \$ 31,100
Purchases ......................................................      \$236,000
Less: Purchase returns and allowances .....                              4,000
Net purchases ................................................         232,000
Freight in ........................................................      3,700
Cost of goods purchased .............................                                     235,700
Cost of goods available for sale ...................                                      266,800
Less: Estimated cost of goods sold.............                                           238,800
Estimated inventory lost in fire ....................                                    \$ 28,000

6-60
*PROBLEM 6-12A

(a)
Cost      Retail

Beginning inventory .................... \$0,260,000          \$0,400,000
Purchases .................................... 01,180,000     1,800,000
Freight in ......................................    5,000
Goods available for sale ............. \$1,445,000             2,200,000
Net sales (\$1,820,000 – \$15,000)                              1,805,000
Ending inventory .........................                   \$ 395,000

Cost-to-retail ratio: \$1,445,000  \$2,200,000 = 65.68%

Estimated inventory at cost: \$395,000 X 65.68% = \$259,436

(b)   \$400,000 X 65.68% = \$262,720

6-61
PROBLEM 6-1B

(a) 1. The goods should not be included in inventory as they were
shipped FOB shipping point on February 26. Title to the goods
transfers to the customer on February 26, the date of shipping.
Since these items were not on the premises, they were not
counted in inventory. No correction is required.

2. The amount should not be included in inventory as they were
shipped FOB destination and not received until March 4. The seller
still owns the inventory. Since these items were not on the
premises, they were not counted in the ending inventory valuation.
No correction Is required.

3. Include \$500 in inventory.

4. Include \$400 in inventory.

5. \$750 should be included in inventory as the goods were shipped
FOB shipping point on February 27. Title passes to Banff on
February 27, the date of shipping.

6. The sale will be recorded on March 2. The goods should be
included in inventory at the end of February at their cost of \$280.

7. The damaged goods should not be included in inventory. They
were on the premises and counted during the inventory count,
therefore they must be deducted from the original ending
inventory valuation.

(b)      \$48,000      Original Feb. 28 inventory valuation
+500       3.
+400       4.
+750       5.
+280       6.
-400      7.
\$49,530      Revised Feb. 28 inventory valuation

6-62
PROBLEM 6-2B

(a)
GENERAL JOURNAL                                                        J1
Date        Account Titles and Explanation                                             Debit   Credit

Apr.   4    Purchases ..........................................................        640
Accounts Payable ......................................                          640

6    Freight In............................................................       40
Cash ............................................................                 40

8    Accounts Receivable ........................................                900
Sales ...........................................................                 900

10   Accounts Payable .............................................               40
Purchase Returns and Allowances...........                                         40

11   Purchases ..........................................................        300
Cash ............................................................                300

13   Accounts Payable (\$640  \$40) ........................                      600
Cash ............................................................                 600

14   Purchases ..........................................................        700
Accounts Payable ......................................                          700

15   Cash ...................................................................     50
Purchase Returns and Allowances...........                                         50

17   Freight In............................................................       30
Cash ............................................................                 30

18   Accounts Receivable ........................................                800
Sales ...........................................................                 800

20   Cash ...................................................................    500
Accounts Receivable .................................                             500

6-63
PROBLEM 6-2B (Continued)

(a) (Continued)

J2
Date        Account Titles and Explanation                                             Debit   Credit

Apr.   21   Accounts Payable .............................................              700
Cash ............................................................                 700

27   Sales Returns and Allowances ........................                        30
Accounts Receivable .................................                             30

30   Accounts Receivable ........................................                900
Sales ...........................................................                 900

30   Cash ...................................................................    500
Accounts Receivable .................................                             500

6-64
PROBLEM 6-2B (Continued)

(b)
Cash
Date         Explanation             Ref.      Debit        Credit    Balance
Apr.     1   Balance                                                   2,500
6                           J1                          40     2,460
11                           J1                         300     2,160
13                           J1                         600     1,560
15                           J1                50               1,610
17                           J1                          30     1,580
20                           J1            500                  2,080
21                           J2                         700     1,380
30                           J2            500                  1,880

Accounts Receivable
Date         Explanation             Ref.      Debit        Credit    Balance
Apr.     8                           J1            900                    900
18                           J1            800                  1,700
20                           J1                         500     1,200
27                           J2                          30     1,170
30                           J2            900                  2,070
30                           J2                         500     1,570

Merchandise Inventory
Date         Explanation             Ref.      Debit        Credit    Balance
Apr.    1    Balance                                                   1,700

Accounts Payable
Date         Explanation            Ref.       Debit        Credit    Balance
Apr.     4                            J1                        640      640
10                            J1            40                   600
13                            J1           600                     0
14                            J1                        700      700
21                            J2           700                     0

6-65
6-66
PROBLEM 6-2B (Continued)

(b) (Continued)

J. Noya, Capital
Date         Explanation             Ref.        Debit        Credit    Balance
Apr.   1     Balance                                                     4,200

Sales
Date         Explanation             Ref.        Debit        Credit    Balance
Apr.    8                             J1                          900       900
18                             J1                          800     1,700
30                             J2                          900     2,600

Sales Returns and Allowances
Date         Explanation             Ref.        Debit        Credit    Balance
Apr.   27                             J2                 30                 30

Purchases
Date         Explanation             Ref.        Debit        Credit    Balance
Apr.    4                             J1             640                    640
11                             J1             300                    940
14                             J1             700                  1,640

Purchase Returns and Allowances
Date         Explanation             Ref.        Debit        Credit    Balance
Apr. 10                               J1                           40       40
15                               J1                           50       90

Freight In
Date         Explanation             Ref.        Debit        Credit    Balance
Apr.    6                             J1                 40                 40
17                             J1                 30                 70

6-67
PROBLEM 6-2B (Continued)

(c)
KICKED-BACK TENNIS SHOP
Trial Balance
April 30, 2003
Debit    Credit
Cash .............................................................................    \$1,880
Accounts Receivable ..................................................                 1,570
Merchandise Inventory ...............................................                  1,700
J. Noya, Capital ...........................................................                   \$4,200
Sales ............................................................................              2,600
Sales Returns and Allowances ..................................                           30
Purchases ...................................................................          1,640
Purchase Returns and Allowances ...........................                                       90
Freight In .....................................................................          70
Totals ...................................................................        \$6,890   \$6,890

(d)
KICKED-BACK TENNIS SHOP
Income Statement (Partial)
For the Month Ended April 30, 2003

Sales revenues
Sales ..........................................................................            \$2,600
Less: Sales returns and allowances .....................                                        30
Net sales ...................................................................                2,570
Cost of goods sold
Inventory, April 1 ......................................................          \$1,700
Purchases ................................................... \$1,640
Less: Purchase returns and allowances...                                     90
Net purchases.............................................              1,550
Cost of goods purchased ........................................                    1,620
Cost of goods available for sale ..............................                     3,320
Inventory, April 30 ....................................................            1,800
Cost of goods sold..............................................                          1,520
Gross profit ....................................................................              \$1,050

6-68
PROBLEM 6-3B

(a)
N-MART DEPARTMENT STORE
Income Statement
For the Year Ended December 31, 2003

Sales revenues
Sales ..........................................................................              \$618,000
Less: Sales returns and allowances ......................                                        8,000
Net sales ...................................................................                  610,000
Cost of goods sold
Inventory, January 1.................................................              \$ 40,500
Purchases ............................................... \$442,000
Less: Purchase returns and allowances                                   6,400
Net purchases.......................................... 435,600
Cost of goods purchased ........................................                   441,200
Cost of goods available for sale ..............................                    481,700
Inventory, December 31 ...........................................                  75,000
Cost of goods sold..............................................                            406,700
Gross profit ....................................................................                 203,300
Operating expenses
Selling expenses
Sales salaries expense................... \$76,000
Sales commissions expense .........                             14,500       \$90,500
Office salaries expense .................. \$32,000
Utilities expense .............................                 18,000
Amortization expenseequipment                                  13,300
Amortization expensebuilding.....                              10,400
Insurance expense .........................                       7,200
Property tax expense .....................                        4,800       85,700
Total operating expenses .........................                                 176,200
Net income .....................................................................                 \$ 27,100

6-69
PROBLEM 6-3B (Continued)
(b)
GENERAL JOURNAL                                                       J2
Date       Account Titles and Explanation                                         Debit    Credit

Dec. 31   Sales .............................................................   618,000
Merchandise Inventory (Dec. 31, 2003) ......                           75,000
Purchase Returns and Allowances ............                            6,400
S. Koo, Capital .........................................                     699,400

S. Koo, Capital .............................................         672,300
Merchandise Inventory (Jan. 1, 2003) ....                                     40,500
Purchases ...............................................                    442,000
Freight In .................................................                   5,600
Sales Salaries Expense ..........................                             76,000
Office Salaries Expense .........................                             32,000
Utilities Expense .....................................                       18,000
Sales Commissions Expense ................                                    14,500
Amortization Expense-Equipment .........                                      13,300
Amortization Expense-Building ...........                                     10,400
Insurance Expense ................................                             7,200
Property Tax Expense ............................                              4,800
Sales Returns and Allowances ..............                                    8,000

S. Koo, Capital .............................................          28,000
S. Koo, Drawings.....................................                         28,000

6-70
PROBLEM 6-3B (Continued)

(c)

Merchandise Inventory
Date       Explanation             Ref.         Debit     Credit    Balance

Jan. 1     Balance                                                  40,500
Dec. 31    Closing entry            J2           75,000             115,500
Dec. 31    Closing entry            J2                     40,500    75,000

S. Koo, Capital
Date       Explanation              Ref.        Debit     Credit    Balance
Jan. 1    Balance                                                 178,600
Dec. 31   Closing entry            J2                    699,400   878,000
Dec. 31   Closing entry            J2          672,300             205,700
Dec. 31   Closing entry            J2           28,000             177,700

6-71
PROBLEM 6-4B

(a)               COST OF GOODS AVAILABLE FOR SALE

Date         Explanation            Units   Unit Cost   Total Cost
Jan. 1       Beginning inventory      400     \$8         \$ 3,200
Feb.20       Purchase                 700       9          6,300
May 5        Purchase                 500     10           5,000
Aug.12       Purchase                 300     11           3,300
Dec. 8       Purchase                 100     12           1,200
Total              2,000                \$19,000

(b)                                 FIFO

(1)    Cost of Goods Sold
Unit    Total
Date      Units Cost      Cost
Feb. 1      400    \$ 8 \$ 3,200
Feb.20      700      9     6,300
May 5       400    10      4,000
1,500         \$13,500

(2)    Ending Inventory
Unit  Total
Date     Units Cost      Cost
Dec. 8     100 \$ 12     \$1,200
Aug.12     300     11    3,300
May 5      100     10    1,000
500*         \$5,500

*2,000 – 1,500 = 500

Check: CGS + EI         = GAS
\$13,500 + \$5,500 = \$19,000

6-72
PROBLEM 6-4B (Continued)

(b) (Continued)

Weighted average unit cost: \$19,000  2,000 = \$9.50

WEIGHTED AVERAGE COST

(1)   Cost of Goods Sold
Unit        Total
Units        Cost        Cost
1,500       \$9.50      \$14,250

(2)     Ending Inventory
Unit  Total
Units         Cost        Cost
500          \$9.50       \$4,750

Check: CGS     + EI     = GAS
\$14,250 + \$4,750 = \$19,000

LIFO

(1)    Cost of Goods Sold
Unit  Total
Date    Units Cost      Cost
Dec. 8    100    \$12 \$ 1,200
Aug.12    300     11    3,300
May 5     500     10    5,000
Feb.20    600      9    5,400
1,500         \$14,900

(2)    Ending Inventory
Unit  Total
Date     Units Cost      Cost
Feb. 1     400     \$ 8 \$3,200
Feb.20     100       9     900
500          \$4,100

Check: CGS     + EI     = GAS
\$14,900 + \$4,100 = \$19,000

6-73
PROBLEM 6-4B (Continued)

(c) (1)   LIFO results in the lowest inventory amount for the balance
sheet, \$4,100.

(2)   FIFO results in the lowest cost of goods sold for the income
statement, \$13,500.

6-74
PROBLEM 6-5B

(a)                                   AUDAS COMPANY
Condensed Income Statement
For the Year Ended December 31, 2003

FIFO        LIFO
Sales ........................................................................   \$665,000    \$665,000
Cost of goods sold
Beginning inventory ........................................                   35,000      35,000
Cost of goods purchased................................                       478,000     478,000
Cost of goods available for sale .....................                        513,000     513,000
Ending inventory .............................................                112,000a     98,000b
Cost of goods sold ..........................................                 401,000     415,000
Gross profit .............................................................        264,000     250,000
Operating expenses................................................                120,000     120,000
Net income ..............................................................        \$144,000    \$130,000
a
(20,000 @ \$4.50) + (5,000 @ \$4.40) = \$112,000
b
(10,000 @ \$3.50) + (15,000 @ \$4.20) = \$98,000

6-75
PROBLEM 6-5B (Continued)

(b) Dear Audas Company:

After preparing the comparative condensed income statements for
2003 under the FIFO and LIFO cost flow assumptions, we have
found the following:

1. The FIFO cost flow assumption produces the more meaningful
inventory amount for the balance sheet because the units are
costed at the most recent purchase prices. These prices
approximate replacement cost, which is the most relevant value
for decision making.

2. The LIFO cost flow assumption produces the more meaningful
net income because current costs (the costs of the most recent
purchases are matched against current revenues (sales).

There exists an illusionary profit of \$14,000 (\$415,000 
\$401,000) under FIFO. Under LIFO, the company has recovered
the current replacement cost of the units (\$415,000) whereas
under FIFO you have only recovered the earlier costs (\$401,000).
This means that under FIFO, the company must reinvest \$14,000
of the gross profit to replace the units used.

3. The FIFO cost flow assumption is most likely to approximate
actual physical flow because the oldest goods are usually sold
first to minimize spoilage and obsolescence.

4. The choice of cost flow assumption does not affect cash flow.
The amount of cash (spent on purchases) will be the same under
either method.

Sincerely,

6-76
PROBLEM 6-6B

(a)   1.   Cost of goods sold 2002           Understated
2.   Cost of goods sold 2003           Overstated
3.   Net income 2002                   Overstated
4.   Net income 2003                   Understated
5.   Combined net income               No effect
6.   Assets for 2002                   Overstated
7.   Assets for 2003                   No effect
8.   Owner’s equity for 2002           Overstated
9.   Owner’s equity for 2003           No effect

2002:      BI + P - EI = CGS
-O=U

Sales - CGS = NI
-U    =O

A = L + OE
O     +O

2003:      BI + P - EI = CGS
O           =O

Sales - CGS = NI
-O =U

A = L + OE
NE + NE
(The net income overstatement in 2002 and
understatement in 2003 cancel each other. At the
end of 2003, owner’s equity is correct.)

(b)   1.   LIFO
2.   LIFO
3.   FIFO
4.   Average cost

6-77
PROBLEM 6-7B

(a) (incorrect)
PELLETIER COMPANY
Income Statement
For the Year Ended July 31

2002            2003
Sales                                        \$300,000       \$320,000
Cost of goods sold
Beginning inventory                          30,000          22,000
Purchases                                   200,000         240,000
Cost of goods available for sale           230,000         262,000
Ending inventory                             22,000          31,000
Cost of goods sold                          208,000         231,000
Gross profit                                   92,000          89,000
Operating expenses                             60,000          64,000
Net income                                   \$ 32,000        \$ 25,000

(correct)
PELLETIER COMPANY
Income Statement
For the Year Ended July 31

2002            2003
Sales                                        \$300,000       \$320,000
Cost of goods sold
Beginning inventory                          30,000          25,000
Purchases                                   200,000         265,000
Cost of goods available for sale           230,000          290,000
Ending inventory                             25,000          31,000
Cost of goods sold                          205,000         259,000
Gross profit                                   95,000          61,000
Operating expenses                             60,000          64,000
Net income (loss)                            \$ 35,000        (\$ 3,000)

(b) The combined effect of the errors at July 31, 2003 before
correction is an overstatement of gross profit and net income of
\$25,000. (\$32,000 + \$25,000 less \$35,000 - \$3,000). This is equal to
the understatement of purchases in 2003. The error in the 2002
inventory is reversed in 2003.
6-78
PROBLEM 6-8B

(a) Purchaser—Schwinghamer Co.

GENERAL JOURNAL
Date        Account Titles and Explanation                                            Debit   Credit

Oct.   1    No entry required

5    Purchases .........................................................        480
Cash ..........................................................                 480

8    Cash ..................................................................    675
Sales ..........................................................                 675

10   Sales Returns and Allowances .......................                       150
Cash ...........................................................                150

15   Purchases .........................................................        225
Cash ..........................................................                 225

16   Cash ..................................................................     45
Purchase Returns and Allowances..........                                         45

20   Cash ..................................................................    960
Sales ..........................................................                 960

25   Purchases .........................................................        100
Cash ...........................................................                100

6-79
PROBLEM 6-8B (Continued)

(b) Seller—Pataki Co.

GENERAL JOURNAL
Date          Account Titles and Explanation                                            Debit   Credit

Oct.     5    Cash ..................................................................    480
Sales ..........................................................                 480

15   Cash ..................................................................    225
Sales ..........................................................                 225

16   Purchase Returns and Allowances .................                           45
Cash ...........................................................                 45

25   Cash ..................................................................    960
Sales ..........................................................                 960

(c)            Ending Inventory
Unit              Total
Date      Units Cost                 Cost
Oct. 25      10    \$ 10               \$100
Oct. 15      10       9                 90
20*                      \$190

*25 + 60 – 45 + 10 + 25 – 5 – 60 + 10 = 20

(d) Cost: \$190
Market: 20 x \$11 = \$220

The inventory should be valued at its cost of \$190. This is the lower
of cost and market.

6-80
*PROBLEM 6-9B

(a)
MOVING AVERAGE COST
Date          Purchases         Sales                    Balance
4/1                                                       \$5,122
4/5                              (12 @ \$197a)   \$2,364    \$2,758
4/12       (65 @ \$202) \$13,130                           \$15,888
4/16                             (50 @ \$201b) \$10,050     \$5,838
4/19       (38 @ \$204) \$7,752                            \$13,590
4/22                             (62 @ \$203c) \$12,586     \$1,004
4/26       (40 @ \$205) \$8,200                             \$9,204
a
\$5,122 ÷ 26 = \$197
b
\$15,888 ÷ 79 = \$201       26 – 12 + 65 = 79
c
\$13,590 ÷ 67 = \$203       79 - 50 + 38 = 67

Ending inventory       \$9,204
Cost of goods sold     \$2,364 + \$10,050 + \$12,586 = \$25,000

Check: EI     + CGS     = GAS
\$9,204 + \$25,000 = \$34,204

(b)
WEIGHTED AVERAGE COST

Weighted average unit cost = \$34,204 ÷ 169d = \$202.39

Ending inventory:   45 x \$202.39 = \$9,107.55
Cost of goods sold: 124e x \$202.39 = \$25,096.36
d
26 + 65 + 38 + 40 = 169
e
12 + 50 + 62 = 124

Check: EI        + CGS        = GAS
\$9,107.55 + \$25,096.36 = \$34,203. 91 (rounding discrepancy only)

6-81
*PROBLEM 6-9B (Continued)

(c)

Sept.    5 Accounts Receivable ....................             3,588
Sales .........................................             3,588

Cost of Goods Sold ......................          2,364
Merchandise Inventory............                         2,364

12 Merchandise Inventory .................             13,130
Accounts Payable ....................                      13,130

16 Accounts Receivable ....................            14,950
Sales .........................................            14,950

Cost of Goods Sold ......................         10,050
Merchandise Inventory............                        10,050

19 Merchandise Inventory.................               7,752
Accounts Payable ....................                       7,752

22 Accounts Receivable ....................            19,158
Sales .........................................            19,158

Cost of Goods Sold ......................         12,586
Merchandise Inventory............                        12,586

26 Merchandise Inventory .................              8,200
Accounts Payable ....................                       8,200

6-82
*PROBLEM 6-9B (Continued)

(d)

Sept.    5 Accounts Receivable .....................            3,588
Sales ..........................................            3,588

12 Purchases ...................................... 13,130
Accounts Payable .....................                     13,130

16 Accounts Receivable ..................... 14,950
Sales ..........................................           14,950

19 Purchases ......................................     7,752
Accounts Payable .....................                      7,752

22 Accounts Receivable ..................... 19,158
Sales ..........................................           19,158

26 Purchases ......................................     8,200
Accounts Payable .....................                      8,200

6-83
*PROBLEM 6-10B

(a)
FIFO

Date            Purchased                            Sold                             Balance

Oct. 1         1                                                                (60 X \$13)      \$780
4
9      8
(120 X \$14) \$1,680                                                (60 X \$13)
(120 X \$14) \$2,460

11     12                                (60 X \$13)
(40 X \$14) \$1,340                (80 X \$14) \$1,120
15
17     (70 X \$15) \$1,050                                                  (80 X \$14)
20                                                                 (70 X \$15) \$2,170

22     25                                (80 X \$14) \$1,120                (70 X \$15) \$1,050

25     (50 x \$16)          \$800                                          (70 X \$15)
(50 X \$16) \$1,850

(50 X \$15)         \$750          (20 X \$15)
28
(50 X \$16) \$1,100

Ending inventory: \$1,100
Cost of goods sold: \$1,340 + \$1,120 + \$750 = \$3,210

(b)
Sales [(100@ \$35) + (80@ \$38) + (50@ \$40)]................                            \$8,540
Cost of goods sold ........................................................            3,210
Gross profit ....................................................................     \$5,330

6-84
*PROBLEM 6-11B

February
Net sales .........................................................                               \$300,000
Cost of goods sold .........................................
Beginning inventory ...............................                              \$ 16,500
Net purchases.........................................               \$200,800
Cost of goods purchased ......................                                    203,700
Cost of goods available for sale ............                                     220,200
Less: Ending inventory ..........................                               00 25,200
Cost of goods sold .................................                                         0195,000
Gross profit.....................................................                                 \$105,000

Gross profit margin = \$105,000 = 35%
\$300,000

March
Net sales .............................................................                       \$260,000
Less: Estimated gross profit                                                                 0 91,000
(35% x \$260,000) ...................................
Estimated cost of goods sold ............................                                        \$169,000

Beginning inventory ...........................................             \$ 25,200
Net Purchases .................................................... \$191,000
Cost of goods purchased ..................................                   194,500
Cost of goods available for sale ........................                    219,700
Less: Estimated cost of goods sold .................                         169,000
Estimated total cost of ending inventory..........                                     50,700
Less: Inventory not lost (20% X \$50,700)..........                                     10,140
Estimated inventory lost in fire
(80% X \$50,700) ...............................................                     \$ 40,560

6-85
*PROBLEM 6-12B

(a)
Sporting                 Jewellery and
Goods                    Cosmetics
Cost           Retail        Cost          Retail

Beginning inventory......... \$047,360              \$0,074,000      \$038,000    \$0,062,000
Purchases ......................... 0670,000       01,166,000      0731,000    01,158,000
Purchase returns..............          (26,000)        (40,000)    (12,000)       (20,000)
Freight in...........................     6,000                       8,000
Goods available for sale .. \$697,360                  1,200,000    \$765,000    01,200,000
Net sales ...........................              (1,120,000)                 (1,160,000)
Ending inventory at retail                         \$     80,000                \$    40,000

Cost-to-retail ratio:

Sporting Goods—\$697,360 ÷ \$1,200,000 = 58.11%

Jewellery and Cosmetics—\$765,000 ÷ \$1,200,000 = 63.75%

Estimated ending inventory at cost:

\$80,000 X 58.11% = \$46,488—Sporting Goods

\$40,000 X 63.75% = \$25,500—Jewellery and Cosmetics

(b) Sporting Goods—\$85,000 X 60% = \$51,000

Jewellery and Cosmetics—\$54,000 X 65% = \$35,100

6-86
BYP 6-1 FINANCIAL REPORTING PROBLEM

(a) The categories of inventory include merchandise held for resale,
and supplies.

(b)                               June 24, 2000         June 30, 1999
Inventory                   \$107 thousand         \$103 thousand

(1) 2000: \$107 ÷ \$5,416 = 2.0%
1999: \$103 ÷ \$24,990 = 0.4%

(2) 2000: \$107 ÷ \$20,844 = 0.5%
1999: \$103 ÷ \$21,465 = 0.5%

Inventory as a percentage of current assets was higher in 2000
than in 1999. Inventory as a percentage of total revenue was
substantially unchanged between 1999 and 2000. The company
had smaller inventories, in both absolute and relative terms, at
the end of 1999 than it did in 2000.

(c) Inventories are valued at the lower of cost or net realizable value,
with cost being determined substantially on a first-in first-out
basis. A different cost flow assumption would affect The Second
Cup’s results, if the price of coffee increases or decreases
greatly during the course of the year. Although given the low
level of inventory in relation to total revenue, the effect may not
be material.

(d) The Second Cup does not disclose any information regarding its
cost of goods sold, other than indirectly through its inventory
valuation disclosure–as indicated in part (c) above.

6-87
BYP 6-2 INTERPRETING FINANCIAL STATEMENTS

(a) Using a perpetual system will enable the coffee chain to keep its
gross profit and inventory up-to-date in a time of changing
prices.

(b) In a period of changing prices, the cost flow assumption can
have a significant impact on income and on evaluations based on
income. By using an average cost flow assumption, variations in
price will be smoothed and therefore net income will be
smoothed as well. Using the average cost flow assumption
allows the coffee chain to average its changing inventory prices
and avoid a distortion of net income in any one period.

6-88
BYP 6-3 INTERPRETING FINANCIAL STATEMENTS

(a) General Motors’ inventories are reported in the balance sheet at
their cost, which is less than their market value (replacement
cost or net realizable value). If their market value was less than
their cost, generally accepted accounting principles would
require that the inventories be reported at the lower of cost and
market value.

(b) GM presents their inventory information using both LIFO and
FIFO for several reasons:

 U.S. accounting standards require companies to disclose the
current (or replacement) cost of ending inventory because of
their concerns that inventory under LIFO may be substantially
undervalued;
 converting the information into FIFO shows the inventory at a
figure closer to its replacement cost, which may be more
meaningful to some decision makers. It also allows more
meaningful analysis, including calculations of the current and
inventory turnover ratios; and
 because GM reports throughout the world, presenting
inventories using both FIFO and LIFO makes comparisons
easier for its users.

(c) The LIFO cost flow assumption means that the oldest costs are
assigned to ending inventory. If its inventory under LIFO is less
than under FIFO, prices must be rising.

6-89
BYP 6-3 (Continued)

(d) LIFO is often used primarily because of income tax benefits in
the U.S. (where it is permitted for tax purposes). In addition, it is
used to better match current costs to current revenues. Many
companies also use other cost flow assumptions, such as FIFO
or average cost, for reasons such as:

 extensive record keeping costs may result under LIFO, where
inventory turnover is very high in certain product lines;
 unwanted involuntary liquidations may result under LIFO in
certain product lines, where inventory levels are unstable; and
 certain product lines can be more susceptible to deflation

(e) This may be due to income tax regulations, which differ between
countries. For example, LIFO is acceptable for tax purposes in
the U.S., but not in Canada. It may also be due to different
economic situations (inflationary conditions, etc.) from country
to country, which affect the appropriateness of alternative
inventory cost flow assumptions.

6-90
BYP 6-4 ACCOUNTING ON THE WEB

Due to the frequency of change with regard to information available
on the world wide web, the Accounting on the Web cases are updated
as required. Their suggested solutions are also updated whenever
necessary, and can be found on-line in the Instructor Resources

6-91
BYP 6-5 COLLABORATIVE LEARNING ACTIVITY

(a)   (1)    Sales .........................................................               \$180,000
Cash sales (\$18,500 x 40%) ....................                                  7,400
Acknowledged credit sales April 1 – 10 .                                        28,000
Sales made but not acknowledged ........                                         4,600
Sales as of April 10 ..................................                       \$220,000

(2)    Purchases ................................................                     \$94,000
Cash purchases April 1-10......................                                  4,200
Credit purchases .....................................              \$12,400
Less: Items in transit ...............................                1,800     10,600
Purchases as of April 10 .........................                            \$108,800

(b)                                                                               2002       2001

Net sales ..........................................................      \$600,000 \$480,000
Cost of goods sold
Inventory, January 1 ................................                   60,000   40,000
Cost of goods purchased .......................                        416,000 356,000
Cost of goods available for sale .............                         476,000 396,000
Inventory, December 31 ..........................                       80,000   60,000
Cost of goods sold ..................................                  396,000 336,000
Gross profit .....................................................        \$204,000 \$144,000

Gross profit margin ........................................                  34%          30%
Average gross profit margin (34% + 30%) ÷ 2                                          32%

(c)   Sales .................................................................              \$220,000
Less: Gross profit (\$220,000 x 32%) ..............                                     70,400
Cost of goods sold ..........................................                        \$149,600

Inventory, January 1 ........................................                         \$ 80,000
Purchases ........................................................                     108,800
Cost of goods available for sale .....................                                188,800
Cost of goods sold (68% of \$220,000)............                                       149,600
Estimated inventory at the time of fire ...........                                   \$ 39,200

(d)   Estimated inventory at the time of the fire ....                                      \$39,200
Less: Inventory salvaged ................................                              19,000
Estimated inventory loss ................................                             \$20,200
6-92
BYP 6-6 COLLABORATIVE LEARNING ACTIVITY

Effect On Fiscal Year
2003                     2002

Beginning inventory      Overstated \$40 million     Not Affected

Ending inventory         Not affected               Overstated \$40 million

Cost of goods sold       Overstated \$40 million     Understated \$40 million

Gross profit             Understated \$40 million    Overstated \$40 million

Net income               Understated \$40 million    Overstated \$40 million

Total assets             Not affected               Overstated \$40 million

Owner’s equity           Not affected               Overstated \$40 million

2002:       BI + P - EI = CGS
-O=U

Sales - CGS = GP ÷ NI
-U    =O

A = L + OE
O     +O

2003:       BI + P - EI = CGS
O           =O

Sales - CGS = GP ÷ NI
-O =U

A = L + OE
NE + NE
(The net income overstatement in 2002 and
understatement in 2003 cancel each other. At the end of
2003, owner’s equity is correct)
6-93
BYP 6-7 COMMUNICATION ACTIVITY

MEMO

To:     Mutahir Kazmi, President

From:   Student

Subject: 2002 Ending Inventory Error

The combined gross profit and net income for 2002 and 2003 are
correct. However, the gross profit and net income for each individual
year are incorrect.

As you know, the 2002 ending inventory was overstated by \$1 million.
This error will cause the 2002 net income to be incorrect because the
ending inventory is used to calculate the 2002 cost of goods sold. Since
the ending inventory is subtracted in the calculation of cost of goods
sold, an overstatement of ending inventory results in an understatement
of cost of goods sold. Therefore, gross profit (sales – cost of goods
sold) is overstated, as is net income.

Unless corrected, this error will also affect 2003 net income. The 2002
ending inventory is also the 2003 beginning inventory. Therefore, the
2003 beginning inventory is also overstated, which causes an
overstatement of cost of goods sold. The 2003 gross profit and net
income are subsequently understated.

If the error is not corrected, the gross profit and net income for 2002
and 2003 will be incorrect. Although the combined net incomes will be
correct (because the overstatement in 2002 cancels the understatement
in 2003), the trend in each year will be misleading.

6-94
BYP 6-8         ETHICS CASE

(a) 1. Maximize gross profit–select lowest cost inventory for cost of
goods sold

Sales [(500 x \$650) + (180 x \$600)] .................                 \$433,000
Cost of goods sold
[(150 x \$300) + (200 x \$350) + (330 x \$375)] .                        238,750
Gross profit .....................................................    \$194,250

2. Minimize gross profit–select highest cost inventory for cost of
goods sold

Sales [(500 x \$650) + (180 x \$600)] .................                 \$433,000
Cost of goods sold
[(130 x \$300) + (200 x \$350) + (350 x \$375)] .                        240,250
Gross profit .....................................................    \$192,750

Difference ........................................................     \$1,500

Reconciliation of difference
20 x (\$375 - \$300) ...........................................          \$1,500

(b)     Average cost flow assumption

Sales [(500 x \$650) + (180 x \$600)] .................                 \$433,000
Cost of goods sold [((150 x \$300) +
(200 x \$350) + (350 x \$375)) ÷ 700 x 680] .....                       239,214
Gross profit .....................................................    \$193,786

(c)     The stakeholders are the investors and creditors of Quality
Diamonds. Choosing which diamonds to sell in a month is
unethical because it is managing income–it is not based on fact as
the diamonds are all identical.

(d)     Quality Diamonds should select the weighted average cost flow
assumption. The specific identification method is not appropriate
because all items are identical. Using the weighted average cost
flow assumption in a time of rising prices will smooth out
variations in prices and result in reasonable values for both the
income statement and balance sheet.

6-95

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