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Chapter 6 Inventory and Cost of Goods Sold

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					Chapter 6

Inventory and Cost of Goods Sold

Short Exercises

                                                  (10 min.)       S 6-1
                                               Billions
        Inventory…………………………                   3.9
          Cash…………………………...                          3.9

        Accounts Receivable………….            19.4
          Sales Revenue……………….                         19.4

        Cost of Goods Sold……………               4.2
          Inventory……………………...                          4.2

        Cash………………………………                    18.9
          Accounts Receivable……….                      18.9




                         Chapter 6   Inventory and Cost of Goods Sold   343
                                                  (10-15 min.)   S 6-2
1. (Journal entries)

       Inventory…………………………………..                    100,000
         Accounts Payable…………………….                            100,000

       Amounts Receivable……………………                  240,000
        Sales Revenue………………………...                             240,000

       Cost of Goods Sold……………………..                 80,000
         Inventory ($100,000 × .80)…………..                        80,000

       Cash ($240,000 × .20)…………………...              48,000
         Accounts Receivable………………...                            48,000


2. (Financial statements)

       BALANCE SHEET
         Current assets:
           Inventory ($100,000 − $80,000)………………. $ 20,000

       INCOME STATEMENT
         Sales revenue………………………………………                        $240,000
         Cost of goods sold………………………………..                      80,000
         Gross profit…………………………………………                        $160,000




344   Financial Accounting 7/e Solutions Manual
                                                   (15-20 min.)         S 6-3
                                      a                  b               c
                                   Average
                                    Cost              FIFO            LIFO
Cost of goods sold:
  Average (24 × $156.67)            $3,760
  FIFO $1,500 + (14 × $160)                          $3,740
  LIFO $3,200 + (4 × $150)                                           $3,800

Ending inventory:
  Average (6 × $156.67)             $ 940
  FIFO (6 × $160)                                         960
  LIFO (6 × $150)                                                         900


Computations:
  Units sold = 24 (10 + 20 − 6)
  Units in ending inventory = 6
  Average cost per unit = $156.67 ($1,500 + $3,200) ÷ (10 + 20)

  Cost per unit:
    First purchase  = $150 ($1,500 ÷ 10 = $150)
    Second purchase = $160 ($3,200 ÷ 20 = $160)




                               Chapter 6   Inventory and Cost of Goods Sold   345
                                                  (10-15 min.)   S 6-4
                        Pinkie Copy Center
                        Income Statement
                  Year Ended December 31, 20XX
                                    Average     FIFO      LIFO
Sales revenue (600 × $20)            $12,000 $12,000 $12,000
Cost of goods sold (600 × $9.90*)       5,940
   (100 × $9) + (500 × $10)                     5,900
   (600 × $10)                                            6,000
Gross profit                            6,060   6,100     6,000
Operating expenses                      3,000   3,000     3,000
Net income                           $ 3,060 $ 3,100 $ 3,000
_____
*
  Average cost per unit:
     Beginning inventory (100 @ $9.20)……………..         $ 920
     Purchases (700 @ $10)……………………………                  7,000
     Goods available…………………….………………                   $7,920
       Average cost per unit $7,920 / 800 units……     $ 9.90




346   Financial Accounting 7/e Solutions Manual
                                                  (10-15 min.)         S 6-5
                       Pinkie Copy Center
                       Income Statement
                 Year Ended December 31, 20XX
                                  Average     FIFO                    LIFO
Sales revenue (600 × $20)          $12,000 $12,000                  $12,000
Cost of goods sold (600 × $9.90*)     5,940
  (100 × $9) + (500 × $10)                    5,900
  (600 × $10)                       ______  ______                    6,000
Gross profit                          6,060   6,100                   6,000
Operating expenses                    3,000   3,000                   3,000
Income before income tax           $ 3,060 $ 3,100                  $ 3,000
Income tax expense (40%)           $ 1,224 $ 1,240                  $ 1,200

*From S 6-4                                        Method to        Method to
                                                   maximize         minimize
                                                   reported         income tax
                                                   income           expense.
                                                   (before
                                                   tax).




                              Chapter 6   Inventory and Cost of Goods Sold   347
                                                     (5 min.)   S 6-6
Microdot managers can purchase lots of inventory before year
end. Under LIFO, these high inventory costs go directly to cost
of goods sold in the current year. As a result, the current year’s
net income drops and that saves on income tax. Saving on
taxes is one reason companies want to decrease their income.



Student responses may vary.




                                                  (5-10 min.)   S 6-7
BALANCE SHEET
  Current assets:
    Inventories, at market (which is lower than cost)……. $ 49,000

INCOME STATEMENT
  Cost of goods sold [$410,000 + ($60,000 − $49,000)]…… $421,000




348   Financial Accounting 7/e Solutions Manual
                                                       (5-10 min.)        S 6-8
                               Dollars in Millions
                               $35,137 − $15,762
Gross profit percentage    =                                   = 0.551
                                    $35,137

                                     $15,762
Inventory turnover         =                         = 8.7 times
                               ($1,693 + $1,926) / 2




                                                       (5-10 min.)        S 6-9
      Beginning inventory……………………………... $ 300,000
  +   Purchases……………………………………….…                      1,600,000
  =   Goods available…………………………………...                 1,900,000
  −   Cost of goods sold:
        Sales revenue………………………. $3,000,000
        Less estimated gross profit (40%) (1,200,000)
        Estimated cost of goods sold………………. (1,800,000)
  =   Estimated cost of ending inventory…………... $ 100,000




                                 Chapter 6   Inventory and Cost of Goods Sold   349
                                                      (5 min.)   S 6-10
                                                              Correct
                                                              Amount
                                                             (Millions)

a.     Net sales (unchanged)……………………………….                     $1,700
b.     Inventory ($360 − $10)………………………………..                   $ 350
c.     Cost of goods sold ($1,180 + $10)…………………               $1,190
d.     Gross profit ($1,700 − $1,190)………………………                $ 510




                                                      (5 min.)   S 6-11
1. Last year’s reported gross profit was understated.
      Correct gross profit last year was $5.6 million ($4.0 + $1.6).

2. This year’s gross profit is overstated.
      Correct gross profit for this year is $3.2 million ($4.8 − $1.6).




350    Financial Accounting 7/e Solutions Manual
                                                   (5-10 min.)        S 6-12
1. Unethical. The company falsified its ending inventory in
  order to cheat the government (and the people) out of taxes.

2. Ethical. There is nothing wrong with buying inventory
  whenever a company wishes.

3. Ethical. Same idea as 2.

4. Unethical. The company falsified its ending inventory and net
  income.

5. Unethical. The company falsified its purchases, cost of
  goods sold, and net income in order to cheat the government
  (and the people) out of income tax.




                                Chapter 6   Inventory and Cost of Goods Sold   351
Exercises

                                                        (15-20 min.)    E 6-13
Req. 1

                                     Perpetual System
                                                           Thousands
       1. Purchases:
          Inventory…………………….……….… 1,200
            Accounts Payable………………….                                   1,200

       2. Sales:
          Cash ($2,000 × .20)…….……………..                      400
          Accounts Receivable ($2,000 × .80).              1,600
            Sales Revenue…………….……….                                    2,000

             Cost of Goods Sold…………………..                    900
               Inventory………………….………....                                 900



Req. 2

                                                           Thousands
       BALANCE SHEET
         Current assets:
           Inventory……………………………….                            $ 670

       INCOME STATEMENT
         Sales revenue…………………………….                           $2,000
         Cost of goods sold………………………                            900
         Gross profit……………………………….                           $1,100




352   Financial Accounting 7/e Solutions Manual
                                                 (15-25 min.)         E 6-14

                           Journal
 DATE      ACCOUNT TITLES AND EXPLANATION               DEBIT         CREDIT


    1 Inventory ($1,870 + $900)……………..                  2,770
        Accounts Payable…………………...                                     2,770

    2 Accounts Receivable (13 @ $500)…..                6,500
        Sales Revenue……………………….                                        6,500

        Cost of Goods Sold…………………….                     2,160*
          Inventory………………………………                                        2,160

    3 Sales revenue…………………………... $6,500
      Cost of goods sold…………………….. 2,160
      Gross profit……………………………... $4,340

        Ending inventory
          ($800 + $1,870 + $900 − $2,160)…...                        $1,410**
_____
 *(5 @ $160) + (8 @ $170) = $2,160
**Or, (5 @ $180) + (3 @ $170) = $1,410




                                Chapter 6   Inventory and Cost of Goods Sold   353
                                                                      (10-15 min.)       E 6-15
1.
                                    Inventory
Begin. Bal.           ( 5 units @ $160) 800
Purchases
  Oct. 15             (11 units @ $170) 1,870 Cost of goods sold
       26             ( 5 units @ $180) 900     (13 units @ $?)                            ?
Ending bal.           ( 8 units @ $?)      ?


                      Cost of Goods Sold                            Ending Inventory

(a) Specific
    unit cost (2 @ $160) + (11 @ $170) = $2,190                (3 @ $160) + (5 @ $180) = $1,380

(b) Average
    cost                  13 × $170*                = $2,210          8 × $170*          = $1,360

_____
                                           ($800 + $1,870 + $900)
      *Average cost per unit      =                                        =      $170
                                                (5 + 11 + 5)

(c) FIFO (5 @ $160) + (8 @ $170)            =       $2,160     (5 @ $180) + (3 @ $170) = $1,410

(d) LIFO (5 @ $180) + (8 @ $170)            =       $2,260     (5 @ $160) + (3 @ $170) = $1,310




2. LIFO produces the highest cost of goods sold, $2,260.
      FIFO produces the lowest cost of goods sold, $2,160.
      The increase in inventory cost from $160 to $170 to $180 per
      unit causes the difference in cost of goods sold.




354     Financial Accounting 7/e Solutions Manual
                                                     (10 min.)       E 6-16
     Cost of goods sold:
       LIFO ($2,260) − FIFO ($2,160)…………………………                          $100
       × Income tax rate………………………………………..                                 .40
     LIFO advantage in tax savings…………………………..                          $ 40



                                                     (15 min.)       E 6-17
1.
         a. FIFO
              Cost of goods sold:
                (5 @ $90) + (6 @ $95)……………...                  $1,020
              Ending inventory:
                6 @ $95………………………………                            $ 570

         b. LIFO
              Cost of goods sold:
                11 @ $95……………………………..                          $1,045
              Ending inventory:
                (5 @ $90) + (1 @ $95)……………...                  $ 545

2.
                          MusicBiz.net
                       Income Statement
                   Month Ended June 30, 20X5

     Sales revenue (3 @ $150) + (8 @ $155)…………….                     $1,690
     Cost of goods sold…………………………………….                                1,020
     Gross profit……………………………………………..                                    670
     Operating expenses…………………………………...                                 320
     Income before income tax……………………………                                350
     Income tax expense (40%)……………………………                                140
     Net income………………………………………………                                    $ 210


                               Chapter 6   Inventory and Cost of Goods Sold   355
                                                   (15 min.)   E 6-18
                                                        Millions
1. Gross profit:                                      FIFO LIFO
   Sales revenue……………………………………                        $5.0    $5.0
   Cost of goods sold
     FIFO: 600,000 × $7……………………………                     4.2
     LIFO: (400,000 × $5) + (100,000 × $6)
            + (100,000 × $7)………………………                            3.3
   Gross profit………………………………………                        $0.8      $1.7


2. Gross profit under FIFO and LIFO differ because inventory
      costs decreased during the period.




356    Financial Accounting 7/e Solutions Manual
                                                 (15-20 min.)         E 6-19
DATE:      _____________

TO:        Jim Deitrick, President of Deitrick Guitar Company

FROM:      Student Name

SUBJECT: Proposal for Increasing Net Income

We can increase net income by not buying our normal
quantities of inventory as we make sales. Inventory costs are
rising, and the company uses the LIFO inventory method.
Under LIFO, the high cost of our inventory purchases goes
straight into cost of goods sold. By slowing our purchases of
inventory, we can keep those high costs out of cost of goods
sold this year. That will keep net income from going lower and
will help net income be as high as possible. Also, our inventory
quantities are above normal, so we don’t need to buy a lot of
inventory before year end.



Student responses will vary.




                                Chapter 6   Inventory and Cost of Goods Sold   357
                                                  (10-15 min.)   E 6-20
  LIFO           1. Generally associated with saving income taxes.

  FIFO           2. Results in a cost of ending inventory that is close
                    to the current cost of replacing the inventory.
Specific
unit cost        3. Used to account for automobiles, jewelry, and art
                    objects.

Average          4. Provides a middle-ground measure of ending
                    inventory and cost of goods sold.

  FIFO           5. Maximizes reported income.

  LIFO           6. Matches the most current cost of goods sold
                    against sales revenue.

  LIFO           7. Results in an old measure of the cost of ending
                    inventory.

  LCM             8. Writes inventory down when replacement cost
                     drops below historical cost.

  LIFO           9. Enables a company to buy high-cost inventory at
                    year end and thereby to decrease reported
                    income and income tax.

  LIFO         10. Enables a company to keep reported income
                   from dropping lower by liquidating older layers of
                   inventory.




358   Financial Accounting 7/e Solutions Manual
                                                 (5-10 min.)        E 6-21
                          Sloan, Inc.
                 Income Statement (partial)
               Year Ended December 31, 20X4
Sales revenue ………………………………………………                                   $125,000
Cost of goods sold [$78,000 + ($14,000 − $12,000)]…                  80,000
Gross profit…………………………………………………                                    $ 45,000


Note: Cost is used for beginning inventory because cost is
      lower than market. Market (replacement cost) is used for
      ending inventory because market is lower than cost at
      year end.




                              Chapter 6   Inventory and Cost of Goods Sold   359
                                                   (15-20 min.)   E 6-22
                    (Amounts in millions or billions)
           a.       $475     $29 + $470 − $24 = $475
           b.       $ 68     $543 − $475 = $68
           c.       Must first solve for d
           d.       $ 55     $74 − $19 = $55
           c.       $ 56     $7 + c − $8 = $55; c = $56
           e.       $ 35     $16 + $19 = $35
           f.       $ 2      f + $16 − $2 = $16; f = $2
           g.       $ 3      $2 + $24 − g = $23; g = $3
           h.       $ 8      $31 − $23 = $8




                      Krispy Kreme Doughnuts, Inc.
                            Income Statement
                       Year Ended January 31, 2006
                                                  (Millions)
          Net sales                                       $ 543
          Cost of goods sold
            Beginning inventory                $ 29
            Net purchases                        470
            Goods available                      499
            Ending inventory                     (24)
            Cost of goods sold                               475
          Gross profit                                        68
          Operating and other expenses                       204
          Net income (Net loss)                           $(136)




360   Financial Accounting 7/e Solutions Manual
                                                (20-30 min.)         E 6-23
                   Gross Profit
    Company        Percentage              Inventory Turnover

                   $68                   $475
Krispy Kreme             = 0.125                    = 17.9 times
                  $543              ($29 + $24) / 2

                   $19                    $55
Hewlett-Packard          = 0.257                            = 7.3 times
                   $74                ($7 + $8) / 2

                   $19                    $16
PepsiCo                  = 0.543                            = 8.0 times
                    35                ($2 + $2) / 2

                    $8                    $23
Best Buy                 = 0.258                            = 9.2 times
                   $31                ($2 + $3) / 2


PepsiCo has the highest gross profit percentage, 54.3%.

Krispy Kreme has the highest rate of inventory turnover, 17.9
times.

Based on these data, PepsiCo looks the most profitable
because PepsiCo’s gross profit percentage is 2 to 4 times the
other companies’ gross profit percentage. And PepsiCo’s
inventory turnover is about half as high as Krispy Kreme’s
turnover.




                               Chapter 6   Inventory and Cost of Goods Sold   361
                                                                 (15 min.)   E 6-24
Req. 1 and 2

                                                  1                        2
                                                FIFO                     LIFO
                                        $138,000 − $85,500        $138,000 − $92,800
Gross profit percentage =
                                             $138,000                  $138,000

                                                  = 0.380               = 0.328

                                              $85,500                   $92,800
Inventory turnover                 =
                                       ($18,000 + $20,000) / 2   ($14,000 + $18,000) / 2

                                              = 4.5 times             = 5.8 times




Req. 3

FIFO makes the company look better on the gross profit
percentage.




Req. 4

LIFO makes the company look better on the rate of inventory
turnover.




362   Financial Accounting 7/e Solutions Manual
                                                (10-15 min.)         E 6-25
Year ended January 31, 20X4:                                       Millions

Budgeted cost of goods sold ($1,175 × 1.08)………..                   $1,269

Budgeted ending inventory……………………………..                                  369

Budgeted goods available………….……………………                                1,638

Actual beginning inventory……………………………..                                (366)

Budgeted purchases……………………………………..                                 $1,272




                               Chapter 6   Inventory and Cost of Goods Sold    363
                                                  (10-15 min.)   E 6-26
      Beginning inventory………………………                   $ 48,000
      Net purchases………………………………                       106,000
      Goods available……….…………………...                   154,000
      Estimated cost of goods sold:
        Net sales revenue……………………… $200,000
        Less estimated gross profit of 40%… (80,000)
        Estimated cost of goods sold………...            120,000
      Estimated cost of inventory destroyed..        $ 34,000


Another reason managers use the gross profit method to
estimate ending inventory is to test the reasonableness of
ending inventory.




364   Financial Accounting 7/e Solutions Manual
                                               (10-15 min.)         E 6-27
                     Dijon Mustard, Inc.
                Income Statement (Corrected)
          Years Ended September 30, 20X5 and 20X4
                             20X5              20X4

Sales revenue                  $149,000           $122,000
Cost of goods sold:
  Beginning inventory $27,000           $12,000
  Net purchases        72,000            66,000
     Goods available   99,000            78,000
  Ending inventory    (16,000)          (27,000)*
  Cost of goods sold             83,000             51,000
Gross profit                     66,000             71,000
Operating expenses               20,000             20,000
Net income                     $ 46,000           $ 51,000


*$18,000 + $9,000 = $27,000


Dijon actually performed poorly in 20X5, compared to 20X4,
with net income down from $51,000 to $46,000.




                              Chapter 6   Inventory and Cost of Goods Sold   365
                                                  (5-10 min.)   E 6-28
a.     Buy inventory late in the year.
b.     Company is using LIFO.
c.     Use average cost.
d.     Use FIFO.
e.     Use FIFO.
f.     Use any method. They all produce the same results
       because costs are stable.




366   Financial Accounting 7/e Solutions Manual
                                                 (20-30 min.)         E 6-29
Req. 1

Actual cost of goods sold =

1.   From purchase in December (30 @ $1,300)……..                     $ 39,000
2.   From purchase in June (50 @ $1,200)…………….                         60,000
3.   From purchase in February (20 @ $1,100)……….                       22,000
4.   From beginning inventory (20 @ $1,000)………...                      20,000
       Actual cost of goods sold………………………..                          $141,000



Req. 2

Cost of goods sold with the additional year-end purchase
   (this would have avoided a LIFO liquidation—that is,
   kept year-end inventory at the same level it was at the
   beginning of the year)

 1. From purchase in December (50* @ $1,300)…….          $ 65,000
 2. From purchase in June (50 @ $1,200)…………….              60,000
 3. From purchase in February (20 @ $1,100)……….            22,000
      Cost of goods sold (with no LIFO liquidation).     $147,000
_____
*Must purchase a total of 50 units in December to keep ending
  inventory at 40 units, which was the level of beginning
  inventory.




                                Chapter 6   Inventory and Cost of Goods Sold   367
                                                                 (20-30 min.)       E 6-30
Sales increased, the gross profit dropped, and net income slid
into a net loss, as shown here:

Dollars in millions                  20X7                      20X6                     20X5

Sales                               $37.0                     $35.9                     $33.7
Cost of sales                        29.7                      28.1                      26.3
Gross profit                          7.3                       7.8                       7.4

Net income (net loss)                 (0.2)                       0.4                      0.5


Gross profit            $7.3                       $7.8                      $7.4
             =                      = 0.197                  = 0.217                   = 0.220
percentage             $37.0                      $35.9                     $33.7

Inventory               $29.7                      $28.1                     $26.3
               =                     = 3.7                      = 3.8                     = 3.9
turnover           ($8.4 + $7.8) / 2          ($7.8 + $7.0) / 2         ($7.0 + $6.4) / 2



Both the gross profit percentage and the rate of inventory
turnover dropped during this period. This suggests that Zmart
was having to discount its merchandise more and more just to
sell the goods. The end result was a net loss in 20X7.

Selling expenses increased significantly, which suggests that
Zmart was having to advertise heavily in order to sell its
inventory.




368   Financial Accounting 7/e Solutions Manual
Practice Quiz
Q6-31   b   ($3,500 + $6,000 − $5,500 = $4,000)
Q6-32   b   ($7,200 − $5,500 = $1,700)
Q6-33   d
Q6-34   d   (1,000 @ $10.60 + 500 @ $10 = $15,600)
Q6-35   d   (1,000 @ $10.60 + 500 @ $10 = $15,600)
Q6-36   a
Q6-37   c   ($144,000 + $216,000 = $360,000)
Q6-38   b
Q6-39   a
Q6-40   d   [$620,000 − ($60,000 + $400,000 − $40,000) =
            $200,000]
Q6-41   a   ($20,000 + X − $15,000 = $90,000; X = $85,000)
Q6-42   d
Q6-43   d   [$300,000 ÷ ($25,000 + $35,000) / 2] = 10 times
Q6-44   c   Net sales = $480,000 ($490,000 − $10,000)
            COGS       = $50,000 + ($205,000 + $20,000 −
                          $4,000 − $6,000) − $40,000
                       = $225,000
            GP%        = ($480,000 − $225,000) / $480,000
                       = .531
Q6-45   a   $50,000 + $75,000 − $90,000 (1 − .30) = $62,000
Q6-46   c
Q6-47   c




                               Chapter 6   Inventory and Cost of Goods Sold   369
Problems
Group A

                                                  (20-30 min.)   P 6-48A
Req. 1

 Inventory…………………………………….                          9,200,000
   Accounts Payable………………………                                      9,200,000

 Accounts Payable………………………….                       8,800,000
   Cash……………………………………….                                           8,800,000

 Cash………………………………………….                             5,000,000
 Accounts Receivable……………………...                    9,400,000
   Sales Revenue…………………………..                                     14,400,000

 Cost of Goods Sold (150,000 × $63.75*). 9,562,500
   Inventory………………………………….                              9,562,500
_____
*($1,000,000 + $9,200,000) ÷ (20,000 + 30,000 + 50,000 + 60,000)
  = $63.75


 Operating Expenses……………………….                      4,000,000
   Cash ($4,000,000 × .80)………………...                               3,200,000
   Accrued Liabilities ($4,000,000 × .20).                          800,000

 Income Tax Expense………………………                  335,000
    Income Tax Payable……………………                           335,000
 [($14,400,000 − $9,562,500 − $4,000,000) × .40 = $335,000]



370   Financial Accounting 7/e Solutions Manual
                                               (continued)         P 6-48A
Req. 2

                            Inventory
         Beg. bal.     1,000,000
         Purchases     9,200,000 COGS                     9,562,500
         End. bal.       637,500



Req. 3

                     Best Buy Store in Nashville
                         Income Statement
                   Year Ended February 28, 20X5
         Sales revenue ……………………………… $14,400,000
         Cost of goods sold………………………..           9,562,500
         Gross profit…………………………………               4,837,500
         Operating expenses………………………. 4,000,000
         Income before tax………………………….              837,500
         Income tax expense (40%)……………….           335,000
         Net income…………………………………. $ 502,500




                                Chapter 6   Inventory and Cost of Goods Sold   371
                                                           (20-30 min.)   P 6-49A
Req. 1

The store uses FIFO.

This is apparent from the flow of costs out of inventory. For
example, the August 11 sale shows unit cost of $40, which
came from the beginning inventory. This is how FIFO, and only
FIFO, works.



Req. 2

Cost of goods sold:
    16 × $40                          =       $ 640
    24 ×       40                     =          960
      9 ×      41                     =          369
    30 ×       41                     =        1,230
                                              $3,199


Sales 16 + 24 = 40 units × $70                         = $2,800
        9 + 30 = 39 units × $72 = 2,808                                   $5,608
Cost of goods sold……………………………………….                                         3,199
Gross profit………………………………………………..                                          $2,409


Req. 3

Cost of August 31 inventory (18 × $42) + (41 × $41).                      $2,437



372   Financial Accounting 7/e Solutions Manual
                                                     (20-30 min.)         P 6-50A
Req. 1

                               Inventory
Begin. bal.     ( 70 units @ $20) 1,400
Purchases:
  Mar. 4        (100 units @ $22)     2,200
       19       (160 units @ $24)     3,840 Cost of goods sold
       25       ( 40 units @ $25)     1,000   (320 units @ $?)                    ?
Ending bal.     ( 50 units @ $?)        ?


                     Cost of Goods Sold                    Ending Inventory

Average cost 320 × $22.8108* = $7,299              50 × $22.8108*          = $1,141
____
*Average cost            ($1,400 + $2,200 + $3,840 + $1,000)
                 =                                                       = $22.8108
  per unit                      (70 + 100 + 160 + 40)


FIFO     (70 @ $20) + (100 @ $22)
              + (150 @ $24)         = $ 7,200 (40 @ $25) + (10 @ $24) = $1,240



LIFO     (40 @ $25) + (160 @ $24)
       + (100 @ $22) + (20 @ $20) = $7,440 (50 @ $20)                          = $1,000




                                       Chapter 6   Inventory and Cost of Goods Sold   373
                                                  (continued)   P 6-50A
Req. 2

LIFO results in the highest cost of goods sold because (a) the
company’s prices are rising and (b) LIFO assigns to cost of
goods sold the cost of the latest inventory purchases. When
costs are rising, these latest inventory costs are the highest,
and that makes cost of goods sold the highest under LIFO.



Student responses may vary.



Req. 3

                        Army-Navy Surplus
                        Income Statement
                   Month Ended March 31, 20XX
      Sales revenue (320 × $45)………………………..                      $14,400
      Cost of goods sold………………………………..                            7,299
      Gross profit…………………………………………                                7,101
      Operating expenses………………………………                              4,000
      Income before income taxes…………………….                         3,101
      Income tax expense (40%)……………………….                          1,240
      Net income………………………………………….                               $ 1,861




374   Financial Accounting 7/e Solutions Manual
                                                                                       (30-40 min.)   P 6-51A
Req. 1 (partial income statements)

                                 Armstrong Aviation Supply
                                     Income Statement
                               Year Ended December 31, 20XX
                                   AVERAGE               FIFO                                     LIFO
Sales revenue                       $127,800           $127,800                                 $127,800
Cost of goods sold                    67,514             67,015                                   67,955
Gross profit                        $ 60,286           $ 60,785                                 $ 59,845


 Computations of cost of goods sold:

    Average cost           ($4,900 + $2,115 + $63,000 + $4,250)
                 =                                                                =   $7.5015
      per unit                   (700 + 300 + 8,400 + 500)

    COGS at average cost    = 9,000 × $7.5015                                                    =    $67,514

    FIFO COGS     = (700 @ $7.00) + (300 @ $7.05) + (8,000 @ $7.50)                              =    $67,015

    LIFO COGS     = (500 @ $8.50) + (8,400 @ $7.50) + (100 @ $7.05)                              =    $67,955




                                   Chapter 6   Inventory and Cost of Goods Sold                                 375
                                                  (continued)   P 6-51A
Req. 2

Use the LIFO method to minimize income tax because cost of
goods sold is highest (gross profit is lowest) under LIFO when
inventory costs are rising.




376   Financial Accounting 7/e Solutions Manual
                                             (15-30 min.)         P 6-52A
AMC should apply the lower-of-cost-or-market rule to account
for inventories. The current replacement cost of ending
inventory is less than AMC’s actual cost, so AMC must write
the inventory down to current replacement cost, with the
following journal entry:

         Cost of Goods Sold………………            80,000
           Inventory………………………...                                      80,000
         To write inventory down to market value.

AMC should report the following amounts in its financial
statements:

BALANCE SHEET
  Inventory at market (which is lower than
    cost of $190,000)………………………………...                           $110,000*

INCOME STATEMENT
  Cost of goods sold ($780,000 + $80,000)………                   $860,000
_____
*$190,000 − $80,000 = $110,000

   Accounting conservatism is the reason to account for
inventory at the lower of cost or market value. Conservatism
directs accountants to write inventory down if cost appears
unrealistically high. In this case the current replacement cost
(market value) of AMC’s ending inventory is less than cost.
Under the lower-of-cost-or-market rule, this requires a write-
down of the inventory value to current replacement cost.


Student responses may vary.



                               Chapter 6   Inventory and Cost of Goods Sold   377
                                                           (20-30 min.)   P 6-53A
Req. 1

                                              Krispy Kreme          Starbucks
                                                 Millions            Millions
 Gross profit percentage:
   Sales…………………….                                 $543                $7,787
   Cost of sales…………...                            475                 3,179
   Gross profit…………….                             $ 68                $4,608

 Gross profit                               $68                  $4,608
                                                = 12.5%                 = 59.2%
 percentage:                               $543                  $7,787

 Inventory turnover:
   Cost of goods sold                              $475                $3,179
                      =
   Average inventory                          ($24 + $29) / 2     ($636 + $546) / 2

                                                  = 17.9 times            = 5.4 times



Req. 2

From these statistics, it’s hard to tell whether Krispy Kreme or
Starbucks is more profitable. Starbucks has a much higher
gross profit percentage. And Krispy Kreme has a much faster
inventory turnover. To evaluate profitability, we should also
consider each company’s selling, general, and administrative
expenses.



378   Financial Accounting 7/e Solutions Manual
                                              (25-30 min.)         P 6-54A
Req. 1 (estimate of ending inventory by the gross profit
       method)

Beginning inventory……………………...                     $ 360,000
Purchases…………………………………. $2,780,000
  Less: Purchase discounts………….           (20,000)
         Purchase returns……………...         (40,000)
  Net purchases………………………….                          2,720,000
Goods available…………………………..                         3,080,000
Cost of goods sold:
  Sales revenue………………………….. $4,430,000
    Less: Sales returns…………………           (750,000)
  Net sales…………………………….….. 3,680,000
  Less: Estimated gross profit of 40%. (1,472,000)
  Estimated cost of goods sold……….                  2,208,000
Estimated cost of ending inventory…...             $ 872,000




                                Chapter 6   Inventory and Cost of Goods Sold   379
                                                  (continued)   P 6-54A
Req. 2 (income statement through gross profit)

                              Amazon.com
                    Income Statement (partial)
                       Month of July, 20XX
     Sales revenue……………………………….                         $4,430,000
        Less: Sales returns……………………...                    (750,000)
        Net sales revenue………………………..                     3,680,000
     Cost of goods sold…………………………                        2,208,000*
     Gross profit…………………………….……                         $1,472,000
_____
*Cost of goods sold:
   Beginning inventory…………………………...                     $ 360,000
   Purchases………………………. $2,780,000
   Less: Purchases discounts...       (20,000)
          Purchase returns……..        (40,000)
   Net purchases………………………………….                           2,720,000
   Cost of goods available for sale…………….                3,080,000
   Less: Ending inventory……………………….                       (872,000)
   Cost of goods sold…………………………….                       $2,208,000




380   Financial Accounting 7/e Solutions Manual
                                            (20-25 min.)         P 6-55A
Req. 1

      Cost of sales, budgeted ($700,000 × 1.08)…. $756,000
    + Ending inventory, budgeted…………………..           50,000
    = Cost of goods available……………………….. 806,000
    − Beginning inventory……………………………               (35,000)
    = Purchases, budgeted …………………………. $771,000



Req. 2

                   Pontiac Convenience Store
                   Budgeted Income Statement
                 Year Ended December 31, 20X3
    Sales ($900,000 × 1.08)……………………….…..                       $972,000
    Cost of sales ($700,000 × 1.08)………………….                     756,000
    Gross profit…………………………………………                                216,000
    Operating expenses ($80,000 − $24,000)……...                  56,000
    Net income…………………………………….……                                $160,000




                              Chapter 6   Inventory and Cost of Goods Sold   381
                                                                (15-20 min.)   P 6-56A
Req. 1 (corrected income statements)

                               Columbia Video Sales
                   Income Statement (adapted; amounts in millions)
                         Years Ended 20X6, 20X5, and 20X4
                                     20X6              20X5              20X4
 Net sales revenue……………...                $36               $33                 $30
 Cost of goods sold:
   Beginning inventory………..     $ 7               $ 6                $ 4
   Purchases……………………             26                24                 22
   Goods available……………..        33                30                 26
   Ending inventory……………          (7)              (7)                (6)
   Cost of goods sold…………                  26                23                  20
 Gross profit……………………..                    10                10                  10
 Operating expenses..………….                  8                  8                  8
 Net income………………………                      $ 2               $ 2                 $ 2




382   Financial Accounting 7/e Solutions Manual
                                               (continued)         P 6-56A
Req. 2

The corrections did not change total net income over the three-
year period. But the corrections drastically altered the trend of
net income — from an increasing pattern to a flat pattern.




Req. 3

The shareholders will not be happy with a flat trend of net
income because the company is making no progress with its
profits.




                                Chapter 6   Inventory and Cost of Goods Sold   383
Problems
Group B

                                                  (20-30 min.)   P 6-57B
Req. 1

 Inventory………………………………………. 8,940,000
   Accounts Payable…………………………        8,940,000

 Accounts Payable…………………………… 8,610,000
   Cash…………………………………………                8,610,000

 Cash……………………………………………. 4,700,000
 Accounts Receivable……………………….. 8,200,000
   Sales Revenue……………………………..             12,900,000

 Cost of Goods Sold………………………..... 8,940,000
   Inventory……………………………………                           8,940,000
 ($6,300,000 + $1,360,000 + $1,280,000 = $8,940,000)


 Operating Expenses………………………… 2,080,000
   Cash ($2,080,000 × 0.60)…………………           1,248,000
   Accrued Liabilities ($2,080,000 × 0.40)..   832,000

 Income Tax Expense………………………... 752,000
    Income Tax Payable………………………                          752,000
 [($12,900,000 − $8,940,000 − $2,080,000) × .40 = $752,000]




384   Financial Accounting 7/e Solutions Manual
                                               (continued)         P 6-57B
Req. 2

                            Inventory
         Beg. bal.     1,500,000
         Purchases     8,940,000 COGS                     8,940,000
         End. bal.     1,500,000



Req. 3

                        Italian Leather Goods
                          Income Statement
                   Year Ended December 31, 20X6
         Sales revenue …………………………… $12,900,000
         Cost of goods sold……………………..           8,940,000
         Gross profit………………………………               3,960,000
         Operating expenses……………………             2,080,000
         Income before tax………………………             1,880,000
         Income tax expense (40%)…………….           752,000
         Net income………………………………. $ 1,128,000




                                Chapter 6   Inventory and Cost of Goods Sold   385
                                                       (20-30 min.)   P 6-58B
Req. 1

The store uses FIFO.

This is apparent from the flow of costs out of inventory. For
example, the July 8 sale shows a unit cost of $19, which came
from the beginning inventory. This is how FIFO, and only FIFO,
works.



Req. 2

Cost of goods sold:
    37 × $19                          =       $ 703
    13 ×       19                     =          247
      4 ×      20                     =           80
    15 ×       20                     =          300
                                              $1,330


Sales    37 + 13 = 50 units × $36 = $1,800
          4 + 15 = 19 units × $37 =    703                        $2,503
Cost of goods sold…………………………………….                                 (1,330)
Gross profit……………………………………………...                                  $1,173



Req. 3

Cost of July 31 inventory (17 × $20)…………………                       $ 340


386   Financial Accounting 7/e Solutions Manual
                                                      (20-30 min.)         P 6-59B
Req. 1

                               Inventory
Begin. bal.     (100 units @ $76) 7,600
Purchases:
  Dec. 3        (200 units @ $81) 16,200
       12       ( 90 units @ $82) 7,380 Cost of goods sold
       24       (240 units @ $85) 20,400 (500 units @ $?)                          ?
Ending bal.     (130 units @ $?)     ?


                       Cost of Goods Sold                   Ending Inventory

Average cost 500 × $81.873*          $40,937        130 × $81.873*             $10,643
____
*Average cost              ($7,600 + $16,200 + $7,380 + $20,400
                   =                                                         = $81.873
  per unit                        (100 + 200 + 90 + 240)



FIFO     (100 @ $76) + (200 @ $81)
       + ( 90 @ $82) + (110 @ $85) = $40,530              130 @ $85          = $11,050


LIFO              (240 @ $85)
                + ( 90 @ $82)                            100 @ $76 +
                + (170 @ $81)          = $41,550          (30 @ $81) = $10,030




                                        Chapter 6   Inventory and Cost of Goods Sold   387
                                                  (continued)   P 6-59B
Req. 2

LIFO cost of goods sold is highest because (a) prices are rising
and (b) LIFO assigns to cost of goods sold the cost of the latest
inventory purchases. When costs are rising, these latest
inventory costs are the highest, and that makes cost of goods
sold the highest under LIFO.



Student responses may vary.



Req. 3

                            Spice, Inc.
                        Income Statement
                  Month Ended October 31, 20XX
      Sales revenue (500 @ $130)……………………..                      $65,000
      Cost of goods sold………………………………..                           41,550
      Gross profit…………………………………………                               23,450
      Operating expenses………………………………                             10,000
      Income before income taxes…………………….                        13,450
      Income tax expense (40%)……………………….                          5,380
      Net income………………………………………….                               $ 8,070




388   Financial Accounting 7/e Solutions Manual
                                                                                    (30-40 min.)   P 6-60B
Req. 1 (partial income statements

                                   Sonic Sound Systems
                                     Income Statement
                               Year Ended December 31, 20XX
                                  AVERAGE               FIFO                                   LIFO
Sales revenue                      $910,000           $910,000                               $910,000
Cost of goods sold                  618,429            610,500                                631,500
Gross profit                       $291,571           $299,500                               $278,500


 Computations of cost of goods sold:

    Average cost   ($121,500 + $201,000 + $140,000 + $259,000)
                 =                                             =                 $343.5714
      per case               (400 + 600 + 400 + 700)

    COGS at average cost   = 1,800 × $343.5714                                                 =    $618,429

    FIFO COGS     = (300 @ $300) + (100 @ $315) + (600 @ $335) + (400 @ $350)
                       + (400 @ $370)                                                          =   $610,500

    LIFO COGS     = (700 @ $370) + (400 @ $350) + (600 @ $335) + (100 @ $315)                  =    $631,500




                                  Chapter 6   Inventory and Cost of Goods Sold                            389
                                                  (continued)   P 6-60B
Req. 2

Use FIFO to report the highest net income because cost of
goods sold is lowest (gross profit is highest) under FIFO when
inventory costs are rising.




390   Financial Accounting 7/e Solutions Manual
                                                (15-20 min.)         P 6-61B
Westside Copiers should apply the lower-of-cost-or-market rule
to account for inventories. The current replacement cost of
ending inventory is less than Westside’s actual cost, so
Westside must write the inventory down to current replacement
cost, with the following journal entry:
           Cost of Goods Sold………… 2,100,000*
             Inventory…………………...                                    2,100,000
           To write inventory down to market value.
            *$8,900,000 − $6,800,000 = $2,100,000

Westside should report the following in its financial statements:

BALANCE SHEET
  Inventory, at market (which is lower than cost
    of $8,900,000)……………………………………... $ 6,800,000

INCOME STATEMENT
  Cost of goods sold ($36,400,000 + $2,100,000*).. $38,500,000

  Accounting conservatism is the reason to account for
inventory at the lower of cost or market value. Conservatism
directs accountants to write inventory down if cost appears
unrealistically high. In this case the current replacement cost
(market value) of Westside’s ending inventory is less than cost,
and the lower-of-cost-or-market rule requires a write-down of
the inventory value to current replacement cost.

Student responses may vary.

                                  Chapter 6   Inventory and Cost of Goods Sold   391
                                                           (20-25 min.)   P 6-62B
Req. 1

                                            Hewlett-Packard         Apple
                                                    Dollars in Billions
 Gross profit percentage:
   Sales……………………                                  $73.6              $19.3
   Cost of sales…………..                             55.2               13.7
   Gross profit……………                              $18.4              $ 5.6

 Gross profit                              $18.4                 $ 5.6
                                                 = 25.0%               = 29.0%
 percentage:                               $73.6                 $19.3

 Inventory turnover:
   Cost of goods sold                          $55.2                 $13.7
                                      =
   Average inventory                      ($7.8 + $6.9) / 2     ($0.3 + $0.2) / 2

                                                  = 7.5 times         = 54.8 times


Req. 2

These statistics suggest that Apple should be more profitable.
Apple has a higher gross profit percentage and also turns its
inventory over more rapidly. On both measures, Apple looks
better. Another factor that figures into which company should
be more profitable is selling, general, and administrative
expenses.




392   Financial Accounting 7/e Solutions Manual
                                              (25-30 min.)         P 6-63B
Req. 1 (estimate of ending inventory by the gross profit
       method)

Beginning inventory………………………                         $1,200,000
Purchases………………………………….. $6,500,000
  Less: Purchase discounts…………..          (100,000)
         Purchase returns………………            (10,000)
  Net purchases…………………………...                          6,390,000
Goods available……………………………                            7,590,000
Cost of goods sold:
  Sales revenue…………………………… $8,600,000
    Less: Sales returns………………….             (20,000)
  Net sales…………………………………. 8,580,000
  Less: Estimated gross profit of 40%.. (3,432,000)
  Estimated cost of goods sold………...                  5,148,000
Estimated cost of ending inventory……                 $2,442,000




                                Chapter 6   Inventory and Cost of Goods Sold   393
                                                  (continued)   P 6-63B
Req. 2 (income statement through gross profit)

                             Kinko’s
                    Income Statement (partial)
                   For the Period Up to the Fire
     Sales revenue…………………………..                   $8,600,000
        Less: Sales returns…………………                   (20,000)
        Net sales revenue…………………...                8,580,000
     Cost of goods sold…………………….                   5,148,000*
     Gross profit……………………………..                   $3,432,000
_____
*Cost of goods sold:
   Beginning inventory………………………... $1,200,000
   Purchases……………………... $6,500,000
   Less: Purchases discounts.       (100,000)
          Purchase returns…….        (10,000)
   Net purchases………………………………..                     6,390,000
   Goods available……………………………...                   7,590,000
   Less: Ending inventory…………………….                (2,442,000)
   Cost of goods sold…………………………. $5,148,000




394   Financial Accounting 7/e Solutions Manual
                                            (20-25 min.)         P 6-64B
Req. 1

      Cost of sales, budgeted ($720,000 × 1.10).. $792,000
    + Ending inventory, budgeted………………...           80,000
    = Cost of goods available……………………... 872,000
    − Beginning inventory…………………………. (70,000)
    = Purchases, budgeted ……………………….. $802,000



Req. 2

                         Pay Less Store
                  Budgeted Income Statement
                 Year Ended December 31, 20X6
     Sales ($960,000 × 1.10)……………………… $1,056,000
     Cost of sales ($720,000 × 1.10)…………….    792,000
     Gross profit…………………………………....            264,000
     Operating expenses ($110,000 − $6,000)…  104,000
     Net income…………………………………….. $ 160,000




                              Chapter 6   Inventory and Cost of Goods Sold   395
                                                                (15-20 min.)   P 6-65B
Req. 1 (corrected income statements)

                                     Oriental Rugs
                   Income Statement (adapted; amounts in thousands)
                           Years Ended 2007, 2006, and 2005
                                      2007               2006              2005
 Net sales revenue……………...                 $1,400             $1,200            $1,100
 Cost of goods sold:
   Beginning inventory……….. $ 450                  $ 200             $ 200
   Purchases……………………               800                700              600
   Goods available……………..        1,250                900              800
   Ending inventory……………          (500)              (450)            (200)
   Cost of goods sold…………                     750                450               600
 Gross profit……………………..                       650                750               500
 Operating expenses…………...                    500                430               450
 Net income………………………                       $ 150              $ 320             $ 50




396   Financial Accounting 7/e Solutions Manual
                                             (continued)        P 6-65B
Req. 2

The corrections did not change total net income over the
three-year period. But the corrections made the company’s
trend of net income look more variable — with net income
rising sharply in 2006 and then dropping in 2007.




                                Chapter 6   Inventory and Cost of Goods Sold 397
Decision Cases
                                                   (50-60 min.) Decision Case 1

Req 1

                                 Duracraft Corporation
                                  Income Statement
                                             FIFO                 LIFO
Sales revenue                            $1,200,000           $1,200,000
Cost of goods sold:                         585,000*             645,000**
Gross profit                                615,000              555,000
Operating expenses                          200,000              200,000
Income before income
   tax expense                               415,000             355,000
Income tax expense
      ($415,000 × .40)                       166,000
      ($355,000 × .40)                                          142,000
Net income                               $ 249,000            $ 213,000
_____
 *$100,000 + $485,000 = $585,000
**$160,000 + $485,000 = $645,000




398   Financial Accounting 7/e Solutions Manual
                                    (continued) Decision Case 1

Reqs. 2

                                FIFO               LIFO
      Net income…………          $249,000           $213,000


FIFO net income is higher because (1) prices are rising (from
$100 to $121.25 to $160), and (2) FIFO and LIFO assign costs to
expense (cost of goods sold) in opposite patterns.



Student responses may vary.




                                Chapter 6   Inventory and Cost of Goods Sold   399
                                                  (15-25 min.) Decision Case 2

Req. 1

This question provides a rich setting for a class discussion.
There’s no single correct answer to this question. Some
students may favor Company B because it reports higher net
income than Company A. B may be preferred because it
appears more successful than A, and B’s stock price may
therefore rise more than A’s stock price. Thus it may appear
that Company B would be a better investment than A.

Other students may prefer Company A because it discloses the
inventory method it uses. Company B does not let outsiders
know which method it uses to account for its inventory. These
students may trust Company A more than B because A is more
willing to “bare its soul to the public.”

Professors can point out that A, the LIFO company, may be
better off because of the lower income taxes that A pays by
using the LIFO method. We don’t know whether Company B is
making the most of this cash-flow advantage of LIFO.


Student responses will vary.



Req. 2

Yes, the authors would prefer managers to be conservative in
accounting for inventory — for all the reasons accountants use
conservatism. If any errors occur, we would prefer to be
pleasantly surprised rather than negatively shocked.



400   Financial Accounting 7/e Solutions Manual
Ethical Issue
Req. 1

Changing accounting methods           year after           year      hurts a
company’s credibility, which makes it hard for the company to
borrow or raise money from outside investors. The question
that arises about such a company is: What is the business
trying to hide?



Req. 2

The consistency principle is violated.


Req. 3

Creditors   and   outside   investors       could      be      harmed          by
accounting changes year after year. It becomes difficult to tell
which changes in the business are real and which changes
result from the shift in the accounting method. Outsiders find it
difficult to track the company’s operating results and financial
position over time. Ultimately the company suffers because
lenders will not want to lend it money, and outsiders will be
reluctant to invest money in the business. This may deprive the
entity of needed funds and hurt its chances for success or
survival.


                                Chapter 6   Inventory and Cost of Goods Sold   401
Focus on Financials: YUM! Brands
                                                                                 (30 min.)

Req. 1

                                                                      Millions
                                                           December 30, December 31,
                                                               2006              2005

Inventory (from the balance sheet)..                            $93              $85


Req. 2

Note 2: Summary of significant accounting policies states, “We
value our inventories at the lower of cost (computed on the
first-in, first-out method) or net realizable value.”


Req. 3

                                                                                   Millions
                                                      Rearranging,

      Beginning Inventory                             Food and paper expense
                                                       (2006 income statement)     $2,549
 + Purchases                                      +   Ending inventory
                                                       (at Dec. 30, 2006)                 93
 = Goods available                                =   Goods available                  2,642
 − Ending Inventory                               −   Beginning inventory
                                                       (at Dec. 31, 2005)             (85)
 = Cost of goods sold                             =   Purchases                    $2,557
    (food and paper expense)



402   Financial Accounting 7/e Solutions Manual
                (continued) Focus on Financials: YUM! Brands

Req. 4

The gross profit percentage improved during 2006:

                            2006                               2005
Company sales…………….. $8,365 100.0%                         $8,225 100.0%
Food and paper expense…. 2,549 30.5%                        2,584 31.4%
Gross profit…………………. $5,816 69.5%                          $5,641 68.6%



Req. 5

YUM’s rate of inventory turnover is fast.

       Cost of goods sold
    (Food and paper expense)       $2,549
                             =                 = 29 times
        Average inventory      ($93 + $85) / 2

Few companies turn their inventory over 29 times per year.




                                Chapter 6   Inventory and Cost of Goods Sold   403
Focus on Analysis: Pier 1 Imports
                                                         (30-40 min.)

Req. 1

a. Inventory on hand at year end, $369 million.
b. Cost of goods sold, $1,175 million.

                                                             Millions
c. Purchases               =    Ending inventory…………………      $ 369
                           +    Cost of goods sold……………….     1,175
                           −    Beginning inventory………….….      (366)
                           =    Purchases………………………….         $1,178



Req. 2

Purchases are most directly related to cash flow because Pier 1
must pay for the inventory it purchases.



Req. 3

                                                             Millions
      Accounts payable at the end of 2005 (this is
        the beginning balance for 2006)………………….               $ 108
+     Purchases during 2006 (Req. 1)…………………….                  1,178
−     Cash payments on account during 2006………….                   (X)
=     Accounts payable at the end of 2006………………               $ 106

      Cash payments (X) = $1,180 million



404   Financial Accounting 7/e Solutions Manual
                        (continued) Focus on Analysis: Pier 1 Imports

Req. 4

Note 1 (Summary of Significant Accounting Policies) states that
Pier 1 values inventories “at the lower of average cost or
market, cost being determined on a weighted average inventory
method.”



Req. 5

(Dollars in millions)          2006                           2005

Gross profit             $1,777 − $1,175              $1,825 − $1,122
                   =
percentage                   $1,777                       $1,825

                        = 33.9%                      = 38.5%


Inventory                     $1,175                       $1,122
                   =
turnover                 ($369 + $366) / 2            ($366 + $374) / 2

                        = 3.20 times                 = 3.03 times


Gross profit percent decreased dramatically during 2006.
Inventory      turnover      increased       a     little.   Overall,        Pier       1’s
combination of (a) gross profit percent and (b) rate of inventory
turnover deteriorated during 2006. These data may explain why
Pier 1 had a net loss in 2006.



                                       Chapter 6     Inventory and Cost of Goods Sold    405
Appendix A
                                                   (10 min.)   S 6A-1
Purchases…………………………………….                          100,000
  Accounts Payable………………………..                                  100,000

Accounts Receivable……………………….                     140,000
  Sales Revenue…………………………….                                    140,000

End-of-period entries:

Cost of Goods Sold…………………………                       20,000
  Inventory (beginning balance)…………                             20,000

Inventory (ending balance)………………..                 30,000
  Cost of Goods Sold……………………...                                 30,000

Cost of Goods Sold…………………………                      100,000
  Purchases………………………………….                                      100,000




406   Financial Accounting 7/e Solutions Manual
                                                    (10 min.)       S 6A-2
1.
           Inventory                 Cost of Goods Sold
         20,000      20,000            20,000       30,000
         30,000                       100,000
                                       90,000



2. Cost of goods sold:
     Beginning inventory……………………………                          $ 20,000
     Purchases………………………………………..                               100,000
     Goods available…………………………………                             120,000
     Ending inventory……………………………….                            (30,000)
     Cost of good sold………………………………                           $ 90,000



3.                   Parkland Technologies
                       Income Statement
                              20XX
     Sales revenue……………………………………… $140,000
     Cost of goods sold (from Req. 2)………………. 90,000
     Gross profit…………………………………….….. $ 50,000




                              Chapter 6   Inventory and Cost of Goods Sold   407
                                                               (10-15 min.)   E 6A-3
               Cost of goods available:

Oct.         1 Beginning inventory………….                    5 @ $160 = $ 800

          8    Purchase……………………….. 4 @                                 160            640
         15    Purchase……………………….. 11 @                                170          1,870
         26    Purchase……………………….. 5 @                                 180            900
         31    Goods available for sale……. 25                                      $4,210



                                  Ending inventory               Cost of goods sold

1.    Specific unit cost (4 @ $160) + (4 @ $170) = $1,320        $4,210 − $1,320   = $2,890

2.    Average cost        $4,210  25 = average
                                                    = $1,347     $4,210 − $1,347   = $2,863
                          unit cost of $168.40* × 8

3.    FIFO                (5 @ $180) + (3 @ $170) = $1,410       $4,210 − $1,410   = $2,800

4.    LIFO                8 @ $160                 = $1,280      $4,210 − $1,280   = $2,930
_____
*$4,210  25 units = $168.40 per unit




408   Financial Accounting 7/e Solutions Manual
                                                 (20-25 min.)         E 6A-4

                           Journal
 DATE        ACCOUNT TITLES AND EXPLANATION                 DEBIT       CREDIT


   1. Purchases ($640 + $1,870 + $900)……… 3,410
        Accounts Payable………………………                                        3,410

   2. Accounts Receivable (17 @ $300)……… 5,100
        Sales Revenue…………………………..                                        5,100

   3. Cost of Goods Sold……………………….                            800
        Inventory (beginning balance)……….                                  800

        Inventory [ending balance: (8 @ $160)].. 1,280
          Cost of Goods Sold…………………….                                    1,280

        Cost of Goods Sold………………………. 3,410
          Purchases………………………………..                                        3,410


                    Cost of Goods Sold
Beginning inventory           Ending inventory                          1,280
  (5 × $160)             800
Purchases              3,410
                       2,930


4. Cost of goods sold:
     Beginning inventory……………………….…… $ 800
     Purchases………………………………………... 3,410
     Goods available…………………….…………… 4,210
     Ending inventory………………………………... (1,280)
     Cost of goods sold……………………………... $2,930



                                Chapter 6   Inventory and Cost of Goods Sold   409
                                                        (20-30 min.)   P 6A-5
Req. 1 and 2

                                      Periodic System

Cost of goods sold:
Beginning inventory (50 × $40)……………                                $2,000
Purchases:                    80 × $41 =                  $3,280
                              18 × 42 =                      756       4,036
Goods available………………………………                                            6,036
Ending inventory (FIFO)
                              26 × $41 =                  $1,066
                              18 × 42 =                      756   (1,822)
Cost of goods sold…………………………..                                     $4,214


Sales           16 + 34 = 50 units × $70 =                $3,500
            9 + 35 + 10 = 54 units × $72 =                 3,888   $7,388
Cost of goods sold…………………………..                                      4,214
Gross profit……………………………………                                         $3,174




410   Financial Accounting 7/e Solutions Manual
                                             (15-20 min.)         P 6A-6
Req. 1 (journal entries)

                                                    (In thousands)
Purchases…………………………………………                             2,900
  Accounts Payable………………………….….                                2,900

Cash ($4,390 × .20)……………………………….                        878
Accounts Receivable ($4,390 × .80)…………..              3,512
  Sales Revenue…………………………………                                          4,390



End-of-period entries:

Cost of goods sold………………………………                           370
  Inventory
  (beginning balance)…………………………..                                          370

Inventory
(ending balance)………………………………….                           560
  Cost of Goods Sold…………………………...                                          560

Cost of Goods Sold……………………………...                      2,900
  Purchases………………………………….…...                                         2,900




                            Chapter 6   Inventory and Cost of Goods Sold    411
                                                  (continued)    P 6A-6
Req. 2 (financial statement amounts)

       BALANCE SHEET                                  (In thousands)
         Current assets:
           Inventory………………………………..                       $     560

       INCOME STATEMENT
         Sales revenue………………………….….                          $4,390
         Cost of goods sold……………………….                         2,710*
         Gross profit………………………………..                          $1,680

_____
*$370 + $2,900 − $560 = $2,710




412   Financial Accounting 7/e Solutions Manual

				
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