Lesson 7

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					                           Task Team of FUNDAMENTAL ACCOUNTING
                              School of Business, Sun Yat-sen University

                                        Lesson 7
                         Merchandise Inventories and Cost of Sales

Calculation and Analyzing Problems
1. The perpetual inventory records of LIBY HOUSEHOLD show 150 units of a particular
product on hand, acquired at the following dates and costs:

                  Purchase Date       Quantity       Unit Cost      Total Cost
                  May 1               50             $100           $ 5,000
                  May 4               100            115            11,500
                  Total on hand       150                           $16,500

On May 6, Pace sold 125 units of this product.
Prepare a journal entry to record the cost of goods sold relating to the sale on May 6, assuming
that LIBY uses:
       a    A LIFO flow assumption.
       b    A FIFO flow assumption.
       c    The average cost (or moving average) flow assumption.

2. Jesica Fashions had the following inventory transactions during the fiscal year ended
December 31, 2002:
                 Jan. 1      Beginning inventory  120 units @ $24/unit
                 Apr. 1      Purchase             150 units @ $29/unit
                 Apr. 5      Sales                100 units @ $48/unit
                 Jul. 7      Purchase             60 units @ $25/unit
                 Aug.12      Purchase             80 units @ $30/unit
                 Sept. 2     Sales                130 units @ $48/unit
Jesica uses a perpetual inventory system.

(1) Compute both cost of goods available for sale and the number of units available for sale.
(2) Compute the number of units remaining in ending inventory.
(3) Compute the cost assigned to ending inventory using (a) FIFO, (b) LIFO, (c) specific
identification (note: 100 units from beginning inventory, 100 units from the April 1, and 30
units from the August 12 purchase are sold), and (d) weighted average.
(4) Compute the gross profit earned by the company for each of the costing methods in part 3.
(5) If Jesica’s manager earns a bonus based on a percent of gross profit, which method of
inventory costing will the manager likely prefer?

3. A-Mart’s prior financial statements report the following related to clothing sales:
                                For Year Ended December 31
               Key Figures                      2000           2001         2002

                          Task Team of FUNDAMENTAL ACCOUNTING
                             School of Business, Sun Yat-sen University

              Cost of goods solds         $84,000      $117,000      $94,000
              Net income                   37,000        48,000       43,000
Now it was find that Inventory on December 31, 2000, is overstated by $6,000, and inventory
on December 31, 2001, is understated by $9,000.

(1) For each key financial statement figure prepare a schedule similar to the following to
show the adjustments necessary to correct the reported amounts.
           Figure:                        2000           2001         2002
           Reported amount
               12/31/2000 error
               12/31/2001 error
           Corrected amount

(2) What is the error in total net income for the combined three-year period resulting from the
inventory errors? Explain.
(3) Explain why the overstatement of inventory by $6,000 at the end of 2000 results in an
overstatement of equity by the same amount in that year.

4. A physical count of Sky Music Company’s inventories taken at December 31 reveals the
       Item                  Units on hand   Cost Per Unit      Market Per Unit
       CD’s                       400             $5                 $6
       Cassettes Tapes            200              4                  3
       DVD’s                      300             10                 12
       Video’s                    100              8                  6

Calculate the lower of cost or market for the inventory (a) as a whole, (b) and applied
separately to each item.

5. LuLu’s Shop was destroyed by a tidal wave Dec. 25, 2004. Fortunately her accountant was able
to piece together the following information concerning purchases and sales:
                                                         At Cost       At Retail
                   January 1 beginning inventory         $93,120       $148,680
                   Cost of goods purchased               218,880        331,320
                   Sales                                                457,200
                   Sales returns                                            9,000

(1) Use the retail inventory method to estimate the lost inventory.
(2) LuLu’s insurance company has offered to pay her $62,430 for her lost inventory. Should
she accept their offer?

                          Task Team of FUNDAMENTAL ACCOUNTING
                             School of Business, Sun Yat-sen University

6. Mac Inc. needs to prepare interim financial statements for the first quarter of 2001. Mac’s
gross profit rate averages 40%. The following information for the first quarter is available
from its records:
                      January 1 beginning inventory            $140,720
                      Cost of goods purchased                   694,080
                      Sales                                   1,164,800
                      Sales returns                               8,640

Use the gross profit method to estimate the company’s first quarter ending inventory.

7. HiTec Corp. had the following invnetory transactions during the year 2002. The company
incurred operating expenses of $3 per unit in selling the units.
               Jan 1       Beg. inventory       750 units @ $12 per unit
               Feb 15      Purchase             2,800 units @ $13 per unit
               Mar 10      Sale                 2,100 units @ $40 per unit
               Apr. 15     Purchase             400 units @ $14 per unit
               Jun 10      Sale                 2,200 units @ $41 per uni
               Oct. 15     Purchase             1,600 units @ $15 per unit
               Nov 15      Sale                 2,600 units @ $42 per uni
               Dec. 21     Purchase             2,300 units @ $16 per unit

(1) Prepare comparative income statements for the company for the three different inventory
costing methods of FIFO, LIFO, and weighted average. Include a detailed cost of goods sold
section as part of each statement. The company uses a perpetual inventory system, and its
income tax rate is 30%.
(2) What advantages and disadvantages are offered by using (a) LIFO and (b) FIFO? Assume
the continuing trend of increasing costs.


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