FFA_3e_Solutions_ch07.doc

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Department
Administrative Studies
Course
ADMS 2510
Professor
John Parkinson
Semester
Fall

Description
CHAPTER 7 Inventory EXERCISES E7-1. The inventory on the December 31, 2014 balance sheet is overstated by $100,000 and on the income statement cost of goods sold will be understated by $100,000 and net income will be overstated by $100,000. With a periodic system cost of goods sold is determined using the equation: Cost of goods sold = Beginning inventory + Purchases – Ending inventory If as a result of the count ending inventory is overstated then cost of goods sold must be understated. E7-3. The company had an opening balance of 300 units, and purchased an additional 800 units for a total of 1100 units. Chetwynd sold 500 units, leaving 600 units in ending inventory. Note that the number of units sold and the number in inventory at the end of the period isn’t affected by the cost formula used. FIFO Number of Number units in Price paid of units Amount ending Ending per unit expensed expensed inventory inventory 1-Jun-15 $8.00 300 $2,400 - $0 12-Jun-15 $9.00 200 $1,800 150 $1,350 22-Jun-15 $10.00 0 $0 450 $4,500 Total 500 $4,200 600 $5,850 Average Cost Number of units Price paid purchased per unit Total 1-Jun-15 300 $8.00 $2,400 12-Jun-15 350 $9.00 $3,150 22-Jun-15 450 $10.00 $4,500 Total 1,100 $10,050 Average Price=$10,050/1,100 units =$9.136 per unit Number of Number of units Price paid units Amount in ending Ending per unit expensed expensed inventory inventory Copyright © 2010 McGraw-Hill Ryerson Ltd. 1 $9.136 500 $4,568 600 $5.481.60 The sum of the amount expensed and ending inventory is off by $0.40 due to rounding the average price per unit. E7-5. The company had an opening balance of 5,500 units, and purchased an additional 14,800 units for a total of 20,300 units. Olds Ltd. sold 13,800 units, leaving 6,500 units in ending inventory. Note that the number of units sold and the number in inventory at the end of the period isn’t affected by the cost formula used. FIFO Price paid Number of Number of units Ending per unit units expensed COGS in ending inventory Inventory 31-Dec-13 $5.50 5,500 $30,250 0 $0 5-Jan-14 6.00 4,400 26,400 0 15-Jan-14 6.50 3,900 25,350 1,500 9,750 22-Jan-14 6.75 - 0 5,000 33,750 31-Jan-14 Balance 13,800 $82,000 6,500 $43,500 Average Cost Number of units Price paid purchased per unit Total 31-Dec-13 5,500 $5.50 $30,250 5-Jan-14 4,400 6.00 26,400 15-Jan-14 5,400 6.50 35,100 22-Jan-14 5,000 6.75 33,750 $125,50 Total 20,300 0 Average Price=$125,500/ 20,300 units $6.182 per unit Number of Number of Price paid Units Units Ending Balance per unit Expensed COGS on Hand Inventory 31-Jan-15 $6.182 13,800 $85,312 6,500 $40,183 The sum of the amount expensed and ending inventory is off by $5.00 due to rounding the average price per unit. E7-7. a. Paper cups are inventory because they are part of the final product sold to the customer. They are supplies inventory. Copyright © 2010 McGraw-Hill Ryerson Ltd. 2 b. China cups and plates are capital assets. These items aren’t used up in production and will be used multiple times. c. Mops and brooms are used on an ongoing basis to keep the restaurant clean. They are cleaning equipment, not inventory. d. Plastic wrap to package baked goods is supplies inventory because the packaging is part of the product that is sold to the customer. e. Coffee beans are inventory. If the beans are sold to customers for home use they are finished goods because they are ready for sale. Beans used to brew coffee for sale to customers are raw materials since they used to make the final product. f. Cooking implements are equipment, not inventory because they are used repeatedly in the production of inventory but will never be part of the finished product. g. Flour, sugar, eggs, and chocolate are used in the baking process and are raw materials inventory because they are the inputs used to make the final product that is sold to customers. h. Unused cleaning supplies would are supplies inventory. Restaurants aren’t in the business of selling cleaning supplies but they are required to maintain a clean establishment thus they are used up in operating the business. E7-9. a. A jewellery store could use specific identification for its high-value, unique items (lower cost items would still use FIFO or average cost). For the high-value items better control over the inventory justifies the added accounting cost. b. An aircraft manufacturer would use specific identification aircraft are high cost items built in small numbers, often to specification to customers. For planes built to specification keeping track of costs that are attributable to the specific plane is important. c. It wouldn’t be practical for a bookstore to use specific identification due to the large quantities of relatively low cost, identical items. However, a bookstore would track the quantities of each title in stock. d. A computer store may or may not use specific identification. If the store sold numerous computers that were all very similar or was a large supplier of computers it might not make economic sense to specifically identify each product. However, if the computers were custom made for each customer then specific identification might be appropriate. e. It wouldn’t be practical for a fruit store to use specific identification due to the large quantities of relatively low cost, identical items that turnover rapidly. E7-11. The effects on gross margin and ending inventory using specific identification if a certain vase were sold are as follows. Vase A Vase B Vase C Vase D Sales $32,00 $32,00 $32,00 $32,00 Copyright © 2010 McGraw-Hill Ryerson Ltd. 3 0 0 0 0 COGS 14,200 8,950 17,150 12,250 $17,80 $23,05 $14,85 $19,75 Gross Margin 0 0 0 0 Remaining Inventory $14,20 $14,20 $14,20 Vase A $ 0 0 0 Vase B 8,950 8,950 8,950 Vase C 17,150 17,150 17,150 Vase D 12,250 12,250 12,250 $38,35 $43,60 $35,40 $40,30 Total 0 0 0 0 a. If Baddeck wanted to minimize profit on the sale, it would sell the vase that cost the most, vase C. The higher expense will result in lower net income. The impact on gross margin and ending inventory of vase C and a comparison with the other vases are shown in the above chart. (GM = $14,850 and Ending Inventory = $35,400) b. If Baddeck wanted to maximize profit on the sale, it would sell the vase that cost the least, vase B. The lower expense will result in higher net income. The impact on gross margin and ending inventory of vase B and a comparison with the other vases are shown in the above chart. (GM = $23,050 and Ending Inventory = $43,600) c. By expensing the most expensive vase as in part a, Baddeck will have a lower amount recorded in its inventory account. The opposite is true if Baddeck expenses the least expensive vase. The circumstances where Baddeck management would want to maximize profit are possible for the following: increase their bonus, avoid violation in terms of contract compliance, try to influence stock prices (if it were a public company), to get a loan, inflate selling price of the company, or to present themselves as good managers. The circumstances where Baddeck management would want to minimize profit are possible for the following: it’s an owner management situation and the manager wants to delay paying income taxes. Yes, in reality Baddeck’s management would have the opportunity to manage the financial statements in this way. Specific identification is the best cost formula to use to achieve one’s objective. By selling a specific vase (possibly the other three vase are in the back storage and this is the only vase on display), management has control over which inventory item is sold. Using the other cost formulas management is required to use either the first vase purchased or an average of the cost of all the vases. E7-13. a. Copyright © 2010 McGraw-Hill Ryerson Ltd. 4 The inventory should be written down if NRV is less than cost. In this case NRV is less than cost by $550,000 ($2,750,000-$2,200,000) so a write down of $550,000 is necessary. b. Dr. Cost of sales 550,000 Cr. Inventory 550,000 c. The inventory should be presented on the balance sheet at its NRV of $2,200,000. E7-15. Inventory Average turnover Average number of days Cost of sales inventory ratio inventory on hand a $558,950 $125,250 4.46 81.84 4,585,15 b 10,500,000 3 2.29 159.40 c 2,750,000 250,000 11.00 33.18 9,850,00 d 52,500,500 0 5.33 68.50 Inventory turnover ratio = cost of sales/average inventory Cost of sales = inventory turnover ratio  average inventory Average inventory = cost of sales/inventory turnover ratio Average Number of days on hand = 365/inventory turnover ratio Inventory turnover ratio = 365/average number of days on hand E7-17. Dec 31 2013 Dec 31 2014 Dec 31 2015 Dec 31 2016 Beginning inventory $370,000 $345,000 $425,000 $400,000 Purchases 875,000 945,000 1,200,000 1,300,000 Ending inventory 345,000 425,000 400,000 480,000 Cost of sales 900,000 865,000 1,225,000 1,220,000 Ending inventory from current year is equal to the beginning inventory in the next year. E7-19. Current Quick Gross Inventory Profit Debt-to- Copyright © 2010 McGraw-Hill Ryerson Ltd. 5 ratio ratio margin Turnover margin equity percentage Ratio percentage ratio a.* Decrease No effect Decrease Increase Decrease Increase b. Increase Increase ** Increase ** Decrease c.* Decrease No effect Decrease Increase Decrease Increase d.* Increase No effect Increase Decrease Increase Decrease e. No effect Decrease No effect Decrease No effect No effect *The analysis assumes the write down and lost inventory are credited to cost of goods sold and the write up of inventory is debited to goods sold. **For the gross margin and profit margin percentages it isn’t possible to determine the effect of the sale of inventory because the percentages before the transaction aren’t known. E7-21. Number Cost of goods Number Selling of units Price paid Available of units price Sales purchased per unit for sale sold per unit Opening inventory 175 $760 $133,000 1-Oct-14 360 720 $259,200 2-Jan-15 270 688 $185,760 1-Apr-15 210 648 $136,080 2-Jul-15 425 620 $263,500 October-December, 2014 405 $1,368 $554,040 January-March, 2015 290 1,296 375,840 April-June, 2015 215 1,240 266,600 July-September, 2015 395 1,112 439,240 Total 1,440 $977,540 1,305 $1,635,720 FIFO Number of Price paid Number of Cost of units Ending per unit units sold goods sold on hand inventory Opening Inventory $760 175 $133,000 0 $0 1-Oct-14 720 360 259,200 0 2-Jan-15 688 270 185,760 0 1-Apr-15 648 210 136,080 0 2-Jul-15 620 290 179,800 135 83,700 30-Sep-15 Balance 1,305 $893,840 135 $83,700 Copyright © 2010 McGraw-Hill Ryerson Ltd. 6 Average Cost Number Cost of goods of units Price paid Available purchased per unit for sale Open Inventory 175 $760 $133,000 1-Oct-14 360 720 259,200 2-Jan-15 270 688 185,760 1-Apr-15 210 648 136,080 2-Jul-15 425 620 263,500 Total 1,440 $977,540 Average Price=$977,540/1,440 units $678.847 Price paid Number of Cost of Number of Ending Balance per unit units sold goods sold units on hand inventory 30-Sep-15 678.847 1,305 $885,896 135 $91,644 Periodic System FIFO Average 30-Sep-15 Sales $1,635,720 $1,635,720 COGS 893,840 885,896 Gross Margin $741,880 $749,824 Ending Inventory $83,700 $91,644 Copyright © 2010 McGraw-Hill Ryerson Ltd. 7 b. To maximize income, you would choose average cost. It has the lowest expense (COGS), which will result in the highest net income. c. To minimize taxes, you would choose FIFO because under FIFO cost of sales is largest thus lowest net income. d. When prices are falling, the relative effects of the two methods are reversed from what is seen when prices are rising. Under FIFO ending inventory lower and cost of goods sold is higher compared with average cost. When prices are rising, ending inventory is higher and cost of goods sold is lower under FIFO than average cost. e. Net realizable value for inventory is 135 units  ($1,112 – $300) = $109,620. Ending Inventory FIFO Average Cost $83,700 $91,644 Market (NRV – selling costs) 109,620 109,620 Lower of cost and market 83,700 91,644 In both cases cost is lower than market so cost is used to value ending inventory and no write down is necessary. E7-23. a & b. Number Selling of units Price paid Number of price Sales purchased per unit units sold per unit Beginning inventory 10,000 $8.25 Purchases during 2014 95,000 8.80 $1,620,00 Sold during 2014 90,000 $18.00 0 $1,620,00 Total 105,000 90,000 0 FIFO Number of Price paid Number of Cost of units on Ending per unit units sold goods sold hand inventory Beginning inventory $8.25 10,000 $82,500 $0 Purchases during 2014 8.80 80,000 704,000 15,000 132,000 31-Dec-14 Balance 90,000 $786,500 15,000 $132,000 Copyright © 2010 McGraw-Hill Ryerson Ltd. 8 Replacement Cost Replacemen Number of t Number of Cost of units on Ending cost units sold goods sold hand inventory Inventory Sold during 2014 $9.00 90,000 $810,000 $0 Ending inventory 9.25 0 15,000 138,750 31-Dec-14 Balance 90,000 $810,000 15,000 $138,750 Kapuskasing Inc. Income Statement For the Year Ended December 31, 2014 FIFO Replacemen t Sales $1,620,000 $1,620,000 COGS 786,500 810,000 Gross Margin 833,500 810,000 Other Expenses 125,000 125,000 Net Income $708,500 $685,000 Ending Inventory $132,000 $138,750 For part b. Dr. Inventory (A+) ($138,750 - $132,000) 6,750 Cr. Holding gain (OE or other comprehensive income +) 6,750 To record the increase in the replacement cost of inventory c. i) FIFO–Amount of Inventory recorded on balance sheet is $132,000 ii) Replacement cost–Amount of inventory recorded on balance sheet is $138,750. This amount represents the replacement cost of the inventory on the date it was sold. d. FIFO and replacement cost are two different methods of valuing inventory. FIFO is acceptable according to GAAP and IFRS, whereas replacement cost isn’t. A stakeholder not aware of the different methods may perceive a company that used FIFO as a better performing company although both companies actually performed the same. The replacement cost method charges the income statement with the cost of replacing the inventory sold, which is more useful for assessing how managers are managing the inventory and for making better prediction of cash flows. The replacement cost is a better indication of the cash that will have to be expended to replace inventory than the cost of the inventory sold. Replacement cost would be more relevant to some stakeholders because it shows the market replacement value of the inventory. FIFO is more reliable because the inventory was actually purchased at the recorded amount and can be verified. Copyright © 2010 McGraw-Hill Ryerson Ltd. 9 Copyright © 2010 McGraw-Hill Ryerson Ltd. 10 PROBLEMS P7-1. In this question students must provide a reasoned explanation for the method selected. The purpose isn’t to calculate all possible ending inventory and cost of goods sold values. The basis of the choice must be the objectives of financial reporting. Assumptions are necessary regarding Mr. Avery’s objectives. For example, for a small business tax minimization might be the most important objective, in which case average cost would be the preferred choice. If Mr. Avery needs financing from the bank he may prefer reporting high income and higher inventory (perhaps the banker will be impressed with the higher net income or perhaps the loan will be based on the amount of inventory), in this case, he would want to use FIFO. It would also be appropriate discuss whether a periodic or perpetual inventory system should be used. Since students should select one or the other, a reason for the choice should be provided. Students shouldn’t do well in the question if there is no discussion of objectives. Calculations are shown below for information purposes. While the discussion of perpetual versus periodic is appropriate students should only be expected to calculate ending inventory and COGS using the periodic method. Number Cost of goods Number Selling of units Price paid Available of units price purchased per unit for sale sold per unit Open 150 $4.00 $600.00 Nov. 10 100 4.50 450.00 Nov. 20 175 4.70 822.50 Nov. 25 180 4.95 891.00 Nov. 12 200 11.00 Nov. 22 340 11.00 Total 605 $2,764.50 540 FIFO Price paid Number of Cost of Number of Ending per unit units sold goods sold units on hand inventory Open $4.00 150 $600.00 $0 Nov. 10 4.50 100 450.00 0 Nov. 20 4.70 175 822.50 0 Nov. 25 4.95 115 569.25 65 321.75 Nov. 30 Balance 540 $2,441.75 65 $321.75 Copyright © 2010 McGraw-Hill Ryerson Ltd. 11 Average Cost Number Cost of goods of units Price paid Available purchased per unit for sale Open 150 $4.00 $600.00 Nov. 10 100 4.50 450.00 Nov. 20 175 4.70 822.50 Nov. 25 180 4.95 891.00 Total 605 $2,763.50 Average Price=$2,76.50/605 units $4.568 Price paid Number of Cost of Number of Ending Balance per unit units sold goods sold units on hand inventory Nov. 30 $4.568 540 $2,466.72 65 $296.92 FIFO Average Sales $5,940.00 $5,940 Cost of goods sold 2,441.75 2,466.72 Gross Margin 3,498.25 3,473.28 Ending Inventory 321.75 296.92 Note that exact answers may vary due to rounding. P7-3. Weybridge (FIFO) Kennetcook (average) Current Assets (CA) $250,295 $202,958 Quick Assets (QA) 58,320 58,320 Current liabilities (CL) 166,000 166,000 Current ratio = CA/CL 1.51 1.22 Quick ratio = QA/CL 0.35 0.35 Beginning inventory $164,000 $127,084 Ending inventory 184,625 137,288 Average inventory (AI) (beg+end)/2 174,313 132,186 Sales 831,000 831,000 Cost of sales (COS) 586,951 634,288 Gross margin (GM) 244,049 196,712 Net Income (NI) 74,649 27,312 Inventory turnover ratio = COS/AI 3.37 4.80 Average Number days = 365/ITR 108.4 76.1 Gross margin percentage = GM/Sales 29.4% 23.7% Copyright © 2010 McGraw-Hill Ryerson Ltd. 12 Profit margin percentage =- NI/Sales 8.98% 3.29% b. The current ratio indicates that Weybridge
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