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EntireChapter76th
Chapter7
ReportingandInterpretingCostofGoodsSoldandInventory
ANSWERSTOQUESTIONS
1.Inventoryoftenisoneofthelargestamountslistedunderassetsonthebalancesheetwhichmeansthatitrepresentsasignificantamountoftheresourcesavailabletothebusiness.Theinventorymaybeexcessiveinamount,whichisaneedlesswasteofresources;alternativelyitmaybetoolow,whichmayresultinlostsales.Therefore,forinternalusersinventorycontrolisveryimportant.Ontheincomestatement,inventoryexertsadirectimpactontheamountofincome.Therefore,statementusersareinterestedparticularlyintheamountofthiseffectandthewayinwhichinventoryismeasured.Becauseofitsimpactonboththebalancesheetandtheincomestatement,itisofparticularinteresttoallstatementusers.
2.Fundamentally,inventoryshouldincludethoseitems,andonlythoseitems,legallyownedbythebusiness.Thatis,inventoryshouldincludeallgoodsthatthecompanyowns,regardlessoftheirparticularlocationatthetime.
3.Thecostprinciplegovernsthemeasurementoftheendinginventoryamount.Theendinginventoryisdeterminedinunitsandthecostofeachunitisappliedtothatnumber.Underthecostprinciple,theunitcostisthesumofallcostsincurredinobtainingoneunitoftheinventoryiteminitspresentstate.
4.Goodsavailableforsaleisthesumofthebeginninginventoryandtheamountofgoodspurchasedduringtheperiod.Costofgoodssoldistheamountofgoodsavailableforsalelesstheendinginventory.
5.Beginninginventoryisthestockofgoodsonhand（ininventory）atthestartoftheaccountingperiod.Endinginventoryisthestockofgoodsonhand（ininventory）attheendoftheaccountingperiod.Theendinginventoryofoneperiodautomaticallybecomesthebeginninginventoryofthenextperiod.
6.（a）Averagecost–Thisinventorycostingmethodinaperiodicinventorysystemisbasedonaweighted-averagecostfortheentireperiod.Attheendoftheaccountingperiodtheaveragecostiscomputedbydividingthegoodsavailableforsaleinunitsintothecostofgoodsavailableforsaleindollars.Thecomputedunitcostthenisusedtodeterminethecostofgoodssoldfortheperiodbymultiplyingtheunitssoldbythisaverageunitcost.Similarly,theendinginventoryfortheperiodisdeterminedbymultiplyingthisaverageunitcostbythenumberofunitsonhand.
（b）FIFO–Thisinventorycostingmethodviewsthefirstunitspurchasedasthefirstunitssold.Underthismethodcostofgoodssoldiscostedattheoldestunitcosts,andtheendinginventoryiscostedatthenewestunitcosts.
（c）LIFO–Thisinventorycostingmethodassumesthatthelastunitspurchasedarethefirstunitssold.Underthismethodcostofgoodssoldiscostedatthelatestunitcostsandtheendinginventoryiscostedattheoldestunitcosts.
（d）Specificidentification–Thisinventorycostingmethodrequiresthateachiteminthebeginninginventoryandeachitempurchasedduringtheperiodbeidentifiedspecificallysothatitsunitcostcanbedeterminedbyidentifyingthespecificitemsold.Thismethodusuallyrequiresthateachitembemarked,oftenwithacodethatindicatesitscost.Whenitissold,thatunitcostisthecostofgoodssoldamount.Itoftenischaracterizedasapick-and-choosemethod.Whentheendinginventoryistaken,thespecificitemsonhand,valuedatthecostindicatedoneachofthem,istheendinginventoryamount.
7.Thespecificidentificationmethodofinventorycostingissubjecttomanipulation.Manipulationispossiblebecauseonecan,atthetimeofeachsale,select（pickandchoose）fromtheshelftheitemthathasthehighestorthelowest（orsomeother）unitcostwithnoparticularrationaleforthechoice.Therationalemaybethatitisdesiredtoinfluence,byarbitrarychoice,boththeamountofincomeandtheamountofendinginventorytobereportedonthefinancialstatements.Toillustrate,assumeitemAisstockedandthreeareontheshelf.Onecost$100;thesecondonecost$115;andthethirdcost$125.Nowassumethatoneunitissoldfor$200.Ifitisassumedarbitrarilythatthefirstunitissold,thegrossprofitwillbe$100;ifthesecondunitisselected,thegrossprofitwillbe$85;oralternatively,ifthethirdunitisselected,thegrossprofitwillbe$75.Thus,theamountofgrossprofit（andincome）willvarysignificantlydependinguponwhichoneofthethreeisselectedarbitrarilyfromtheshelfforthisparticularsale.Thisassumesthatallthreeitemsareidenticalineveryrespectexceptfortheirunitcosts.Ofcourse,theselectionofadifferentunitcost,inthiscase,alsowillinfluencetheendinginventoryforthetworemainingitems.
8.LIFOandFIFOhaveoppositeeffectsontheinventoryamountreportedunderassetsonthebalancesheet.Theendinginventoryisbaseduponeithertheoldestunitcostorthenewestunitcost,dependinguponwhichmethodisused.UnderFIFO,theendinginventoryiscostedatthelatestunitcosts,andunderLIFO,theendinginventoryiscostedattheoldestunitcosts.Therefore,whenpricesarerising,theendinginventoryreportedonthebalancesheetwillbehigherunderFIFOthanunderLIFO.Conversely,whenpricesarefallingtheendinginventoryonthebalancesheetwillbehigherunderLIFOthanunderFIFO.
9.LIFOversusFIFOwillaffecttheincomestatementintwoways:
（1）theamountofcostofgoodssoldand
（2）income.Whenthepricesarerising,FIFOwillgivealowercostofgoodssoldamountandhenceahigherincomeamountthanwillLIFO.Incontrast,whenpricesarefalling,FIFOwillgiveahighercostofgoodssoldamountand,asaresult,alowerincomeamount.
10.Whenpricesarerising,LIFOcausesalowertaxableincomethandoesFIFO.Therefore,whenpricesarerising,incometaxislessunderLIFOthanFIFO.Alowertaxbillsavescash（reducescashoutflowforincometax）.ThetotalamountofcashsavedisthedifferencebetweenLIFOandFIFOinventoryamountsmultipliedbytheincometaxrate.
11.LCMisappliedwhenmarket（definedascurrentreplacementcost）islowerthanthecostofunitsonhand.Theendinginventoryisvaluedatmarket（lower）,which（a）reducesnetincomeand（b）reducestheinventoryamountreportedonthebalancesheet.TheeffectofapplyingLCMistoincludetheholdinglossontheincomestatement（asapartofCGS）intheperiodinwhichthereplacementcostdropsbelowcostratherthanintheperiodofactualsale.
12.Whenaperpetualinventorysystemisused,theunitcostmustbeknownforeachitemsoldatthedateofeachsalebecauseatthattimetwothingshappen:
（a）theunitssoldandtheircostsareremovedfromtheperpetualinventoryrecordandthenewinventorybalanceisdetermined;（b）thecostofgoodssoldisdeterminedfromtheperpetualinventoryrecordandanentryintheaccountsismadeasadebittoCostofgoodssoldandacredittoInventory.Incontrast,whenaperiodicinventorysystemisusedtheunitcostneednotbeknownatthedateofeachsale.Infact,theperiodicsystemisdesignedsothatcostofgoodssoldforeachsaleisnotknownatthetimeofsale.Attheendoftheperiod,undertheperiodicinventorysystem,costofgoodssoldisdeterminedbyaddingthebeginninginventorytothetotalgoodspurchasedfortheperiodandsubtractingfromthattotaltheendinginventoryamount.Theendinginventoryamountisdeterminedbymeansofaphysicalinventorycountofthegoodsremainingonhandandwiththeunitsvaluedonaunitcostbasisinaccordancewiththecostprinciple（byapplyinganappropriateinventorycostingmethod）.
ANSWERSTOMULTIPLECHOICE
1.a）
2.d）
3.a）
4.b）
5.c）
6.c）
7.a）
8.c）
9.c）
10.a）
Authors'RecommendedSolutionTime
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AlternateProblems
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*Duetothenatureofthesecasesandprojects,itisverydifficulttoestimatetheamountoftimestudentswillneedtocompletetheassignment.Aswithanyopen-endedproject,itispossibleforstudentstodevotealargeamountoftimetotheseassignments.Whilestudentsoftenbenefitfromtheextraeffort,wefindthatsomebecomefrustratedbytheperceiveddifficultyofthetask.Youcanreducestudentfrustrationandanxietybymakingyourexpectationsclear.Forexample,whenourgoalistosharpenresearchskills,wedevoteclasstimetodiscussingresearchstrategies.Whenwewantthestudentstofocusonarealaccountingissue,weoffersuggestionsaboutpossiblecompaniesorindustries.
MINI-EXERCISES
M7–1.
TypeofBusiness
TypeofInventoryMerchandisingManufacturing
MerchandiseX
FinishedgoodsX
WorkinprocessX
RawmaterialsX
M7–2.
Torecordthepurchaseof90newshirtsinaccordancewiththecostprinciple（perpetualinventorysystem）:
Inventory（+A）2,500
Cash（A）2,500
Cost:
$2,180+$175+$145=$2,500.
The$120interestexpenseisnotapropercostofthemerchandise;itisrecordeda
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