Finance Chapter 5 Learning Tree Inc The Moving Average Method Used What The Amount Assigned

Chapter 5: Inventories and Cost of Goods Sold

223. Presented below is a partially completed income statement of Lake, Inc. for 2016.

Net Sales

$ A

Cost of Sales:

Beginning Inventory

B

Net Purchases

138,193

Available for Sale

149,315

Less: Ending Inventory

C

Cost of Sales

136,225

Gross Profit

72,978

Selling, General and Administrative Expenses

D

Operating Income

$ 9,083

Using the partially completed income statement for Lake, Inc., determine each of the following for 2016.

A) Net Sales

B) Beginning Inventory

C) Ending Inventory

D) Selling, General and Administrative Expenses

ANSWER:

A) $209,203 ($136,225 + $72,978)

B) $11,122 ($149,315 – $138,193)

C) $13,090 ($149,315 – $136,225)

D) $63,895 ($72,978 – $9,083)

DIFFICULTY:

Easy

LEARNING OBJECTIVES:

FACC.PONO.13.05-02 – LO: 05-02

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Analyzing

224. The cost of goods sold for Johnnie, Inc. totaled $1,305,000. Sales returns and purchase returns were $3,000 and

$4,000, respectively. Purchases totaled $1,300,000. Discounts taken by Johnnie totaled $7,000, while discounts taken by

customers totaled $5,000. Beginning inventory was $90,000. Determine the amount of ending inventory to be reported on

Johnnie, Inc.’s balance sheet.

ANSWER:

$74,000

$90,000 (Beginning Inventory) + $1,300,000 (Purchases) – $4,000 (Purchase returns)

– $7,000 (Discounts) – $1,305,000 (Cost of goods sold) = $74,000

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Analyzing

225. Gently Used Cars is a dealer that uses the periodic inventory system. The data presented below is from the

accounting records of Gently for the year ended December 31, 2016.

Sales

$585,000

Sales Discounts

3,000

Purchases

420,000

Purchase Returns

5,000

Inventory (January 1)

33,000

Inventory (December 31)

37,000

Operating Expenses

146,000

Transportation-in

10,000

Retained Earnings (January 1)

71,000

Using the amounts provided above, calculate the cost of goods sold for 2016.

ANSWER:

$421,000

$33,000 (Inventory at January 1) + $420,000 (Purchases) + $10,000 (Transportation-in) –

$5,000 (Purchase Returns) – $37,000 (Inventory at December 31) = $421,000

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Analyzing

Grappa, Inc.

Grappa, Inc. reported the following information for 2017 and 2016:

2017

2016

Sales

$951,200

$890,000

Sales discounts

12,000

23,000

Purchases

580,000

600,000

Inventory, December 31

46,000

40,000

Transportation-in

18,000

19,000

Purchase discounts

4,000

5,000

226. Refer to the information for Grappa, Inc.

How much is the cost of purchases for 2017?

ANSWER:

$580,000 (Purchases) + $18,000 (Transportation-in) – $4,000 (Purchase discounts) =

$594,000

DIFFICULTY:

Easy

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Analyzing

227. Refer to the information for Grappa, Inc.

What amount is cost of goods available for sale for 2017?

ANSWER:

$580,000 (Purchases) + $18,000 (Transportation-in) – $4,000 (Purchase discounts) +

$40,000 (Inventory Dec. 31, 2016) = $634,000

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Analyzing

228. Refer to the information for Grappa, Inc.

How much is cost of goods sold for 2017?

ANSWER:

$580,000 (Purchases) + $18,000 (Transportation-in) – $4,000 (Purchase discounts) +

$40,000 (Inventory, December 31, 2016) – $46,000 (Inventory, December 31, 2017) =

$588,000

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Analyzing

229. Refer to the information for Grappa, Inc.

How much is net sales for 2017? What other components that Grappa did not report could be included in this

computation?

ANSWER:

$951,200 (Sales) – $12,000 (Sales discounts) = $939,200

Sales returns and allowances

DIFFICULTY:

Easy

LEARNING OBJECTIVES:

FACC.PONO.13.05-02 – LO: 05-02

KEYWORDS:

Bloom’s: Analyzing

230. Refer to the information for Grappa, Inc.

How much of every dollar is gross profit for 2017?

ANSWER:

($939,200 – $588,000)/$939,200 = 37.4%, or about 37 1/2 cents per dollar

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-04 – LO: 05-04

KEYWORDS:

Bloom’s: Analyzing

Cooking Corner

Cooking Corner reported inventory on its balance sheet at December 31, 2015 at $32,000. During 2016, Cooking Corner

purchased goods totaling $634,000 on account with terms of 2/10, n/30, FOB shipping point. Total charges paid by

Cooking Corner directly to the freight company were $1,000. At the end of 2016, inventory on hand totaled to $45,000.

Net sales for 2016 totaled $1,300,000. Cooking Corner employs a periodic inventory system.

231. Refer to the information about Cooking Corner.

How much would Cooking Corner pay its supplier if Cooking Corner paid for one-half of the goods acquired within the

discount period, and the other half after the expiration of the discount period?

ANSWER:

Payment within discount period: ($634,000 × 1/2) × 98% = $310,660

Payment after discount period: ($634,000 × 1/2) = $317,000

Total paid = $310,660 + $317,000 = $627,660

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Analyzing

232. Refer to the information about Cooking Corner.

How much is cost of goods available for sale for 2016 assuming Cooking Corner takes advantage of one-half of the cash

discounts?

ANSWER:

$32,000 (Beginning Inventory) + $627,660 (Purchases) + $1,000 (Transportation-in) =

$660,660

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Analyzing

233. Refer to the information about Cooking Corner.

How much is Cooking Corner’s cost of goods sold assuming that Cooking Corner takes advantage of one-half of the cash

discount?

ANSWER:

$32,000 (Beginning Inventory) + $627,660 (Purchases) + $1,000 (Transportation-in) –

$45,000 (Ending Inventory) = $615,660

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Analyzing

Digital Forces

Selected data from the financial statements for Digital Forces is presented below.

Net Sales—2017

$200,000

Cost of Sales—2017

136,000

Selling, General & Administrative Expenses—2017

63,000

Other Operating Expenses—2017

600

Income Taxes—2017

3,000

Inventories—Dec. 31, 2016

11,000

Inventories—Dec. 31, 2017

13,000

Retained Earnings—Dec. 31, 2017

39,000

234. Refer to the financial statement information for Digital Forces.

Determine the dollar amount of cost of goods purchased for Digital Forces for 2017.

ANSWER:

$136,000 (Cost of Sales – 2018) + $13,000 (Inventories – Dec. 31, 2017) –

$11,000 (Inventories – Dec. 31, 2016) = $138,000

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Analyzing

235. Refer to the financial statement information for Digital Forces.

What portion of every dollar is available to cover operating costs and to contribute to profits for 2017?

ANSWER:

($200,000 – $136,000)/$200,000 = 32%, or 32 cents out of every dollar of sales

DIFFICULTY:

Easy

LEARNING OBJECTIVES:

FACC.PONO.13.05-04 – LO: 05-04

KEYWORDS:

Bloom’s: Analyzing

236. The following data is available for one of the products sold by Wild Optics Company, which uses the periodic

inventory system:

Dec. 1

On hand, 10 units at $8.00 each

$ 80

5

Purchased 30 units at $7.80 each

234

18

Purchased 40 units at $8.15 each

326

24

Purchased 20 units at $8.25 each

165

Available for sale during December—100 units

$805

At the end of December, Wild Optics had 25 units on hand. The 75 units sold created revenue of $13 each. Determine the

amounts for the December 31 ending inventory, the cost of goods sold for December, and the gross margin for December

for each of the inventory costing methods listed below.

Ending Inventory

Cost of Goods Sold

Gross Profit

a. Weighted average

b. FIFO

c. LIFO

ANSWER:

Ending Inventory

Cost of Goods Sold

Gross Profit

a. Weighted

average

($805/100) × 25

= $201.25

($805/100) × 75

= $603.75

(75 × $13) – $603.75 =

$371.25

b. FIFO

(20 × $8.25) +

(5 × $8.15)

= $205.75

(10 × $8.00) +

(30 × $7.80) +

(35 × $8.15) =

$599.25

(75 × $13 ) – $599.25 =

$375.75

c. LIFO

(10 × $8.00) +

(15 × $7.80)

= $197.00

(20 × $8.25) +

(40 × $8.15) +

(15 × $7.80) = $608.00

(75 × $13 ) – $608.00 =

$367.00

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-06 – LO: 05-06

KEYWORDS:

Bloom’s: Analyzing

237. School Time Corp. completed a physical inventory at the end of 2016. A review of the physical inventory procedures

and records uncovered several errors that are described below. In the columns provided, indicate the effect, if any, on the

four financial statement items listed. Use the following codes for your answers:

O Overstatement

U Understatement

NE No Effect

Balance Sheet

Income Statement

Ending

Inventory

Retained

Earnings

Cost of

Goods Sold

Net Income

a.

One batch of goods was

counted twice.

b.

One page of items was

misplaced when the inventory

was calculated.

c.

Goods sold FOB shipping

point were included in School

Time’s inventory.

d.

Goods in transit from a

supplier, FOB shipping point,

were not included in

inventory.

ANSWER:

Balance Sheet

Income Statement

Ending

Inventory

Retained

Earnings

Cost of

Goods Sold

Net

Income

a.

One batch of goods

was counted twice.

O

U

O

b.

One page of items was

misplaced when the

inventory was

calculated.

U

O

U

c.

Goods sold FOB

shipping points were

included in School

Time’s inventory.

O

U

O

d.

Goods in transit from a

supplier, FOB shipping

point, were not

included in inventory.

U

O

U

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-08 – LO: 05-08

KEYWORDS:

Bloom’s: Analyzing

238. The cost of Garmin Corp.’s inventory at the end of the year was $85,000; however, due to obsolescence, the cost to

replace the inventory was only $65,000. Prepare the journal entry needed at the end of the year.

ANSWER:

Dec. 31

Loss on Decline in Value of Inventory

20,000

Inventory

20,000

To record decline in value of inventory.

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net

Income

Inventory

20,000

(20,000)

Loss on

Decline in

Value of

Inventory

20,000

(20,000)

DIFFICULTY:

Easy

LEARNING OBJECTIVES:

FACC.PONO.13.05-09 – LO: 05-09

KEYWORDS:

Bloom’s: Analyzing

239. Carrington, Inc. began the year with $130,000 in merchandise inventory and ended the year with $190,000. Sales and

cost of goods sold for the year were $900,000 and $640,000, respectively. (Use a 360 day year in your calculations.)

Required:

1. Compute Carrington’s inventory turnover ratio.

2. Compute the number of days’ sales in inventory.

ANSWER:

1. Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory = $640,000 /

($130,000 + $90,000) / 2 = $640,000 /$160,000 = 4 times

2. Number of Days’ Sales in Inventory = Number of Days in the Period / Inventory Turnover

Ratio = 360 / 4 = 90 days

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-10 – LO: 05-10

KEYWORDS:

Bloom’s: Analyzing

Learning Tree, Inc.

The following data is available for one of the products sold by Learning Tree, Inc., which uses the perpetual inventory

system:

May 1

On hand, 1,000 units at $2.00 each

$2,000

5

Purchased 2,000 units at $2.75 each

5,500

10

Sold 2,500 units at $16 each

18

Purchased 2,000 units at $4.00 each

8,000

24

Sold 1,500 units at $12 each

31

On hand, 1,000 units

240. Refer to the data for Learning Tree, Inc.

If the moving average method is used, what is the amount assigned to cost of goods sold for the 2,500 units sold on May

10?

ANSWER:

$6,250

($2,000 + $5,500)/3,000 × 2,500 = $6,250

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-12 – LO: 05-12

KEYWORDS:

Bloom’s: Analyzing

241. Refer to the data for Learning Tree, Inc.

If the moving average method is used, what is the amount assigned to the ending inventory on May 30?

ANSWER:

$3,700

Ending inventory on May 10: ($7,500/3,000) × (3,000 – 2,500) = $1,250

or 500 units @ $2.50 each

Ending inventory on May 30:[ [(500 × $2.50) + (2,000 × $4.00)]/2,500] × 1,000 = $3,700

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-12 – LO: 05-12

KEYWORDS:

Bloom’s: Analyzing

242. Refer to the data for Learning Tree, Inc.

If the LIFO method is used, what is the amount assigned to cost of goods sold for the 2,500 units sold on May 10?

ANSWER:

$6,500

(2,000 × $2.75) + (500 × $2.00) = $6,500

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-12 – LO: 05-12

KEYWORDS:

Bloom’s: Analyzing

243. Refer to the data for Learning Tree, Inc.

If the LIFO method is used, what is the amount assigned to the ending inventory on May 30?

ANSWER:

$3,000

(500 × $2.00) + (500 × $4.00) = $3,000

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-12 – LO: 05-12

KEYWORDS:

Bloom’s: Analyzing

244. Refer to the data for Learning Tree, Inc.

Explain why the amounts for ending inventory are different under the two average cost methods—weighted average

(periodic) and moving average (perpetual).

ANSWER:

The amounts for ending inventory and cost of goods sold are different because a new

(moving) average cost must be calculated after each purchase and assigned to cost of goods

sold for sales prior to the next purchase under the perpetual system. Under the periodic

system, a single (weighted) average cost is calculated for the entire period and assigned to all

units regardless of when they were sold.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-12 – LO: 05-12

KEYWORDS:

Bloom’s: Applying

245. Refer to the data for Learning Tree, Inc.

Explain why the amounts are different for LIFO under periodic and perpetual inventory systems.

ANSWER:

The amounts for ending inventory and cost of goods sold are different because under the

perpetual system, costs must be assigned to cost of goods sold as units are sold during the

period using the LIFO flow assumption. Thus, some of the units on hand early in the period

are assigned to cost of goods sold when the perpetual system is used. Under the periodic

system, costs are assigned to units only at the end of the period. Thus, it is assumed that the

earliest units are still on hand under the periodic system.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-12 – LO: 05-12

KEYWORDS:

Bloom’s: Applying

Share, Inc.

The following data is available for one of the products sold by Share, Inc., which uses a perpetual inventory system.

May 1

On hand, 10 units at $2 each

8

Sold 6 units at $10 each

14

Purchased 30 units at $3 each

23

Sold 24 units at $10 each

246. Refer to the data for Share, Inc.

If the moving average method is used, how much is cost of goods sold for May?

ANSWER:

May 8

Sale (6 units × $2)

$12.00

May 23

[Sale (4 units × $2) + (30 units × $3)]/34 × 24

69.12

Total

$81.12

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-12 – LO: 05-12

KEYWORDS:

Bloom’s: Analyzing

247. Refer to the data for Share, Inc.

If the moving average method is used, how much is ending inventory on May 30?

ANSWER:

$28.80

($98/34 ×10) = $28.80 (possible difference due to rounding)

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-12 – LO: 05-12

KEYWORDS:

Bloom’s: Analyzing

248. Refer to the data for Share, Inc.

Required:

1. If the FIFO method is used, how much is ending inventory on May 30?

2. How does this differ from the amount calculated using a periodic system and FIFO?

ANSWER:

1. 10 × $3.00 = $30

2. There is no difference. The FIFO amounts are the same under both a periodic and a

perpetual assumption.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-12 – LO: 05-12

KEYWORDS:

Bloom’s: Analyzing

249. Refer to the data for Share, Inc.

If the LIFO method is used, how much is cost of goods sold for May?

ANSWER:

$84.00

(6 × $2.00) + (24 × $3.00) = $84.00

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-12 – LO: 05-12

KEYWORDS:

Bloom’s: Analyzing

Essay

250. Describe how the inventories of manufacturers differ from the inventories of retailers.

ANSWER:

Manufacturers have to produce the products they sell whereas retailers purchase products

which are ready to sell (i.e., the retailers purchase finished goods from manufacturers).

Inventories of manufacturers, therefore, will consist of raw materials, work in process, and

finished goods.

DIFFICULTY:

Easy

LEARNING OBJECTIVES:

FACC.PONO.13.05-01 – LO: 05-01

KEYWORDS:

Bloom’s: Applying

251. Several transactions of sales and purchase activities for Genoa Department Store are described below.

A)

Genoa purchases shoes from Nike on credit.

B)

Genoa returns defective shoes to Nike before payment is made to Nike for the shoes

purchased in transaction A.

C)

Genoa pays for the shoes purchased from Nike.

D)

Genoa sells shoes to its customers for cash and on credit.

E)

Credit customers return shoes to Genoa for a refund.

F)

Credit customers pay their account balances to Genoa.

Required: For each transaction described above, describe the economic effects of the transaction on the company under a

periodic inventory system.

ANSWER:

A) Liabilities increase and stockholders’ equity decreases (through an increase in expenses)

B) Liabilities decrease and equity increases (through a decrease in expenses)

C) Assets and liabilities decrease.

D) Assets increase and stockholders’ equity (revenue) increases.

E) Assets decrease and stockholders’ equity decreases.

F) Assets increase and decrease by the same amount

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Applying

252. Flores Department Store currently uses the periodic inventory system.

Required: Explain what the advantages would be to Flores if it uses the perpetual inventory system. Assume that Flores

can use a computer system which is linked to its cash registers and that all products have bar codes that can be read by bar

code readers attached to the cash registers.

ANSWER:

If Flores uses the perpetual system, it will have better control of its inventory. Losses due to

theft, shrinkage, etc. can be identified at the end of the accounting period when a physical

inventory count is taken. Also, information will be available on inventory balances and cost

of goods sold for interim financial statements; these items must be estimated under a periodic

system. The perpetual system would also allow Flores to determine which items sell well and

to keep sufficient quantities on hand to meet customer demands. When the perpetual

inventory system is linked to the computer, the cost of maintaining a perpetual inventory can

be decreased and the efficiency of the system can be improved. Flores will have information

that is more current and will obtain that information more quickly with the computer system.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Applying

253. Giant-Mart purchased a big shipment of shoes from Right Balance, Inc. on credit near the end of its accounting

period. Right Balance shipped the shoes in January and Giant-Mart received the shoes in February. Assume that Giant-

Mart’s accounting period ends on January 31, while Right Balance’s accounting period ends on May 31.

Required: If the shoes are shipped FOB destination, who will pay the freight costs? If the shoes are shipped FOB

shipping point, who will pay the freight costs?

ANSWER:

If the shoes are shipped FOB destination by Right Balance, Right Balance should pay the

freight charges. If the shoes are shipped FOB shipping point, Giant-Mart should pay the

freight charges.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Applying

254. Giant-Mart purchased a large shipment of shoes from Primus, Inc. on credit near the end of its accounting period.

Primus shipped the shoes in January and Giant-Mart received the shoes in February. Assume that Giant-Mart’s accounting

period ends on January 31, while Primus’ accounting period ends on May 31. Answer each independent question in the set

that follows.

Required: If the shoes are shipped FOB destination, when should Giant-Mart record the purchase? If the shoes are

shipped FOB shipping point, when should Giant-Mart record the purchase?

ANSWER:

If the shoes are shipped FOB destination, Giant-Mart should not record the purchase until the

shoes are received in February; title passes when the shoes are received. If the shoes are

shipped FOB shipping point, Giant-Mart should record the purchase when the shoes are

shipped in January; title passes when the shoes are shipped.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Applying

255. Giant-Mart purchased a large shipment of shoes from Primus, Inc. on credit near the end of its accounting period.

Primus shipped the shoes in January and Giant-Mart received the shoes in February. Assume that Giant-Mart’s accounting

period ends on January 31, while Giant’s accounting period ends on May 31. Answer each independent question in the set

that follows.

Required: Under what shipping terms would Giant-Mart include the shoes as part of inventory on its January 31 balance

sheet?

ANSWER:

Giant-Mart will include the shoes in its January 31 balance sheet only if title to the shoes has

been passed from Primus to Giant-Mart. This occurs if the shoes are shipped FOB shipping

point.

DIFFICULTY:

Easy

LEARNING OBJECTIVES:

FACC.PONO.13.05-03 – LO: 05-03

KEYWORDS:

Bloom’s: Applying

during fiscal 2017, Focal Point Industries changed its inventory valuation method for

results from operations and allows its inventory valuation method to be in agreement with its

inventories held outside the U.S.

DIFFICULTY:

Moderate

KEYWORDS:

Bloom’s: Applying

256. Explain the relationship between the valuation of inventory and income measurement as it relates to the balance sheet

and the income statement.

ANSWER:

Cost or other values must be assigned to merchandise that makes up a company’s inventory.

As the merchandise is sold, these costs are assigned to cost of goods sold (expense). Since

expenses are deducted from revenues to determine the net income or net loss for the period,

inventory valuation affects the amount of income or loss measured.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-05 – LO: 05-05

KEYWORDS:

Bloom’s: Applying

257. In the following information from the 2017 annual reports of Focal Point Industries all figures have been rounded to

millions of dollars.

Balance Sheet Data

May 31, 2017

May 31, 2016

Raw materials

$ 25.8

$ 52.1

Work in process

44.8

34.7

Finished goods

1,132.7

1,303.8

Inventories at FIFO

1,203.3

1,390.6

Adjustment to LIFO

5.6

21.9

Cash Flow Data (Operating Activities)

Net income

$451.4

$399.9

Additions to net income:

Depreciation

198.2

100.2

Amortization

30.6

49.0

Changes in assets and liabilities:

Inventories

197.3

(58.0)

Accounts payable and other

(170.4)

(70.1)

Required:

(1) Describe what costs are included in each of the three types of inventories listed above for Focal Point Industries.

(2) Even though the footnote describing the inventory costing method(s) used by Focal Point Industries is not provided

above, what can you conclude about the inventory costing method(s) used by the company?

ANSWER:

(1) “Raw materials” consists of materials and supplies which have not yet been placed into

process to produce the company’s products. “Work in process” includes materials and

supplies, direct labor, and manufacturing overhead costs for products started but not

completed during the period. “Finished goods” includes raw materials and supplies, direct

labor, and manufacturing overhead used to produce products that were completed but not

sold during the period.

(2) Control Industries must be using the LIFO inventory method for at least some, if not all,

of its inventories because the company has disclosed the amount of the adjustment that

converts its inventories at FIFO to LIFO. There is a significant difference in the “adjustment

goods sold; this means that inventories increased in 2017 from 2016.

Moderate

FACC.PONO.13.05-11 – LO: 05-11

Bloom’s: Applying

258. In the following information from the 2017 annual reports of Focal Point Industries all figures have been rounded to

millions of dollars.

Balance Sheet Data

May 31, 2017

May 31, 2016

Raw materials

$ 25.8

$ 52.1

Work in process

44.8

34.7

Finished goods

1,132.7

1,303.8

Inventories at FIFO

1,203.3

1,390.6

Adjustment to LIFO

5.6

21.9

Cash Flow Data (Operating Activities)

Net income

$451.4

$399.9

Additions to net income:

Depreciation

198.2

100.2

Amortization

30.6

49.0

Changes in assets and liabilities:

Inventories

187.3

(58.0)

Accounts payable and other

(170.4)

(70.1)

Required:

(1) Explain what the amount “adjustment to LIFO” represents. What effects has this “adjustment” had on Focal Point

Industries’ net earnings in 2016 and 2017?

(2) What method of determining cash flows from operating activities has Focal Point Industries used in preparing its

statement of cash flows? Explain your answer.

(3) From 2016 to 2017, what change in the inventory balance (increase or decrease) occurred in each year as a result of

operating activities? What was the effect on the company’s cash flow each year as a result of the inventory change?

ANSWER:

(1) The “adjustment to LIFO” of inventories is the amount by which current replacement cost

of inventories exceeds the actual cost assigned to inventory under the LIFO method. Through

the use of the LIFO method, Focal Point Industries has been able to assign recent, higher

costs to the cost of products sold and retain older, lower costs in its asset balances for

inventories. Thus, Focal Point Industries has reported lower amounts for net income than it

would if the FIFO method had been used. It also benefits from the lower taxable income

reported to the IRS. Focal Point Industries believes that this has not had a material effect on

their operating results. It has switched to a FIFO valuation method at the end of fiscal 2017.

(2) Since Focal Point Industries has added back depreciation and amortization to net income,

259. What is LIFO inventory liquidation? Why is it important to disclose the effects of a LIFO inventory liquidation

ANSWER:

A LIFO liquidation means that some of the inventory items included in inventory under the

LIFO method have been sold, i.e., the company sold more units of merchandise than it

purchased during the year. If the units sold in the LIFO liquidation had been carried in

inventory at older, lower prices, these lower prices will have been assigned to cost of goods

sold. Thus, income will be higher than it would have been if the company had purchased

enough units at current prices to maintain its inventory at the lower prices. If the effects of

this unexpected LIFO liquidation are material, the information may be relevant to some of

the users of the financial statements.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-07 – LO: 05-07

KEYWORDS:

Bloom’s: Applying

260. Carrington Inc. manufactures digital cameras and has experienced noticeable declines in the purchase price of many

of the components it uses, including memory components. Which inventory costing method should Carrington use if it

wants to maximize net income? Explain your answer.

ANSWER:

For Carrington, the use of LIFO will have the effect of maximizing net income if a company

is experiencing a decline in the unit cost of inventory. Last-in, first-out charges the most

recent purchases to cost of goods sold. If prices are declining, the amounts charged to cost of

goods sold will be less than if either the weighted average method or FIFO is used. Because

less is charged to cost of goods sold, net income will be higher.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-07 – LO: 05-07

KEYWORDS:

Bloom’s: Applying

261. If an entity overstates its ending inventory for the current year, what are the effects on assets, cost of goods sold,

income before taxes, and retained earnings for the current year?

ANSWER:

An overstatement of ending inventory for the current period results in an understatement of

cost of goods sold and an overstatement of income before taxes for the same period. Cost of

goods sold is understated because the overstated ending inventory figure is deducted from the

cost of goods available for sale to determine cost of goods sold. Thus, a larger portion of the

cost of goods available for sale is assigned to inventory and a smaller portion is assigned to

cost of goods sold than should be. The overstated inventory figure also overstates the amount

reported as an asset on the balance sheet. The overstatement of income results in an

overstatement of retained earnings when net income is transferred to retained earnings

through a closing entry.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-08 – LO: 05-08

KEYWORDS:

Bloom’s: Applying

262. Assume that a company is experiencing increasing inventory prices and prepares its financial statements in

accordance with IFRS. Which costing method should it use to pay the least amount of taxes? Explain your answer.

ANSWER:

If a company prepares its financial statements in accordance with IFRS, it is not allowed to

use LIFO which would result in the lowest amount of taxes as inventory costs are increasing.

Under IFRS, LIFO cannot be used; so the weighted average method will result in the largest

cost of goods sold, the lowest income, and consequently the lowest income tax for the

company.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-09 – LO: 05-09

KEYWORDS:

Bloom’s: Applying

263. Bower Corp.’s cost of sales has remained steady over the last two years. During this same time period, however, its

inventory has increased considerably. What does this information tell you about the company’s inventory turnover?

Explain your answer.

ANSWER:

Inventory turnover equals cost of goods sold (cost of sales) divided by average inventory. If

the cost of sales remains constant while the denominator (average inventory) increases,

inventory turnover will decrease. This indicates that inventory is staying on the shelf for a

longer time. The company should probably evaluate the salability of its inventory.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.05-10 – LO: 05-10

KEYWORDS:

Bloom’s: Applying