Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
Chapter 7
Reporting and Interpreting Cost of Goods Sold
and Inventory
ANSWERS TO QUESTIONS
1. Inventory often is one of the largest amounts listed under assets on the balance
sheet which means that it represents a significant amount of the resources
available to the business. The inventory may be excessive in amount, which is a
3. The cost principle governs the measurement of the ending inventory amount.
5. Beginning inventory is the stock of goods on hand (in inventory) at the start of the
6. (a) Average cost–This inventory costing method in a periodic inventory
system is based on a weighted-average cost for the entire period. At the
end of the accounting period the average cost is computed by dividing the
goods available for sale in units into the cost of goods available for sale
7-2 Solutions Manual
© 2014 by McGraw-Hill Global Education Holdings, LLC. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
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identifying the specific item sold. This method usually requires that each
item be marked, often with a code that indicates its cost. When it is sold,
that unit cost is the cost of goods sold amount. It often is characterized as
7. The specific identification method of inventory costing is subject to manipulation.
Manipulation is possible because one can, at the time of each sale, select (pick
and choose) from the shelf the item that has the highest or the lowest (or some
other) unit cost with no particular rationale for the choice. The rationale may be
8. LIFO and FIFO have opposite effects on the inventory amount reported under
assets on the balance sheet. The ending inventory is based upon either the
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
Financial Accounting, 8/e 7-3
ending inventory on the balance sheet will be higher under LIFO than under
FIFO.
9. LIFO versus FIFO will affect the income statement in two ways: (1) the amount of
cost of goods sold and (2) income. When the prices are rising, FIFO will give a
10. When prices are rising, LIFO causes a lower taxable income than does FIFO.
Therefore, when prices are rising, income tax is less under LIFO than FIFO. A
11. LCM is applied when market (defined as current replacement cost) is lower than
the cost of units on hand. The ending inventory is valued at market (lower),
12. When a perpetual inventory system is used, the unit cost must be known for each
item sold at the date of each sale because at that time two things happen: (a) the
units sold and their costs are removed from the perpetual inventory record and
the new inventory balance is determined; (b) the cost of goods sold is
1. c)
2. d)
3. a)
4. a)
5. c)
6. c)
7. a)
8. c)
9. c)
10. a)
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
Authors’ Recommended Solution Time
(Time in minutes)
Mini-exercises
Exercises
Problems
Alternate
Problems
Cases and
Projects
No.
Time
No.
Time
No.
Time
No.
Time
No.
Time
1
5
1
15
1
30
1
30
1
20
2
5
2
20
2
30
2
40
2
20
3
5
3
20
3
40
3
35
3
20
4
10
4
10
4
40
4
40
4
20
5
5
5
15
5
45
5
40
6
5
6
15
6
50
6
20
7
5
7
30
7
40
7
30
8
5
8
30
8
40
8
*
9
10
9
30
9
35
10
30
10
20
11
15
12
20
Continuing Case
13
15
1
30
14
20
15
20
16
20
17
20
18
20
19
15
20
20
21
25
22
25
* Due to the nature of these cases and projects, it is very difficult to estimate the
amount of time students will need to complete the assignment. As with any open-ended
project, it is possible for students to devote a large amount of time to these
assignments. While students often benefit from the extra effort, we find that some
become frustrated by the perceived difficulty of the task. You can reduce student
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
MINI-EXERCISES
M7–1.
Type of Business
Type of Inventory Merchandising Manufacturing
M7–2.
To record the purchase of 90 new shirts in accordance with the cost principle (perpetual
inventory system):
M7–3.
(1) Part of
inventory
(2) Expense
as incurred
X
X
X
X
X
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
M7–9.
Understatement of the 2014 ending inventory by $50,000 caused 2014 pretax income to
be understated and 2015 pretax income to be overstated by the same amount.
E7–1
Item
Amount
Explanation
Ending inventory (physical count on
December 31, 2014)
$34,500
Per physical inventory.
a.
Goods purchased and in transit
+ 700
Goods purchased and in transit,
F.O.B. shipping point, are owned
by the purchaser.
b.
Samples out on trial to
customer
+ 1,800
Samples held by a customer on
trial are still owned by the vendor;
no sale or transfer of ownership
has occurred.
c.
Goods in transit to customer
Goods shipped to customers,
F.O.B. shipping point, are owned
by the customer because
ownership passed when they were
delivered to the transportation
company. The inventory correctly
excluded these items.
d.
Goods sold and in transit
+ 1,500
Goods sold and in transit, F.O.B.
destination, are owned by the seller
until they reach destination.
Correct inventory, December 31, 2014
$38,500
E7–2.
(Italics for missing amounts only.)
Case A Case B Case C
Net sales revenue ………. $7,500 $4,800 $5,000
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
E7–3.
(Italics and bold for missing amounts only.)
Case
Sales
Revenue
Beg.
Inven-
tory
Pur-
chases
Total
Avail-
able
Ending
Inventory
Cost of
Goods
Sold
Gross
Profit
Ex–
penses
Pretax
Income
or
(Loss)
A
$ 650
$100
$700
$800
$500
$300
$350
$200
$150
B
1,100
200
900
1,100
300
800
300
150
150
C
600
150
350
500
300
200
400
100
300
D
800
150
550
700
300
400
400
200
200
E
1,000
200
900
1,100
600
500
500
550
(50)
E7–4.
Computations:
Simply rearrange the cost of goods sold equation
BI + P – EI = CGS
7-10 Solutions Manual
© 2014 by McGraw-Hill Global Education Holdings, LLC. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
E7-5
Average
Units FIFO LIFO Cost
Cost of goods sold:
Beginning inventory ($5) …………. 2,000 $10,000 $10,000 $10,000
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
E7–6
Average
Units FIFO LIFO Cost
Cost of goods sold:
Beginning inventory ($5) …………. 2,000 $10,000 $10,000 $10,000
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
E7–7. (continued)
Req. 1 (continued)
(4) Cost of goods sold (10,000 units sold):
Case A FIFO:
(when prices are rising) and hence (a) reduces income tax and (b) as a result reduces
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
E7–8. (continued)
Req. 1 (continued)
(4) Cost of goods sold (24,000 units sold):
Case A FIFO:
(when prices are rising) and hence (a) reduces income tax and (b) as a result reduces
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
E7–9. (continued)
Req. 3
When prices are falling, the opposite effect occurs–LIFO produces higher net income
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
E7–10. (continued)
Req. 3
Ranking in order of favorable cash flow: The higher rankings are given to the methods
that produce the lower income tax expense because the lower the income tax expense
the higher the cash savings.