978-1133939283 Chapter 7 Solution Manual Part 5

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Units Cost Amount

10 60 49

19 (60) 49

47052

15 70 52

120 53

23 (70) 52

(120) 53

25 40 54

30 40 54

100 55

Balance

Ending inventory

Date

Sale

Balance

P8. Perpetual Inventory System and Inventory Costing Methods (Continued)

2. Perpetual inventory system—FIFO method

Balance

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Units Cost Amount

10 60 49

31 60 49

46049

10 52

15 60 49

10 52

120 53

23 (50) 54

(120) 53

(10) 52

25 40 49

30 40 49

100 55

3. Perpetual inventory system—LIFO method

In a long period of rising prices, how realistic the inventory value of the balance

sheet is will depend on the inventory method used by the company. For instance, if

the company uses the average method, the inventory should reflect the average

price paid over the past year. If the LIFO method is used, the inventory prices will

likely reflect lower prices paid many years before. If the FIFO method is used, the in-

Cost of goods sold for March equals the total cost of the sale made on March 19, or $4,680.

Cost of goods sold for April equals the total cost of the sale made on April 23, or $10,560.

Balance

P8. Perpetual Inventory System and Inventory Costing Methods (Concluded)

Balance

Ending inventory

Date

Ending inventory

Sale

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Cost Retail

1. Month-end inventory at cost estimated

October 31 physical inventory

The retail method is an efficient way for companies to operate because sales employees

P9. Retail Method

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Schedule to Estimate Inventory Destroyed

April 22, 2014

Zubac Company

P10. Gross Profit Method

Management may want to estimate the cost of inventory for interim reports or esti-

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taxes will be less under LIFO. Thus, although the actual transactions during the year (sales,

net purchases, operating expenses, and so on) are the same, income taxes will be less if

LIFO is used. In recent years, oil prices have been going up, which would be advantageous

under LIFO.

result in lower income taxes. When the most recent cost of a good is charged against the

sales price, an amount approximating replacement cost is used. In periods of rising prices,

the cost of the most recent purchase will be higher than the costs of earlier purchases,

resulting in a lower income before income taxes. Consequently, in this situation income

A company like ExxonMobil may choose LIFO because management believes that LIFO is

more closely tied to the reality that goods must be replaced when sold and that LIFO may

down would appear on the income statement.

creased by the amount that market value exceeded cost. This inconsistency is a prime

example of the application of the accounting convention of conservatism, which states

that losses (cost exceeds market) are recorded, but gains (market exceeds cost) are not

recorded until a definite transaction occurs.

was down, income was reduced by the amount that cost exceeded market value. How-

ever, in the next year when market value exceeded the LIFO cost, income was not in-

If prices decline enough in the third year so that market falls below cost, another write-

C2. Interpreting Financial Reports: LCM and Conservatism

C3. Interpreting Financial Reports: FIFO and LIFO

The LCM rule resulted in a write-down in the first year of $325 million because the market

The inconsistency between the two years is that in the first year when the market value

many years as a result of technological advances, and so LIFO is not the most appropri-

ate method to use.

chases, which are charged against revenues through cost of goods sold, are usually

higher in times of rising prices, the reported income and the resulting income taxes and

cash flows are both lower. The opposite effects result in times of declining prices.

These tendencies explain the difference in the inventory costing methods used by the

chemical and computer industries, since an important motivation in both industries is to

C1. Conceptual Understanding: LIFO Inventory Method

LIFO—or last-in, first-out—is an inventory pricing method that transfers the costs of the

most recent purchases to cost of goods sold while retaining the costs of the earliest pur-

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( + ) / 2

times

*Rounded

Days’ Inventory on Hand Number of Days in a Year

7.2

CVS’s Days’ Inventory on Hand:

Inventory Turnover

$10,519.0

2010 = $75,559.0

$10,343.0$10,695.0

=$86,539.0 = 8.3 times*

$10,370.5

2011 = $86,539.0

$10,695.0$10,046.0

CVS’s Inventory Turnover (in millions):

Inventory Turnover = Cost of Goods Sold

Average Inventory

that shows improved inventory planning and the need for less investment in inventory.

each item of merchandise inventory. Employees can take the physical inventory by re-

cording quantity and selling prices. These data can then be converted to cost by the com-

The inventory turnover increased from 7.2 times in 2010 to 8.3 times in 2011, resulting in

a decrease in days’ inventory on hand of almost 7 days. This is a significant difference

pany’s accountants.

mally come into play for CVS if it bought inventory that it was unable to sell at regular

prices but had to sell at prices below cost.

The retail inventory method is ideal for retail companies that use a standard markup on

C4. Annual Report Case: Inventory Costing Methods and Ratios

It is unlikely that very much of the inventory is valued at market. Market value would nor-

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days

times

days

times

365

6.7 = 54.5

*Rounded

53.7 days*

days*

While Walgreens remained steady from 2010 to 2011, CVS improved. However, Wal-

greens had a lower inventory turnover. The most important conclusion to draw is that

C5. Comparison Analysis: Inventory Efficiency

Days’ Inventory on Hand Number of Days in a Year

Inventory Turnover

Walgreens’ Days’ Inventory on Hand:

2011

==2010 365

6.8

8.3

7.2

44.0

50.7 days

2011:

CVS’s Average Days’ Inventory on Hand (from C4):

2011:

2010:

=$48,444.0 = 6.8 times*

$7,083.5

Inventory Turnover* = Cost of Goods Sold

Average Inventory

CVS’s Inventory Turnover (from C4):

times

days

times

Walgreens’ Inventory Turnover:

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C8. Continuing Case: Annual Report Project

Note to Instructor: Answers will vary depending on the company selected by the students.

Because the goods ordered by The Executive Woman have not been separated, they will

be included in the inventory count on December 31. If the auditors do not detect this situ-

ation, the 2014 ending inventory will be overstated. This overcounting, combined with the

inclusion of the sale in 2014 sales, will lead to an overstatement of 2014 income before

income taxes by the amount of the cost of the inventory not separated for shipment. This

overstatement will lead, in turn, to an understatement of 2015 income before income taxes

Dell to become one of the most efficient companies in history.

C7. Ethical Dilemma: Inventories, Income Determination, and Ethics

Using supply-chain management in a just-in-time operating environment allows companies

to use technology to attempt to reduce their levels of inventory. Under supply-chain man-

agement, a company uses the Internet for business-to-business (B to B) e-commerce to

manage its inventory and purchasing. In a just-in-time operating environment, the company

uses supply-chain management to work closely with suppliers to coordinate and schedule

inventory management provides a challenge to JCPenney’s management, but it is prob-

ably not the best match because, although they both sell to the end customer, the nature

of their businesses is very different. JCPenney must display inventory for customers to

shipments so that goods arrive just in time as they are needed. This strategy has enabled

than people want.

Comparisons among companies are important because it enables the management of

the companies to benchmark themselves against other well-managed companies. Dell’s

C6. Evaluation of Inventory Levels

Since JCPenney’s inventory turnover is 3.8, its average inventory on hand is about 100

days compared to Dell’s, which is about 10 days. This is a big business advantage to Dell

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