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P9-4. Determining the effects of absorption and variable costing
(LO 12)
Requirement 1:
Absorption Cost: 2017
Ending inventory [55,000 @ $8]
Absorption Cost: 2018
Ending inventory [70,000 @ $9]
Absorption Cost: 2019
Ending inventory [45,000 @ $8.3478]
There are two factors that affect the gross profit margin when absorption
costing is used:
(1) The relationship between sales and production. When production
© 2018 by McGraw-Hill Education. 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. 9-1
(2) Variations in production levels because fixed costs per unit (that
impact both cost of goods sold and inventory) go down as production
increases.
Considering these factors in regards to Mastrolia’s data we find that in
2017, production exceeded sales (as was the case in the previous year)
thus raising gross margin. In 2018, production again exceeded sales, but
overall production was lower than in 2017. So while some of the current
period’s fixed costs went to inventory, the 30,000 units of 2018 production
Requirement 2:
Variable Cost: 2017
Ending inventory [55,000 @ $4]
Variable Cost: 2018
Ending inventory [70,000 @ $4]
© 2018 by McGraw-Hill Education. 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. 9-2
Variable Cost: 2019
Ending inventory [45,000 @ $4]
Sales volume is the only factor affecting variations in gross profit margin
when variable costing is used. Break even for Mastrolia stands at 83,333
Requirement 3:
As plant manager, I would prefer absorption costing assuming bonus
achievement/maximization is my goal. As explained in Requirement (2),
gross margin under variable costing depends entirely on sales volume. As
P9-5. Determining items to be included in inventory (LO 3)
Inventory Accounts payable Net sales
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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. 9-3
P9-6. Choosing a cost flow assumption (LO 4, 7, 9)
Responses to each of the issues raised follow.
d. If firms liquidate LIFO layers when inventory levels are falling,
then they may have to pay taxes on LIFO liquidations (i.e.,
cumulative holding gains from inflation). FIFO cannot solve the
e. This is not possible. LIFO ensures better matching, but FIFO
f. Not necessarily. If securities markets are “efficient,” then higher
income due to a different accounting method does not ensure a
income.
P9-7. Choosing a cost flow assumption (LO 4, 5, 7, 9)
Requirement 1:
Units in ending inventory = units purchased - units sold = 72,000 -
62,000 = 10,000.
Ending Inventory under Periodic FIFO
Units Cost/Unit Total
By subtracting the ending inventory amount of $150,000 from the
© 2018 by McGraw-Hill Education. 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. 9-4
Requirement 2:
Ending Inventory under Periodic LIFO
Units Cost/Unit Total
By subtracting the ending inventory amount of $150,000 from the
goods available for sale, we compute cost of goods sold as follows:
Gross Margin = $984,000 - $678,000 = $306,000
The company has to disclose the ending LIFO reserve under the
LIFO method.
Since the company started doing business only during 2017, there is
no beginning LIFO reserve.
FIFO COGS = LIFO COGS + Beginning LIFO reserve - Ending
LIFO reserve
Requirement 3:
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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. 9-5
Current Output Current Input
Operating
Date Units Sold Price Price Margin
Requirement 4:
a) The LIFO inventory accounting method does a good job of
matching revenues and expenses during both inflationary and
b) The specific identification method matches the physical flow of
goods with revenue. However this is not the objective of the
matching principle. The objective is to match the revenue flow
with the cost flow. The specific identification method is
c) Given the inflationary situation faced by the company, the FIFO
inventory accounting method can be used to maximize current
d) Given the inflationary situation faced by the company, the LIFO
inventory accounting method can be used to minimize current
profits and, hence, minimize the present value of future income
e) This is not allowed. Under the LIFO conformity rule, if a company
uses LIFO for tax purposes, it must choose LIFO for financial
© 2018 by McGraw-Hill Education. 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. 9-6
© 2018 by McGraw-Hill Education. 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. 9-7
P 9-8. Computing dollar-value LIFO (LO 13)
Date
Inventory @
current year
costs
Inventory @
base year costs
Inventory layers @
base year costs
Inventory layers restated
using appropriate indexes
Dollar-value
LIFO inventory
= $372,727
$10,971 (2018)
$7,589 (2020)
$10,971 x 1.04 = 11,410
$7,589 x 1.10 = 8,348
© 2018 by McGraw-Hill Education. 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. 9-8
P9-9. Correcting inventory errors (LO 14)
Effect on
Erro
r
12/31/2017
Ending
inventory
12/31/2018
Ending
inventory
2017 Cost
of goods
sold
2018 Cost
of goods
sold
12/31/2017
Accounts
payable
12/31/2018
Accounts
payable
P9-10. Analyzing gross margins and cash flow sustainability (LO 8)
Requirement 1:
FIFO income for 2016 is:
Sales revenues:
Pounds
Cost of goods sold:
Pounds
Minus:
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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
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Requirement 2:
Parque Corporation did not earn a profit from its operating activities
in 2016. This becomes evident after computing the amount of
realized holding gains that are automatically included in the
$190,000 FIFO net income figure in part 1. The computation is:
Date of Yelpin Amount of Pounds Realizable
Cost Change Cost Change in Inventory Holding
Gain
B.I. + Purch. - Sales
Realizable holding gains (i.e., the holding gains that arose during
2016) totaled $340,000. On a FIFO basis, all of these gains were
realized in 2016 and included in income. (Since 4th-quarter sales of
2016 FIFO Income
$190,000
Thus, it is evident that Parque reported profits only because yelpin
costs were rising in 2016.
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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
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Requirement 3:
With current sales volume of 2,650,000 pounds and cash operating
costs of $2,800,000, the $1 per pound markup is too low to
generate profitable operating performance. This condition was
Under these conditions, Parque’s ability to repay the loan from
operating profits (which are identical to operating cash flows in this
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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. 9-11
