Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
7-37
P7–10. (Supplement A)
Req. 1 Pretax operating profit (loss) for the current year had FIFO accounting been
employed instead of LIFO.
Difference in beginning inventory* (LIFO to FIFO) $2,076
Less: Difference in ending inventory* (LIFO to FIFO) 2,226
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
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ALTERNATE PROBLEMS
AP7−1.
a) Goods available for sale for all methods:
Unit Total
Units Cost Cost
January 1, 2011–Beginning inventory 390 $32 $12,480
b) and c)
1. Average cost:
2. First-in, first-out:
3. Last-in, first-out:
4. Specific identification:
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
AP7–2.
Req. 1
NEWRIDGE COMPANY
Partial Income Statement
For the Month Ended January 31, 2012
(a) (b) (c) (d)
Average Specific
Cost FIFO LIFO Identification
Sales revenue* $3,840 $3,840 $3,840 $3,840
Computations:
*Sales revenue = 240 units @ $16 = $3,840.
**Cost of Goods Sold Amounts:
a)
Average Cost
Number of Units
x
Unit Cost
Total
Cost
120
x
$8
$ 960
380
x
9
3,420
200
x
2,200
700
for Sale
$6,580
700 units
Cost of Goods Sold
=
$9.40 x 240 units
=
$2,256
Cost of Goods Sold
Units
Unit
Cost
Total
Cost
b)
FIFO
First Units in (Beginning Inventory)
120
$8
$ 960
Next Units in (January 12)
120
9
1,080
Total Cost of Goods Sold (FIFO)
240
$2,040
c)
LIFO
Last Units in (January 26)
Next Units in (January 12)
40
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
7-40
AP7–2. (continued)
Cost of Goods Sold
Units
Unit
Cost
Total Cost
d)
Specific
First sale
100
$ 8
$ 800
Cost of Ending Inventory Amounts:
a)
Average Cost
Ending Inventory
=
$9.40 x 460 units
=
$4,324
Ending Inventory
Units
Unit
Cost
Total Cost
b)
FIFO
Last Units in (January 26)
200
$11
$2,200
Next Units in (January 12)
260
Total Ending Inventory FIFO
460
c)
LIFO
First Units in (Beginning Inventory)
120
Next Units in (January 12)
340
Total Ending Inventory LIFO
460
January 26
Total Ending Inventory (Spec.)
$4,520
Ending Inventory
Units
Unit
Cost
Total Cost
d)
Specific
Beginning
20
$ 8
$ 160
Identification
January 12
240
9
2,160
Identification
Second sale
Total Cost of Goods Sold
$2,060
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
AP7–2. (continued)
$156.
Req. 4
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
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AP7–3.
Req. 1
Prices Rising Prices Falling
A B C D
FIFO LIFO FIFO LIFO
Sales revenue (510 units) $13,260 $13,260 $13,260 $13,260
Cost of goods sold:
Expenses 5,000 5,000 5,000 5,000
Pretax income 3,500 3,260 3,330 3,570
Income tax expense (30%) 1,050 978 999 1,071
Net income $2,450 $2,282 $2,331 $2,499
*Inventory computations:
Req. 2
The above tabulation demonstrates that when prices are rising, FIFO gives a higher net
income than LIFO. When prices are falling, the opposite effect results. The difference
Req. 3
When prices are rising, LIFO derives a more favorable cash position (than FIFO) equal
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
AP7–3. (continued)
Req. 4
Either method can be defended reasonably. If one focuses on current income and EPS,
FIFO derives a more favorable result (higher than LIFO when prices are rising).
less relevant inventory valuation on the balance sheet.
AP7–4.
Req. 1
COLCA COMPANY
Income Statements Corrected
2011 2012 2013 2014
Sales revenue $60,000 $63,000 $65,000 $68,000
Cost of goods sold 39,000 41,000* 46,000* 46,000
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
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AP7–4. (continued)
Req. 2
2011 2012 2013 2014
Gross profit ratio (gross profit ÷ sales):
Before correction:
$21,000 ÷ $60,000 = .35
Req. 3
The error would have the following effect on income tax expense:
2012 2013
Before correction:
2012: $3,000 x 30% = $900
2013: $4,000 x 30% = $1,200
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
7-45
CASES AND PROJECTS
ANNUAL REPORT CASES
CP7–1
Req. 1
The company held $294,928 thousand of merchandise inventory at the end of the
current year. This is disclosed on the balance sheet.
Req. 2
The company purchased $1,823,208 thousand during the current year. The beginning
and ending inventory balances are disclosed on the balance sheet and cost of goods
sold is disclosed on the income statement. Purchases during the year can be computed
Req. 3
The company uses the average cost method to determine the cost of its inventory. This
is disclosed in Note 2 under “Merchandise Inventory.” It indicates that inventory is
valued at the lower of average cost or market.
Req. 4
American Eagle Outfitters
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
CP7–2.
Req. 1
Given the general trend of little or no inflation every year, it would be unlikely that the
replacement cost of Urban Outfitters’ inventory would be lower than its current book
value. And, unless a severe market downturn (or extreme change in fashion) took
Req. 2
The company uses the first-in, first-out method to determine the cost of its inventory.
This is disclosed in Note 2 under “Inventories.”
Req. 3
If the company had overstated its ending inventory by $10 million, its income before
Req. 4
Urban Outfitters
Inventory
=
Cost of Goods Sold
$1,121,140
=
6.56
Turnover
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
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CP7–3
Req. 1
American Eagle
Outfitters
Urban Outfitters
Inventory
=
Cost of Goods Sold
$1,814,765
=
6.24
$1,121,140
=
6.56
Req. 2
Industry
Average
American Eagle
Outfitters
Urban Outfitters
5.92
6.24
6.56
Both American Eagle Outfitters and Urban Outfitters have a higher inventory
Turnover
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
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FINANCIAL REPORTING AND ANALYSIS CASES
CP7–4.
Req. 1 Production costs included in inventory become cost of goods sold expense on
the income statement in the period the goods are sold.
CP7–5.
Req. 1
Caterpillar
2008
2007
2006
Inventories – LIFO
$8,781
$7,204
$6,351
Plus: LIFO Reserve
Inventories – FIFO
$9,821
$8,754
Cost of goods sold: LIFO
+ Beginning LIFO Reserve
– Ending LIFO Reserve
Cost of goods sold: FIFO
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
7-49
2008 LIFO
Inventory turnover = $38,415 = 4.8
CP7–5. (continued)
DEERE (as provided)
2008 LIFO 7.3
2008 FIFO 4.9
Req. 2
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
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Req. 3
The FIFO inventory turnover ratio is normally thought to be a more accurate indicator
when prices are changing because LIFO can include very old inventory prices in ending
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
CRITICAL THINKING CASES
CP7–6.
1. The press release states that management believes LIFO is more appropriate
2. The decrease in pre-tax income was $28,165,000. Thus, ending inventory was
decreased by $28,165,000 and cost of goods sold was increased by $28,165,000.
3. This $9,858,000 tax postponement is significant and is likely to be the main reason
that management adopted LIFO. A decrease in net income is normally a negative
Chapter 07 – Reporting and Interpreting Cost of Goods Sold and Inventory
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CP7–7.
To: The Files
From: The New Staff Member
Re: Effect of restatement
1. The Company understated purchases by $47.3 million. This causes cost of
$47.3 x (1 – .404) = $28.2 million overstatement
2. The restatement of the purchases caused the board to rescind management’s
3. If it is assumed that bonuses are a fixed portion of net income, the bonus rate
can be roughly estimated using the amounts computed in parts 1 and 2.
4. The Board likely tied management compensation to net income to align the
interests of management with that of shareholders. Typically, increases in net
FINANCIAL REPORTING AND ANALYSIS PROJECTS
CP7–8.
The solution to this case will depend on the company and/or accounting period selected
for analysis.