CHAPTER 8
Valuation of Inventories: A Cost-Basis Approach
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics
Questions
Brief
Exercises
Exercises
Problems
Concepts
for Analysis
1.
Inventory accounts;
determining quantities,
costs, and items to be
included in inventory;
the inventory equation;
balance sheet disclosure.
4, 5, 6, 7, 8
1, 3
1, 2, 3,
4, 5, 6
1, 2, 3
1, 2, 3, 5
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Questions
Brief
Exercises
Exercises
Problems
Concepts
for Analysis
1.
Understand inventory
classifications and different
inventory systems.
1, 2, 3
1, 2
4,5,6
5.
Determine the effects of
inventory errors on the
financial statements.
24, 25, 26
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
Level of
Difficulty
Time
(minutes)
E8.1
Inventoriable goods and costs.
Moderate
15–20
E8.2
Inventoriable goods and costs.
Moderate
10–15
E8.3
Inventoriable goods and costs.
Moderate
10–15
E8.4
Inventoriable goods and costs—perpetual.
Moderate
10–15
E8.5
Inventoriable goods and costs—error adjustments.
Complex
15–20
E8.6
Determining merchandise amounts—periodic.
Moderate
10–20
E8.7
Purchases recorded net.
10–15
E8.8
Purchases recorded, gross method.
Moderate
20–25
E8.9
Periodic versus perpetual entries.
Moderate
15–25
E8.10
FIFO and LIFO—periodic and perpetual.
Moderate
15–20
E8.11
FIFO, LIFO and average-cost determination.
Moderate
20–25
E8.12
FIFO, LIFO, average-cost inventory.
Moderate
15–20
E8.13
Compute FIFO, LIFO, average-cost—periodic.
Moderate
15–20
E8.14
FIFO and LIFO—periodic and perpetual.
10–15
E8.15
FIFO and LIFO; income statement presentation.
Moderate
15–20
E8.16
FIFO and LIFO effects.
Moderate
20–25
E8.17
FIFO and LIFO—periodic.
Moderate
10–15
E8.18
LIFO effect.
Moderate
10–15
E8.19
Alternate inventory methods—comprehensive.
Moderate
25–30
E8.20
Dollar-value LIFO.
Moderate
5–10
E8.21
Dollar-value LIFO.
Moderate
15–20
E8.22
Dollar-value LIFO.
Moderate
20–25
E8.23
Dollar-value LIFO.
Moderate
15–20
E8.24
Inventory errors—periodic.
Moderate
10–15
E8.25
Inventory errors.
Moderate
10–15
E8.26
Inventory errors.
Moderate
15–20
P8.1
Various inventory issues.
Moderate
30–40
P8.2
Inventory adjustments.
Moderate
25–35
P8.3
Purchases recorded gross and net.
Moderate
20–25
P8.4
Compute FIFO, LIFO, and average-cost.
Complex
40–55
P8.5
Compute FIFO, LIFO, and average-cost.
Complex
40–55
and perpetual.
P8.7
Financial statement effects of FIFO and LIFO.
Moderate
30–40
P8.8
Dollar-value LIFO.
Moderate
30–40
P8.9
Internal indexes—dollar-value LIFO.
25–35
P8.10
Internal indexes—dollar-value LIFO.
Complex
30–35
P8.11
Dollar-value LIFO.
Moderate
40–50
ASSIGNMENT CHARACTERISTICS TABLE (Continued)
Item
Description
Level of
Difficulty
Time
(minutes)
CA8.1
Inventoriable goods and costs.
Moderate
15–20
CA8.2
Inventoriable goods and costs.
Moderate
15–25
CA8.3
Inventoriable goods and costs.
Moderate
25–35
CA8.4
Accounting treatment of purchase discounts.
15–25
CA8.5
General inventory issues.
Moderate
20–25
CA8.6
LIFO inventory advantages.
Moderate
15–20
CA8.7
Average-cost, FIFO, and LIFO.
Moderate
15–20
CA8.8
LIFO application and advantages.
Moderate
25–30
CA8.9
Dollar-value LIFO issues.
Moderate
25–30
CA8.10
FIFO and LIFO.
Moderate
30–35
CA8.11
LIFO Choices
Moderate
20–25
ANSWERS TO QUESTIONS
1. In a retailing concern, inventory normally consists of only one category that is the product awaiting
2. (a) Inventories are unexpired costs and represent future benefits to the owner. A statement
of financial position includes a listing of all unexpired costs (assets) at a specific point in time.
Because inventories are assets owned at the specific point in time for which a statement of
3. In a perpetual inventory system, data are available at any time on the quantity and dollar amount
of each item of material or type of merchandise on hand. A physical inventory is a physical count
4. No, Mishima, Inc. should not report this amount on its balance sheet. As consignee, it does not
5. Repurchase agreements (product financing arrangements) are essentially off-balance-sheet
financing devices. These arrangements make it appear that a company has sold its inventory or
6. (a) Inventory.
(b) Not shown, possibly in a note to the financial statements if material.
7. Cost, which has been defined generally as the price paid or consideration given to acquire an
asset, is the primary basis for accounting for inventories. As applied to inventories, cost means the
8. By their nature, product costs “attach” to the inventory and are recorded in the inventory account.
These costs are directly connected with the bringing of goods to the place of business of the buyer
and converting such goods to a salable condition. Such charges would include freight charges on
goods purchased, other direct costs of acquisition, and labor and other production costs incurred
9. Cash discounts (purchase discounts) should not be accounted for as financial income when pay–
ments are made. Income should be recognized when the performance obligation is satisfied
11. Arguments for the specific identification method are as follows:
(1) It provides an accurate and ideal matching of costs and revenues because the cost is
Arguments against the specific identification method include the following:
(1) The cost of using it restricts its use to goods of high unit value.
12. The first-in, first-out method approximates the specific identification method when the physical flow
of goods is on a FIFO basis. When the goods are subject to spoilage or deterioration, FIFO is
particularly appropriate. In comparison to the specific identification method, an attractive aspect of
FIFO is the elimination of the danger of artificial determination of income by the selection of
advantageously priced items to be sold. The basic assumption is that costs should be charged in
The results achieved by the average-cost method resemble those of the specific identification
method where items are chosen at random or there is a rapid inventory turnover. Compared with
the specific identification method, the average-cost method has the advantage that the goods
need not be individually identified; therefore accounting is not so costly and the method can be
applied to fungible goods. The average-cost method is also appropriate when there is no marked
trend in price changes. In opposition, it is argued that the method is illogical. Since it assumes that
all sales are made proportionally from all purchases and that inventories will always include units
from the first purchases, it is argued that the method is illogical because it is contrary to the
chronological flow of goods. In addition, in periods of price changes there is a lag between current
costs and costs assigned to income or to the valuation of inventories.
13. A company may obtain a price index from an outside source (external index)—the government, a
trade association, an exchange—or by computing its own index (internal index) using the double
14. Under the double extension method, LIFO inventory is priced at both base-year costs and current-
year costs. The total current-year cost of the inventory is divided by the total base-year cost to
obtain the current-year index.
The index for the LIFO pool consisting of product A and product B is computed as follows:
Base-Year Cost
Current-Year Cost
Product
Units
Unit
Total
Unit
Total
25,500
$260,100
10,350
$1,007,460
Base-Year Cost
15. The LIFO method results in a smaller net income because later costs, which are higher than
earlier costs, are matched against revenue. Conversely, in a period of falling prices, the LIFO
16. The dollar-value method uses dollars instead of units to measure increments, or reductions in a
LIFO inventory. After converting the closing inventory to the same price level as the opening
inventory, the increases in inventories, priced at base-year costs, is converted to the current price
level and added to the opening inventory. Any decrease is subtracted at base-year costs to
determine the ending inventory.
17. (a) LIFO layer—a LIFO layer (increment) is formed when the ending inventory at base-year prices
exceeds the beginning inventory at base-year prices.
18.
December 31, 2020 inventory at December 31, 2019 prices, $1,053,000 ÷ 1.08 ………..
$975,000
Less: Inventory, December 31, 2019 ………………………………………………………………….
800,000
Increment added during 2020 at December 31, 2020 prices, $175,000 X 1.08 …………..
$189,000
Add: Inventory at December 31, 2019 ……………………………………………………….…………
800,000
19. Phantom inventory profits occur when the inventory costs matched against sales are less than the
replacement cost of the inventory. The cost of goods sold therefore is understated and profit is
considered overstated. Phantom profits are said to occur when FIFO is used during periods of
rising prices.
20. This omission would have no effect upon the net income for the year, since the purchases and the
ending inventory are understated in the same amount. With respect to financial position, both the
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 8.1
RIVERA COMPANY
Balance Sheet (Partial)
December 31
Current assets
Cash ………………………………………………………….
$ 190,000
Receivables (net) ………………………………………..
Finished goods ……………………………………
Work in process ………………………………….
Prepaid insurance ………………………………………
41,000
BRIEF EXERCISE 8.2
Inventory (150 X $34) ……………………………………………….
5,100
Accounts Payable …………………………………………..
5,100
Accounts Payable (6 X $34) ……………………………………..
Inventory ……………………………………………………….
Accounts Receivable (125 X $50) …………………………..
6,250
Sales ………………………………………………………………
6,250
Cost of Goods Sold (125 X $34)…………………………..
4,250
Inventory ……………………………………………………….
4,250
BRIEF EXERCISE 8.3
December 31 inventory per physical count ………………………
$ 200,000
Goods-in-transit purchased FOB shipping point ………………
25,000
Goods-in-transit sold FOB destination …………………………..
22,000
BRIEF EXERCISE 8.4
Weighted average cost per unit
$11,850
=
$ 11.85
1,000
Ending inventory 400 X $11.85 =
$ 4,740
Cost of goods available for sale
$11,850
Deduct ending inventory
4,740
BRIEF EXERCISE 8.5
April 23
350 X $13
=
$ 4,550
April 15
50 X $12
=
600
Ending inventory
$ 5,150
Cost of goods available for sale
$11,850
Deduct ending inventory
5,150
BRIEF EXERCISE 8.6
April 1 250 X $10 =
$ 2,500
April 15 150 X $12 =
1,800
Ending inventory
$ 4,300
Cost of goods available for sale
$11,850
Deduct ending inventory
4,300
BRIEF EXERCISE 8.7
FIFO inventory balance at December 31, 2020 ………………….
$2,900,000
LIFO inventory balance at December 31, 2020 ………………….
(1,500,000)
LIFO reserve at December 31, 2020 …………………………………
LIFO reserve at December 31, 2020 …………………………………
LIFO reserve at January 1, ………………………………………………
(1,300,000)
LIFO effect for 2020 ………………………………………………………..
BRIEF EXERCISE 8.8
2019
$100,000
2020
$119,900 ÷ 1.10 = $109,000
$100,000 X 1.00 ……………………………………………………
$100,000
$9,000* X 1.10 ………………………………………………………
$100,000 X 1.00 ……………………………………………………
$9,000 X 1.10 ……………………………………………………….
$7,000** X 1.16 ……………………………………………………..
8,120
BRIEF EXERCISE 8.9
2020 inventory at base amount ($22,140 ÷ 1.08)
$ 20,500
2019 inventory at base amount
(19,750)
Increase in base inventory
$ 750
2020 inventory under LIFO
Layer one $19,750 X 1.00
Layer two $ 750 X 1.08
$ 20,560
2021 inventory at base amount ($25,935 ÷ 1.14)
2020 inventory at base amount
2021 inventory under LIFO
Layer one $19,750 X 1.00
Layer two $ 750 X 1.08
Layer three $ 2,250 X 1.14
$ 23,125
BRIEF EXERCISE 8.10
Cost of goods sold as reported ……………………………………….
$1,400,000
Overstatement of 12/31/19 inventory ……………………………….
(110,000)
Overstatement of 12/31/20 inventory ……………………………….
Corrected cost of goods sold ………………………………….
12/31/20 retained earnings as reported …………………………...
Overstatement of 12/31/20 inventory ……………………………….
Corrected 12/31/20 retained earnings ………………………
EXERCISE 8.1 (15–20 minutes)
Items 1, 3, 5, 8, 11, 13, 14, 16, and 17 would be reported as inventory in the
financial statements.
The following items would not be reported as inventory:
2. Cost of goods sold in the income statement.
EXERCISE 8.2 (10–15 minutes)
Inventory per physical count
$441,000
Goods in transit to customer, f.o.b. destination
+ 38,000
The consigned goods of $61,000 are not owned by Jose Oliva and were
properly excluded.
EXERCISE 8.3 (10–15 minutes)
1. Include. Ownership of the merchandise passes to customer only
when it is shipped.
EXERCISE 8.4 (10–15 minutes)
1.
Raw Materials Inventory …………………………..
8,100
Accounts Payable …………………………………………..
8,100
2.
Raw Materials Inventory …………………………..
Accounts Payable …………………………………………..
3.
No adjustment necessary.
Accounts Payable …………………………………………………..
7,500
Raw Materials Inventory …………………………..
7,500
Raw Materials Inventory …………………………..
Accounts Payable …………………………………………..
EXERCISE 8.5 (15–20 minutes)
(a)
Inventory December 31, 2020 (unadjusted)
$234,890
Transaction 2
13,420
Transaction 3
-0-
Transaction 4
-0-
Transaction 5
Transaction 6
Transaction 7
Transaction 8
1,500
(b)
Transaction 3
Sales Revenue ………………………………………..
12,800
Accounts Receivable …………………………..
12,800
(To reverse sale entry in 2020)
Transaction 4
Purchases (Inventory) ……………………………..
Accounts Payable …………………………..
Transaction 8
Sales Returns and Allowances…………………
Accounts Receivable ………………………
EXERCISE 8.6 (10–20 minutes)
2019
2020
2021
Sales
$290,000
$360,000
$410,000
Sales Returns
(11,000)
(13,000)
(20,000)
Net Sales
279,000
347,000
390,000
Ending Inventory
Purchases
260,000
Purchase Returns and Allowances
8,000
Cost of Good Sold
(233,000)
Gross Profit
$ 46,000
$ 91,000
$ 97,000
EXERCISE 8.7 (10–15 minutes)
(a)
May 10
Purchases ……………………………………………………….
14,700
Accounts Payable …………………………..
14,700
($15,000 X .98)
May 11
Purchases ……………………………………………………….
13,068
($13,200 X .99)
May 19
Accounts Payable …………………………..
14,700
Cash ……………………………………………………….
14,700
May 24
Purchases ……………………………………………………….
11,270
11,270
EXERCISE 8.7 (Continued)
(b)
May 31
Purchase Discounts Lost …………………………..
132
Accounts Payable
($13,200 X .01) ……………………………………………..
(Discount lost on purchase of
May 11, $13,200, terms 1/15, n/30)
EXERCISE 8.8 (20–25 minutes)
(a)
Feb. 1
Inventory [$10,800 – ($10,800 X .10)] ………………………..
9,720
Accounts Payable …………………………..
9,720
Inventory ……………………………………………………….
Feb. 13
Accounts Payable ($9,720 – $2,250) …………………………
7,470
Inventory (.03 X $7,470) …………………………..
Cash ……………………………………………………….
(b)
Feb. 1
Purchases [$10,800 – ($10,800 X .10)] ………………………
9,720
Accounts Payable …………………………..
9,720
Purchase Returns and Allowances ……………………….
2,250
Feb. 13
Accounts Payable ($9,720 – $2,250) …………………………
Purchase Discounts (.03 X $7,470) ………………………..
Cash ……………………………………………………….
(c)
Purchase price (list)
$10,800.00
Less: Trade discount (.10 X $10,800)
1,080.00
Price on which cash discount based
Less: Cash discount (.03 X $9,720)
EXERCISE 8.9 (15–25 minutes)
(a)
Jan. 4
Accounts Receivable …………………………..
640
Sales Revenue (80 X $8) …………………………..
640
Jan. 11
Purchases ($150 X $6) …………………………..
900
Accounts Payable …………………………..
900
Jan. 13
Accounts Receivable …………………………..
Sales Revenue (120 X $8.75) …………………………..
Jan. 20
Purchases (160 X $7) …………………………..
Accounts Payable …………………………..
Jan. 27
Accounts Receivable …………………………..
900
Sales Revenue (100 X $9) …………………………..
900
Jan. 31
Inventory ($7 X 110) …………………………..
770
Cost of Goods Sold…………………………..
Purchases ($900 + $1,120) …………………………..
Inventory (100 X $5) …………………………..
500
(b)
Sales revenue ($640 + $1,050 + $900)
$2,590
EXERCISE 8.9 (Continued)
(c)
Jan. 4
Accounts Receivable …………………………..
640
Sales Revenue (80 X $8) …………………………..
640
Cost of Goods Sold …………………………..
400
Inventory (80 X $5) …………………………..
400
Jan. 11
Inventory ……………………………………………………….
900
Accounts Payable (150 X $6) …………………………..
900
Jan. 13
Accounts Receivable …………………………..
1,050
Sales Revenue (120 X $8.75) …………………………..
Cost of Goods Sold …………………………..
700
Inventory ([(20 X $5) +
Jan. 20
Inventory ……………………………………………………….
1,120
Accounts Payable (160 X $7) …………………………..
1,120
Jan. 27
Accounts Receivable …………………………..
900
Sales Revenue (100 X $9) …………………………..
900
Cost of Goods Sold …………………………..
650
Inventory [(50 X $6) +
(50 X $7)] ……………………………………………………..
650
(d)
Sales revenue
$2,590