Time and Purposes of Concepts for Analysis (Continued)
CA 8-10 (Time 30–35 minutes)
Purpose—to provide the student with an opportunity to analyze the effect of changing from the FIFO
CA 8-11 (Time 20–25 minutes)
Purpose—to provide the student with an opportunity to analyze the ethical implications of purchasing
decisions under LIFO.
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 8-1
(a) Purchased merchandise in transit at the end of an accounting period to which legal title has
passed should be recorded as purchases within the accounting period. If goods are shipped f.o.b.
(b) Inventory ………………………………………………………………………………….. 35,300
Accounts Payable (Supplier) ……………………………………………………. 35,300
CA 8-2
(a) If the terms of the purchase are f.o.b. shipping point (manufacturer’s plant), Strider Enterprises
should include in its inventory goods purchased from its suppliers when the goods are shipped.
For accounting purposes, title is presumed to pass at that time.
(d) Products on consignment represent inventories owned by Strider Enterprises, which are physically
transferred to another enterprise. However, Strider Enterprises retains title to the goods until their
sale by the other company (Chavez Inc.).
CA 8-3
(a) According to FASB ASC 330-10–30–1:
“As applied to inventories, cost means in principle the sum of the applicable expenditures and
charges directly or indirectly incurred in bringing an article to its existing condition and
location.”
The discussion includes the following: “Selling expenses constitute no part of the inventory costs.”
To the extent that warehousing is a necessary function of importing merchandise before it can be
sold, certain elements of warehousing costs might be considered an appropriate cost of inventory
In theory, warehousing costs are considered a product cost because these costs are incurred to
maintain the product in a salable condition. However, in practice, warehousing costs are most fre-
quently treated as a period cost.
(b) It is correct to conclude that obsolete items are excludable from inventory. Cost attributable to
such items is “nonuseful” and “nonrecoverable” cost (except for possible scrap value) and should
(c) The primary use of the airplanes should determine their treatment on the balance sheet. Since the
airplanes are held primarily for sale, and chartering is only a temporary use, the airplanes should
be classified as current assets. Depreciation would not be appropriate if the planes are considered
inventory. FASB ASC Glossary entry for “Inventory” states in part that the term Inventory “excludes
long-term assets subject to depreciation accounting, or goods which, when put into use, will be so
classified.”
(d) The transaction is a product financing arrangement and should be reported by the company as
CA 8-4
(a) Cash discounts should not be accounted for as financial income when payments are made.
CA 8-4 (Continued)
(b) Cash discounts should not be accounted for as a reduction of cost of goods sold for the period
when payments are made. Cost of goods sold should be reduced when the earnings process is
(c) Cash discounts should be accounted for as a direct reduction of purchase cost because they
CA 8-5
(a) 1. Inventories are unexpired costs and represent future benefits to the owner. A balance sheet
2. Beginning and ending inventories are included in the computation of net income only for
the purpose of arriving at the cost of goods sold during the period of time covered by the
statement. Goods included in the beginning inventory which are no longer on hand are expired
costs to be matched against revenues earned during the period. Goods included in the ending
inventory are unexpired costs to be carried forward to a future period, rather than expensed.
(b) Financial accounting has as its goal the proper reporting of financial transactions and events in
accordance with generally accepted accounting principles. Income tax accounting has as its goal
the reporting of taxable transactions and events in conformity with income tax laws and regulations.
(c) FIFO and LIFO are inventory costing methods employed to measure the flow of costs. FIFO
CA 8-6
(a) Inventory profits occur when the inventory costs matched against sales are less than the replace–
ment cost of the inventory. The cost of goods sold therefore is understated and net income is con–
sidered overstated. By using LIFO (rather than some method such as FIFO), more recent costs
are matched against revenues and inventory profits are thereby reduced.
CA 8-6 (Continued)
(b) As long as the price level increases and inventory quantities do not decrease, a deferral of income
CA 8-7
(a) The average-cost method assumes that inventories are sold or issued evenly from the stock on
hand; the FIFO method assumes that goods are sold or used in the order in which they are
purchased (i.e., the first goods purchased are the first sold or used); and the LIFO method
matches the cost of the last goods purchased against revenue.
(b) The weighted-average-cost method combines the cost of all the purchases in the period with the
CA 8-8
(a) 1. The LIFO method (periodic) allocates costs on the assumption that the last goods purchased
2. The dollar-value method of LIFO inventory valuation is a procedure using dollars instead of
units to measure increments or reductions in inventory. The method presumes that goods in
the inventory can be classified into pools or homogenous groups. After the grouping into pools
the ending inventory is priced at the end-of-year prices and a price index number is applied to
CA 8-8 (Continued)
(b) The advantages of the dollar-value method over the traditional LIFO method are as follows:
1. The application of the LIFO method is simplified because, under the pooling procedure, it is not
necessary to assign costs to opening and closing quantities of individual items. As a result,
LIFO liquidation is less possible.
The disadvantages of the dollar-value method as compared to the traditional LIFO method are
as follows:
1. Due to technological innovations and improvements over time, material changes in the com–
position of inventory may occur. Items found in the ending inventory may not have existed
during the base year. Thus, conversion of the ending inventory to base-year prices may be
(c) The basic advantages of LIFO are:
1. Matching—In LIFO, the more recent costs are matched against current revenues to provide a
better measure of current earnings.
2. Tax benefits—As long as the price level increases and inventory quantities do not decrease, a
deferral of income taxes occurs.
The major disadvantages of LIFO are:
1. Reduced earnings—Because current costs are matched against current revenues, net income
is lower than it is under other inventory methods when price levels are increasing.
2. Inventory understated—The inventory valuation on the balance sheet is ordinarily outdated
because the oldest costs remain in inventory.
CA 8-9
(a) A LIFO pool is a group of similar items which are combined and accounted for together under the
LIFO inventory method.
(d) Price indexes are used in the dollar-value LIFO method to: (1) convert the ending inventory at
current year-end cost to base-year cost, and (2) determine the current-year cost for each inventory
layer other than the base-year layer.
(e) The dollar-value LIFO method measures the increases and decreases in a pool in terms of total
dollar value, not by the physical quantity of the goods in the inventory pool. As a result, the dollar–
CA 8-10
(a) FIFO (Amounts in thousands, except earnings per share)
2014
2015
2016
Sales revenue
$11,000
$12,000
$15,600
Cost of goods sold
Beginning inventory
8,000
7,200
9,000
Purchases
8,000
9,900
12,000
Cost of goods available for sale
16,000
17,100
21,000
1. Ending inventory*
(7,200)
(9,000)
(9,000)
Cost of goods sold
8,800
8,100
12,000
Gross profit
2,200
3,900
3,600
Operating expense (15% of sales)
Depreciation expense
300
Income before taxes
250
1,800
Income tax expense (40%)
100
720
2. Net income
$ 150
$ 1,080
CA 8-10 (Continued)
2014
2015
2016
3. Earnings per share
$ 0.15
$ 1.08
$ 0.58
4. Cash balance
Beginning balance
$ 400
$ 1,150
$ 230
Sales proceeds
Purchases
Operating expenses
Property, plant, and equipment
Income taxes
(100)
(720)
Dividends
(150)
Ending balance
LIFO (Amounts in thousands, except earnings per share)
2014
2015
2016
Sales revenue
$11,000
$12,000
$15,600
Cost of goods sold
Beginning inventory
8,000
7,200
8,100
Purchases
8,000
9,900
12,000
Cost of goods available for sale
16,000
20,100
1. Ending inventory**
(7,200)
Cost of goods sold
8,800
9,000
12,900
Gross profit
2,200
3,000
2,700
Operating expense
Depreciation expense
300
300
300
Income before taxes
900
2. Net income
$ 150
$ 540
$ 36
3. Earnings per share
$ 0.15
$ 0.54
$ 0.04
CA 8-10 (Continued)
2014
2015
2016
4. Cash balance
Beginning balance
$ 400
$ 1,150
$ 590
Sales proceeds
11,000
12,000
15,600
Operating expenses
Dividends
(b) According to the computation in (a), Harrisburg Company can achieve
the goal of income tax savings by switching to the LIFO method. As
shown in the schedules, under the LIFO method, Harrisburg will have
CA 8-11
(a) Major stakeholders are investors, creditors, Wilkens’ management
(including the president and plant accountant), and other employees
of Wilkens Company. The inventory purchase in this instance reduces
net income substantially and lowers Wilkens Company’s tax liability.
(b) No, the president would not recommend a year-end inventory pur–
chase because under FIFO there would be no effect on net income.
FINANCIAL STATEMENT ANALYSIS CASE 1
(a)
Sales ………………………………………………………………
$618,876,000
Cost of goods sold* …………………………………………
474,206,000
Gross profit …………………………………………………….
144,670,000
Selling and administrative expense …………………..
Income from operations …………………………………..
Other expense …………………………………………………
Income before income tax ………………………………..
$ 17,846,000
$475,476,000
(b) $17,846,000 income before taxes X 46.6% tax = $8,316,236 tax;
(c) No, the use of different costing methods does not necessarily mean
that there is a difference in the physical flow of goods. As explained
the physical flow of the goods.
FINANCIAL STATEMENT ANALYSIS CASE 2
(a) The most likely physical flow of goods for a pharmaceutical manufac-
turer would be FIFO; that is, the first goods manufactured would be the
(b) Noven should consider first whether the inventory costing method
will make a difference. If the prices in the economy, especially if the
(c) This amount is likely not shown in a separate inventory account
because it is immaterial; that is, it is not large enough to make a differ-
ence with investors. Another possible reason is that no goods have yet
FINANCIAL STATEMENT ANALYSIS CASE 3
Feb. 25
Feb. 26
Feb. 27
2012
2011
2010
Revenues …………………………..…
$36,100
$37,534
$40,597
Cost of sales …………………………
28,010
29,124
31,444
(264)
FIFO adjusted cost of sales …….
(a)
2012
2011
(1)
Inventory turnover @LIFO
12.67
12.63
(2)
Inventory turnover @FIFO
11.18
(b)
2012
2011
(1)
Inventory turnover using sales and LIFO
16.33
16.28
(2)
Inventory turnover using sales and FIFO
14.55
(c) Using sales instead of cost of goods sold accounts for the mark-up in
the inventory. By using cost of goods sold, there is a better matching
of the costs associated to inventory, and should result in more useful
information.
ACCOUNTING, ANALYSIS, AND PRINCIPLES
Accounting
(a) FIFO
Residential pumps:
Ending inventory cost = (300 X $500) + (200 X $475) = $ 245,000
Commercial pumps:
Ending inventory at cost = (500 X $1,000) = $ 500,000
Total ending inventory at cost = $245,000 + $500,000 = $ 745,000
Total cost of goods sold = $1,305,000 + $400,000 = $1,705,000
(b) Dollar-value LIFO (one pool)
Current
Inventory at
base cost
Conversion
price index
Inventory at
LIFO cost
Ending inventory
Base inventory ($80,000 + $480,000)
$560,000
1.000
$560,000
Layer ($600,000 – $560,000)
ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued)
Analysis
(a) The purpose of a current ratio is to provide some indication of the
resources the company has available to meet short term obligations,
lower values.
(b) The U.S. Securities and Exchange Commission requires companies
using LIFO to disclose the current cost of their inventories. Many
Principles
Companies can change from one inventory accounting method to
another, but not back and forth. Changes in accounting method (when
not mandated by a regulatory body such as the FASB) should be to
PROFESSIONAL RESEARCH
(a) According to FASB ASC 605-15-15:
15-2 The guidance in this Subtopic applies to the following
transactions:
a. Sales in which a product may be returned, whether as a
matter of contract or as a matter of existing practice, either
by the ultimate customer or by a party who resells the
b. Sales by a manufacturer who repurchases the product subject
to an operating lease with the buyer.
(b) The guidance in this subtopic (FASB ASC 605-15-15) does not apply to
the following transactions:
c. Sales transactions in which a customer may return defective goods,
such as under warranty provisions. (See Topic 460 regarding war–
PROFESSIONAL RESEARCH (Continued)
> Right of Return (FASB ASC 605-15)
05-3 It is the practice in some industries for customers to be given the
right to return a product to the seller under certain circumstances.
(c) Yes, different industries should be allowed to make different types of
policies. (FASB ASC 605-15-05).
05-4 Sometimes, the returns occur very soon after a sale is made, as
(d) According to FASB ASC 605-15-25:
25-3 The ability to make a reasonable estimate of the amount of future
returns depends on many factors and circumstances that will vary
from one case to the next. However, any of the following factors
may impair the ability to make a reasonable estimate:
PROFESSIONAL RESEARCH (Continued)
25-4 The existence of one or more of the factors in the preceding
PROFESSIONAL SIMULATION
Explanation
To: Norwel Management
From: Student
Re: Advantages of LIFO
The major advantages of the LIFO inventory method include better matching
of costs with revenues, deferral of income taxes, improved cash flow, and
minimization of the impact of future price declines on future earnings.