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.
1, 2, 3, 4,
5, 6, 8, 9
1, 3
1, 2, 3,
4, 5, 6
1, 2, 3
1, 2, 3, 5
5.
Flow assumptions.
12, 13, 16,
18, 20
5, 6, 7
9, 13, 14,
15, 16, 17,
18, 19, 20,
21, 22
1, 4, 5,
6, 7
5, 6, 7, 8, 11
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Questions
Brief
Exercises
Exercises
Problems
Concepts
for
Analysis
1. Identify major classifications of inventory.
1
1
2. Distinguish between perpetual and
periodic inventory systems.
3
2
4, 9, 13,
17
4, 5, 6
financial statements.
4. Understand the items to include as
inventory cost.
8
3
1, 2, 3, 4,
5, 6, 7, 8
1, 2, 3
CA8-1,
CA8-2,
CA8-4
18, 19, 20,
22
CA8–10
6. Explain the significance and use of a
LIFO reserve.
13, 18
21
CA8–11
7. Understand the effect of LIFO
liquidations.
20
8. Explain the dollar-value LIFO method.
14, 15, 17,
19
8, 9
22, 23, 24,
25, 26
1, 8, 9,
10, 11
CA8-9
of LIFO.
CA8-8,
inventory methods.
2
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
Level of
Difficulty
Time
(minutes)
E8-1
Inventoriable costs.
Moderate
15–20
E8-2
Inventoriable costs.
Moderate
10–15
E8-3
Inventoriable costs.
Simple
10–15
E8-4
Inventoriable costs—perpetual.
Simple
10–15
E8-5
Inventoriable costs—error adjustments.
Moderate
15–20
E8-6
Determining merchandise amounts—periodic.
Simple
10–20
E8-7
Purchases recorded net.
Simple
10–15
E8-8
Purchases recorded, gross method.
Simple
20–25
E8-9
Periodic versus perpetual entries.
Moderate
15–25
E8–10
Inventory errors—periodic.
Simple
10–15
E8–11
Inventory errors.
Simple
10–15
E8–12
Inventory errors.
Moderate
15–20
E8–13
FIFO and LIFO—periodic and perpetual.
Moderate
15–20
E8–14
FIFO, LIFO and average-cost determination.
Moderate
20–25
E8–15
FIFO, LIFO, average-cost inventory.
Moderate
15–20
E8–16
Compute FIFO, LIFO, average-cost—periodic.
Moderate
15–20
E8–17
FIFO and LIFO—periodic and perpetual.
Simple
10–15
E8–18
FIFO and LIFO; income statement presentation.
Simple
15–20
E8–19
FIFO and LIFO effects.
Moderate
20–25
E8–20
FIFO and LIFO—periodic.
Simple
10–15
E8–22
Alternate inventory methods—comprehensive.
Moderate
25–30
E8–23
Dollar-value LIFO.
Simple
E8–24
Dollar-value LIFO.
Simple
15–20
E8–25
Dollar-value LIFO.
Moderate
20–25
E8–26
Dollar-value LIFO.
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.
Simple
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.
Moderate
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 costs.
Moderate
15–20
CA8-2
Inventoriable costs.
Moderate
15–25
CA8-3
Inventoriable costs.
Moderate
25–35
CA8-4
Accounting treatment of purchase discounts.
Simple
15–25
CA8-5
General inventory issues.
Moderate
20–25
CA8-6
LIFO inventory advantages.
Simple
15–20
CA8-7
Average-cost, FIFO, and LIFO.
Simple
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
SOLUTIONS TO CODIFICATION EXERCISES
CE8-1
(a) Inventory is the aggregate of those items of tangible personal property that have any of the
following characteristics:
a. Held for sale in the ordinary of business.
b. To process of production for such sale.
c. To be currently consumed in the production of goods or services to be available for sale.
The term inventory embraces goods awaiting sale (the merchandise of a trading concern and the
finished goods of a manufacturer), goods in the course of production (work in process), and goods
(b) A customer is a reseller or a consumer, either an individual or a business that purchases a
vendor’s products or services for end use rather than for resale. This definition is consistent with
paragraph 280-10–50-42, which states that a group of entities known to a reporting entity to be
under common control shall be considered as a single customer, and the federal government, a
state government, a local government (for example, a country or municipality), or a foreign
government each shall be considered as a single customer.
45–19 Many sellers charge customers for shipping and handling in amounts in amounts that exceed
the related costs incurred. The components of shipping and handling costs, and the
determination of the amounts billed to customers for shipping and handling, may differ from
CE8-2 (Continued)
45–20 For those entities that determine under the indicators listed in paragraphs 605–45–45-4 through
45-18 that shipping and handling fees shall be reported gross, all amounts billed to a customer
45–21 Also, shipping and handling costs shall not be deducted from revenues (that is, netted against
shipping and handling revenues).
CE8-3
FASB ASC 330-10–35-1 and 15 with respect to adjustments to Lower of Cost or Market:
35-1 A departure from the cost basis of pricing the inventory is required when the utility of the goods
is no longer as great as their cost. Where there is evidence that the utility of goods, in their
35–15 Only in exceptional cases may inventories properly be stated above cost. For example,
precious metals having a fixed monetary value with no substantial cost of marketing may be
CE8-4
FASB ASC 330-10-S99-3 (SAB Topic 11.F, LIFO Liquidations) The following is the text of SAB
Topic 11.F, LIFO Liquidations.
Facts: Registrant on LIFO basis of accounting liquidates a substantial portion of its LIFO inventory and
as a result includes a material amount of income in its income statement which would not have been
recorded had the inventory liquidation not taken place.
Question: Is disclosure required of the amount of income realized as a result of the inventory liquidation?
ANSWERS TO QUESTIONS
1. In a retailing concern, inventory normally consists of only one category that is the product awaiting
resale. In a manufacturing company, inventories consist of raw materials, work in process, and
finished goods. Sometimes a manufacturing or factory supplies inventory account is also included.
2. (a) Inventories are unexpired costs and represent future benefits to the owner. A statement of
(b) 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 state-
inventory are unexpired costs to be carried forward to a future period, rather than expensed.
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
own this merchandise and therefore it is inappropriate for it to recognize this merchandise as part
of its inventory.
5. Product financing arrangements are essentially off-balance-sheet financing devices. These arrange-
6. (a) Inventory.
(b) Not shown, possibly in a note to the financial statements if material.
7. 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
8. 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
Questions Chapter 8 (Continued)
9. 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
in processing the goods up to the time of sale.
10. Cash discounts (purchase discounts) should not be accounted for as financial income when pay-
11. $60.00, $63.00, $61.80. (Freight-In not included for discount.)
12. 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 specifi–
cally identified with the sales price.
Arguments against the specific identification method include the following:
(1) The cost of using it restricts its use to goods of high unit value.
13. 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
Questions Chapter 8 (Continued)
probably least similar to current replacement costs. On the other hand, this method produces a
balance sheet value for the asset close to current replacement costs. It is claimed that FIFO is
deceptive when used in a period of rising prices because the reported income is not fully available
since a part of it must be used to replace inventory at higher cost.
The results achieved by the average-cost method resemble those of the specific identification
If it is assumed that actual cost is the appropriate method of valuing inventories, last-in, first-out is
not theoretically correct. In general, LIFO is directly adverse to the specific identification method
because the goods are not valued in accordance with their usual physical flow. An exception is the
application of LIFO to piled coal or ores which are more or less consumed in a LIFO manner.
Proponents argue that LIFO provides a better matching of current costs and revenues.
14. 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
15. 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
Questions Chapter 8 (Continued)
16. The LIFO method results in a smaller net income because later costs, which are higher than
17. 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.
18. (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.
19.
December 31, 2014 inventory at December 31, 2013 prices, $1,053,000 ÷ 1.08 ………..
$975,000
Less: Inventory, December 31, 2013 …………………………………………………………………..
800,000
Increment added during 2014 at December 31, 2014 prices, $175,000 X 1.08 …………..
$189,000
Add: Inventory at December 31, 2013 ………………………………………………………………….
800,000
20. 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.
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 8-1
RIVERA COMPANY
Balance Sheet (Partial)
December 31
Current assets
Cash …………………………………………………………..
$ 190,000
Receivables (net) …………………………………………
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
BRIEF EXERCISE 8-4
Cost of goods sold as reported ……………………………………….
$1,400,000
Overstatement of 12/31/13 inventory ……………………………….
(110,000)
Overstatement of 12/31/14 inventory ……………………………….
Overstatement of 12/31/14 inventory ……………………………….
BRIEF EXERCISE 8-5
Weighted average cost per unit
$11,850
=
$ 11.85
1,000
Cost of goods available for sale
$11,850
Deduct ending inventory
4,740
BRIEF EXERCISE 8-6
April 23
350 X $13
=
$ 4,550
April 15
50 X $12
=
600
Ending inventory
Cost of goods available for sale
$11,850
Deduct ending inventory
5,150
BRIEF EXERCISE 8-7
April 1 250 X $10 =
$ 2,500
April 15 150 X $12 =
1,800
Cost of goods available for sale
Deduct ending inventory
4,300
BRIEF EXERCISE 8-8
2013
$100,000
2014
$119,900 ÷ 1.10 = $109,000
$100,000 X 1.00 ……………………………………………………
$100,000
$9,000* X 1.10 ………………………………………………………
9,900
$109,900
$100,000 X 1.00 ……………………………………………………
$100,000
$9,000 X 1.10 ……………………………………………………….
9,900
$118,020
**$116,000 – $109,000
BRIEF EXERCISE 8-9
2014 inventory at base amount ($22,140 ÷ 1.08)
$ 20,500
2013 inventory at base amount
(19,750)
Increase in base inventory
$ 750
Layer one $19,750 X 1.00
Layer two $ 750 X 1.08
2014 inventory at base amount
Increase in base inventory
Layer one $19,750 X 1.00
Layer two $ 750 X 1.08
Layer three $ 2,250 X 1.14
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.
4. Not reported in the financial statements.
6. 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
Goods in transit from vendor, f.o.b. seller
+ 51,000
EXERCISE 8-3 (10–15 minutes)
1. Include. Ownership of the merchandise passes to customer only
when it is shipped.
2. Do not include. Title did not pass until January 3.
EXERCISE 8-4 (10–15 minutes)
1.
Raw Materials Inventory …………………………..
8,100
Accounts Payable …………………………………………..
8,100
2.
Raw Materials Inventory …………………………..
28,000
Accounts Payable …………………………………………..
28,000
3.
No adjustment necessary.
Accounts Payable …………………………………………………..
7,500
Raw Materials Inventory …………………………..
7,500
Raw Materials Inventory …………………………..
Accounts Payable …………………………………………..
19,800
EXERCISE 8-5 (15–20 minutes)
(a)
Inventory December 31, 2014 (unadjusted)
$234,890
Transaction 2
13,420
Transaction 3
-0-
Transaction 4
-0-
Transaction 5
Transaction 6
Transaction 7
Transaction 8
Inventory December 31, 2014 (adjusted)
$237,392
(b)
Transaction 3
Sales Revenue ………………………………………..
12,800
Accounts Receivable …………………………..
12,800
(To reverse sale entry in 2014)
Transaction 4
Purchases (Inventory) ……………………………..
Accounts Payable …………………………..
Transaction 8
Sales Returns and Allowances…………………
Accounts Receivable ………………………
EXERCISE 8-6 (10–20 minutes)
2013
2014
2015
Sales
$290,000
$360,000
$410,000
Sales Returns
(11,000)
(13,000)
(20,000)
Net Sales
279,000
347,000
390,000
Beginning Inventory
Ending Inventory
Purchases
242,000
260,000
Purchase Returns and Allowances
Cost of Good Sold
*This was given as the beginning inventory for 2014.
**This was calculated as the ending inventory for 2014.
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
Accounts Payable …………………………..
13,068
($13,200 X .99)
May 19
Accounts Payable …………………………..
14,700
Cash ……………………………………………………….
14,700
May 24
Purchases ……………………………………………………….
11,270
Accounts Payable
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 ……………………………………………………….
2,250
Feb. 13
Accounts Payable ($9,720 – $2,250) …………………………
7,470
Inventory (3% 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 (3% 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 (3% 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 …………………………..
1,050
Sales Revenue (120 X $8.75) …………………………..
Jan. 20
Purchases (160 X $7) …………………………..
1,120
Accounts Payable …………………………..
Jan. 27
Accounts Receivable …………………………..
900
Sales Revenue (100 X $9) …………………………..
900
Jan. 31
Inventory ($7 X 110) …………………………..
770
Cost of Goods Sold…………………………..
1,750*
Purchases ($900 + $1,120) …………………………..
2,020
Inventory (100 X $5) …………………………..
500
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) +
(100 X $6)] ……………………………………………………
700
Jan. 20
Inventory ……………………………………………………….
1,120
Accounts Payable (160 X $7) …………………………..
1,120
Jan. 27
Accounts Receivable …………………………..
900
Sales Revenue (100 X $9) …………………………..
Cost of Goods Sold …………………………..
650
Inventory [(50 X $6) +
(d)
Sales revenue