Chapter 8 The Differences From One Yearend Another Are

P8-14 (continued)

2. (continued)

In 2011, the company experienced an unexpected increase in demand for

3. Purchase of an additional 7,000 units avoids the LIFO liquidation profit and

therefore saves income taxes on that amount.

4. The income tax savings over the 4-year period are equal to the difference in

the inventory values times the income tax rate.

Inventory December 31, 2011:

P8-15

1. MARINO COMPANY

Schedule for Computation of Ending Inventory

Beginning inventory $100,000

Purchases $300,000

Beginning Inventory + Purchases (net) – Cost of Goods Sold = Ending Inventory

$100,000 + $291,264 – $320,000 = $71,264

2. Under the LIFO periodic cost flow assumption, the net purchases for the period

will first be included in cost of goods sold.

8-59

P8-16 (AICPA adapted solution)

1. Inventory per books $60,570

Understatement per client’s computations 3,000

Physical inventory, per client $63,570

2. Corrected physical inventory at November 30 $57,700

Less: Direct labor included $10,000

Overhead included (200% of direct labor) 20,000 (30,000)

Inventory of materials at November 30 $27,700

Add: Purchases 24,700

8-60

P8-17 (AICPA adapted solution)

Inventory

Accounts

Payable

Sales

Initial amounts

Adjustments:

Increase (decrease)

1.

2.

$1,250,000

(155,000)

(22,000)

$1,000,000

(155,000)

None

$9,000,000

None

ANSWERS TO CASES

C8-1 (AICPA adapted solution)

1. a. Inventories are unexpired costs and represent future benefits to the owner. A

statement of financial position includes a listing of unexpired costs and future benefits

as the owner’s assets at a specific point in time. Because inventories are assets owned

2. 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

C8-1 (continued)

3. FIFO and LIFO are inventory costing methods employed to measure the flow of cost. FIFO

matches the first cost incurred with the first revenue produced whereas LIFO matches the

most recent cost incurred with the first revenue produced after the cost is incurred. (This, of

4. The advantages of the dollar value LIFO method result from the use of a cost index and

inventory pools. The dollar value LIFO method requires less detailed record-keeping,

because it is not necessary to record continuously the value of each item in inventory, or to

C8-2 (AICPA adapted solution)

a. 1. When using LIFO, the most recently incurred costs are included in cost of goods sold on

the earnings statement, and the earlier costs are included in the inventory reported on

the statement of financial position. When using FIFO, the earlier costs are included in

cost of goods sold on the earnings statement, and the later, more current costs are

included in the inventory on the statement of financial position.

C8-2 (continued)

a. 2. The use of FIFO as an inventory method results in recognizing all elements of earnings at

the time of sale. Holding gains (or losses) are combined with the operating (trading)

earnings and are not separately identified. Holding gains arise from holding inventory

during periods of rising prices. Operating earnings result from selling a product at a

price above current cost.

Under FIFO, the operating cycle is viewed as cash to merchandise and back to cash

again; therefore, reported earnings are net of goods (actually) sold. An assumed FIFO

b. The account Reserve for Replacement of LIFO Inventory may also be called Excess of

Replacement Cost over LIFO Cost of Basic Inventory Temporarily Liquidated. The use of

this account arises when there are fewer units in ending inventory than in beginning

inventory for a company using LIFO. This sale of part of the inventory results in

8-63

C8-2 (continued)

b. (continued)

C8-3 (AICPA adapted solution)

1. a. Cash discounts should not be accounted for as financial income when payments are

made. Income should be recognized when the earning process is complete (when

Taylor sells the inventory). Furthermore, cash discounts should not be recorded when

the payments are made because in order to properly match a cash discount with the

2. Inventories would be lower using the LIFO inventory method instead of the FIFO method

over a substantial time period when purchase prices of household appliances are rising

because the inventories are at the oldest (lower) purchase prices instead of the most

C8-4 (AICPA adapted solution)

1. a. The specific identification method requires each unit to be clearly distinguished from

similar units either by description, identification number, location, or other

8-64

C8-4 (continued)

1. (continued)

b. It is appropriate for Happlia to use the specific identification method because each

2. a. Happlia should include in inventory carrying amounts all necessary and reasonable

costs to get an appliance into a useful condition and place for sale. Common (or

joint) costs should be allocated to individual units. Such costs exclude the excess costs

3. The 2010 income statement should report in cost of goods sold all inventory costs

C8-5 (AICPA adapted solution)

Arguments in favor of the procedure of the Atgar Corporation are:

1. The net cash price is all that is “surrendered” by the company in exchange for the goods

and, therefore, is the real cost of the purchases.

Arguments against the procedure are principally those of expediency:

1. The gross amount is always shown on the order and on the supplier’s invoice, but the

discounted amount is rarely shown. It is easier to record the invoice as rendered.

C8-5 (continued)

C8-6

1. The correct inventory cost is the invoice price less all available discounts plus related

acquisition and overhead costs:

2. The correct cost would not change if the discount was not taken. The additional $2,000 is

treated as a finance expense for the period and is not included in inventory cost because

3. According to GAAP, “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.” Even if the storage and handling costs are fixed and not

C8-7 (AICPA adapted solution)

1. The average cost method is based on the assumption that the average costs of the goods

in the beginning inventory and the goods purchased during the period should be used for

both the inventory and the cost of goods sold.

8-66

C8-7 (continued)

2. In an inflationary economy, LIFO provides a better matching of current costs with current

3. Where there is evidence that the utility of goods to be disposed of in the ordinary course of

C8-8

1. In an economy of continuing inflation, the LIFO method provides a better matching of

current costs with current revenue, thereby eliminating effects of holding gains (inventory

profit) from net income. Since the units that are sold are replaced at current costs, the

2. Adoption of the LIFO method results in a lower valuation of inventory on the balance sheet,

which affects the computation and evaluation of current assets, working capital, and any

3. There is a difference between the effect of the change to LIFO on earnings and on the

inventory valuation because of two factors. First, the Ford Motor Company was using the

4. Probably, for a Ford dealer (an automobile retailer), the specific identification method of

inventory valuation would be preferable to LIFO. It is the most relevant and consistent

8-67

C8-9

1. The Kelly Company has continued to use FIFO even though it has experienced rising costs

for the last 5 years and expects that trend to continue. It is likely that the primary reason is

to manipulate income because the policy has some significant negative aspects:

a. The payment of additional income taxes.

However, there are several appropriate reasons for the company‘s use of FIFO:

a. To report higher income, perhaps in order to positively affect ratios or management

compensation.

The decision by the King Company to increase the number of LIFO pools it uses to account

for its inventory is difficult to explain. The use of a larger number of pools means that fewer

types of inventory are included in each pool. Therefore, the advantages of LIFO are more

easily lost as quantities of some items decline in a period. It is most likely a change that is

made to manipulate income through the recognition of LIFO liquidation profits, even

though it would result in paying higher income taxes.

2. Students may raise ethical issues such as:

a. Conflicts between the interests of different stakeholders–particularly management and

stockholders.

8-68

C8-9 (continued)

2. (continued)

C8-10

1. To: Robin Smith

From: Student

1. The adoption of a just-in-time (JIT) inventory system.

In the first situation, the holding gain does represent an increase in the wealth of the

company because the inventory will not be replaced. However, you should exclude it from

income in any trend analysis you do because it cannot occur again. It is likely that there will

also be gains in the next year or two as the company continues to implement the system.

particular company.

2. Students may raise ethical issues, such as:

a. Conflicts between the interests of different stakeholders–particularly management and

stockholders.

8-69

C8-11

Note to the Instructor: The student is required to base the answer on the selection of a

particular business.

To avoid exchange gains and losses entirely, and thereby avoid volatile earnings, the

company would have to specify that all its transactions are expressed in terms of dollars.

C8-12

1. Coca-Cola uses the average cost or FIFO methods (p. 74). The company presumably

based its selection on the cost trends in the various parts of its business. Both average cost

2. 2007: $10,406 ÷ $2,220 = 4.69; 2006: $8,164 ÷ $1,641 = 4.98 (p. 66 and p. 67).

3. Inventory 10,985a

Accounts Payable 10,985

C8-13

Note to Instructor: This case does not have a definitive answer. From a financial reporting

perspective, GAAP is identified and summarized. From an ethical perspective, various issues

are raised for discussion purposes.

From a financial reporting perspective, the issue is the costs that should be included in the

cost of the inventory. GAAP specify that cost includes the price paid or the consideration

From an ethical perspective, the primary stakeholders are the professors, the used book

company and its employees, the publisher of the textbook, the authors of the textbook, the

ANSWERS TO RESEARCH SIMULATIONS

R8-1

Note to Instructor: Students are expected to cite references to GAAP in their research of

this issue. They might use the FARS electronic database, pronouncements listed on the FASB

web site, the FASB Original Pronouncements, the FASB Current Text, or other primary sources

of GAAP to obtain these references. They may also use the FASB Accounting Standards

Codification which is cited in parentheses.

To: President, Philip Morris

From: Student

I have researched the issue of “trade loading.” According to FASB Statement of Concepts

8-71

R8-1 (continued)

Unless there are “hidden” agreements between Philip Morris and the distributors, the

transactions do meet the two general revenue recognition criteria and the six specific

R8-2

Note to Instructor: Students are expected to cite references to GAAP in their research of

this issue. They might use the FARS electronic database, pronouncements listed on the FASB

web site, the FASB Original Pronouncements, the FASB Current text, or other primary sources

of GAAP to obtain these references. They may also use the FASB Accounting Standards

Codification which is cited in parentheses.

To: President, Fenimore Company

From: Student

I have researched the issue of which method of accounting for manufacturing cost

variances is consistent with GAAP. According to ARB 43, Chapter 4, par. 6, fn 3 (FASB Cod.

# 330-10-30), standard costs are acceptable for inventory valuation if they are adjusted at