Chapter 9 Computation Cost Goods Sold During June 2010

P9-12 (AICPA adapted solution)

RED DEPARTMENT STORE

Computation of Estimated Inventory

Using Retail Inventory Method

December 31, 2010

Cost Retail

P9-13

1. Cost Retail

Beginning inventory $ 25,000 $ 60,000

Net purchases ($75,000 – $2,000;

$180,000 – $5,000) 73,000 175,000

P9-13(continued)

2.

Ending inventory at retail: $80,000

Ending inventory at retail in base-year prices: $80,000 ÷ 1.05 = $76,190

P9-14

2010

Cost Retail

Beginning inventory $ 50,000 $100,000

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P9-14(continued)

Change at relevant current costs:

$10,2300.465x

100

108

x$20,370 =

Ending inventory at cost:

Goods available for sale $310,230 $670,000

Less: Sales (600,000)

Ending inventory at retail $ 70,000

P9-14 (continued

Ending inventory at cost:

$60,230 – $29,795 = $30,435 (remaining base-year layer)

2012

Cost Retail

Beginning inventory $ 30,435 $ 70,000

Ending inventory at retail at base-year prices:

2009 2010 2011 2012

Cost Retail Cost Retail Cost Retail Cost Retail

Beginning inventory $ 40,000 $ 80,000 $ 33,333 $ 70,000 $ 39,999 $ 90,000 $ 44,963 $110,000

Cost-to-retail ration: 0.59

80,000$

40,000$

=

125

100

x130,000

104,000

Inventory change at retail at base-year prices:

$ 66,667 – $80,000

(13,333)

P9-15

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P9-16

2010

Cost Retail

Beginning inventory $ 40,000 $ 90,000

Goods available for sale $140,000 $280,000

Less: Sales (200,000)

Ending inventory at retail $ 80,000

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P9-16 (continued)

2011

Cost Retail

Beginning inventory $ 33,550 $ 80,000

Purchases $160,000 $350,000

Ending inventory at retail at base-year prices:

100

$120,000 x = $109,091

110

Inventory change at retail at base-year prices:

$109,091 – $75,472 = $33,619

P9-17

1. Current year: Ending inventory is correctly stated. Net income is overstated

by $17,500 because purchases are understated and, therefore, cost of goods

2. Current year: Ending inventory is understated by $4,300. Net income is

understated by $4,300, because cost of goods sold is overstated.

3. Current and following year: The results for both years will be the same as in 2.

4. Current year: Ending inventory is understated. Net income is correct because

5. Current year: Ending inventory is overstated. Net income is overstated

P9-18 (AICPA adapted solution)

LAYNE CORPORATION

Adjustments to Initial Amounts

As of December 31, 2010

Inventory

Accounts

Payable

Net Sales

Initial amounts

$1,750,000

$1,200,000

$8,500,000

ANSWERS TO CASES

C9-1 (AICPA adapted solution)

1. The retail inventory method can be employed to estimate retail, wholesale, and

manufacturing finished goods inventories.

2. Since the retail method is based on an estimated cost ratio involving total merchandise

available during the period, its validity depends on the underlying assumption that the

C9-1 (continued)

2. (continued)

Where there are a number of inventory subdivisions for which differing rates of markon are

maintained, there is no assurance that the ending inventory mix will be representative of the

total merchandise handled during the period. In such cases, accurate results can be

obtained by subclassifications by rate of markon.

3. The advantages of using the retail method as compared with cost methods include the

following:

4. The treatments to be accorded net markups and net markdowns must be considered in

light of their effects on the estimated cost ratio. If both net markups and net markdowns

are used in arriving at the cost ratio, ending inventory will be converted to an estimated

C9-2 (AICPA adapted solution)

1. THE SHELLY CORPORATION

Computation of Gross Profit Ratio

Sales $840,000

Cost of goods sold

2. Computation of Cost of Goods Sold During June 2010

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C9-2 (continued)

3. Computation of Inventory at June 30, 2010,

by the Gross Profit Method

Inventory, May 31, 2010 $ 95,000

Purchases to June 30, 2010 per

general ledger 800,000

C9-3 (AICPA adapted solution)

a. 1. For its 2011 models, Blaedon should include in inventory carrying amounts all necessary

average net realizable value less the profit margin, if any, assigned.

b. 1. Using FIFO, Blaedon would assign the earliest lawnmower costs to cost of goods sold.

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C9-4 (AICPA adapted solution)

1. If the terms of the purchase are FOB shipping point (manufacturer’s plant), Retail, Inc.,

4. Because Retail, Inc., calculates the estimated cost of its ending inventory using the

conventional (lower-of-cost-or-market) retail inventory method, net markdowns are

5. Products on consignment represent inventories owned by Retail, Inc., which are physically

C9-5 (AICPA adapted solution)

1. (a) Diane’s inventoriable cost includes all costs incurred to get the lighting fixtures ready for

sale to the customer. It includes not only the purchase price of the fixtures but also the

2. (a) The lower of cost or market rule is used for valuing inventories because of the concept

of balance sheet conservatism and because the decline in the utility of the inventories

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C9-5 (continued)

3. Diane’s beginning inventories at cost and at retail are included in the calculation of the cost

ratio.

C9-6 (AICPA adapted solution)

1. Purchases from various suppliers are generally included in Caddell’s inventory when Caddell

3. (a) The advantages of using the dollar value LIFO inventory cost flow method are to

reduce the cost of accounting for inventory according to the LIFO method and to

4. Caddell should account for the inventories consigned to Reed Company as part of

inventory. Caddell retains title to the goods until their sale by Reed; therefore the earnings

process has not been completed.

5. In applying the lower of cost or market method, market does not exceed the ceiling or fall

below the floor. The ceiling is equal to the net realizable value, i.e., estimated selling price

C9-7 (AICPA adapted solution)

1. The insurance costs on the raw materials while they were in transit from the supplier should

2. a. Hanlon’s inventory should be reported at net realizable value. According to the lower

C9-7 (continued)

3. Generally, ending inventory would have been higher and cost of goods sold would have

been lower had Hanlon used the LIFO inventory method. Inventory quantities increased

C9-8 (AICPA adapted solution)

1. Hudson should account for the warehousing costs related to its wholesale inventories as

2. a. The lower of cost or market method produces a more realistic estimate of future cash

flows to be realized from assets, which is consistent with the principle of conservatism,

and recognizes (matches) the anticipated loss in the income statement in the period in

3. a. Hudson’s freight-in costs should be included only in the cost amounts to determine the

cost to retail percentage.

4. By not deducting net markdowns from the retail amounts to determine the cost to retail

percentage, Hudson produces a lower cost to retail percentage than would result if net

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C9-9

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, there are two primary issues. First, if the purchase is

made in the current year, the cost to retail ratio (for purchases) will be reduced because of

From an ethical perspective, both issues involve whether management should make

decisions for the purpose of affecting the amount of income that is reported. Obviously

management may, but should it? The primary stakeholders are the company’s current and

potential stockholders and creditors. Kelly has two incentives for delaying the purchase, but

the effects are short-run and will be counterbalanced in the next period. Also, since the