Four Methods of Inventory Valuation

CHAPTER 8 ALTERNATE PROBLEMS

Problem 8.1A

Four Methods of Inventory Valuation

On January 27, 2002, Nilesome, Inc. sold 800 widgets to Warren Supplies. Immediately prior to this sale, Nilesome’s perpetual inventory records for widgets included the following cost layers:

Purchase DateQuantityUnit CostTotal Cost

Dec. 9, 2001...... 500$30$15,000

Jan. 19, 2002...... 1,0003333,000

Total on hand...... 1,500$48,000

Instructions

Note: We present this problem in the normal sequence of the accounting cycle – that is, journal entries before ledger entries. However, you may find it helpful to work part b first.

Prepare a separate journal entry to record the cost of goods sold relating to the January 27 sale of 800 widgets, assuming that Nilesome uses:

1.Specific identification (400) of the units sold were purchased on December 9, and the remaining 400 were purchased on January 19).

2.Average cost.

3.FIFO.

4.LIFO.

Complete a subsidiary ledger record for widgets using each of the four inventory valuation methods listed above. Your inventory records should show both purchases of this product, the sale on January 19, and the balance on hand at December 9, January 19, and January 27. Use the formats for inventory subsidiary records illustrated in Chapter 8 of the text.
Refer to the cost of goods sold figures computed in part a. For financial reporting purposes, can the company use the valuation method that resulted in the lowest cost of goods sold if, for tax purposes, it used the method that resulted in the highest cost of goods sold? Explain.

Problems 8.2A and 8.3A are based on the following data:

Land Travel sells ATVs. One of Land Travel’s most popular models is the Morado. During the current year, Land Travel purchased eight of these cycles at the following costs:

UnitsUnitTotal

Purchase DatePurchasedCostCost

Apr. 1...... 3$3,700$11,100

Apr. 17...... 43,90015,600

May 5...... 34,00012,000

10$38,700

On April 25, Land Travel sold four Morado’s to the Julie Sports racing team. The remaining six ATVs remained in inventory at June 30, the end of Land Travel’s fiscal year.

Problem 8.2A

Alternative Cost Flow Assumptions in a Perpetual System

Assume that Land Travel uses a perpetual inventory system. (See the data give on page 8-2.)

Instructions

Compute (a) the cost of goods sold relating to the sale on April 25 and (b) the ending inventory of Morado ATVs at June 30, using the following cost flow assumptions:

1.Average cost (Round cost to nearest whole dollar)

2.FIFO

3.LIFO

Show the number of units and the unit costs of each layer comprising the cost of goods sold and ending inventory.

Using the cost figures computed in part a, answer the following questions:

1.Which of the three cost flow assumptions will result in Land Travel reporting the highest net income for the current year? Would this always be the case? Explain.

2.Which of the three cost flow assumptions will minimize the income taxes owed by Land Travel for the year. Would you expect this usually to be the case? Explain.

3.May Land Travel use the cost flow assumption that results in the highest net income for the current year in its financial statements, but use the cost flow assumption that minimizes taxable income for the current year in its income tax return? Explain.

Problem 8.3A

Alternative Cost Flow Assumptions in a Periodic System

Assume that Land Travel uses a periodic inventory system. (See the data give on page 8-2.)

Instructions

Compute (a) the cost of goods sold relating to the sale on April 25 and (b) the ending inventory of Morado ATVs at June 30, using the following cost flow assumptions:

1.Average cost

2.FIFO

3.LIFO

Show the number of units and the unit costs of each layer comprising of the ending inventory. You may determine the cost of goods sold by deducting ending inventory from the cost of goods available for sale.

If Land Travel uses the LIFO cost flow assumptions for financial reporting purposes, can it use the FIFO method for income tax purposes? Explain.

Problem 8.4A

Year-End Adjustments; Shrinkage Losses and LCM

Mike’s Bikes uses a perpetual inventory system. At December 31, the perpetual inventory records indicate the following quantities of a particular bike:

UnitTotal

QuantityCostCost

First purchase (oldest)...... 100$130$13,000

Second purchase...... 13014018,200

Third purchase...... 70150 10,500

Total...... 300$41,700

A year-end physical inventory, however, shows only 290 of these bikes on hand.

In its financial statements, Mike’s values its inventories at the lower-of-cost-or-market. At year-end, the per-unit replacement cost of this tree is $155.

Instructions

Prepare the journal entries required to adjust the inventory records at year-end assuming that:

Mike’s uses:

1.Average cost

2.Last-in, first-out

Mike’s uses the first-in, first-out method. However, the replacement cost of the bikes at year-end is $120 apiece, rather than $155 stated originally. (Make separate journal entries to record (1) the shrinkage losses and (2) the restatement of the inventory at a market value lower than cost. Record the shrinkage losses fist.)
Assume that the company had been experiencing monthly inventory shrinkage of 20 to 30 bikes for several months. In response, management placed several hidden security cameras throughout the premises. Within days, an employee was caught on film loading bikes into his pickup truck. The employee’s attorney asked that the case be dropped because the company had “unethically used a hidden camera to entrap his client.” Do you agree with the attorney? Defend your answer.

Problem 8.5A

Periodic Inventory Costing Procedures

Viking Sound uses a period inventory system. One of the store’s products is Dynomak. The inventory quantities, purchases, and sales of this produce for the most recent year are as follows:

NumberCostTotal

of Unitsper UnitCost

Inventory, Jan. 1...... 30$100$ 3,000

First purchase...... 401024,080

Second purchase...... 601056,300

Third purchase...... 101071,070

Fourth purchase...... 60108 6,480

Goods available for sale...... 200$20,930

Units sold during the year...... 160

Inventory, Dec. 31...... 40

Instructions

Using periodic costing procedures, compute the cost of the December 31 inventory and the cost of goods sold for the year under each of the following cost assumptions:

1.First-in, first-out

2.Last-in, first-out

3.Average cost (Round to the nearest dollar, except unit cost.)

Which of the three inventory pricing methods provides the most realistic balance sheet valuation of inventory in the light of the current replacement cost of the Dynomaks? Does this same method also produce the most realistic measure of income in light of the costs being incurred by Viking Sound to replace the Dynomaks when they are sold? Explain.

Problem 8.6A

Effects of Inventory Errors on Earnings

The owners of Gel Hardware are offering the business for sale. The income statements of the business for the three years of its existence are summarized below.

200220012000

Net sales...... $950,000$900,000$800,000

Cost of goods sold...... 589,000585,000 536,000

Gross profit on sales...... $361,000$315,000$264,000

Gross profit percentage...... 38%35%33%

In negotiations with prospective buyers of the business, the owners of Gel are calling attention to the rising trends of the gross profit and of the gross profit percentage as very favorable elements

Assume that you are retained by a prospective purchaser of the business to make an investigation of the fairness and reliability of the enterprise’s accounting records and financial statements. You find everything in order except for the following: (1) An arithmetic error in the computation of inventory at the end of 2000 has caused a $30,000 understatement in that inventory and (2) a duplication of figures in the computation of inventory at the end of 2002 had caused an overstatement of $90,000 in that inventory. The company uses the periodic inventory system and these errors have not been brought to light prior to your investigation.

Instructions

Prepare a revised three-year schedule similar to the one illustrated in Chapter 8 of the text.
Comment on the trend of gross profit and gross profit percentage before and after the revision.

Problem 8.7A

Retail Method

Over-the-Top is a popular music store. During the current year, the company’s cost of goods available for sale amounted to $416,000. The retail sales value of this merchandise amounted to $800,000. Sales for the year were $620,000.

Instructions

Using the retail method, estimate (1) the cost of goods sold during the year and (2) the inventory at the end of the year.
At year-end, Over-the-Top takes a physical inventory. The general manager walks through the warehouse counting each type of product and reading its retail price into a tape recorder. From the recorded information, another employee prepares a schedule listing the entire ending inventory at retail sales prices. The schedule prepared for the current year reports ending inventory at $170,000 at retail sales prices.

1.Use the cost ratio computed in part a to reduce the inventory counted by the general manager from its retail value to an estimate of its costs.

2.Determine the estimated shrinkage losses (measured at cost) incurred by Over-the-Top during the year.

3.Computer Over-the-Top’s gross profit for the year. (Include inventory shrinkage losses in the cost of goods sold.)

What controls might Over-the-Top implement to reduce inventory shrinkage?

Alternate Problems for use with Financial and Managerial Accounting, 12e8-1