instructor's manual chapter (8)
TRANSCRIPT
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Chapter 08 - Inventories and The Cost of Goods Sold
8 INVENTORIES ANDTHE COST OF GOODS SOLD
Chapter Summary
The chapter is a detailed introduction to the cost flow assumptions used to value inventories andmeasure the cost of goods sold.
Application of specific identification, average cost, I! and "I! is first e#amined within theconte#t of a perpetual inventor$ s$stem. The impact of the flow assumption emplo$ed on income ta#es isdiscussed in detail. The need for a ph$sical inventor$ to assess inventor$ shrin%age is also reviewed as are
the accounting procedures necessar$ to record inventor$ shrin%age. A &rief presentation of lower-of-cost-or-mar%et write downs concludes the discussion of perpetual s$stems.
Application of the flow assumptions within a periodic s$stem is ne#t e#plained. 'e alsodemonstrate that restatement of ending inventor$ &$ the periodic method results in the ma#imum ta#advantage from the "I! flow assumption.
The chapter covers a num&er of additional issues surrounding inventor$ accounting. Theseinclude( the financial statement effects of inventor$ errors) the retail and gross profit methods for estimatingending inventor$) and, an anal$sis of the inventor$ turnover ratio.
Learning Objectives
1. In a p er pe t u al inv en to r$ s$s te m , d et er m in e th e cos t of goo ds sold usin g *a+s pec i fi c i dent i f ica t i o n , *&+ av er a g e co st , * c+ FIFO , a nd *d+ LIFO. iscusst he adv an tag es and sh or tco mi n g s of each met h o d.
2. #plain the need for ta%ing a ph$sical inventor$.
3. ecord s hr in k a g e lo s s e s and o ther $ear -end ad/us tments to inven tor$.
4. In a per iodic inventor$ s$s tem, determine the ending inventor$ and the cos t o fgoods sold using
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goods sold using
Chapter 08 - Inventories and The Cost of Goods Sold
6 irst-in, first-out method
7 "ast-in, first-out method# valuation of the methodsa Specific identification$ Average costc irst-in, first-outd "ast-in, first-out
% o inventor$ methods reall$ affect performance1& The principle of consistenc$11 2ust-in-time *2IT+ inventor$ s$stem - see Case in Point*page 34#+
' Ta%ing a ph$sical inventor$1 ecording shrin%age losses2 "C3 and other write-downs of inventor$
a The lower-of-cost-or-mar%et *"C3+ rule3 The $ear-end cutoff of transactions
a 3atching revenue and the cost of goods sold$ Goods in transit - see Your Turn*page 351+
4 4eriodic inventor$ s$stemsa Appl$ing flow assumption in a periodic s$stem$ Specific identificationc Average costd I!e "I! - see Case in Point*page 353+f eceiving the ma#imum ta# &enefit from the "I! methodg 4ricing the $ear-end inventor$ &$ computer
5 International inancial eporting Standards6 Importance of an accurate valuation of inventor$
a ffects of an error in valuing ending inventor$$ Inventor$ errors affect two $earsc ffects of errors in inventor$ valuation( a summar$
7 Techni5ues for estimating the cost of goods sold and the ending inventor$# The gross profit method
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Chapter 08 - Inventories and The Cost of Goods Sold
Topical coverage and suggested assignment
*ome+ork "ssignment,-o 'e (ompleted rior to (lass/
(lass0eetings on
(hapter
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(overage)isc!ssion!estions
'riefercises ercises ro$lems
(ritical-hinking
(ases
1 A 1, 7, 1, 7, 7, 17 9 :, ;,
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Chapter 08 - Inventories and The Cost of Goods Sold
General comments
As in the previous edition, we emphasie the perpetual inventor$ s$stem primaril$ &ecause this is themethod now in predominant use. Teaching with an emphasis on perpetual inventor$ s$stems has a num&erof &enefits in the classroom.
!f greatest importance, a perpetual s$stem shifts the focal point of cost assignment from endinginventor$ to the cost of goods sold. As a result, the names of the flow assumptions finall$ ?mean what the$sa$.? or e#ample, ?first-in, first-out? means that the first costs are used in the cost assignment process)?last-in, first-out? means that the last costs are used. Bnder a periodic s$stem, the reverse is true.*#perienced instructors will remem&er tr$ing to e#plain to students that ?first-in, first-out? actuall$ means
that the latest costs are assigned to inventor$, whereas ?last-in, first-out? reall$ means the first costs areassigned.+ot onl$ do students more 5uic%l$ grasp the concepts underl$ing the flow assumptions when we
assume a perpetual inventor$ s$stem, &ut the$ also 5uic%l$ grasp the effects of using different assumptionsduring a period of rising prices. This ena&les us to emphasie the effects of different methods uponearnings, income ta# considerations, and even the implications of "I! reserves.
'e use #ercise 2to illustrate the &asic cost-flow assumptions and follow it with a discussion of#ercise 11 to demonstrate the effects of using alternative methods. #ercise 12 presents a morechallenging anal$sis of the same points. 'e also discuss in class such topics as ?/ust-in-time? s$stems,
inventor$ shrin%age, and the factors management should consider in determining the optimal sie of acompan$@s inventor$. These discussions portra$ inventor$ as ph$sical goods moving in and out of the&usiness, rather than merel$ as a dollar amount. 'e find that these discussions contri&ute to students@interest, and also to their understanding of the importance of inventories to accountants, managers, andinvestors.
Supplemental Exercises
Business WeekExercises
Detailers vs. 9u$ers( 'ho 'ill 9lin% irstE, Business Week, ecem&er 1:, 700, discusses theconse5uences of retailers %eeping stoc%s low for the 700 Fuletide season, while consumers are awaitingsales #plain how e#cessive inventories can hurt a retailers &ottom line
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Chapter 08 - Inventories and The Cost of Goods Sold
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Indicate the &est answer for each 5uest ion in the space provided.
1 The primar$ purpose of an inventor$ flow assumption is to(a Increase inventor$ turnover.$ Increase gross profit.c etermine which uni t cost s are ass igned to inven tor$ and which
are assigned to the cost of goods sold.d 3inimie ta#a&le income during periods of rising prices.
2 uring a period of s teadi l$ rising prices , which of the followinginven tor$ valua tion methods is li%el$ to resul t in the lowes t cost ofgoods solda "I!.$ I!.c The retail method.d The gross profit met hod.
3 The primar$ reason for the populari t$ of the "I! flow assumption isthat this method(a Is most appropriate when each i tem in inventor$ is uni5ue.$ Tends to minimie ta#a&le income.c Causes inventor$ to &e reporte d at or near its current
replacement cost.
d educes the amount of mone$ Dtied upE in inventor$.
4 In a periodic inventor$ s$stem, the cost of goods sold is determined &$(a 3ultipl$ing net sales for the period &$ a cost ratio.
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Chapter 08 - Inventories and The Cost of Goods Sold
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Ace S$st e ms , Inc. us es a per pe tu al inve nt or $ s$s te m. The co mp an $ s&eginni ng inven tor$ of a particular prod uct an d its purchases during themonth of 2anuar$ were as follows(
!ant i t ;ni t (o st -o ta l
(ost
9eginning inventor$ *2an. 1+ .................. 10 J7;.:0 J7;:4urchase *2an. 1:+ ..................................... 1: J78.00 J>704urch as e *2an. 7+ ..................................... : J7: Total ......................................................... 0 J8>0
!n 2anuar$ 78, Ace S$s tems sell s 18 uni ts of thi s product . The other 17units remain in inventor$ at 2anuar$ 1.
1 Re fer to abov e da ta . Assuming that Ace S$s tems uses the average
cost flow assumption, the cost of goods sold to &e recorded at 2anuar$78 is(a J:0>. c J>
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Chapter 08 - Inventories and The Cost of Goods Sold
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Canfield uses a perpetual inventor$ s$stem. The compan$s &eginning inventor$ of aparticul ar product an d its purc hases during the mo nth of 2anua r$ were as follows (
!an ti t ;nit (ost
-otal (ost
9eginning inventor$ *2an. 1+ ...................................... :0 J= J004urchase *2an. 10+ ......................................................... 7: J; J1;:4urch as e *2an. 77+ ......................................................... 7: J8 J700 Total ......................................................................... 100 J=;:
!n 2anuar$ 7:, Canfield sells :: uni ts of this product. The other >: units remain ininventor$ at 2anuar$ 1.
a etermine the cost of goods sold using each of the following flow assum ption s(
*1+ "I! JKKKKKKKKKKKKK
*7+ I! JKKKKKKKKKKKKK
*+ Average cost JKKKKKKKKKKKKK
$ etermine the cost of the >: uni ts in inventor$ a t 2anuar$ 1 using each of thefollowing flow ass um pti ons (
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Chapter 08 - Inventories and The Cost of Goods Sold
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Sherman lec tri c uses a per iodic inven tor$ s$s tem. The &eg inning inven tor$ of aparticul ar product, and the purchases during the curr ent $ear, were as follows (
2an. 1 9eginning inve nt or $ ..................... =0 units L J10: M J =,003ar. 8 4urc ha se ........................................... 0 units L J11 : M , >: 0Aug. 11 4urchase ........................................... oods =old
a Average cost JKKKKKKKKKKKKKKK JKKKKKKKKKKKKKKK
$ irst -in, first -ou t JKKKKKKKKKKKKKKK JKKKKKKKKKKKKKKK
c "ast -in, first -ou t JKKKKKKKKKKKKKKK JKKKKKKKKKKKKKKK
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Chapter 08 - Inventories and The Cost of Goods Sold
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Chapter 08 - Inventories and The Cost of Goods Sold
Assignment Guide to Ch!te" 8
'rief
ercisesercises ro$l e m s (ase s 8et
1 R 10 1- 1:1
7 > : = ; 8 1 7 >
-i me e s t im a t e ,i n m in ! t e s / 10 0
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)iff ic!l t rating 3 3 S 3 S 3 3 3 3 3 Learni n g O$ec t i ves 1, 7
1 , 7 , 11,17
1 . In a p er pe t ! al inv en t or s s t e m?
d et er m in e th e c os t of g o o d s s ol d
! si n g , a/ s p e c if i c id e n ti f ic a t i o n ? , $/
average cos t ? , c/ F IF O? an d ,d/ LIFO.
)is c! s s th e a dv an t a g e s a nd
s ho r tc o m i n g s o f e ac h m et h o d .2 . pl ai n t he n ee d fo r ta ki ng a
p h s i ca l i n ven tor . 1, :
3. e co rd shri nk ag e lo ss e s an d ot he r
e ar : e n d a d ! s t m e n t s t o in v en t o r . = 1,= 4 . In a pe ri od ic inv en t or s s t e m?
d et e r mi n e t he e nd in g in ve n t or a nd
th e c os t of g o o d s s ol d ! s in g , a/
s p e c if i c i d e n ti f ic a t i o n , $/ a v e r a g e
cos t ? , c/ FIFO? an d ,d/ LIFO.
1, 7 , , > ,:
1 , , > , ;
5 . pl ai n t he e ff ec t s o n th e i nc om e
s ta t e m e n t o f e rr or s in i nv e nt o r
val!at ion.
;, 8 1, 8
6. sti ma t e th e c o st of g oo d s s old an d
e nd in g in ve n t or $ t he g ro s s pr of it
m e th o d a nd $ t h e r et a il m et h o d . 1, < , 10 7 . (o mp !t e th e inv en t or t!r no v er ra te
a n d e p l ai n i ts ! s e s . , 1:
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