ACO 201 Problems Chapter 6 Solutions, Spring 2013

Brief Exercises B. Ex. 6.1 B. Ex. 6.2 B. Ex. 6.3 Analysis B. Ex. 6.4 B. Ex. 6.5 Analysis B. Ex. 6.6 B. Ex. 6.7 B. Ex. 6.8 B. Ex. 6.9 B. Ex. 6.10 B. Ex. 6.11 6.1 1, 6 6.2 1 6.3 2, 5, 8 6.4 3, 8 6.5 Evaluating performance 6, 8 6.6 3 6.7 4 6.8 4 6.9 5, 8 6.10 Cash discounts 6 6.11 Evaluating performance 8 6.12 3–5 6.13 Periodic inventory system 4, 5 Comparison of inventory systems Analysis, communication Analysis, communication, judgment Analysis Communication, judgment Analysis, communication, judgment Analysis Relationships within periodic inventory systems Selecting an inventory system Analysis, communication, judgment Analysis, communication OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL THINKING CASES Accounts receivable subsidiary ledger Perpetual inventory system - computation of income Periodic inventory system - determine cost of goods sold 2, 3, 8 Periodic inventory system - inventory balance during year 2, 4, 8 Analysis 2, 4, 8 Computation of gross profit Special journals 7 Analysis 8 Communication, judgment Ethics, fraud, and corporate governance 6 Analysis Sales returns and allowances 6 Analysis Benefit of taking a purchase discount 2, 4, 8 Analysis Periodic inventory system - closing process 2, 4 Analysis Periodic inventory system - working backwards through the COGS section 2, 8 Analysis 7 Analysis Learning Topic Objectives Skills Analysis, communication Effects of basic merchandising transactions Analysis, communication, judgment Exercises Understanding inventory cost flows Objectives Perpetual inventory systems Topic Taking a physical inventory Periodic inventory systems CHAPTER 6 MERCHANDISING ACTIVITIES Analysis, communication Analysis, communication Skills You as a student Analysis Learning © The McGraw-Hill Companies, Inc., 2010 Overview 6.14 8 6.15 Using an annual report 8 Problems Sets A, B 6.1 A,B 1, 3, 8 6.2 A,B 1-3, 6, 8 and interpretation 6.3 A,B 8 6.4 A,B 3, 6 6.5 A,B 3, 6 6.6 A,B 2, 3, 6 6.7 A,B 1, 3, 6 6.8 A,B 1–8 6.1 5 6.2 4, 8 6.3 3–5, 7 6.4 8 & corporate governance) 6.5 8 6.6 8 annual report (Internet) technology Learning Objectives Exercises Topic Objectives Topic Skills Learning Analysis, communication Analysis, communication, judgment Trend analysis Analysis, communication Income statement preparation Net cost and gross price methods Merchandising transactions Analysts' evaluation of company (Business Week) Evaluating inventory systems Manipulating income (Ethics, fraud Real World: CVS Corporation Analysis, communication Communication, judgment Critical Thinking Cases Real World: GAP Exploring an Communication, research, Communication, judgment Selecting an inventory system Communication, judgment A cost-benefit analysis Analysis, communication, judgment Analysis, communication, judgment A comprehensive problem Analysis, communication, judgment Difference between income and cash flows Analysis, communication Analysis, communication Analysis, communication Analysis, communication Skills Evaluating profitability Analysis, communication, judgment Correcting Errors - Recording of Merchandising Transactions Accrual Accounting, Cash Flow, and Fair Value © The McGraw-Hill Companies, Inc., 2010 Overview (p. 2) DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES Problems (Sets A and B) 35 Medium 6.2 A,B 15 Easy 6.3 A,B 20 Medium 6.4 A,B 6.5 A,B 30 Strong 6.6 A,B 45 Strong A problem that requires students to evaluate the effects of accounting errors on various balance sheet and income statement accounts and to prepare journal entries to correct the errors. The problem requires the errors to be corrected both assuming that the books remain open and assuming that the books have already been closed. Below are brief descriptions of each problem and case. These descriptions are accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume use of the partially filled-in working papers. 6.1 A,B Claypool Hardware/Big Oak Lumber Hendry's Boutique/Harry's Haberdashery Knauss Supermarkets/Jill's Department Store Introduction to both perpetual inventory systems and financial statement analysis. After making journal entries for merchandising transactions, students are asked to compare the company’s gross profit rate with the industry average and draw conclusions. Siogo Shoes and Sole Mates/Hip Pants and Sleek Lamprino Appliance/Mary's TV Students prepare an income statement for a small retail store using information from an adjusted trial balance. Using this income statement, they are asked to compute the company’s gross profit margin, evaluate customer satisfaction, interpret the meaning of several accounts, and identify the accounts in the store’s operating cycle. Illustrates performance evaluation of a merchandising company using changes in net sales, sales per square foot of selling space, and comparable store sales. King Enterprises/Queen Enterprises 30 Medium A comprehensive problem on merchandising transactions. Also asks students to evaluate whether it is worthwhile to take advantage of a 1/10, n/30 cash discount. A straightforward comparison of the net cost and gross invoice price methods of recording purchases of merchandise. © The McGraw-Hill Companies, Inc., 2010 Overview Desc. Problems (continued) 6.7 A,B 30 Strong 6.8 A,B 40 Strong Genuine Accessories/Computer Resources CPI/SUI A comprehensive problem addressing every learning objective in the chapter. Closely parallels the Demonstration Problem . A problem that requires students to calculate gross profit under an accrual-based system and under a cash-based system, and to explain the difference between the two computations. Also, students are introduced to fair value accounting, and are required to prepare a journal entry to revalue inventory (for loan evaluation purposes) to fair value. © The McGraw-Hill Companies, Inc., 2010 Overview Desc. (p.2) Critical Thinking Cases Selecting an Inventory System A Cost-Benefit Analysis Group Assignment - Evaluating an Inventory System 6.4 Manipulating Income 20 Medium Ethics, Fraud & Corporate Governance CVS Is Riding High for Now 15 Medium Business Week Exploring the Annual Report of GAP, Inc. Internet Students must react to a supervisor's request to alter financial records in order to improve the appearance of the company's financial performance. 6.6 25 Easy 6.5 Students are asked to discuss why prescription drug plans may reduce the gross margin of CVS, a giant drug store chain. Visit the home page of Gap, Inc., and gather financial information to evaluate sales performance. 25 Medium 35 Medium 6.3 No time estimate Students are to visit two local businesses to gain an understanding of the inventory systems in use. They are then asked to evaluate those systems in terms of the information needs and resources of the businesses. 6.2 6.1 Students are asked the type of inventory system they would expect to find in various types of business operations. Leads to an open-ended discussion of why different types of businesses maintain different types of inventory systems. A very practical assignment. Using the company’s markup policy, students are asked to determine the amount of shrinkage loss included in the cost of goods sold in a business using a periodic inventory system. Having determined the amount of loss, they then are asked to evaluate the economic benefit of hiring a security guard. © The McGraw-Hill Companies, Inc., 2010 Desc. of Prob & Cases SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 1. 2. 3. 4. 5. 6. 7. 8. Inventory shrinkage refers to the decrease (shrinkage) in inventory resulting from such factors as theft, breakage, and spoilage. In a company using a perpetual inventory system, shrinkage is measured and accounted for by taking a physical inventory and adjusting the accounting records to reflect the actual quantities on hand. In a perpetual inventory system, ledger accounts for inventory and the cost of goods sold are kept perpetually up-to-date. The Inventory account is debited whenever goods are purchased. When sales occur, Cost of Goods Sold is debited and Inventory is credited for the cost of the merchandise sold. An inventory subsidiary ledger is maintained showing the cost and quantity of every type of product in the inventory. The operating cycle of a business is the sequence of transactions by which the company normally generates its revenue and its cash receipts from customers. In a merchandising company, this cycle includes: (1) purchasing merchandise; (2) selling merchandise, often on account; and (3) collecting accounts receivable from customers. Both wholesalers and retailers are merchandising companies and, therefore, buy their inventory in a ready-to-sell condition. Wholesalers, however, buy large quantities of merchandise directly from manufacturers and then sell this merchandise in smaller quantities to many different retailers. Wholesalers usually operate from a central location and do not sell directly to the final consumer. Retailers, in contrast, buy from wholesalers and then resell the merchandise to the final consumer. General ledger accounts show the total amounts of various assets, liabilities, revenue, and expenses. While these total amounts are used in financial statements, company personnel need more detailed information about the items comprising these totals. This detail is provided in subsidiary ledgers. Subsidiary ledgers are needed to show the amounts receivable from individual customers, the amounts owed to individual creditors, and the quantities and costs of the specific products in inventory. In summary, wholesalers emphasize distribution of the product to the places (retailers) where it is needed. Retailers specialize in meeting the needs of their local customers. The cost of goods sold appears in the income statement of any business that sells merchandise, but not in the income statement of a business that sells only services. The cost of goods sold represents the original cost to the seller of the merchandise it sells. Green Bay Company is not necessarily more profitable than New England Company. Profitability is measured by net income, not by gross profit. For a merchandising company (or manufacturer) to earn a net income, its gross profit must exceed its expenses (including nonoperating items). Green Bay’s gross profit exceeds that of New England by $70,000. However, if Green Bay’s operating expenses (and nonoperating items) exceed those of New England by more than $70,000, New England is the more profitable company. Revenue from sales amounts to $1,070,000 (gross profit, $432,000, plus cost of goods sold, $638,000). Net income is equal to $42,000 (gross profit, $432,000, minus expenses, $390,000). © The McGraw-Hill Companies, Inc., 2010 Q1-7 9. 10. 11. a. b. 12. A balance arises in the Purchase Discounts Lost account when the company fails to take advantage of an available cash discount and, therefore, pays more than the net cost of the merchandise. In most well-managed companies, management has a policy of taking all available cash discounts. Therefore, the balance in the Purchase Discounts Lost account represents a cost arising from failure to adhere to this policy. If this balance becomes significant, management will take corrective action to assure that the company does take advantage of future discount opportunities. 8.cont In a periodic inventory system, up-to-date records are not maintained either for inventory or for the cost of goods sold. The beginning and ending inventory are determined by a physical count. Purchases are recorded in a Purchases account, and no entries are made to record the cost of individual sales transactions. Rather, the cost of goods sold is determined by a computation made at the end of the year (beginning inventory, plus purchases, minus ending inventory). (a) $51,500; (b) $65,000; (c) $49,800; (d) $61,600. Special journals are used to record transactions that occur frequently. A general journal is still used for recording unusual transactions that do not fit the format of any special journal. The statement is correct. A perpetual inventory system requires an entry updating the inventory records as each item of merchandise is sold. In the days of manual accounting systems, only businesses that sold a small number of high-cost items could use a perpetual system. For example, perpetual inventory systems were used in auto dealerships and jewelry stores, but not in supermarkets. A general journal is capable of recording any type of business transaction. However, recording transactions in this type of journal is a relatively slow and cumbersome process. In addition, the person maintaining the journal must have sufficient background in accounting to correctly interpret all types of accounting transactions. Also, because the journal is used to record all types of transactions, it must remain in the accounting department, rather than being located “in the field” where a specific type of transaction occurs. A special journal is an accounting record or device that is designed for recording one specific type of transaction in a highly efficient manner. As the journal is used only in recording one type of transaction, the person maintaining the journal usually does not require an extensive background in accounting. Also, the journal may be located in the field where the transactions occur. Today, point-of-sale terminals have made perpetual inventory systems available to almost every type of business. These terminals “read” identification codes attached to each item of merchandise; the computer then looks up both the sales price and the cost of the merchandise in computer-based files and records the sale instantly. © The McGraw-Hill Companies, Inc., 2010 Q8-12 14. 15. 16. 17. 18. This is equivalent to an investment with a rate of return of approximately 29% (4%  36550 = 29.2%). The financial statements would not include sales tax expense because sales taxes are not an expense of the business entity. Rather, these taxes are collected from the customer and forwarded by the business to the state government. Until the taxes have been sent to the governmental authorities, a liability for sales taxes payable does appear in the balance sheet of the business. (The entry to record the collection of sales taxes consists of a debit to Cash or Accounts Receivable and a credit to Sales Taxes Payable.) 13. The freight charges should not be charged to delivery expense. Delivery expense is a selling expense, matched with (offset against) the sales revenue of the current period. Freight charges on inbound shipments are part of the cost of acquiring the inventory, not an expense of the current period. Transportation charges on inbound shipments should be added to the cost of the purchased merchandise or, as a matter of practical convenience, included in the cost of goods sold during the period. Yes; Outback should take advantage of 4/10, n/60 cash discounts even if it must borrow the money to do so at an annual rate of 13%. Paying 50 days earlier and taking the discount saves 4%. An increase in net sales normally is viewed as a positive change. But to evaluate a specific company’s performance, it is necessary to determine the reasons for this change, and the overall financial impact. Gross profit margin, also called gross profit rate, is gross profit expressed as a percentage of net sales revenue. It may be computed for the company as a whole (the overall gross profit margin), for specific sales departments, and for individual products. Management often may improve the company’s overall profit margin by raising sales prices or by concentrating sales efforts on products with higher margins. In a manufacturing company, management often is able to increase margins by reducing the cost of manufacturing the merchandise that the company sells. To sellers, the “cost” of offering cash discounts is the resulting reduction in revenue. This cost is measured by initially recording the account receivable from the customer at the full invoice price and then recording any discounts taken by customers in a separate account (Sales Discounts). Buyers, however, incur a cost when discounts are lost, not when they are taken. Therefore, buyers design their accounting systems to measure any discounts lost. This is accomplished by initially recording the account payable to the supplier at net cost—that is, net of any allowable cash discounts. This practice means that any discounts lost must be recorded in a separate expense account. The increase in net sales is a good sign, but it does not necessarily mean the company’s marketing strategies have been successful. This increase might have stemmed entirely from the opening of new stores, or from inflation. Also, an increase in net sales does not mean that gross profit has increased. Perhaps this increase in sales stemmed from selling more low-margin merchandise, in which case, gross profit might even have declined. In that case this would have been an unsuccessful marketing strategy. © The McGraw-Hill Companies, Inc., 2010 Q13-18 20. An inventory subsidiary ledger is maintained under a perpetual inventory system but not under a periodic inventory system. Under a perpetual inventory system, each purchase and sale of individual inventory items is tracked. Under a periodic inventory system, the actual physical quantity of inventory items on hand is only determined at the time that a physical inventory count is taken, typically once a year. 19. Even companies that use a perpetual inventory system will generally complete a physical count of their merchandise inventory at least once a year to compare their actual physical inventory with what the perpetual inventory records indicate should be on hand. There are typically differences between the physical count of inventory and what the perpetual records indicate due to breakage, spoilage, and employee and customer theft. This difference is referred to as "shrink(age)" in the retail industry - one of the truly great euphemisms of all time -and is a closely watched performance metric by management in the retail industry. © The McGraw-Hill Companies, Inc., 2010 Q19-20 SOLUTIONS TO BRIEF EXERCISES Office Today's gross profit is $160 million ($800 million - $640 million). Its gross profit percentage is 20% ($160 million/$800 million). Office Today's gross profit should provide the company with the ability to cover other expenses and to provide a return to its shareholders. The accounts receivable balance in the general ledger should be $850, the total of the customer accounts with debit balances. The two customer accounts with credit balances would be reclassified as accounts payable. Alberto & Sons' gross profit for October is $1,500, the $30 gross profit on each item ($80 selling price - $50 cost) multiplied by the 50 units sold during October. B. Ex 6.1 B. Ex. 6.2 B. Ex. 6.3 The balance in Neel & Neal's inventory account at February 1st would be $300,000, the same balance as of the beginning of the year. Under a periodic inventory system, the inventory account balance on the balance sheet is only updated when a physical inventory count is taken, which generally only occurs on a yearly basis. Please note that the inventory balance cannot be computed by adding the $250,000 of inventory purchases to the beginning inventory balance, and then subtracting the $400,000 in sales. The inventory account balance is generally stated at the cost of the inventory items purchased, whereas the $400,000 of sales is recorded at the retail price at which the goods are sold. The cost of goods sold for Murphy Co. is $650,000. Add the purchases of $600,000 to the beginning inventory of $300,000, and then subtract the $250,000 of ending inventory. B. Ex. 6.5 B. Ex 6.6 Yang & Min Inc. purchased $600,000 of goods during the year. Since Yang & Min had an ending inventory of $200,000 and cost of goods sold of $500,000, we then know that Yang & Min had goods available for sale of $700,000 (all goods available for sale are either sold - cost of goods sold - or are still held at the end of the year - inventory). Goods available for sale either existed at the beginning of the year - beginning inventory - or were purchased during the year - purchases. Since Yang & Min's goods available for sale are $700,000 and its beginning inventory is $100,000 Yang & Min must have purchased $600,000 of goods during the year. B. Ex. 6.4 © The McGraw-Hill Companies, Inc., 2010 BE6.1-6 330,000 Inventory (beginning balance)…………… 80,000 Purchases…………………………………. 250,000 30,000 Cost of Goods Sold……………………….. 30,000 300,000 Cost of Goods Sold……………………….. 300,000 2,000 Accounts Receivable (or Cash)………….. 2,000 To reduce the balance of the Cost of Goods Sold account by the cost of merchandise still on hand at year-end. B. Ex 6.10 Allowance granted for defective merchandise. Examples of special journals include: sales journal, cash receipts journal, cash payments journal, purchases journal, and payroll journal. Income Summary………………………………….. B. Ex 6.11 To close the Cost of Goods Sold account to Income Summary. Pag Inc.'s equivalent annual rate of return by always paying its bills within the discount period, and thereby receiving a 1% cash discount on the amount of its purchases, is 18.25% (1% x 365/20). B. Ex. 6.8 Sales Returns and Allowances B. Ex. 6.9 The customer return was received before year end and as such needs to be recorded in the period in which it occurred. Your cooperation with the controller's scheme to overstate income will expose you to severe civil and criminal penalties, notwithstanding the potential damage to your reputation and the unethical course of action that the controller is asking you to pursue. You should try to convince the controller of these facts. Failing this, you might avail yourself of the "hotline" that all public companies are required to maintain to provide an anonymous mechanism for employees to report concerns about improper accounting practices. If all else fails, you are better off leaving the company than exposing yourself to the harsh sanctions associated with securities fraud. Cost of Goods Sold………………………………… To close the accounts contributing to the cost of goods sold for the year. Inventory (ending balance)……………………….. B. Ex 6.7 © The McGraw-Hill Companies, Inc., 2010 BE6.7-11 Ex 6.1 a. b. c. Option #4 Advantages : Control over cash receipts and inventory is maintained by the bookstore. The bookstore is a high traffic area that caters to students, alumni, and visitors. Disadvantages : The bookstore earns a 6% sales commission, meaning the band receives only 94% of the total proceeds. The band must wait the entire year before the bookstore settles its account. Thus, the band may experience difficulty in paying for the inventory it purchases. SOLUTIONS TO EXERCISES Option #2 enables the band to have the least possible amount of cash invested in inventory at any given time throughout the basketball season. Option #3 enables the band to convert sales into cash immediately as shirts are sold. Thus, a combination of options #2 and #3 will result in the shortest operating cycle. Option #1 results in the band having an excessive amount invested in inventory early in the season. Option #4 requires that the band wait until the end of the season to collect its account receivable from the bookstore. Thus, a combination of options #1 and #4 will result in the longest operating cycle. Option #1 Advantages : A 5% purchase discount applies to the purchase. Disadvantages : A large amount of cash is invested in inventory early in the season. The band must pay in advance for an entire season of inventory. Ordering inventory for an entire season exposes the band to a high risk of purchasing too many or too few T-shirts. Option #2 Disadvantages : Maintaining control over cash receipts and inventory is potentially more complex. Advantages : T-shirts are ordered only when inventory levels become depleted. Smaller amounts of cash are invested in inventory throughout the season. Ordering shirts as needed reduces the risk of purchasing too many or too few. Disadvantages : A 5% purchase discount does not apply. Option #3 Advantages : Cash is collected immediately. Members of the band become an entire “sales force” promoting interest in the product. The band receives 100% of all sales proceeds. © The McGraw-Hill Companies, Inc., 2010 E6.1 Trans- Net - Cost of - All Other = Net Assets = Liabilities + Owners' action Sales Goods Sold Expenses Income Equity a. NE NE NE NE I I NE b. I NE NE I I NE I c. NE I NE D D NE D d. NE NE NE NE NE NE NE e. NE I NE D D NE D Ex 6.3 a. Step 1 Net sales Multiplied by the gross profit margin Equals gross profit Step 2 Net sales Less: cost of goods sold Equals gross profit (see Step 1) Step 3 Cost of goods sold ($1.2 billion - $132 million) b. Step 1 Merchandise inventory (beginning of the year) Add: Purchases Less: Merchandise inventory (end of the year) Equals cost of goods sold (see part a) Step 2 Purchases ($1,068 billion + $57 million - $69 million) c. d. 1,068,000,000 $ 69,000,000 $ PC Connection uses a perpetual inventory system for several reasons: (1) its inventory has a relatively high unit cost, (2) its sales volume is extremely high, as evidenced by its $1.2 billion in net sales, (3) immediate information about the availability of specific products is required when customers contact the company to place orders, and (4) the benefits derived from using a perpetual system outweigh the cost of implementing and maintaining it. 57,000,000 1,068,000,000 $ ? 1,056,000,000 $ Balance Sheet Income Statement Ex 6.2 The company’s low gross profit margin of 11% reflects the intense levels of price competition in the personal computing industry. In order to stay competitive, computer retailers like PC Connection have significantly reduced selling prices to their customers. With gross profit being only eleven cents of every sales dollar, it is essential that these retailers control other expenses (such advertising expense, wages expense, and insurance expense) in order to remain profitable. 1,200,000,000 $ x 11% 132,000,000 $ 1,200,000,000 $ ? 132,000,000 $ © The McGraw-Hill Companies, Inc., 2010 E6.2,3 a. Net sales - Cost of goods sold = Gross profit $ 26,000,000 ? $ 15,000,000 b. Beginning inventory + Purchases - Cost of goods sold = Ending Inventory $ 6,450,000 $ 9,500,000 $ 4,950,000 c. Ex. 6.5 a. b. Wal-Mart reported a significant increase in its overall sales growth of 14%, but only a 3% increase in comparable store sales. The disparity between these two statistics may suggest that Wal-Mart’s revenue growth was in large part attributed to new stores. The stability of Wal-Mart’s gross profit rate implies that the company did not face weakening demand or intensified price competition. Kmart’s performance was far less impressive. The statistics reported in the text were released subsequent to the company declaring bankruptcy. Kmart’s total sales grew by only 3%, and its comparable store sales decreased by 0.1%. The 10% decline in the company’s gross profit rate suggests that it faced weakening demand and increased price competition. Percentage changes in comparable store sales represent the increase or decrease in net sales of the same stores from one period to the next. By factoring out the effects of opening new stores (and/or closing existing stores), this statistic provides a better measure of marketing strategy effectiveness and revenue growth. Ex. 6.4 Cost of goods sold = $11,000,000 $11,000,000 (from part a) The entry to record inventory shrinkage at the end of the year increased the Cost of Goods Sold account and reduced its Merchandise Inventory account by $10,000. Thus, immediately prior to recording inventory shrinkage, the Cost of Goods Sold account had a debit balance of $10,990,000 ($11,000,000 computed in part a minus $10,000), whereas the Merchandise Inventory account had a debit balance of $4,960,000 ($4,950,000 computed in part b plus $10,000). The change in net sales provides an overall measure of the effectiveness of the company in generating revenue. A major limitation of this measure is that sales may have changed largely because of the opening of new stores or the closing of unprofitable ones. Thus, an increase in net sales is not always “good,” and a decrease is not always “bad.” Users of financial statements often compute changes in gross profit rates from one period to the next. Increasing margins often mean that a company’s net sales growth is outpacing its growth in the cost of goods sold. This often is the result of successful marketing strategies. A declining gross profit rate, on the other hand, may indicate weakening customer demand or intensified price competition. © The McGraw-Hill Companies, Inc., 2010 E6.4,5 Ex. 6.6 a. b. 4,000 c. Ex. 6.7 a. $ 2,800 30,200 33,000 3,000 $ 30,000 c. Dec. 33,000 Inventory (Dec. 31, year 1) …………… Purchases ……………………………… 3,000 Cost of Goods Sold ……………………… $ 79,600 30,000 $ 49,600 e. The reason why an actual physical count is likely to indicate a smaller inventory than does the perpetual inventory records is inventory shrinkage —the normal loss of inventory through theft, breakage, and spoilage. To reduce inventory to the quantities reflected in the year-end physical count. Both portions of the preceding entry should be posted to the general ledger. In addition, the reduction in inventory should be posted to the inventory subsidiary ledger accounts in which the shortages were determined to exist. The amounts of beginning and ending inventory were determined by taking complete physical inventories at (or near) the ends of year 1 and year 2. “Taking a complete physical inventory” means physically counting the number of units of each product on hand and then determining the cost of this inventory by reference to per-unit purchase co