ACO 201 Problems Chapter 8 Solutions, Spring 2013

Brief Learning Exercises Objectives B. Ex. 8.1 FIFO inventory 1, 4 B. Ex. 8.2 LIFO inventory 1, 4 B. Ex. 8.3 Average inventory 4 B. Ex. 8.4 FIFO and LIFO inventory 4 Analysis B. Ex. 8.5 FIFO and Average inventory 4 B. Ex. 8.6 Inventory shrinkage 3 Analysis B. Ex. 8.7 Inventory error 5 Analysis B. Ex. 8.8 Inventory error 5 B. Ex. 8.9 Inventory turnover 7 B. Ex. 8.10 Inventory turnover 7 8.1 Accounting terminology 1–7 8.2 Cost flow assumptions 1 8.3 Physical flows vs. cost flows 4 8.4 Effects of different cost flows 4 8.5 Transfer of title 2 8.6 Inventory write-downs 3 8.7 Periodic inventory systems 4 8.8 Inventory errors 5 8.9 Gross profit method 6 8.10 Retail method 6 8.11 1, 7 8.12 1, 7 8.13 7 8.14 7 8.15 7 Analysis Analysis Analysis Analysis CHAPTER 8 INVENTORIES AND THE Topic Analysis Analysis Analysis COST OF GOODS SOLD OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL THINKING CASES Topic Skills Analysis Exercises Real World: Home Depot, Inc. Examining an annual report Analysis Analysis Analysis Analysis Analysis, communication, judgment Analysis Real World: General Motors Corporation Evaluating cost flow assumptions Analysis, communication, judgment Skills Learning Objectives Analysis Analysis, judgment Analysis Analysis Real World: Ford Motor Company FIFO vs. LIFO analysis Real World: Kraft Foods, Inc. Inventory turnover Real World: Wal-Mart LIFO reserves Analysis Analysis Analysis, communication © The McGraw-Hill Companies, Inc., 2010 Overview 8.1 A,B Inventory cost flow assumptions 1 8.2 A,B Cost flow assumptions: Perpetual 1 8.3 A,B Cost flow assumptions: Periodic 4 8.4 A,B Inventory shrinkage 1–3 8.5 A,B Periodic inventory systems 4 8.6 A,B Effects of inventory errors 5 8.7 A,B Retail method 2, 3, 6 8.8 A,B 1, 7 8.1 Inventory errors 5 8.2 LIFO Liquidation 4 Dealing with the bank 8.4 7 Inventory turnover 8.5 7 Problems Sets A, B Analysis, judgment Topic Learning Objectives Skills Analysis, judgment Real World: Wal-Mart/J.C. Penney FIFO vs. LIFO comparisons Analysis, judgment Analysis, communication, judgment Analysis, judgment Analysis, communication Analysis Analysis, communication, judgment (Business Week) Analysis, communication, judgment Real World: EMC Corporation Analysis, communication, technology Real World: Safeway, Inc., and Staples, Inc. Inventory turnover rates (Internet) Critical Thinking Cases Analysis, communication, judgment (Ethics, fraud & corporate governance) Analysis, communication, judgment 8.3 Analysis, communication, judgment 3 © The McGraw-Hill Companies, Inc., 2010 Overview(p.2) DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES Problems (Sets A and B) 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. 8.2 A,B BassTrack/Dome, Inc. (Perpetual) A comprehensive problem calling for measurement of the cost of goods sold and valuation of inventory by specific identification and three different flow assumptions. Requires both journal entries and maintenance of inventory subsidiary ledger records. Speed World Cycles/Sea Travel (Perpetual) 8.1 A,B 8.3 A,B 8.4 A,B Mario’s Nursery/Sam's Lawn Mowers 8.5 A,B 8.6 A,B Mach IV Audio/Roman Sound FIFO, LIFO, and average cost in a periodic inventory system. Students also are asked to answer questions about the characteristics of these flow assumptions. Hexagon Health Foods/City Software A series of income statements for a business being offered for sale indicates a rising trend in gross profit. The student is given information on errors in inventory and asked to prepare revised income statements and to evaluate the trend of gross profit. 8.7 A,B 8.8 A,B Between the Ears/Sing Along Illustration of the retail method and its use in estimating inventory shrinkage. Wal-Mart/J.C. Penney Using data compiled from the company's financial statements under LIFO, students must make necessary adjustments such that resulting financial ratios will be comparable to those computed under FIFO. Requires a review of ratios introduced in previous chapters. 25 Medium 20 Strong 35 Medium 30 Strong 20 Medium 20 Medium 20 Medium Compute the cost of goods sold and ending inventory by three different flow assumptions, and answer questions regarding the characteristics of these assumptions. Speed World Cycles/Sea Travel (Periodic) 25 Easy Adjustments under various flow assumptions to reflect the taking of a physical inventory. Also requires a write-down of the remaining inventory to a market value below cost. Computations similar to those in Problem 8-2 except that periodic costing procedures are used in place of a perpetual inventory system. © The McGraw-Hill Companies, Inc., 2010 Description Problems Critical Thinking Cases Inventory Errors LIFO Liquidation Dealing with the Bank Ethics, Fraud & Corporate Governance EMC Corporation Business Week Safeway and Staples No time limit Internet Strong 20 Medium Dramatic illustration of the potential effect of a LIFO liquidation. Excellent case for illustrating why finance and marketing majors should understand accounting. Students are required to evaluate ethical implications of manipulating financial statement information in order to be in compliance with bank covenants. Also requires analytical understanding of working capital relationships. 10 Easy 8.3 8.1 15 Medium 30 Strong While interviewing for a position as controller, the job applicant learns that the employer has an inventory “problem.” Inventories have been understated consistently in past income tax returns. 8.2 8.5 Students are asked to consider trade-offs between inventory turnover and product quality. Requires an analytical interpretation of inventory performance measures reported by a grocery chain and an office supply chain. 8.4 © The McGraw-Hill Companies, Inc., 2010 Desc. of Cases SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 1. 3. 4. a. b. c. 5. 6. 7. The specific identification method should be used by the art gallery. Each item is unique and prices vary widely. Therefore, the gross profit on a sale can be determined logically only by a method that offsets the cost of a specific painting against its sales price. The ending inventory will be stated at the cost incurred for the individual paintings on hand at the end of the year. In measuring the results of operations, accountants consider the flow of costs to be more important than the physical flow of specific units of merchandise. Therefore, a cost flow assumption need not correspond to the physical movement of the company’s merchandise. During a period of rising purchase costs, FIFO results in the highest reported profits, as the cost of goods sold is measured using the oldest (and lowest) costs. LIFO results in the lowest taxable income, as the cost of goods sold consists of the most recent (and highest) purchase costs. As the FIFO method assigns the oldest costs to the cost of goods sold, the most recent purchase costs remain in the Inventory account. Therefore, FIFO results in a valuation of inventory that is closest to current replacement costs. Under these unusual circumstances of unchanging purchase prices throughout the year, FIFO and LIFO would produce exactly the same results in the financial statements. The ending inventory under both methods would be equal to the number of units on hand at year-end multiplied by the same unit price. 2. LIFO means “last-in, first-out.” Thus, the most recently acquired units are assumed to be the first sold, and the cost of goods sold is based upon the most recent cost layers. The cost of merchandise represents an asset—inventory—until the merchandise is sold. At the date of sale, the cost of the merchandise is reclassified as an expense—cost of goods sold—which is “matched” against the related sales revenue. The use of a cost flow assumption eliminates the need for separately identifying each unit sold and looking up its cost. Thus, the time and effort involved in recording the cost of goods sold can be reduced significantly. In addition, the use of a flow assumption enables management to match sales revenue with relatively current merchandise costs and also to minimize the company's income taxes expense. Under the average-cost method, all units in the inventory are valued at the same average cost. (The average cost is recomputed after every purchase transaction.) Therefore, the cost of goods sold is based upon this average cost per unit. The FIFO flow assumption means “first-in, first-out.” Therefore, each sale is assumed to consist of the oldest units in the inventory, and the unit costs in the oldest cost layers are transferred to the cost of goods sold. Generally accepted accounting principles permit the use of inventory cost flow assumptions whenever the items comprising the inventory are similar in terms of cost, function, and sales price. © The McGraw-Hill Companies, Inc., 2010 Q1-7 8. 9. 10. 11. 12. 13. The inventory on hand and the cost of goods sold are not determined until year-end. At the end of the year, a complete physical inventory is taken to determine the amount of inventory on hand. The cost of goods sold then is determined by a computation, as shown below: + Purchases Cost of Goods Available for Sale - Ending Inventory Cost of Goods Sold No, Apex is not violating the accounting principle of consistency by using different accounting methods for different segments of its inventories. The varying nature of inventory items explains in part why several methods of valuation are generally acceptable. The principle of consistency is violated when a company changes inventory methods from one year to the next, because such changes cause net income to differ from what it would have been if the change in accounting method had not occurred. Consistency is an important aid in making financial statements comparable from one year to the next. The phrase “just-in-time inventory system” relates primarily to the management of inventories within manufacturing companies. With respect to purchase of raw materials, just-in-time means that materials arrive just in time for use in the production process. With respect to finished goods, the just- in-time concept means that goods are shipped to customers (sold) immediately upon completion of production. An advantage of the just-in-time concept is that it reduces or eliminates the amounts of the manufacturer’s inventories of materials and finished goods. This reduces the amount of capital that the business must invest in these inventories and also any related costs such as storage and insurance. The primary risk of the just-in-time approach for goods to be shipped to customers is that promised delivery dates may not be met due to unavoidable production delays. The primary reason for taking a physical inventory is to adjust the perpetual inventory records for shrinkage losses such as theft, spoilage, or breakage. The physical inventory usually is taken near the end of the fiscal year, so that the balance sheet will reflect the correct amount of inventory on hand, and the income statement will reflect the shrinkage losses for the year. A company might write down its inventory to a carrying value below cost if the inventory has become obsolete (or otherwise unsalable), or to reflect a current replacement cost below historical cost. A cutoff of transactions means determining that transactions occurring near year-end are recorded in the proper accounting period. If merchandise is in transit at year-end, the ownership of this merchandise is determined by the terms of shipment. If the terms are F.O.B. destination , the goods belong to the seller until they reach their destination. If the terms of shipment are F.O.B. shipping point, the merchandise in transit belongs to the buyer. Beginning Inventory In a periodic inventory system, the cost of merchandise purchased during the year is debited to a Purchases account, rather than to the Inventory account. When merchandise is sold, an entry is made recognizing the sales revenue, but no entry is made reducing the Inventory account or recognizing the cost of goods sold. © The McGraw-Hill Companies, Inc., 2010 Q8-13 14. a. b. c. 15. 16. 17. 18. 19. 20. Errors in the valuation of ending inventory are said to be “counterbalancing” or “self-correcting” because these errors have opposite effects upon the gross profit (and net income) reported in each of two successive years. The cumulative amount of gross profit reported over the two-year period will be correct, and the balance sheet will be correct at the end of the second year. The inventory turnover is computed by dividing the cost of goods sold by the average amount of inventory maintained during the period. The higher the inventory turnover, the more efficient is management’s use of the asset to generate sales. This measurement is of interest to short-term creditors because it indicates how quickly the company is able to sell its merchandise. This is a major step in converting the inventory into cash, which, in turn, can be used to pay the short-term creditors’ claims. The average-cost method begins with a determination of the average per-unit cost of all units available for sale during the year (cost of goods available for sale divided by the number of units available for sale). The units in the year-end inventory then are priced at this average per-unit cost. Under the FIFO flow assumption, the oldest goods (first-in) are assumed to be the first sold. Therefore, the ending inventory is assumed to consist of the most recently purchased units. Ending inventory $56,000 , computed as follows: $40,000 + $100,000  ($112,000  .75) = $56,000. No. The inventory must be presented in the balance sheet at cost. The inventory stated at retail price will be reduced to a cost basis by applying the cost percentage, which is the ratio prevailing between cost and selling price during the current period. This “counterbalancing” effect stems from the fact that an error in the valuation of the ending inventory of one year represents an error in the beginning inventory of the following year. Ending and beginning inventory amounts have opposite effects on the calculation of cost of goods sold. Under the gross profit method, the cost of goods sold is estimated by applying the historical cost ratio (100% minus the gross profit rate) to the net sales of the current period. Subtracting this estimated cost of goods sold from the cost of goods available for sale (beginning inventory plus purchases) provides an estimate of ending inventory. Companies that use a periodic inventory system find the gross profit method useful in preparing interim financial statements. These companies also may use this method in estimating the inventory on hand at the date of a fire, theft, or other casualty. The method also may be used to confirm the reasonableness of the amount determined by a year-end physical inventory. Under the LIFO method, the most recently acquired merchandise is assumed to be the first sold. Therefore, the ending inventory is assumed to consist of the oldest units (including the beginning inventory). Relative to a perpetual inventory system, periodic LIFO costing procedures usually result in more recent (higher) costs being assigned to the cost of goods sold. In fact, even goods purchased on the last day of the year are assumed to have been sold under periodic costing procedures. A higher cost of goods sold, in turn, means less taxable income. Thus, a company usually can maximize the income tax benefits of LIFO by restating its year-end inventory to the costs indicated by periodic LIFO costing procedures. © The McGraw-Hill Companies, Inc., 2010 Q14-20 21. a. b. c. 22. a. b. 23. a. b. c. Using LIFO during a period of rising costs should result in a lower net income than would be reported under the FIFO method. LIFO assigns the most recent purchase costs to the cost of goods sold. When costs are rising, the most recent costs also tend to be the highest costs. LIFO assigns the more recent (higher) costs to the cost of goods sold, and the older (lower) costs to inventory. The inventory turnover rate is computed by dividing the cost of goods sold by the average inventory. Therefore, use of the LIFO method should indicate a higher inventory turnover rate than would the FIFO method. By assigning the more recent (higher) purchase prices to the cost of goods sold, LIFO minimizes taxable income and income taxes expense. This is, perhaps, the primary reason for the popularity of the LIFO method. In a period of declining prices, use of the FIFO method will minimize the reported rate of gross profit. This is because the oldest (and therefore highest) purchase costs will be assigned to the cost of goods sold. Again the answer is the first company. As LIFO minimizes net income during a period of rising prices, it also minimizes the amount of income taxes that a company must pay. The Internal Revenue Service allows a company to use the LIFO method in its income tax returns only if the company also uses the LIFO method in its financial statements. Thus, only the company using LIFO is eligible to receive the income tax benefits of the LIFO method. By using FIFO in its financial statements, the second company is precluded from using the LIFO method in its income tax returns. The first company is using the more conservative method—LIFO—in pricing its inventory. The LIFO (last-in, first-out) method of pricing inventory assigns older costs to inventory and more recent costs to the cost of goods sold. The FIFO method (first-in, first-out), in contrast, assigns the more recent costs to inventory and the older costs to the cost of goods sold. Thus, during a period of rising prices, the LIFO method results in a lower valuation of inventory and a higher valuation of the cost of goods sold than does the FIFO method. The net cash flow from operating activities will be higher than if Computer Products had used LIFO. This is because the flow assumption in use has no effect upon the cash receipts from customers or cash payments to suppliers, but it does affect income taxes. By using FIFO in this period of declining prices, the older and higher costs will be assigned to the cost of goods sold, thereby minimizing taxable income. This, in turn, will minimize income tax payments—a cash outflow that enters into the determination of net cash flow from operating activities. (Note to instructor: In the more common situation of rising replacement costs, it would be LIFO that would minimize the gross profit rate and increase net cash flow from operating activities.) No. An inventory flow assumption affects only the allocation of costs between ending inventory and the cost of goods sold. It has no effect upon the amounts of cash, either collected from customers or paid to merchandise suppliers. © The McGraw-Hill Companies, Inc., 2010 Q21-23 B.Ex. 8.1 B.Ex. 8.2 B.Ex. 8.3 B.Ex. 8.4 B.Ex. 8.5 Average cost: 10 @ $10 = $100 20 @ $11 = 220 30 $320 B.Ex. 8.6 5,000 5,000 B.Ex. 8.7 B.Ex. 8.8 Cost of goods sold (460,000) Gross profit $530,000 Rather than ending inventory being $670,000, it is correctly restated at $620,000 ($670,000 - $50,000). Correction of this error will cause cost of goods sold to increase by $50,000. Average cost inventory: 5 units @ $10.67 = $53.35 (average cost) Inventory Shrinkage Loss ($100,000 x 5%) Sales $990,000 Inventory FIFO: (25 @ $5.00) + (100 @ $5.05) = $630.00 The difference is only $3.75 due to the relatively small difference in price of the two purchases ($.05). $1,148/370 units = $3.10 per unit Ending inventory: (370 units - 125 units) x $3.10 = $760 LIFO: (25 @ $5.05) + (100 @ $5.00) = $626.25 SOLUTIONS TO BRIEF EXERCISES 50 units @ $2.00 = $100 (the oldest costs) Units in ending inventory: 100 + 100 - 75 = 125 units (12 units @ $21) + (3 units @ $20) = $312 (the most recent costs)\ 100 units @ $3.05 = $ 305 150 units @ $3.10 = 465 370 $1,148 120 units @ $3.15 = 378 LIFO inventory: 5 units @ $10 = $50 (oldest costs) $320/30 = $10.67 Units in ending inventory: 10 + 20 - 25 = 5 units © The McGraw-Hill Companies, Inc., 2010 BE8.1,2,3,4,5,6,7,8 B.Ex. 8.9 B.Ex. 8.10 Inventory turnover: $500,000 / $128,000 = 3.91 Inventory turnover for 2009: $90 / $35 = 2.57 The turnover inventory is higher in 2008, indicating that management did a better job of managing its inventory in 2008 than in 2009. This same relationship can be seen by calculating the average number of days to sell inventory, which is lower in 2008, as indicated below: 2008 365 / 3.15 = 115.9 Average number of days to sell inventory: 365 / 3.91 = 93.35 2009 365 / 2.57 = 142.0 Average days to sell inventory: Inventory turnover for 2008: $85 / $27 = 3.15 © The McGraw-Hill Companies, Inc., 2010 BE8.9,10 Ex. 8.1 a. b. c. d. LIFO method e. FIFO method f. Ex. 8.2 a. 137,800 137,800 $93,000 44,800 Cost of goods sold …………… $137,800 b. 137,700 137,700 c. 137,000 137,000 70 @ $1,500 …………………… $105,000 20 @ $1,600 …………………… 32,000 Cost of goods sold …………… $137,000 d. 138,000 Inventory …………………………………… 138,000 30 @ $1,600 …………………… $48,000 90,000 $138,000 To record the cost of 90 Millenium computers sold to Apex Publishers. Cost determined by the LIFO flow assumption: 60 @ $1,500 ………………… Cost of goods sold …………… SOLUTIONS TO EXERCISES Inventory …………………………………… Inventory …………………………………… Average-cost method Inventory …………………………………… Cost of Goods Sold ………………………………………… Flow assumption Cost of Goods Sold ………………………………………… 62 @ $1,500 …………………… 28 @ $1,600 …………………… Specific identification To record the cost of 90 Millenium computers sold to Apex Publishers. Cost determined by the FIFO flow assumption: Retail method To record the cost of 90 Millenium computers sold to Apex Publishers. Cost determined by the specific identification method: To record the cost of 90 Millenium computers sold to Apex Publishers. Cost determined by the average-cost method: Cost of Goods Sold ………………………………………… Cost of Goods Sold ………………………………………… 90 @ $1,530 ($153,000  100 units) © The McGraw-Hill Companies, Inc., 2010 E8.1,2 e. Ex. 8.3 a. 1. 2. 3. b. c. Under FIFO, the cost of goods sold is based on the oldest costs. Thus, relative to using LIFO, the FIFO method will result in higher net income during periods of rising prices, which will increase a company’s income tax liability. In the balance sheet, the FIFO method reports inventory at the most current costs. The LIFO method, on the other hand, reports the same inventory at older, more conservative, and perhaps out-of-date costs. In order for a company to account for its entire inventory as a single, combined, “pool,” all items should be relatively homogeneous. Obviously, the physical properties of heating oil, coal, and kerosene differ significantly. Keeping separate inventory records for each fuel type makes the reported figures more meaningful and gives management more control over the operations of the business. If management determined, for example, that one of its product lines is unprofitable, it might decide to discontinue selling that product and focus attention on the profitable products. As heating oil is purchased and put into storage tanks, it mixes completely with the heating oil remaining in these tanks from prior purchases. As oil is pumped into the company’s delivery trucks, it actually represents a blend of multiple purchase costs. Thus, the average- cost method appears to best describe the physical flow of the heating oil inventory. The company’s large coal storage bins are loaded and emptied from the top by giant machines, making the most recent coal acquired the most recent coal sold. Thus, the LIFO method best describes the physical flow of the coal inventory. The kerosene inventory is stored on shelves in 5-gallon containers. Management probably “rotates” this stock on a regular basis. Thus, the FIFO method best describes the physical flow of the kerosene inventory. The LIFO method would probably result in the lowest income tax liability for the company (assuming that fuel prices are rising). The LIFO method allocates the most recent purchase prices to the cost of goods sold for the period. Thus, in periods of rising prices, LIFO usually results in a higher cost of goods sold and, consequently, a lower taxable income than other allocation methods. © The McGraw-Hill Companies, Inc., 2010 E8.3 Ex. 8.4 a. b. 1. $125,000 15,000 $110,000 2. taxes x 40%)…………………………………………………… $44,000 3. $110,000 44,000 Net income (assuming LIFO) ………………………………… $66,000 4. $123,250 8,500 $131,750 Ex. 8.5 The inventory at December 31 amounts to $725,000, computed by adding the $125,000 inbound shipment of merchandise to $600,000 of merchandise on hand. Terms of the $125,000 shipment were F.O.B. shipping point; therefore, title passed at the point of shipment on December 28 and the goods were the property of the buyer (Jensen) while in transit. The $95,000 outbound shipment was correctly handled. Title to these goods passed to the customer on December 30 when the goods were shipped, so they are not part of the Jensen inventory at December 31. This shipment was billed on December 30, so the account receivable is properly included in the balance sheet. In addition to the $125,000 increase in inventory, accounts payable should be increased by $125,000. Jensen owns the merchandise at December 31 and has a liability to pay for it. Income before income taxes (as reported under FIFO) ……… Less: Additional cost of goods sold had LIFO been in use use ($1,865,000 - $1,850,000)…………………………………… Income before income taxes (assuming LIFO) ……………… Income taxes expense under LIFO ($110,000 income before Income before income taxes (LIFO basis, part 1 ) …………… Less: Income taxes expense under LIFO (part 2 ) …………… paid, minus $44,000 from part 2)……………………………. Net cash provided by operating activities (assuming LIFO) … LIFO results in a higher cost of goods sold than does FIFO when the replacement costs of merchandise are rising. Under LIFO, the most recent (higher) costs are assigned to the cost of goods sold, and the oldest (lower) costs to inventory. This situation reverses under FIFO. Because LIFO assigns the oldest (lowest) costs to inventory, it is reasonable to expect that the LIFO inventory would be lower than that resulting from FIFO valuation, not higher. Dollar amounts stated in thousands: Net cash provided by operating activities (as reported) under FIFO)…………………………………………………… Add: Income tax savings had LIFO been in use ($52,500 © The McGraw-Hill Companies, Inc., 2010 E8.4,5 Ex. 8.6 a. 1. 2,400 2,400 $9,400 Replacement cost (28 units @ $250) …… 7,000 $2,400 2. 5,250 5,250 3,750 3,750 b. 1. 1,200 1,200 2. 930 930 3. Loss from Write-down of Inventory …………………… Cost ……………………………………. Cost of Goods Sold ………………………………………. Inventory ……………………………………… Inventory ……………………………………… To write down the inventory of 28 units of WordCrafter to the lower-of-cost-or-market: To recognize the sales revenue from the sale of 15 WordCrafter programs @ $350, cash. Cost of Goods Sold ………………………………………… Sales …………………………………………… To record shrinkage loss of 3 units of WordCrafter software using the FIFO flow assumption (3 units @ $400). To record shrinkage loss of 3 units of WordCrafter software using the LIFO flow assumption (3 units @ $310). Using the FIFO method would result in a $270 lower net income figure than using the LIFO method ($1,200  $930 = $270). This is due to the reduction in price paid for the second purchase. Although the company would report a lower net income figure using FIFO, it would not really be any less efficient in conducting operations. An inventory valuation method affects only the allocation of costs between ending inventory and cost of goods sold. It has no effect upon the total costs actually incurred in purchasing or manufacturing inventory. Cost of Goods Sold ………………………………………… Inventory ……………………………………… Reduction in carrying value …………… To record cost of 15 WordCrafter programs sold on January 9 using the FIFO flow assumption. (All units are carried in inventory at $250 following the year-end reduction to the lower-of-cost-or-market.) Inventory ……………………………………… Cash ………………………………………………………… © The McGraw-Hill Companies, Inc., 2010 E8.6 Ex. 8.7 a. b. c. d. Ex. 8.8 a. 2009 2008 350,000 $ 250,000 $ Correction of understatement of inventory at end of 2008 …… (40,000) 40,000 310,000 $ 290,000 $ For 2008: $640,000 42.67% For 2009: $710,000 35.50% c. b. Correction of owner's equity: Average cost $79.60 (20 units @ $3.98). (Average cost = $438/110 units = $3.98) FIFO, $99.00 (19 units @ $5.00 + 1 unit @ $4.00). LIFO, $65.50 (9 units @ $3.00 + 11 units @ $3.50). Only the FIFO method results in the same ending inventory valuation in both periodic and perpetual costing environments. Under the average cost and LIFO methods, periodic and perpetual systems usually result in different valuations due to the timing of inventory purchases and sales. Under FIFO, the value assigned to ending inventory is the same using periodic or perpetual procedures, regardless of when purchases or sales occur during the period. Compute corrected net income figures: Net income as reported ……………………………………… Net income as corrected ……………………………………… Gross profit percentage ($710,000  $2,000,000) …………… Owner’s equity at the end of 2008 should be increased by $40,000 to $540,000. At the end of 2009 the owner’s equity of $580,000 requires no correction because the inventory error counterbalanced, as evidenced by the fact that the combined net income for the two years was $600,000, both before and after the correction of net income for the individual years. Gross profit percentage ($640,000  $1,500,000) …………… Adjusted gross profit ($750,000  $40,000) ………………… Compute gross profit amounts and gross profit percentages for each year based on corrected data