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Chapter 6

Merchandise Inventory
Review Questions
1. Briefly explain three types of accounting principles that affect merchandise inventories.

Three types of accounting principles that affect merchandise inventories are: the consistency
principle which dictates that businesses should use the same accounting methods and procedures
from period to period; the disclosure principle according to which a company’s financial statements
should report enough information for outsiders to make knowledgeable decisions about the
company; and the materiality concept where a company must perform strictly proper accounting
only for significant items.

2. What does the disclosure principle require?

The disclosure principle requires that a company must report enough information in its financial
statements for outsiders to make knowledgeable decisions about the company.

3. Discuss the materiality concept. Is the dollar amount that is material the same for a company that has
annual sales of $10,000 compared with a company that has annual sales of $1,000,000?

The materiality concept states that a company must perform strictly proper accounting only for
significant items. Information is significant—or, in accounting terms, material—when it would
cause someone to change a decision. The amount that is material for a company with annual sales of
$10,000 is not the same as the amount that is material for a company with annual sales of
$1,000,000. For example, $1,000 is 10% of $10,000 but is only 0.1% of $1,000,000. Thus, $1,000
is material for a company with annual sales of $10,000 but not for a company with annual sales of
$1,000,000.

4. Why do merchandisers need control over their merchandise inventory?

Good controls ensure that inventory purchases and sales are properly authorized and accounted for
by the accounting system.

5. Under a perpetual inventory system, what are the four inventory costing methods and how does each
method determine ending merchandise inventory and cost of goods sold?

The four inventory costing methods are specific identification, FIFO (First-In, First-Out), LIFO
(Last-In, First-Out), and weighted-average. The specific identification method uses the specific cost
of each unit of inventory to determine cost of goods sold and ending merchandise inventory. The
FIFO method assumes that the first costs into merchandise inventory are the first costs out to cost of
goods sold. Ending merchandise inventory is based on the costs of the most recent purchases. The
LIFO method assumes that the last costs into merchandise inventory are the first costs out to cost of
goods sold. This method leaves the oldest costs—those of beginning inventory and the earliest
purchases of the period—in ending merchandise inventory. The weighted-average method is based
on the weighted average cost of inventory that is calculated after each purchase of inventory. After
each purchase, weighted average cost per unit is determined by dividing the cost of goods available
6-1
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for sale by the number of units available. When using a perpetual inventory system and the
weighted-average inventory costing method, a new weighted average cost per unit is computed after
each purchase. Cost of goods sold and ending merchandise inventory are based on the same
weighted average cost per unit.

6. When using a perpetual inventory system and the weighted-average inventory costing method, when
does the business compute a new weighted-average cost per unit?

When using a perpetual inventory system and the weighted-average inventory costing method, a new
weighted average cost per unit is computed after each purchase.

7. Explain the benefits of the four inventory costing methods and the different ways they affect the
income statement and balance sheets.

Four costing methods can be used to determine merchandise inventory costs. These are:
a. Specific identification method which uses the specific cost of each unit of inventory to determine
ending inventory and to determine cost of goods sold.
b. First-in, first-out (FIFO) method where the first costs into inventory are the first costs out to cost
of goods sold and the ending inventory is based on the costs of the most recent purchases.
c. Last-in, first-out (LIFO) method where last costs into inventory are the first costs out to cost of
goods sold and ending inventory is based on the costs of the oldest inventory.
d. Weighted-average method which is a method based on the weighted average cost per unit of
inventory after each purchase. Weighted average cost per unit is determined by dividing the cost
of goods available for sale by the number of units available for sale.

The FIFO method results in the lowest cost of goods sold and the highest gross profit when costs are
rising. The LIFO method results in the highest cost of goods sold and the lowest gross profit when
costs are rising. The weighted-average method generates amounts for cost of goods sold and gross
profit that fall between FIFO and LIFO if costs are consistently increasing or decreasing.

8. What does the lower-of-cost-or-market (LCM) rule require?

The lower-of-cost-or-market (LCM) rule requires that merchandise inventory be reported in the
financial statements at the lower of its historical cost or market value. For merchandise inventory,
market value generally means current replacement cost (the cost to replace the inventory on hand).

9. What account is debited when recording the adjusting entry to write down merchandise inventory
under the LCM rule?

In the adjusting entry to write down merchandise inventory, Cost of Goods Sold is debited (and
Merchandise Inventory is credited).

10. What is the effect on cost of goods sold, gross profit, and net income if ending merchandise
inventory is understated?

If ending merchandise inventory is understated, cost of goods sold is overstated, gross profit is
understated, and net income is understated.

© 2016 Pearson Education, Ltd. 6-2


11. When does an inventory error cancel out, and why?

One period’s ending merchandise inventory becomes the next period’s beginning merchandise
inventory. As a result, an error in ending merchandise inventory carries over into the next period.
Ending merchandise inventory is subtracted from the cost of goods available for sale in one period
and the same amount is added as beginning merchandise inventory in the next period. Therefore, an
inventory error cancels out after two periods.

12. Briefly discuss the measurement between the inventory turnover and days’ sales in inventory.

Companies try to manage their inventory levels such that they will have just enough inventory to
meet customer demand without investing large amounts of money in inventory sitting on the shelves
gathering dust. Inventory turnover measures how rapidly merchandise inventory is sold. Days’ Sales
in Inventory measures the average number of days that inventory is held by a company. A high rate
of turnover indicates ease in selling inventory; a low rate indicates difficulty. A lower days’ sales in
inventory is preferable because it indicates that the company is able to sell its inventory quickly,
thereby reducing its inventory storage and insurance costs, as well as reducing the risk of holding
obsolete inventory..

13. What can you say about a company’s performance when the company’s days’ sales in inventory are
high?

If a company has a high days’ sales in inventory, this indicates that the company has difficulty
selling its products quickly. Thus, its inventory storage and insurance costs will also be high, and the
risk it carries of holding obsolete inventory will also increase.

14A. When using the periodic inventory system, which inventory costing method(s) always produces
the same result as when using the perpetual inventory system?

When using a periodic inventory system, the specific identification and FIFO inventory costing
methods produce the same results as when using a perpetual inventory system.

15A. Why would a company use the gross profit method?

A company will use the gross profit method to estimate the value of its ending merchandise
inventory when it has only partial records showing its beginning merchandise inventory, records
from vendors showing net purchases, and sales revenue information. They can use their gross
profit percentage from historical records and estimate the cost of goods sold. Then it can subtract
this from the cost of goods available for sale to estimate ending merchandise inventory.

6-3
© 2016 Pearson Education, Ltd.
Short Exercises
For all short exercises, assume the perpetual inventory system is used unless stated otherwise.

S6-1 Determining inventory accounting principles


Learning Objective 1

Ward Hardware used the FIFO inventory costing method in 2017. Ward plans to continue using the
FIFO method in future years. Which accounting principle is most relevant to Ward’s decision?

SOLUTION

The consistency principle is most relevant to Ward’s decision.

S6-2 Determining inventory costing methods


Learning Objective 2

Ward Hardware does not expect costs to change dramatically and wants to use an inventory costing
method that averages cost changes.

Requirements
1. Which inventory costing method would best meet Ward’s goal?
2. Assume Ward wanted to expense out the newer purchases of goods instead. Which inventory costing
method would best meet that need?

SOLUTION

Requirement 1

The weighted-average inventory costing method would best meet Ward’s goal.

Requirement 2

The LIFO inventory costing method would best meet that need.

Use the following information to answer Short Exercises S6-3 through S6-6.

Montana Cycles started July with 25 bicycles that cost $36 each. On July 16, Montana bought 35
bicycles at $60 each. On July 31, Montana sold 33 bicycles for $105 each.

S6-3 Preparing a perpetual inventory record and journal entries—Specific identification


Learning Objective 2

Requirements
1. Prepare Montana Cycle’s perpetual inventory record assuming the company uses the specific
identification inventory costing method. Assume that Montana sold 20 bicycles that cost $36 each
and 13 bicycles that cost $60 each.
2. Journalize the July 16 purchase of merchandise inventory on account and the July 31 sale of
merchandise inventory on account.
© 2016 Pearson Education, Ltd. 6-4
SOLUTION
Requirement 1

Perpetual Inventory Record: Specific Identification

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Jul. 1 25 units × $ 36 = $ 900
$ 900
16 35 units × $ 60 = $ 2,100 25 units × $ 36 = $ 900
$ 3,000
35 units × $ 60 = $ 2,100
31 20 units × $ 36 = $ 720 5 units × $ 36 = $ 180
$ 1,500 $ 1,500
13 units × $ 60 = $ 780 22 units × $ 60 = $ 1,320
Totals 35 units $ 2,100 33 units $ 1,500 27 units $ 1,500

© 2016 Pearson Education, Ltd.


S6-3, cont.
Requirement 2

Date Accounts and Explanation Debit Credit


Jul. 16 Merchandise Inventory 2,100
Accounts Payable 2,100
Purchased inventory on account.

31 Accounts Receivable 3,465 (a)


Sales Revenue 3,465 (a)
Sale on account.

31 Cost of Goods Sold 1,500 (b)


Merchandise Inventory 1,500 (b)
Recorded the cost of goods sold.

Calculations:
(a)
Total sales revenue = Number of bicycles sold × Sales price per bicycle
= 33 bicycles x $105 per bicycle
= $3,465

(b)
Calculated in Requirement 1.

© 2016 Pearson Education, Ltd.


S6-4 Preparing a perpetual inventory record and journal entries—FIFO
Learning Objective 2

Requirements
1. Prepare Montana Cycle’s perpetual inventory record assuming the company uses the FIFO inventory costing method.
2. Journalize the July 16 purchase of merchandise inventory on account and the July 31 sale of merchandise inventory on account.

SOLUTION

Requirement 1

Perpetual Inventory Record: FIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Jul. 1 25 units × $ 36 = $ 900
$ 900
16 35 units × $ 60 = $ 2,100 25 units × $ 36 = $ 900
$ 3,000
35 units × $ 60 = $ 2,100
31 25 units × $ 36 =$ 900 27 units × $ 60 = $ 1,620
$ 1,380 $ 1,620
8 units × $ 60 =$ 480
Totals 35 units $ 2,100 33 units $ 1,380 27 units $ 1,620

© 2016 Pearson Education, Ltd.


S6-4, cont.
Requirement 2

Date Accounts and Explanation Debit Credit


Jul. 16 Merchandise Inventory 2,100
Accounts Payable 2,100
Purchased inventory on account.

31 Accounts Receivable 3,465 (a)


Sales Revenue 3,465 (a)
Sale on account.

31 Cost of Goods Sold 1,380 (b)


Merchandise Inventory 1,380 (b)
Recorded the cost of goods sold.

Calculations:
(a)
Total sales revenue = Number of bicycles sold x Sales price per bicycle
= 33 bicycles x $105 per bicycle
= $3,465

(b)
Calculated in Requirement 1.

© 2016 Pearson Education, Ltd.


S6-5 Preparing a perpetual inventory record and journal entries—LIFO
Learning Objective 2

Requirements
1. Prepare Montana Cycle’s perpetual inventory record assuming the company uses the LIFO inventory costing method.
2. Journalize the July 16 purchase of merchandise inventory on account and the July 31 sale of merchandise inventory on account.

SOLUTION

Requirement 1

Perpetual Inventory Record: LIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Jul. 1 25 units × $ 36 = $ 900
$ 900
16 35 units × $ 60 = $ 2,100 25 units × $ 36 = $ 900
$ 3,000
35 units × $ 60 = $ 2,100
31 33 units × $ 60 = $ 1,980 25 units × $ 36 = $ 900
$ 1,980 $ 1,020
2 units × $ 60 = $ 120
Totals 35 units $ 2,100 33 units $ 1,980 27 units $ 1,020

© 2016 Pearson Education, Ltd.


S6-5, cont.
Requirement 2

Date Accounts and Explanation Debit Credit


Jul. 16 Merchandise Inventory 2,100
Accounts Payable 2,100
Purchased inventory on account.

31 Accounts Receivable 3,465 (a)


Sales Revenue 3,465 (a)
Sale on account.

31 Cost of Goods Sold 1,980(b)


Merchandise Inventory 1,980(b)
Recorded the cost of goods sold.

Calculations:
(a)
Total sales revenue = Number of bicycles sold x Sales price per bicycle
= 33 bicycles x $105 per bicycle
= $3,465

(b)
Calculated in Requirement 1.

© 2016 Pearson Education, Ltd.


S6-6 Preparing a perpetual inventory record and journal entries—Weighted-average
Learning Objective 2

Requirements
1. Prepare Montana Cycle’s perpetual inventory record assuming the company uses the weighted-average inventory costing method.
2. Journalize the July 16 purchase of merchandise inventory on account and the July 31 sale of merchandise inventory on account.

SOLUTION

Requirement 1

Perpetual Inventory Record: Weighted-Average

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Total Unit
Date Quantity Cost Total Cost Quantity Cost Cost Quantity Cost Total Cost
Jul. 1 25 units × $ 36 = $ 900
16 35 units × $ 60 = $ 2,100 60 units × $ 50 (a) = $ 3,000
31 33 units × $ 50 = $ 1,650 27 units × $ 50 = $ 1,350
Totals 35 units $ 2,100 33 units $ 1,650 27 units $ 1,350

Calculations:
(a)
Weighted average cost per unit = Cost of goods available for sale / Number of units available
= ($900 + $2,100) / (25 units + 35 units)
= $3,000 / 60 units
= $50 per unit

© 2016 Pearson Education, Ltd.


S6-6, cont.
Requirement 2

Date Accounts and Explanation Debit Credit


Jul. 16 Merchandise Inventory 2,100
Accounts Payable 2,100
Purchased inventory on account.

31 Accounts Receivable 3,465 (b)


Sales Revenue 3,465 (b)
Sale on account.

31 Cost of Goods Sold 1,650 (c)


Merchandise Inventory 1,650 (c)
Recorded the cost of goods sold.

Calculations:
(b)
Total sales revenue = Number of bicycles sold × Sales price per bicycle
= 33 bicycles × $105 per bicycle
= $3,465

(c)
Calculated in Requirement 1.

© 2016 Pearson Education, Ltd.


Note: Short Exercises S6-4, S6-5, and S6-6 must be completed before attempting Short Exercise S6-7.

S6-7 Comparing Cost of Goods Sold under FIFO, LIFO, and Weighted-average
Learning Objective 3

Refer to Short Exercises S6-4 through S6-6. After completing those exercises, answer the following
questions:

Requirements
1. Which inventory costing method produced the lowest cost of goods sold?
2. Which inventory costing method produced the highest cost of goods sold?
3. If costs had been declining instead of rising, which inventory costing method would have produced
the highest cost of goods sold?

SOLUTION

Requirement 1

The FIFO inventory costing method produced the lowest Cost of Goods Sold.

Requirement 2

The LIFO inventory costing method produced the highest Cost of Goods Sold.

Requirement 3

The FIFO inventory costing method would have produced the highest Cost of Goods Sold if costs had
been declining instead of rising.

S6-8 Applying the lower-of-cost-or-market rule


Learning Objective 4

Assume that a Nixon BBQ Burger restaurant has the following perpetual inventory record for hamburger
patties:

At July 31, the accountant for the restaurant determines that the current replacement cost of the ending
merchandise inventory is $405. Make any adjusting entry needed to apply the lower-of-cost-or-market
rule. Merchandise inventory would be reported on the balance sheet at what value on July 31?

© 2016 Pearson Education, Ltd.


SOLUTION

Make any adjusting entry needed to apply the lower-of-cost-or-market rule. (Record debits first, then
credits. Exclude explanations from journal entries. For situations that do not require an entry, make sure
to select “No entry required” in the first cell in the “Accounts” column and leave all other cells blank.)

Date Accounts and Explanation Debit Credit


Jul. 31 No entry required

Merchandise inventory would be reported on the balance sheet at what value on July 31?
In this case, Nixon BBQ Burger’s balance sheet would report the inventory as follows:

NIXON BBQ BURGER


Balance Sheet (Partial)
Current Assets:
Merchandise inventory, at cost $360

© 2016 Pearson Education, Ltd.


S6-9 Determining the effect of an inventory error
Learning Objective 5

Mountain Pool Supplies’s merchandise inventory data for the year ended December 31, 2017, follow:

Requirements
1. Assume that the ending merchandise inventory was accidentally overstated by
$1,300. What are the correct amounts for cost of goods sold and gross profit?
2. How would the inventory error affect Mountain Pool Supplies’s cost of goods sold and gross profit
for the year ended December 31, 2018, if the error is not corrected in 2017?

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

For the year ended December 31, 2017, the correct amounts for cost of goods sold and gross profit are
$29,400 and $16,600, respectively.

Calculations:

If ending inventory is overstated by $1,300,


then cost of goods sold is understated by $1,300.

$ 28,100 Incorrect cost of goods sold


1,300 Understatement
$ 29,400 Correct cost of goods sold

If cost of goods sold is understated by $1,300,


then gross profit is overstated by $1,300.

$ 17,900 Incorrect gross profit


(1,300) Overstatement
$ 16,600 Correct gross profit

This can be proved as follows:

Sales Revenue $ 46,000


Cost of Goods Sold:
Beginning Merchandise Inventory $ 3,500
Net Cost of Purchases 30,000
Cost of Goods Available for Sale 33,500
Less: Ending Merchandise Inventory ($5,400 − $1,300) 4,100
Cost of Goods Sold 29,400
Gross Profit $ 16,600

Requirement 2

Ending merchandise inventory on December 31, 2017 is the same as beginning merchandise inventory
on January 1, 2018. Thus, if ending merchandise inventory on December 31, 2017 is overstated by
$1,300, beginning merchandise inventory on January 1, 2018 is also overstated by $1,300.

Effects for the year ended December 31, 2018: If beginning inventory is overstated by $1,300, then cost
of goods sold is overstated by $1,300 and gross profit is understated by $1,300.

© 2016 Pearson Education, Ltd.


S6-10 Computing the rate of inventory turnover and days’ sales in inventory
Learning Objective 6

Kota Pelangi Enterprise reported the following figures in its annual financial statements:

Calculate the rate of inventory turnover and days’ sales in inventory for Kota Pelangi Entreprise for the
year.

SOLUTION

a) rate of inventory turnover = Cost of Goods Sold ÷ Average Inventory = 5121m ÷ 965m

= 5.31 times per year

b) days’ sales in inventory = (Average inventory ÷cost of goods sold) × 365


= (965 ÷ 5121) × 365 = 68.8days

© 2016 Pearson Education, Ltd.


Use the following information to answer Short Exercises S6A-11 through S6A-13.

During the month of January 2014, Beng’s Motorcycle Supplies recorded the following:

At July 31, Cambridge counts nine units of merchandise inventory on hand.

S6A-11 Computing periodic inventory amounts—FIFO


Learning Objective 7
Appendix 6A

Show the calculation for the January 2014 transactions if Beng was using the FIFO method of inventory
costing. Use a table with the following headings.

SOLUTION

Purchases Sales Balances


Date Units Unit Cost Total Units Unit Cost Total Units Unit Cost Total
1/1 100 $10 $1000
5/1 40 $12 $480 100 $10 $1000
40 $12 480
140 1480
10/1 60 $10 $600 40 $10 $400
40 $12 480
80 880
15/1 70 $13 $910 40 $10 $400
40 $12$13 480
70 910
150 $1790
25/1 40 $10$12 $400 30 $12 $360
10 120 70 $13 910
100 $1270

S6A-12 Computing periodic inventory amounts—LIFO


© 2016 Pearson Education, Ltd.
Learning Objective 7
Appendix 6A

Show the calculation for the January 2014 transactions if Beng was using the LIFO method of inventory
costing. Use the same table.

SOLUTION

Purchases Sales Balances


Date Units Unit Cost Total Units Unit Cost Total Units Unit Cost Total
1/1 100 $10 $1000
5/1 40 $12 $480 100 $10 $1000
40 $12 480
140 1480
10/1 40 $12$10 $480 80 $10 $800
20 $200
60 $680
15/1 70 $13 $910 80 $10 $800
70 $13 910
150 $1710
25/1 50 $13 $650 80 $10 $800
20 $13 2600
100 $1060

S6A-13 Computing periodic inventory amounts—Weighted-average


Learning Objective 7
Appendix 6A

Show the calculation for the January 2014 transactions if Beng was using the weighted-average method
of inventory costing. Use the same table.

SOLUTION

Purchases Sales Balances


Date Units Unit Cost Total Units Unit Cost Total Units Unit Cost Total
1/1 100 $10 $1000
5/1 40 $12 $480 140 $10.57 $1480
10/1 60 $10.57 $634 80 $10.57 $846
15/1 70 $13 $910 150 $11.71 $1756
25/1 50 $11.71 $585 100 $11.71 $1171

10.57 = $1480/140 units


11.71 = $1756/150 units

© 2016 Pearson Education, Ltd.


Exercises
For all exercises, assume the perpetual inventory system is used unless stated otherwise.

E6-14 Using accounting vocabulary


Learning Objectives 1, 2

Match the accounting terms with the corresponding definitions.

SOLUTION

1. c
2. h
3. f
4. e
5. g
6. d
7. b
8. a

© 2016 Pearson Education, Ltd.


E6-15 Comparing inventory methods
Learning Objective 2
1. Ending Merch. Inv. $14.14

Fast Mart, a regional convenience store chain, maintains milk inventory by the gallon. The first month’s
milk purchases and sales at its Freeport, Florida, location follow:

Requirements
1. Determine the amount that would be reported in ending merchandise inventory on November 15
using the FIFO inventory costing method.
2. Determine the amount that would be reported in ending merchandise inventory on November 15
using the LIFO inventory costing method.
3. Determine the amount that would be reported in ending merchandise inventory on November 15
using the weighted-average inventory costing method. Round all amounts to the nearest cent.

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1
Enter the transactions in chronological order, calculating new inventory on hand balances after each
transaction. Once all of the transactions have been entered into the perpetual record, calculate the
quantity and total cost of merchandise inventory purchased, sold, and on hand at the end of the period.

© 2016 Pearson Education, Ltd.


E6-15 , cont.

Requirement 2
Enter the transactions in chronological order, calculating new inventory on hand balances after each
transaction. Once all of the transaction have been entered into the perpetual record, calculate the
quantity and total cost of merchandise inventory purchased, sold, and on hand at the end of the period.

Requirement 3
Enter the transactions in chronological order, calculating new inventory on hand balances after each
transaction. Once all of the transactions have been entered into the perpetual record, calculate the
quantity and total cost of merchandise inventory purchased, sold, and on hand at the end of the period.

© 2016 Pearson Education, Ltd.


Use the following information to answer Exercises E6-16 through E6-18.

Putter’s Choice carries an inventory of putters and other golf clubs. The sales price of each putter is
$119. Company records indicate the following for a particular line of Putter’s Choice putters:

E6-16 Measuring and journalizing merchandise inventory and cost of goods sold—FIFO
Learning Objective 2
1. CoGS $2,940

Requirements
1. Prepare a perpetual inventory record for the putters assuming Putter’s Choice uses the FIFO
inventory costing method. Then identify the cost of ending inventory and cost of goods sold for the
month.
2. Journalize Putter’s Choice’s inventory transactions using the FIFO inventory costing method.
(Assume purchases and sales are made on account.)

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Perpetual Inventory Record: FIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Nov. 22 units × $ 60 = $ 1,320
1 $ 1,320
6 12 units × $ 60 = $ 720 10 units × $ 60 = $ 600
$ 720 $ 600
8 25 units × $ 81 = $ 2,025 10 units × $ 60 = $ 600
$ 2,625
25 units × $ 81 = $ 2,025
17 10 units × $ 60 = $ 600 10 units × $ 81 = $ 810
$ 1,815 $ 810
15 units × $ 81 = $1,215
30 5 units × $ 81 = $ 405 5 units × $ 81 =$ 405
$ 405 $ 405
Totals 25 units $ 2,025 42 units $ 2,940 5 units $ 405

Using FIFO, the cost of ending merchandise inventory is $405 and cost of goods sold is $2,940.

© 2016 Pearson Education, Ltd.


E6-16, cont.
Requirement 2

Date Accounts and Explanation Debit Credit


Nov. 6 Accounts Receivable 1,428 (a)
Sales Revenue 1,428 (a)
Sale on account.

6 Cost of Goods Sold 720 (d)


Merchandise Inventory 720 (d)
Recorded the cost of goods sold.

8 Merchandise Inventory 2,025


Accounts Payable 2,025
Purchased inventory on account.

17 Accounts Receivable 2,975 (b)


Sales Revenue 2,975 (b)
Sale on account.

17 Cost of Goods Sold 1,815 (d)


Merchandise Inventory 1,815 (d)
Recorded the cost of goods sold.

30 Accounts Receivable 595 (c)


Sales Revenue 595 (c)
Sale on account.

30 Cost of Goods Sold 405 (d)


Merchandise Inventory 405 (d)
Recorded the cost of goods sold.

© 2016 Pearson Education, Ltd.


E6-16, cont.
Requirement 2, cont.

Calculations:

Total sales revenue = Number of putters sold × Sales price per putter
(a)
Nov. 6 sale:
= 12 putters × $119 per putter
= $1,428
(b)
Nov. 17 sale:
= 25 putters × $119 per putter
= $2,975
(c)
Nov. 30 sale:
= 5 putters × $119 per putter
= $595

(d)
Calculated in Requirement 1.

E6-17 Measuring ending inventory and cost of goods sold in a perpetual inventory system—LIFO
Learning Objective 2
1. Ending Merch. Inv. $300

Requirements
1. Prepare Putter’s Choice’s perpetual inventory record for the putters assuming Putter’s Choice uses
the LIFO inventory costing method. Then identify the cost of ending inventory and cost of goods
sold for the month.
2. Journalize Putter’s Choice’s inventory transactions using the LIFO inventory costing method.
(Assume purchases and sales are made on account.)

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Perpetual Inventory Record: LIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Nov. 22 units × $ 60 = $ 1,320
1 $ 1,320
6 12 units × $ 60 = $ 720 10 units × $ 60 = $ 600
$ 720 $ 600
8 25 units × $ 81 = $ 2,025 10 units × $ 60 = $ 600
$ 2,625
25 units × $ 81 = $ 2,025
17 25 units × $ 81 = $ 2,025 10 units × $ 60 = $ 600
$ 2,025 $ 600
30 5 units × $ 60 =$ 300 5 units × $ 60 =$ 300
$ 300 $ 300
Totals 25 units $ 2,025 42 units $ 3,045 5 units $ 300

Using LIFO, the cost of ending merchandise inventory is $300 and cost of goods sold is $3,045.

© 2016 Pearson Education, Ltd.


E6-17, cont.
Requirement 2

Date Accounts and Explanation Debit Credit


Nov. 6 Accounts Receivable 1,428 (a)
Sales Revenue 1,428 (a)
Sale on account.

6 Cost of Goods Sold 720 (d)


Merchandise Inventory 720 (d)
Recorded the cost of goods sold.

8 Merchandise Inventory 2,025


Accounts Payable 2,025
Purchased inventory on account.

17 Accounts Receivable 2,975 (b)


Sales Revenue 2,975 (b)
Sale on account.

17 Cost of Goods Sold 2,025 (d)


Merchandise Inventory 2,025 (d)
Recorded the cost of goods sold.

30 Accounts Receivable 595 (c)


Sales Revenue 595 (c)
Sale on account.

30 Cost of Goods Sold 300 (d)


Merchandise Inventory 300 (d)
Recorded the cost of goods sold.

© 2016 Pearson Education, Ltd.


E6-17, cont.
Requirement 2, cont.

Calculations:

Total sales revenue = Number of putters sold × Sales price per putter
(a)
Nov. 6 sale:
= 12 putters × $119 per putter
= $1,428
(b)
Nov. 17 sale:
= 25 putters × $119 per putter
= $2,975
(c)
Nov. 30 sale:
= 5 putters × $119 per putter
= $595

(d)
Calculated in Requirement 1.

E6-18 Measuring ending inventory and cost of goods sold in a perpetual inventory system—
Weighted-average
Learning Objective 2
1. CoGS $2,970

Requirements
1. Prepare Putter’s Choice’s perpetual inventory record for the putters assuming Putter’s Choice uses
the weighted-average inventory costing method. Round weighted-average cost per unit to the nearest
cent and all other amounts to the nearest dollar. Then identify the cost of ending inventory and cost
of goods sold for the month.
2. Journalize Putter’s Choice’s inventory transactions using the weighted-average inventory costing
method. (Assume purchases and sales are made on account.)

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Perpetual Inventory Record: Weighted-Average

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Total Unit
Date Quantity Cost Total Cost Quantity Cost Cost Quantity Cost Total Cost
Nov. 22 units × $ 60 = $ 1,320
1
6 12 units × $ 60 = $ 720 10 units × $ 60 = $ 600
8 25 units × $ 81 = $ 2,025 35 units × $ 75(a) = $ 2,625
17 25 units × $ 75 = $ 1,875 10 units × $ 75 = $ 750
30 5 units × $ 75 = $ 375 5 units × $ 75 = $ 375
Totals 25 units $ 2,025 42 units $ 2,970 5 units $ 375

Using weighted-average, the cost of ending merchandise inventory is $375 and cost of goods sold is $2,970.

Calculations:

Weighted average cost per unit = Cost of goods available for sale / Number of units available
(a)
After the Nov. 8 purchase:
= ($600 + $2,025) / (10 units + 25 units)
= $2,625 / 35 units
= $75 per unit

© 2016 Pearson Education, Ltd.


E6-18, cont.
Requirement 2

Date Accounts and Explanation Debit Credit


Nov. 6 Accounts Receivable 1,428 (a)
Sales Revenue 1,428 (a)
Sale on account.

6 Cost of Goods Sold 720 (e)


Merchandise Inventory 720 (e)
Recorded the cost of goods sold.

8 Merchandise Inventory 2,025


Accounts Payable 2,025
Purchased inventory on account.

17 Accounts Receivable 2,975 (b)


Sales Revenue 2,975 (b)
Sale on account.

17 Cost of Goods Sold 1,875 (e)


Merchandise Inventory 1,875 (e)
Recorded the cost of goods sold.

30 Accounts Receivable 595 (c)


Sales Revenue 595 (c)
Sale on account.

30 Cost of Goods Sold 375 (e)


Merchandise Inventory 375 (e)
Recorded the cost of goods sold.

© 2016 Pearson Education, Ltd.


E6-18, cont.
Requirement 2, cont.

Calculations:

Total sales revenue = Number of putters sold × Sales price per putter
(a)
Nov. 6 sale:
= 12 putters × $119 per putter
= $1,428
(b)
Nov. 17 sale:
= 25 putters × $119 per putter
= $2,975
(c)
Nov. 30 sale:
= 5 putters × $119 per putter
= $595

(e)
Calculated in Requirement 1.

E6-19 Comparing amounts for cost of goods sold, ending inventory, and gross profit—FIFO and
LIFO
Learning Objectives 2, 3

Assume that JR Toys store bought and sold a line of dolls during December as follows:

JR Toys uses the perpetual inventory system.

Requirements
1. Compute the cost of goods sold, cost of ending merchandise inventory, and gross profit using the
FIFO inventory costing method.
2. Compute the cost of goods sold, cost of ending merchandise inventory, and gross profit using the
LIFO inventory costing method.
3. Which method results in a higher cost of goods sold?
4. Which method results in a higher cost of ending merchandise inventory?
5. Which method results in a higher gross profit?

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Begin by computing the cost of goods sold and cost of ending merchandise inventory using the FIFO
inventory costing method. Enter the transactions in chronological order, calculating new inventory on
hand balances after each transaction. Once all of the transactions have been entered into the perpetual
record, calculate the quantity and total cost of merchandise inventory purchased, sold, and on hand at the
end of the period.

Gross profit is $202 using the FIFO inventory costing method.

© 2016 Pearson Education, Ltd.


E6-19, cont.

Requirement 2
Begin by computing the cost of goods sold and cost of ending merchandise inventory using the LIFO
inventory costing method. Enter the transactions in chronological order, calculating new inventory on
hand balances after each transaction. Once all of the transactions have been entered into the perpetual
record, calculate the quantity and total cost of merchandise inventory purchased, sold, and on hand at the
end of the period.

Requirement 3
The method with the higher cost of goods sold is LIFO.

Requirement 4
The method with the higher cost of merchandising inventory is FIFO.

Requirement 5
The method with the higher gross profit is FIFO.

© 2016 Pearson Education, Ltd.


E6-20 Comparing cost of goods sold and gross profit—FIFO, LIFO, and weighted-average
methods
Learning Objectives 3
1. COGS $2,072

Assume that JR Tire store completed the following perpetual inventory transactions for a line of tires:

Requirements
1. Compute cost of goods sold and gross profit using the FIFO inventory costing method.
2. Compute cost of goods sold and gross profit using the LIFO inventory costing method.
3. Compute cost of goods sold and gross profit using the weighted-average inventory costing method.
(Round weighted-average cost per unit to the nearest cent and all other amounts to the nearest
dollar.)
4. Which method results in the largest gross profit, and why?

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Begin by computing the cost of goods sold and cost of ending merchandise inventory using the FIFO
inventory costing method. Enter the transactions in chronological order, calculating new inventory on
hand balances after each transaction. Once all of the transactions have been entered into the perpetual
record, calculate the quantity and total cost of merchandise inventory purchased, sold, and on hand at the
end of the period.

© 2016 Pearson Education, Ltd.


E6-20, cont.

Requirement 2

Begin by computing the cost of goods sold and cost of ending merchandise inventory using the LIFO
inventory costing method. Enter the transactions in chronological order, calculating new inventory on
hand balances after each transaction. Once all of the transactions have been entered into the perpetual
record, calculate the quantity and total cost of merchandise inventory purchased, sold, and on hand at the
end of the period.

© 2016 Pearson Education, Ltd.


E6-20, cont.
Requirement 3

Begin by computing the cost of goods sold and cost of ending merchandise inventory using the
weighted-average inventory costing method. Enter the transactions in chronological order, calculating
new inventory on hand balances after each transaction. Once all of the transactions have been entered
into the perpetual record, calculate the quantity and total cost of merchandise inventory purchased, sold,
and on hand at the end of the period.

Requirement 4
The FIFO method results in the largest gross profit because during times of increasing inventory prices,
this method will produce the lowest cost of goods sold.

© 2016 Pearson Education, Ltd.


E6-21 Applying the lower-of-cost-or-market rule to merchandise inventories
Learning Objective 4
1. CR Merch. Inv. $1,000

Rapid Resources, which uses the FIFO inventory costing method, has the following account balances at
May 31, 2017, prior to releasing the financial statements for the year:

Rapid has determined that the current replacement cost (current market value) of the
May 31, 2017, ending merchandise inventory is $13,500.

Requirements
1. Prepare any adjusting journal entry required from the information given.
2. What value would Rapid report on the balance sheet at May 31, 2017, for merchandise inventory?

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit


May 31 Cost of Goods Sold 1,000 *
Merchandise Inventory 1,000 *
To write merchandise inventory down
to market value.

* Calculations:

$ 13,500 Current replacement cost of inventory


(14,500) Cost of inventory prior to adjustment
($ 1,000) Adjustment needed

Requirement 2

Merchandise inventory would be reported at $13,500 on the May 31, 2017 balance sheet.

© 2016 Pearson Education, Ltd.


E6-22 Applying the lower-of-cost-or-market rule to inventories
Learning Objective 4
2. GP $62,500

Nature Foods reports merchandise inventory at the lower-of-cost-or-market. Prior to releasing its
financial statements for the year ended January 31, 2017, Nature’s preliminary income statement, before
the year-end adjustments, appears as follows:

Nature has determined that the current replacement cost of ending merchandise inventory is $19,500.
Cost is $21,000.

Requirements
1. Journalize the adjusting entry for merchandise inventory, if any is required.
2. Prepare a revised partial income statement to show how Nature Foods should report sales, cost of
goods sold, and gross profit.

SOLUTION

Requirement 1

Inventory adjustment = Inventory cost – Inventory replacement value


= $21,000 – $19,500
= $1,500

Date Accounts and Explanation Debit Credit


Jan. 31 Cost of Goods Sold 1,500
Merchandise Inventory 1,500
To write merchandise inventory down
to market value.

© 2016 Pearson Education, Ltd.


E6-22, cont.
Requirement 2

Cost of Goods Sold = Cost of goods sold prior to adjustment + Inventory adjustment
= $51,000 + $1,500
= $52,500

NATURE FOODS
Income Statement (Partial)
Year Ended January 31, 2017

Sales Revenue $ 115,000


Cost of Goods Sold 52,500
Gross Profit $ 62,500

E6-23 Measuring the effect of an inventory error


Learning Objective 5
b. Correct GP $25,000

La Castle Bakery reported sales revenue of $41,000 and cost of goods sold of $21,000. Compute La
Castle’s correct gross profit if the company made either of the following independent accounting errors.
Show your work.
a. Ending merchandise inventory is overstated by $5,000.
b. Ending merchandise inventory is understated by $5,000.

SOLUTION

(a) Correct gross profit is $15,000.

Calculations:

As Reported:
Sales Revenue $ 41,000
Less: Cost of Goods Sold 21,000
Gross Profit $ 20,000

If ending inventory is overstated by $5,000,


then cost of goods sold is understated by $5,000.
And, if cost of goods sold is understated by $5,000,
then gross profit is overstated by $5,000.

$ 20,000 Incorrect gross profit


(5,000) Overstatement
$ 15,000 Correct gross profit

© 2016 Pearson Education, Ltd.


E6-23, cont.

(b) Correct gross profit is $25,000.

Calculations:

If ending inventory is understated by $5,000,


then cost of goods sold is overstated by $5,000.
And, if cost of goods sold is overstated by $5,000,
then gross profit is understated by $5,000.

$ Incorrect gross profit *


20,000
5,000 Understatement
$ Correct gross profit
25,000

* Calculated in (a).

E6-24 Correcting an inventory error—two years


Learning Objective 5
2. 2017, understated $5,000
(Requirement 1 only)

Natural Bite Grocery reported the following comparative income statements for the years ended June 30,
2017 and 2016:

During 2017, Natural Bite discovered that ending 2016 merchandise inventory was overstated by
$5,000.

Requirements
1. Prepare corrected income statements for the two years.

© 2016 Pearson Education, Ltd.


2. State whether each year’s net income—before your corrections—is understated or overstated, and
indicate the amount of the understatement or overstatement.

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Corrected income statements:

NATURAL BITE GROCERY


Income Statements
Years Ended June 30, 2017 and 2016
2017 2016

Sales Revenue $ 137,000 $ 122,000


Cost of Goods Sold:
Beginning Merchandise Inventory $ 9,000(a) $ 13,000
Net Cost of Purchases 79,000 72,000
Cost of Goods Available for Sale 88,000 85,000
Less: Ending Merchandise Inventory 19,000 9,000 (a)
Cost of Goods Sold 69,000 76,000
Gross Profit 68,000 46,000
Operating Expenses 30,000 19,000
Net Income $ 38,000 $ 27,000

Calculations:
(a)

$ 14,000 Incorrect Merchandise Inventory


(5,000) Overstatement
$ 9,000 Correct Merchandise Inventory

© 2016 Pearson Education, Ltd.


E6-24, cont.
Requirement 2

Before correction, net income for the year ended June 30, 2017 is understated by $5,000 and net income
for the year ended June 30, 2016 is overstated by $5,000.

Calculations:

Year Ended
June 30, 2017 June 30, 2016
Incorrect net income $ 33,000 $ 32,000
Correct net income (b) (38,000) (27,000)
Overstatement (understatement) of net income $ (5,000) $ 5,000

(b)
Calculated in Requirement 1.

E6-25 Computing inventory turnover and days’ sales in inventory


Learning Objective 6
2. 60.43 days

New Home reported the following income statement for the year ended December 31, 2017:

Requirements
1. Compute New Home’s inventory turnover rate for the year. (Round to two decimal places.)
2. Compute New Home’s days’ sales in inventory for the year. (Round to two decimal places.)

© 2016 Pearson Education, Ltd.


SOLUTION
Requirement 1
Inventory turnover is 6.04 times for the year.

Calculations:
(Beginning merchandise inventory
Average merchandise inventory =
+ Ending merchandise inventory) / 2
= ($8,800 + $13,000) / 2
= $10,900
Inventory turnover = Cost of goods sold / Average merchandise inventory

= $65,800 / $10,900

= 6.04 times for the year

Requirement 2

Days’ sales in inventory is 60.43 days for the year.

Calculations:
Days’ sales in inventory = 365 days / Inventory turnover
= 365 days / 6.04 times*
= 60.43 days
* Calculated in Requirement 1.

E6A-26 Comparing ending merchandise inventory, cost of goods sold, and gross profit using the
periodic inventory system—FIFO, LIFO, and weighted- average methods
Learning Objective 7
Appendix 6A
2. CoGS $899

Assume that Heavenly Coffee Shop completed the following periodic inventory transactions for a line of
merchandise inventory:

Requirements
1. Compute ending merchandise inventory, cost of goods sold, and gross profit using the FIFO
inventory costing method.
2. Compute ending merchandise inventory, cost of goods sold, and gross profit using the LIFO
inventory costing method.

© 2016 Pearson Education, Ltd.


3. Compute ending merchandise inventory, cost of goods sold, and gross profit using the weighted-
average inventory costing method. (Round weighted-average cost per unit to the nearest cent and all
other amounts to the nearest dollar.)
SOLUTION

Requirement 1

Using FIFO, ending merchandise inventory is $232, cost of goods sold is $883, and gross profit is $365.

Calculations:

Goods Available for Sale:


Unit Total
Date Quantity Cost Cost
June 1 19 units × $ 27 = $ 513
12 7 units × $ 28 = $ 196
24 14 units × $ 29 = $ 406
Totals 40 units $ 1,115

Number of units 11 units for first sale + 21 units for second sale
=
sold
= 32 units

Sales revenue = 32 units sold × $39 sale price per unit


= $1,248

Number of units in
ending merchandise = 40 units available for sale – 32 units sold
inventory
= 8 units

FIFO ending 8 units × $29 per unit


=
merchandise inventory
= $232

FIFO Cost of Goods Sold:


Cost of Goods Available for Sale $ 1,115
Less: Ending Merchandise Inventory 232
Cost of Goods Sold $ 883

FIFO Gross Profit:


Sales Revenue $ 1,248
Less: Cost of Goods Sold 883
Gross Profit $ 365

© 2016 Pearson Education, Ltd.


E6A-26, cont.
Requirement 2

Using LIFO, ending merchandise inventory is $216, cost of goods sold is $899, and gross profit is $349.

Calculations:

LIFO ending merchandise inventory = 8 units × 27 per unit


= $216

LIFO Cost of Goods Sold:


Cost of Goods Available for Sale(a) $1,115
Less: Ending Merchandise Inventory 216
Cost of Goods Sold $ 899

LIFO Gross Profit:


Sales Revenue(a) $ 1,248
Less: Cost of Goods Sold 899
Gross Profit $ 349

(a)
Calculated in Requirement 1.

© 2016 Pearson Education, Ltd.


E6A-26, cont.
Requirement 3

Using weighted-average, ending merchandise inventory is $223, cost of goods sold is $892, and gross
profit is $356.

Calculations:

Weighted-average $1,115 cost of goods available for sale


=
cost per unit / 40 units available for sale
= $27.88 per unit

Weighted-average ending merchandise inventory = 8 units × $27.88 per unit


= $223

Weighted-average Cost of Goods Sold:


Cost of Goods Available for Sale(b) $1,115
Ending Merchandise Inventory (223)
Cost of Goods Sold $ 892

Weighted-average Gross Profit:


Sales Revenue (b) $ 1,248
Less: Cost of Goods Sold 892
Gross Profit $ 356

(b)
Calculated in Requirement 1.

© 2016 Pearson Education, Ltd.


E6A-27 Computing periodic inventory amounts
Learning Objective 7
Appendix 6A

Consider the data of the following companies:

Requirements
1. Supply the missing amounts in the preceding table.
2. Prepare the income statement for the year ended December 31, 2017, for Ash Company, which uses
the periodic inventory system. Include a complete heading, and show the full computation of cost of
goods sold. Ash’s operating expenses for the year were $11,000.

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

(a) is $65,000; (b) is $136,000; (c) is $21,000; (d) is $30,000; (e) is $31,000; (f) is $32,000; (g) is
$36,000.

Calculations:

(a)

Gross Profit = Net Sales Revenue – Cost of Goods Sold

Thus:
Cost of Goods Sold = Net Sales Revenue – Gross Profit
= $103,000 – $38,000
= $65,000

(b)

Gross Profit = Net Sales Revenue – Cost of Goods Sold

Thus:
Net Sales = Cost of Goods Sold + Gross Profit
= $94,000 + $42,000
= $136,000

(c)

Ending Beginning Merchandise Inventory


Merchandise = + Net Purchases
Inventory – Cost of Goods Sold
= $25,000 + $90,000 – $94,000
= $21,000

© 2016 Pearson Education, Ltd.


E6A-27, cont.
Requirement 1, cont.

(d)

Ending Beginning Merchandise Inventory


Merchandise = + Net Purchases
Inventory – Cost of Goods Sold

Thus:
Beginning Ending Merchandise Inventory
Merchandise = – Net Purchases
Inventory + Cost of Goods Sold
= $23,000 – $57,000 + $64,000
= $30,000

(e)

Gross Profit = Net Sales Revenue – Cost of Goods Sold


= $95,000 – $64,000
= $31,000

(g) Note: calculate (g) before (f)

Gross Profit = Net Sales Revenue – Cost of Goods Sold

Thus:
Cost of Goods Sold = Net Sales Revenue – Gross Profit
= $83,000 – $47,000
= $36,000

© 2016 Pearson Education, Ltd.


E6A-27, cont.
Requirement 1, cont.

(f)

Ending Beginning Merchandise Inventory


Merchandise = + Net Purchases
Inventory – Cost of Goods Sold

Thus:
Ending Merchandise Inventory
Net Purchases = – Beginning Merchandise Inventory
+ Cost of Goods Sold
= $8,000 – $12,000 + $36,000*
= $32,000

* Calculated as (g), above.

Requirement 2

ASH COMPANY
Income Statement
Year Ended December 31, 2017

Net Sales $ 103,000


Cost of Goods Sold:
Beginning Merchandise Inventory $ 20,000
Net Cost of Purchases 64,000
Cost of Goods Available for Sale 84,000
Less: Ending Merchandise Inventory 19,000
Cost of Goods Sold 65,000
Gross Profit 38,000
Operating Expenses 11,000
Net Income $ 27,000

© 2016 Pearson Education, Ltd.


Problems (Group A)
For all problems, assume the perpetual inventory system is used unless stated otherwise.

P6-28A Accounting for inventory using the perpetual inventory system—FIFO, LIFO, and
weighted-average
Learning Objectives 3
2. Ending Merch. Inv., $2,700

Fit Planet began January with merchandise inventory of 80 crates of vitamins that cost a total of $3,600.
During the month, Fit Planet purchased and sold merchandise on account as follows:

Requirements
1. Prepare a perpetual inventory record, using the FIFO inventory costing method, and determine the
company’s cost of goods sold, ending merchandise inventory, and gross profit.
2. Prepare a perpetual inventory record, using the LIFO inventory costing method, and determine the
company’s cost of goods sold, ending merchandise inventory, and gross profit.
3. Prepare a perpetual inventory record, using the weighted-average inventory costing method, and
determine the company’s cost of goods sold, ending merchandise inventory, and gross profit. (Round
weighted-average cost per unit to the nearest cent and all other amounts to the nearest dollar.)
4. If the business wanted to pay the least amount of income taxes possible, which method would it
choose?

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Begin by computing the cost of goods sold and cost of ending merchandise inventory using the FIFO
inventory costing method. Enter the transactions in chronological order, calculating new inventory on
hand balances after each transaction. Once all of the transactions have been entered into the perpetual
record, calculate the quantity and total cost of merchandise inventory purchased, sold, and on hand at the
end of the period.

© 2016 Pearson Education, Ltd.


P6-28A, cont.

Requirement 2

Begin by computing the cost of goods sold and cost of ending merchandise inventory using the LIFO
inventory costing method. Enter the transactions in chronological order, calculating new inventory on
hand balances after each transaction. Once all of the transactions have been entered into the perpetual
record, calculate the quantity and total cost of merchandise inventory purchased, sold, and on hand at the
end of the period.

Requirement 3

© 2016 Pearson Education, Ltd.


Begin by computing the cost of goods sold and cost of ending merchandise inventory using the
weighted-average inventory costing method. Enter the transactions in chronological order, calculating
new inventory on hand balances after each transaction. Once all of the transactions have been entered
into the perpetual record, calculate the quantity and total cost of merchandise inventory purchased, sold,
and on hand at the end of the period.

Requirement 4
If the business wanted to pay the least amount of income taxes possible, they would choose LIFO.

© 2016 Pearson Education, Ltd.


P6-29A Accounting for inventory using the perpetual inventory system—FIFO, LIFO, and
weighted-average, and comparing FIFO, LIFO, and weighted-average
Learning Objectives 2, 3
5. FIFO GP $4,850

Iron Man began August with 65 units of iron inventory that cost $30 each. During
August, the company completed the following inventory transactions:

Requirements
1. Prepare a perpetual inventory record for the merchandise inventory using the FIFO inventory costing
method.
2. Prepare a perpetual inventory record for the merchandise inventory using the LIFO inventory costing
method.
3. Prepare a perpetual inventory record for the merchandise inventory using the weighted-average
inventory costing method.
4. Determine the company’s cost of goods sold for August using FIFO, LIFO, and weighted-average
inventory costing methods.
5. Compute gross profit for August using FIFO, LIFO, and weighted-average inventory costing
methods.
6. If the business wanted to maximize gross profit, which method would it select?

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Perpetual Inventory Record: FIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Aug. 1 65 units × $ 30 = $ 1,950
$ 1,950
3 50 units × $ 30 = $ 1,500 15 units × $ 30 = $ 450
$ 1,500 $ 450
8 85 units × $ 50 = $ 4,250 15 units × $ 30 = $ 450
$ 4,700
85 units × $ 50 = $ 4,250
21 15 units × $ 30 = $ 450 20 units × $ 50 = $ 1,000
$ 3,700 $ 1,000
65 units × $ 50 = $ 3,250
30 20 units × $ 45 =$ 900 20 units × $ 50 = $ 1,000
$ 1,900
20 units × $ 45 = $ 900
Totals 105 units $ 5,150 130 units $ 5,200 40 units $ 1,900

© 2016 Pearson Education, Ltd.


P6-29A, cont.
Requirement 2

Perpetual Inventory Record: LIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Aug. 1 65 units × $ 30 = $ 1,950
$ 1,950
3 50 units × $ 30 = $ 1,500 15 units × $ 30 = $ 450
$ 1,500 $ 450
8 85 units × $ 50 = $ 4,250 15 units × $ 30 = $ 450
$ 4,700
85 units × $ 50 = $ 4,250
21 80 units × $ 50 = $ 4,000 15 units × $ 30 = $ 450
$ 4,000 $ 700
5 units × $ 50 = $ 250
30 20 units × $ 45 =$ 900 15 units × $ 30 = $ 450
5 units × $ 50 = $ 250 $ 1,600
20 units × $ 45 = $ 900
Totals 105 units $ 5,150 130 units $ 5,500 40 units $ 1,600

© 2016 Pearson Education, Ltd.


P6-29A, cont.
Requirement 3

Perpetual Inventory Record: Weighted-Average

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Aug. 1 65 units × $ 30 = $ 1,950
3 50 units × $30 = $ 1,500 15 units × $ 30 = $ 450
(a)
8 85 units × $ 50 = $ 4,250 100 units × $ 47 = $ 4,700
21 80 units × $47 = $ 3,760 20 units × $ 47 = $ 940
(b)
30 20 units × $ 45 = $ 900 40 units × $ 46 = $ 1,840
Totals 105 units $ 5,150 130 units $ 5,260 40 units $ 1,840

Calculations:

Weighted average cost per unit = Cost of goods available for sale / Number of units available
(a)
After the Aug. 8 purchase:
= ($450 + $4,250) / (15 units + 85 units)
= $4,700 / 100 units
= $47 per unit
(b)
After the Aug. 30 purchase:
= ($940 + $900) / (20 units + 20 units)
= $1,840 / 40 units
= $46 per unit

© 2016 Pearson Education, Ltd.


P6-29A, cont.
Requirement 4

Cost of goods sold is $5,200 using FIFO, $5,500 using LIFO, and $5,260 using weighted-average.
(Amounts calculated in Requirements 1, 2, and 3, respectively.)

Requirement 5

Gross profit is $4,850 using FIFO, $4,550 using LIFO, and $4,790 using weighted-average.

Calculations:

Sales revenue = Number of units sold × Sales price per unit

Aug. 3 sale:
= 50 units × $81 per unit
= $4,050

Aug. 21 sale:
= 80 units × $75 per unit
= $6,000

Total sales revenue = Sales revenue from Aug. 3 sale + Sales revenue from Aug. 21 sale
= $4,050 + $6,000
= $10,050

FIFO LIFO Weighted-


Average
Total Sales Revenue $ 10,050 $ 10,050 $ 10,050
Cost of Goods Sold (5,200) (5,500) (5,260)
Gross Profit $ 4,850 $ 4,550 $ 4,790

Requirement 6

If the business wanted to maximize gross profit they would select FIFO.

© 2016 Pearson Education, Ltd.


P6-30A Accounting principles for inventory and applying the lower-of-cost- or-market rule
Learning Objectives 1, 4
3. CoGS $420,000

Some of E and S Electronics’s merchandise is gathering dust. It is now December 31, 2016, and the
current replacement cost of the ending merchandise inventory is $20,000 below the business’s cost of
the goods, which was $105,000. Before any adjustments at the end of the period, the company’s Cost of
Goods Sold account has a balance of $400,000.

Requirements
1. Journalize any required entries.
2. At what amount should the company report merchandise inventory on the balance sheet?
3. At what amount should the company report cost of goods sold on the income statement?
4. Which accounting principle or concept is most relevant to this situation?

SOLUTION
Requirement 1

Date Accounts and Explanation Debit Credit


Dec. 31 Cost of Goods Sold 20,000
Merchandise Inventory 20,000
To write merchandise inventory down
to market value.

Requirement 2

Merchandise inventory should be reported at $85,000 on the balance sheet.

Calculations:
$ Merchandise inventory prior to adjustment
105,000
(20,000) Adjustment
$ 85,000 Merchandise inventory, adjusted

Requirement 3

Cost of goods sold should be reported at $420,000 on the income statement.

Calculations:
$ Cost of goods sold prior to adjustment
400,000
20,000 Adjustment
$ Cost of goods sold, adjusted
420,000

Requirement 4

© 2016 Pearson Education, Ltd.


The conservatism principle is most relevant to this situation.

© 2016 Pearson Education, Ltd.


P6-31A Correcting inventory errors over a three-year period and computing inventory turnover
and days’ sales in inventory
Learning Objectives 5, 6
2. 2017, overstated $7,000

Lake Air Carpets’s books show the following data. In early 2018, auditors found that the ending
merchandise inventory for 2015 was understated by $6,000 and that the ending merchandise inventory
for 2017 was overstated by $7,000. The ending merchandise inventory at December 31, 2016, was
correct.

Requirements
1. Prepare corrected income statements for the three years.
2. State whether each year’s net income—before your corrections—is understated or overstated, and
indicate the amount of the understatement or overstatement.
3. Compute the inventory turnover and days’ sales in inventory using the corrected income statements
for the three years. (Round all numbers to two decimals.)

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Corrected income statements:

LAKE AIR CARPETS


Income Statements
Years Ended December 31,
2017, 2016, and 2015
2017 2016 2015

Net Sales Revenue $ 208,000 $ 164,000 $ 177,000


Cost of Goods Sold:
Beginning Merchandise Inventory $ 21,000 $ 34,000(b) $ 39,000
Net Cost of Purchases 140,000 103,000 91,000
Cost of Goods Available for Sale 161,000 137,000 130,000
Less: Ending Merchandise Inventory 26,000(a) 21,000 34,000(b)
Cost of Goods Sold 135,000 116,000 96,000
Gross Profit 73,000 48,000 81,000
Operating Expenses 52,000 25,000 35,000
Net Income $ 21,000 $ 23,000 $ 46,000

Calculations:
December 31
2017 2015
Incorrect Merchandise Inventory $ 33,000 $ 28,000
Understatement (Overstatement) (7,000) 6,000
(a)
Correct Merchandise Inventory $ 26,000 $ 34,000(b)

© 2016 Pearson Education, Ltd.


P6-31A, cont.
Requirement 2

Before correction, net income is overstated by $7,000 in 2017, overstated by $6,000 in 2016, and
understated by $6,000 in 2015.

Calculations:
2017 2016 2015
(c)
Correct Net Income $ 21,000 $ 23,000 $ 46,000
Incorrect Net Income (28,000) (29,000) (40,000)
Understatement (Overstatement) $( 7,000) $( 6,000) $ 6,000

(c)
Calculated in Requirement 1.

Requirement 3

Inventory turnover is 5.74 times in 2017, 4.22 times in 2016, and 2.63 in 2015. Days’ sales in inventory
is 63.59 days in 2017, 86.49 days in 2016, and 138.78 days in 2015.

Calculations:

(Beginning merchandise inventory


Average merchandise inventory =
+ Ending merchandise inventory) / 2

Year Ended Dec. 31, 2017:


= ($21,000 + $26,000) / 2
= $23,500
Year Ended Dec. 31, 2016:
= ($34,000 + $21,000) / 2
= $27,500
Year Ended Dec. 31, 2015:
= ($39,000 + $34,000) / 2
= $36,500

© 2016 Pearson Education, Ltd.


P6-31A, cont.
Requirement 3, cont.

Cost of goods sold


Inventory turnover =
/ Average merchandise inventory

Year Ended Dec. 31, 2017:


= $135,000 / $23,500
= 5.74 times for the year

Year Ended Dec. 31, 2016:


= $116,000 / $27,500
= 4.22 times for the year
Year Ended Dec. 31, 2015:
= $96,000 / $36,500
= 2.63 times for the year

Days’ sales in inventory = 365 days / Inventory turnover

Year Ended Dec. 31, 2017:


= 365 days / 5.74 times
= 63.59 days

Year Ended Dec. 31, 2016:


= 365 days / 4.22 times
= 86.49 days
Year Ended Dec. 31, 2015:
= 365 days / 2.63 times
= 138.78 days

© 2016 Pearson Education, Ltd.


P6A-32A Accounting for inventory using the periodic inventory system— FIFO, LIFO, and
weighted-average, and comparing FIFO, LIFO, and weighted-average
Learning Objectives 7
Appendix 6A
1. LIFO Ending Merch. Inv., $6,240

Contemporary Electronic Center began July with 60 units of merchandise inventory that cost $68 each.
During July, the store made the following purchases:

Jepson uses the periodic inventory system, and the physical count at July 31 indicates that 90 units of
merchandise inventory are on hand.

Requirements
1. Determine the ending merchandise inventory and cost of goods sold amounts for the July financial
statements using the FIFO, LIFO, and weighted-average inventory costing methods.
2. Sales revenue for July totaled $23,000. Compute Contemporary’s gross profit for July using each
method.
3. Which method will result in the lowest income taxes for Contemporary? Why?
4. Which method will result in the highest net income for Contemporary? Why?

© 2016 Pearson Education, Ltd.


SOLUTION

© 2016 Pearson Education, Ltd.


P6A-32A, cont.

Requirement 1

© 2016 Pearson Education, Ltd.


P6A-32A, cont.

Requirement 2

Requirement 3
The LIFO method will result in the lowest income taxes because under this method, the company’s
gross profit is the lowest.

The FIFO method will result in the highest net income because under this method, company’s gross
profit is the highest.

© 2016 Pearson Education, Ltd.


Problems (Group B)
For all problems, assume the perpetual inventory system is used unless stated otherwise.

P6-33B Accounting for inventory using the perpetual inventory system—FIFO, LIFO, and
weighted-average
Learning Objectives 2, 3
2. Ending Merch. Inv., $4,550

Fit World began January with merchandise inventory of 90 crates of vitamins that cost a total of $5,850.
During the month, Fit World purchased and sold merchandise on account as follows:

Requirements
1. Prepare a perpetual inventory record, using the FIFO inventory costing method, and determine the
company’s cost of goods sold, ending merchandise inventory, and gross profit.
2. Prepare a perpetual inventory record, using the LIFO inventory costing method, and determine the
company’s cost of goods sold, ending merchandise inventory, and gross profit.
3. Prepare a perpetual inventory record, using the weighted-average inventory costing method, and
determine the company’s cost of goods sold, ending merchandise inventory, and gross profit. (Round
weighted-average cost per unit to the nearest cent and all other amounts to the nearest dollar.)
4. If the business wanted to pay the least amount of income taxes possible, which method would it
choose?

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Using FIFO, cost of goods sold is $24,330, ending merchandise inventory is $6,020, and gross profit is $8,390.

Perpetual Inventory Record: FIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Jan. 1 90 units × $ 65 (a) = $ 5,850
$ 5,850
2 130 units × $ 76 = $ 9,880 90 units × $ 65 = $ 5,850
$ 15,730
130 units × $ 76 = $ 9,880
5 90 units × $ 65 = $ 5,850 80 units × $ 76 = $ 6,080
$ 9,650 $ 6,080
50 units × $ 76 = $ 3,800
16 170 units × $ 86 = $14,620 80 units × $ 76 = $ 6,080
$ 20,700
170 units × $ 86 = $14,620
27 80 units × $ 76 = $ 6,080 70 units × $ 86 = $ 6,020
$ 14,680 $ 6,020
100 units × $ 86 = $ 8,600
Totals 300 units $24,500 320 units $ 24,330 70 units $ 6,020

© 2016 Pearson Education, Ltd.


P6-33B, cont.
Requirement 1, cont.

Calculations:
(a)
Jan. 1 inventory unit cost = Total cost / Total number of units
= $5,850 / 90 units
= $65 per unit

Sales revenue = Number of crates sold × Sales price per crate

Sale 1:
= 140 crates × $100 per crate
= $14,000

Sale 2:
= 180 crates × $104 per crate
= $18,720

Total sales revenue = Sales revenue from Sale 1 + Sales revenue from Sale 2
= $14,000 + $18,720
= $32,720

Total Sales Revenue $ 32,720


Cost of Goods Sold (24,330)
Gross Profit $ 8,390

© 2016 Pearson Education, Ltd.


P6-33B, cont.
Requirement 2

Using LIFO, cost of goods sold is $25,800, ending merchandise inventory is $4,550, and gross profit is $6,920.

Perpetual Inventory Record: LIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
(b)
Jan. 1 90 units × $ 65 = $ 5,850
$ 5,850
2 130 units × $ 76 = $ 9,880 90 units × $ 65 = $ 5,850
$15,730
130 units × $ 76 = $ 9,880
5 130 units × $ 76 = $ 9,880 80 units × $ 65 = $ 5,200
$10,530 $ 5,200
10 units × $ 65 = $ 650
16 170 units × $ 86 = $14,620 80 units × $ 65 = $ 5,200
$19,820
170 units × $ 86 = $14,620
27 170 units × $ 86 =$14,620 70 units × $ 65 = $ 4,550
$15,270 $ 4,550
10 units × $ 65 = $ 650
Totals 300 units $ 24,500 320 units $25,800 70 units $ 4,550
(b)
Calculated in Requirement 1.

Total Sales Revenue(c) $ 32,720


Cost of Goods Sold (25,800)
Gross Profit $ 6,920

(c)
Calculated in Requirement 1.

P6-33B, cont.
Requirement 3

© 2016 Pearson Education, Ltd.


Using weighted-average, cost of goods sold is $24,655, ending merchandise inventory is $5,695, and gross profit is $8,065.

Perpetual Inventory Record: Weighted-Average

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Jan. 1 90 units × $ 65.00 (d) = $ 5,850
2 130 units × $ 76 = $ 9,880 220 units × $ 71.50 (e) = $15,730
5 140 units × $71.50 = $10,010 80 units × $ 71.50 = $ 5,720
16 170 units × $ 86 = $14,620 250 units × $ 81.36 (f) = $20,340
27 180 units × $81.36 = $14,645 70 units × $ 81.36 = $ 5,695
Totals 300 units $24,500 320 units $24,655 70 units $ 5,695

(d)
Calculated in Requirement 1.
Weighted average cost per unit = Cost of goods available for sale / Number of units available
(e)
After Purchase 1:
= ($5,850 + $9,880) / (90 units + 130 units)
= $15,730 / 220 units
= $71.50 per unit
(f)
After Purchase 2:
= ($5,720 + $14,620) / (80 units + 170 units)
= $20,340 / 250 units
= $81.36 per unit

© 2016 Pearson Education, Ltd.


P6-33B, cont.
Requirement 3, cont.

Total Sales Revenue(g) $ 32,720


Cost of Goods Sold (24,655)
Gross Profit $ 8,065

(g)
Calculated in Requirement 1.

Requirement 4

If the business wanted to pay the least amount of income taxes possible, they would choose LIFO.

© 2016 Pearson Education, Ltd.


P6-34B Accounting for inventory using the perpetual inventory system—FIFO, LIFO, and
weighted-average, and comparing FIFO, LIFO, and weighted-average
Learning Objectives 2, 3
5. FIFO GP $5,640

Decorative Steel began January with 70 units of iron inventory that cost $25 each. During January, the
company completed the following inventory transactions:

Requirements
1. Prepare a perpetual inventory record for the merchandise inventory using the FIFO inventory costing
method.
2. Prepare a perpetual inventory record for the merchandise inventory using the LIFO inventory costing
method.
3. Prepare a perpetual inventory record for the merchandise inventory using the weighted-average
inventory costing method.
4. Determine the company’s cost of goods sold for January using FIFO, LIFO, and weighted-average
inventory costing methods.
5. Compute gross profit for January using FIFO, LIFO, and weighted-average inventory costing
methods.
6. If the business wanted to maximize gross profit, which method would it select?

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Perpetual Inventory Record: FIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Jan. 1 70 units × $ 25 = $ 1,750
$ 1,750
3 60 units × $ 25 = $ 1,500 10 units × $ 25 = $ 250
$ 1,500 $ 250
8 80 units × $ 43 = $ 3,440 10 units × $ 25 = $ 250
$ 3,690
80 units × $ 43 = $ 3,440
21 10 units × $ 25 = $ 250 20 units × $ 43 = $ 860
$ 2,830 $ 860
60 units × $ 43 = $ 2,580
30 20 units × $ 49 =$ 980 20 units × $ 43 =$ 860
$ 1,840
20 units × $ 49 =$ 980
Totals 100 units $ 4,420 130 units $ 4,330 40 units $ 1,840

© 2016 Pearson Education, Ltd.


P6-36B, cont.
Requirement 2

Perpetual Inventory Record: LIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Jan. 1 70 units × $ 25 = $ 1,750
$ 1,750
3 60 units × $ 25 = $ 1,500 10 units × $ 25 = $ 250
$ 1,500 $ 250
8 80 units × $ 43 = $ 3,440 10 units × $ 25 = $ 250
$ 3,690
80 units × $ 43 = $ 3,440
21 70 units × $ 43 = $ 3,010 10 units × $ 25 = $ 250
$ 3,010 $ 680
10 units × $ 43 = $ 430
30 20 units × $ 49 =$ 980 10 units × $ 25 = $ 250
10 units × $ 43 = $ 430 $ 1,660
20 units × $ 49 = $ 980
Totals 100 units $ 4,420 130 units $ 4,510 40 units $ 1,660

© 2016 Pearson Education, Ltd.


P6-34B, cont.
Requirement 3

Perpetual Inventory Record: Weighted-Average

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Jan. 1 70 units × $ 25 = $ 1,750
3 60 units × $ 25 = $ 1,500 10 units × $ 25 = $ 250
(a)
8 80 units × $ 43 = $ 3,440 90 units × $ 41 = $ 3,690
21 70 units × $ 41 = $ 2,870 20 units × $ 41 = $ 820
(b)
30 20 units × $ 49 = $ 980 40 units × $ 45 = $ 1,800
Totals 100 units $ 4,420 130 units $ 4,370 40 units $ 1,800

Calculations:

Weighted average cost per unit = Cost of goods available for sale / Number of units available
(a)
After the Jan. 8 purchase:
= ($250 + $3,440) / (10 units + 80 units)
= $3,690 / 90 units
= $41 per unit
(b)
After the Jan. 30 purchase:
= ($820 + $980) / (20 units + 20 units)
= $1,800 / 40 units
= $45 per unit

© 2016 Pearson Education, Ltd.


P6-34B, cont.
Requirement 4

Cost of goods sold is $4,330 using FIFO, $4,510 using LIFO, and $4,370 using weighted-average.
(Amounts calculated in Requirements 1, 2, and 3, respectively.)

Requirement 5

Gross profit is $5,640 using FIFO, $5,460 using LIFO, and $5,600 using weighted-average.

Calculations:

Sales revenue = Number of units sold × Sales price per unit

Jan. 3 sale:
= 60 units × $74 per unit
= $4,440

Jan. 21 sale:
= 70 units × $79 per unit
= $5,530

Total sales revenue = Sales revenue from Jan. 3 sale + Sales revenue from Jan. 21 sale
= $4,440 + $5,530
= $9,970

FIFO LIFO Weighted-


Average
Total Sales Revenue $ 9,970 $ 9,970 $ 9,970
Cost of Goods Sold (4,330) (4,510) (4,370)
Gross Profit $ 5,640 $ 5,460 $ 5,600

Requirement 6

If the business wanted to maximize gross profit they would select FIFO.

© 2016 Pearson Education, Ltd.


P6-35B Accounting principles for inventory and applying the lower-of-cost-or- market rule
Learning Objectives 1, 4
3. CoGS $425,000

Some of G and A Electronics’s merchandise is gathering dust. It is now December 31, 2016, and the
current replacement cost of the ending merchandise inventory is $25,000 below the business’s cost of
the goods, which was $100,000. Before any adjustments at the end of the period, the company’s Cost of
Goods Sold account has a balance of $400,000.

Requirements
1. Journalize any required entries.
2. At what amount should the company report merchandise inventory on the balance sheet?
3. At what amount should the company report cost of goods sold on the income statement?
4. Which accounting principle or concept is most relevant to this situation?

© 2016 Pearson Education, Ltd.


SOLUTION
Requirement 1

Date Accounts and Explanation Debit Credit


Dec. 31 Cost of Goods Sold 25,000
Merchandise Inventory 25,000
To write merchandise inventory down to market value.

Requirement 2

Merchandise inventory should be reported at $75,000 on the balance sheet.

Calculations:
$100,000 Merchandise inventory prior to adjustment
(25,000) Adjustment
$ 75,000 Merchandise inventory, adjusted

Requirement 3

Cost of goods sold should be reported at $425,000 on the income statement.

Calculations:
$ Cost of goods sold prior to adjustment
400,000
25,000 Adjustment
$ Cost of goods sold, adjusted
425,000

Requirement 4

The conservatism principle is most relevant to this situation.

© 2016 Pearson Education, Ltd.


P6-36B Correcting inventory errors over a three-year period and computing inventory turnover
and days’ sales in inventory
Learning Objectives 5, 6
2. 2017, overstated $7,000

Evergreen Carpets’s books show the following data. In early 2018, auditors found that the ending
merchandise inventory for 2015 was understated by $6,000 and that the ending merchandise inventory
for 2017 was overstated by $7,000. The ending merchandise inventory at December 31, 2016, was
correct.

Requirements
1. Prepare corrected income statements for the three years.
2. State whether each year’s net income—before your corrections—is understated or overstated, and
indicate the amount of the understatement or overstatement.
3. Compute the inventory turnover and days’ sales in inventory using the corrected income statements
for the three years. (Round all numbers to two decimals.)

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1
Corrected income statements:

EVERGREEN CARPETS
Income Statements
Years Ended December 31, 2017, 2016, and 2015
2017 2016 2015

Net Sales Revenue $ 218,000 $ 161,000 $ 176,000


Cost of Goods Sold:
Beginning Merchandise Inventory $ 21,000 $ 31,000(b) $ 41,000
Net Cost of Purchases 130,000 98,000 83,000
Cost of Goods Available for Sale 151,000 129,000 124,000
Less: Ending Merchandise Inventory 26,000(a) 21,000 31,000(b)
Cost of Goods Sold 125,000 108,000 93,000
Gross Profit 93,000 53,000 83,000
Operating Expenses 75,000 29,000 43,000
Net Income $ 18,000 $ 24,000 $ 40,000

Calculations:
December 31
2017 2015
Incorrect Merchandise Inventory $ 33,000 $ 25,000
Understatement (Overstatement) (7,000) 6,000
(a)
Correct Merchandise Inventory $ 26,000 $ 31,000(b)

© 2016 Pearson Education, Ltd.


P6-36B, cont.
Requirement 2

Before correction, net income is overstated by $7,000 in 2017, overstated by $6,000 in 2016, and
understated by $6,000 in 2015.

Calculations:
2017 2016 2015
Correct Net Income(c) $ 18,000 $ 24,000 $ 40,000
Incorrect Net Income (25,000) (30,000) (34,000)
Understatement (Overstatement) $( 7,000) $( 6,000) $ 6,000

(c)
Calculated in Requirement 1.

Requirement 3

Inventory turnover is 5.32 times in 2017, 4.15 times in 2016, and 2.58 in 2015. Days’ sales in inventory
is 68.61 days in 2017, 87.95 days in 2016, and 141.47 days in 2015.

Calculations:

(Beginning merchandise inventory


Average merchandise inventory =
+ Ending merchandise inventory) / 2

Year Ended Dec. 31, 2017:


= ($21,000 + $26,000) / 2
= $23,500
Year Ended Dec. 31, 2016:
= ($31,000 + $21,000) / 2
= $26,000
Year Ended Dec. 31, 2015:
= ($41,000 + $31,000) / 2
= $36,000

© 2016 Pearson Education, Ltd.


P6-36B, cont.
Requirement 3, cont.

Cost of goods sold


Inventory turnover =
/ Average merchandise inventory

Year Ended Dec. 31, 2017:


= $125,000 / $23,500
= 5.32 times for the year

Year Ended Dec. 31, 2016:


= $108,000 / $26,000
= 4.15 times for the year

Year Ended Dec. 31, 2015:


= $93,000 / $36,000
= 2.58 times for the year

Days’ sales in inventory = 365 days / Inventory turnover

Year Ended Dec. 31, 2017:


= 365 days / 5.32 times
= 68.61 days

Year Ended Dec. 31, 2016:


= 365 days / 4.15 times
= 87.95 days

Year Ended Dec. 31, 2015:


= 365 days / 2.58 times
= 141.47 days

© 2016 Pearson Education, Ltd.


P6A-37B Accounting for inventory using the periodic inventory system— FIFO, LIFO, and
weighted-average, and comparing FIFO, LIFO, and weighted-average
Learning Objectives 3, 7
Appendix 6A
1. LIFO Ending Merch. Inv., $10,200

Best Yet Electronic Center began October with 100 units of merchandise inventory that cost $78 each.
During October, the store made the following purchases:

Best Yet uses the periodic inventory system, and the physical count at October 31 indicates that 130
units of merchandise inventory are on hand.

Requirements
1. Determine the ending merchandise inventory and cost of goods sold amounts for the October
financial statements using the FIFO, LIFO, and weighted-average inventory costing methods.
2. Sales revenue for October totaled $23,000. Compute Best Yet’s gross profit for October using each
method.
3. Which method will result in the lowest income taxes for Best Yet? Why? Which method will result
in the highest net income for Best Yet? Why?

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Using FIFO, ending merchandise inventory is $11,080 and cost of goods sold is $8,600.

Using LIFO, ending merchandise inventory is $10,200 and cost of goods sold is $9,480.

Using weighted-average, ending merchandise inventory is $10,660 and cost of goods sold is $9,020.

Calculations:

Goods Available for Sale:


Unit Total
Date Quantity Cost Cost
Oct. 1 100 units × $ 78 = $ 7,800
3 40 units × $ 80 = $ 3,200
12 60 units × $ 82 = $ 4,920
18 40 units × $ 94 = $ 3,760
Totals 240 units $ 19,680

FIFO Ending Merchandise Inventory:


Unit Total
Quantity Cost Cost
40 units × $ 94 = $ 3,760
60 units × $ 82 = $ 4,920
30 units × $ 80 = $ 2,400
Totals 130 units $11,080

© 2016 Pearson Education, Ltd.


P6A-37B, cont.
Requirement 1, cont.

FIFO Cost of Goods Sold:


Cost of Goods Available for Sale $ 19,680
Ending Merchandise Inventory (11,080)
Cost of Goods Sold $ 8,600

Alternatively, FIFO Cost of Goods Sold:

Unit Total
Quantity Cost Cost
100 units × $ 78 = $ 7,800
10 units × $ 80 =$ 800
Totals 110 units $ 8,600

LIFO Ending Merchandise Inventory:


Unit Total
Quantity Cost Cost
100 units × $ 78 = $ 7,800
30 units × $ 80 = $ 2,400
Totals 130 units $ 10,200

LIFO Cost of Goods Sold:


Cost of Goods Available for Sale $ 19,680
Ending Merchandise Inventory (10,200)
Cost of Goods Sold $ 9,480

Alternatively, LIFO Cost of Goods Sold:


Unit Total
Quantity Cost Cost
40 units × $ 94 = $ 3,760
60 units × $ 82 = $ 4,920
10 units × $ 80 = $ 800
Totals 110 units $ 9,480

© 2016 Pearson Education, Ltd.


P6A-37B, cont.
Requirement 1, cont.
Weighted-average $19,680 cost of goods available for sale
=
cost per unit / 240 units available for sale
= $82 per unit

Weighted-Average Ending 130 units × $82 per unit


=
Merchandise Inventory
= $10,660

Weighted-Average Cost of Goods Sold:


Cost of Goods Available for Sale $ 19,680
Ending Merchandise Inventory (10,660)
Cost of Goods Sold $ 9,020

Alternatively, Weighted-Average Cost of Goods Sold:


= 110 units sold × $82 per unit
= $9,020

Requirement 2
Gross profit is $14,400 using FIFO, $13,520 using LIFO, and $13,980 using weighted-average.

Calculations:

FIFO LIFO Weighted-


Average
Sales Revenue $ 23,000 $ 23,000 $ 23,000
Cost of Goods Sold * (8,600) (9,480) (9,020)
Gross Profit $ 14,400 $ 13,520 $ 13,980

*Calculated in Requirement 1.

Requirement 3
LIFO results in the lowest income taxes and FIFO results in the highest net income. Under LIFO, the
last costs into inventory are the first costs out to cost of goods sold. When inventory costs are rising,
LIFO results in the highest cost of goods sold; thus, the lowest gross profit, net income, and taxable
income.Under FIFO, the first costs into inventory are the first costs out to cost of goods sold. When
inventory costs are rising, FIFO results in the lowest cost of goods sold; thus, the highest gross profit,
net income, and taxable income.

Weighted-average method amounts fall somewhere in between FIFO and LIFO since this method is
based on the weighted average cost of inventory during the period.

© 2016 Pearson Education, Ltd.


Continuing Problem
P6-38 Accounting for inventory using the perpetual inventory system—FIFO

This problem continues the Daniels Consulting situation from Problem P5-45
in Chapter 5. Consider the January transactions for Daniels Consulting that were presented in Chapter 5.
(Cost data have been removed from the sale transactions.) Daniels uses the perpetual inventory system.

Requirements
1. Prepare perpetual inventory records for January for Daniels using the FIFO inventory costing
method. (Note: You must calculate the cost of goods sold on the 18th, 28th, and 31st.)
2. Journalize the transactions for January 18th, 28th, and 31st (adjusting entry d only) using the
perpetual inventory record created in Requirement 1.

© 2016 Pearson Education, Ltd.


SOLUTION

Requirement 1

Perpetual Inventory Record: FIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
(a)
Jan. 7 50 units × $ 22 = $ 1,100(a) 50 units × $ 22 = $ 1,100
$ 1,100
18 40 units × $ 22 =$ 880 10 units × $ 22 = $ 220
$ 880 $ 220
22 185 units × $ 26(b) = $ 4,810 10 units × $ 22 = $ 220
$ 5,030
185 units × $ 26 = $ 4,810
28 10 units × $ 22 = $ 220 60 units × $ 26 = $ 1,560
$ 3,470 $ 1,560
125 units × $ 26 = $ 3,250
31 10 units(c) × $ 26 = $ 260 50 units × $ 26 = $ 1,300
$ 260 $ 1,300
Totals 235 units $ 5,910 185 units $ 4,610 50 units $ 1,300

© 2016 Pearson Education, Ltd.


P6-38, cont.
Requirement 1, cont.
Calculations:
Unit cost of inventory purchased = Total cost / Total number of units
(a)
Jan. 7 purchase:
= ($1,050 + $50 freight-in) / 50 units
= $1,100 / 50 units
= $22 per unit
(b)
Jan. 22 purchase:
= $4,810 / 185 units
= $26 per unit
(c)
Units adjustment for
inventory shrinkage:
50 units per physical count
(60 units) per inventory records
(10 units) adjustment needed

Requirement 2
Date Accounts and Explanation Debit Credit
Jan. 18 Accounts Receivable 2,625
Sales Revenue 2,625
Sales on account.

Cost of Goods Sold 880 (e)


Software Inventory 880 (e)
Recorded the cost of goods sold.

28 Cash 5,265
Sales Revenue 5,265
Cash sales.

Cost of Goods Sold 3,470 (e)


Software Inventory 3,470 (e)
Recorded the cost of goods sold.

31 Cost of Goods Sold 260(e)


Software Inventory 260(e)
Adjustment for inventory shrinkage.

(e) Calculated in Requirement 1

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Practice Set
This problem continues the Crystal Clear Cleaning problem begun in Chapter 2 and continued through
Chapter 5.

P6-39 Accounting for inventory using the perpetual inventory system—FIFO

Consider the December transactions for Crystal Clear Cleaning that were presented in Chapter 5. (Cost
data have been removed from the sale transactions.) Crystal Clear uses the perpetual inventory system.

Requirements
1. Prepare perpetual inventory records for December for Crystal Clear Cleaning using the FIFO
inventory costing method. (Note: You must calculate the cost of goods sold on the 11th, 28th, and
31st.)
2. Journalize the transactions for December 11th, 28th, and 31st (adjusting entry a only) using the
perpetual inventory record created in Requirement 1.

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SOLUTION

Requirement 1
Perpetual Inventory Record: FIFO

Purchases Cost of Goods Sold Inventory on Hand


Unit Unit Unit
Date Quantity Cost Total Cost Quantity Cost Total Cost Quantity Cost Total Cost
Dec. 2 475 units × $ 6.00(a) = $ 2,850 475 units × $ 6.00 = $ 2,850
$ 2,850
5 600 units × $ 7.50(b) = $ 4,500 475 units × $ 6.00 = $ 2,850
$ 7,350
600 units × $ 7.50 = $ 4,500
7 (75 units) × $ 6.00 = ($ 450) 400 units × $ 6.00 = $ 2,400
$ 6,900
600 units × $ 7.50 = $ 4,500
9 ($ 87) (c) 400 units × $ 6.00 = $ 2,400
$ 6,813
600 units × $ 7.355(e) = $ 4,413(d)
11 285 units × $ 6.00 = $ 1,710 115 units × $ 6.00 = $ 690
$ 1,710 $ 5,103
600 units × $ 7.355 = $ 4,413
12 ($ 72) (f) 115 units × $ 5.37(h) = $ 618(g)
$ 5,031
600 units × $ 7.355 = $ 4,413
15 (22 units) × $ 6.00 = ($ 132) 22 units × $ 6.00 = $ 132
($ 132) 115 units × $ 5.37 = $ 618 $ 5,163
600 units × $ 7.355 = $ 4,413
28 22 units × $ 6.00 =$ 132 472 units × $ 7.355 = $ 3,472
115 units × $ 5.37 =$ 618 $1,691 $ 3,472
128 units × $ 7.355 =$ 941
31 44 units(i) × $ 7.355 =$ 324 428 units × $ 7.355 = $ 3,148
$ 324 $ 3,148
Totals 1,000 units $ 6,741 572 units $ 3,593 428 units $ 3,148

© 2016 Pearson Education, Ltd.


P6-39, cont.
Requirement 1, cont.

Calculations:

Unit cost of inventory purchased = Total cost / Total number of units


(a)
Dec. 2 purchase:
= $2,850 / 475 units
= $6.00 per unit
(b)
Dec. 5 purchase:
= $4,500 / 600 units
= $7.50 per unit

December 9:
Amount due,
= $4,500 total invoice – $150 freight-in included
net of freight-in
= $4,350

(c) $4,350 amount due net of freight-in


Purchase discount =
× 0.02 percentage purchase discount
= $87

(d)
Total cost of the
600-units-layer of inventory, = $4,500 total cost before discount – $87 discount
net of purchase discount
= $4,413

(e)
Unit cost of the
600-units-layer of inventory, = $4,413 total cost net of discount / 600 units
net of purchase discount
= $7.355 per unit

© 2016 Pearson Education, Ltd.


P6-39, cont.
Requirement 1, cont.

December 12:
Amount due,
= $2,850 cost of 475 units – $450 cost of 75 units returned
net of purchase return
= $2,400

(f) $2,400 amount due net of purchase return


Purchase discount =
× 0.03 percentage purchase discount
= $72

(g)
Total cost of the
115-units-layer of inventory, = $690 total cost before discount – $72 discount
net of purchase discount
= $618

(h)
Unit cost of the
115-units-layer of inventory, = $618 total cost net of discount / 115 units
net of purchase discount
= $5.37 per unit

(i)
Units adjustment for
inventory shrinkage:
428 units per physical count
(472 units) per inventory records
( 44 units) Adjustment needed

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P6-39, cont.
Requirement 2

Date Accounts and Explanation Debit Credit


Dec. 11 Accounts Receivable 3,990
Sales Revenue 3,990
Sales on account.

Cost of Goods Sold 1,710


Merchandise Inventory 1,710
Recorded the cost of goods sold.

28 Cash 3,975
Sales Revenue 3,975
Cash sale.

Cost of Goods Sold 1,691


Merchandise Inventory 1,691
Recorded the cost of goods sold.

31 Cost of Goods Sold 324


Merchandise Inventory 324
Adjustment for inventory shrinkage.

© 2016 Pearson Education, Ltd.


Critical Thinking
Decision Case 6-1

Suppose you manage Campbell Appliance. The store’s summarized financial state- ments for 2017, the
most recent year, follow:

Assume that you need to double net income. To accomplish your goal, it will be very difficult to raise
the prices you charge because there is a discount appliance store nearby. Also, you have little control
over your cost of goods sold because the appliance manufacturers set the amount you must pay.
Identify several strategies for doubling net income.

© 2016 Pearson Education, Ltd.


SOLUTION

Strategies for doubling net income include the following:

 Analyze the mix and level of operating expenses to identify opportunities to increase efficiencies
(via cost control) and effectiveness (via sales in excess of costs). This would include reducing
costs by eliminating non-value-added activities (e.g., some general and administrative activities)
and focusing on activities with the greatest likelihood of increasing sales and yielding returns in
excess of the cost of resources invested (e.g., advertising, marketing, and promotion activities).
 Consider offering specialty high-quality products that yield higher profit margins (products that
the nearby discount applicant store might not offer).
 Train employees in effective customer relationship skills to increase first-time sales, repeat
business, and new business created by favorable word-of-mouth.
 Offer superior post-sales customer support using resources already available (no additional
investment or new employees required).

Fraud Case 6-1

Ever since he was a kid, Carl Montague wanted to be a pro football player. When that didn’t work out,
he found another way to channel his natural competitive spirit: He bought a small auto parts store in
Kentucky that was deep in red ink (negative earnings). At the end of the year, he created “ghost”
inventory by recording fake inventory purchases. He offset these transactions by “adjustments” to Cost
of Goods Sold, thereby boosting profit and strengthening the balance sheet. Fortified with great
financials, he got bank loans that allowed him to build up a regional chain of stores, buy a local sports
franchise, and take on the lifestyle of a celebrity. When the economy in the region tanked, he could no
longer cover his losses with new debt or equity infusions, and the whole empire fell like a house of
cards.

Requirements
1. Name several parties that could have been hurt by the actions of Carl Montague.
2. What kind of adjustment to Cost of Goods Sold (debit or credit) would have the effect of boosting
earnings?

SOLUTION

Requirement 1

Parties that could have been hurt by the actions of Carl Montague include creditors who weren’t paid
(principal and/or interest), providers of equity who lost their investment, and employees who lost their
jobs.

Requirement 2

A credit reduces Cost of Goods Sold (an expense), and thus has the effect of boosting earnings.

© 2016 Pearson Education, Ltd.


Financial Statement Case 6-1

The notes are an important part of a company’s financial statements, giving valuable details that would
clutter the tabular data presented in the statements. This case will help you learn to use a company’s
inventory notes. Visit http://www.pearsonhighered.com/Horngren to view a link to Starbucks
Corporation’s Fiscal 2013 Annual Report. Access the financial statements and related notes, and
answer the following questions:

Requirements
1. Which inventory costing method does Starbucks use? How does Starbucks value its inventories? See
Note 1.
2. By using the cost of goods sold formula, you can compute net purchases, which are not reported in
the Starbucks statements. How much were Starbucks’s inventory purchases during the year ended
September 29, 2013?
3. Determine Starbucks’s inventory turnover and days’ sales in inventory for the year ended September
29, 2013. (Round each ratio to one decimal place.) How do Starbucks’s inventory turnover and days’
sales in inventory compare with Green Mountain Coffee Roasters, Inc.’s for the year ended
September 28, 2013? Explain.

SOLUTION

Requirement 1

Inventories are stated at the lower of cost (primarily moving cost average) or market. Starbucks
Corporation uses the moving average method.

Requirement 2

Starbucks’s net purchases of inventory were $6,252 (in millions) during the year ended September 29,
2013.

Calculations:

Beginning Inventory + Net Purchases – Ending Inventory = Cost of Goods Sold

Thus:

Net Purchases = Ending Inventory + Cost of Goods Sold – Beginning Inventory


= $1,111.2 + $6,382.3 – $1,241.5
= $6,252

(Dollar amounts in millions)

© 2016 Pearson Education, Ltd.


Financial Statement Case 6-1, cont.
Requirement 3

For the fiscal year ended September 28, 2013, Green Mountain Coffee Roasters had an inventory
turnover of 3.79 times and days’ sales in inventory of 96.3 days.

For the fiscal year ended September 29, 2013, Starbucks’ inventory turnover is 5.4 times, and days’
sales in inventory is 67.6 days.

For the fiscal years ending in 2013:


Starbucks’ inventory turnover (5.4 times) is higher than that of Green Mountain Coffee Roasters (3.79
times; year ended September 28, 2013) and Starbucks’ days’ sales in inventory (67.6 days) is lower than
that of Green Mountain Coffee (96.3 days; year ended September 28, 2013). Both measures for
Starbucks compare favorably to Green Mountain. Starbucks sold its average level of inventory more
times than did Green Mountain, and Starbucks held its average inventory for a shorter time than did
Green Mountain.

Calculations:

Starbucks
Fiscal year ended September 29, 2013 (in millions):
Average inventory = (Beginning inventory + Ending inventory) / 2
= ($1,241.5 + $1,111.2) / 2
= $1,176.4

Inventory turnover = Cost of goods sold / Average inventory


= $6,382.3 / $1,176.4
= 5.4 times for the year

Days’ sales in inventory = 365 days / Inventory turnover


= 365 days / 5.4 times
= 67.6 days

© 2016 Pearson Education, Ltd.


Team Project 6-1

Obtain the annual reports of as many companies as you have team members—one company per team
member. Most companies post their financial statements on their Web sites.

Requirements
1. Identify the inventory method used by each company.
2. Compute each company’s gross profit percentage, inventory turnover, and days’ sales in inventory
for the most recent two years.
3. For the industries of the companies you are analyzing, obtain the industry averages for gross profit
percentage and inventory turnover from Robert Morris Associates, Annual Statement Studies; Dun
and Bradstreet, Industry Norms and Key Business Ratios; or Leo Troy, Almanac of Business and
Industrial Financial Ratios.
4. How well does each of your companies compare with the average for its industry? What insight
about your companies can you glean from these ratios?

SOLUTION

Students’ answers will vary since different annual reports will be obtained.

© 2016 Pearson Education, Ltd.

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