Accounting Principles 7Th Canadian Edition Volume 1 By Jerry J. Weygandt

Accounting Principles 7Th Canadian Edition Volume 1 By Jerry J. Weygandt

CHAPTER 6 INVENTORY COSTING CHAPTER STUDY OBJECTIVES 1. Describe the steps in determining inventory quantities. The steps in determining inventory quantities are (1) taking a physical inventory of goods on hand, and (2) determining the ownership of goods in transit, on consignment, and in similar situations. 2. Calculate cost of goods sold and ending inventory in a perpetual inventory system using the specific identification, FIFO, and weighted average methods of cost determination. Costs are allocated to the Cost of Goods Sold account each time a sale occurs in a perpetual inventory system. The cost is determined by specific identification or by one of two cost formulas: FIFO (first-in, first-out) and weighted average. Specific identification is used for goods that are not ordinarily interchangeable. T is method tracks the actual physical flow of goods, allocating the exact cost of each merchandise item to cost of goods sold and ending inventory. The FIFO cost formula assumes a first-in, first-out cost flow for sales. Cost of goods sold consists of the cost of the earliest goods purchased. Ending inventory is determined by allocating the cost of the most recent purchases to the units on hand. The weighted average cost formula is used for goods that are homogeneous or non-distinguishable. Under weighted average, a new weighted (moving) average unit cost is calculated after each purchase and applied to the number of units sold. Inventory is updated by subtracting cost of goods sold for each sale from the previous ending inventory balance. 3. Explain the financial statement effects of inventory cost determination methods. Specific identification results in the best match of costs and revenues on the income statement. When prices are rising, weighted average results in a higher cost of goods sold and lower profit than FIFO. Weighted average results in a better match on the income statement because it results in an expense amount made up of more current costs. On the balance sheet, FIFO results in an ending inventory that is closest to the current (replacement) value and the best balance sheet valuation. All three methods result in the same cash flow. 4. Determine the financial statement effects of inventory errors. An error in beginning inventory will have a reverse effect on profit in the current year (e.g., an overstatement of beginning inventory results in an overstatement of cost of goods sold and an understatement of prof t). An error in the cost of goods purchased will have a reverse effect on profit (e.g., an overstatement of purchases results in an overstatement of cost of goods sold and an understatement of profit). An error in ending inventory will have a similar effect on profit (e.g., an overstatement of ending inventory results in an understatement of cost of goods sold and an overstatement of profit). If ending inventory errors are not corrected in the following period, their effect on profit for the second period is reversed and total prof t for the two years will be correct. On the balance sheet, ending inventory errors will have the same effects on total assets and total owner’s equity, and no effect on liabilities. 5. Value inventory at the lower of cost and net realizable value. The cost of the ending inventory is compared with its net realizable value. If the net realizable value is lower, a write-down is recorded, which results in an increase in cost of goods sold, and a reduction in inventory. The write-down is reversed if the net realizable value of the inventory increases, but the value of the inventory can never be higher than its original cost. 6. Demonstrate the presentation and analysis of inventory. Ending inventory is reported as a current asset on the balance sheet at the lower of cost and net realizable value. Cost of goods sold is reported as an expense on the income statement. Additional disclosures include the cost determination method. The inventory turnover ratio is a measure of liquidity. It is calculated by dividing the cost of goods sold by average inventory. It can be converted to days sales in inventory by dividing 365 days by the inventory turnover ratio. 7. Calculate ending inventory and cost of goods sold in a periodic inventory system using FIFO and weighted average inventory cost formulas (Appendix 6A). Under the FIFO cost formula, the cost of the most recent goods purchased is allocated to ending inventory. The cost of the earliest goods on hand is allocated to cost of goods sold. Under the weighted average cost formula, the total cost available for sale is divided by the total units available to calculate a weighted average unit cost. The weighted average unit cost is applied to the number of units on hand at the end of the period to determine ending inventory. Cost of goods sold is calculated by subtracting ending inventory from the cost of goods available for sale. The main difference between applying cost formulas in a periodic inventory system and applying cost formulas in a perpetual inventory system is the timing of the calculations. In a periodic inventory system, the cost formula is applied at the end of the period. In a perpetual inventory system, the cost formula is applied at the date of each sale to determine the cost of goods sold. 8. Estimate ending inventory using the gross profit and retail inventory methods (Appendix 6B). Two methods of estimating inventories are the gross profit method and the retail inventory method. Under the gross prof t method, the gross profit margin is applied to net sales to determine the estimated cost of goods sold. The estimated cost of goods sold is subtracted from the cost of goods available for sale to determine the estimated cost of the ending inventory. Under the retail inventory method, a cost-to-retail ratio is calculated by dividing the cost of goods available for sale by the retail value of the goods available for sale. This ratio is then applied to the ending inventory at retail to determine the estimated cost of the ending inventory.   EXERCISES Exercise 1 Workman Art Sales uses the perpetual inventory system. On September 30, 2017, the company’s year end, a physical count was taken of the inventory on hand. The cost of the inventory on hand was determined to be $325,400. However, the accountant has questions about the following items: 1. On the store shelves, the staff counted 7 paintings held by Workman on consignment from a local artist. The paintings are included on the inventory count at a cost of $4,200. 2. On September 30, a shipment of goods was sent to a customer, FOB destination. The cost of the goods shipped is $7,800, and freight, which is to be paid by Workman, will cost $200. These items are not included in the inventory count. Delivery is expected to take three days. 3. On October 2, a freight company delivered goods that cost $10,000 to Workman’s warehouse. The goods had been shipped by the vendor on September 29, FOB shipping point. Freight on this shipment will amount to $500 and will be paid by the appropriate party. The goods are not included on the inventory count. 4. On September 30 a loyal customer visited Workman’s retail shop and asked that certain items be set aside for him. The goods set aside have a cost of $1,300. The customer intends to let Workman know no later than October 2 whether or not he wishes to finalize the sale and have the goods shipped to his home. The freight will cost $50 and will be paid by Workman. The sales person was fairly sure the customer will take the items; and so prepared the sales invoice on September 30. The items are not included on the inventory count. 5. Residing in Workman’s warehouse is merchandise costing $5,000 that was purchased in September and found to be defective. Workman’s purchasing manager has arranged with the vendor to accept return of the goods and has packaged them for return shipment. The vendor processed a credit to Workman’s account on September 28, and has arranged to have the goods picked up on October 1. The items are included on the inventory count. Instructions Calculate the correct inventory balance at September 30, 2017. For each of the above items, explain the basis of your treatment of the item. Solution 1 (15 min.) List $325,400 Unadjusted inventory balance 1. (4,200) The goods on consignment do not belong to Workman. 2. 7,800 Because they were sent FOB destination, the goods belong to Workman until delivered. 3. 10,500 The goods are the responsibility of Workman from the shipping point. Include freight-in in the merchandise inventory cost. 4. 1,300 Because the sale is not final, the goods belong to Workman, not the customer. 5. (5,000) Because the vendor has approved the return and processed the credit, ______ these goods should not be included in Workman’s inventory. $335,800 Adjusted inventory balance. Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the steps in determining inventory quantities. Section Reference: Determining Inventory Quantities CPA: Financial Reporting Exercise 2 Helsinki Furniture Sales uses the periodic inventory system. On April 30, 2017, the company’s year end, a physical count was taken of the inventory on hand in both the warehouse and the retail store area for the purpose of determining cost of goods sold and ending inventory value. The preliminary inventory list prepared by the warehouse manager shows a total inventory on hand of $738,000. The following are items that the warehouse manager noted on a separate sheet. None of these items are currently part of the final inventory listing because the manager was not sure how they should be treated for inventory purposes. 1. On April 30, Helsinki shipped an order to a customer, FOB shipping point. The cost of the goods shipped is $9,650. Freight, which is to be paid by the appropriate party, will cost $375. 2. On April 30, a customer visited Helsinki’s shop and selected a desk that she wanted to purchase and paid for it in full. The sales price of the desk was $3,500, and the cost was $2,200. The customer intends to send a truck to pick up the desk no later than May 2. The freight will cost $50 and will be paid by the customer. A “Sold” sign has been placed on the desk but it is still on display in the store. 3. Residing in Helsinki’s warehouse is furniture costing $21,000 that was purchased in April and needs to be returned. The goods were special ordered for a customer who has since decided not to buy them after all. Helsinki’s supplier has agreed to accept return of the goods and will allow a full credit on Helsinki’s account as soon as they are received. A freight company is scheduled to pick up the merchandise on the morning of May 1, and so they have been set aside near the loading dock. The freight, which will be paid by the customer as a fee for the cancellation, is to cost $300. 4. Helsinki sells some of its merchandise in smaller towns by placing samples on consignment with local hardware stores. The manager noted that 15 desks at a cost of $1,200 each and 30 chairs at $75 each are currently out on consignment. 5. On May 2, a freight company delivered goods that cost $65,000 to Helsinki’s warehouse. The goods had been shipped by the vendor on April 29, FOB destination. Freight on this shipment will amount to $400 and will be paid by the appropriate party. Instructions Calculate the correct inventory balance at April 30, 2017. For each of the above items, explain the basis of your treatment of the item. Solution 2 (15 min.) List $738,000 Unadjusted inventory balance 1. 0 Because the sale is FOB shipping point, the customer has already taken title at April 30. The freight is the customer’s responsibility. 2. 0 The sale was completed on April 30, so the desk does not belong to Helsinki and should not be included in their inventory. 3. 21,000 The goods are in Helsinki’s possession, and at this point they have not yet received a credit from the vendor, so the goods should be included in inventory. 4. 20,250 The goods belong to Helsinki even though they are not in their possession. Total cost is ($1,200 x 15) + ($75 x 30) = $20,250 5. 0 Because the goods are shipped FOB destination, Helsinki does not get title until they arrive. The vendor is responsible for the freight. ______ $779,250 Adjusted inventory balance Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the steps in determining inventory quantities. Section Reference: Determining Inventory Quantities CPA: Financial Reporting Exercise 3 Fyodorov Company, using a periodic inventory system, has just completed a physical inventory count at year end, December 31, 2017. Only the items on the shelves, in storage, and in the receiving area were counted. The inventory amounted to $60,000. During the audit, the independent CPA discovered the following additional information: 1. There were goods in transit on December 31, 2017, from a supplier with terms FOB destination, costing $8,000. Because the goods had not arrived, they were excluded from the physical inventory count. 2. On December 27, 2017, a regular customer purchased goods for cash amounting to $1,000 and left them for pickup on January 4, 2018. Fyodorov Company had paid $500 for the goods and, because they were on hand, included them in the physical inventory count. 3. Fyodorov Company, on the date of the inventory count, received notice from a supplier that goods ordered earlier, at a cost of $4,000, had been delivered to the transportation company on December 28, 2017; the terms were FOB shipping point. Because the shipment had not arrived on December 31, 2017, it was excluded from the physical inventory. 4. On December 31, 2017, there were goods in transit to customers, with terms FOB shipping point, amounting to $800 (expected delivery on January 8, 2018). Because the goods had been shipped, they were excluded from the physical inventory count. 5. On December 31, 2017, Fyodorov Company shipped $2,500 worth of goods to a customer, FOB destination, in Thunder Bay. The goods arrived in Thunder Bay on January 5, 2018. Because the goods were not on hand, they were not included in the physical inventory count. 6. Fyodorov Company, as the consignee, had goods on consignment that cost $8,000. Because these goods were on hand as of December 31, 2017, they were included in the physical inventory count. Instructions Analyze the above information for Fyodorov Company and calculate a corrected amount for the ending inventory. Explain the basis for your treatment of each item. Solution 3 (20 min.) List: $60,000 Unadjusted inventory balance 1. 0 Because the goods were shipped FOB destination, the title will pass to Fyodorov upon arrival. Properly excluded. 2. 500 Goods should be excluded. The customer owns them. 3. + 4,000 Goods belong to Fyodorov. Title passed when supplier delivered the goods to the transportation company. 4. 0 Because the goods were shipped FOB shipping point, Fyodorov no longer has title to these goods. Properly excluded. 5. + 2,500 Goods were shipped FOB destination. Fyodorov retains title until the customer receives them. 6. – 8,000 These goods are owned by the consignor, not the consignee, and should not be included in Fyodorov’s inventory. ______ $58,000 Corrected inventory Bloomcode: Analysis Difficulty: Medium Learning Objective: Describe the steps in determining inventory quantities. Section Reference: Determining Inventory Quantities CPA: Financial Reporting Exercise 4 Dark Matter Coffee is a sole proprietorship owned by Evan Fantom. The company is in its second year of operations and only has one coffee blend available in one size. Evan does not have any background in accounting and would like your expertise to determine the individual and total impact of the following items on the ending inventory balance for the company’s December 31, 2017 year end. 1. Evan keeps all inventory in his basement which he claims has a total cost of $40,000 (500 units). Of this amount, 50 units costing $3,000 spilled and could not be salvaged or sold. 2. Evan has 80 units with a cost of $5,500 loaded in a delivery van ready to be shipped to customers. The terms of these sales are FOB destination. 3. Evan has decided to try and sell goods on consignment for the first time. At year end, Evan has shipped out 100 units on consignment for a total cost of $7,750. These goods have not yet been sold by the consignee at year end and Evan has not received any proceeds. Solution 4 (10 min.) 1. The damaged goods (50 units) costing $3,000 should not be included in the ending inventory balance. This leaves 450 units with a cost of $37,000 to be included in ending inventory. 2. The terms FOB destination implies that title to the goods remain with Dark Matter until the goods have reached the destination and delivery is complete. All 80 units costing $5,500 should be included in ending inventory. 3. Legal title to the goods on consignment remains with Dark Matter until ultimate sale to the end consumer since the consignee is only acting as an agent to facilitate the sale. As a result the 100 units costing $7,750 should be included in ending inventory. Total impact on the December 31, 2017 ending inventory = 450 + 80 + 100 = 630 units; $37,000 + 5,500 + $7,750 = $50,250 Bloomcode: Analysis Difficulty: Easy Learning Objective: Describe the steps in determining inventory quantities. Section Reference: Determining Inventory Quantities CPA: Financial Reporting Exercise 5 Olynik Company uses the perpetual inventory system and the weighted average cost formula. The following information is available for the month of June: Date Explanation Units Unit Cost Jun 1 Beginning Inventory 200 $10 Jun 15 Purchase 300 11 Jun 17 Sale 250 ? Jun 24 Purchase 400 12 Instructions Prepare a schedule to show cost of goods sold and the value of the ending inventory for the month of June. Solution 5 (10 min.) Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Jun 1 200 $10.00 $2,000 Jun 15 300 $11 $3,300 500 10.60 5,300 Jun 17 250 $10.60 $2,650 250 10.60 2,650 Jun 24 400 12 4,800 650 11.46 7,450 700 $8,100 250 $2,650 Cost of Goods Sold: $2,650 Ending Inventory: $7,450 Check: Beginning Inventory + Purchases − Cost of Goods Sold = Ending Inventory: $2,000 + $8,100 – $2,650 = $7,450 Bloomcode: Application Difficulty: Medium Learning Objective: Calculate cost of goods sold and ending inventory in a perpetual inventory system using the specific identification, FIFO, and weighted average methods of cost determination. Section Reference: Inventory Cost Determination Methods CPA: Financial Reporting Exercise 6 Gabbins Company uses the perpetual inventory system and the FIFO cost formula. Purchases Sales Units Unit Cost Units Selling Price/Unit Mar 1 Beginning inventory 100 $50 3 Purchase 60 $60 4 Sales 70 $100 10 Purchase 200 $70 16 Sales 80 $110 19 Sales 80 $110 25 Sales 50 $110 30 Purchase 40 $75 Instructions a) Using the inventory and sales data above, calculate the value assigned to cost of goods sold in March and to the ending inventory at March 31. b) Prepare the journal entries to record the sales on March 4 and March 19. All sales are made on credit. Solution 6 (20 min.) a) Purchases Cost of Goods Sold Balance Date Units Cost Total Units Cost Total Units Cost Total Mar 1 100 $50 $ 5,000 Mar 3 60 $60 $ 3,600 100 60 50 60 8,600 Mar 4 70 $50 $3,500 30 60 50 60 5,100 Mar 10 200 70 14,000 30 60 200 50 60 70 19,100 Mar 16 30 50 50 60 4,500 10 200 60 70 14,600 Mar 19 10 70 60 70 5,500 130 70 9,100 Mar 25 50 70 3,500 80 70 5,600 Mar 30 40 75 3,000 80 40 70 75 8,600 300 $20,600 280 $17,000 Ending Inventory: $8,600 Cost of Goods Sold: $17,000 Check: Beginning Inventory + Purchases − Cost of Goods Sold = Ending Inventory: $5,000 + $20,600 − $17,000 = $8,600 b) Mar 4 Accounts Receivable 7,000 Sales (70 x $100) 7,000 Cost of Goods Sold 3,500 Inventory (70 x $50) 3,500 Mar 19 Accounts Receivable 8,800 Sales (80 x $110) 8,800 Cost of Goods Sold 5,500 Inventory [(10 x $60) + (70 x $70)] 5,500 Bloomcode: Application Difficulty: Hard Learning Objective: Calculate cost of goods sold and ending inventory in a perpetual inventory system using the specific identification, FIFO, and weighted average methods of cost determination. Section Reference: Inventory Cost Determination Methods CPA: Financial Reporting