ACCT 220. Solutions – Chapter 6

ACCT 220 SOLUTIONS – CHAPTER 6 2. Inventory items have two common characteristics: (1) they are owned by the company and (2) they are intended to be sold to customers in the ordinary course of business. 11. Plato Company is using the FIFO method of inventory costing, and York Company is using the LIFO method. Under FIFO, the latest goods purchased remain in inventory. Thus, the inventory on the balance sheet should be close to current costs. The reverse is true of the LIFO method. Plato Company will have the higher gross profit because cost of goods sold will include a higher proportion of goods purchased at earlier (lower) costs. 18. An inventory turnover ratio that is too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory outages may also cause customer ill will and result in lost future sales. *22. (a) Petra Company’s 2003 net income will be understated $5,000; (b) 2004 net income will be overstated $5,000; and (c) the combined net income for the two years will be correct. BRIEF EXERCISE 6-5 Cost of goods sold under: LIFO FIFO Beginning inventory $6 × 100 $6 × 100 Purchases $7 × 200 $7 × 200 $8 × 150 $8 × 150 Cost of goods available for sale $ 3,200 $ 3,200 Less: Ending inventory $ 1,300 $ 1,550 Cost of goods sold $ 1,900 $ 1,650 Since the cost of goods sold is $250 less under FIFO ($1,900 – $1,650) that is the amount of the phantom profit. It is referred to as “phantom profit” because, FIFO matches current selling prices with old inventory costs. To replace the units sold the company will have to pay the current price of $8 per unit, rather than the $6 per unit which some of the units were priced at under FIFO. Therefore, profit under LIFO is more representative of what the company can expect to earn in future periods. EXERCISE 6-5 (a) (1) FIFO Beginning inventory (200 × $5) .......................... Purchases June 12 (300 × $6) ........................................ June 23 (500 × $7) ........................................ Cost of goods available for sale ........................ Less: Ending inventory (160 × $7) ................... Cost of goods sold.............................................. $1,000 $1,800 3,500 5,300 6,300 1,120 $5,180 (2) LIFO Cost of goods available for sale ........................ Less: Ending inventory (160 × $5) ................... Cost of goods sold.............................................. (3) AVERAGE COST Cost of Goods Available for Sale $6,300 ÷ Total Units Weighted Average Available for Sale = Unit Cost 1,000 $6.30 Ending inventory (160 × $6.30) $1,008 Cost of goods sold (840 × $6.30) $5,292 or $6,300 – $1,008 = $5,292 (b) The FIFO method will produce the highest ending inventory because costs have been rising. Under this method, the $6,300 800 $5,500 earliest costs are assigned to cost of goods sold, and the latest costs remain in ending inventory. The LIFO method will produce the highest cost of goods sold for Newport Company. Under LIFO the most recent costs are charged to cost of goods sold and the earliest costs are included in the ending inventory. (a) The average cost ending inventory ($1,008) is higher than LIFO ($800) but lower than FIFO ($1,120). For cost of goods sold, average cost ($5,292) is higher than FIFO ($5,180) but lower than LIFO ($5,500). (b) The simple average would be (($5 + $6 + $7)/3) = $6. However, the average cost method uses a weighted average unit cost, not a simple average of unit costs. PROBLEM 6-3A (a) COST OF GOODS AVAILABLE FOR SALE Date Total Cost Jan. 1 Mar. 15 July 20 Sept. 4 Dec. 2 (b) Sold Date Sept. 4 Dec. 2 Explanation Units Beginning inventory Purchase Purchase Purchase Purchase Total 100 300 200 300 100 1,000 Ending Inventory Units 50 100 150* *1,000 – 850 = 150 Unit Cost $ 28 30 FIFO Total Cost $1,400 3,000 $4,400 Unit Cost $20 24 25 28 30 $ 2,000 7,200 5,000 8,400 3,000 $25,600 Cost of Goods Cost of goods available for sale Less: Ending inventory Cost of goods sold $25,600 4,400 $21,200 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost Jan. 1 100 $ 20 $ 2,000 Mar. 15 300 24 7,200 July 20 200 25 5,000 Sept. 4 250 28 7,000 850 $21,200 PROBLEM 6-3A (Continued) AVERAGE COST Ending Inventory Sold Cost of Goods Cost of goods available for sale Less: Ending inventory Cost of goods sold $25,600 ÷ 1,000 = $25.60 Units 150 Unit Cost $25.60 Total Cost $3,840 $25,600 3,840 $21,760 Proof of Cost of Goods Sold Unit Total Units Cost Cost 850 $25.60 $21,760 Sold Date Jan. 1 Mar. 15 Ending Inventory Units 100 50 150 Unit Cost $ 20 24 LIFO Total Cost $2,000 1,200 $3,200 Cost of Goods Cost of goods available for sale Less: Ending inventory Cost of goods sold $25,600 3,200 $22,400 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost Mar. 15 250 $ 24 $ 6,000 July 20 200 25 5,000 Sept. 4 300 28 8,400 Dec. 2 100 30 3,000 850 $22,400 (c) FIFO produces the highest cost for the balance sheet $4,400. LIFO produces the highest cost of goods sold for the income statement $22,400.