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Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

CHAPTER 6 Reporting and Analyzing Inventory ASSIGNMENT CLASSIFICATION TABLE Exercises

A Problems

B Problems

1, 2

1, 2

1A

1B

3, 6

2. Apply the methods of 5, 6, 7, cost determination using *18, *20, specific identification, *21 FIFO, and average under a perpetual inventory system.

3, 4, 5, 6, *14, *15

3, 4, 5, 6, 2A, 3A, 7, *15, *16 4A, 5A, 6A, *15A, *16A

2B, 3B, 4B, 5B, 6B, *15B, *16B

3, 5, 6, 7

3. Explain the effects on financial statement of choosing each of the inventory cost determination methods.

8, 9, 10

7

3, 6, 7, 12

3A, 5A

3B, 5B

1, 3, 5, 7

4. Identify the effects of inventory errors on the financial statements

11, 12, 13

8, 9

8, 9

4A, 7A, 8A 4B, 7B, 8B 4

5. Demonstrate the presentation and analysis of inventory.

14, 15, 16, 10, 11, 12 17

10, 11, 12

6A, 7A, 8A, 9A, 10A, 11A, 12A, *14A

*6. Apply the FIFO and average cost inventory cost determination methods under a periodic inventory system (Appendix 6A).

*18, *19, *20, *21

*13, *14, *15, *16

*13A, *13B, *14A, *14B, *15A, *16A *15B, *16B

Study Objectives 1. Describe the steps in determining inventory quantities.

Questions 1, 2, 3, 4

Brief Exercises

*13, *14, *15

6B, 7B, 8B, 9B, 10B, 11B, 12B, *14B

BYP

1, 2, 4

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendices to each chapter.

Solutions Manual 6-1 Chapter 6 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Simple

30-40

1A

Identify items in inventory.

2A

Apply specific identification.

Moderate

30-40

3A

Apply perpetual FIFO and answer questions about effects.

Moderate

30-40

4A

Apply perpetual average cost and discuss errors.

Moderate

30-40

5A

Apply perpetual FIFO and average cost; compare effects.

Moderate

35-45

6A

Record transactions using perpetual average cost; apply LCNRV.

Moderate

30-40

7A

Determine effects of inventory error for two years.

Moderate

20-25

8A

Determine effects of inventory errors for multiple years.

Moderate

25-30

9A

Determine and record LCNRV.

Moderate

15-25

10A

Record and present LCNRV valuation for multiple periods.

Moderate

15-25

11A

Calculate ratios and comment on liquidity.

Moderate

25-30

12A

Compare ratios; comment on liquidity and profitability. Moderate

25-30

*13A

Apply periodic FIFO and average cost.

Moderate

25-35

*14A

Prepare partial financial statements and assess effects.

Moderate

20-30

*15A

Apply perpetual and periodic FIFO.

Moderate

25-35

*16A

Apply perpetual and periodic average cost.

Moderate

25-35

Simple

30-40

1B

Identify items in inventory.

Solutions Manual 6-2 Chapter 6 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number 2B

Description Apply specific identification.

Difficulty Level Moderate

Time Allotted (min.) 25-35

3B

Apply perpetual FIFO and answer questions about effects.

Moderate

30-40

4B

Apply perpetual average cost and discuss errors.

Moderate

30-40

5B

Apply perpetual FIFO and average cost; compare effects.

Moderate

30-40

6B

Record transactions using perpetual FIFO; apply LCNRV.

Moderate

30-40

7B

Determine effects of inventory error for two years.

Moderate

25-35

8B

Determine effects of inventory errors for multiple years.

Moderate

25-35

9B

Determine and record LCNRV.

Moderate

15-25

10B

Record and present LCNRV valuation for multiple periods.

Moderate

15-25

11B

Calculate ratios and comment on liquidity.

Moderate

25-30

12B

Compare ratios; comment on liquidity and profitability. Moderate

25-30

*13B

Apply periodic FIFO and average cost.

Moderate

25-35

*14B

Prepare partial financial statements and assess effects.

Moderate

20-30

*15B

Apply perpetual and periodic FIFO.

Moderate

25-35

*16B

Apply perpetual and periodic average cost.

Moderate

25-35

Solutions Manual 6-3 Chapter 6 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

ANSWERS TO QUESTIONS 1. Taking a physical inventory involves actually counting, weighing or measuring each kind of inventory on hand. Retailers, such as hardware stores, generally have thousands of different items to count. This is normally done when the store is closed to minimize errors due to the movement of merchandise. Tom will probably count items and mark the quantity, description, and inventory number on pre-numbered inventory tags (unless the company has more advanced technology that can read bar codes on inventory products – we will assume that they do not). He should only include items in the inventory that are in saleable condition. Ideally, strong internal control should be exerted over the physical inventory count. For example, Tom should not have responsibility for the custody or record-keeping for the inventory. He should also count in teams of two, or there should be a second counter checking the accuracy of the count. Adjustments may also have to be made to the physical inventory count for any goods in transit. For example, inventory purchased FOB shipping point that is still in transit will have to be included in inventory. Inventory that has been shipped by Kikujiro to customers FOB destination and not received by the customer before year-end will also have to be included in the count. Finally, any of Kikujiro’s inventory held by other retailers on consignment will have to be included in the count as well. 2.

Internal control consists of all the related methods and measures adopted within an organization to help it achieve reliable financial reporting, effective and efficient operations, and compliance with relevant laws and regulations. The use of internal control procedures will result in a more accurate and reliable inventory count. For example, the counting should be done by employees who do not have responsibility for the custody or record-keeping for the inventory. Each counter should verify the validity of each inventory item by checking that the items actually exist, how many there are and what condition they are in. To ensure accuracy, counting should be completed in teams of two and all inventory counts should be rechecked. Finally pre-numbered inventory tags should be used to ensure that all inventory is counted and none is counted twice. The pre-numbering of the tags will assist in the retracing of the count back to the physical inventory on hand and will also assist in establishing to the completeness of the count, when the inventory is compiled from the tags.

3.

(a) The goods will be included in Janine Ltd.’s (the seller’s) inventory if the terms of sale are FOB destination. (b) The goods will be included in Fastrak Corporation’s (the buyer’s) inventory if the terms of sale are FOB shipping point.

Solutions Manual 6-4 Chapter 6 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 4.

(a) Include: the inventory items belong to Kingsway. (b) Include: the inventory items belong to Kingsway. (c) Exclude: the customer has purchased the inventory item and legal ownership has passed to the customer.

5. The specific identification method tracks the physical flow of individual inventory items, matching the cost of the actual item sold against the revenue from that item. An example of inventory where the specific identification would be appropriate would be for goods that are not ordinarily interchangeable, such as automobiles with unique serial numbers. The FIFO inventory cost method assumes the first inventory purchased is the first inventory sold. The most recent purchases are assumed to remain in ending inventory. Inventory such as groceries could be accounted for using the FIFO cost method since older items should be sold first. The average cost method assumes that all goods available for sale are indistinguishable or homogeneous. Inventory such as hardware could be accounted for using an average cost method. 6. Average assumes that the goods available for sale are identical. FIFO assumes that the first goods purchased are the first to be sold. Specific identification matches the actual physical flow of merchandise. 7. A new weighted average unit cost must be calculated after each purchase because a new cost amount is added to the “cost pool”. This changes the total dollars in the cost pool and the quantity of units on hand in the cost pool. A sale withdraws units and total dollars from the cost pool at the weighted average cost. This does not affect the weighted average cost of the remaining units. That is, the weighted average cost of the remaining units is unchanged after a sale. 8. A company should consider: • Whether the goods are interchangeable or not, or whether they are produced or segregated for specific projects; • Whether the method corresponds most closely to the physical flow of goods; • Whether the method reports inventory on the statement of financial position that is close to the inventory’s most recent cost; and • Whether the method is used for other inventories with a similar nature and usage. 9. Average produces the better income statement valuation because the cost of goods sold is determined using more recent inventory prices. This better matches current costs with current revenues. FIFO produces the better valuation on the statement of financial position because the ending inventory is determined using the most recent prices. Since the normal intent is to replace the inventory after it is sold, the most recent prices are more relevant for decision-making. Solutions Manual 6-5 Chapter 6 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 10. (a) No effect – cash is not affected by the choice of inventory cost methods. (b) In a period of declining prices, FIFO will produce a lower ending inventory as inventory is determined using the most recent (lower) prices. Average will produce a higher ending inventory as ending inventory incorporates the higher older prices. (c) The cost of goods sold effect is opposite to that of ending inventory. Hence, cost of goods sold will be higher under FIFO and lower under the average cost method. (d) Because of the effect on the cost of goods sold as outlined in (c), profit will be lower under FIFO and higher under average. (e) The impact on retained earnings will be the same as the impact on profit and ending inventory—lower in a period of declining prices using FIFO and higher using average cost. 11. The error should be corrected if it will change the figures presented on the financial statements. While retained earnings may not change, other financial statement items and comparative figures may change. This information may impact a user’s decision. 12. (a) Mila Ltd.’s 2014 profit will be understated by $5,000. This is because an understatement of ending inventory will result in an overstatement of cost of goods sold. If cost of goods sold is overstated, then profit will be understated. (b) 2014 retained earnings will be understated by $5,000 because profit is understated (see (a) above). (c) 2014 total shareholders’ equity will be understated by $5,000 because the retained earnings balance is understated (see (b) above). (d) 2015 profit will be overstated $5,000. This is because beginning inventory is understated by $5,000, which will result in an understatement of cost of goods sold (recognizing that 2014 ending inventory is 2015 beginning inventory). If cost of goods sold is understated, then profit will be overstated. (e) 2015 retained earnings will be correct because the understatement in profit in 2014 and overstatement in 2015 will cancel each other. (f) 2015 total shareholders’ equity will be correct because the retained earnings balance is correct.

Solutions Manual 6-6 Chapter 6 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 13. (a) At the end of the fiscal year, before the inventory is adjusted to the inventory count, Shediac’s assets (Merchandise Inventory) would be overstated and its liabilities would be overstated (Accounts Payable). There would be no effect on shareholders’ equity. (b) Since the merchandise is not on hand at the time of the inventory count, the shipment from Bathurst would not be counted. This in turn would cause the inventory count to be lower than the perpetual inventory record. Normally when such a discrepancy arises, the Inventory account will be adjusted downward with a credit to reflect the amount of merchandise actually on hand. The corresponding debit in this adjusting entry would be to Cost of Goods Sold. The summary effect of the initial error and the count adjustment would be an overstatement in Cost of Goods Sold and Accounts Payable. Because Cost of Goods Sold is overstated, gross profit and profit are understated as well as Retained Earnings. At the end of Shediac’s current year, after the adjustment is made for the results of the inventory count, the overall impact on the accounting equation is no effect on assets, an overstatement of liabilities (Accounts Payable), and an understatement of shareholders’ equity (Retained Earnings). 14. (a) Cost refers to the original cost of inventory as determined by using specific identification, or the FIFO or average cost methods. (b) Net realizable value is the selling price less any costs required to make the goods ready for sale. (c) The lower of cost and net realizable value rule should be applied at the end of the accounting period, before financial statements are prepared. 15. Cost of Goods Sold is debited when recording a decline in inventory value under the lower of cost and net realizable value rule because a decline in the value of inventory is considered to be a cost of buying and selling merchandise. These declines are usually considered part of the risk associated with carrying inventory and part of the costs of carrying a variety and quantity of goods on hand. 16. An increase in the days in inventory ratio from one year to the next would be seen as deterioration in the company’s efficiency in managing inventory. It means that the inventory is being held for a longer period of time, which increases the risk of spoilage and obsolescence.

Solutions Manual 6-7 Chapter 6 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accounting, Sixth Canadian Edition

Answers to Questions (Continued) 17. (a) An inventory turnover ratio that is too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory shortages may also cause customer ill will and result in lost future sales. (b) If the inventory turnover is too low, it may indicate that the company is having difficulty selling its inventory and the inventory may become obsolete. *18. Periodic and perpetual inventory systems differ in the accounting treatment for inventories. Under a perpetual inventory system inventory records are updated for every purchase and sale transaction. The cost of goods sold is recorded each time a sale is made. Under a periodic system, the inventory is only updated at the end of the period when a physical inventory count is performed. Inventory purchases throughout the year are debited to a Purchases account in a periodic inventory system rather than a Merchandise Inventory account. When a sale is recorded in a periodic inventory system, no entry is made to record the cost of the sale. Cost of goods sold is calculated separately after the physical inventory count is performed. *19. Ending inventory is known as a result of the physical inventory count. To determine cost of goods sold, the total amount of inventory available for sale needs to be determined first in order to determine what inventory has been sold (goods available for sale – ending inventory = cost of goods sold). Goods sold are not tracked separately in a periodic inventory system. *20. In both systems, the first costs in are the costs assigned to the goods sold so no matter what system is used, the cost of goods sold will always consist of the oldest units and these would are assumed to be on hand when using either method. *21. In a perpetual system, the average cost per item is recalculated every time a purchase transaction takes place. In a periodic system, the average is determined based on the total goods available for sale during the period. If there are cost changes during the period, the average cost per item will differ in a perpetual and periodic inventory system.

Solutions Manual 6-8 Chapter 6 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine

Financial Accountin...