CHAPTER 19

INVENTORIES

DISCUSSION QUESTIONS

SOLUTIONS

3. Must a company use the inventory costing method that best conforms to the actual
physical movement of the goods? Explain.

There is no need for the cost flow assumption used in inventory costing to reflect the
actual physical movement of the goods. The FIFO assumption, which assumes first
costs in are the first costs out, would also reflect the physical flow of goods in many
organisations, especially if the organisation is dealing with perishable goods. But the
standard does not require FIFO to be applied even if the physical flow reflects that the
oldest goods are sold first. Furthermore, if goods sold in an entity are homogeneous
in nature and age is not really an issue e.g. petrol and oil, perhaps the average cost
flow assumption better reflects the actual flow of merchandise; but an entity is not
required to use an average cost flow assumption.
Indeed, if the actual physical flow of goods in an entity reflects that the last goods in
are the first goods out, the entity is not allowed by the standard to use a LIFO
assumption.

8. ‘Now that we have adopted the perpetual inventory system, we no longer need to
conduct a costly and time-consuming stocktake’. Discuss.

Even if an entity is using a perpetual inventory system, a full physical stocktake is

necessary to determine whether any merchandise has been lost, stolen or destroyed;
and can verify the accuracy of the perpetual inventory records. It is important in
general purpose financial statements that the cost of inventory, as recorded by the
perpetual system, is a faithful representation of the level of inventory on hand.
However, when conducting the stocktake, be aware of the potential pitfalls involved,
e.g. including merchandise which has been sold or is on consignment in the physical
count, or omitting merchandise which has been purchased but is not present in the
warehouse at the end of the reporting period.

10. Why do inventory errors affect at least two reporting periods?

Any error made in determining inventory at the end of the reporting period
automatically affects the next period as well, because the inventory is an asset,
carried forward in the statement of financial position to be sold in the new
period. Hence, when the inventory is sold in the new period, cost of sales in
this reporting period will be incorrect if the incorrect inventory figure were
carried forward from the previous period.
Exercise 19.3 Lower of cost and net realisable value

A.
Inventory Units on Hand Cost per Total Net LC and
Item Unit Cost Realisable NRV of
Value per Individual
Unit Items

3011 70 $3.00 $210.00 $2.80 $196.00

2507 30 7.00 210.00 8.50 210.00
601 18 30.00 540.00 26.00 468.00
4500 52 3.50 182.00 6.00 182.00
2825 45 6.00 270.00 5.00 225.00
$1 412.00 $1 281.00

B. Profit is reduced by $131 ($1 412 - $1 281). In the statement of financial position,
inventory, total assets and equity are both reduced by $131.

Exercise 19.5 Inventory cost methods – perpetual inventory

System

1. Moving average method

Purchases Sales Balance

Date Explanatio Units Unit Total Unit Unit Total Units Unit Total
n Cost Cost Cost Cost Cost Cost
1/5 Beg. Invent. 80 $5.00 $400.00
3/5 Purchases 90 $6.00 $540 170 5.53 940.00
10/5 Sales 110 $5.53 $608.30 60 5.53 331.70
12/5 Purchases 90 7.00 630 150 6.41 961.70
17/5 Sales 80 $6.41 512.80 70 6.41 448.90
25/5 Sales 30 $6.41 $192.30 40 6.41 $256.60
$1 313.40

Ending inventory $256.60

Cost of sales $1 313.40
2. Specific identification

Ending inventory:
12 units @ $5.00 $60 00
25 units @ $6.00 150.00
3 units @ $7.00 21.00
40 units $231.00

Cost of sales
68 units @ $5.00 $340.00
65 units @ $6.00 390.00
87 units @ $7.00 609.00
220 units $1 339.00

3. FIFO method

Purchases Sales Balance

Date Explanatio Units Unit Total Units Unit Total Units Unit Total
n Cost Cost Cost Cost Cost Cost
1/5 Beg. invent. 80 $5.00 $400
3/5 Purchases 90 $6.00 $540 80 $5.00
90 $6.00 940
10/5 Sales 80 $5.00 $400.00
30 $6.00 $180.00 60 $6.00 360
12/5 Purchases 90 $7.00 $630 60 $6.00
90 $7.00 990
17/5 Sales 60 $6.00 $360.00
20 $7.00 $140.00 70 $7.00 490
25/5 Sales 30 $7.00 $210.00 40 $7.00 280

$1 290.00

Ending inventory $280.00

Cost of sales $1 290.00
Exercise 19.6

A. Weighted average method: Periodic

Ending inventory = 11 x average cost $38.47 = $423.17

$280  $418  $400  $210

Average cost = = $38.47
34 units
Cost of sales = 23 units x $38.47 = $884.81

B. Moving average method: Perpetual

Purchases Sales Balance

Date Explanatio Units Unit Total Units Unit Total Units Unit Total
n Cost Cost Cost Cost Cost Cost
1/7 Beg. invent. 8 $35.00 $280.00
14/8 Purchases 11 $38 $418 19 $36.74 $698.00
25/9 Sales 9 $36.74 $330.66 10 $36.74 $367.34
8/1 Purchases 10 $40 $400 20 $38.37 $767.34
3/3 Purchases 5 $42 $210 25 $39.09 $977.34
13/4 Sales 11 $39.09 $429.99 14 $39.09 $547.35
10/6 Sales 3 $39.09 $117.27 11 $39.09 $430.08
$877.92

Ending inventory $430.08

Cost of sales $877.92

C. FIFO: Periodic

Ending inventory:
5 units @ $42.00 $210.00
6 units @ $40.00 $240.00
11 units $450.00

Cost of sales = $1 308 - $450 = $858

or
8 units @ $35.00 $280.00
11 units @ $38.00 $418.00
4 units @ $40.00 $160.00
23 units $858.00
D. FIFO: Perpetual
Purchases Sales Balance
Date Explanation Units Unit Total Units Unit Total Cost Units Unit Total
Cost Cost Cost Cost Cost
1/7 Beg. invent. 8 $35.00 $280
14/8 Purchases 11 $38 $418 8 $35.00
11 $38.00 $698
25/9 Sales 8 $35.00 $280.00
1 $38.00 $38.00 10 $38.00 $380
8/1 Purchases 10 $40 $400 10 $38.00
10 $40.00 $780
3/3 Purchases 5 $42 $210 10 $38.00
10 $40.00
5 $42.00 $990
13/4 Sales 10 $38.00 $380.00 9 $40.00
1 $40.00 $40.00 5 $42.00 $570
10/6 Sales 3 $40.00 $120.00 6 $40.00
5 $42.00 $450
$858.00

Ending inventory $450.00

Cost of sales $858.00

E. FIFO reported the same ending inventory balance and cost of sales under the periodic
and perpetual system. The reported ending inventory balance and cost of sales for all
options resulted in variations. The highest ending inventory balance was recorded
using FIFO. The lowest inventory balance was recorded using the weighted average
method (periodic). In all cases, the cost of sales is inversely related to ending
inventory, i.e. the highest inventory balance corresponds with the lowest reported cost
of sales and the lowest ending inventory balance corresponds with the highest cost of
sales calculation.
Problem 19.1 Inventory cost flow methods – periodic inventory system
1.
Specific Identification
Cost of sales
400 units @ $3.00 $1 200
400 units @ $3.15 1 260
300 units @ $3.30 990
200 units @ $3.50 700
1 300 units $4 150

Ending inventory
200 units @ $3.00 $600
100 units @ $3.15 315
50 units @ $3.30 165
300 units @ $3.50 1 050
650 units $2 130

2. FIFO:
Units
Goods available (per question) 1 950 $6 280
Ending inventory (650 units):
500 units @ $3.50 (500) (1 750)
150 units @ $3.30 (150) (495)
Cost of sales 1 300 $4 035

3. LIFO:
Units
Goods available 1 950 $6 280
Ending inventory (650 units):
600 @ $3.00 (600) (1 800)
50 @ $3.15 (50) (157.50)
Cost of sales 1 300 $4 322.50

4. Weighted average:
Units Unit Amount
Cost
Beginning inventory 600 $3.00 $1 800
10/12 Purchase 500 $3.15 1 575
15/12 Purchase 350 $3.30 1 155
23/12 Purchase 500 $3.50 1 750
Goods available 1 950 $6 280
$6 280  1 950 = $3.22 per unit (rounded)

Goods available 1 950 $3.22 $6 280

Ending inventory (650) $3.22 (2 093)
Cost of sales (rounded) 1 300 $4 187
 Income Statement
Spec. FIFO LIFO W’ted
Ident. Av.
Sales $5 525 $5 525 $5 525 $5 525
Beginning inventory 1 800 1 800 1 800 1 800
Purchases 4 480 4 480 4 480 4 480
Goods available for sale 6 280 6 280 6 280 6 280
Ending inventory 2 130 2 245 1 957.5 2 093
Cost of sales 4 150 4 035 4 322.5 4 187
Gross profit 1 375 1 490 1 202.5 1 338

B. The highest gross profit was reported using FIFO. With FIFO cost of sales is lowest
because it is assumed to consist of the earliest (lowest) costs. (Inventory prices are
rising). FIFO also reported the highest ending inventory balance since it is valued at
the most recent higher prices. This is a result of the direct relationship between
inventory values and profit. The higher the value placed on ending inventory, the
higher the reported gross profit.

C.
Income Statement
FIFO LIFO
Sales $5 525 $5 525
Beginning inventory 1 800 1 800
Purchases 2 730 2 730
Goods available for sale 4 530 4 530
Ending inventory (150 units) 495 450
Cost of sales 4 035 4 080
Gross profit $1 490 $1 445
D.
Income Statement
FIFO LIFO
Sales $5 525 $5 525
Beginning inventory 1 800 1 800
Purchases 6 640 6 640
Goods available for sale 8 440 8 440
Ending inventory (1250 units) *4 405 **3 870
Cost of sales 4 035 4 570
Gross profit $1 490 $955

* FIFO **LIFO
150 @ 3.30 = $ 495 600 @ 3.00 = $1 800
500 @ 3.50 = 1 750 500 @ 3.15 = 1 575
600 @ 3.60 = 2 160 150 @ 3.30 = 495
$4 405 $3 870

E. FIFO reported the same cost of sales and gross profit in all cases. This is because the
increases and decreases in ending inventory were offset by the same increases and
decreases in purchases. LIFO reported three different cost of sales and gross profit
results. This is because the ending inventory valuations were altered by recent
purchases or non-purchases using LIFO assumptions.