Libby 4ce Solutions Manual - Ch08

Chapter 8
Reporting and Interpreting Cost of Sales and

Inventory
Revised: April 25, 2011
ANSWERS TO QUESTIONS
1. Inventory often is one of the largest amounts listed under assets on the statement of
financial position, which means that inventory represents a significant amount of the
resources available to the business. The inventory may be excessive in amount, which
is a needless waste of resources; alternatively it may be too low, which may result in
lost sales. Therefore, for internal users inventory control is very important. On the
income statement, inventory exerts a direct impact on the amount of income.
Therefore, statement users are interested particularly in the amount of this effect and
the way in which inventory is measured. Because of its impact on both the statement
of financial position and the income statement, inventory is of particular interest to all
statement users.
2. Fundamentally, inventory should include those items, and only those items, legally
owned by the business. That is, inventory should include all goods ready for sale and
in saleable condition that the company owns, regardless of their particular location at
the time.
3. The cost principle governs the measurement of the ending inventory amount. The
ending inventory is determined in units and the cost of each unit is applied to that
number. Under the cost principle, the unit cost is the sum of all costs incurred in
obtaining one unit of the inventory item in its present state.
4. The cost of goods available for sale is the sum of the beginning inventory and the cost
of goods purchased during the period. Cost of sales is the cost of goods available for
sale less the ending inventory.
5. Beginning inventory is the stock of goods on hand (in inventory) at the start of the
accounting period. Ending inventory is the stock of goods on hand (in inventory) at
the end of the accounting period. The ending inventory of one period automatically
becomes the beginning inventory of the next period.
Financial Accounting, 4ce, Libby, Libby, Short, Kanaan, Gowing © 2011 McGraw-Hill Ryerson Limited. All rights reserved.
8-1
6. When a perpetual inventory system is used, the unit cost must be known for each
item sold at the date of each sale for the following reasons. First, the units sold and
their costs are removed from the perpetual inventory record and the new inventory
balance is determined. Second, an up-to-date cost of sales figure is determined from the
perpetual inventory record and an entry in the accounts is made as a debit to Cost of
sales and a credit to Inventory. In contrast, when a periodic inventory system is used
the unit cost need not be known at the date of each sale. In fact, the periodic system is
designed so that cost of sales for each sale is not known at the time of sale. At the end
of the period, under the periodic inventory system, cost of sales is determined by
adding the beginning inventory to the total goods purchased for the period and
subtracting from that total the ending inventory amount. The ending inventory
amount is determined by means of a physical count of the inventory of goods
remaining on hand, where the units are valued on a unit cost basis in accordance with
the cost principle (by applying an appropriate inventory costing method).
7. The periodic inventory model reflects the way in which that system operates. Under
this system the beginning inventory and purchases (during the period) are
accumulated, the sum of which is goods available for sale. It is necessary, therefore,
that the ending inventory be determined by actual inventory count at the end of the
period. Cost of sales is computed by subtracting the ending inventory from goods
available for sale. The model: BI + P – EI = COS reflects the fact that, under the periodic
inventory model, cost of sales is computed as a residual amount.
In contrast, the perpetual inventory system involves maintaining a continuous

(running or perpetual) inventory record during the accounting period. The beginning
inventory, each purchase during the period, and each sale during the period, are
entered in the perpetual inventory record in units and dollars of cost. The cost of each
sale is also recorded on an ongoing basis. The difference between the goods available
less cost of sales is the ending inventory. Thus, the perpetual inventory model: BI + P –
COS = EI, reflects the fact that ending inventory is computed as a residual amount in
the inventory record.
8-2
8. (a) Weighted-average cost – This inventory costing method in a periodic inventory
system is based on a weighted-average cost for the entire period. At the end of the
accounting period the average cost is computed by dividing the number of units
available for sale into the cost of goods available for sale. The computed average unit
cost then is used to determine the cost of sales for the period by multiplying the units
sold by this average unit cost. Similarly, the ending inventory for the period is
determined by multiplying this average unit cost by the number of units on hand.
(b) FIFO – This inventory costing method views the first units purchased as the first
units sold. Under this method, cost of sales is measured at the oldest unit costs (since
the items purchased first are presumed to be the items sold first), and the ending
inventory is measured at the newest unit costs (since the items still on hand are
presumed to be the ones purchased most recently).
(c) Specific identification – This inventory costing method requires that each item in
the beginning inventory and each item purchased during the period be identified
specifically so that its unit cost can be determined by identifying the specific item sold.
This method usually requires that each item be marked, often with a code that
indicates its cost. When it is sold, that unit cost is the cost of sales. It often is
characterized as a pick-and-choose method. When the ending inventory is taken, the
specific items on hand, valued at the cost indicated on each item, represent the ending
inventory amount.
9. The specific identification method of inventory costing is subject to manipulation

when the units are identical. Manipulation is possible because one can, at the time of
each sale, select (pick and choose) from the shelf the item that has the highest or the
lowest (or some other) unit cost with no particular rationale for the choice. This may
be done with the objective of increasing or decreasing both the amount of profit and
the amount of ending inventory to be reported on the financial statements. To
illustrate, assume item A is stocked and three are on the shelf. One cost $100; the
second one cost $115; and the third cost $125. Now assume that one unit is sold for
$200. If it is assumed arbitrarily that the first unit is sold, the gross profit will be $100;
if the second unit is selected, the gross profit will be $85; or alternatively, if the third
unit is selected, the gross profit will be $75. Thus, the amount of gross profit (and
income) will vary significantly depending upon which one of the three is selected
arbitrarily from the shelf for this particular sale. This assumes that all three items are
identical in every respect except for their unit costs. Of course, the selection of a
different unit cost, in this case, also will influence the cost of the ending inventory, i.e.,
cost of the two remaining items.
8-3
10. Weighted Average and FIFO have different effects on the inventory amount reported
under assets on the statement of financial position. The ending inventory is based
upon either a mix of unit costs or the newest unit costs, depending upon which method
is used. Under FIFO, the ending inventory is measured at the latest unit costs, and
under Weighted Average, the ending inventory is measured at a mix of unit costs.
Therefore, when prices are rising, the ending inventory reported on the statement of
financial position will be higher under FIFO than under Weighted Average. Conversely,
when prices are falling, the ending inventory on the statement of financial position will
be higher under Weighted Average than under FIFO.
11. Weighted Average and FIFO will affect the income statement in two ways: (1) the
amount of cost of sales and (2) profit. When the prices are rising, FIFO will give a lower
cost of sales and hence a higher profit than will Weighted Average. In contrast, when
prices are falling, FIFO will give a higher cost of sales and, as a result, a lower profit.
12. When prices are rising, the FIFO method gives a lower cost of sales than the weighted
average method. As a result, pretax profit is higher under FIFO than weighted average.
Consequently, the income tax expense and the related cash outflow will be greater
under FIFO than the weighted average cost method. The reverse is true if prices are
falling.
13. The lower of cost or net realizable value (LCNRV) is applied when the net realizable
value of the inventory item is lower than its cost. The ending inventory is then valued
at the net realizable value, which (a) reduces profit and (b) reduces the inventory
amount reported on the statement of financial position. The effect of applying LCNRV
is to include the loss on inventory valuation on the income statement (as a part of the
cost of sales) in the period in which the market value drops rather than in the period of
actual sale.
14. When the net realizable value of inventory is less than its cost the inventory is written
down to the net realizable value. If the value increases the write down is reversed up
to the original cost. In contrast a holding gain is the increase in market value of
inventory during the period it is held by the company. IFRS does not permit
recognition of holding gains.
Authors' Recommended Solution Time

(Time in minutes)
Alternate Cases and

Exercises Problems Problems Projects
No. Time No. Time No. Time No. Time
1 5E 1 30 M 1 40 M 1 30 M
2 15 E 2 40 M 2 30 M 2 20 M
3 20 E 3 30 M 3 35 M 3 20 M
8-4
4 15 E 4 40 M 4 30 M 4 60 D
5 15 E 5 45 M 5 30 M 5 30 D
6 15 M 6 45 M 6 30 D
7 20 M 7 50 M 7 30 M
8 20 M 8 30 M 8 60 D
9 25 D 9 30 M 9 40 D
10 20 E 10 *
11 25 M
12 35 M
13 35 M
14 20 M
15 20 E
16 10 E
17 15 E
18 20 M
19 15 M
20 20 M
E = Easy M = Moderate D = Difficult
* Due to the nature of these cases and projects, it is very difficult to estimate the amount of
time students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While students
often benefit from the extra effort, we find that some become frustrated by the perceived
difficulty of the task. You can reduce student frustration and anxiety by making your
expectations clear. For example, when our goal is to sharpen research skills, we devote
class time discussing research strategies. When we want the students to focus on a real
accounting issue, we offer suggestions about possible companies or industries.
8-5
EXERCISES
E8–1
To record the purchase of 80 new shirts in accordance with the cost principle (perpetual
inventory system):
Inventory (+A)........................................................................................ 2,500

Cash (–A).................................................................................... 2,500
Cost: $2,180 + $175 + $145 = $2,500.
The $120 interest amount is not included in the cost of the merchandise; it is initially
recorded as prepaid interest expense and later as interest expense.
E8–2
Item Amount Explanation
Ending inventory (physical count on $50,000 Per physical inventory

December 31, 2010)
a. Goods purchased and in transit + 300 Goods purchased and in transit, F.O.B.
shipping point, are owned by the
purchaser.
b. Samples out on trial to customer + 400 Samples held by a customer on trial

are still owned by the vendor; no sale
or transfer of ownership has occurred.
c. Goods in transit to customer Goods shipped to customers, F.O.B.

customer because ownership passed
when they were delivered to the
transportation company. The
inventory correctly excluded these
items.
d. Goods sold and in transit + 1,000 Goods sold and in transit, F.O.B.
destination, are owned by the seller
until they reach destination.
Correct inventory, December 31, 2010 $51,700
8-6
E8–3
(Underscore for missing amounts only.)
Pretax
Beg. Total Profit
Sales Inven- Pur- Avail- Ending Cost of Gross Operating or
Case Revenue tory chases able Inventory Sales Profit Expenses (Loss)
A $ 650 $100 $700 $800 $500 $300 $350 200 $150
B 900 200 800 1,000 250 750 150 150 0
C 600 150 350 500 300 200 400 100 300
D 800 100 600 700 250 450 350 250 100
E 1,000 200 900 1,100 600 500 500 550 (50)
E8–4
(Underscore for missing amounts only.)
Case A Case B Case C
Sales revenue ............................................................... $ 8,000 $6,000 $ 6,195

Sales returns and allowances............................... 150 500 275
Net sales revenue....................................................... 7,850 5,500 5,920
Beginning inventory................................................. 11,000 6,500 4,000
Purchases ............................................................... 5,000 8,770 9,420
Transportation-in...................................................... 100 120 170
Purchase returns........................................................ 350 600 220
Cost of goods available for sale........................... 15,750 14,790 13,370
Ending inventory....................................................... 10,000 10,740 7,970
Cost of sales ............................................................... 5,750 4,050 5,400
Gross profit ............................................................... 2,100 1,450 520
Expenses (operating)............................................... 1,300 1,950 520
Pretax profit (loss).................................................... $ 800 $ (500) $ -0-
8-7
E8–5
Computations (in millions):

Cost of sales
Revenue .......................................................................... $14,256
– Gross profit ................................................................... 5,447
= Cost of sales .................................................................. $8,809
Purchases: Simply rearrange the basic inventory model (BI + P – EI = COS):

P = COS + EI - BI
Cost of sales (see above).......................................... $8,809

+ Ending inventory ....................................................... 1,506
– Beginning inventory ................................................ (1,575)
= Purchases ...................................................................... $8,740
E8–6
Req. 1
Profit for 2011 will be overstated. An understatement of purchases produces an

understatement of cost of sales which, in turn, produces an overstatement of the current
period’s income.
BI + P - EI = COS; both P and COS are understated
Req. 2
Profit for 2012 will be understated. An overstatement of purchases produces an

overstatement of cost of sales, which in turn, produces an understatement of the current
period’s income.
BI + P - EI = COS; both P and COS are overstated
Req. 3
Retained Earnings at December 31, 2011, will be overstated because of the overstatement
of profit for 2011.
Req. 4
Retained Earnings at December 31, 2012, will be correct because the overstatement of
profit for 2011 and understatement of Profit for 2012 will offset one another.
8-8
E8–7
CASE A: Perpetual inventory system:

January 14 Trade receivables (+A).................................................................................800
Sales (+R  +SE) (20 units at $40)................................................ 800
Cost of sales (+E  -SE)...............................................................................400
Inventory (−A) (20 units at $20)..................................................... 400
April 9 Inventory (+A) (15 units at $20).............................................................300

Trade payables (+L)............................................................................... 300
September 2 Trade receivables (+A).................................................................................
2,250
Sales (+R  +SE) (45 units at $50)................................................ 2,250
Cost of sales (+E  -SE)...............................................................................900

Inventory (–A) (45 units at $20)...................................................... 900
End of year No year-end adjusting entry needed because the
number of units left at year end is 100 – 20 + 15 – 45
= 50, which is equal to the physical count of units
available at year end.
CASE B: Periodic inventory system:

January 14 Trade receivables (+A).................................................................................800
Sales (+R  +SE) (20 units at $40)................................................ 800
April 9 Purchases (+T) (15 units at $20)............................................................300

Trade payables (+L)............................................................................... 300
September 2 Trade receivables (+A).................................................................................

2,250
Sales (+R  +SE) (45 units at $50)................................................ 2,250
End of year 2,300

Cost of sales (+E  –SE)..............................................................................
Purchases (–T) ......................................................................................... 300
Inventory (–A) (Beginning: 100 units at $20)........................... 2,000
Inventory (+A) (Ending: 50 units at $20).......................................... 1,000
Cost of sales (−E  +SE)...................................................................... 1,000
Calculation of cost of sales:

Beginning inventory (100 units at $20) $2,000
Add purchases 300
Cost of goods available for sale $2,300
Ending inventory (physical count—50 units at $20) 1.000
Cost of sales $1,300
8-9
E8–8
Req. 1
When the ending inventory is overstated, cost of sales is understated which in turn results
in an overstatement of profit. Gibson’s profit from operations should be reduced by
$8,806,000 and tax expense should be reduced by $3,460,758 (i.e., $8,806,000 x 0.393).
Therefore, profit should be:
As reported:............................................................................... $25,852,000
Increase in cost of sales........................................................ (8,806,000)
Reduction in tax expense..................................................... 3,460,758
Corrected profit........................................................................ $20,506,758
Req. 2
The incorrect accounts can be summarized as follows:
Year of Subsequent
Account Error Year
Beginning inventory correct overstated

Cost of sales understated overstated
Ending inventory overstated correct
Profit overstated understated
Retained earnings overstated correct
Taxes payable* overstated understated
Income tax expense overstated understated
*The income tax payable for each year is incorrect by the same amount, therefore the total
income tax paid was correct.
8-10
E8–9
Req. 1
The $400 understatement of ending inventory produced pretax profit amounts that were
incorrect by $400 for each quarter. However, the effect on pretax profit for each quarter
was opposite (i.e., the first quarter pretax profit was understated by $400, and in the
second quarter it was overstated by $400). This self-correcting effect produces a correct
combined profit for the two quarters.
Req. 2
The error caused the pretax profit for each quarter to be incorrect [see (1) above];
therefore, the EPS for the first quarter was understated, and the EPS for the second quarter
was overstated.
Req. 3
First Quarter 2011 Second Quarter 2011
Sales revenue............................................................ $11,000 $18,000

Cost of sales:
Beginning inventory...................................... $4,000 $ 4,200
Purchases............................................................ 3,000 13,000
Cost of goods available for sale......... 7,000 17,200
Ending inventory............................................. 4,200 9,000
Cost of sales................................................ 2,800 8,200
Gross profit ............................................................ 8,200 9,800
Expenses ............................................................ 5,000 6,000
Pretax profit ............................................................ $3,200 $3,800
Req. 4
First Quarter 2011 Second Quarter 2011
Incorrect Error Incorrect Error
Amount Correct Amount Amount Correct Amount
(if any) Amount (if any) (if any) Amount (if any)
Beginning inventory $4,000 $4,000 No error 3,800 $4,200 $400 under
Ending inventory 3,800 4,200 400 under $9,000 9,000 No error
Cost of sales 3,200 2,800 400 over 7,800 8,200 400 under
Gross profit 7,800 8,200 400 under 10,200 9,800 400 over
Pretax income 2,800 3,200 400 under 4,200 3,800 400 over
8-11
E8–10
Weighted
Units FIFO Average
Cost of sales:
Beginning inventory ($8)................... 3,000 $24,000 $24,000
Purchases (March 21) ($9)................ 5,000 45,000 45,000
(August 1) ($7)................. 2,000 14,000 14,000
Goods available for sale....... 10,000 83,000 83,000
Ending inventory*................................. 4,000 32,000 33,200
Cost of sales................................ 6,000 $51,000 $49,800
*Ending inventory computations:

FIFO: (2,000 units @ $7) + (2,000 units @ $9) = $32,000
Average: $83,000 ÷ 10,000 units = $8.30 per unit

4,000 units @ $8.30 = $33,200
E8–11
Req. 1
LUNAR COMPANY
Income Statement (Partial)
For the Year Ended December 31, 2011
Case A Case B
FIFO Weighted Average
Sales revenue1................................................................ $330,000 $330,000

Cost of sales:
Beginning inventory........................................ 36,000 36,000
Purchases.............................................................. 194,000 194,000
Cost of goods available for sale2....... 230,000 230,000
Ending inventory3............................................. 114,000 103,500
Cost of sales................................................. 116,000 126,500
Gross profit ................................................................. 214,000 203,500
Expenses (operating).................................................. 85,000 85,000
Pretax profit ................................................................. $129,000 $118,500
Computations:
1. Sales: (5,000 units @ $30) + (6,000 units @ $30) = $330,000
2. Cost of goods available for sale (for both cases):
8-12
E8–11 (continued)
Units Unit Cost Total Cost
Beginning inventory 3,000 $12 $ 36,000

Purchase, April 11, 2011 9,000 10 90,000
Purchase, June 1, 2011 8,000 13 104,000
Cost of goods available for sale 20,000 $230,000
3. Ending inventory = 20,000 units available – 11,000 units sold = 9,000 units
Case A FIFO:
(8,000 units @ $13 = $104,000) +
(1,000 units @ $10 = $10,000) = $114,000
Case B Weighted Average:

$230,000 ÷ 20,000 units = $11.50 per unit
9,000 units @ $11.50 = $103,500
Req. 2 (See Requirement 1 for figures)
Comparison of Amounts
Case A Case B
Pretax Profit $129,000 $118,500
Difference $10,500
Ending Inventory 114,000 103,500

Difference 10,500
The above tabulation demonstrates that the difference in pretax profit between the two
cases is the same as the difference in ending inventory, i.e., the cost of the beginning
inventory and purchases were the same in both cases. Differences in inventory have a
dollar-for-dollar effect on pretax profit.
Req. 3
Weighted Average may be preferred for income tax purposes because it reports less taxable
income (when prices are rising) and hence (a) reduces income tax and (b) as a result
reduces cash outflows for the period.
8-13
E8–11 (continued)
Req. 4
b. Purchases (+T) (9,000 x $10)................................................................... 90,000

Trade payables (+L)............................................................................... 90,000
c. Trade receivables (+A) ................................................................................ 150,000

Sales (+R  +SE) (5,000 X $30)....................................................... 150,000
d. Purchases (+T) (8,000 x $13)................................................................... 104,000

Trade payables (+L)............................................................................... 104,000
e. Trade receivables (+A) ................................................................................ 180,000

Sales (+R  +SE) (6,000 X $30)....................................................... 180,000
f. Operating expenses (+E  –SE).............................................................. 85,000

Cash (–A) and/or Accrued liabilities (+L).................................. 85,000
Dec.31 Cost of sales (+E  –SE).............................................................................. 230,000

Inventory (–A) (beginning) .............................................................. 36,000
Purchases (–T)......................................................................................... 194,000
Inventory (+A) (ending).............................................................................. 114,000
Cost of sales (−E  +SE)..................................................................... 114,000
8-14
E8–12
Req. 1
SCORESBY, INC.
Income Statement
Case A Case B
Sales revenue1............................................. $786,000 $786,000

Cost of sales:
Beginning inventory.................... 56,000 56,000
Purchases............................................. 259,000 259,000
Goods available for sale2... 315,000 315,000
Ending inventory3.......................... 88,000 74,080
Cost of sales............................... 227,000 240,920
Gross profit ................................................ 559,000 545,080
Expenses ................................................ 500,000 500,000
Pretax profit ................................................ $ 59,000 $ 45,080
Computations:
(1) Sales: (10,000 units @ $29) + (16,000 units @ $31) = $786,000
(2) Goods available for sale (for both cases):
Units Unit Cost Total Cost
Beginning inventory 7,000 $8 $ 56,000

Purchase, March 5, 2009 19,000 9 171,000
Purchase, September 19, 2009 8,000 11 88,000
Goods available for sale 34,000 $315,000
(3) Ending inventory (34,000 available – 26,000 units sold = 8,000 units):
Case A – FIFO:
8,000 units @ $11 = $88,000
Case B – Weighted Average:

$315,000 ÷ 34,000 units = $9.26 per unit
8,000 units @ $9.26 = $74,080
8-15
8-16
E8–12 (continued)
Req. 2
Case A Case B
Pretax Profit $59,000 $45,080
Difference $13,920
Ending Inventory 88,000 74,080

Difference 13,920
The above tabulation demonstrates that the pretax profit difference between the two cases
is exactly the same as the inventory difference. Differences in inventory have a dollar-for-
dollar effect on pretax profit.
Req. 3
The weighted average cost method may be preferred for income tax purposes because it
reports less taxable income (when prices are rising) and hence (a) reduces income tax and
(b) as a result reduces cash outflows for the period.
Req. 4
b. Inventory (+A) (19,000 x $9).................................................................... 171,000

Trade payables (+L)............................................................................... 171,000

Sales (+R  +SE) (10,000 X $29).................................................... 290,000
Cost of sales (+E) (7,000 x $8 + 3,000 * $9)....................................... 83,000
Inventory (–A) ......................................................................................... 83,000
d. Inventory (+A) (8,000 x $11).................................................................... 88,000

Trade payables (+L)............................................................................... 88,000

Sales (+R  +SE) (16,000 X $31).................................................... 496,000
Cost of sales (+E  –SE) (16,000 x $9)................................................ 144,000
Inventory (–A) ......................................................................................... 144,000

8-17
E8–13
Req. 1
Inventory Costing Method
Weighted
Summarized Income Statement Units FIFO Average
Sales revenue (@ $70)........................................ 12,300* $861,000 $861,000
Cost of sales:
Beginning inventory (@ $35).................. 3,000 105,000 105,000
Purchases (@ $38)........................................ 12,000 456,000 456,000
Cost of goods available for sale....... 15,000 561,000 561,000
Ending inventory**....................................... 2,700 102,600 100,980
Cost of sales............................................... 12,300 458,400 460,020
Gross profit.............................................................. 402,600 400,980
Expenses (operating).......................................... 213,000 213,000
Pretax profit............................................................. 189,600 187,980
Income tax expense (30%)***................. 56,880 56,394
Profit ......................................................................... $132,720 $131,586
*Units sold = 3,000 + 12,000 – 2,700 = 12,300
**Inventory computations:
FIFO: 2,700 units @ $38 = $102,600
Average: Cost of goods available for sale [(3,000 units @ $35) + (12,000 units
@ $38)] ÷ 15,000 units
= $561,000 ÷ 15,000 units = $37.40 per unit
$37.40 x 2,700 units = $100,980
***The amount for income tax expense computed here is for financial reporting purposes only. The
actual amount of the income tax burden will depend on the applicable income tax legislation. The
topic of financial reporting versus income tax reporting is explored in detail in more advanced
accounting texts.
Req. 2
When prices are rising (as they are in this problem) the use of FIFO results in higher profit
(compared to Weighted average) because FIFO allocates older (lower) unit costs to cost of
sales first, i.e., cost of sales is lower under FIFO compared to Weighted average. Weighted
average may be preferred for income tax purposes because it reports less taxable income
(when prices are rising) and hence reduces income tax and cash outflows for the period.
Req. 3
When prices are falling, the use of weighted average cost produces higher profit (compared
to FIFO) because FIFO allocates the old (higher) unit costs to cost of sales first. However,
FIFO may be preferred for income tax purposes because it reports less taxable income than
the weighted average cost method.
8-18
E8–14
Req. 1
Weighted
FIFO Average
Cost of sales:
Beginning inventory (330 units @ $34*).... $11,220 $11,220
Purchases (475 units @ $36*).......................... 17,100 17,100
Cost of goods available for sale (805 units*) 28,320 28,320
Ending inventory (510 units)**....................... 18,290 17,942
Cost of sales (295 units)...................................... $10,030 $10,378
* By inference
**Computation of ending inventory:

FIFO: (475 units x $36) + (35 units x $34) = $18,290
Weighted Average:
Cost per unit = ($11,220 + $17,100) / (805) = $35.18
Req. 2
Weighted
FIFO Average
Sales revenue ($50 x 295*)............................................... $14,750 $14,750
Cost of sales:
Beginning inventory.............................................. 11,220 11,220
Purchases.................................................................... 17,100 17,100
Cost of Goods available for sale......... 28,320 28,320
Ending inventory (per above).......................... 18,290 17,942
Cost of sales................................................ 10,030 10,378
Gross profit ........................................................................... 4,720 4,372
Expenses ........................................................................... 1,600 1,600
Pretax profit ........................................................................... $ 3,120 $ 2,772
* The number of units is the same as computed in requirement 1.
Req. 3
From a cash flow perspective, use of the weighted-average method results in lower pretax
profit and lower income tax. (If prices were falling, the use of FIFO would result in a lower
income tax burden.)
8-19
E8–15
LCNRV
Item Quantity Total Cost Total Market Valuation
A 50 x $15 = $ 750 x $12 = $ 600 $ 600

B 80 x 30 = 2,400 x 40 = 3,200 2,400
C 10 x 45 = 450 x 52 = 520 450
D 30 x 25 = 750 x 30 = 900 750
E 350 x 10 = 3,500 x 5 = 1,750 1,750
Total $7,850 $6,970 $5,950
Inventory valuation that should be used (LCNRV) $5,950
Req. 2
The write-down to lower of cost or net realizable value will increase cost of sales by the
amount of the write-down:
Write down = Total Cost  LCNRV Valuation = $7,850  $5,950 = $1,900
Req. 3
The book value of the 20 units, $100 (20 x $5), should be increased to $150 (20 x $7.50).
The difference of $50 is a reversal of the write-down that was made in the previous year.
This will effectively reduce the cost of sales for the year 2012 by $50, and increase the cost
of ending inventory by $50.
E8–16
Req. 1
Cost of sales (+E  –SE).............................................................................. 68,089

Raw Materials Inventory (–A) ......................................................... 68,089
Req. 2
The book value of the raw materials should be increased to their original cost of $9,347
even though their net realizable value is greater than their original cost. IFRS does not
permit recognition of the holding gain (i.e. the increase above the original cost). The result
of this would be a reduction in the cost of sales on the 2010 income statement and an
increase in the inventory on the statement of financial position.
Raw Materials Inventory (+A) ($9,347 - $7,634)............................ 1,713

Cost of sales (−E  +SE)..................................................................... 1,713
8-20
E8–17
Req. 1 (Dollars are in millions)
Inventory turnover = Cost of sales = $134,661 = 5.35

Average Inventory ($22,475 + $27,836)/2
Average days to sell inventory = 365 / inventory turnover = 365 / 5.35 = 68.22 days
Req. 2
The inventory turnover ratio reflects how many times average inventory was produced
and sold during the period. Thus, Sony Ericsson produced and sold its average inventory
about 5 times during the year.
The average number of days to sell inventory indicates the average time it takes the
company to produce and deliver inventory to customers. Thus, Sony Ericsson takes an
average of about 68 days to produce and deliver its computer inventory to its customers.
E8–18
CASE A – FIFO:
Cost of goods available for sale for FIFO:

Units (19 + 25 + 50)............................................................................. 94
Amount ($228 + 375 + 800)............................................................ $1,403
Ending inventory: 94 units – 40 units – 28 units = 26 units.
Ending inventory (26 units x $16)............................................... $ 416

Cost of sales ($1,403 – $416).......................................................... $ 987
Inventory turnover = Cost of sales = $987 = 3.07

Average Inventory ($228 + $416)/2
8-21
E8–18 (continued)
CASE B – Weighted Average:
Goods available for sale for Weighted Average:

Units (19 + 25)....................................................................................... 44
Amount ($190 + 375)......................................................................... $565
Cost per unit = $565 ÷ 44 = $12.84

Cost of sales 40 @ $12.84 = $513.60
Inventory 4 @ $12.84 = $51.36
Goods available for sale for Weighted Average:

Units (4 + 50).......................................................................................... 54
Amount ($51 + 800)............................................................................ $851
Cost per unit = $851 ÷ 54 = $15.76

Cost of sales 28 @ $15.76 = $441
Inventory 26 @ $15.76 = $410
Ending inventory: 26 units (see Case A).
Ending inventory (26 units x $15.76)......................................... $ 411 (rounded)

Cost of sales ($514 + $441).............................................................. $ 955
Inventory turnover = Cost of sales = $955 = 3.18

Average Inventory ($190+$411)/2
The FIFO inventory turnover ratio is normally thought to be a better indicator when prices
are changing because the weighted-average cost can include very old inventory prices in
ending inventory balances. This is less of a concern with a perpetual inventory system as
the average cost is updated more frequently.
E8–19
Current Year Previous Year Change
Inventory $22,813,850 – $20,838,171 = $1,975,679
Trade payables $9,462,883 – $9,015,376 = $447,507
Increases in inventory cause cash flow from operations to decrease by $1,975,679. This
amount is subtracted in the computation of cash flow from operations. First Team Sports
was able to offset some of this by increasing its trade payables by $447,507, which
increases cash flow from operations. This amount is added in the computation of cash flow
from operations. Effectively, the Company is financing a portion of its growing inventories
through supplier credit.
8-22
E8–20 (Appendix 8A)
Req. 1 Trade receivables (+A) ................................................................................

1,600
Sales (+R  +SE)..................................................................................... 1,600
Cost of sales (+E  –SE)..............................................................................900
Inventory (–A).......................................................................................... 900
Req. 2 (a) Cash (+A) ($1,600 x 0.98)...........................................................................

1,568
Sales discounts (+XR  –SE) ($1,600 x 0.02)................................... 32
Trade receivables (–A).......................................................................... 600
Req. 2 (b) Cash (+A).............................................................................................................

1,600
Trade receivables (–A).......................................................................... 1,600
Req. 3 Inventory (+A)..................................................................................................

7,920
Trade payables (+L) ($8,000 x 0.99).............................................. 7,920
Req. 4 (a) Trade payables (–L)....................................................................................... 7,920

Cash (–A)..................................................................................................... 7,920
Req. 4 (b) Trade payables (–L)....................................................................................... 7,920

Purchase discounts lost (+E → −SE)……………….. 80
Cash (–A) .................................................................................................... 8,000
8-23
PROBLEMS
P8–1
Item Amount Explanation
Ending inventory (physical count on $65,000 Per physical inventory.

December 31, 2011)
a. Goods out on trial to customer + 750 Goods held by a customer on trial

are still owned by the vendor; no
sale or transfer of ownership has
occurred.
b. Goods in transit from supplier Goods shipped by a supplier, F.O.B.

destination, are owned by the
supplier until delivery at destination.
The physical inventory correctly
excluded these items.
c. Goods in transit to customer Goods shipped to a customer, F.O.B.

customer because ownership passed
when they were delivered to the
transportation company. The
physical inventory correctly
excluded these items.
d. Goods held for customer pickup – 1,590 Goods sold, but held for customer
pick-up, are owned by the customer.
Ownership has passed.
e. Goods purchased and in transit + 2,550 Goods purchased and in transit,

F.O.B. shipping point, are owned by
the purchaser.
f. Goods sold and in transit + 850 Goods sold and in transit, F.O.B.
destination, are owned by the seller
until they reach destination.
g. Goods held on consignment – 4,750 Goods held on consignment are

owned by the consignor (the
manufacturer), not by the consignee.
Correct inventory, December 31, 2011 $62,810
8-24
P8–2
Req. 1
CLEMENT COMPANY
Corrected Income Statement
2013 2012 2011 2010
Sales revenue $58,000 $62,000 $51,000 $50,000

Cost of sales 37,000 46,000* 32,000* 32,500
Gross profit 21,000 16,000 19,000 17,500
Operating expenses 12,000 14,000 12,000 10,000
Pretax profit $ 9,000 $ 2,000 $ 7,000 $ 7,500
* Increase in the ending inventory in 2011 by $3,000 causes a decrease in cost of sales by
the same amount. Therefore, cost of sales for 2011 is $35,000 – $3,000 = $32,000.
Because the 2011 ending inventory is carried over as the 2012 beginning inventory, cost
of sales for 2012 was understated by $3,000. Thus, the correct cost of sales amount for
2012 is $43,000 + $3,000 = $46,000.
Req. 2
2013 2012 2011 2010
Gross profit percentage (gross profit ÷ sales):

Before correction:
$21,000 ÷ $58,000 = .36
$19,000 ÷ $62,000 = .31
$16,000 ÷ $51,000 = .31
$17,500 ÷ $50,000 = .35
After correction:
No change .36
$16,000 ÷ $62,000 = .26
$19,000 ÷ $51,000 = .37
No change .35
The corrected ratios are less consistent than the original ratios but the original ratios are
both below those of 2010 and 2013. After correction, the ratio for 2011 is consistent with
the ratios for 2010 and 2013 but the reduced ratio for 2012 warrants further investigation.
8-25
P8–2 (continued)
Req. 3
The error would have the following effect on income tax expense:
2012 2011
Before correction:
2012: $5,000 x 30% = $1,500
2011: $4,000 x 30% = $1,200
After correction:
2012: $2,000 x 30% = 600
2011: $7,000 x 30% = 2,100
Difference $ 900 $ (900)
The income tax expense would have been understated by $900 in 2011 and overstated by
$900 in 2012. This is the amount of the error times the tax rate ($3,000 x 30% = $900).
8-26
P8–3
Req. (a) Cost of goods available for sale for all methods:
Unit Total
Units Cost Cost
January 1, 2012 – Beginning inventory 400 $30 $12,000

February 20, 2012 – Purchase 600 32 19,200
June 30, 2012 – Purchase 500 36 18,000
Cost of goods available for sale 1,500 $49,200
Ending inventory: 1,500 units – (700 + 100 – 20) units = 720 units
Req. (b) and (c)
1. Weighted-average cost:
Average unit cost $49,200 ÷ 1,500 = $32.80
Ending inventory (720 units x $32.80) $23,616
Cost of sales ($49,200 – $23,616) $25,584
2. First-in, first-out:
Ending inventory (500 units x $36)
+ (220 units x $32) $25,040
Cost of sales ($49,200 – $25,040) $24,160
3. Specific identification
Ending inventory (120 units x $30)
+ (180 units x $32)
+ (420 units x $36) $24,480
Cost of sales ($49,200 – $24,480) $24,720
As a shareholder, I prefer the weighted-average method because it results in the highest

cost of sales. This reduces pretax profit, income tax payable and future cash outflows.
8-27
P8–4
Req. 1
REGINA COMPANY
Partial Income Statement
For the Month Ended January 31, 2012
(a) (b) (c)

Weighted Specific
Average FIFO Identification
Sales revenue* $12,600 $12,600 $12,600
Cost of sales** 3,758 3,700 3,800
Gross profit $ 8,842 $ 8,900 $ 8,800
Computations:
*(400 + 300) units @ $18 = $12,600
**Cost of sales:
The cost of goods available for sale = $2,500 + 3,600 + 1,280 = $7,380
Weighted average
The total cost of sales is the sum of the cost of sales on January 10 and the cost of sales on
January 17.
January 10 sale:
Weighted-average cost = $2,500/500 = $5

Cost of sale = 400 units x $5 = $2,000
January 17 sale:
Weighted-average cost = ($2,500 – $2,000 + $3,600) / (500 – 400 + 600) = $5.86

Cost of sale = 300 units x $5.86 = $1,758
Total cost of sales = $2,000 + $1,757 = $3,757
FIFO
Cost of sales = (400 x $5) + (100 x $5 + 200 x $6) = $3,700
Specific Identification
Cost of sales = (400 x $5) + (300 x $6) = $3,800
8-28
P8–4 (continued)
Req. 2a
The FIFO method reports the highest pretax profit (see gross profit calculation per Req. 1
above).
Req. 2b
Because the specific identification method cost reports the lowest pretax profit (see gross
profit calculation per Req. 1 above) this method would produce the lowest income tax
expense.
Req. 2c
The specific identification method will provide a more favourable cash flow because less
cash will be paid for income tax than would be paid under the other two methods (for the
reasons given in Req. 2b).
Req. 3
January 10 Trade receivables (+A) ................................................................................

7,200
Sales (+R  +SE)..................................................................................... 7,200
Cost of sales (+E  –SE)..............................................................................2,000
Inventory (–A).......................................................................................... 2,000
January 12 Inventory (+A)..................................................................................................
3,600
Trade payables (+L)............................................................................... 3,600
5,400
Sales (+R  +SE)....................................................................................... 5,400
Cost of sales (+E  –SE)..............................................................................1,700
Inventory (–A).......................................................................................... 1,700
(100 units @ $5 + 200 units @ $6)
January 26 Inventory (+A)..................................................................................................
1,280
Trade payables (+L)............................................................................... 1,280
8-29
P8–5
Req. 1
Prices Rising Prices Falling
Case A Case B Case C Case D
Weighted Weighted
FIFO Average FIFO Average
Sales revenue (500 units) $12,000 $12,000 $12,000 $12,000
Cost of sales:
Beginning inventory (300 units) 3,300 3,300 3,600 3,600
Purchases (400 units) 4,800 4,800 4,400 4,400
Cost of goods available for sale 8,100 8,100 8,000 8,000
Ending inventory (200 units)* 2,400 (a) 2,314 (b) 2,200 (c) 2,286 (d)
Cost of sales (500 units) 5,700 5,786 5,800 5,714
Gross profit 6,300 6,214 6,200 6,286
Expenses (operating) 4,000 4,000 4,000 4,000
Pretax profit 2,300 2,214 2,200 2,286
Income tax expense (30%) 690 664 660 686
Profit $1,610 $1,550 $1,540 $1,600
*Inventory computations:
(a) FIFO: 200 units @ $12.00 = $2,400
(b) W.A.: 200 units @ ($8,100 ÷ 700) = $2,314
(c) FIFO: 200 units @ $11.00 = $2,200
(d) W.A.: 200 units @ ($8,000 ÷ 700) = $2,286
Req. 2
The above tabulation demonstrates that when prices are rising, the use of FIFO results in
higher profit than would be the case under Weighted Average. This is because FIFO allocates
the older (lower) unit costs to cost of sales whereas Weighted Average combines the impact
of lower and higher unit costs in computing the cost of sales. When prices are falling, the
opposite effect results. The difference in pretax profit (as between FIFO and Weighted
Average) is the same as the difference in cost of sales but in the opposite direction. The
difference in profit (i.e., after tax) is equal to the difference in cost of sales multiplied by one
minus the income tax rate.
Req. 3
Because pretax profit is higher under FIFO than under Weighted Average when prices are
rising, the FIFO method will result in a higher cash outflow resulting from the increase in
income tax payable. The opposite is true when prices are falling. We assume here that the
company can choose which of these two methods to use for tax purposes.
8-30
P8–5 (continued)
Req. 4
Either method can be defended reasonably. If one focuses on current profit and earnings
per share, FIFO derives a more favorable result (higher than Weighted Average) when
prices are rising. However, these comparative results will reverse if prices fall.
FIFO provides a better statement of financial position valuation (inventories are valued at
more recent prices), but FIFO does not match current expense (cost of sales) with current
revenues very well on the income statement, especially in periods of changing unit costs of
inventory items. Alternatively, Weighted Average better matches expenses with revenues
but it produces an inventory value that does not reflect recent prices to the same extent as
FIFO.
With regard to cash flows, Weighted Average results in lower tax payments than FIFO
when prices are rising, and vice versa if prices are falling.
P8–6
Req. 1
The cost of ending inventory is the balance of the Inventory account at the end of the
period taking into consideration the beginning inventory, the purchases during the year
and the cost of sales on January 24 and March 16. The calculations are presented in the
summary table below.
Cost of Sales Calculation (Weighted-Average Perpetual)
Cost of units purchased and sold

Date Transaction Units Cost Total
January 1 Beginning inventory 500 x $2.50 = $ 1,250
January 24 Sale (300) x $2.50 (750)
200 x $2.50 500
February 8 Purchase 600 x $2.60 1,560
Number of units available for sale (NUAS) = 800 $2,060 COGAS
March 16 Sale (560) x $2.575 (1,442)
240 x $2.575 618
June 11 Purchase 300 x $2.75 825
Number of units available for sale (NUAS) = 540 $1,443 Cost of ending inventory
COGAS $2,060
First weighted-average cost per unit = = = $2.575
NUAS 800
Cost of ending inventory = $1,443
P8–6 (continued)
8-31
Req. 2
Sales $3,552 (a)

Cost of sales 2,186 (b)
Gross profit (FIFO) $1,366
(a) (300 @ $4) + (560 @ $4.20) = $3,552

(b) (300 @ $2.50) + (200 @ $2.50 + 360 @ $2.60) = $2,186
Req. 3
In this case unit costs are rising steadily. One should therefore expect gross profit to be
lower under the weighted average costing method compared to FIFO since more recent
(higher) purchase costs are included in cost of sales under the weighted average method,
and older (lower) costs are included in cost of sales under FIFO.
Req. 4

1,200
Sales (+R  +SE)..................................................................................... 1,200
Cost of sales (+E  –SE).............................................................................. 750
Inventory (–A).......................................................................................... 750
February 8 Inventory (+A) .................................................................................................
1,560
Trade payables (+L)............................................................................... 1,560
March 16 Trade receivables (+A) ................................................................................
2,352
Sales (+R  +SE)..................................................................................... 2,352
Cost of sales (+E  –SE).............................................................................. 1,442
Inventory (–A).......................................................................................... 1,442
June 11 Inventory (+A) ................................................................................................. 825
Trade payables (+L)............................................................................... 825
Req. 5
a) The ending inventory is currently reported at a cost of $1,449 (= 300 @$2.75 + 240 @
$2.60). A reduction of 100 units in inventory will cause a reduction of $260 (100 @
$2.60) in inventory cost. Hence, the cost of sales is overstated by $260.
b) Current assets (inventory) would be understated by $260 (as calculated above).
8-32
P8–7
Req. 1
SMART COMPANY
Income Statement (LCM basis)
Sales revenue $280,000
Cost of sales:
Beginning inventory $ 31,000
Purchases 184,000
Cost of goods available for sale 215,000
Ending inventory 37,850*
Cost of sales 177,150
Gross profit 102,850
Operating expense 62,000
Pretax profit 40,850
Income tax expense ($40,850 x 30%) 12,255
Profit $ 28,595
*Computation of ending inventory on LCNRV basis:

Net
Realizable
Item Quantity Original Cost Value LCNRV Valuation
A 3,050 x $3 = $ 9,150 x $4 = $12,200 $ 9,150

B 1,500 x 5 = 7,500 x 3.50 = 5,520 5,250
C 7,100 x 1.50 = 10,650 x 3.50 = 24,850 10,650
D 3,200 x 6 = 19,200 x 4 = 12,800 12,800
Total $46,500 $55,370
LCNRV inventory valuation $37,850
Req. 2
Amount of
FIFO LCNRV Change
Item Changed Cost Basis Basis (Decrease)
Ending inventory $ 46,500 $ 37,850 ($8,650)
Cost of sales 168,500 177,150 8,650
Gross profit 111,500 102,850 (8,650)
Pretax profit 49,500 40,850 (8,650)
Income tax expense 14,850 12,255 (2,595)
Profit 34,650 28,595 (6,055)
8-33
P8–7 (continued)
Analysis
Ending inventory, cost of sales, gross profit, and pretax profit each changed by $8,650,
which is the change in the valuation of the ending inventory. Income tax expense decreased
because the increase in cost of sales reduced pretax profit.
Profit was reduced by $6,055, which is the increase in cost of sales, $8,650, less the income
tax savings of $2,595.
Req. 3
LCNRV is an exception to the cost principle. Conceptually, LCNRV is based on the view that
when market value (in this case, net realizable value) is less than the cost incurred for the
merchandise, any such goods on hand should be valued at the lower market price. The
effect is to include the holding loss (i.e., the drop from the recorded cost to the currently
lower market value) in the cost of sales amount of the period in which the market price fell
so that profit is not overstated. LCNRV recognizes holding losses in this manner; however,
it does not recognize holding gains.
Req. 4
LCNRV reduced pretax profit and income tax expense. There was cash savings of $2,595
for 2010 (assuming the LCNRV results are included on the income tax return). In
subsequent periods pretax profit will be greater by the $8,650 and hence, income tax and
cash outflow will be more. The only real gain to the company would be the time value of
money between 2010 and the subsequent periods when increased income taxes must be
paid (of course, a change in tax rates would affect this analysis).
8-34
P8–8 (Dollars are in thousands)
Req.1
Projected No change from

change beginning of year
Inventory = Cost of sales $7,008,984 = 17.5 $7,008,984 = 14.1
Turnover Average Inventory $400,005* $495,700**
* ($495,700 + $304,310) ÷ 2
** ($495,700 + $495,700) ÷ 2
Req.2
Projected decrease in inventory = $495,700 – $304,310 = $191,390
There would be a $191,390 increase in cash flow from operating activities, because a
decrease in inventory would increase cash, all other items held constant.
Req.3
An increase in the inventory turnover ratio indicates an increase in the number of times
average inventory was produced and sold during the period. If sales and cost of sales
remain unchanged, then the higher ratio reflects a decrease in inventory on hand which
means that less cash is tied up in inventory. Alternatively, a higher ratio could result from
an increase in sales, indicating that inventory is moving more quickly through the
production process to the ultimate customer. As a consequence, the increase in sales is
likely to result in increased collections from customers, which increase cash flow from
operations. The excess cash can, for example, be invested to earn interest income, or used
to reduce borrowings, thereby reducing interest expense. In reality an increase could be a
result of both a reduction in inventory levels and an increase in sales.
8-35
P8–9 (Appendix 8A)
(a) Cash (+A) ............................................................................................................ 275,000

Sales (+R  +SE)..................................................................................... 275,000
Cost of sales (+E  –SE).............................................................................. 137,500
Inventory (−A).......................................................................................... 137,500
(b) Sales returns and allowances (+XR  –SE) ...................................... 1,600

Cash (−A)..................................................................................................... 1,600
Inventory (+A).................................................................................................. 800
Cost of sales (−E  +SE)...................................................................... 800
(c1) Inventory (+A) ................................................................................................. 5,000

Trade payables (+L)............................................................................... 5,000
(c2) Inventory (+A) ................................................................................................. 120,000

Trade payables (+L)............................................................................... 120,000
(d) Store equipment (+A)................................................................................... 2,200

Cash (–A)..................................................................................................... 2,200
(e) Office supplies inventory (+A) ................................................................ 700

Cash (–A)..................................................................................................... 700
(f) Inventory (+A) ................................................................................................. 400

Cash (–A)..................................................................................................... 400
(g1) Trade payables (–L) ...................................................................................... 5,000

Cash (–A)..................................................................................................... 5,000
(g2) Trade payables (–L) ...................................................................................... 120,000

Cash (–A) (120,000 x 0.97)................................................................. 116,400
Inventory (–A) (120,000 x 0.03)...................................................... 3,600
8-36
ALTERNATE PROBLEMS
AP8–1
Req. 1
2012 2011 2010 2009
Sales revenue $2,025,000 $2,450,000 $2,700,000 $2,975,000

Cost of sales 1,505,000 1,605,000 1 1,804,000 2 2,113,000
Gross profit 520,000 845,000 896,000 862,000
Operating expenses 490,000 513,000 538,000 542,000
Pretax profit 30,000 332,000 358,000 320,000
Income tax expense (30%) 9,000 99,600 107,400 96,000
Profit $ 21,000 $ 232,400 $ 250,600 $ 224,000
1
$1,627,000 – $22,000 = $1,605,000. 2
$1,782,000 + $22,000 = $1,804,000.
Req. 2
There was an overstatement of the ending inventory in 2010 by $22,000; this caused cost of
sales for 2010 to be understated and 2010 profit to be overstated. Similarly, because this
error was carried over automatically to 2011 as the beginning inventory, cost of sales for
2011 was overstated and 2011 profit was understated. The amounts for 2009 and 2012
were not affected. This is called a self-correcting or counterbalancing error. Cumulative
profit for the four-year period was not affected.
Req. 3
The effect of the error on income tax expense was:
2010 2011
Income tax expense reported $114,000 $93,000

Correct income tax expense (see Req. 1) 107,400 99,600
Income tax expense overstatement (understatement) $ 6,600 $(6,600)
Alternatively, the amount of over (under)statement may be computed directly:

$22,000 x 30% = $6,600.
8-37
AP8–2
Req. (a) Cost of goods available for sale for all methods:
Unit Total
Units Cost Cost
January 1, 2012 – Beginning inventory 1,800 $2.50 $ 4,500

January 30, 2012 – Purchase 2,500 3.10 7,750
May 1, 2012 – Purchase 1,200 4.00 4,800
Goods available for sale 5,500 $17,050
Ending inventory: 5,500 units – (1,450 + 1,900) units = 2,150 units
Req. (b) and (c)
1. Weighted-average cost:
Average unit cost $17,050 ÷ 5,500 = $3.10
Ending inventory (2,150 units x $3.10) $6,665
Cost of sales ($17,050 – $6,665) $10,385
2. First-in, first-out:
Ending inventory (1,200 units x $4.00) +
(950 units x $3.10) $7,745
Cost of sales ($17,050 – $7,745) $9,305
3. Specific identification:
Cost of sales [1,450 x 2/5 x $2.50 + 1,450 x 3/5 x $3.1
+ (1,800 – 580) units x $2.50
+ (1,900 – 1,220) x $4] $9,917
Ending inventory ($17,050 – $9,917) $7,133
4. As a shareholder, I prefer the weighted-average method because it results in the

highest cost of sales. This reduces pretax profit, income tax payable and future cash
outflows.
8-38
AP8–3
Req. 1
Units (cartons) sold = 500 + 700 = 1,200
Cost of sales (FIFO, perpetual) consists of the following:
Cost of sale on Jan. 5 = 500 x $20 ($16,000 / 800) = $10,000

Cost of sale on Jan. 21 = (300 x $20) + [400 x $22 ($13,200 / 600)] = 14,800
Total cost $24,800
Req. 2
The weighted average cost per unit should be computed twice, once after the purchase on
January 19, and the second computation is after the purchase on January 29.
WAC1 = $16,000 + $13,200 – (500 x $20) = $19,200 = $21.33 (rounded)

800 + 600 – 500 900
WAC2 = (900 x $21.33) + $11,000 = $30.200 = $21.57

900 + 500 1,400
Units in ending inventory = 1,900 – 500 – 700 = 700
Cost of ending inventory = 700 x $21.57 = $15,099
Req. 3
Using FIFO, the cost of sales would not change if a periodic inventory system were used
instead of perpetual system.
Under a periodic inventory system, the weighted average unit cost is computed once, at the
end of the accounting period, whereas the moving weighted average unit cost changes after
each purchase of merchandise. The WAC under a periodic system would be:
WAC = $16,000 + $13,200 + $11,000 = $40,200 = $21.16 (rounded)

800 + 600 + 500 1,900
A unit cost of $21.16 would be used to compute ending inventory compared to $21.57
under the moving average method.
8-39
AP8–4 (Dollars are in thousands)
Req. 1
Projected No change from

change beginning of year
Inventory = Cost of sales $480,441 = 3.88 $480,441 = 3.97
Turnover Average Inventory $123,892.5* $120,804
* ($120,804 + $126,981) ÷ 2
Req. 2
Increase in inventory = $126,981 – $120,804 = $6,177
There was a $6,177 decrease in cash flow from operating activities, because an increase in
inventory would decrease cash, all other items held constant.
Req. 3
A decrease in the inventory turnover ratio indicates a decrease in the number of times
average inventory was produced and sold during the period. Assuming that sales and cost
of sales remain unchanged the higher ratio must mean an increase in inventory on hand
which means more cash is tied up in inventory. Alternatively a lower ratio may indicate
that inventory moves more slowly through the production process to the ultimate
customer. As a consequence, the company must maintain more inventory on hand, all other
things being equal. This can damage the company because more money is tied up in
inventory and as a result, cash flow from operations will be lower. The additional cash
needed prevents other productive investments or leads to higher borrowings, thereby
increasing interest expense. Higer inventory levels also increase the risk of obsolescence.
8-40
AP8–5 (Appendix 8A)
(a) Cash (+A) ............................................................................................................ 228,000

Trade receivables (+A) ................................................................................ 72,000
Sales (+R  +SE)..................................................................................... 300,000
Cost of sales (+E  –SE).............................................................................. 150,000
Inventory (–A).......................................................................................... 150,000
(b) Sales returns and allowances (+XR  –SE) ...................................... 5,000

Cash (−A)..................................................................................................... 3,000
Inventory (+A) ................................................................................................. 2,500
Cost of sales (−E  +SE)...................................................................... 2,500
(c1) Inventory (+A) ................................................................................................. 4,000

Trade payables (+L)............................................................................... 4,000
(c2) Inventory (+A) ................................................................................................. 68,000

Trade payables (+L)............................................................................... 68,000
(d) Inventory (+A).................................................................................................. 1,500

Cash (–A)..................................................................................................... 1,500
(e) Cash (+A)............................................................................................................. 36,000

(f1) Trade payables (–L) ...................................................................................... 4,000

Cash (–A)..................................................................................................... 4,000
(f2) Trade payables (–L) ...................................................................................... 68,000

Cash (–A)..................................................................................................... 66,640
Inventory (–A).......................................................................................... 1,360
(g) Office equipment (+A) ................................................................................. 1,000

Cash (–A)..................................................................................................... 1,000
8-41
CASES AND PROJECTS
FINDING AND INTERPRETING FINANCIAL INFORMATION
CP8–1
This response is based on the financial statements for the year ended December 31, 2008
Req. 1
The company owned £767 million of inventories as at December 31, 2008. This
information is disclosed on the statement of financial position.
Req. 2
It is estimated that the company purchased (and produced) goods at a total cost of £2,816
million during the year. The beginning and ending inventory balances are disclosed on the
statement of financial position and cost of sales is disclosed on the income statement.
Purchases during the year can be computed by rearranging the basic inventory equation
(BI + P – EI = COS):
Cost of sales (note 3 (a))............................................................... £2,870

+ Ending inventory ....................................................................... 767
– Beginning inventory ..................................................................... (821)
= Purchases............................................................................................ £2,816
Req. 3
The company uses the weighted-average cost method to determine the cost of its
inventory. This information is disclosed as part of Note 1 (r) (Significant Accounting
Policies) as follows:
Inventories are recorded at the lower of average cost and estimated net realisable value.
Cost comprises direct material and labour costs together with the relevant factory
overheads (including depreciation) on the basis of normal activity levels. Amounts are
removed from inventory based on the average value of the items of inventory removed.
Req. 4
Inventory = Cost of sales £2,870 = 3.61

Turnover Average Inventory £794*
* (£767 + £821) ÷ 2
The inventory turnover tells you approximately how many times the company sells or
turns over it inventory in a one-year period.
CP8–1 (continued)
8-42
Req. 5
Inventories decreased by £54 million (£767 – £821) based on the amounts disclosed on the
statement of financial position at December 31, 2008. The decrease in inventories
increased net cash provided by operating activities for the year.
CP8–2
Req. 1
The company uses the first-in-first-out (FIFO) method to determine the cost of its raw
materials inventory and purchased finished goods, and average cost for other inventories.
This information is disclosed as part of Note 1 Significant accounting policies which states:
Raw materials and purchased finished goods are valued at purchase cost. Work in
progress and manufactured finished goods are valued at production cost. Production cost
includes direct production costs and an appropriate pro- portion of production overheads
and factory depreciation.
Raw material inventories and purchased finished goods are accounted for using the FIFO (first in,
first out) method. The weighted average cost method is used for other inventories.
An allowance is established when the net realizable value of any inventory item is lower than the
value calculated above.
Req. 2
Nestlé’s ending inventory consists of four elements: raw materials, work-in-progress,
sundry supplies, and finished goods. Since the company purchases, roasts and sells roasted
coffee to customers, its inventory balance is composed primarily of finished goods as
shown in Note 6 to the financial statements.
Req. 3
The inventory turnover ratio for Nestle is computed as follows (amounts in millions):
Inventory = Cost of sales = CHF 47,339 = 5.09

Turnover Average Inventory (CHF 9,342 + 9,272) / 2
Req. 4
Profit before tax and associates as presented in the statement is CHF 21,833. If inventory is
overstated it means that profit is also overstated and therefore an overstatement of
inventory by 10 would mean that profit before tax and associates should be 21,823.
8-43
CP8–3
Req. 1 (Dollars are in thousands.)
Inventory turnover = Cost of Sales / Average Inventory
Cadbury
Inventory = Cost of sales = £m 2,870 = 3.61
Turnover Average Inventory £m 794*
*(£m 767 + £m 821) ÷ 2
Nestlé
Inventory = Cost of sales = CHF 47,339 = 5.09
Turnover Average Inventory (CHF 9,342 + 9,272) / 2
The turnover ratios of the two companies are different. Nestlé’s ratio is higher than
Cadbury’s, indicating that Nestle may be managing its inventories better than Cadbury. The
main reason for the differences in the turnover ratios is the nature of the products that are
sold by these companies.
Req. 2
The FIFO and average cost methods may or may not yield large differences in the cost of
sales depending on the change in the prices of goods purchased and/or produced during
the year. If prices are relatively stable, no significant differences would be expected.
However, if merchandise prices at the beginning of the year are markedly different from
the end-of-year prices, then large differences in the computations of cost of sales may
result.
8-44
CP8–4
The solution to this case is adapted from the solution to Paper II of the 2005 Uniform
Evaluation for the Chartered Accountant designation, retrieved from “Filling the GAAP to
IFRS: Teaching Supplements for Canada’s Accounting Academics, CD3–Questions and Answers
Pack, Canadian Institute of Chartered Accountants: Toronto, 2008.
Req. 1
The areas of concern are as follows.
Revenues
There is no control over the cash portion of the revenues. Cash sales represent 25% of the
sales, which is a material amount in relation to the financial statements. Marco stated that
he sometimes pockets cash sales rather than recording the sale on the register (the amount
reported to us is approximately $10,000). In addition, some of the employees are also in a
position to pocket cash sales as they are left in the store unattended. Therefore, it will be
difficult to establish the total amount of cash sales.
Control over credit sales also seems weak. Amounts owed by customers are recorded at the
time of delivery on a specially designated sheet of paper kept by the cash register. As cash is
received, their balance is reduced. There is no sign of pre-numbered invoices being used to
control the invoicing process. It is possible that some credit sales were never recorded on
the list or that some account balances on the list have already been paid but have not been
removed from the list. There is no easy way to make sure that the trade receivables list is
reasonably accurate. Credit sales represent a significant portion of MPP’s revenue (50% of
total revenue). It will therefore be very difficult to ensure that the revenue amount related
to credit sales is complete.
Trade receivables
When Carla prepared the income statement, she included a bad debt expense estimated at
17% of the trade receivables. We will have to make sure that this estimate is reasonable
and is based on her best estimate of the unrecoverable amounts. Given that 50% of sales
are on credit, that there is no policy for granting credit and that customers usually do not
pay on time, we may need to increase the provision for, or even write off, unrecoverable
balances. As it is already six months after year-end, we should be able to determine
whether the bad debt expense recorded is plausible based on subsequent receipts.
8-45
CP8–4 (continued)
Inventory
Marco determined the value of the inventory by writing up a list of what was in the stock
room on December 31 and applying prices obtained from current supplier price lists to the
quantities noted. Current prices should not be used, as inventory should be valued at the
lower of cost and net realizable value. However, since the inventory turnover seems to be
high, the misstatement is likely not material.
We should also find out if there is any obsolete inventory. But here again, obsolescence is
unlikely since the inventory turnover seems high.
Expense cut-off
Marco has a corporate credit card on which he makes MPP’s purchases. Items purchased on
the credit card are expensed in the year as long as a statement is received from the credit
card company in time to be included in the financial statements. If the statement comes in
too late, the expenses get picked up the following year. In other words, we have a cut-off
problem which can easily be resolved by reviewing the credit card statements received
after year-end and identifying the purchases that relate to the previous fiscal year.
Marco sometimes makes personal purchases on the corporate credit card. Marco estimates
that he charged about $4,000 of personal expenses to the corporate credit card in each of
the last two years. We will have to review the credit card statements to determine the
amount of personal expenses incurred.
Req. 2
Dear Mr. Douga,
Your business has performed far better than your draft income statement shows. I
recalculated the balances of specific elements of the income statements, found below, in
accordance with the accrual basis of accounting. Based on my calculations, your business
earned a profit in both 2010 and 2009. This is good news because being profitable will
make it easier to obtain a bank loan. Unfortunately, MPP was also profitable in 2010 for tax
purposes, and as a result taxes will have to be paid to the taxation authorities.
These statements are based on the information you provided me, which I have assumed to
be accurate. The income statements therefore give a reasonable indication of the actual
performance of the company. The adjustments made to the statements thus far are as
follows:
8-46
CP8–4 (continued)
Marco Professional Print Shop Ltd.
INCOME STATEMENT
For the year ended December 31
2010 2009
Sales Note 1 $375,242 $281,539

Cost of merchandise sold Note 2 120,962 88,012
Gross profit 254,280 193,527
Operating expenses:
Selling, general & administrative expenses Note 3 38,204 31,249
Salaries Note 4 65,099 58,740
Advertising and promotion 34,727 29,503
Utilities 18,300 17,900
Rent 22,000 22,000
Bad debt expense 2,754 1,955
Other expenses 16,618 12,444
197,702 173,791
Operating profit 56,578 19,736
Non-operating expenses:
Bank charges 2,000 1,500
Interest on loans from relatives 5,000 5,000
Profit before depreciation and income taxes $ 49,578 $ 13,236
Notes
1. Sales
$10,000 has been added to Sales each year to account for the cash sales that you put in your
pocket rather than in the cash register. Sales have also been adjusted for trade receivables.
MPP currently uses the cash basis of accounting for recording sales but, under IFRS, accrual
accounting must be followed. According to IAS1.27 and 28, “An entity shall prepare its
financial statements, except for cash flow information, using the accrual basis of
accounting. When the accrual basis of accounting is used, items are recognised as assets,
liabilities, equity, income and expenses (the elements of financial statements) when they
satisfy the definitions and recognition criteria for those elements in the Framework.”
Therefore, as long as the sales on credit meet the definition of revenue, they have to be
recorded as well. That means the closing amount of trade receivables each year must be
added to that year’s sales. For 2010, the ending amount of trade receivables for 2009 is
deducted from Sales for 2010.
2010 Sales: $360,547 + $10,000 + $16,200 – $11,505 = $375,242
2009 Sales: $260,034 + $10,000 + $11,505 = $281,539
8-47
CP8–4 (continued)
2. Cost of merchandise sold

The value of the inventory you calculated could be wrong, as the prices you used may not
be the same as the prices you paid when you bought the items (i.e., their cost). Per IAS2.9,
“Inventories shall be measured at the lower of cost and net realisable value.” You should
attempt to “cost out” the inventory based on the historical prices you paid for the items. If
the prices have been fairly consistent over time, the adjustment from current prices to cost
may not be significant.
Cost of merchandise sold is too high in your income statement. MPP has expensed the cost
of all the supplies and the merchandise purchased whereas only the cost of the items
actually used or sold should be expensed. To determine the correct amount of inventory
sold, I have subtracted the ending inventory at cost from purchases each year. For 2010, I
added 2009’s ending inventory since that amount would have been sold in 2010.
2010 Cost of merchandise sold: $124,984 + $8,200 – $12,222 = $120,962

2009 Cost of merchandise sold: $96,212 – $8,200 = $88,012
3. Selling, general, and administrative expenses

Selling, general, and administrative expenses have been reduced by $4,000 each year, your
estimate of the personal expenses that you charged to MPP’s corporate credit card. The
nature of the amounts should be determined. The amounts could be an expense (i.e.,
salary), a dividend (if so, it would be excluded from profit) or a loan to you, the
shareholder.
4. Payments to employees
The Payments to employees account has been replaced with Salaries and reduced by
$25,000 each year for the money you took out of the company for personal expenses. Carla
included these amounts in the Payments to employees account on the income statement. As
in the case the $4,000 discussed above, the $25,000 could be a salary, a dividend, or a loan
to you.
Also, employees are paid their gross earnings by cheque at the end of each week. It is not
clear whether MPP remits to the government the employer’s contributions related to the
payroll. I will need more information before adjusting the salary expense for MPP’s
contributions.
8-48
CP8–4 (continued)
5. Computers, printers, copiers, scanners, furniture and fixtures

Carla included in the income statement the costs of the printing and scanning equipment,
furniture and fixtures. Those items are property, plant and equipment assets as they meet
the requirements set out in IAS16.7, “The cost of an item of property, plant and equipment
shall be recognized as an asset if, and only if: it is probable that future economic benefits
associated with the item will flow to the entity and the cost of the item can be measured
reliably.” Therefore, the cost of these assets should be capitalized and recognized over their
useful lives for the business. This is called deprecation. I need more information to
determine the useful lives of these assets in order to decide on the appropriate
depreciation policy. For tax purposes, they can be depreciated on a different basis from that
used for accounting purposes.
Req. 3
From our discussion, the controls surrounding cash seem to be an area of concern. I
suggest that you make improvements as soon as possible, although they are not as pressing
as preparing the financial statements for the bank. The suggestions I have are as follows.
 Control of cash––In my view MPP has some serious cash control issues that need
attention. The problem is that you and Carla have no way to check whether cash is
adequately protected. You often leave your employees in charge of the store which
gives them the opportunity to take cash, either from the cash register or in the same
way you do, by putting cash from cash sales directly into their pockets. If you happen
to hire a dishonest employee, you could easily be out of pocket. The fact that only you,
or Carla, control the cash when you are in the store shows that you understand the
importance of cash controls. You need to take steps to tighten the controls over cash
when you are not there. One step would be to make employees aware that you are
monitoring cash. For example, you could count the cash in the register before you leave
the store and again once you return. You should insist that your employees give
customers their receipts, so employees (and you) have to ring up all sales transactions
on the cash register. You could install surveillance cameras, ostensibly to protect
employees but they would also serve to monitor the actions of employees in your
absence.
8-49
CP8–4 (continued)
 Purchasing and inventory control—from your description of the business it appears

that you have a very casual way of keeping track of your inventory. Running short of
inventory or carrying too much inventory can be costly. If you run out of inventory you
may be unable to meet the needs of your customers. And if you have too much
inventory, you have cash tied up in inventory that could be used for other purposes.
You visually survey your inventory regularly, but you still seem to run out of things
from time to time. In those instances you are required to purchase the materials at
retail which is more costly than paying wholesale prices from your suppliers. You
should consider negotiating a supply arrangement to take advantage of potential
discounts and regular periodic deliveries.
With better inventory controls, it might be possible to determine whether the use of
inventory is reasonable given the revenues that are being earned. If there seem to be
significant shortfalls in inventory relative to the cash collected, that might be an
indication of theft.
 Collection of trade receivables—you ask your credit customers to pay within 10 days,
but you do not seem to do very much to ensure that your customers comply. A quick
calculation indicates that the average collection period for your receivables is over 22
days [365/(credit sales/average trade receivables)], more than twice as long as the
period you supposedly allow. Trade receivables tie up your cash, so it is important to
collect from customers as quickly as possible. You should keep better track of who owes
you money and call customers to ask for payment once an amount is overdue, especially
customers who regularly pay late.
In addition, you may want to develop a better system for recording trade receivables as
the designated sheet maintained by the register is accessible to all employees and
would be easy to alter. A simple spreadsheet could be created to keep track of
outstanding balances, and access to the spreadsheet could be restricted.
 Payments to suppliers—currently you pay your suppliers as soon as you receive the
invoice. While it is a good strategy to pay your bills on time, paying them too early or
not taking advantage of available discounts comes at a cost. Some companies offer
discounts for prompt payment (for example, a 2% discount for paying within 10 days).
It is not clear whether your suppliers offer these discounts or whether you take
advantage of them.
 Separation of personal expenses from business expenses––You should also make sure
your personal expenses are segregated from your business expenses. Recording all the
transactions on the cash register (as recommended above) as well as always using a
separate credit card for your personal expenses will help solve that problem.
8-50
CP8–5
Req. 1
a. Collections from customers = Revenues + Beginning trade receivables – Ending trade

receivables
2008: $15,370.0 + 199.0 – 235.5 = $15,333.5
2009: $15,781.1 + 235.3 – 209.2 = $15,807.2
b. Merchandise purchases = Cost of sales + Ending inventory – Beginning inventory
2008: $13,146.5 + 444.5 – 382.1 = $13,208.9

2009: $13,334.5 + 400.3 – 444.5 = $13,290.3
c. Payments to suppliers = Merchandise purchases + Beginning trade payables – Ending

trade payables
2008: $13,208.9 + 537.0 – 618.0 = $13,127.9

2009: $13,290.3 + 618.0 – 510.3 = $13,398.0
d. Inventory turnover = Cost of sales / Average inventory
2008: $13,146.5 / [(444.5 + 382.1)/2] = 31.81

2009: $13,334.5 / [(400.3 + 444.5)/2] = 31.57
Average days to sell inventory = 365 / Inventory turnover
2008: 365 / 31.81 = 11.47 days

2009: 365 / 31.57 = 11.56 days
e. Trade receivables turnover = Revenues / Average trade receivables
2008: $15,370.0 / [(199.0 + 235.5)/2] = 70.75

2009: $15,781.1 / [(235.3 + 209.2)/2] = 71.01
Average collection period = 365 / Inventory turnover
2008: 365 / 70.75 = 5.16 days

2009: 365 / 71.01 = 5.14 days
f. Average period to convert inventory to cash = Average days to sell inventory

+ Average collection period
2008: 11.47 days + 5.16 days = 16.63 days
2009: 11.56 days + 5.14 days = 16.70 days
8-51
CP8–5 (continued)
Req. 2
The changes in trade receivables, inventory and trade payables are reported on the
statement of cash flows as adjustments to profit as follows:
Operating activities:
Profit ($368.6 – 114.7) $253.9
Adjustments for items that do not affect cash:
Decrease in trade receivables 26.1
Decrease in inventory 44.2
Decrease in trade payables (107.7)
Req. 3
Assuming that the costs of units purchased have increased during fiscal year 2009, the cost
of sales would be higher if the weighted average costing method is used instead of FIFO.
This is because the FIFO costs would include earlier costs that are lower. This would result
in a lower profit figure.
Req. 4
The purchased merchandise should be included in ending inventory because it belongs to

the company as of that date even if it is not in the company’s warehouse yet. An increase in
ending inventory will reduce the cost of sales, increase gross profit, pretax profit, income
tax expense, and profit. The increase in profit would be $1,400 x [1 – 114.7 / 368.6)] =
$966.0.
8-52
CP8–6
Req. 1
a. Collections from customers = Net sales + Beginning trade receivables – Ending trade
receivables
2007: $770.2 + 84.2 – 108.0 = $746.4
2008: $892.5 + 108.0 – 124.6 = $875.9
a. Merchandise purchases = Cost of sales + Ending inventory – Beginning inventory

2007: $358.3 + 187.1 – 131.0 = $414.4
2008: $424.5 + 228.8 – 187.1 = $466.2
b. Payments to suppliers = Merchandise purchases + Beginning trade payables – Ending

trade payables
2007: $414.4 + 96.9 – 127.6 = $383.7
2008: $466.2 + 127.6 – 149.2 = $444.6
d. Inventory turnover = Cost of sales / Average inventory

2007: $358.3 / [(187.1 + 131.0)/2] = 2.25
2008: $424.5 / [(228.8 + 187.1)/2] = 2.04
Average days to sell inventory = 365 / Inventory turnover
2007: 365 / 2.25 = 162.22 days

2008 365 / 2.04 = 178.92 days
e. Trade receivables turnover = Net sales / Average trade receivables

2007: $770.2 / [(84.2 + 108.0)/2] = 8.01
2008: $892.5 / [(108.0 + 124.6)/2] = 7.67
Average collection period = 365 / Inventory turnover

2007: 365 / 8.01 = 45.57 days
2008: 365 / 7.67 = 47.59 days
f. Average period to convert inventory to cash = Average days to sell inventory

+ Average collection period
2007: 162.22 days + 45.57 days = 207.79 days

2008: 178.92 days + 47.59 days = 226.51 days
8-53
CP8–6 (continued)
Req. 2
The changes in trade receivables, inventory and trade payables are reported on the
statement of cash flows as adjustments to profit as follows:
Operating activities:
Profit ($170.5 – 48.6) $121.9
Adjustments for items that do not affect cash:
Increase in trade receivables (16.6)
Increase in inventory (41.7)
Increase in trade payables 21.6
Req. 3
Assuming that the costs of units purchased have increased during fiscal year 2008, the cost
of sales would be lower if the FIFO inventory costing method is used instead of the
weighted average costing method. This would result in a higher profit figure.
Req. 4
The purchased merchandise should not be included in ending inventory because it does
not belong to the company until it arrives at the company’s warehouse. A decrease in
ending inventory will increase the cost of sales, decrease gross profit, pretax profit, income
tax expense, and profit. The decrease in profit would be €1,200,000 x [1 – 48.6 / 170.5)] =
€857,947.
8-54
CP8–7
Req. 1
Inventory turnover = Cost of sales / Average inventory = Sales x 0.77 / Average inventory
Average number of days to sell inventory = 365 / Inventory turnover
Loblaw Companies Ltd. 2008 2007 2006 2005

Inventory turnover 11.24 11.12 10.87 11.15
Average number of days to sell inventory 32.47 32.82 33.58 32.74
Shoppers Drug Mart Corp.
Inventory turnover 4.41 4.48 4.63 4.68
Average number of days to sell inventory 82.77 81.47 78.83 77.99
Req. 2
Some of the items that Loblaws added to its line of products, such as appliances, take
longer to sell than food items. And it seems that the addition of new items to its line of
products did not improve its inventory turnover. It is possible that the volume of such
items is relatively small compared to its main line of products. In contrast, one would
expect the inventory turnover of Shoppers Drug Mart to increase following the
introduction of food items. But this depends on the type of items that have been added and
their shelf life. The inventory turnover actually declined for the four year period.
It should be noted that we also need to examine the profitability associated with the
addition of the new product lines for both companies. The additional product lines could
have increased the companies’ profit figures even though there was no apparent
improvement in inventory turnover ratios.
The ratios calculated are also based on an assumed cost of sales percentage – the actual
may differ from this.
8-55
CRITICAL THINKING CASES
CP8–8
Req. 1 and Req. 2
Financial Programmable
Calculators Calculators
Number of units in inventory on December 31 per physical count…… 19,600 7,600
Number of units purchased from January 1 to April 30……………….. 15,600 9,000
Total number of units available for sale………………………………… 35,200 16,600
Number of units in inventory on April 30……………………………….. 6,400 3,900
Number of units that were presumably sold……………………………. 28,800 12,700
Cost of sales using weighted average cost:
Financial calculators: 28,800 x $8.40…………………………………. $241,920
Programmable calculators: 12,700 x $29.657……………………….. $376,644
(7,600 x $29.25 + 9,000 x $30.00) / 16,600
Sales revenue based on units taken from the warehouse
Financial calculators: Cost of sales / 0.70 …………………… 345,600
Programmable calculators: Cost of sales / 0.75………………. 502,192
Actual sales revenue……………………………………………………… 343,200 496,400
Difference …………………………………………………………………. 2,400 5,792
Average sales price
Financial calculators: Average cost / 0.70……………………………. 12
Programmable calculators: Average cost* / 0.75……………………. 39.54
*Average cost per unit sold = $376,644 / 12,700
Number of missing calculators (= Difference / Average sales price) 200 146
Apparent loss due to the theft of calculators = $2,400 + $5,792 = $8,192
Req. 3
The loss per year would be $8,192 x 3 periods of 4 months each = $24,576.
The cost of installing a new inventory system and quarterly physical inventory counts
would be $4,000 + 4 x $1,000 = $8,000.
The net savings would equal $16,576. The company should definitely proceed with these
additional expenditures.
8-56
CP8–9
To: The Files

From: The New Staff Member
Re: Effect of restatement
Req. 1
The Company understated purchases by $47.3 million. This causes cost of sales to be
understated and pretax earnings to be overstated by $47.3 million. Net earnings are
overstated by that amount times 1 – tax rate:
$47.3 x (1 – .404) = $28.2 million overstatement
Req. 2
The restatement of the purchases caused the board to cancel management’s bonuses.
Accordingly, pretax profit will increase by $2.2 million, and net earnings will increase by
that amount times 1 – tax rate.
$2.2 x (1 – .404) = $1.3 million increase
Req. 3
If it is assumed that bonuses are a fixed portion of net earnings, the bonus rate can be
roughly estimated using the amounts computed in parts 1 and 2.
Change in bonus
= Bonus rate per dollar of net earnings
Change in net earnings
$2.2 million
= $.078 per dollar of net earnings
$28.2 million
Req. 4
The Board likely tied management compensation to net earnings to align the interests of
management with those of shareholders. Typically, increases in net earnings will fuel a rise
in the stock price. This type of compensation scheme does create the possibility that
unethical management may alter the financial results to receive higher bonuses.
8-57
FINANCIAL REPORTING AND ANALYSIS TEAM PROJECT
CP8–10
The solution to this case will depend on the company and/or accounting period selected
for analysis.
8-58
Appendix 8B
Last-in, First-out Method
Revised: January 30, 2011
EXERCISES
E1
Req. 1
LUNAR COMPANY
Income Statement (Partial)

FIFO LIFO Moving Avg.
Sales revenue1............................................... $330,000 $330,000 $330,000
Cost of sales ............................................ 116,000 2 128,000 3 123,500 4
Gross profit ................................................ 214,000 202,000 206,500
Expenses (operating)................................ 85,000 85,000 85,000
Pretax profit ................................................ $129,000 $117,000 $121,500
Ending inventory $114,000 5 $102,000 6 $106,500 7
Computations:
(1) (5,000 @ $30) + (6,000 @ $30) = $330,000
(2) (3,000 @ $12) + (2,000 @ $10) + (6,000 @ $10) = $116,000
(3) (5,000 @ $10) + (6,000 @ $13) = $128,000
(4) Total cost of sales is the sum of cost of sales for the May 1 sale, and cost of sales for
the July 3 sale.
Re: May 1 sale:

5,000 x (3,000 @ $12) + (9,000 @ $10) = 5,000 x $126,000 = $52,500
3,000 + 9,000 12,000
Re: July 3 sale:

6,000 x $126,000 - $52,500 + (8,000 @ $13) = 6,000 x $177,500 = $71,000
12,000 – 5,000 + 8,000 15,000
Total cost of sales = $52,500 + $71,000 = $123,500
8-59
E1 (continued)
(5) (1,000 @ $10) + (8,000 @ $13) = $114,000

(6) (3,000 @ $12) + (4,000 @ $10) + (2,000 @ $13) = $102,000
(7) $177,500 - $71,000 (see calculation (4) above) = $106,500
or 9,000 @ $11.83 = $106,470, rounded to $106,500
Req. 2
FIFO LIFO Moving Avg.
Pretax Profit $129,000 $117,000 $121,500

Ending Inventory $114,000 $102,000 $106,500
The differences in pretax profit among the three cases are directly related to the differences
in ending inventory; the cost of beginning inventory being the same in all cases. For
example, if one compares Cases A and C, pretax profit and ending inventory are each higher
by $7,500 under Case A.
Req. 3
The LIFO inventory method may be preferred for income tax purposes because it reports
less taxable profit (when prices are rising) and hence (a) reduces income tax and (b) as a
result reduces cash outflows for the period.
8-60
E1 (continued)
Req. 4
b. Inventory (+A) (9,000 x $10).................................................................... 90,000

Trade payables (+L)............................................................................... 90,000

Sales (+R  +SE) (5,000 x $30)....................................................... 150,000
Cost of sales (+E  –SE) ............................................................................. 50,000
Inventory (–A) (5,000 x $10) ............................................................ 50,000
d. Inventory (+A) (8,000 x $13).................................................................... 104,000

Trade payables (+L)............................................................................... 104,000

Sales (+R  +SE) (6,000 x $30)....................................................... 180,000
Cost of sales (+E  –SE) ............................................................................. 78,000
Inventory (–A) (6,000 x $13) ............................................................ 78,000

E2
Req. 1
The reported ending inventory for Ford was $6,816.8 million. If FIFO were used
exclusively, the ending inventory would have been $1,235 million higher than reported, or
$8,051.8 million.
Req. 2
The restated cost of sales amount must reflect the restatement of both beginning and
ending inventory:
Beginning inventory ................................................................... $1,246 million

Less: Ending inventory .............................................................. 1,235 million
Impact on cost of sales ............................................................... $ 11 million
If FIFO were used exclusively, the cost of sales would have been $74,315 + $11 = $74,326
million.
8-61
PROBLEMS
P1
Req. 1
Sales revenue (45 @ $25,000) $1,125,000
Cost of sales (40 @ $13,000) + (5 @ $12,000) 580,000
Expenses (operating) 300,000
Pretax profit $ 245,000
Ending inventory (10 @ $12,000) $ 120,000

(15 units + 40 units – 45 units = 10 units)
Req. 2
Sales revenue (as above) $1,125,000
Cost of sales (20 @ $14,000) + (25 @ $13,000) 605,000
Expenses (operating) 300,000
Pretax profit $ 220,000
Ending inventory (15 @ $13,000) + (15 @ $12,000) $ 375,000

(15 units + 40 units + 20 units – 45 units = 30 units)
Req. 3
The purchase of the 20 additional units will cause a decrease in pretax profit by $25,000
($245,000 – $220,000), and a corresponding decrease in profit. As a manager this will not
be in my favour as my bonus is likely to be reduced with a lower profit for the year.
The decision to not buy additional units may be harmful to the company if the unit cost is
expected to increase in the future. A delay in purchasing additional units will result in
increased expenses in the future and reduced profit.
Req. 4
If FIFO is used, then the cost of ending inventory would be $130,000 (10 units x $13,000),
which exceeds the market value of the test equipment. As a result, the ending inventory
would be reported at $125,000.
If LIFO is used, then the cost of ending inventory is $120,000 (10 units x $12,000), which is
lower than its market value of $125,000 (10 units x $12,500). In this case, the ending
inventory will be reported at cost of $120,000.
8-62
P2
Req. 1
Income statement restated on LIFO basis: (Millions)

Sales revenue $850
Cost of sales ($400 + $120 – $75) 445
Gross profit 405
Expenses (operating) 310
Pretax profit $ 95
Req. 2
The decrease in pretax profit was $140 – $95 = $45 (million). This decrease was caused by
using LIFO (instead of FIFO) because (1) prices were rising significantly and (2) LIFO
allocates the new (higher) unit costs to cost of sales while FIFO allocates the old (lower)
unit costs to cost of sales.
Req. 3
Because LIFO is not permitted for tax purposes in Canada there is no cash flow advantage
by adopting LIFO. Shareholders probably would not agree among themselves on this
decision and would give various reasons such as the following:
(1) Desirable because LIFO better matches current costs with current revenues.
(2) Desirable because there may be less demand for wage increases by employees.
(3) Undesirable because it is a deliberate attempt to manipulate profit.
(4) Undesirable because costing should (ideally) be consistent with the physical flow of
goods (FIFO).
(5) Undesirable because FIFO is more logical and it is not subject to manipulation by
year-end purchases (or failure to purchase).
(6) Undesirable because by reducing reported profit (and hence retained earnings) a
smaller amount of dividends may be declared.
(7) Undesirable because FIFO better measures the ending inventory valuation reported
on the statement of financial position.
(8) Undesirable because FIFO was acceptable and nothing fundamental has changed to
warrant the adoption of LIFO.
8-63
P3
Req. 1
Cost of goods available = (500 @ $2.50) + (600 @ $2.60) + (300 @ $2.75)

= $1,250 + $1,560 + $825 = $3,635
Total cost of sales is the sum of cost of sales for the January 24 sale and cost of sales for the
March 16 sale.
Re: January 24 sale:
(300 @ $2.50) = $750
Re: March 16 sale:
560 x $1,250 – $750 + $1,560 = 560 x $2,060 = $1,442

500 + 600 – 300 800
Total cost of sales = $750 + $1,442 = $2,192
Cost of ending inventory (moving average method) = $3,635 – $2,192 = $1,443
Req. 2
Sales $3,552 (a)

Cost of sales 2,186 (b)
Gross profit (FIFO) $1,366
(a) (300 @ $4) + (560 @ $4.20) = $3,552

(b) (300 @ $2.50) + (200 @ $2.50) + (360 @ $2.60) = $2,186
Req. 3
In this case purchase prices are rising steadily. One should therefore expect gross profit to
be lower under LIFO compared to FIFO since more recent (higher) purchase costs are
included in cost of sales under LIFO.
8-64
P3 (continued)
Req. 4
January 24 Trade receivables or Cash (+A) ............................................................... 1,200

Sales (+R  +SE)..................................................................................... 1,200
Cost of sales (+E  –SE) ............................................................................. 750

Inventory (–A) ......................................................................................... 750
(300 x $2.50)
February 8 Purchases (+T) ................................................................................................

1,560
Trade payables (+L)............................................................................... 1,560
March 16 Trade receivables or Cash (+A) ............................................................... 2,352

Sales (+R  +SE)..................................................................................... 2,352
Cost of sales (+E  –SE) ............................................................................. 1,436

Inventory (–A) ......................................................................................... 1,436
(200 x $2.50 + 360 x $2.60)
June 11 Purchases (+T) ................................................................................................ 825

Trade payables (+L)............................................................................... 825
Req. 5 (Comparison with answers for P8.6, requirements 1, 2 and 3)
Cost of Ending Inventory

P8-6, Req. 1: Weighted Average Method $1,402
P3, Req. 1: Moving Average Method 1,443
Comment
The cost of ending inventory is higher under the moving average method (perpetual
inventory system) because the entire purchase of June 11 (last purchase, and highest unit
cost of all purchases) is included in the ending inventory.
Gross Profit
P8-6, Req. 1: FIFO, periodic system $1,366
P3, Req. 1: FIFO, perpetual system 1,366
Comment
FIFO (periodic) will always show the same gross profit as obtained under FIFO (perpetual).
This is because both approaches determine the amounts for ending inventory and cost of
sales in (effectively) the same way.
8-65
P3 (continued)
Comparison of answers for Req. 3 in P8-6 and P3
Gross profit would be higher under LIFO (perpetual) than under LIFO (periodic). This is
because under LIFO (perpetual) a portion of the cost of sales expense includes 300 units from
beginning inventory (lowest unit cost), whereas under LIFO (periodic) these same 300 units
(that are included in cost of sales) are based on later purchases (higher unit cost).
CASES AND PROJECTS
CP1
Req. 1
The note does not state that the company also adopted LIFO for tax purposes, but it is
reasonable to assume that this change was also made on their tax return (LIFO is permitted
for tax purposes in the United States). The reduction in profit would also mean a reduction
in income taxes payable.
Req. 2
The after-tax effect was to reduce profit by $16 million. Since the company is in the 34%
tax bracket, this means that the decrease in pretax profit was approximately $24 million.
Thus, ending inventory was decreased by approximately $24 million and cost of sales was
increased by $24 million. This resulted in a decrease in tax expense of approximately $8
million and a decrease in profit of $16 million.
This $8 million tax postponement is significant and is likely to be the main reason that
management adopted LIFO. A decrease in profit is normally a negative sign to analysts,
since it normally implies a decline in future cash flows. In this case, however, the change
had a positive cash flow effect (if the assumption discussed above is correct). Most analysts
would look favorably on a change, the only effect of which is to provide the company with
an additional $8 million in cash in the short-term.
8-66

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Chapter 8

Reporting and Interpreting Cost of Sales and

In contrast, the perpetual inventory system involves maintaining a continuous

9. The specific identification method of inventory costing is subject to manipulation

Authors' Recommended Solution Time

Alternate Cases and

E = Easy M = Moderate D = Difficult

Inventory (+A)........................................................................................ 2,500

Cost: $2,180 + $175 + $145 = $2,500.

Item Amount Explanation

Ending inventory (physical count on $50,000 Per physical inventory

b. Samples out on trial to customer + 400 Samples held by a customer on trial

c. Goods in transit to customer Goods shipped to customers, F.O.B.

(Underscore for missing amounts only.)

Case A Case B Case C

Sales revenue ............................................................... $ 8,000 $6,000 $ 6,195

Computations (in millions):

Purchases: Simply rearrange the basic inventory model (BI + P – EI = COS):

Cost of sales (see above).......................................... $8,809

Profit for 2011 will be overstated. An understatement of purchases produces an

BI + P - EI = COS; both P and COS are understated

Profit for 2012 will be understated. An overstatement of purchases produces an

BI + P - EI = COS; both P and COS are overstated

CASE A: Perpetual inventory system:

April 9 Inventory (+A) (15 units at $20).............................................................300

Cost of sales (+E  -SE)...............................................................................900

CASE B: Periodic inventory system:

April 9 Purchases (+T) (15 units at $20)............................................................300

September 2 Trade receivables (+A).................................................................................

End of year 2,300

Calculation of cost of sales:

The incorrect accounts can be summarized as follows:

Beginning inventory correct overstated

Sales revenue............................................................ $11,000 $18,000

*Ending inventory computations:

Average: $83,000 ÷ 10,000 units = $8.30 per unit

Sales revenue1................................................................ $330,000 $330,000

Beginning inventory 3,000 $12 $ 36,000

Case B Weighted Average:

Req. 2 (See Requirement 1 for figures)

Ending Inventory 114,000 103,500

b. Purchases (+T) (9,000 x $10)................................................................... 90,000

c. Trade receivables (+A) ................................................................................ 150,000

d. Purchases (+T) (8,000 x $13)................................................................... 104,000

e. Trade receivables (+A) ................................................................................ 180,000

f. Operating expenses (+E  –SE).............................................................. 85,000

Dec.31 Cost of sales (+E  –SE).............................................................................. 230,000

Sales revenue1............................................. $786,000 $786,000

Expenses ................................................ 500,000 500,000

Pretax profit ................................................ $ 59,000 $ 45,080

Units Unit Cost Total Cost

Beginning inventory 7,000 $8 $ 56,000

Case B – Weighted Average:

Ending Inventory 88,000 74,080

b. Inventory (+A) (19,000 x $9).................................................................... 171,000

c. Trade receivables (+A) ................................................................................ 290,000

d. Inventory (+A) (8,000 x $11).................................................................... 88,000

e. Trade receivables (+A) ................................................................................ 496,000

f. Operating expenses (+E  –SE).............................................................. 500,000