Chapter 7

Exercise 7.1

Inventory would normally include the following items:

• Salaries of assembly line workers
• Raw materials
• Salary of factory foreman
• Heating cost for the factory
• Miscellaneous supplies used in production process
• Costs to ship raw materials from the supplier to the factory
• Electricity cost for the factory
• Depreciation of factory machines
• Property taxes on factory building
• Discounts for early payment of raw material purchases
• Salaries of the factory’s janitorial staff

All of these costs can be considered either direct costs or attributable overhead costs. The CEO’s and sales team salaries would not be considered costs directly attributable to the purchase and conversion of inventory.

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Exercise 7.2

	FOB Shipping	FOB Destination
Owns the goods while in transit	P	S
Is responsible for the loss if goods are damaged in transit	P	S
Pays for the shipping costs	P	S

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Exercise 7.3

1. The company would allocate $150,000 of overhead at the rate of $150,000 ÷ 105,000 = $1.4286 per unit. As a practical matter, the company may choose to simply allocate based on the standard rate of $1.50 per unit and record a small overhead recovery through cost of sales. This would be reasonable as the volume produced is close to the standard volume used to determine the rate.
2. The company would allocate $45,000 of overhead, using the standard rate of $1.50 per unit. The remaining overhead would need to be expensed. This is necessary to avoid over-valuing the inventory.
3. The company would allocate $150,000 of overhead at the rate of $150,000 ÷ 160,000 = $0.9375 per unit. The standard rate cannot be used here, as it would over-absorb the overhead cost into inventory.

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Exercise 7.4

Date	Purchase	Sale	Balance	Balance of Units
May 1			8 × $550.00 = $4,400	8
May 5	50 × $560.00		(8 × $550.00) + (50 × $560.00) = $32,400	58
May 8	10 × $575.00		(8 × $550.00) + (50 × $560.00) + (10 × $575.00) = $38,150	68
May 15		(8 × $550.00) + (7 × $560.00) = $8,320	(43 × $560.00) + (10 × $575.00) = $29,830	53
May 22	12 × $572.00		(43 × $560.00) + (10 × $575.00) + (12 × $572) = $36,694	65
May 25		(23 × $560.00) = $12,880	(20 × $560.00) + (10 × $575.00) + (12 × $572) = $23,814	42

Cost of Goods Sold for May = (8,320 + 12,880) = $21,200

Ending Inventory on May 31 = $23,814

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Exercise 7.5

Date	Purchase	Sale	Balance	Average Cost	Balance of Units
May 1			8 × $550.00 = $4,400		8
May 5	50 × $560.00		(8 × $550.00) + (50 × $560.00) = $32,400		58
May 8	10 × $575.00		(8 × $550.00) + (50 × $560.00) + (10 × $575.00) = $38,150	$561.03	68
May 15		15 × ($38,150 ÷ 68) = $8,415.45	(53 × $561.03)  = $29,734.55	$561.03	53
May 22	12 × $572.00		(53 × $561.03) + (12 × $572) = $36,598.55	$563.05	65
May 25		23 × ($36,598.55 ÷ 65) = $12,950.15	(42 × $563.05)  = $23,648.40	$563.05	42

Cost of Goods Sold for May = (8,415.45 + 12,950.15) = $21,365.60

Ending Inventory on May 31 = $23,648.40

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Exercise 7.6

1. No grouping
   

   Description	Category	Cost ($)	Selling Price	LCNRV
   Brake pad #1	Brake pads	159	140	140
   Brake pad #2	Brake pads	175	180	175
   Total brake pads		334	320	315
   Soft tire	Tires	325	337	325
   Hard tire	Tires	312	303	303
   Total tires		637	640	628

   Total LCNRV = (315 + 628) = 943

   Current carrying value = ($334 + 637) = 971

   Adjustment required = (943 − 971) = (28)

   Journal entry required:
   

2. With grouping
   

   Description	Category	Cost ($)	Selling Price	LCNRV
   Brake pad #1	Brake pads	159	140
   Brake pad #2	Brake pads	175	180
   Total brake pads		334	320	320
   Soft tire	Tires	325	337
   Hard tire	Tires	312	303
   Total tires		637	640	637

   Only the brake pad category needs to be written down.

   Total adjustment required = (320 − 334) = 14

   Journal entry required:
   

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Exercise 7.7

NOTE: Positive amounts represent overstatements and negative amounts represent understatements.

Item	Inventory	A/R	A/P	Net Income
A	(82,000)	–		(82,000)
B	(4,000)	–	(6,000)	2,000
C	(27,000)	–	–	(27,000)
D	(2,000)	3,500	–	1,500
Total	(115,000)	3,500	(6,000)	(105,500)

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Exercise 7.8

1. 

   

    

   

    

   

2. The journal entries would be the same, except any income statement accounts (cost of goods sold and sales returns) would be replaced with an adjustment to retained earnings.

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Exercise 7.9

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Exercise 7.10

Gross profit margin, by year:

2020: 3,058 ÷ 20,722 = 14.76%

2019: 2,831 ÷ 13,972 = 20.26%

The company’s sales increased significantly between 2019 and 2020. This appears to be a positive result. The company’s gross profit also increased. However, the gross profit margin decreased by 5.5%, which represents potential loss profits of approximately $1.1 billion on the current sales volume. To investigate further, one should look at budgets and other management plans, as well as industry averages and competitor information. It would also be useful to look at longer trends to see if this decline in profitability is unique to this year or the sign of a longer term trend. Management explanations of the declining margin percentage, contained in the annual report, should also be evaluated to determine if the causes relate to slashing sales prices to increase volumes, increasing cost structures, or some combination of the two. Other macroeconomic data may also be useful in explaining the change.

Inventory Turnover Period, by year:

2020: [(2,982 + 1,564) ÷ 2 ÷ 17,164] × 365 = 48.34 days

2019: [(1,564 + 1,239) ÷ 2 ÷ 11,141] × 365 = 45.91 days

Inventory turnover has slowed from the previous year, indicating that goods are being held longer. This is also indicated by the build up of inventory over the three year period. Although the increased inventory may be reasonable as sales increase, the increase in the turnover period could create cash flow problems if the trend continues. Again, other comparative data is needed, such as budgets and industry averages, to evaluate the meaning of this result.

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Exercise 7.11

Item	Cost	Selling Price	Disposal Costs	NRV(1)	LCNRV
DWE223	$1,950	$2,230	$99	$2,131	$1,950
CWQ103	5,120	4,960	112	4,848	4,848
BMA112	4,280	4,615	225	4,390	4,280
AAW102	3,965	4,430	91	4,339	3,965
	$15,315				$15,043
NRV(1) = net realizable value (selling price - disposal costs)

Adjustment needed for inventory:

Cost	$15,315
LCNRV	$15,043
decrease:	$272
Loss due to decline in inventory value		272
Inventory			272
***NOTE - cost of goods sold can be used (direct write off)

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Exercise 7.12

Dec 31, Y5	Loss on Purcahse Contract		399,300
		Liability for Onerous Contract		399,300
	the decrease in value should be recorded ($3,456,900 - $3,057,600)
Y6 - possession	Purchases		3,057,600
	Liability for Onerous Contract		399,300
		Accounts Payable		3,456,900
	In Y6 - when the contract is satisfied and Highbury takes possession of the items the amount of the agreed upon liability has to be recorded.
	However, the items are only worth $3,057,600 which is the current, market value.
	With IFRS, we only record potential losses, not gains (Conservatism).
Y6 - payment	Accounts Payable		3,456,900
		Cash		3,456,900

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Exercise 7.13

1. Gross margin method

Beginning inventory (at cost)		135,460
Purchases (at cost)		2,569,840
Goods available for sale		2,705,300
Sales (actual @ selling price)	3,156,900
Less Gross profit (30% of sales)	947,070
Sales (at cost)		2,209,830
Estimated ending inventory		$495,470

2. Determine the markup – to estimate inventory

First, gross profit as a percent of sales must be calculated
30% (100% + 30%)	23.08%
Beginning inventory (at cost)			135,460
Purchases (at cost)			2,569,840
Goods available for sale			2,705,300
Sales (actual @ selling price)		3,156,900
Less Gross profit (23.08% of sales)		728,515
Sales (at cost)			2,428,385
Estimated ending inventory			$276,915
If cost of sales =	2,428,385
30% markup =	728,515	(cost of sales × 30% = $2,428,385 × 30%)
Sales (actual @ selling price)	3,156,900
Or - $3,156,900 / 1.30	2,428,385	(is the cost)

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Exercise 7.14

1. Ending inventory overstated

2. Purchase not recorded

3. Ending inventory and purchases understated