Chapter 7

Solutions

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.


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

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.

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


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


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:
    General Journal. Loss due decline in inventory value 28 under debit. Inventory 28 under credit.

  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:
    General Journals. Loss due to decline in inventory value 14 under debit. Inventory 14 under credit.


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)

Exercise 7.8

  1. General journal. Inventory 82,000 under debit. Cost of goods sold 82,000 under credit.

    General journal. Inventory 4,000 under debit. Cost of goods sold 2,000 under debit. Accounts payable 6,000 under credit.

     

    General Jounral. Inventory 27,000 under debit. Cost of good sold 27,000 under credit.

     

    General Journal. Inventory 2,000 under debit; Cost of good sold 2,000 under credit; sales returns and allowances 3,500 under debit; Accounts receivable 3,500 under credit.

  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.

Exercise 7.9

Inventory on January 1

Purchases (net of returns)

Goods available for sale

Sales

Less gross profit (35% × $955,000)

Estimated cost of goods sold

Estimated inventory on March 4

Less undamaged goods (90,000 × (1 − 0.35))

Inventory damaged by fire

 

 

 

$955,000

334,250

$ 275,000

634,000

909,000

 

 

620,750

288,250

(58,500)

$ 229,750


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.


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)

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

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)

Exercise 7.14

1. Ending inventory overstated

1. Working capital Overstated by $5,300
2. Current ratio Overstated
3. Retained earnings Overstated by $5,300
4. Net income Overstated by $5,300

2. Purchase not recorded

1. Working capital No effect
2. Current ratio Overstated
3. Retained earnings No effect
4. Net income No effect

3. Ending inventory and purchases understated

1. Working capital Overstated by $3,890
2. Current ratio Overstated
3. Retained earnings Overstated by $3,890
4. Net income Overstated by $3,890

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