# 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
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
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:

### 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.

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)

 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