ACCT 220
SOLUTIONS – CHAPTER 6
2.Inventory items have two common characteristics: (1) they are owned by the company and (2) they are intended to be sold to customers in the ordinary course of business.
11.Plato Company is using the FIFO method of inventory costing, and York Company is using the LIFO method. Under FIFO, the latest goods purchased remain in inventory. Thus, the inventory on the balance sheet should be close to current costs. The reverse is true of the LIFO method. Plato Company will have the higher gross profit because cost of goods sold will include a higher proportion of goods purchased at earlier (lower) costs.
18.An inventory turnover ratio that is too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory outages may also cause customer ill will and result in lost future sales.
*22.(a) Petra Company’s 2003 net income will be understated $5,000; (b) 2004 net income will be overstated $5,000; and (c) the combined net income for the two years will be correct.
BRIEF EXERCISE 6-5
Cost of goods sold under:
LIFO / FIFOBeginning inventory / $6 × 100 / $6 × 100
Purchases / $7 × 200 / $7 × 200
$8 × 150 / $8 × 150
Cost of goods available for sale / $ 3,200 / $ 3,200
Less: Ending inventory / $ 1,300 / $ 1,550
Cost of goods sold / $ 1,900 / $ 1,650
Since the cost of goods sold is $250 less under FIFO ($1,900 – $1,650) that is the amount of the phantom profit. It is referred to as “phantom profit” because, FIFO matches current selling prices with old inventory costs. To replace the units sold the company will have to pay the current price of $8 per unit, rather than the $6 per unit which some of the units were priced at under FIFO. Therefore, profit under LIFO is more representative of what the company can expect to earn in future periods.
EXERCISE 6-5
(a)(1) FIFO
Beginning inventory (200 × $5)...... $1,000
Purchases
June 12 (300 × $6)...... $1,800
June 23 (500 × $7)...... 3,500 5,300
Cost of goods available for sale...... 6,300
Less: Ending inventory (160 × $7)...... 1,120
Cost of goods sold...... $5,180
(2) LIFO
Cost of goods available for sale...... $6,300
Less: Ending inventory (160 × $5)...... 800
Cost of goods sold...... $5,500
(3) AVERAGE COST
Cost of GoodsTotal UnitsWeighted Average
Available for SaleAvailable for Sale=Unit Cost
$6,3001,000$6.30
Ending inventory (160 × $6.30) $1,008
Cost of goods sold (840 × $6.30) $5,292
or $6,300 – $1,008 = $5,292
(b)The FIFO method will produce the highest ending inventory because costs have been rising. Under this method, the earliest costs are assigned to cost of goods sold, and the latest costs remain in ending inventory. The LIFO method will produce the highest cost of goods sold for Newport Company. Under LIFO the most recent costs are charged to cost of goods sold and the earliest costs are included in the ending inventory.
(a)The average cost ending inventory ($1,008) is higher than LIFO ($800) but lower than FIFO ($1,120). For cost of goods sold, average cost ($5,292) is higher than FIFO ($5,180) but lower than LIFO ($5,500).
(b)The simple average would be (($5 + $6 + $7)/3) = $6. However, the average cost method uses a weighted average unit cost, not a simple average of unit costs.
PROBLEM 6-3A(a)COST OF GOODS AVAILABLE FOR SALE
Date ExplanationUnitsUnit CostTotal Cost
Jan. 1Beginning inventory100$20$ 2,000
Mar.15Purchase300247,200
July20Purchase200255,000
Sept.4Purchase300288,400
Dec.2Purchase 10030 3,000
Total1,000$25,600
(b)FIFO
Ending InventoryCost of Goods Sold
UnitTotalCost of goods
DateUnitsCostCost available for sale$25,600
Sept.450$ 28$1,400Less: Ending
Dec.210030 3,000 inventory 4,400
150*$4,400Cost of goods sold$21,200
*1,000 – 850 = 150
Proof of Cost of Goods Sold
UnitTotal
DateUnitsCostCost
Jan. 1100$ 20$ 2,000
Mar.15300247,200
July20200255,000
Sept.425028 7,000
850$21,200
PROBLEM 6-3A (Continued)
AVERAGE COST
Ending InventoryCost of Goods Sold
Cost of goods
$25,600 ÷ 1,000 = $25.60 available for sale$25,600
Less: Ending
UnitTotal inventory 3,840
UnitsCostCostCost of goods sold$21,760
150$25.60$3,840
Proof of Cost of Goods Sold
UnitTotal
UnitsCostCost
850$25.60$21,760
LIFO
Ending InventoryCost of Goods Sold
UnitTotalCost of goods
DateUnitsCostCost available for sale$25,600
Jan. 1 100$ 20$2,000Less: Ending
Mar. 15 5024 1,200 inventory 3,200
150$3,200Cost of goods sold$22,400
Proof of Cost of Goods Sold
UnitTotal
DateUnitsCostCost
Mar.15250$ 24$ 6,000
July20200255,000
Sept.4300288,400
Dec.210030 3,000
850$22,400
(c)FIFO produces the highest cost for the balance sheet $4,400. LIFO produces the highest cost of goods sold for the income statement $22,400.