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 / FIFO
Beginning 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 SaleAvailable 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.