ACCY112 Spring 2013-Week 5

9.

Questions: DQ19.9; EQ19.1; EQ19.3; EQ19.11; EQ19.12; PQ19.1 If the ending inventory is understated because of an error, what is the effect on profit in that reporting year and in the next reporting year? What is the effect on the value of assets as reported in the statement of financial position at the end of each year? If ending inventory is understated, cost of sales in that reporting year will be overstated and hence, profits will be understated. This is so because cost of sales is calculated basically by the formula: Cost of sales = Beginning inventory + Net cost of purchases Ending inventory In the balance sheet/statement of financial position, if inventory is understated at the end of the year, then obviously total assets are also understated. In the next year, assuming no additional errors, and assuming that the inventory is fully sold, there will be no error in the inventory balance at the end of that year.

Exercise 19 .1

Determining ending inventory

EMERALD LTD

Required: A. For each point, determine the effects on Emerald Ltds 31 December account balances. B. What is the correct ending inventory? A. Account Purchases Sales Inventory stock-take -$1 200 +$4 500 No Change +$6 400 -$6 100 No Change +$800 Inventory (Balance) $55 200 Dr $59 700 Dr $59 700 Dr $66 100 Dr $60 000 Dr $60 000 Dr $60 800 Dr

1. 2. 3. 4. 5. 6.

Purchases Purchases Inventory Inventory Purchases Sales

No change -$2 000 +$5 500 -

Effect on account balances: Purchases increased $3 500 Sales decreased $1 200 Inventory increased $5 600 B. The correct ending inventory is $60 800.

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Exercise 19.3

Lower of cost and net realisable value

SLACK LTD

Required: A. Determine the ending inventory value at 30 June 2013, applying the lower of cost and net realisable value rule to the individual items. B. What effect did application of the rule rather than cost have on the financial statements of the company? A. Inventory Item 3011 2507 601 4500 2825 Units on Hand Cost per Unit $3.00 7.00 30.00 3.50 6.00 Total Cost Net Realisable Value per Unit $2.60 8.50 27.00 2.50 7.00 LC and NRV of Individual Items $182.00 210.00 486.00 130.00 270.00 $1 278.00

70 30 18 52 45

$210.00 210.00 540.00 182.00 270.00 $1 412.00

B.

Profit is reduced by $134 ($1 412 - $1 278). In the balance sheet/statement of financial position, inventory, total assets and equity are all reduced by $134. Effects of inventory errors ORFF BROS.

Exercise 19.11

Required: A. Determine the correct amount of profit for each of the 3 years. B. Determine the total profit for the 3-year period as shown and as corrected. A. 2013 Net sales Beginning inventory Net purchases Goods available for sale Ending inventory Cost of sales Gross profit Other expenses Profit $68 000 16 000 30 000 46 000 16 000 30 000 38 000 16 000 $22 000 2014 $78 000 16 000 36 000 52 000 14 000 38 000 40 000 14 000 $26 000 2015 $70 000 14 000 22 000 36 000 12 000 24 000 46 000 19 000 $27 000

B.

Total profit as originally shown: $20 000 + $34 000 + 21 000 = $75 000 Corrected total profit as per A. $22 000 + $26 000 + $27 000 = $75 000 Total profit for the three years remains the same. Inventory errors are eliminated over time. Page 2 of 6

CLOSED LTD Required: A. Calculate estimated cost of the inventory at 30 April 2013 using the retail inventory method. B. What key assumptions underlie the validity of this estimate of inventory cost? A. Cost Inventory, 1 April 2013 Net purchases Total merchandise available Cost-to-retail percentage: $316 000/$494 000 = 64% Less: Sales during period Estimated ending inventory at retail prices Applicable cost percentage Estimated ending inventory at cost, 30 April $100 000 216 000 316 000 Selling Price $170 000 324 000 494 000

Exercise 19.12 Part A

Retail inventory and gross profit methods

390 000 $104 000 64% $66 560

B. Part B

The accuracy of the retail method depends upon the assumption that the ending inventory contains the same relative proportions of goods at various mark-ups as the goods available for sale. DOLLY LTD

Required: Determine the amount of Dolly Ltds claim for the inventory loss. Beginning inventory Net purchases Cost of goods available for sale Net sales Estimated gross profit (40%) Estimated cost of sales Estimated inventory lost by fire $320 000 904 800 1 224 800 613 200 $611 600

$1 022 000 (408 800)

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Problem 19.1

Inventory cost flow methods periodic inventory system MOVEIT LTD

Required: A. Prepare an income statement down to gross profit for December, using each of the following costing methods: 1. specific identification, assuming that 400 units were sold from the beginning inventory, 400 units were sold from the first purchase, 200 units were sold from the 15 December purchase, and the remainder from the 23 December purchase. 2. FIFO 3. LIFO 4. weighted average. B. Which cost flow method(s) resulted in the highest gross profit on sales? the highest ending inventory? Explain your results. C. Prepare an income statement down to gross profit for December, using the FIFO and LIFO costing methods and assuming that the 23 December purchase had been delayed until January. D. The management of Moveit Ltd expects the unit cost to increase to $3.85 excluding GST early in the next period. In anticipation of the price increase, a purchase of 600 additional units was made on 29 December at a unit cost of $3.60 excluding GST. Prepare an income statement down to gross profit for December, using the FIFO and LIFO costing methods. E. Compare your results obtained in requirements A, C and D. Explain why your results are or are not the same. A.1. Specific Identification Cost of sales 400 units @ $3.00 400 units @ $3.15 200 units @ $3.30 300 units @ $3.50 1 300 units Ending inventory 300 units @ $3.00 100 units @ $3.15 100 units @ $3.30 200 units @ $3.50 700 units 2. FIFO: Goods available (per question) Ending inventory (700 units): 500 units @ $3.50 200 units @ $3.30 Cost of sales Units 2 000 (500) (200) 1 300 $6 415 (1 750) (660) $4 005

$1 200 1 260 660 1 050 $4 170

$900 315 330 700 $2 245

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3.

LIFO: Goods available Ending inventory (700 units): 700 @ $3.00 Cost of sales Units 2 000 (700) 1 300 $6 415 (2 100) $4 315

4.

Weighted average: Units Beginning inventory 10/12 Purchase 15/12 Purchase 23/12 Purchase Goods available $6 415 2 000 = $3.21 per unit (rounded) Goods available Ending inventory Cost of sales (rounded) 700 500 300 500 2 000 Unit Cost $3.00 $3.15 $3.30 $3.50 Amount $2 100 1 575 990 1 750 $6 415

2 000 (700) 1 300

$3.21 $3.21

$6 415 (2 247) $4 168

Income Statement Spec. Ident. Sales Beginning inventory Purchases Goods available for sale Ending inventory Cost of sales Gross profit $5 525 2 100 4 315 6 415 2 245 4 170 1 355 FIFO $5 525 2 100 4 315 6 415 2 410 4 005 1 520 LIFO $5 525 2 100 4 315 6 415 2 100 4 315 1 210 Wted Av. $5 525 2 100 4 315 6 415 2 247 4 168 1 357

B.

The highest gross profit was reported using FIFO. FIFO also reported the highest ending inventory balance since it is valued at the most recent higher prices. This is a result of the direct relationship between inventory values and profit. The higher the value placed on ending inventory, the higher the reported gross profit.

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C.

Income Statement FIFO Sales Beginning inventory Purchases Goods available for sale Ending inventory (200 units) Cost of sales Gross profit $5 525 2 100 2 565 4 665 660 4 005 $1 520 LIFO $5 525 2 100 2 565 4 665 600 4 065 $1 460

D.

Income Statement FIFO Sales Beginning inventory Purchases Goods available for sale Ending inventory (1300 units) Cost of sales Gross profit $5 525 2 100 6 475 8 575 *4 570 4 005 $1 520 LIFO $5 525 2 100 6 475 8 575 **4 005 4 570 $955

* FIFO 200 @ 3.30 = $ 660 500 @ 3.50 = 1 750 600 @ 3.60 = 2 160 $4 570

**LIFO 700 @ 3.00 = $2 100 500 @ 3.15 = 1 575 100 @ 3.30 = 330 $3 870

E.

FIFO reported the same cost of sales and gross profit in all cases. This is because the increases and decreases in ending inventory were offset by the same increases and decreases in purchases. LIFO reported three different cost of sales and gross profit results. This is shows that ending inventory and cost of sales valuations can be altered (manipulated) by recent purchases or non-purchases using LIFO assumptions.

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