Business School

ACCT1501 Accounting and Financial Management 1A

Session 2 2015

TUTORIAL WEEK 9 Solutions to Preparation Questions

Preparation Questions:
Inventory: DQ 9.1, 9.7, 9.16, P9.1, P9.2, P9.6
Non-current assets: DQ 10.5, 10.14, 10.16, P10.2, 10.4, P10.15
CHAPTER 9 [Inventory]
DQ9.1
The periodic inventory system is a method of calculating inventory that uses data on
beginning inventory, additions to inventory, and an end-of-period count to deduce the cost of
goods sold. No records are maintained for individual inventory items.
By contrast, the perpetual inventory system is a method of controlling inventory that
maintains continuous records on the flow of units of inventory.
DQ9.7
The term inventory cost flow assumption is the assumption made about the order in
which units of inventory move into and out of a business. It is used to compute inventory
asset values and cost of goods sold expense based on assumptions about the flow inventory.
Examples are first in first out, weighted average and last in first out.
DQ9.16
During periods of rising prices, weighted average results in reporting a higher cost of
goods sold and lower net profit than the FIFO method. Both methods are permitted for
accounting and income tax purposes. Weighted average tends to result in lower income tax
and you should be happy if you think the resulting tax saving is a good idea. If the market for
the companys shares is efficient, enough other shareholders will think the tax saving is a
good idea and so the price of the companys shares will go up.
If the lower profit had negative effects, for example risking violation of debt
arrangements, the stock market might not react positively to the change. Similarly if the
reduction in net profit prevented the company from paying its regular and expected dividend,
you would react negatively.

Problem 9.1
1. Cost
of
goods
sold
= 865 000 @ $5 = $4 325 000

under

perpetual

inventory

system

2. Cost of goods sold under periodic inventory method:

$
Inventory at beginning
500 000
Add: Purchases
4 250 000
4 750 000
Deduct: Inventory at end
350 000
Cost of goods sold
$4 400 000
3 In this case, the comparison of #1 and #2 shows that Razzmatazz has an inventory shortage:
COGS should be $4 325 000 but based on the ending inventory count it would be deduced to
be $4 400 000. The latter figure includes $75 000 of unexplained shortage. On a per-unit
basis, only 865 000 units were sold, but 880 000 are gone: those 15 000 units represent lost
income of $11.00 $5.00 = $6.00 each, for a total lost income of $90 000.
So it appears that Razzmatazz needs better control over its inventory. Whether a perpetual
inventory system is the answer, or rather just better physical control to stop theft or losses of
units, is not clear from the sparse data. A perpetual system does not prevent loss, as we can
see here, because such a system is being used and there are still losses, but it does identify
loss, and management may feel that information (and the threat of discovery to anyone
tempted to steal) is worth the cost. Such cost may be relatively high (fairly small-value items
and fairly large volume), but the losses are fairly high too.
Problem 9.2
1.
Frog Ltd
General journal
a. Perpetual
inventory

$
Inventory
Accounts payable
Credit purchases during the period

120 000

Accounts receivable
Sales revenue
Sales on credit during the period

210 000

Cost of goods sold expense

Inventory
Cost of goods sold expense: 50% mark-up 210
000 x 100/150 = $120 000

140 000

Inventory shortage expense

Inventory
Shortage: record indicates inventory should be
$40 000 + $120 000 $140 000 = $20 000 but
only $19 800 is on hand

200

Operating expenses

$
120 000

210 000

140 000

200

35 000

Cash
Expenses paid in cash

35 000

Profit and loss summary

Cost of goods sold expense
Inventory shortage expense
Operating expenses
Closing entry

175 200

Sales revenue
Profit and loss summary
Closing entry

210 000

Profit and loss summary

Retained profits
Transfer of net profit

140 000
200
35 000

210 000
34 800
34 800

Frog Ltd
General journal
b Periodic inventory
Purchase expense
Accounts payable
Credit purchases during the period
Accounts receivable
Sales revenue
Sales on credit during the period
Operating expenses
Cash
Expenses paid in cash

$
120 000

120 000
210 000
210 000
35 000
35 000

Profit and loss summary

Purchase expense
Operating expenses
Inventory (1 July 2011)
Closing entry

195 000

Inventory (30 June 2012)

Sales revenue
Profit and loss summary
Closing entry

19 800
210 000

Profit and loss summary

Retained profits
Transfer of net profit

120 000
35 000
40 000

229 800
34 800
34 800

2. a. Perpetual inventory
Frog Ltd
Income Statement for year ended 30 June 2012
$
Sales
Less:

Cost of goods sold

Inventory shortage
Gross profit
Less: Operating expenses
Net profit

140 000
200

$
210 000
140 200
69 800
35 000
34 800

b. Periodic inventory
Frog Ltd
Income Statement for year ended 30 June 2012
$
Sales
Less:

Cost of goods sold

Inventory 1 July 2011
Purchases
Available for sale
Less: Inventory 30 June 2012
Cost of goods sold
Gross profit
Less: Operating expenses
Net profit

$
210 000

40 000
120 000
160 000
19 800
140 200
69 800
35 000
34 800

Problem 9.6
1. a. Perpetual FIFO
COGS = 60 x $5 + (50 x $5 + 70 x $6) + (10 x $6 + 80 x $7) = $1590
Closing inventory = 30 x $7 + 100 x $8 = $1010
b. Perpetual LIFO
COGS = 60 x $6 + (110 x $7 + 10 x $6) + 90 x $8 = $1910
Closing inventory = 110 x $5 + 10 x $6 + 10 x $8 = $690
2 Only Closing inventory is adjusted the net realisable value is designed to prevent
companies overstating their asset values. Therefore under both FIFO and LIFO, Closing
inventory should be $650 (130 x $5). FIFO Closing inventory should be reduced by $360,
LIFO by $40.

CHAPTER 10 [Non-current assets]

DQ10.5
The following methods of depreciation are available:
i. straight-line;
ii. reducing balance
iii. units-of-production
With the straight-line method, depreciation expense is the same each year of the assets
useful life so profit is reduced by the same amount each year.
4

With the reducing balance method expense is larger in the earlier years than in the later years
so profit is reduced by larger amounts in the early years of the assets life.
With the units-of-production method the expense depends on each years volume of
production, so the reduction in profit varies according to the amount of production achieved.
DQ10.14
You may get some idea as to the age of the assets, how worn-out they are, and whether many of
the assets will need to be replaced soon. It is possible to have a better understanding of changes
in the productive capacity of the firm. (Depreciable) assets are usually much more important to
the company, and in evaluating it, than are things like prepaid expenses.
DQ10.16
Depreciation has been defined as a process whereby the decline in service potential of
an asset through wear, tear and obsolescence is progressively brought to account as a periodic
charge against revenue.
In each period in which the asset is used to generate revenue, a portion of its cost is
matched against that revenue, i.e., it is treated as depreciation expense. Cost is taken as the
basis of depreciation numbers on the assumption that the acquisition cost of an asset reflects its
value at the time of acquisition.
Depreciation, as well as being an allocation of cost over the useful life of the asset, also
reflects the decline in the value (= service potential) of the asset over its useful life. Value
here implies value-in-use, i.e., the asset will be used in the ongoing operations of the entity
viewed as a going concern, i.e., one, which is expected to continue its operations into the
future. According to this view, if an asset is acquired to be used its exchange value (market
selling price) is irrelevant by definition the asset was not acquired to be re-sold.
Also, until the asset is sold then there is no transaction that can provide objective
information as to its exchange value. On the other hand, the residual value of the asset is not
depreciated. By definition, residual value refers to the value of the asset at the end of its
useful life. At this stage the asset will be disposed of and its carrying amount is matched against
any revenue from disposal. At this point it is its value in exchange rather than value in use
which is relevant; so that it is appropriate that some portion of the cost of the asset remain
unallocated so that it can be matched against revenue from disposal (if any).
Problem 10.2
1 a. Van $20,000 + $5,000 + $1,000 = $26,000 (Costs of making ready for use).
b. Cost not market value, i.e. $3,200
2 a. $26,000
(26,000 800) 4
= $6,300.
b. Rollers will last for 2 years.
Year 1, 9/12 x 50% x 3,200
= 1,200.
c. Three year licence but purchased on 1 February, therefore 11/36 amortisation
$1,375 is the amortisation expense.
3. Property, Plant and Equipment
Property, Plant and Equipment
Intangible Assets
5

Problem 10.4
1.
Total cost of the asset
2.
3.

= $1,000,000 + $7,500+ $18,000

= $1,025,500
Depreciation expense
= $1,025,500/10
= $102,550
Accumulated depreciation = $102,550*2
= $205,100

Problem 10.15
Machine 1
Dr Cash
Dr Accumulated Depreciation
Dr Loss on Sale
Cr Machine

10,000
15,000
15,000
40,000

Machine 2
Dr Cash
Dr Accounts Receivable
Dr Loss on Sale
Cr Machine

20,000
10,000
32,500
62,500

Machine 3
Dr Machine Write-off
Cr Machine

100,000
100,000