8 Valuation of Inventories: A Cost-Basis Approach CONCEPTS FOR ANALYSIS 8
CONCEPTS FOR ANALYSIS
CA8-1 (Inventoriable Goods and Costs) You are asked to travel to Milwaukee to observe and verify the inventory of the Milwaukee branch of one of your clients. You arrive on Thursday, December 30, and find that the inventory procedures have just been started. You spot a railway car on the sidetrack at the unloading door and ask the warehouse superintendent, Buck Rogers, how he plans to inventory the contents of the car. He responds, “We are not going to include the contents in the inventory.”
Later in the day, you ask the bookkeeper for the invoice on the carload and the related freight bill. The invoice lists the various items, prices, and extensions of the goods in the car. You note that the carload was shipped December 24 from Albuquerque, f.o.b. Albuquerque, and that the total invoice price of the goods in the car was $35,300. The freight bill called for a payment of $1,500. Terms were net 30 days. The bookkeeper affirms the fact that this invoice is to be held for recording in January.
Instructions
(a) Does your client have a liability that should be recorded at December 31? Discuss.
(b) Prepare a journal entry(ies), if required, to reflect any accounting adjustment required. Assume a perpetual inventory system is used by your client.
(c) For what possible reason(s) might your client wish to postpone recording the transaction?
CA8-2 (Inventoriable Goods and Costs) Clay Mattews, an inventory control specialist, is interested in better understanding the accounting for inventories. Although Clay understands the more sophisticated computer inventory control systems, he has little knowledge of how inventory cost is determined. In studying the records of Strider Enterprises, which sells normal brand-name goods from its own store and on consignment through Chavez Inc., he asks you to answer the following questions.
Instructions
(a) Should Strider Enterprises include in its inventory normal brand-name goods purchased from its suppliers but not yet received if the terms of purchase are f.o.b. shipping point (manufacturer’s plant)? Why?
(b) Should Strider Enterprises include freight-in expenditures as an inventory cost? Why?
(c) If Strider Enterprises purchases its goods on terms 2/10, net 30, should the purchases be recorded gross or net? Why?
(d) What are products on consignment? How should they be reported in the financial statements?
(AICPA adapted)
CA8-3 (Inventoriable Goods and Costs) George Solti, the controller for Garrison Lumber Company, has recently hired you as assistant controller. He wishes to determine your expertise in the area of inventory accounting and therefore asks you to answer the following unrelated questions.
(a) A company is involved in the wholesaling and retailing of automobile tires for foreign cars. Most of the inventory is imported, and it is valued on the company’s records at the actual inventory cost plus freight-in. At year-end, the warehousing costs are prorated over cost of goods sold and ending inventory. Are warehousing costs considered a product cost or a period cost?
(b) A certain portion of a company’s “inventory” is composed of obsolete items. Should obsolete items that are not currently consumed in the production of “goods or services to be available for sale” be classified as part of inventory?
(c) A company purchases airplanes for sale to others. However, until they are sold, the company charters and services the planes. What is the proper way to report these airplanes in the company’s financial statements?
(d) A company wants to buy coal deposits but does not want the financing for the purchase to be reported on its financial statements. The company therefore establishes a trust to acquire the coal deposits. The company agrees to buy the coal over a certain period of time at specified prices. The trust is able to finance the coal purchase and pay off the loan as it is paid by the company for the minerals. How should this transaction be reported?
CA8-4 (Accounting Treatment of Purchase Discounts) Shawnee Corp., a household appliances dealer, purchases its inventories from various suppliers. Shawnee has consistently stated its inventories at FIFO cost.
Instructions
Shawnee is considering alternate methods of accounting for the cash discounts it takes when paying its suppliers promptly.
From a theoretical standpoint, discuss the acceptability of each of the following methods.
(a) Financial income when payments are made.
(b) Reduction of cost of goods sold for the period when payments are made.
(c) Direct reduction of purchase cost.
(AICPA adapted)
CA8-5 (General Inventory Issues) In January 2017, Susquehanna Inc. requested and secured permission from the commissioner of the Internal Revenue Service to compute inventories under the last-in, first-out (LIFO) method and elected to determine inventory cost under the dollar-value LIFO method. Susquehanna Inc. satisfied the commissioner that cost could be accurately determined by use of an index number computed from a representative sample selected from the company’s single inventory pool.
Instructions
(a) Why should inventories be included in (1) a balance sheet and (2) the computation of net income?
(b) The Internal Revenue Code allows some accountable events to be considered differently for income tax reporting purposes and financial accounting purposes, while other accountable events must be reported the same for both purposes.
Discuss why it might be desirable to report some accountable events differently for financial accounting purposes than for income tax reporting purposes.
(c) Discuss the ways and conditions under which the FIFO and LIFO inventory costing methods produce different inventory valuations. Do not discuss procedures for computing inventory cost.
(AICPA adapted)
CA8-6 (LIFO Inventory Advantages) Jane Yoakam, president of Estefan Co., recently read an article that claimed that at least 100 of the country’s largest 500 companies were either adopting or considering adopting the last-in, first-out (LIFO) method for valuing inventories. The article stated that the firms were switching to LIFO to (1) neutralize the effect of inflation in their financial statements,
(2) eliminate inventory profits, and (3) reduce income taxes. Ms. Yoakam wonders if the switch would benefit her company.
Estefan currently uses the first-in, first-out (FIFO) method of inventory valuation in its periodic inventory system. The company has a high inventory turnover rate, and inventories represent a significant proportion of the assets.
Ms. Yoakam has been told that the LIFO system is more costly to operate and will provide little benefit to companies with high turnover. She intends to use the inventory method that is best for the company in the long run rather than selecting a method just because it is the current fad.
Instructions
(a) Explain to Ms. Yoakam what “inventory profits” are and how the LIFO method of inventory valuation could reduce them.
(b) Explain to Ms. Yoakam the conditions that must exist for Estefan Co. to receive tax benefits from a switch to the LIFO method.
CA8-7 WRITING (Average-Cost, FIFO, and LIFO) Prepare a memorandum containing responses to the following items.
(a) Describe the cost flow assumptions used in average-cost, FIFO, and LIFO methods of inventory valuation.
(b) Distinguish between weighted-average-cost and moving-average-cost for inventory costing purposes.
(c) Identify the effects on both the balance sheet and the income statement of using the LIFO method instead of the FIFO method for inventory costing purposes over a substantial time period when purchase prices of inventoriable items are rising. State why these effects take place.
CA8-8 WRITING (LIFO Application and Advantages) Geddes Corporation is a medium-sized manufacturing company with two divisions and three subsidiaries, all located in the United States. The Metallic Division manufactures metal castings for the automotive industry, and the Plastic Division produces small plastic items for electrical products and other uses. The three subsidiaries manufacture various products for other industrial users.
Geddes Corporation plans to change from the lower of first-in, first-out (FIFO)-cost-or market method of inventory valuation to the last-in, first-out (LIFO) method of inventory valuation to obtain tax benefits. To make the method acceptable for tax purposes, the change also will be made for its annual financial statements.
Instructions
(a) Describe the establishment of and subsequent pricing procedures for each of the following LIFO inventory methods.
(1) LIFO applied to units of product when the periodic inventory system is used.
(2) Application of the dollar-value method to LIFO units of product.
(b) Discuss the specific advantages and disadvantages of using the dollar-value LIFO application as compared to specific goods LIFO (unit LIFO). (Ignore income tax considerations.)
(c) Discuss the general advantages and disadvantages claimed for LIFO methods.
CA8-9 WRITING (Dollar-Value LIFO Issues) Arruza Co. is considering switching from the specific-goods LIFO approach to the dollar-value LIFO approach. Because the financial personnel at Arruza know very little about dollar-value LIFO, they ask you to answer the following questions.
(a) What is a LIFO pool?
(b) Is it possible to use a LIFO pool concept and not use dollar-value LIFO? Explain.
(c) What is a LIFO liquidation?
(d) How are price indexes used in the dollar-value LIFO method?
(e) What are the advantages of dollar-value LIFO over specific-goods LIFO?
CA8-10 WRITING (FIFO and LIFO) Harrisburg Company is considering changing its inventory valuation method from FIFO to LIFO because of the potential tax savings. However, management wishes to consider all of the effects on the company, including its reported performance, before making the final decision.
The inventory account, currently valued on the FIFO basis, consists of 1,000,000 units at $8 per unit on January 1, 2017. There are 1,000,000 shares of common stock outstanding as of January 1, 2017, and the cash balance is $400,000.
The company has made the following forecasts for the period 2017–2019.
Instructions
(a) Prepare a schedule that illustrates and compares the following data for Harrisburg Company under the FIFO and the
LIFO inventory method for 2017–2019. Assume the company would begin LIFO at the beginning of 2017.
(1) Year-end inventory balances. (3) Earnings per share.
(2) Annual net income after taxes. (4) Cash balance.
Assume all sales are collected in the year of sale and all purchases, operating expenses, and taxes are paid during the year incurred.
(b) Using the data above, your answer to (a), and any additional issues you believe need to be considered, prepare a report that recommends whether or not Harrisburg Company should change to the LIFO inventory method. Support your conclusions with appropriate arguments.
(CMA adapted)
CA8-11 ETHICS (LIFO Choices) Wilkens Company uses the LIFO method for inventory costing. In an effort to lower net income, company president Mike Wilkens tells the plant accountant to take the unusual step of recommending to the purchasing department a large purchase of inventory at year-end. The price of the item to be purchased has nearly doubled during the year, and the item represents a major portion of inventory value.
Instructions
Answer the following questions.
(a) Identify the major stakeholders. If the plant accountant recommends the purchase, what are the consequences?
(b) If Wilkens Company were using the FIFO method of inventory costing, would Mike Wilkens give the same order? Why or why not?
