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Chapter 8: Question 2Q (page 421)
Why should inventories be included in (a) a statement of financial position and (b) the computation of net income?
Inventories are the main trading commodity. So it must be accounted for both making sales and keeping in hand.
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As compared with the FIFO method of costing inventories, does the LIFO method result in a larger or smaller net income in a period of rising prices? What is the comparative effect on net income in a period of falling prices?
Assume that in an annual audit of Harlowe Inc. at December 31, 2017, you findthe following transactions near the closing date.
1. A special machine, fabricated to order for a customer, was finished and specifically segregated in the back part of the shippingroom on December 31, 2017. The customer was billed on that date and the machine excluded from inventory althoughit was shipped on January 4, 2018.
2. Merchandise costing \(2,800 was received on January 3, 2018, and the related purchase invoice recorded January 5. Theinvoice showed the shipment was made on December 29, 2017, f.o.b. destination.
3. A packing case containing a product costing \)3,400 was standing in the shipping room when the physical inventory wastaken. It was not included in the inventory because it was marked “Hold for shipping instructions.” Your investigationrevealed that the customer’s order was dated December 18, 2017, but that the case was shipped and the customer billedon January 10, 2018. The product was a stock item of your client.
4. Merchandise received on January 6, 2018, costing \(680 was entered in the purchase journal on January 7, 2018. The invoiceshowed shipment was made f.o.b. supplier’s warehouse on December 31, 2017. Because it was not on hand at December31, it was not included in inventory.
5. Merchandise costing \)720 was received on December 28, 2017, and the invoice was not recorded. You located it in thehands of the purchasing agent; it was marked “on consignment.”
Instructions
Assuming that each of the amounts is material, state whether the merchandise should be included in the client’s inventory, andgive your reason for your decision on each item.
Define “cost” as applied to the valuation of inventories.
In an article that appeared in the Wall Street Journal, the phrases “phantom (paper) profits” and “high LIFO profits” through involuntary liquidation were used. Explain the sephrases.
The management of Tritt Company has asked its accounting department to describe the effect upon the company’s financial position and its income statements of accounting for inventorieson the LIFO rather than the FIFO basis during 2017 and 2018. The accounting department is to assume that the change to LIFO wouldhave been effective on January 1, 2017, and that the initial LIFO base would have been the inventory value on December 31, 2016. Thefollowing are the company’s financial statements and other data for the years 2017 and 2018 when the FIFO method was employed.
Financial Position as of
12/31/16 12/31/17 12/31/18
Cash \( 90,000 \)130,000 \(154,000
Accounts receivable 80,000 100,000 120,000
Inventory 120,000 140,000 176,000
Other assets 160,000 170,000 200,000
Total assets \)450,000 \(540,000 \)650,000
Accounts payable \( 40,000 \) 60,000 \( 80,000
Other liabilities 70,000 80,000 110,000
Common stock 200,000 200,000 200,000
Retained earnings 140,000 200,000 260,000
Total liabilities and equity \)450,000 \(540,000 \)650,000
Income for Years Ended
12/31/17 12/31/18
Sales revenue \(900,000 \)1,350,000
Less: Cost of goods sold 505,000 756,000
Other expenses 205,000 304,000
710,000 1,060,000
Income before income taxes 190,000 290,000
Income taxes (40%) 76,000 116,000
Net income \(114,000 \) 174,000
Other data:
1. Inventory on hand at December 31, 2016, consisted of 40,000 units valued at \(3.00 each.
2. Sales (all units sold at the same price in a given year):
2017—150,000 units @ \)6.00 each 2018—180,000 units @ \(7.50 each
3. Purchases (all units purchased at the same price in given year):
2017—150,000 units @ \)3.50 each 2018—180,000 units @ $4.40 each
4. Income taxes at the effective rate of 40% are paid on December 31 each year.
Instructions
Name the account(s) presented in the financial statements that would have different amounts for 2018 if LIFO rather than FIFOhad been used, and state the new amount for each account that is named. Show computations.
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