4. How inventory is measured in a manufacturing company.
5. The difference between product costs and period costs.
6. How overhead rates are calculated.
@
7.1 Finding Cost of Sales Directly and by Deduction
As we saw in the income statement in Part 6, the first item subtracted
from sales revenue is called {b}Cost of sales{n}. It is the cost of the same goods
or services whose revenue is included in the sales amount. This is an example
of the M{1,8,2} concept. (Some businesses call this item {b}Cost of goods
{b}sold{n}.)
*1
ATCHING - OK - Very good!
MATCHING - OK - Very good!
- HINT - This is an example of the MATCHING concept.
@
7.2
In most businesses the cost of sales is the {1,8 } item of
(A) smallest (B) largest
expense, amounting to as much as 85% to 90% of sales revenue in a profitable
supermarket.
*1
- POST - {b}{a,4,29}{r}
LARGEST - OK - Right.
B - OK - Right.
SMALLEST - QUIT - No, it is the largest item of expense!
A - QUIT - No, it is the largest item of expense!
@
7.3
In some entities, matching cost of sales and sales revenue is easy.
For example, an automobile dealer keeps a record of the cost of each automobile
in its inventory. If the dealer sold two automobiles during a given month,
one for $8,000 that had cost $6,000, and the other for $10,000 that had cost
$7,500, sales revenue for the period would be recorded as ${1,-6}, and
cost of sales as ${2,-6}.
*1
18,000 - OK - Good.
18000 - OK - Good.
13,500 - NO - No, sales revenue is $8,000 + $10,000.
- HINT - The sales revenue is $8,000 + $10,000.
*2
13,500 - OK - Yes, that's the cost of sales.
13500 - OK - Yes, that's the cost of sales.
- HINT - Total cost of sales is $6,000 + $7,500.
@
7.4
A dealer sold an automobile costing $6,000 for $8,000 cash. What
would be the journal entry that records the effect of this transaction solely
upon the Sales Revenue account and upon the Cash account? {s}
{d}
Dr. {1,-13 } ............................. 8,000 {s}
{d}
Cr. {2,-13 } ......................... 8,000 {s}
{d}
Choose from (A) Sales revenue or (B) Cash.
*1
CASH - OK - Good.
B - OK - Good.
SALES REVENUE - QUIT - No, Cash -- an asset increases, so there's a debit to Cash.
A - QUIT - No, Cash -- an asset increases, so there's a debit to Cash.
*2
SALES REVENUE - OK - Correct.
A - OK - Correct.
CASH - QUIT - No, the debit was to Cash; the credit is to Sales Revenue.
B - QUIT - No, the debit was to Cash; the credit is to Sales Revenue.
@
7.5
A dealer sold an automobile costing $6,000 for $8,000 cash. What
would the journal entry be for recording the effect of this transaction
solely upon the Inventory and Cost of Sales accounts? {s}
{d}
Dr. {1,-13 } ............................. 6,000 {s}
{d}
Cr. {2,-13 } ......................... 6,000 {s}
{d}
Choose from (A) Inventory or (B) Cost of sales.
*1
COST OF SALES - OK - Sure -- debit Cost of Sales.
B - OK - Sure -- debit Cost of Sales.
INVENTORY - QUIT - No, there will be a credit to Inventory -- a decrease in an asset.
A - QUIT - No, there will be a credit to Inventory -- a decrease in an asset.
*2
INVENTORY - OK - That's right.
A - OK - That's right.
COST OF SALES - QUIT - No, there was a DEBIT to Cost of Sales.
B - QUIT - No, there was a DEBIT to Cost of Sales.
@
7.6
A dealer that sells refrigerators might keep a record of its
inventory of each type of refrigerator, something like the record in
Exhibit 10. This is called a {b}perpetual inventory{n} record. {s}
{d}
"Receipts" are {1,9 } in inventory, and "Shipments to Customers"
(A) decreases (B) increases
are {2,9} in inventory.
(A) decreases (B) increases
*1
- POST - {b}{a,11,30}{r}
INCREASES - OK - Yes.
B - OK - Yes.
DECREASES - QUIT - No, "receipts" are incoming merchandise, so they increase inventory.
A - QUIT - No, "receipts" are incoming merchandise, so they increase inventory.
*2
- POST - {b}{a,15,13}decreases
DECREASES - OK - Correct.
A - OK - Correct.
INCREASES - QUIT - No, a sale decreases inventory.
B - QUIT - No, a sale decreases inventory.
@
7.7
Information in the perpetual inventory records corresponds to that in
the Inventory account. Considering only Refrigerator #602, we see that the
beginning balance in the Inventory account on May 1 was ${1,-5}. {s}
{d}
There were receipts during May of ${2,-5}, which added to inventory;
these were {3,3,1} [Dr. or Cr.?] to the Inventory account. {s}
{d}
Sales during May decreased inventory by ${4,-5}, which was a {5,3,1}.
This decrease in inventory represented Cost of Sales in May, which was
${6,-5}.
*1
800 - OK - Correct.
800 - OK - Correct.
*2
2,000 - OK - Yes.
2000 - OK - Yes.
*3
DR. - OK - Good -- inventory increased.
CR. - QUIT - No, inventory -- an asset -- increased, so there was a DEBIT.
CR - QUIT - No, inventory -- an asset -- increased, so there was a DEBIT.
*4
1,800 - OK - That's right.
1800 - OK - That's right.
*5
CR. - OK - Correct.
CR. - OK - Correct.
DR. - QUIT - No, the decrease in inventory was a credit.
DR - QUIT - No, the decrease in inventory was a credit.
*6
1,800 - OK - Very good.
1800 - OK - Very good.
1,000 - NO - No, that is inventory remaining at the end of the month.
1000 - NO - No, that is inventory remaining at the end of the month.
- HINT - Cost of sales is the same as Cost of shipments.
@
7.8{s}
Using the TOTALS in the perpetual inventory record of Exhibit 10,
enter the inventory transactions for May in the T-accounts given below.
(The inventory purchases were on credit.)
{b} Inventory
{l,20}{c,194}{l,20}
Beg. Bal. 800 │
{1,5} │ {2,5}
│
{b} Cost of Sales
{l,20}{c,194}{l,20}
{3,5} │
│
{b} Accounts Payable
{l,20}{c,194}{l,20}
│ {4,5}
│
*1
2,000 - OK - Right.
2000 - OK - Right.
1,800 - NO - No, the $1,800 is a CREDIT to Inventory.
1800 - NO - No, the $1,800 is a CREDIT to Inventory.
1,000 - NO - No, that is the balance, not a transaction.
1000 - NO - No, that is the balance, not a transaction.
- HINT - The debit here is the cost of receipts.
*2
1,800 - OK - Good.
1800 - OK - Good.
2,000 - NO - No, sales decreased inventory by $1,800.
2000 - NO - No, sales decreased inventory by $1,800.
- HINT - There was a decrease in inventory of $1,800 due to sales.
*3
1,800 - OK - Yes.
1800 - OK - Yes.
2,000 - NO - No, that's the cost of RECEIPTS, not sales.
2000 - NO - No, that's the cost of RECEIPTS, not sales.
- HINT - Remember that debits must equal credits.
*4
2,000 - OK - Good!
2000 - OK - Good!
1,800 - NO - No, Acc. Pay. records what is owed for the purchases.
1800 - NO - No, Acc. Pay. records what is owed for the purchases.
1,000 - NO - No, that's the cost of goods on hand.
1000 - NO - No, that's the cost of goods on hand.
- HINT - Remember that debits must equal credits.
@
7.9
Refrigerators that cost $1,800 were sold in May for $2,500. Complete the
following partial income statement, assuming these were the only items sold. {s}
{d}
{b} Income Statement
{b} May
Sales revenue $ {1,5}
Cost of sales {2,5} {s}
{l,7}
Gross Margin {3,5}
*1
2,500 - OK - Good -- sales revenue was $2,500.
2500 - OK - Good -- sales revenue was $2,500.
- HINT - The refrigerators sold for $2,500; that's the sales revenue.
*2
1,800 - OK - Yes, cost of sales was $1,800.
1800 - OK - Yes, cost of sales was $1,800.
- HINT - The cost of goods sold, or cost of sales, was $1,800.
*3
700 - OK - Right.
700 - OK - Right.
- HINT - Well, the difference here is $700.
@
7.10
If an entity has a P{1,9} inventory, as was illustrated here,
finding cost of sales in a month is easy. We shall next show how to deduce
cost of sales in a business that does not have this record. This method is
the process of {b}deduction.
*1
ERPETUAL - OK - Correct.
PERPETUAL - OK - Correct.
@
7.11
A hardware store carries so many relatively low-value items
that it is not practical to keep a perpetual inventory record for each
separate item. Thus, when the salesperson rings up a sale on the cash
register, a record is made of the {1,13,3 } but not of the
(A) cost of sales (B) sales revenue
{2,13,3}.
(A) cost of sales (B) sales revenue
*1
- POST - {b}{a,10,37}{r}
SALES REVENUE - OK - That's right.
B - OK - That's right.
COST OF SALES - QUIT - No, the salesperson rings up what you are charged, that is, the sales revenue.
A - QUIT - No, the salesperson rings up what you are charged, that is, the sales revenue.
*2
- POST - {b}{a,14,13}cost of sales
COST OF SALES - OK - Good.
A - OK - Good.
SALES REVENUE - QUIT - The salesperson DID record sales revenue.
B - QUIT - The salesperson DID record sales revenue.
@
7.12
Because a hardware store does not keep a record of the cost of each
item in inventory, it {1,-1}
(A) can arrive at cost of sales by direct tally.
(B) must deduce cost of sales by an indirect method.
*1
- POST - {b}{a,8,13}{r}
B - OK - Yes, of course.
A - QUIT - No, since there is no record, cost of sales must be deduced.
@
7.13
Items in a hardware store's {b}beginning inventory{n} on January 1, 19x1,
{1,8} available for sale during 19x1. Additional items {b}purchased{n} and
(A) were (B) were not
placed on shelves during 19x1 {2,8} available for sale during 19x1.
(A) were (B) were not
*1
- POST - {b}{a,6,13}were
WERE - OK - Sure!
A - OK - Sure!
WERE NOT - QUIT - No, they were available -- otherwise the store is not in business!
B - QUIT - No, they were available -- otherwise the store is not in business!
*2
- POST - {b}{a,10,13}were
WERE - OK - That's right.
A - OK - That's right.
WERE NOT - QUIT - They might not have been sold, but they WERE available for sale.
B - QUIT - They might not have been sold, but they WERE available for sale.
@
7.14
Thus the goods available for sale in a period are the sum of
the B{1,9,4} inventory plus P{2,9,4} during the period.
*1
EGINNING - OK - Correct.
BEGINNING - OK - Correct.
*2
URCHASES - OK - Right.
PURCHASES - OK - Right.
@
7.15
On January 1, 19x1, Cantal Hardware had an inventory that cost
$200,000. During 19x1, it purchased $600,000 of additional merchandise.
The cost of goods {b}available for sale{n} in 19x1 was ${1,-7}.
*1
800,000 - OK - Good.
800000 - OK - Good.
600,000 - NO - No, that's only part of the total available.
600000 - NO - No, that's only part of the total available.
200,000 - NO - No, that's only part of the total available.
200000 - NO - No, that's only part of the total available.
- HINT - No, the total is the sum of $200,000 and $600,000.
@
7.16
Accountants assume that goods available for sale during a period
either were in inventory at the end of the period or were sold. Thus, if
goods costing $800,000 were available for sale during 19x1 and goods costing
$300,000 were in inventory on December 31, 19x1, cost of sales in 19x1 is
assumed to be ${1,-7}.
*1
500,000 - OK - Okay.
500000 - OK - Okay.
- HINT - {a,21,1}The cost of sales is the difference between $800,000 and $300,000.
@
7.17
At the end of each accounting period, all goods currently on hand
are counted. This process is called {b}taking a physical inventory{n}. Since its
purpose is to find the cost of the goods that were sold, each item is valued
at its {1,13,3}.
(A) cost (B) selling price
*1
- POST - {b}{a,10,13}cost
COST - OK - That's right.
A - OK - That's right.
SELLING PRICE - QUIT - {a,21,1}No, selling price might tell what you sell the remainder for, but it would not {a,22,1}help find the cost of goods already sold.
B - QUIT - {a,21,1}No, selling price might tell what you sell the remainder for, but it would not {a,22,1}help find the cost of goods already sold.
@
7.18
In order to determine the ending inventory of one period and the
beginning inventory of the next period, how many physical inventories must
be taken? {1,-1}
*1
1 - OK - {a,20,1}Good. You just need one, because the ending inventory of one period is the same as {a,21,1}the beginning inventory of the next!
- HINT - {a,20,1}You just need one, because the ending inventory of one period is the same as {a,21,1}the beginning inventory of the next!
@
7.19
"Cost of sales" and "Cost of goods sold" mean the same thing. We
shall use the shorter term, {b}cost of sales{n}. In the deduction method for
determining cost of sales, the rationale is as follows: Goods are assumed
to have been sold if they are {u}not{n} in inventory at the {1,9}
(A) beginning (B) end
of the period.
*1
- POST - {b}{a,10,30}{r}
END - OK - Sure.
B - OK - Sure.
BEGINNING - QUIT - {a,20,1}Well, maybe this IS a bit confusing, but we are talking about a period of time.{a,21,1}The goods were all there at the beginning -- those that are gone at the end are{a,22,1}assumed to be sold.
A - QUIT - {a,20,1}Well, maybe this IS a bit confusing, but we are talking about a period of time.{a,21,1}The goods were all there at the beginning -- those that are gone at the end {a,22,1}are assumed to be sold.
@
7.20
Sometimes goods in inventory are stolen, damaged, or spoiled. The
assumption that goods not in the closing inventory have been sold is not
necessarily valid. However, steps are taken to discover and record these
{b}shrinkages.
@
7.21
A hardware store {1,8 } keep track perpetually of individual
(A) does (B) does not
items in inventory. It finds its cost of sales by the process of deduction,
which requires taking a {2,9 } inventory. An automobile dealership
(C) perpetual (D) physical
finds its cost of sales directly from its {3,9} inventory records.
(C) perpetual (D) physical
*1
- POST - {b}{a,4,26}{r}
DOES NOT - OK - Yes.
B - OK - Yes.
DOES - QUIT - No, a hardware store has too many items to keep track of individual ones.
A - QUIT - No, a hardware store has too many items to keep track of individual ones.
*2
- POST - {b}{a,10,31}{r}
PHYSICAL - OK - Correct.
D - OK - Correct.
PERPETUAL - QUIT - No, remember that perpetual inventory is not practical for a hardware store.
C - QUIT - No, remember that perpetual inventory is not practical for a hardware store.
*3
- POST - {b}{a,14,13}perpetual
PERPETUAL - OK - Yes, an automobile dealership can keep perpetual inventory.
C - OK - Yes, an automobile dealership can keep perpetual inventory.
PHYSICAL - QUIT - No, an automobile dealership CAN keep a perpetual inventory.
D - QUIT - No, an automobile dealership CAN keep a perpetual inventory.
@
7.22
Complete the following table.
{b} Cost
Beginning inventory .................. $ 400
Purchases ............................ 1,600 {s}
{l,6}
Total goods available ................ {1,5}
Ending inventory ..................... 500
{l,6}
Cost of sales ........................ {2,5}
*1
2,000 - OK - Yes, that is the total.
2000 - OK - Yes, that is the total.
- HINT - The total is $400 + $1,600, or $2,000.
*2
1,500 - OK - Good -- that is the cost of sales.
1500 - OK - Good -- that is the cost of sales.
- HINT - {a,21,1}The cost of sales is the difference between total goods and ending inventory.
@
7.23
The same situation is shown in the following diagram. Fill in the blanks.
{s}
{b} Goods available
┌{l,21 }┐ ┌{l,21}┐
│ Purchases $1,600 │ │ Cost of sales │
│ │ │ │
│ │ = │ │
│ │ │ │
│ │ ├{l,21}┤
├{l,21 }┤ │ │
│ Beginning │ │ Ending │
│ inventory $ 400 │ │ inventory $ 500 │
└{l,21 }┘ └{l,21}┘ {d}
Total ${1,-5} Total ${3,-5 }
{a,9,51}${2,-5}
*1
2,000 - OK - Right -- total goods available is $2,000.
2000 - OK - Right -- total goods available is $2,000.
- HINT - This total must be $2,000, as before.
*2
1,500 - OK - Right -- both sides must add up to the same amount.
1500 - OK - Right -- both sides must add up to the same amount.
- HINT - Both sides must add up to the same amount.
*3
2,000 - OK - Correct.
2000 - OK - Correct.
- HINT - This sum is ALSO $2,000.
@
7.24 Inventory Valuation: FIFO and LIFO
Complete the following table, filling in all blank spaces.
- HINT - Careful -- 300 times $1.10 per unit is $330.
*3
360 - OK - Yes.
- HINT - No, 300 times $1.20 is $360.
*4
1,090 - OK - That's right.
1090 - OK - That's right.
- HINT - The total cost is $400 + $330 + $360, or $1,090.
@
7.28
The problem now is: What unit cost should we assign to the ending
inventory? There are three choices: (1) we could assume that the older fuel
oil was sold, leaving the newer fuel oil in inventory; (2) we could assume
that the newer fuel oil was sold, leaving the older fuel in inventory; or
(3) we could assume that a mixture of old and new oil was sold. Since the
fuel oil purchased at different times has been mixed together in the storage
tank, we {1,11} a record of the cost of the particular fuel oil
(A) have (B) do not have
actually sold during the month. Therefore the solution is not clearcut.
*1
- POST - {b}{a,16,26}{r}
DO NOT HAVE - OK - Right, there's no way to tell which oil was delivered to a particular customer.
B - OK - Right, there's no way to tell which oil was delivered to a particular customer.
HAVE - QUIT - No, at this point we do not know which oil was sold when.
A - QUIT - No, at this point we do not know which oil was sold when.
@
7.29
In this situation, many companies make the {u}F{n}irst-{u}I{n}n {u}F{n}irst-{u}O{n}ut
(FIFO) assumption. They assume that the goods that come into the inventory
{1,5} are the first to move out.
(A) first (B) last
*1
- POST - {b}{a,8,13}first
FIRST - OK - Correct.
A - OK - Correct.
LAST - QUIT - No, first in, first out.
B - QUIT - No, first in, first out.
@
7.30
{b} Lewis Fuel Company Units Unit Cost Total Cost {s}
{l,28} {l,5} {l,9} {l,10}
Beginning inventory, April 1 400 $1.00 $ 400
Purchase, April 10 300 1.10 330
Purchase, April 20 300 1.20 360
Total goods available 1,000 1,090
Ending inventory, April 30 600
Cost of sales, April 400
{d}
If you applied the FIFO method to the April data of Lewis Fuel
Company, you would assume that the {1,5} fuel oil was sold during the
(A) newer (B) older
month and that the {2,5} fuel oil remains in the ending inventory.
(A) newer (B) older
*1
- POST - {b}{a,16,29}{r}
OLDER - OK - Good.
B - OK - Good.
NEWER - QUIT - No, you would assume that the oil which went into inventory first sold first.
A - QUIT - No, you would assume that the oil which went into inventory first sold first.
*2
- POST - {b}{a,20,13}newer
NEWER - OK - Right -- if the older oil sold, the newer oil remains.
A - OK - Right -- if the older oil sold, the newer oil remains.
OLDER - QUIT - No, the older oil was sold, leaving newer oil in inventory.
B - QUIT - No, the older oil was sold, leaving newer oil in inventory.
@
7.31
{b} Lewis Fuel Company Units Unit Cost Total Cost {s}
{l,28} {l,5} {l,9} {l,10}
Beginning inventory, April 1 400 $1.00 $ 400
Purchase, April 10 300 1.10 330
Purchase, April 20 300 1.20 360
Total goods available 1,000 1,090
Ending inventory, April 30 600
Cost of sales, April 400
The FIFO method assumes that the older units were sold during the
period; therefore the ending inventory of 600 units of fuel oil is the most
recently purchased fuel oil -- that is, the 300 units that were purchased
on April 20 at ${1,-4}, and the 300 units that were purchased on April 10
at ${2,-4}.
*1
1.20 - OK - Right.
120 - OK - Okay.
360 - NO - The cost per unit is needed here.
*2
1.10 - OK - Yes.
110 - OK - Okay.
@
7.32
{b} Lewis Fuel Company Units Unit Cost Total Cost {s}
{l,28} {l,5} {l,9} {l,10}
Beginning inventory, April 1 400 $1.00 $ 400
Purchase, April 10 300 1.10 330
Purchase, April 20 300 1.20 360
Total goods available 1,000 1,090
Ending inventory, April 30 600
Cost of sales, April 400
Calculate the ending inventory below, using the FIFO method.
{b} FIFO Method
Goods available ..................................... $
Ending inventory:
300 units at ${1,4} ........................ ${2,3}
300 units at ${3,4} ........................ {4,3}
Total 600 units ..................................... {5,3}
Cost of sales .......................................
*1
1.20 - OK - Correct.
1.10 - QUIT - Okay, but let's start with $1.20.
- HINT - No, the April 20 oil was purchased for $1.20.
*2
360 - OK - Yes.
- HINT - This figure should be $360, or 300 times $1.20.
*3
1.10 - OK - Good.
- HINT - The other batch of oil cost $1.10 per unit.
*4
330 - OK - Right.
- HINT - The answer here is $330, or 300 times $1.10.
*5
690 - OK - That's it.
- HINT - This is just the total of $360 and $330, or $690.
@
7.33
Earlier, you found the amount of goods available for sale to be $1,090.
Enter this amount in your calculation, and subtract the ending inventory of
$690 from it. The difference is the FIFO {u}cost of sales{n}.
{s}
{b} FIFO Method
Goods available ..................................... ${1,5}
Ending inventory:
300 units at $1.20 ........................ $360
300 units at $1.10 ........................ 330
Total 600 units ..................................... 690
Cost of sales ....................................... {2,3}
*1
1,090 - OK - Right.
1090 - OK - Right.
- HINT - Just enter the $1,090.
*2
400 - OK - Correct.
- HINT - $1,090 minus $690 equals $400!
@
7.34
The FIFO method assumes that the oldest units, that is, those
F{1,5} In, were the first to be sold, i.e., that they were the First Out.
The LIFO method assumes the opposite, namely that the {2,6} units,
(A) oldest (B) newest
which were the Last In, were the first to be sold, i.e., that they were
the First Out, hence the name, {u}L{n}ast-{u}I{n}n {u}F{n}irst-{u}O{n}ut.
*1
IRST - OK - Correct.
FIRST - OK - Correct.
*2
- POST - {b}{a,8,29}{r}
NEWEST - OK - Right.
B - OK - Right.
OLDEST - QUIT - No, LIFO assumes the newest units were sold first.
A - QUIT - No, LIFO assumes the newest units were sold first.
@
7.35
{b} Lewis Fuel Company Units Unit Cost Total Cost {s}
{l,28} {l,5} {l,9} {l,10}
Beginning inventory, April 1 400 $1.00 $ 400
Purchase, April 10 300 1.10 330
Purchase, April 20 300 1.20 360
Total goods available 1,000 1,090
Ending inventory, April 30 600
Cost of sales, April 400
Since the LIFO method assumes that the units sold were the last
ones purchased, the ending inventory is assumed to consist of the units in
beginning inventory, plus the earliest units purchased. In the Lewis Fuel
Company data [repeated above], the ending inventory was 600 units, and in
the LIFO method these 600 units are assumed to be the {1,3} units in
beginning inventory plus {2,3} of the units purchased on April 10.
*1
400 - OK - Yes.
- HINT - Look again -- how many units in beginning inventory?
*2
200 - OK - Correct.
- HINT - Only 200 of the April 10 units are in ending inventory.
@
7.36{s}
{b} Lewis Fuel Company Units Unit Cost Total Cost {s}
{l,28} {l,5} {l,9} {l,10}
Beginning inventory, April 1 400 $1.00 $ 400
Purchase, April 10 300 1.10 330
Purchase, April 20 300 1.20 360
Total goods available 1,000 1,090
Ending inventory, April 30 600
Cost of sales, April 400
Using the LIFO method, enter the amount available for sale, $1,090,
calculate the ending inventory, and subtract to find the cost of sales.
{b} LIFO Method
Goods available ..................................... ${1,5}
Ending inventory:
400 units at ${2,4} ........................ ${3,3}
200 units at ${4,4} ........................ {5,3}
Total 600 units ..................................... {6,3}
Cost of sales ....................................... {7,3}
*1
1,090 - OK - Right.
1090 - OK - Right.
- HINT - Just enter the $1,090.
*2
1.00 - OK - Right.
- HINT - The original 400 units at $1.00 are still in inventory.
*3
400 - OK - Yes.
*4
1.10 - OK - Good.
1.20 - NO - No, the 200 units are assumed to be older oil at $1.10.
- HINT - The 200 units are assumed to be April 10 oil at $1.10.
*5
220 - OK - OK.
*6
620 - OK - Correct.
- HINT - This is just the total of $400 and $220, or $620.
*7
470 - OK - Good.
- HINT - Cost of sales (LIFO) is $1,090 minus $620, or $470.
@
7.37
{b} Lewis Fuel Company Units Unit Cost Total Cost {s}
{l,28} {l,5} {l,9} {l,10}
Beginning inventory, April 1 400 $1.00 $ 400
Purchase, April 10 300 1.10 330
Purchase, April 20 300 1.20 360
Total goods available 1,000 1,090
Ending inventory, April 30 600
Cost of sales, April 400
The third method is the {b}average-cost{n} method. It calculates the cost
of both the ending inventory and the cost of sales at the average cost per unit
of the goods available. For Lewis Fuel Company, the number of units available
in April was 1,000, and the total cost of these goods was $1,090, so the
average cost per unit was ${1,4}.
*1
1.09 - OK - That's right.
- HINT - Average cost is $1,090 ÷ 1,000, or $1.09.
@
7.38
{b} Lewis Fuel Company Units Unit Cost Total Cost {s}
{l,28} {l,5} {l,9} {l,10}
Beginning inventory, April 1 400 $1.00 $ 400
Purchase, April 10 300 1.10 330
Purchase, April 20 300 1.20 360
Total goods available 1,000 1,090
Ending inventory, April 30 600
Cost of sales, April 400
Using an average cost of $1.09 per unit, find the cost of sales with
the average-cost method below.
{b} Average-Cost Method
Goods available ...................................... $1,090
Ending Inventory 600 units at ${1,4} ................... {2,3}
Cost of sales 400 units at ${3,4} ................... {4,3}
*1
1.09 - OK - Yes, that is the average cost per unit.
- HINT - In this method, use the average cost for all units.
*2
654 - OK - Good.
- HINT - Multiplying 600 by $1.09 gives $654.
*3
1.09 - OK - Correct.
- HINT - Again, use $1.09, which is the average cost for all units.
*4
436 - OK - Right.
- HINT - This is 400 times $1.09, or $436.
@
7.39
Most businesses try to sell their oldest goods first, so the goods
that were first in are likely to be the goods {1,9}. The FIFO method
(A) last out (B) first out
reflects this practice.
*1
- POST - {b}{a,6,29}{r}
FIRST OUT - OK - Yes, that's right.
B - OK - Yes, that's right.
LAST OUT - QUIT - No, selling the oldest goods first means they were first out.
A - QUIT - No, selling the oldest goods first means they were first out.
@
7.40
Exhibit 11 summarizes the results of the three methods for calculating
cost of sales. We see that cost of sales under FIFO was ${1,-3} and under
LIFO it was ${2,-3}. Cost of sales was {u}higher{n} under LIFO.
*1
400 - OK - Correct.
*2
470 - OK - Yes.
@
7.41
In most companies, in periods of inflation, when prices are rising,
this same relationship holds; that is, cost of sales is {1,6} under LIFO
(A) lower (B) higher
than under FIFO.
*1
- POST - {b}{a,6,29}{r}
HIGHER - OK - You're right.
B - OK - You're right.
LOWER - QUIT - No, cost of sales was $400 for FIFO and $470 for LIFO.
A - QUIT - No, cost of sales was $400 for FIFO and $470 for LIFO.
@
7.42
In calculating income taxes, cost of sales is one of the items
subtracted from revenue in order to find taxable income. {s}
{d}
Assume the revenue of Lewis Fuel Company was $1,000. Disregarding other
expenses, if cost of sales was $470, taxable income would be ${1,-3}.
If cost of sales was $400, taxable income would be ${2,-3}.
*1
530 - OK - Yes.
- HINT - $1,000 minus $470 equals $530.
*2
600 - OK - Correct.
- HINT - Taxable income would be $600 ($1,000 minus $400).
@
7.43
As can be seen from the preceding, the higher the cost of sales,
the {1,6} the taxable income. The lower the taxable income, the
(A) lower (B) higher
{2,6} will be the income tax based on that income.
(A) lower (B) higher
*1
- POST - {b}{a,6,13}lower
LOWER - OK - Right.
A - OK - Right.
HIGHER - QUIT - {a,20,1}No, a higher cost of sales means you subtract more from revenue, leaving a {a,21,1}LOWER taxable income.
B - QUIT - {a,20,1}No, a higher cost of sales means you subtract more from revenue, leaving a {a,21,1}LOWER taxable income.
*2
- POST - {a,20,1}{c,32,79}{b}{a,10,13}lower
LOWER - OK - Good.
A - OK - Good.
HIGHER - QUIT - No, lower -- tax is based on taxable income and rises or falls with the income.
B - QUIT - No, lower -- tax is based on taxable income and rises or falls with the income.
@
7.44
Since companies usually prefer to pay as low an income tax as they
legally can, they prefer the method that results in the higher cost of sales.
If prices are rising, this is usually the {1,4} method.
*1
LIFO - OK - Good.
FIFO - NO - No, LIFO.
@
7.45
Any of the methods described above is permitted in calculating
taxable income. However, a company cannot switch back and forth between
methods from one year to the next.
@
7.46 Inventory Valuation: Adjustments to Market
We have assumed, so far, that inventory is recorded at its cost.
Suppose, however, that the market value of the inventory falls below its
original cost. The conservatism concept suggests that we should record
the inventory at the {1,6} amount.
(A) higher
(B) lower
*1
- POST - {b}{a,12,13}{r}
LOWER - OK - {a,21,1}Yes, because the conservatism concept states that one should recognize {a,22,1}{u}decreases{n} in owners' equity as soon as they are {u}reasonably possible{n}.
B - OK - {a,21,1}Yes, because the conservatism concept states that one should recognize {a,22,1}{u}decreases{n} in owners' equity as soon as they are {u}reasonably possible{n}.
HIGHER - QUIT - {a,21,1}No, the conservatism concept states that one should recognize {u}decreases{n} {a,22,1}in owners' equity as soon as they are {u}reasonably possible{n}.
A - QUIT - {a,21,1}No, the conservatism concept states that one should recognize {u}decreases{n} {a,22,1}in owners' equity as soon as they are {u}reasonably possible{n}.
@
7.47
For this reason, if, as of the date of a balance sheet, the market
value of an item of inventory is lower than its original cost, the item
is "written down" to its market value. For example, an item whose original
cost was $100, and whose current market value is $80, should be written down
by ${1,-3}.
*1
20 - OK - Right.
20 - OK - Right.
- HINT - It should be "written down" by $100 minus $80, or $20.
@
7.48
In "writing down" inventory, the Inventory account is {1,8},
(A) debited (B) credited
and Cost of Sales is {2,8}.
(A) debited (B) credited
*1
- POST - {b}{a,4,29}{r}
CREDITED - OK - Correct.
B - OK - Correct.
DEBITED - QUIT - No, "writing down" Inventory decreases an asset, so it is a credit.
A - QUIT - No, "writing down" Inventory decreases an asset, so it is a credit.
*2
- POST - {b}{a,8,13}debited
DEBITED - OK - Yes.
A - OK - Yes.
CREDITED - QUIT - No, a DEBIT to Cost of Sales offsets the credit to Inventory.
B - QUIT - No, a DEBIT to Cost of Sales offsets the credit to Inventory.
@
7.49
If inventory is written down by $20, what would the appropriate
journal entry be? {s}
{d}
Dr. {1,-13 } ............................ 20 {s}
{d}
Cr. {2,-13 } ........................ 20 {s}
{d}
Choose from (A) Cost of sales, or (B) Inventory.
*1
COST OF SALES - OK - Yes, that's right.
A - OK - Yes, that's right.
INVENTORY - QUIT - No, the debit is to Cost of Sales.
B - QUIT - No, the debit is to Cost of Sales.
*2
INVENTORY - OK - Good.
B - OK - Good.
COST OF SALES - QUIT - No, there was a debit to Cost of Sales.
A - QUIT - No, there was a debit to Cost of Sales.
@
7.50 Inventory in a Manufacturing Company
Retail stores, wholesalers, and distributors are {1,13}
(A) merchandising (B) manufacturing
companies. A company that makes shoes is a {2,13} company.
(A) merchandising (B) manufacturing
*1
- POST - {b}{a,4,13}merchandising
MERCHANDISING - OK - That's right.
A - OK - That's right.
MANUFACTURING - QUIT - No, these companies do not manufacture anything.
B - QUIT - No, these companies do not manufacture anything.
*2
- POST - {b}{a,8,37}{r}
MANUFACTURING - OK - Correct.
B - OK - Correct.
MERCHANDISING - QUIT - Maybe it merchandises too, but its primary function is MANUFACTURING.
A - QUIT - Maybe it merchandises too, but its primary function is MANUFACTURING.
@
7.51
A {1,13} business sells finished items acquired from
(A) merchandising (B) manufacturing
other businesses. A {2,13} business converts raw materials
(A) merchandising (B) manufacturing
into finished, salable products and then sells these products.
*1
- POST - {b}{a,4,13}merchandising
MERCHANDISING - OK - Good.
A - OK - Good.
MANUFACTURING - QUIT - No, merchandising.
B - QUIT - No, merchandising.
*2
- POST - {b}{a,8,37}{r}
MANUFACTURING - OK - Right.
B - OK - Right.
MERCHANDISING - QUIT - No, it MAKES the product, so it's a manufacturing business.
A - QUIT - No, it MAKES the product, so it's a manufacturing business.
@
7.52
A merchandising company buys its goods in salable form and receives
an invoice showing the cost for each item. The costs on these invoices are
the amounts used to record the additions to inventory. A manufacturing
company adds value to the raw material it buys; it must include these
{b}conversion costs{n} in its inventory and in its cost of sales. {s}
{d}
Evidently the problem of measuring inventory and cost of sales is more
difficult in a {1,13} company.
(A) merchandising (B) manufacturing
*1
- POST - {b}{a,17,37}{r}
MANUFACTURING - OK - Yes, you're right.
B - OK - Yes, you're right.
MERCHANDISING - QUIT - No, it's harder to determine cost of sales in a manufacturing company.
A - QUIT - No, it's harder to determine cost of sales in a manufacturing company.
@
7.53
In a manufacturing business, the cost of a finished product consists
of three things:
(1) cost of raw {b}materials{n} used directly on that product;
(2) cost of {b}labor{n} used directly on that product;
(3) a fair share of {b}overhead{n}, or general costs associated with the
production process.
@
7.54
Some materials, such as oil for lubricating machinery, are not used
directly on a product. The materials that are used {u}directly{n} on the product
are called D{1,6,2} materials. Similarly, the labor used directly to make
the product is called D{2,6,2} labor.
*1
IRECT - OK - Yes.
DIRECT - OK - Yes.
*2
IRECT - OK - Correct.
DIRECT - OK - Correct.
@
7.55
Production overhead consists of all other production costs, that is,
costs that are not direct M{1,9,3} or direct L{2,5,2}.
*1
ATERIALS - OK - Right.
MATERIALS - OK - Right.
MATERIAL - OK - Right.
ATERIAL - OK - Right.
*2
ABOR - OK - Yes.
LABOR - OK - Yes.
@
7.56
The three elements of production cost -- direct labor, direct materials,
and overhead -- are added together to determine the total cost of the finished
product. Until the product is sold, this amount is held in inventory. When
the product is sold, this amount becomes Cost of Sales. Thus, if a product
requires $5 of direct labor, $7 of direct materials, and $3 of overhead, the
product will be costed at ${1,-2} as long as it is in the Inventory account.
When it is sold, Cost of Sales will be ${2,-2}.
*1
15 - OK - Good.
- HINT - No, add up the three elements of production cost.
*2
15 - OK - Right.
- HINT - {a,21,1}No, Cost of Sales is the same amount as the total cost held in Inventory.
@
7.57
The process of assigning these production costs to products is called
{b}cost accounting{n}. The assignment of costs to various services in banks,
schools, hotels, and all types of service organizations also involves
C{1,15,3} [two words]. We shall discuss some of its major problems.
*1
OST ACCOUNTING - OK - Right.
COST ACCOUNTING - OK - Right.
@
7.58{s} Product Costs and Period Costs
Costs are divided into two categories, each of which is treated
differently for purposes of accounting:
(1) {b}product costs{n} -- those that are associated with the production
of products, and
(2) {b}period costs{n} -- those that are associated with the general sales
and administrative activities of the accounting period.
For example, the cost of heating the offices of the sales department would
{d}be considered a {1,7} cost. The cost of heating the production plant
(A) product (B) period
itself would be a {2,7} cost.
(A) product (B) period
*1
- POST - {b}{a,13,28}{r}
PERIOD - OK - Fine.
B - OK - Fine.
PRODUCT - QUIT - No, heating the office is a general cost of the accounting PERIOD.
A - QUIT - No, heating the office is a general cost of the accounting PERIOD.
*2
- POST - {b}{a,17,13}product
PRODUCT - OK - Yes.
A - OK - Yes.
PERIOD - QUIT - This time it's a PRODUCT cost, since heating the plant is part of production.
B - QUIT - This time it's a PRODUCT cost, since heating the plant is part of production.
@
7.59
It is relatively easy to keep track of the first two elements of
the product cost mentioned earlier: the {1,6,2} labor and the {2,6,2}
materials. However, the measurement of overhead costs is more difficult.
*1
DIRECT - OK - Good.
*2
DIRECT - OK - Correct.
@
7.60
Those overhead costs that are classified as product costs are added
to the direct labor costs and direct material costs in order to find the
amount at which the products are costed in the Inventory account. Thus, if
Jones Manufacturing Company spent $10,000 on production overhead during
19x1, spent $100,000 on direct labor and $20,000 on direct materials, and
if no products were sold, its Inventory item on the balance sheet will
{1,8} by ${2,-7}.
(A) increase
(B) decrease
*1
- POST - {b}{a,16,9}{r}
INCREASE - OK - You're right.
A - OK - You're right.
DECREASE - QUIT - No, since no products are sold, inventory will increase.
B - QUIT - No, since no products are sold, inventory will increase.
*2
130,000 - OK - Good.
130000 - OK - Good.
- HINT - Inventory value is $10,000 + $100,000 + $20,000.
@
7.61
Product costs do not affect income {u}until the product is sold{n}. At
that time, product costs become Cost of Sales. Thus, if $10,000 of overhead
is counted a product cost in 19x1, and if the goods with which these product
costs were associated are sold in 19x2, the $10,000 of overhead costs will
appear as a part of Cost of Sales in {1,4}.
(A) 19x1 (B) 19x2
*1
- POST - {b}{a,12,26}{r}
19X2 - OK - Right!
B - OK - Right!
19X1 - QUIT - If the goods are sold in 19x2, the $10,000 becomes Cost of Sales in 19x2, too.
A - QUIT - If the goods are sold in 19x2, the $10,000 becomes Cost of Sales in 19x2, too.
@
7.62
On the other hand, costs that are classified as {b}period{n} costs are
treated as part of the operating expenses of the period during which they
are incurred. For example, if Jones Manufacturing Company classified
$50,000 of its 19x1 costs as period costs, and if the shoes produced
during 19x1 were not sold until 19x2, the $50,000 of period costs would
nevertheless be an expense in {1,4}.
(A) 19x1 (B) 19x2
*1
- POST - {b}{a,14,13}19x1
19X1 - OK - Sure.
A - OK - Sure.
19X2 - QUIT - No, the $50,000 is associated with the PERIOD of 19x1.
B - QUIT - No, the $50,000 is associated with the PERIOD of 19x1.
@
7.63
Suppose that in January the total overhead costs in Lee Shoe Company
were $100,000, and that 40% of this overhead was associated with the
production activities of the business and 60% with the general sales and
administrative activities. {s}
{d}
In this example, the amount of overhead that is a product cost is
${1,-6}, and the amount that is a period cost is ${2,-6}.
*1
40,000 - OK - Correct.
40000 - OK - Correct.
60,000 - NO - No, that is the PERIOD cost.
60000 - NO - No, that is the PERIOD cost.
- HINT - The product cost is 40% of $100,000.
*2
60,000 - OK - Yes.
60000 - OK - Yes.
- HINT - The period cost is 60% of $100,000.
@
7.64
Since Lee Shoe Company recognized $60,000 as a period cost for
January, this $60,000 will be charged as an expense {1,-1}
(A) in January.
(B) whenever the products manufactured in January are sold.
(The word "charged" means the same as "debited.")
*1
- POST - {b}{a,6,13}{r}
A - OK - That's right.
B - QUIT - No, the period cost is associated with January, so it is charged in January.
@
7.65
Suppose the shoes manufactured in January are sold in February.
The $40,000 of product overhead costs will be included in {1,13,3}
[what account?] at the end of January and will be part of Cost of Sales
