CHAPTER 7 HOMEWORK SOLUTIONS
Inventory often is one of the largest amounts listed under assets on the
balance sheet which means that it represents a significant amount of the
resources available to the business.
The inventory may be excessive in
amount, which is a needless waste of resources; alternatively it may be
too low, which may result in lost sales.
Therefore, for internal users
inventory control is very important.
On the income statement, inventory
exerts a direct impact on the amount of income.
users are interested particularly in the amount of this effect and the way in
which inventory is measured.
Because of its impact on both the balance
sheet and the income statement, it is of particular interest to all statement
Fundamentally, inventory should include those items, and only those
items, legally owned by the business.
That is, inventory should include all
goods that the company owns, regardless of their particular location at the
Goods available for sale is the sum of the beginning inventory and the
amount of goods purchased during the period.
Cost of goods sold is the
amount of goods available for sale less the ending inventory.
The specific identification method of inventory costing is subject to
Manipulation is possible because one can, at the time of
each sale, select (pick and choose) from the shelf the item that has the
highest or the lowest (or some other) unit cost with no particular rationale
for the choice.
The rationale may be that it is desired to influence, by
arbitrary choice, both the amount of income and the amount of ending
inventory to be reported on the financial statements.
To illustrate, assume
item A is stocked and three are on the shelf. One cost $100; the second
one cost $115; and the third cost $125.
Now assume that one unit is sold
If it is assumed arbitrarily that the first unit is sold, the gross
profit will be $100; if the second unit is selected, the gross profit will be
$85; or alternatively, if the third unit is selected, the gross profit will be
Thus, the amount of gross profit (and income) will vary significantly
depending upon which one of the three is selected arbitrarily from the
shelf for this particular sale.
This assumes that all three items are
identical in every respect except for their unit costs.
Of course, the
selection of a different unit cost, in this case, also will influence the ending
inventory for the two remaining items.