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Unformatted text preview: 7-1Odd-numbered SolutionsCHAPTER 7INVENTORIES: THE SOURCE OF OPERATING PROFITSQuestions, Short Exercises, Exercises, Problems, and Cases: Answers and Solutions7.1See the text or the glossary at the end of the book.7.3Depreciation on manufacturing equipment is a product cost and remains ininventory accounts until the firm sells the manufactured goods.Depreciation on selling and administrative equipment is a period expense,because the use of such equipment does not create an asset with futureservice potential.7.5The accountant allocates the total income (cash inflow minus cash outflow)over the periods between purchase and sale. The inventory valuationmethod dictates this allocation. The acquisition cost valuation methodallocates all of the income to the period of sale. A current cost valuationmethod allocates holding gains and losses to the periods when a firm holdsinventory and an operating margin (sales minus replacement cost of goodssold) to the period of sale. A lower-of-cost-or-market valuation allocatesholding losses to the periods when a firm holds inventory and holding gainsplus operating margins to the period of sale.7.7Accounting reports cost flows, not flows of physical quantities. Cost flowassumptions trace costs, not physical flows of goods. With specificidentification, management manipulates cost flows by controlling goodsflows.7.9a.Higher cost of goods sold amount:LIFOLower cost of goods sold amount:FIFOb.Higher cost of goods sold amount:FIFOLower cost of goods sold amount:LIFO7.11a.FIFO typically uses older acquisition costs for cost of goods sold thanLIFO (except during a period of dipping into a LIFO layer), whereasLIFO uses older acquisition costs for ending inventory than FIFO. Thelarger the rate of change in the acquisition cost of inventory items, themore the older costs will differ from current costs and the larger will bethe difference in cost of goods sold and ending inventory values betweenFIFO and LIFO.Odd-numbered Solutions7-27.11 continued.b.As the rate of inventory turnover increases, purchases during a periodcomprise an increasing proportion of cost of goods sold for that periodunder both FIFO and LIFO and differences in the beginning or endinginventory values under FIFO and LIFO play a decreasing role. Becausepurchases are the same regardless of the cost flow assumption, cost ofgoods sold under FIFO and LIFO should not differ significantly (unlessthe firm experienced dips into old LIFO layers).c.The inventory turnover ratio relates cost of goods sold to averageinventories. A faster inventory turnover means a smaller level ofinventories in the denominator relative to cost of goods sold in thenumerator. The difference between FIFO and LIFO amounts in thedenominator depends on the age of a firm’s LIFO layers and the rate ofchange in the cost of inventory items since the firm adopted LIFO....
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- Fall '07
- Fiscal Year, Net Income, ........., FIFO and LIFO accounting