Ch_07

Ch_07 - CHAPTER 7 INVENTORIES: THE SOURCE OF OPERATING...

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7-1 Solutions CHAPTER 7 INVENTORIES: THE SOURCE OF OPERATING PROFITS Questions, Short Exercises, Exercises, Problems, and Cases: Answers and Solutions 7.1 See the text or the glossary at the end of the book. 7.2 The underlying principle is that acquisition cost includes all costs required to prepare an asset for its intended use. Assets provide future services. Costs that a firm must incur to obtain those expected services add value to the asset. Accountants therefore include such costs in the acquisition cost valuation of the asset. 7.3 Depreciation on manufacturing equipment is a product cost and remains in inventory 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 future service potential. 7.4 Both the Merchandise Inventory and Finished Goods Inventory accounts include the cost of completed units ready for sale. A merchandising firm acquires the units in finished form and debits Merchandise Inventory for their acquisition cost. A manufacturing firm incurs direct material, direct labor, and manufacturing overhead costs in transforming the units to a finished, salable condition. The Raw Materials Inventory and Work-in- Process Inventory accounts include such costs until the completion of manufacturing operations. Thus, the accountant debits the Finished Goods Inventory account for the cost of producing completed units. The accountant credits both the Merchandise Inventory and Finished Goods Inventory accounts for the cost of units sold and reports them as current assets on the balance sheet. 7.5 The accountant allocates the total income (cash inflow minus cash outflow) over the periods between purchase and sale. The inventory valuation method dictates this allocation. The acquisition cost valuation method allocates all of the income to the period of sale. A current cost valuation method allocates holding gains and losses to the periods when a firm holds inventory and an operating margin (sales minus replacement cost of goods sold) to the period of sale. A lower-of-cost-or-market valuation allocates holding losses to the periods when a firm holds inventory and holding gains plus operating margins to the period of sale.
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Solutions 7-2 7.6 Income increases in the year of change because of the recognition of the unrealized holding gains. Cost of goods sold in the next year will increase by the same amount, so that income in the second year will be less by the same amount as it was greater in the year of change. Over long enough time spans, accounting income equals cash inflows minus cash outflows; the valuation method affects the timing of income recognition, not its amount.
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Ch_07 - CHAPTER 7 INVENTORIES: THE SOURCE OF OPERATING...

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