ch07 - CHAPTER 7 MERCHANDISE INVENTORY E74 Ending inventory...

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CHAPTER 7 MERCHANDISE INVENTORY E7–4 12/31/04: Ending inventory: Cost of Goods Sold = (Beginning Inventory + Purchases) – Ending Inventory $10,002 = $11,899 – Ending Inventory Ending Inventory = $1,897 12/31/05: Purchases: Cost of Goods Sold = (Beginning Inventory + Purchases) – Ending Inventory $10,408 = $1,897 + Purchases – $2,162 Purchases = $10,673 Goods Available for Sale = $12,570 12/31/06: Ending inventory: Cost of Goods Sold = (Beginning Inventory + Purchases) – Ending Inventory $11,713 = $2,162 + $12,152 – Ending Inventory Ending Inventory = $2,601 Goods Available for Sale = $14,314 E7–7 a. If Marian wants to maximize profits and ending inventory, she should sell the customer the lowest priced coat (i.e., Coat 4). If she sells Coat 4, Marian would report the following gross profit and ending inventory. Gross Profit Ending Inventory Revenues $ 12,000 Coat 1 $ 8,400 COGS of Coat 4 6,800 Coat 2 7,100 Gross profit $ 5,200 Coat 3 7,600 Total $ 23,100 Marian may have several reasons to maximize profits and ending inventory. If Marian's Furs has borrowed money and entered into debt covenants, the debt covenants may contain clauses stipulating a certain current ratio, debt/equity ratio, and so forth. By maximizing profits and inventory, Marian can also minimize the probability that she will violate one of these ratios, thereby decreasing the chance that she will violate her debt covenants. Further, if Marian has a bonus linked to accounting earnings, she could maximize her bonus by maximizing profits. b. If Marian wants to minimize profits and ending inventory, she should sell the customer the highest priced coat (i.e., Coat 1). If she sells Coat 1, Marian would report the following gross profit and ending inventory. Gross Profit Ending Inventory Revenues $ 12,000 Coat 2 $ 7,100 1
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COGS of Coat 1 8,400 Coat 3 7,600 Gross profit $ 3,600 Coat 4 6,800 Total $ 21,500 The most likely reason Marian would want to minimize profits and ending inventory is to minimize taxes. Minimizing profits would minimize current tax payments, thereby minimizing the present value of tax payments. Further, some states charge taxes on a company's assets, thereby providing an incentive to minimize assets.
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