Solutions Manual, Chapter 7
ANSWERS TO QUESTIONS
An accurate valuation of ending inventory is needed to report the proper net income for the
period. Ending inventory is deducted from cost of goods available for sale to yield cost of
An understated ending inventory overstates the cost of goods sold. Cost of goods sold is,
in turn, subtracted from sales, and this causes an equal understatement of net income for
The ending inventory of one period is the beginning inventory of the next period. Thus, one
inventory error affects two accounting periods.
To “take a physical inventory count” means that one determines the actual physical
quantities of goods on hand by counting, weighing, measuring, and so on. These quantities
are then multiplied by unit costs to obtain the total cost of the inventory on hand.
Despite the fact that taking a physical inventory count is not specifically an accounting
function, the accountant is very involved in this important event. Because of the importance
of inventory in measuring periodic income, the accountant must be assured that the
inventory count is accurate. For this reason, the accountant frequently plans and
coordinates the actual taking of the physical inventory count.
The cost of inventory is the total outlay necessary to obtain the goods and place them in a
desired condition and location for sale. In theory, this cost includes gross selling price less
cash discount plus transportation-in, insurance, and handling costs. The indirect costs
would have to be allocated to inventory under some method that is arbitrary. Thus, these
costs are often not included in the cost of inventory.
The accounts that are not used under perpetual inventory procedure are Purchases,
Purchase Discounts, Purchase Returns and Allowances, and Transportation-In. The
Merchandise Inventory account is debited or credited instead of debiting or crediting these
Two entries are necessary. First, debit Accounts Receivable and credit Sales at the selling
price. Then, debit Cost of Goods Sold and credit Merchandise Inventory at cost.
Under perpetual procedure, the accountant can compare the results of the physical
inventory count with the balance in the Merchandise Inventory account to determine any
inventory shortages. Under periodic procedure, this same comparison cannot be made.
The development of computerized accounting software packages makes it much easier to
track units and dollars in and out of the company as is required under perpetual inventory
procedure. The additional control over inventory under perpetual inventory procedure also
The cost flow assumption relates to the order in which the costs of goods are assumed to
flow through a firm. The physical flow of goods is the order in which actual units of
inventory are moved through a firm.
In prior years, the theoretical merit of an inventory