Chapter Eight Questions
 

1. Define the term merchandise inventory.

The products that merchandising companies buy and sell are called merchandise inventory.
 

2. Identify three examples of merchandise inventory.

Food, clothing, textbooks, toys, automobiles, appliances, etc.
 

3. What is the major difference between merchandising and manufacturing?

Merchandising companies sell the products they purchase. Manufacturing companies take the products they purchase, combine them with other products to create different products, which they then sell.
 

4. Identify four major steps involved with merchandise inventory.

Step 1: purchase merchandise from suppliers.

Step 2: sell merchandise to customers.

Step 3: collect cash from customers.

Step 4: pay cash to suppliers.
 

5. What is the primary objective of the four merchandise inventory steps you identified in question 4?

The primary objective of merchandising companies is to increase their resources by charging customers more than it cost the companies to buy the products and get them to customers.
 

6. How is gross profit calculated?

Gross profit = net sales - cost of goods sold.
 

7. Why is gross profit important to merchandising companies?

Unless companies can charge customers more than it cost the companies to buy the products, it is virtually impossible for them to increase their resources through management activities.
 

8. State the formula for calculating gross profit percentage.

Gross profit percentage = gross profit / net sales.
 

9. How often are merchandise inventory records updated in a perpetual inventory system?

Perpetual inventory systems update inventory records constantly. Whenever a transaction occurs that changes merchandise, the perpetual inventory system updates the inventory records.
 

10. How does a perpetual inventory system differ from a periodic inventory system?

Periodic inventory systems update inventory records only at the end of an accounting period, while perpetual inventory systems update inventory records constantly. For practical purposes this means periodic inventory systems update inventory records at the end of each month, while perpetual inventory systems may update inventory records numerous times each day.
 

11. What is the reason merchandising companies inspect the merchandise they purchase?

Merchandise is inspected to make certain it is what the company ordered and is in good enough condition to be sold to customers.
 

12. What is the most important use merchandising companies make of their merchandise inventory?

Most merchandise inventory is sold to customers.
 

13. Why do merchandising companies maintain some merchandise inventory at the end of each accounting period?

Merchandising companies keep some inventory on hand at the end of each period in order to have merchandise available to be sold to customers at the beginning of the next period.
 

14. After a merchandising company purchases merchandise, what are the three most important actions the company can take with the merchandise?

Return it to suppliers.

Sell it to customers.

Keep it on hand to sell to customers next period.
 

15. After a merchandising company purchases merchandise, inspects it, and returns any unwanted items, what are the two most important actions the company can take with the remaining merchandise?

Sell it to customers.

Keep it on hand to sell to customers next period.
 

16. What is the relationship between a company's cost of goods sold and its ending merchandise inventory?

Merchandise available for sale - cost of goods sold = ending merchandise inventory.
 

17. Identify the name of the largest expense on the income statement of most merchandising companies.

Cost of goods sold.
 

18. What does a FIFO inventory system do with the first unit costs coming into a merchandising company?

FIFO assigns the first unit costs to the first units sold during the period.
 

19. What does a FIFO inventory system do with the last unit costs coming into a merchandising company?

FIFO assigns the last unit costs to the units remaining in inventory at the end of the period.
 

20. What does a LIFO inventory system do with the first unit costs that coming into a merchandising company?

LIFO assigns the first unit costs to the units remaining in inventory at the end of the period, which in a LIFO perpetual inventory system may be the end of a day rather than the end of a month.
 

21. What does a LIFO inventory system do with the last unit costs coming into a merchandising company?

LIFO assigns the last unit costs to the first units sold during the period.
 

22. What is the difference between tax planning and tax evasion?

Tax planning involves the legal choosing among accounting methods to minimize or postpone the payment of income taxes. Tax evasion is the illegal, willful violation of income tax laws.
 

23. In what section of the balance sheet is merchandise inventory reported?

Merchandise inventory is reported on the balance sheet as a current asset.
 

24. On which financial statement and in which section is the cost of goods sold reported?

The cost of goods sold is reported on the income statement in its own section immediately following net sales revenue.
 
 

Chapter Eight Exercises
 

Exercise 8.1: Merchandising Income

 The Chang Corporation began operations on September 1. During September, the company purchased 1,000 pairs of gloves at a cost of $30 per pair. By the end of September, the company had sold all the gloves for $42 per pair. The company's operating expenses for September were $8,000 and its effective income tax rate was 40%.

1. Determine the company's September sales revenue.

 $42,000 = 1,000 pairs of gloves x $42 per pair.
 

2. Determine the company's September cost of goods sold.

 $30,000 = 1,000 pairs of gloves x $30 per pair.
 

3. Determine the company's September gross profit.
 

Sales

$42,000

Cost of Goods Sold

$30,000

Gross Profit

$12,000

 
 
4. Determine the company's September income before taxes.
 

Sales

$42,000

Cost of Goods Sold

$30,000

Gross Profit

$12,000

Operating Expenses

$8,000

Income Before Taxes

$4,000

 
 
5. Determine the company's September income taxes expense.
 

Sales

$42,000

Cost of Goods Sold

$30,000

Gross Profit

$12,000

Operating Expenses

$8,000

Income Before Taxes

$4,000

Income Taxes Expense ($1,600 x .40

$1,600

 
 
6. Determine the company's September net income.
 

Sales

$42,000

Cost of Goods Sold

$30,000

Gross Profit

$12,000

Operating Expenses

$8,000

Income Before Taxes

$4,000

Income Taxes Expense

$1,600

Net Income

$2,400

 
 
7. If the Chang Corporation paid cash for all its September purchases, operating expenses, and income taxes expense, by what dollar amount did the company's resources increase in September as a result of buying and selling merchandise?

 Cash  would have increased by $2,400 and stockholders' equity would have increased by $2,400 (net income).
 

Exercise 8.2: Gross Profit Percentage

 The following information is from the records of the Masse Corporation.
 

 

Year 3

Year 2

Year 1

Sales

$22,959

$22,384

$22,145

Cost of Goods Sold

$17,405

$17,109

$17,079

Gross Profit

$5,554

$5,275

$5,066

Operating Expenses

$4,805

$4,601

$4,418

Income from Operations

$749

$674

$648

Other Revenues and (Expenses)

($328)

($390)

($475)

Income Before Taxes

$421

$284

$173

Income Taxes Expense

$152

$113

$72

Net Income

$269

$171

$101

1. Calculate the Masse Corporation's gross profit percentage for Year 3.

Gross profit percentage = gross profit / sales

Gross Profit Percentage = $5,554 / $22,959 = .242 = 24.2%
 

2. Calculate the Masse Corporation's gross profit percentage for Year 2.

Gross profit percentage = $5,275 / $22,384 = .236 = 23.6%
 

3. Calculate the Masse Corporation's gross profit percentage for Year 1.

Gross profit percentage = $5,066 / $22,145 = .229 = 22.9%
 

4. Comment on the trend you see in the company's gross profit percentage.

The company's gross profit has been increasing each year.  This increase could be due to increased sales prices, decreased purchase prices, or sales of higher profit margin products.
 

Exercise 8.3: Beginning Merchandise Inventory

During February, the Reeney Corporation purchased $56,000 of merchandise inventory and returned $4,000 of the merchandise. The company sold to customers merchandise that cost the company $42,000. At the end of February, the company had $15,000 of merchandise on hand.

Calculate the cost of merchandise inventory the Reeney Corporation had on hand at the beginning of February.
 

Beginning Inventory

$5,000

 

 

Purchases

$56,000

$4,000

Purchases Returns

 

 

$42,000

Cost of Goods Sold

Ending Inventory

$15,000

 

 

 
 
Exercise 8.4: Merchandise Purchases

At the beginning of March, the Chandran Corporation had merchandise inventory of $8,000 on hand. During March, the Chandran Corporation returned $3,000 of the merchandise it purchased in March. The company sold to customers merchandise that cost the company $24,000. At the end of March, the company had $11,000 of merchandise on hand.

Calculate the cost of merchandise inventory the Chandran Corporation purchased during March.
 

Beginning Inventory

$8,000

 

 

Purchases

$30,000

$3,000

Purchases Returns

 

 

$24,000

Cost of Goods Sold

Ending Inventory

$11,000

 

 

 
 
Exercise 8.5: Purchases Returns

At the beginning of April, the Damron Corporation had merchandise inventory of $19,000 on hand. During April, the Damron Corporation purchased $63,000 of merchandise inventory. The company sold to customers merchandise that cost the company $71,000. At the end of April, the company had $6,000 of merchandise on hand.

Calculate the cost of merchandise the Damron Corporation returned during April.
 

Beginning Inventory

$19,000

 

 

Purchases

$63,000

$5,000

Purchases Returns

 

 

$71,000

Cost of Goods Sold

Ending Inventory

$6,000

 

 

 
 
Exercise 8.6: Cost of Goods Sold

At the beginning of May, the Dumais Corporation had merchandise inventory of $7,000 on hand. During May, the Dumais Corporation purchased $36,000 of merchandise inventory. The company returned merchandise that cost the company $2,000. At the end of May, the company had $4,000 of merchandise on hand.

Calculate the cost of merchandise the Dumais Corporation sold to its customers during May.
 

Beginning Inventory

$7,000

 

 

Purchases

$36,000

$2,000

Purchases Returns

 

 

$37,000

Cost of Goods Sold

Ending Inventory

$4,000

 

 

 
 
Exercise 8.7: Ending Merchandise Inventory

At the beginning of June, the Pierce Corporation had on hand merchandise that cost $27,000. During June, the company purchased $106,000 of merchandise inventory and returned $18,000 of the merchandise. The company sold to customers merchandise that cost the company $96,000.

Calculate the cost of merchandise inventory that the Pierce Corporation had on hand at the end of June.
 

Beginning Inventory

$27,000

 

 

Purchases

$106,000

$18,000

Purchases Returns

 

 

$96,000

Cost of Goods Sold

Ending Inventory

$19,000

 

 

 
 
Exercise 8.8: Merchandising Journal Entries

Prepare the journal entries required to record the following transactions of the Katsikas Corporation.   Before you prepare each entry, determine the transaction's effects on the company's resources and sources of resources.

July 1: Purchased $15,000 of merchandise on account.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

+ $15,000

=

+ $15,000

 

 

 

 

 

Date

Description

Post.
Ref.

Debits

Credits

July 1

Merchandise Inventory

 

15,000

 

 

     Accounts Payable

 

 

15,000

 

Merchandise purchased

 

 

 

 
    
July 5: Sold on account $3,500 of merchandise to customers for $5,900.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $3,500

+ $5,900

=

 

 

 

 

- $3,500

+ $5,900

 

Date

Description

Post.
Ref.

Debits

Credits

July 5

Cost of Goods Sold

 

3,500

 

 

     Merchandise Inventory

 

 

3,500

 

Merchandise sold

 

 

 

 

 

 

 

 

 5

Accounts Receivable

 

5,900

 

 

     Sales

 

 

5,900

 

Sales on account

 

 

 

 
 
July 9: Returned for credit $800 of merchandise purchased on July 1.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $800

=

- $800

 

 

 

 

 

Date

Description

Post.
Ref.

Debits

Credits

July 9

Accounts Payable

 

800

 

 

     Merchandise Inventory

 

 

800

 

Purchases returns

 

 

 

 
 
July 14: Paid cash for $9,000 of additional merchandise.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

+ $9,000
- $9,000

 

 

 

 

 

 

 

Date

Description

Post.
Ref.

Debits

Credits

July 14

Merchandise Inventory

 

9,000

 

 

     Cash

 

 

9,000

 

Merchandise purchased

 

 

 

 
 
July 18: Sold $4,800 of merchandise to customers for $8,000 cash.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $4,800

+ $8,000

=

 

 

 

 

- $4,800

+ $8,000

 

Date

Description

Post.
Ref.

Debits

Credits

July 18

Cost of Goods Sold

 

4,800

 

 

     Merchandise Inventory

 

 

4,800

 

Merchandise sold

 

 

 

 

 

 

 

 

18

Cash

 

8,000

 

 

     Sales

 

 

8,000

 

Cash sales

 

 

 

 
 
July 21: Purchased $12,000 of merchandise on account.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

+ $12,000

=

+ $12,000

 

 

 

 

 

Date

Description

Post.
Ref.

Debits

Credits

July 21

Merchandise Inventory

 

12,000

 

 

     Accounts Payable

 

 

12,000

 

Merchandise purchased

 

 

 

 
 
July 25: Sold on account $6,500 of merchandise to customers for $11,000.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $6,500

+ $11,000

=

 

 

 

 

- $6,500

+ $11,000

 

Date

Description

Post.
Ref.

Debits

Credits

July 25

Cost of Goods Sold

 

6,500

 

 

     Merchandise Inventory

 

 

6,500

 

Merchandise sold

 

 

 

 

 

 

 

 

25

Accounts Receivable

 

11,000

 

 

     Sales

 

 

11,000

 

Sales on account

 

 

 

 
 
July 27: Paid $6,000 cash as partial payment for merchandise purchased on July 1.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $6,000

=

- $6,000

 

 

 

 

 

Date

Description

Post.
Ref.

Debits

Credits

July 27

Accounts Payable

 

6,000

 

 

     Cash

 

 

6,000

 

Payment for merchandise

 

 

 

 
 
July 30: Returned for credit $1,200 of merchandise purchased on July 21.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $1,200

=

- $1,200

 

 

 

 

 

Date

Description

Post.
Ref.

Debits

Credits

July 30

Accounts Payable

 

1,200

 

 

     Merchandise Inventory

 

 

1,200

 

Purchases returns

 

 

 

 
 
Exercise 8.9: FIFO Inventory Costing

The Lord Corporation began July with 15 units of merchandise inventory on hand. Each unit had cost the company $22. During July, the company made the following purchases: July 7, 18 units at $25 each; July 19, 23 units at $27 each; and July 27, 24 units at $29 each. The company made the following sales in July: July 12, 17 units at $50 each; July 21, 22 units at $50 each; and July 29, 27 units at $50 each. The company uses the FIFO perpetual inventory method.

1. Calculate the company’s July cost of goods sold
 

July 12

15 units x $22 = $330

 

2 units x $25 = $50

 

 

July 21

16 units x $25 = $400

 

6 units x $27 = $162

 

 

July 29

17 units x $27 = $459

 

10 units x $29 = $290

 

 

Total

$1,691

 
 
2. Calculate the company’s cost of the merchandise inventory on hand on July 31.
 

July 27

14 units x $29 = $406

 

 

Total

$406

Check:
 

Cost of goods sold

$1,691

Plus: Ending inventory

$406

Merchandise available for sale

$2,097

 
 
Exercise 8.10: LIFO Inventory Costing

The Connors Corporation began July with 15 units of merchandise inventory on hand. Each unit had cost the company $22. During July, the company made the following purchases: July 7, 18 units at $25 each; July 19, 23 units at $27 each; and July 27, 24 units at $29 each. The company made the following sales in July: July 12, 17 units at $50 each; July 21, 22 units at $50 each; and July 29, 27 units at $50 each. The company uses the LIFO perpetual inventory method.

1. Calculate the company’s July cost of goods sold.
 

July 12

17 units x $25 = $425

 

 

July 21

22 units x $27 = $594

 

 

July 29

24 units x $29 = $696

 

1 unit x $27 = $27

 

1 unit x $25 = $25

 

1 unit x $22 = $22

 

 

Total

$1,789

 
 
2. Calculate the company’s cost of the merchandise inventory on hand on July 31.
 

July 1

14 units x $22 = $308

 

 

Total

$308

Check:
 

Cost of goods sold

$1,789

Plus: Ending inventory

$308

Merchandise available for sale

$2,097

 
 
Exercise 8.11: FIFO Versus LIFO Inventory Costing

The Garnick Company reported annual sales of $20,000,000. If the company used the FIFO inventory method, its cost of goods sold would have been $11,000,000. The cost of goods sold under LIFO would have been $11,500,000. Operating expenses for the company were $6,000,000 during the year. The company estimates its income taxes expense to be approximately 40% of income before taxes.

1. Calculate the company’s net income under the FIFO inventory method.

$1,800,000 (see below)
 
 
2. Calculate the company’s net income under the LIFO inventory method.

$1,500,000 (see below)
 
 
3. Calculate the income tax advantage the company would realize if it were to use the LIFO inventory method.

$200,000 (see below)
 

 

FIFO

LIFO

FIFO - LIFO

Sales

$20,000,000

$20,000,000

 

Cost of Goods Sold

$11,000,000

$11,500,000

 

Gross Profit

$9,000,000

$8,500,000

 

Operating Expenses

$6,000,000

$6,000,000

 

Income Before Taxes

$3,000,000

$2,500,000

 

Income Taxes Expense

$1,200,000

$1,000,000

$200,000

Net Income

$1,800,000

$1,500,000

 


Chapter Eight Problem

Problem 8.1: Inventory Costing: FIFO, LIFO Perpetual

 

            The Braucher Merchandising Corporation, which is owned by Matthew Braucher, began May operations with merchandise inventory of 12 units, each of which cost $58.  During May, Braucher Merchandising made the following purchases: (1) May 4, 24 units @ $59 per unit, (2) May 15, 36 units @ $61 per unit, (3) May 26, 28 units @ $64 per unit.   During May the Company sold the following units at a sales price of $105 per unit: May 6, 21 units, May 20, 27 units, May 28, 27 units.   Operating expenses in May were $2,600.  The Company estimates its income taxes expense will be approximately 35% of income before taxes.

            You have been asked by Matthew Braucher to assist him in deciding which inventory costing method to use in accounting for the Braucher Merchandising Corporation's May activity.

 

Part 1. Determine the following for the Braucher Merchandising Corporation:

 

 

 

FIFO

LIFO

Perpetual

Inventory dollar amount on May 1

$696

$696

Dollar amount of purchases made in May

$5,404

$5,404

Cost of goods available for sale during May

$6,100

$6,100

Cost of goods sold during May

$4,500

$4,614

Inventory dollar amount on May 31

$1,600

$1,486

 

 

FIFO inventory cost flows:

 

 

May 1 on hand 12 units

12 units @ $58

$696

May 4 purchased 24 units

24 units @ $59

$1,416

May 6 sold 21 units

12 units @ $58

9 units @ $59

 

$1,227

May 15 purchased 36 units

36 units @ $61

$2,196

May 20 sold 27 units

15 units @ $59

12 units @ $61

 

$1,617

May 26 purchased 28 units

28 units @ $64

$1,792

May 28 sold 27 units

24 units @ $61

3 units @ $64

 

$1,656

May 31 on hand 25 units

25 units @ $64

$1,600

 

            May purchases = $1,416 (May 4) + $2,196 (May 15) + $1,792 (May 26) = $5,404.

 

            May cost of goods available for sale = $696 (May 1 beginning inventory) + $5,404 (May purchases) = $6,100.

 


            May cost of goods sold = $1,227 (May 6) + $1,617 (May 20) + $1,656 (May 28) = $4,500.

 

            Proof: $696 (May 1 beginning inventory) + $5,404 (May purchases) - $4,500 (May cost of goods sold) = $1,600 (May 31 ending inventory).

 

 

LIFO perpetual inventory cost flows:

 

 

May 1 on hand 12 units

12 units @ $58

$696

May 4 purchased 24 units

24 units @ $59

$1,416

May 6 sold 21 units

21 units @ $59

$1,239

May 15 purchased 36 units

36 units @ $61

$2,196

May 20 sold 27 units

27 units @ $61

$1,647

May 26 purchased 28 units

28 units @ $64

$1,792

May 28 sold 27 units

27 units @ $64

$1,728

May 31 on hand 25 units

12 units @ $58

3 units @ $59

9 units @ $61

1 unit @ $64

 

 

 

$1,486

 

            May purchases = $1,416 (May 4) + $2,196 (May 15) + $1,792 (May 26) = $5,404.

 

            May cost of goods available for sale = $696 (May 1 beginning inventory) + $5,404 (May purchases) = $6,100.

 

            May cost of goods sold = $1,239 (May 6) + $1,647 (May 20) + $1,728 (May 28) = $4,614.

 

            Proof: $696 (May 1 beginning inventory) + $5,404 (May purchases) - $4,614 (May cost of goods sold) = $1,486 (May 31 ending inventory).

 

 


Part 2. Calculate the Braucher Merchandising Corporation's May net income using the FIFO and LIFO perpetual cost flow assumptions.  Round all calculations to the nearest dollar.

 

Braucher Merchandising Corporation

Income Statements

For the Month Ended May 31

 

 

 

FIFO

LIFO

Perpetual

Sales

$7,875

$7,875

Cost of Goods Sold

$4,500

$4,614

Gross Profit

$3,375

$3,261

Operating Expenses

$2,600

$2,600

Income Before Taxes

$775

$661

Income Taxes Expense

$271

$231

Net Income

$504

$430

 

            Sales = 75 units @ $105 = $7,875.

 

 

Part 3. How much more cash would the Braucher Merchandising Corporation have available if it uses LIFO perpetual? $40.  The cash difference between inventory methods is a result of the income taxes payments difference, which in this case is $40 ($271 - $231).


 

Solutions Menu

Chapter Seven

Chapter Nine