Periodic and perpetual inventory system pdf

Perpetual Inventory System And Inventory Valuation Methods

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6

Reporting and Analyzing Inventory

 CHAPTER PREVIEW 

In the previous chapter, we discussed the accounting for merchandise inventory using a perpetual inventory system. In this chapter, we explain the methods used to calculate the cost of inventory on hand at the balance sheet date and the cost of goods sold. We conclude by illustrating methods for analyzing inventory.

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“Where Is That Spare Bulldozer Blade?”

Let's talk inventory—big, bulldozer-size inventory. Caterpillar Inc. is the world's largest manufacturer of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines. It sells its products in over 200 countries, making it one of the most successful U.S. exporters.

In the past, Caterpillar's pro�itability suffered, but today it is very successful. A big part of this turnaround can be attributed to effective management of its inventory. Imagine what it costs Caterpillar to have too many bulldozers sitting around in inventory—a situation the company de�initely wants to avoid. Yet, Caterpillar must also make sure it has enough inventory to meet demand.

At one time during a 7-year period, Caterpillar's sales increased by 100%, while its inventory increased by only 50%. To achieve this dramatic reduction in the amount of resources tied up in inventory, while continuing to meet customers' needs, Caterpillar used a two-pronged approach. First, it completed a factory modernization program, which dramatically increased its production ef�iciency. The program reduced by 60% the amount of inventory the company processed at any one time.

It also reduced by an incredible 75% the time it takes to manufacture a part.

Second, Caterpillar dramatically improved its parts distribution system. It ships more than 100,000 items daily from its 23 distribution centers strategically located around the world (10 million square feet of warehouse space—remember, we're talking bulldozers). The company can virtually guarantee that it can get any part to anywhere in the world within 24 hours.

These changes led to record exports, pro�its, and revenues for Caterpillar. It would have seemed that things couldn't have been better. But industry analysts, as well as the company's managers, thought otherwise. In order to maintain Caterpillar's position as the industry leader, management began another major overhaul of inventory production and inventory management processes. The goal: to cut the number of repairs in half, increase productivity by 20%, and increase inventory turnover by 40%.

In short, Caterpillar's ability to manage its inventory has been a key reason for its past success and will very likely play a huge part in its future pro�itability as well.

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LEARNING OBJECTIVE 1

Discuss how to classify and determine inventory. 

Two important steps in the reporting of inventory at the end of the accounting period are the classi�ication of inventory based on its degree of completeness and the determination of inventory amounts.

CLASSIFYING INVENTORY How a company classi�ies its inventory depends on whether the �irm is a merchandiser or a manufacturer. In a merchandising company, such as those described in Chapter 5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch05#ch05) , inventory consists of many different items. For example, in a grocery store, canned goods, dairy products, meats, and produce are just a few of the inventory items on hand. These items have two common characteristics: (1) they are owned by the company, and (2) they are in a form ready for sale to customers in the ordinary course of business. Thus, merchandisers need only one inventory classi�ication, merchandise inventory, to describe the many different items that make up the total inventory.

In a manufacturing company, some inventory may not yet be ready for sale. As a result, manufacturers usually classify inventory into three categories: �inished goods, work in process, and raw materials. Finished goods inventory is manufactured items that are completed and ready for sale. Work in process is that portion of manufactured inventory that has begun the production process but is not yet complete. Raw materials are the basic goods that will be used in production but have not yet been placed into production.

For example, Caterpillar classi�ies earth-moving tractors completed and ready for sale as �inished goods. It classi�ies the tractors on the assembly line in various stages of production as work in process. The steel, glass, tires, and other components that are on hand waiting to be used in the production of tractors are identi�ied as raw materials. Illustration 6-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo1#c06- �ig-0001) shows an excerpt from Note 7 of Caterpillar's annual report.

ILLUSTRATION 6-1 Composition of Caterpillar's inventory

By observing the levels and changes in the levels of these three inventory types, �inancial statement users can gain insight into management's production plans. For example, low levels of raw materials and high levels of �inished goods suggest that management believes it has enough inventory on hand, and production will be slowing down—perhaps in anticipation of a recession. Conversely, high levels of raw materials and low levels of �inished goods probably signal that management is planning to step up production.

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Many companies have signi�icantly lowered inventory levels and costs using just-in-time (JIT) inventory methods. Under a just-in-time method, companies manufacture or purchase goods only when needed. Dell is famous for having developed a system for making computers in response to individual customer requests. Even though it makes computers to meet a customer's particular speci�ications, Dell is able to assemble the computer and put it on a truck in less than 48 hours. The success of a JIT system depends on reliable suppliers. By integrating its information systems with those of its suppliers, Dell reduced its inventories to nearly zero. This is a huge advantage in an industry where products become obsolete nearly overnight.

The accounting concepts discussed in this chapter apply to the inventory classi�ications of both merchandising and manufacturing companies. Our focus throughout most of this chapter is on merchandise inventory. Additional issues speci�ic to manufacturing companies are discussed in managerial accounting courses.

 ACCOUNTING ACROSS THE ORGANIZATION 

FORD

A Big Hiccup

JIT can save a company a lot of money, but it isn't without risk. An unexpected disruption in the supply chain can cost a company a lot of money. Japanese automakers experienced just such a disruption when a 6.8-magnitude earthquake caused major damage to the company that produces 50% of their piston rings. The rings themselves cost only $1.50, but you cannot make a car without them. As a result, the automakers were forced to shut down production for a few days—a loss of tens of thousands of cars.

Similarly, a major snowstorm halted production at the Canadian plants of Ford. A Ford spokesperson said, “Because the plants run with just-in-time inventory, we don't have large stockpiles of parts sitting around. When you have a somewhat signi�icant disruption, you can pretty quickly run out of parts.”

Sources: Amy Chozick, “A Key Strategy of Japan's Car Makers Back�ires,” Wall Street Journal (July 20, 2007); and Kate Linebaugh, “Canada Military Evacuates Motorists Stranded by Snow,” Wall Street Journal (December 15, 2010).

What steps might the companies take to avoid such a serious disruption in the future? (Go to WileyPLUS for this answer and additional questions.)

▼ HELPFUL HINT

Regardless of the classi�ication, companies report all inventories under Current Assets on the balance sheet.

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DETERMINING INVENTORY QUANTITIES No matter whether they are using a periodic or perpetual inventory system, all companies need to determine inventory quantities at the end of the accounting period. If using a perpetual system, companies take a physical inventory for the following reasons. The �irst is to check the accuracy of their perpetual inventory records. The second is to determine the amount of inventory lost due to wasted raw materials, shoplifting, or employee theft.

Companies using a periodic inventory system must take a physical inventory for two different purposes: to determine the inventory on hand at the balance sheet date, and to determine the cost of goods sold for the period.

Determining inventory quantities involves two steps: (1) taking a physical inventory of goods on hand and (2) determining the ownership of goods.

Taking a Physical Inventory

Companies take the physical inventory at the end of the accounting period. Taking a physical inventory involves actually counting, weighing, or measuring each kind of inventory on hand. In many companies, taking an inventory is a formidable task. Retailers such as Target, True Value Hardware, or Home Depot have thousands of different inventory items. An inventory count is generally more accurate when a limited number of goods are being sold or received during the counting. Consequently, companies often “take inventory” when the business is closed or when business is slow. Many retailers close early on a chosen day in January—after the holiday sales and returns, when inventories are at their lowest level—to count inventory. Wal-Mart, for example, has a year- end of January 31.

ETHICS NOTE

In a famous fraud, a salad oil company �illed its storage tanks mostly with water. The oil rose to the top, so auditors thought the tanks were full of oil. The company also said it had more tanks than it really did: it repainted numbers on the tanks to confuse auditors.

 ETHICS INSIGHT 

Leslie Fay

Falsifying Inventory to Boost Income

Managers at women's apparel maker Leslie Fay were convicted of falsifying inventory records to boost net income in an attempt to increase management bonuses. In another case, executives at Craig Consumer Electronics were accused of defrauding lenders by manipulating inventory records. The indictment said the company classi�ied “defective goods as new or refurbished” and claimed that it owned certain shipments “from overseas suppliers” when, in fact, Craig either did not own the shipments or the shipments did not exist.

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What effect does an overstatement of inventory have on a company's �inancial statements? (Go to WileyPLUS for this answer and additional questions.)

Determining Ownership of Goods

One challenge in determining inventory quantities is making sure a company owns the inventory. To determine ownership of goods, two questions must be answered: Do all of the goods included in the count belong to the company? Does the company own any goods that were not included in the count?

GOODS IN TRANSIT

A complication in determining ownership is goods in transit (on board a truck, train, ship, or plane) at the end of the period. The company may have purchased goods that have not yet been received, or it may have sold goods that have not yet been delivered. To arrive at an accurate count, the company must determine ownership of these goods.

Goods in transit should be included in the inventory of the company that has legal title to the goods. Legal title is determined by the terms of the sale, as shown in Illustration 6-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo1#c06-�ig-0002) and described below.

ILLUSTRATION 6-2 Terms of sale

1. When the terms are FOB (free on board) shipping point, ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller.

2. When the terms are FOB destination, ownership of the goods remains with the seller until the goods reach the buyer.

CONSIGNED GOODS

In some lines of business, it is common to hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of the goods. These are called consigned goods.

For example, you might have a used car that you would like to sell. If you take the item to a dealer, the dealer might be willing to put the car on its lot and charge you a commission if it is sold. Under this agreement, the dealer would not take ownership of the car, which would still belong to you. If an inventory count were taken, the car would not be included in the dealer's inventory because the dealer does not own it.

Many car, boat, and antique dealers sell goods on consignment to keep their inventory costs down and to avoid the risk of purchasing an item that they will not be able to sell. Today, even some manufacturers are making

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consignment agreements with their suppliers in order to keep their inventory levels low.

ANATOMY OF A FRAUD

Ted Nickerson, CEO of clock manufacturer Dally Industries, had expensive tastes. To support this habit, Ted took out large loans, which he collateralized with his shares of Dally Industries stock. If the price of Dally's stock fell, he was required to provide the bank with more shares of stock. To achieve target net income �igures and thus maintain the stock price, Ted coerced employees in the company to alter inventory �igures. Inventory quantities were manipulated by changing the amounts on inventory control tags after the year-end physical inventory count. For example, if a tag said there were 20 units of a particular item, the tag was changed to 220. Similarly, the unit costs that were used to determine the value of ending inventory were increased from, for example, $125 per unit to $1,250. Both of these fraudulent changes had the effect of increasing the amount of reported ending inventory. This reduced cost of goods sold and increased net income.

Total take: $245,000

THE MISSING CONTROL

Independent internal veri�ication. The company should have spot-checked its inventory records periodically, verifying that the number of units in the records agreed with the amount on hand and that the unit costs agreed with vendor price sheets.

Source: Adapted from Wells, Fraud Casebook (2007), pp. 502–509.

DO IT! 1

Rules of Ownership

Hasbeen Company completed its inventory count. It arrived at a total inventory value of $200,000. You have been given the information listed below. Discuss how this information affects the reported cost of inventory.

1. Hasbeen included in the inventory goods held on consignment for Falls Co., costing $15,000.

2. The company did not include in the count purchased goods of $10,000, which were in transit (terms: FOB shipping point).

3. The company did not include in the count inventory that had been sold with a cost of $12,000, which was in transit (terms: FOB shipping point).

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Action Plan ✓ Apply the rules of ownership to goods held on consignment.

✓ Apply the rules of ownership to goods in transit.

SOLUTION

The goods of $15,000 held on consignment should be deducted from the inventory count. The goods of $10,000 purchased FOB shipping point should be added to the inventory count. Item 3 was treated correctly. Sold goods of $12,000 which were in transit FOB shipping point should not be included in the ending inventory. Inventory should be $195,000 ($200,000−$15,000+$10,000).

Related exercise material: BE6-1, DO IT! 6-1, E6-1, E6-2, and E6-3.

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LEARNING OBJECTIVE 2

Apply inventory cost �low methods and discuss their �inancial effects. 

Inventory is accounted for at cost. Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale. For example, freight costs incurred to acquire inventory are added to the cost of inventory, but the cost of shipping goods to a customer is a selling expense. After a company has determined the quantity of units of inventory, it applies unit costs to the quantities to determine the total cost of the inventory and the cost of goods sold. This process can be complicated if a company has purchased inventory items at different times and at different prices.

For example, assume that Crivitz TV Company purchases three identical 50-inch TVs on different dates at costs of $700, $750, and $800. During the year, Crivitz sold two TVs at $1,200 each. These facts are summarized in Illustration 6-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0003) .

ILLUSTRATION 6-3 Data for inventory costing example

Cost of goods sold will differ depending on which two TVs the company sold. For example, it might be $1,450 ($700+$750), or $1,500 ($700+$800), or $1,550 ($750+$800). In this section, we discuss alternative costing methods available to Crivitz.

SPECIFIC IDENTIFICATION If Crivitz can positively identify which particular units it sold and which are still in ending inventory, it can use the speci�ic identi�ication method of inventory costing. For example, if Crivitz sold the TVs it purchased on February 3 and May 22, then its cost of goods sold is $1,500 ($700+$800), and its ending inventory is $750 (see Illustration 6-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0004) ). Using this method, companies can accurately determine ending inventory and cost of goods sold.

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ILLUSTRATION 6-4 Speci�ic identi�ication method

Speci�ic identi�ication requires that companies keep records of the original cost of each individual inventory item. Historically, speci�ic identi�ication was possible only when a company sold a limited variety of high-unit- cost items that could be identi�ied clearly from the time of purchase through the time of sale. Examples of such products are cars, pianos, or expensive antiques.

Today, with bar coding, electronic product codes, and radio frequency identi�ication, it is theoretically possible to do speci�ic identi�ication with nearly any type of product. The reality is, however, that this practice is still relatively rare. Instead, rather than keep track of the cost of each particular item sold, most companies make assumptions, called cost �low assumptions, about which units were sold.

ETHICS NOTE

A major disadvantage of the speci�ic identi�ication method is that management may be able to manipulate net income. For example, it can boost net income by selling units purchased at a low cost, or reduce net income by selling units purchased at a high cost.

COST FLOW ASSUMPTIONS Because speci�ic identi�ication is often impractical, other cost �low methods are permitted. These differ from speci�ic identi�ication in that they assume �lows of costs that may be unrelated to the actual physical �low of goods. There are three assumed cost �low methods:

1. First-in, �irst-out (FIFO)

2. Last-in, �irst-out (LIFO)

3. Average-cost

There is no accounting requirement that the cost �low assumption be consistent with the physical movement of the goods. Company management selects the appropriate cost �low method.

To demonstrate the three cost �low methods, we will use a periodic inventory system. We assume a periodic system because very few companies use perpetual LIFO, FIFO, or average-cost to cost their inventory and related cost of goods sold. Instead, companies that use perpetual systems, as shown in Chapter 5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch05#ch05) , often use an assumed cost (called a standard cost) to record cost of goods sold at the time of sale. Then, at the end of the period when they count their inventory, they recalculate cost of goods sold using periodic FIFO, LIFO, or average-cost as shown in this chapter and adjust cost of goods sold to this recalculated number.1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06ifrs#c06-note-0004)

To illustrate the three inventory cost �low methods, we will use the data for Houston Electronics' Astro condensers, shown in Illustration 6-5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0005) .

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ILLUSTRATION 6-5 Data for Houston Electronics

From Chapter 5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch05#ch05) , the cost of goods sold formula in a periodic system is:

(Beginning Inventory+Purchases)−Ending Inventory=Cost of Goods Sold

Houston Electronics had a total of 1,000 units available to sell during the period (beginning inventory plus purchases). The total cost of these 1,000 units is $12,000, referred to as cost of goods available for sale. A physical inventory taken at December 31 determined that there were 450 units in ending inventory. Therefore, Houston sold 550 units (1,000 − 450) during the period. To determine the cost of the 550 units that were sold (the cost of goods sold), we assign a cost to the ending inventory and subtract that value from the cost of goods available for sale. The value assigned to the ending inventory depends on which cost �low method we use. No matter which cost �low assumption we use, though, the sum of cost of goods sold plus the cost of the ending inventory must equal the cost of goods available for sale—in this case, $12,000.

First-In, First-Out (FIFO)

The �irst-in, �irst-out (FIFO) method assumes that the earliest goods purchased are the �irst to be sold. FIFO often parallels the actual physical �low of merchandise because it generally is good business practice to sell the oldest units �irst. Under the FIFO method, therefore, the costs of the earliest goods purchased are the �irst to be recognized in determining cost of goods sold, regardless of which units were actually sold. (Note that this does not mean that the oldest units are sold �irst, but that the costs of the oldest units are recognized �irst. In a bin of picture hangers at the hardware store, for example, no one really knows, nor would it matter, which hangers are sold �irst.) Illustration 6-6 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig- 0006) shows the allocation of the cost of goods available for sale at Houston Electronics under FIFO.

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ILLUSTRATION 6-6 Allocation of costs—FIFO method

Under FIFO, since it is assumed that the �irst goods purchased were the �irst goods sold, ending inventory is based on the prices of the most recent units purchased. That is, under FIFO, companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed. In this example, Houston Electronics prices the 450 units of ending inventory using the most recent prices. The last purchase was 400 units at $13 on November 27. The remaining 50 units are priced using the unit cost of the second most recent purchase, $12, on August 24. Next, Houston Electronics calculates cost of goods sold by subtracting the cost of the units not sold (ending inventory) from the cost of all goods available for sale.

Illustration 6-7 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0007) demonstrates that companies also can calculate cost of goods sold by pricing the 550 units sold using the prices of the �irst 550 units acquired. Note that of the 300 units purchased on August 24, only 250 units are assumed sold. This agrees with our calculation of the cost of ending inventory, where 50 of these units were assumed unsold and thus included in ending inventory.

ILLUSTRATION 6-7 Proof of cost of goods sold

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▼ HELPFUL HINT

Note the sequencing of the allocation: (1) compute ending inventory, and (2) determine cost of goods sold.

▼ HELPFUL HINT

Another way of thinking about the calculation of FIFO ending inventory is the LISH assumption—last in still here.

Last-In, First-Out (LIFO)

The last-in, �irst-out (LIFO) method assumes that the latest goods purchased are the �irst to be sold. LIFO seldom coincides with the actual physical �low of inventory. (Exceptions include goods stored in piles, such as coal or hay, where goods are removed from the top of the pile as they are sold.) Under the LIFO method, the costs of the latest goods purchased are the �irst to be recognized in determining cost of goods sold. Illustration 6-8 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0008) shows the allocation of the cost of goods available for sale at Houston Electronics under LIFO.

ILLUSTRATION 6-8 Allocation of costs—LIFO method

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Under LIFO, since it is assumed that the �irst goods sold were those that were most recently purchased, ending inventory is based on the prices of the oldest units purchased. That is, under LIFO, companies obtain the cost of the ending inventory by taking the unit cost of the earliest goods available for sale and working forward until all units of inventory have been costed. In this example, Houston Electronics prices the 450 units of ending inventory using the earliest prices. The �irst purchase was 100 units at $10 in the January 1 beginning inventory. Then, 200 units were purchased at $11. The remaining 150 units needed are priced at $12 per unit (August 24 purchase). Next, Houston Electronics calculates cost of goods sold by subtracting the cost of the units not sold (ending inventory) from the cost of all goods available for sale.

Illustration 6-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0009) demonstrates that we can also calculate cost of goods sold by pricing the 550 units sold using the prices of the last 550 units acquired. Note that of the 300 units purchased on August 24, only 150 units are assumed sold. This agrees with our calculation of the cost of ending inventory, where 150 of these units were assumed unsold and thus included in ending inventory.

ILLUSTRATION 6-9 Proof of cost of goods sold

Under a periodic inventory system, which we are using here, all goods purchased during the period are assumed to be available for the �irst sale, regardless of the date of purchase.

▼ HELPFUL HINT

Another way of thinking about the calculation of LIFO ending inventory is the FISH assumption—�irst in still here.

Average-Cost

The average-cost method allocates the cost of goods available for sale on the basis of the weighted-average unit cost incurred. Illustration 6-10 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0010) presents the formula and a sample computation of the weighted-average unit cost.

ILLUSTRATION 6-10 Formula for weighted-average unit cost

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The company then applies the weighted-average unit cost to the units on hand to determine the cost of the ending inventory. Illustration 6-11 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0011) shows the allocation of the cost of goods available for sale at Houston Electronics using average-cost.

ILLUSTRATION 6-11 Allocation of costs—average-cost method

We can verify the cost of goods sold under this method by multiplying the units sold times the weighted-average unit cost (550×$12=$6,600). Note that this method does not use the simple average of the unit costs. The simple average is $11.50 ($10+$11+$12+$13=$46; $46÷4). The average-cost method instead uses the average weighted by the quantities purchased at each unit cost.

FINANCIAL STATEMENT AND TAX EFFECTS OF COST FLOW METHODS Each of the three assumed cost �low methods is acceptable for use under GAAP. For example, Reebok International Ltd. and Wendy's International currently use the FIFO method of inventory costing. Campbell Soup Company, Krogers, and Walgreens use LIFO for part or all of their inventory. Bristol-Myers Squibb, Starbucks, and Motorola use the average-cost method. In fact, a company may also use more than one cost �low method at the same time. Stanley Black & Decker Manufacturing Company, for example, uses LIFO for domestic inventories and FIFO for foreign inventories. Illustration 6-12 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0012) (in the margin) shows the use of the three cost �low methods in 500 large U.S. companies.

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ILLUSTRATION 6-12 Use of cost �low methods in major U.S. companies

The reasons companies adopt different inventory cost �low methods are varied, but they usually involve at least one of the following three factors: (1) income statement effects, (2) balance sheet effects, or (3) tax effects.

DECISION TOOLS

Analyzing �inancial statement and tax effects helps users determine which inventory costing method best meets the company's objectives.

Income Statement Effects

To understand why companies might choose a particular cost �low method, let's examine the effects of the different cost �low assumptions on the �inancial statements of Houston Electronics. The condensed income statements in Illustration 6-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06- �ig-0013) assume that Houston sold its 550 units for $18,500, had operating expenses of $9,000, and is subject to an income tax rate of 30%.

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ILLUSTRATION 6-13 Comparative effects of cost �low methods

Note the cost of goods available for sale ($12,000) is the same under each of the three inventory cost �low methods. However, the ending inventories and the costs of goods sold are different. This difference is due to the unit costs that the company allocated to cost of goods sold and to ending inventory. Each dollar of difference in ending inventory results in a corresponding dollar difference in income before income taxes. For Houston, an $800 difference exists between FIFO and LIFO cost of goods sold.

In periods of changing prices, the cost �low assumption can have signi�icant impacts both on income and on evaluations of income, such as the following.

1. In a period of in�lation, FIFO produces a higher net income because lower unit costs of the �irst units purchased are matched against revenue.

2. In a period of in�lation, LIFO produces a lower net income because higher unit costs of the last goods purchased are matched against revenue.

3. If prices are falling, the results from the use of FIFO and LIFO are reversed. FIFO will report the lowest net income and LIFO the highest.

4. Regardless of whether prices are rising or falling, average-cost produces net income between FIFO and LIFO.

To management, higher net income is an advantage. It causes external users to view the company more favorably. In addition, management bonuses, if based on net income, will be higher. Therefore, when prices are rising (which is usually the case), companies tend to prefer FIFO because it results in higher net income.

Others believe that LIFO presents a more realistic net income number. That is, LIFO matches the more recent costs against current revenues to provide a better measure of net income. During periods of in�lation, many challenge the quality of non-LIFO earnings, noting that failing to match current costs against current revenues leads to an understatement of cost of goods sold and an overstatement of net income. As some indicate, net income computed using FIFO creates “paper or phantom pro�its”—that is, earnings that do not really exist.

Balance Sheet Effects

A major advantage of the FIFO method is that in a period of in�lation, the costs allocated to ending inventory will approximate their current cost. For example, for Houston Electronics, 400 of the 450 units in the ending inventory are costed under FIFO at the higher November 27 unit cost of $13.

Conversely, a major shortcoming of the LIFO method is that in a period of in�lation, the costs allocated to ending inventory may be signi�icantly understated in terms of current cost. The understatement becomes greater over prolonged periods of in�lation if the inventory includes goods purchased in one or more prior accounting periods. For example, Caterpillar has used LIFO for 50 years. Its balance sheet shows ending inventory of $14.5 billion. But the inventory's actual current cost if FIFO had been used is $17.0 billion.

▼ HELPFUL HINT

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A tax rule, often referred to as the LIFO conformity rule, requires that if companies use LIFO for tax purposes, they must also use it for �inancial reporting purposes. This means that if a company chooses the LIFO method to reduce its tax bills, it will also have to report lower net income in its �inancial statements.

Tax Effects

We have seen that both inventory on the balance sheet and net income on the income statement are higher when companies use FIFO in a period of in�lation. Yet, many companies use LIFO. Why? The reason is that LIFO results in the lowest income taxes (because of lower net income) during times of rising prices. For example, in Illustration 6-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0013) income taxes are $750 under LIFO, compared to $990 under FIFO. The tax savings of $240 makes more cash available for use in the business.

 INTERNATIONAL INSIGHT 

ExxonMobil Corporation

Is LIFO Fair?

ExxonMobil Corporation, like many U.S. companies, uses LIFO to value its inventory for �inancial reporting and tax purposes. In one recent year, this resulted in a cost of goods sold �igure that was $5.6 billion higher than under FIFO. By increasing cost of goods sold, ExxonMobil reduces net income, which reduces taxes. Critics say that LIFO provides an unfair “tax dodge.” As Congress looks for more sources of tax revenue, some lawmakers favor the elimination of LIFO. Supporters of LIFO argue that the method is conceptually sound because it matches current costs with current revenues. In addition, they point out that this matching provides protection against in�lation.

International accounting standards do not allow the use of LIFO. Because of this, the net income of foreign oil companies such as BP and Royal Dutch Shell are not directly comparable to U.S. companies, which can make analysis dif�icult.

Source: David Reilly, “Big Oil's Accounting Methods Fuel Criticism,” Wall Street Journal (August 8, 2006), p. C1.

What are the arguments for and against the use of LIFO? (Go to WileyPLUS for this answer and additional questions.)

KEEPING AN EYE ON CASH

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You have just seen that when prices are rising the use of LIFO can have a big effect on taxes. The lower taxes paid using LIFO can signi�icantly increase cash �lows. To demonstrate the effect of the cost �low assumptions on cash �low, we will calculate net cash provided by operating activities using the data for Houston Electronics from Illustration 6-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0013) . To simplify our example, we assume that Houston's sales and purchases are all cash transactions. We also assume that operating expenses, other than $4,600 of depreciation, are cash transactions.

FIFO LIFO Average-Cost Cash received from customers $18,500 $18,500 $18,500 Cash purchases of goods 11,000 11,000  11,000 Cash paid for operating expenses ($9,000 − $4,600) 4,400 4,400   4,400 Cash paid for taxes 990 750 870 Net cash provided by operating activities $ 2,110 $ 2,350 $ 2,230

LIFO has the highest net cash provided by operating activities because it results in the lowest tax payments. Since cash �low is the lifeblood of any organization, the choice of inventory method is very important.

LIFO also impacts the quality of earnings ratio. Recall that the quality of earnings ratio is net cash provided by operating activities divided by net income. Here, we calculate the quality of earnings ratio under each cost �low assumption.

FIFO LIFO Average- Cost

Net income (from Illustration 6-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06- �ig-0013) )

$2,310 $1,750 $2,030

Quality of earnings ratio 0.91 1.34     1.1

LIFO has the highest quality of earnings ratio for two reasons. (1) It has the highest net cash provided by operating activities, which increases the ratio's numerator. (2) It reports a conservative measure of net income, which decreases the ratio's denominator. As discussed earlier, LIFO provides a conservative measure of net income because it does not include the phantom pro�its reported under FIFO.

USING INVENTORY COST FLOW METHODS CONSISTENTLY Whatever cost �low method a company chooses, it should use that method consistently from one accounting period to another. Consistent application enhances the ability to analyze a company's �inancial statements over successive time periods. In contrast, using the FIFO method one year and the LIFO method the next year would make it dif�icult to compare the net incomes of the two years.

Although consistent application is preferred, it does not mean that a company may never change its method of inventory costing. When a company adopts a different method, it should disclose in the �inancial statements the change and its effects on net income. A typical disclosure is shown in Illustration 6-14

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(http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0014) , using information from recent �inancial statements of Quaker Oats (now a unit of PepsiCo).

ILLUSTRATION 6-14 Disclosure of change in cost �low method

▼ HELPFUL HINT

As you learned in Chapter 2 (c02.xhtml) , consistency and comparability are important characteristics of accounting information.

DO IT! 2

Cost Flow Methods

The accounting records of Shumway Ag Implement show the following data.

Beginning inventory 4,000 units at $3 Purchases 6,000 units at $4 Sales 7,000 units at $12

Determine (a) the cost of goods available for sale and (b) the cost of goods sold during the period under a periodic system using (i) FIFO, (ii) LIFO, and (iii) average-cost.

Action Plan ✓ Understand the periodic inventory system.

✓ Allocate costs between goods sold and goods on hand (ending inventory) for each cost �low method.

✓ Compute cost of goods sold for each cost �low method.

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Related exercise material: BE6-2, BE6-3, BE6-5, DO IT! 6-2, E6-4, E6-5, E6-6, E6-7, and E6-8.

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LEARNING OBJECTIVE 3

Explain the statement presentation and analysis of inventory. 

PRESENTATION As indicated in Chapter 5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch05#ch05) , inventory is classi�ied in the balance sheet as a current asset immediately below receivables. In a multiple-step income statement, cost of goods sold is subtracted from net sales. There also should be disclosure of (1) the major inventory classi�ications, (2) the basis of accounting (cost, or lower-of-cost-or-market), and (3) the cost method (FIFO, LIFO, or average-cost).

Wal-Mart Stores, Inc., for example, in its January 31, 2014, balance sheet reported inventories of $44,858 million under current assets. The accompanying notes to the �inancial statements, as shown in Illustration 6-15 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo3#c06-�ig-0015) , disclosed the following information.

ILLUSTRATION 6-15 Inventory disclosures by Wal-Mart

As indicated in this note, Wal-Mart values its inventories at the lower-of-cost-or-market using LIFO and FIFO.

LOWER-OF-COST-OR-MARKET The value of inventory for companies selling high-technology or fashion goods can drop very quickly due to changes in technology or changes in fashions. These circumstances sometimes call for inventory valuation methods other than those presented so far. For example, at one time, purchasing managers at Ford decided to make a large purchase of palladium, a precious metal used in vehicle emission devices. They made this large purchase because they feared a future shortage. The shortage did not materialize, and by the end of the year the price of palladium had plummeted. Ford's inventory was then worth $1 billion less than its original cost. Do you think Ford's inventory should have been stated at cost, in accordance with the historical cost principle, or at its lower replacement cost?

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As you probably reasoned, this situation requires a departure from the cost basis of accounting. This is done by valuing the inventory at the lower-of-cost-or-market (LCM) in the period in which the price decline occurs. LCM is a basis whereby inventory is stated at the lower of either its cost or market value as determined by current replacement cost. LCM is an example of the accounting convention of conservatism. Conservatism means that the approach adopted among accounting alternatives is the method that is least likely to overstate assets and net income.

Companies apply LCM to the items in inventory after they have used one of the cost �low methods (speci�ic identi�ication, FIFO, LIFO, or average-cost) to determine cost. Under the LCM basis, market is de�ined as current replacement cost, not selling price. For a merchandising company, current replacement cost is the cost of purchasing the same goods at the present time from the usual suppliers in the usual quantities. Current replacement cost is used because a decline in the replacement cost of an item usually leads to a decline in the selling price of the item.

To illustrate the application of LCM, assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated. LCM produces the results shown in Illustration 6-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo3#c06-�ig-0016) . Note that the amounts shown in the �inal column are the lower-of-cost-or-market amounts for each item.

ILLUSTRATION 6-16 Computation of lower-of-cost-or-market

Adherence to LCM is important. Acer Inc. recently took a charge of $150 million on personal computers, which declined in value before they could be sold. A Chinese manufacturer of silicon wafers for solar energy panels, LDK Solar Co., was accused of violating LCM. When the �inancial press reported accusations that two-thirds of its inventory of silicon was unsuitable for processing, the company's stock price fell by 40%.

INTERNATIONAL NOTE Under U.S. GAAP, companies cannot reverse inventory write-downs if inventory increases in value in subsequent periods. IFRS permits companies to reverse write-downs in some circumstances.

DO IT! 3a

LCM Basis

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Tracy Company sells three different types of home heating stoves (gas, wood, and pellet). The cost and market value of its inventory of stoves are as follows.

Cost Market

Gas $ 84,000 $ 79,000 Wood  250,000  280,000 Pellet  112,000  101,000

Determine the value of the company's inventory under the lower-of-cost-or-market approach.

Action Plan ✓ Determine whether cost or market value is lower for each

inventory type.

✓ Sum the lower value of each inventory type to determine the total value of inventory.

SOLUTION

The lower value for each inventory type is gas $79,000, wood $250,000, and pellet $101,000. The total inventory value is the sum of these �igures, $430,000.

Related exercise material: BE6-7, DO IT! 6-3a, E6-9, and E6-10.

ANALYSIS For companies that sell goods, managing inventory levels can be one of the most critical tasks. Having too much inventory on hand costs the company money in storage costs, interest cost (on funds tied up in inventory), and costs associated with the obsolescence of technical goods (e.g., computer chips) or shifts in fashion (e.g., clothes). But having too little inventory on hand results in lost sales. In this section, we discuss some issues related to evaluating inventory levels.

Inventory Turnover

The inventory turnover is calculated as cost of goods sold divided by average inventory. It indicates the liquidity of inventory by measuring the number of times the average inventory “turns over” (is sold) during the year. Inventory turnover can be divided into 365 days to compute days in inventory, which indicates the average number of days inventory is held.

High inventory turnover (low days in inventory) indicates the company has minimal funds tied up in inventory —that it has a minimal amount of inventory on hand at any one time. Although minimizing the funds tied up in

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inventory is ef�icient, too high an inventory turnover may indicate that the company is losing sales opportunities because of inventory shortages. For example, investment analysts at one time suggested that Of�ice Depot had gone too far in reducing its inventory—they said they were seeing too many empty shelves. Thus, management should closely monitor this ratio to achieve the best balance between too much and too little inventory.

In Chapter 5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch05#ch05) , we discussed the increasingly competitive environment of retailers, such as Wal-Mart and Target. Wal-Mart has implemented just-in-time inventory procedures as well as many technological innovations to improve the ef�iciency of its inventory management. The following data are available for Wal-Mart.

(in millions) 2014 2013

Ending inventory $ 44,858 $43,803 Cost of goods sold 358,069

Illustration 6-17 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo3#c06-�ig-0017) presents the inventory turnovers and days in inventory for Wal-Mart and Target, using data from the �inancial statements of those corporations for 2014 and 2013.

ILLUSTRATION 6-17 Inventory turnovers and days in inventory

The calculations in Illustration 6-17 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo3#c06-�ig-0017) show that Wal-Mart turns its inventory more frequently than Target (8.1 times for Wal-Mart versus 6.1 times for Target). Consequently, the average time an item spends on a Wal-Mart shelf is shorter (45.1 days for Wal-Mart versus 59.8 days for Target).

This analysis suggests that Wal-Mart is more ef�icient than Target in its inventory management. Wal-Mart's sophisticated inventory tracking and distribution system allows it to keep minimum amounts of inventory on hand, while still keeping the shelves full of what customers are looking for.

DECISION TOOLS

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Inventory turnover and days in inventory help users determine how long an item is in inventory.

 ACCOUNTING ACROSS THE ORGANIZATION 

Sony

Too Many TVs or Too Few?

Financial analysts closely monitor the inventory management practices of companies. For example, some analysts following Sony expressed concern because the company built up its inventory of televisions in an attempt to sell 25 million liquid crystal display (LCD) TVs—a 60% increase over the prior year. A year earlier, Sony had cut its inventory levels so that its quarterly days in inventory was down to 38 days, compared to 61 days for the same quarter a year before that. But in the next year, as a result of its inventory build-up, days in inventory rose to 59 days. Management said that it didn't think that Sony's inventory levels were too high. However, analysts were concerned that the company would have to engage in very heavy discounting in order to sell off its inventory. Analysts noted that the losses from discounting can be “punishing.”

Source: Daisuke Wakabayashi, “Sony Pledges to Corral Inventory,” Wall Street Journal Online (November 2, 2010).

For Sony, what are the advantages and disadvantages of having a low days in inventory measure? (Go to WileyPLUS for this answer and additional questions.)

ADJUSTMENTS FOR LIFO RESERVE Earlier, we noted that using LIFO rather than FIFO can result in signi�icant differences in the results reported in the balance sheet and the income statement. With increasing prices, FIFO will result in higher income than LIFO. On the balance sheet, FIFO will result in higher reported inventory. The �inancial statement differences from using LIFO normally increase the longer a company uses LIFO.

Use of different inventory cost �low assumptions complicates analysts' attempts to compare companies' results. Fortunately, companies using LIFO are required to report the difference between inventory reported using LIFO and inventory using FIFO. This amount is referred to as the LIFO reserve. Reporting the LIFO reserve enables analysts to make adjustments to compare companies that use different cost �low methods.

Illustration 6-18 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo3#c06-�ig-0018) presents an excerpt from the notes to Caterpillar's 2014 �inancial statements that discloses and discusses Caterpillar's LIFO reserve.

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ILLUSTRATION 6-18 Caterpillar's LIFO reserve

Caterpillar has used LIFO for over 50 years. Thus, the cumulative difference between LIFO and FIFO re�lected in the Inventory account is very large. In fact, the 2014 LIFO reserve of $2,430 million is 20% of the 2014 LIFO inventory of $12,205 million. Such a huge difference would clearly distort any comparisons you might try to make with one of Caterpillar's competitors that used FIFO.

To adjust Caterpillar's inventory balance, we add the LIFO reserve to reported inventory, as shown in Illustration 6-19 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo3#c06-�ig-0019) . That is, if Caterpillar had used FIFO all along, its inventory would be $14,635 million, rather than $12,205 million.

ILLUSTRATION 6-19 Conversion of inventory from LIFO to FIFO

The LIFO reserve can have a signi�icant effect on ratios that analysts commonly use. Using the LIFO reserve adjustment, Illustration 6-20 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo3#c06-�ig- 0020) calculates the value of the current ratio (current assets ÷ current liabilities) for Caterpillar under both the LIFO and FIFO cost �low assumptions.

ILLUSTRATION 6-20 Impact of LIFO reserve on ratios

As Illustration 6-20 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo3#c06-�ig-0020) shows, if Caterpillar used FIFO, its current ratio would be 1.48:1 rather than 1.39:1 under LIFO. Thus, Caterpillar's liquidity appears stronger if a FIFO assumption were used in valuing inventories.

CNH Global, a competitor of Caterpillar, uses FIFO to account for its inventory. Comparing Caterpillar to CNH without converting Caterpillar's inventory to FIFO would lead to distortions and potentially erroneous decisions.

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DECISION TOOLS

Adjusting inventory from LIFO to FIFO helps users analyze the impact of LIFO on the company's reported income.

DO IT! 3b

Inventory Turnover

Early in 2017, Westmoreland Company switched to a just-in-time inventory system. Its sales, cost of goods sold, and inventory amounts for 2016 and 2017 are shown below.

2016 2017

Sales revenue $2,000,000 $1,800,000 Cost of goods sold  1,000,000    910,000 Beginning inventory    290,000    210,000 Ending inventory    210,000     50,000

Determine the inventory turnover and days in inventory for 2016 and 2017. Discuss the changes in the amount of inventory, the inventory turnover and days in inventory, and the amount of sales across the two years.

Action Plan ✓ To �ind the inventory turnover, divide cost of goods sold by

average inventory.

✓ To determine days in inventory, divide 365 days by the inventory turnover.

✓ Just-in-time inventory reduces the amount of inventory on hand, which reduces carrying costs. Reducing inventory levels by too much has potential negative implications for sales.

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SOLUTION

The company experienced a very signi�icant decline in its ending inventory as a result of the just-in-time inventory. This decline improved its inventory turnover and its days in inventory. However, its sales declined by 10%. It is possible that this decline was caused by the dramatic reduction in the amount of inventory that was on hand, which increased the likelihood of “stockouts.” To determine the optimal inventory level, management must weigh the bene�its of reduced inventory against the potential lost sales caused by stockouts.

Related exercise material: BE6-8, DO IT! 6-3b, E6-11, E6-12, and E6-13.

USING DECISION TOOLS—MANITOWOC COMPANY The Manitowoc Company is located in Manitowoc, Wisconsin. In recent years, it has made a series of strategic acquisitions to grow and enhance its market-leading positions in each of its three business segments: (1) cranes and related products (crawler cranes, tower cranes, and boom trucks), (2) food service equipment (commercial ice-cube machines, ice-beverage dispensers, and commercial refrigeration equipment), and (3) marine operations (shipbuilding and ship-repair services). The company reported inventory of $644.5 million for 2014 and of $720.8 million for 2013. Here is the inventory note taken from the 2014 �inancial statements.

THE MANITOWOC COMPANY Notes to the Financial Statements Inventories: The components of inventories at December 31, 2014 and December 31, 2013 are summarized as follows: (in millions) 2014   2013  

Inventories—gross: Raw materials $226.2  $259.0  Work-in-process 103.7  130.2  Finished goods 414.8  436.8  Total inventories—gross 744.7  826.0  Excess and obsolete inventory reserve (64.0)  (69.0)  Net inventories at FIFO cost 680.7  757.0  Excess of FIFO costs over LIFO value (36.2)  (36.2) 

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THE MANITOWOC COMPANY Notes to the Financial Statements Inventories: The components of inventories at December 31, 2014 and December 31, 2013 are summarized as follows: (in millions) 2014   2013  

Inventories—net (as reported on balance sheet) $644.5  $720.8 

Manitowoc carries inventory at the lower-of-cost-or-market using the �irst-in, �irst-out (FIFO) method for approximately 84% and 87% of total inventory for 2014 and 2013, respectively. The remainder of the inventory is costed using the last-in, �irst-out (LIFO) method.

Additional facts (amounts in millions):

2014 Current liabilities $1,011.3 2014 Current assets (as reported) 1,186.1 2014 Cost of goods sold 2,900.4

INSTRUCTIONS

Answer the following questions.

1. Why does the company report its inventory in three components?

2. Why might the company use two methods (LIFO and FIFO) to account for its inventory?

3. Perform each of the following.

(a) Calculate the inventory turnover and days in inventory using the LIFO inventory.

(b) Calculate the 2014 current ratio using LIFO and the current ratio using FIFO. Discuss the difference.

SOLUTION

1. The Manitowoc Company is a manufacturer, so it purchases raw materials and makes them into �inished products. At the end of each period, it has some goods that have been started but are not yet complete (work in process).

By reporting all three components of inventory, a company reveals important information about its inventory position. For example, if amounts of raw materials have increased signi�icantly compared to the previous year, we might assume the company is planning to step up production. On the other hand, if levels of �inished goods have increased relative to last year and raw materials have declined, we might conclude that sales are slowing down—that the company has too much inventory on hand and is cutting back production.

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2. Companies are free to choose different cost �low assumptions for different types of inventory. A company might choose to use FIFO for a product that is expected to decrease in price over time. One common reason for choosing a method other than LIFO is that many foreign countries do not allow LIFO; thus, the company cannot use LIFO for its foreign operations.

3. This represents a 3.4% increase in the current ratio [(1.21−1.17)/1.17].

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LEARNING OBJECTIVE *4

APPENDIX 6A: Apply inventory cost �low methods to perpetual inventory records. 

Each of the inventory cost �low methods described in the chapter for a periodic inventory system may be used in a perpetual inventory system. To illustrate the application of the three assumed cost �low methods (FIFO, LIFO, and average-cost), we will use the data shown in Illustration 6A-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo4#c06-�ig-0021) and in this chapter for Houston Electronics' Astro condensers.

ILLUSTRATION 6A-1 Inventoriable units and costs

FIRST-IN, FIRST-OUT (FIFO) Under FIFO, the cost of the earliest goods on hand prior to each sale is charged to cost of goods sold. Therefore, the cost of goods sold on September 10 consists of the units on hand January 1 and the units purchased April 15 and August 24. Illustration 6A-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo4#c06- �ig-0022) (page 288) shows the inventory under a FIFO method perpetual system.

ILLUSTRATION 6A-2 Perpetual system—FIFO

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The ending inventory in this situation is $5,800, and the cost of goods sold is $6,200 [(100@$10)+(200@$11)+ (250@$12)].

The results under FIFO in a perpetual system are the same as in a periodic system. (See Illustration 6-6 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0006) on page 274 where, similarly, the ending inventory is $5,800 and cost of goods sold is $6,200.) Regardless of the system, the �irst costs in are the costs assigned to cost of goods sold.

LAST-IN, FIRST-OUT (LIFO) Under the LIFO method using a perpetual system, the cost of the most recent purchase prior to sale is allocated to the units sold. Therefore, the cost of the goods sold on September 10 consists of all the units from the August 24 and April 15 purchases plus 50 of the units in beginning inventory. The ending inventory under the LIFO method is computed in Illustration 6A-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo4#c06-�ig-0023) .

ILLUSTRATION 6A-3 Perpetual system—LIFO

The use of LIFO in a perpetual system will usually produce cost allocations that differ from use of LIFO in a periodic system. In a perpetual system, the latest units purchased prior to each sale are allocated to cost of goods sold. In contrast, in a periodic system, the latest units purchased during the period are allocated to cost of goods sold. Thus, when a purchase is made after the last sale, the LIFO periodic system will apply this purchase to the previous sale. See Illustration 6-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0009) (on page 276) where the proof shows the 400 units at $13 purchased on November 27 applied to the sale of 550 units on September 10.

As shown above, under the LIFO perpetual system the 400 units at $13 purchased on November 27 are all applied to the ending inventory.

The ending inventory in this LIFO perpetual illustration is $5,700 and cost of goods sold is $6,300. Compare this to the LIFO periodic illustration (Illustration 6-8 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0008) on page 275) where the ending inventory is $5,000 and cost of goods sold is $7,000.

AVERAGE-COST The average-cost method in a perpetual inventory system is called the moving-average method. Under this method, the company computes a new average after each purchase. The average cost is computed by dividing

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the cost of goods available for sale by the units on hand. The average cost is then applied to (1) the units sold, to determine the cost of goods sold, and (2) the remaining units on hand, to determine the ending inventory amount. Illustration 6A-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo4#c06-�ig- 0024) shows the application of the average-cost method by Houston Electronics.

ILLUSTRATION 6A-4 Perpetual system—average-cost method

As indicated above, the company computes a new average each time it makes a purchase. On April 15, after 200 units are purchased for $2,200, a total of 300 units costing $3,200 ($1,000+$2,200) are on hand. The average unit cost is $10.667 ($3,200÷300). On August 24, after 300 units are purchased for $3,600, a total of 600 units costing $6,800 ($1,000+$2,200+$3,600) are on hand at an average cost per unit of $11.333 ($6,800÷600). Houston Electronics uses this unit cost of $11.333 in costing sales until another purchase is made, when the company computes a new unit cost. Accordingly, the unit cost of the 550 units sold on September 10 is $11.333, and the total cost of goods sold is $6,233. On November 27, following the purchase of 400 units for $5,200, there are 450 units on hand costing $5,767 ($567+$5,200) with a new average cost of $12.816 ($5,767÷450).

Compare this moving-average cost under the perpetual inventory system to Illustration 6-11 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo2#c06-�ig-0011) (on page 277) showing the weighted-average method under a periodic inventory system.

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LEARNING OBJECTIVE *5

APPENDIX 6B: Indicate the effects of inventory errors on the �inancial statements. 

Unfortunately, errors occasionally occur in accounting for inventory. In some cases, errors are caused by failure to count or price the inventory correctly. In other cases, errors occur because companies do not properly recognize the transfer of legal title to goods that are in transit. When inventory errors occur, they affect both the income statement and the balance sheet.

INCOME STATEMENT EFFECTS The ending inventory of one period automatically becomes the beginning inventory of the next period. Thus, inventory errors affect the computation of cost of goods sold and net income in two periods.

The effects on cost of goods sold can be computed by entering incorrect data in the formula in Illustration 6B-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo5#c06-�ig-0025) and then substituting the correct data.

ILLUSTRATION 6B-1 Formula for cost of goods sold

If beginning inventory is understated, cost of goods sold will be understated. If ending inventory is understated, cost of goods sold will be overstated. Illustration 6B-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo5#c06-�ig-0026) shows the effects of inventory errors on the current year's income statement.

ILLUSTRATION 6B-2 Effects of inventory errors on current year's income statement

An error in the ending inventory of the current period will have a reverse effect on net income of the next accounting period. This is shown in Illustration 6B-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo5#c06-�ig-0027) . Note that the

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understatement of ending inventory in 2016 results in an understatement of beginning inventory in 2017 and an overstatement of net income in 2017.

ILLUSTRATION 6B-3 Effects of inventory errors on two years' income statements

Over the two years, total net income is correct because the errors offset each other. Notice that total two-year income using incorrect data is $35,000 ($22,000+$13,000), which is the same as the total two-year income of $35,000 ($25,000+$10,000) using correct data. Also note in this example that an error in the beginning inventory does not result in a corresponding error in the ending inventory for that period. The correctness of the ending inventory depends entirely on the accuracy of taking and costing the inventory at the balance sheet date under the periodic inventory system.

ETHICS NOTE

Inventory fraud increases during recessions. Such fraud includes pricing inventory at amounts in excess of its actual value, or claiming to have inventory when no inventory exists. Inventory fraud is usually done to overstate ending inventory, thereby understating cost of goods sold and creating higher income.

BALANCE SHEET EFFECTS The effect of ending inventory errors on the balance sheet can be determined by using the basic accounting equation: Assets=Liabilities+Stockholders' Equity. Errors in the ending inventory have the effects shown in Illustration 6B-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo5#c06-�ig-0028) .

ILLUSTRATION 6B-4 Effects of ending inventory errors on balance sheet

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The effect of an error in ending inventory on the subsequent period was shown in Illustration 6B-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch06lo5#c06-�ig-0027) . Recall that if the error is not corrected, the combined total net income for the two periods would be correct. Thus, total stockholders' equity reported on the balance sheet at the end of 2017 will also be correct.

REVIEW AND PRACTICE

LEARNING OBJECTIVES REVIEW 1. Discuss how to classify and determine inventory. Merchandisers need only one

inventory classi�ication, merchandise inventory, to describe the different items that make up total inventory. Manufacturers, on the other hand, usually classify inventory into three categories: �inished goods, work in process, and raw materials. To determine inventory quantities, manufacturers (1) take a physical inventory of goods on hand and (2) determine the ownership of goods in transit or on consignment.

2. Apply inventory cost �low methods and discuss their �inancial effects. The primary basis of accounting for inventories is cost. Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale. Cost of goods available for sale includes (a) cost of beginning inventory and (b) cost of goods purchased. The inventory cost �low methods are speci�ic identi�ication and three assumed cost �low methods—FIFO, LIFO, and average-cost.

The cost of goods available for sale may be allocated to cost of goods sold and ending inventory by speci�ic identi�ication or by a method based on an assumed cost �low. When prices are rising, the �irst-in, �irst-out (FIFO) method results in lower cost of goods sold and higher net income than the average-cost and the last-in, �irst-out (LIFO) methods. The reverse is true when prices are falling. In the balance sheet, FIFO results in an ending inventory that is closest to current value, whereas the inventory under LIFO is the farthest from current value. LIFO results in the lowest income taxes (because of lower taxable income).

3. Explain the statement presentation and analysis of inventory. Companies use the lower-of-cost-or-market (LCM) basis when the current replacement cost (market) is less than cost. Under LCM, companies recognize the loss in the period in which the price decline occurs.

Inventory turnover is calculated as cost of goods sold divided by average inventory. It can be converted to average days in inventory by dividing 365 days by the inventory turnover. A higher inventory turnover or lower average days in inventory suggests that management is trying to keep inventory levels low relative to its sales level.

The LIFO reserve represents the difference between ending inventory using LIFO and ending inventory if FIFO were employed instead. For some companies this difference can be signi�icant, and ignoring it can lead to inappropriate conclusions when using the current ratio or inventory turnover.

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4. Apply inventory cost �low methods to perpetual inventory records. Under FIFO, the cost of the earliest goods on hand prior to each sale is charged to cost of goods sold. Under LIFO, the cost of the most recent purchase prior to sale is charged to cost of goods sold. Under the average-cost method, a new average cost is computed after each purchase.

5. Indicate the effects of inventory errors on the �inancial statements. In the income statement of the current year: (1) An error in beginning inventory will have a reverse effect on net income (e.g., overstatement of inventory results in understatement of net income, and vice versa). (2) An error in ending inventory will have a similar effect on net income (e.g., overstatement of inventory results in overstatement of net income). If ending inventory errors are not corrected in the following period, their effect on net income for that period is reversed, and total net income for the two years will be correct.

In the balance sheet: Ending inventory errors will have the same effect on total assets and total stockholders' equity and no effect on liabilities.

DECISION TOOLS REVIEW

GLOSSARY REVIEW Average-cost method An inventory costing method that uses the weighted-average unit cost to

allocate the cost of goods available for sale to ending inventory and cost of goods sold.

Consigned goods Goods held for sale by one party although ownership of the goods is retained by another party.

Current replacement cost The cost of purchasing the same goods at the present time from the usual suppliers in the usual quantities.

Days in inventory Measure of the average number of days inventory is held; calculated as 365 divided by inventory turnover.

Finished goods inventory Manufactured items that are completed and ready for sale.

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First-in, �irst-out (FIFO) method An inventory costing method that assumes that the earliest goods purchased are the �irst to be sold.

Fob destination Freight terms indicating that ownership of goods remains with the seller until the goods reach the buyer.

Fob shipping point Freight terms indicating that ownership of goods passes to the buyer when the public carrier accepts the goods from the seller.

Inventory turnover A ratio that indicates the liquidity of inventory by measuring the number of times average inventory is sold during the period; computed by dividing cost of goods sold by the average inventory during the period.

Just-in-time (JIT) inventory Inventory system in which companies manufacture or purchase goods only when needed.

Last-in, �irst-out (LIFO) method An inventory costing method that assumes that the latest units purchased are the �irst to be sold.

Lifo reserve For a company using LIFO, the difference between inventory reported using LIFO and inventory using FIFO.

Lower-of-cost-or-market (LCM) A basis whereby inventory is stated at the lower of either its cost or its market value as determined by current replacement cost.

Raw materials Basic goods that will be used in production but have not yet been placed in production.

Speci�ic identi�ication method An actual physical-�low costing method in which particular items sold and items still in inventory are speci�ically costed to arrive at cost of goods sold and ending inventory.

Weighted-average unit cost Average cost that is weighted by the number of units purchased at each unit cost.

Work in process That portion of manufactured inventory that has begun the production process but is not yet complete.

PRACTICE MULTIPLE-CHOICE QUESTIONS (LO 1)

1. When is a physical inventory usually taken?

(a) When the company has its greatest amount of inventory.

(b) When a limited number of goods are being sold or received.

(c) At the end of the company's �iscal year.

(d) Both (b) and (c).

(LO 1)

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2. Which of the following should not be included in the physical inventory of a company?

(a) Goods held on consignment from another company.

(b) Goods shipped on consignment to another company.

(c) Goods in transit from another company shipped FOB shipping point.

(d) All of the above should be included.

(LO 1)

3. As a result of a thorough physical inventory, Railway Company determined that it had inventory worth $180,000 at December 31, 2017. This count did not take into consideration the following facts. Rogers Consignment Store currently has goods worth $35,000 on its sales �loor that belong to Railway but are being sold on consignment by Rogers. The selling price of these goods is $50,000. Railway purchased $13,000 of goods that were shipped on December 27, FOB destination, that will be received by Railway on January 3. Determine the correct amount of inventory that Railway should report.

(a) $230,000.

(b) $215,000.

(c) $228,000.

(d) $193,000.

(LO 2)

4. Kam Company has the following units and costs.

Units Unit Cost

Inventory, Jan. 1  8,000 $11 Purchase, June 19 13,000  12 Purchase, Nov. 8  5,000  13

If 9,000 units are on hand at December 31, what is the cost of the ending inventory under FIFO?

(a) $99,000.

(b) $108,000.

(c) $113,000.

(d) $117,000.

(LO 2)

5. From the data in Question 4, what is the cost of the ending inventory under LIFO?

(a) $113,000.

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(b) $108,000.

(c) $99,000.

(d) $100,000.

(LO 2)

6. Davidson Electronics has the following:

Units Unit Cost

Inventory, Jan. 1  5,000 $ 8 Purchase, April 2 15,000  10 Purchase, Aug. 28 20,000  12

If Davidson has 7,000 units on hand at December 31, the cost of ending inventory under the average-cost method is:

(a) $84,000.

(b) $70,000.

(c) $56,000.

(d) $75,250.

(LO 2)

7. In periods of rising prices, LIFO will produce:

(a) higher net income than FIFO.

(b) the same net income as FIFO.

(c) lower net income than FIFO.

(d) higher net income than average-cost.

(LO 2)

8. Cost of goods available for sale consists of two elements: beginning inventory and:

(a) ending inventory.

(b) cost of goods purchased.

(c) cost of goods sold.

(d) All of the answer choices are correct.

(LO 2)

9. Considerations that affect the selection of an inventory costing method do not include:

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(a) tax effects.

(b) balance sheet effects.

(c) income statement effects.

(d) perpetual versus periodic inventory system.

(LO 3)

10. The lower-of-cost-or-market rule for inventory is an example of the application of:

(a) the conservatism convention.

(b) the historical cost principle.

(c) the materiality concept.

(d) the economic entity assumption.

(LO 3)

11. Which of these would cause inventory turnover to increase the most?

(a) Increasing the amount of inventory on hand.

(b) Keeping the amount of inventory on hand constant but increasing sales.

(c) Keeping the amount of inventory on hand constant but decreasing sales.

(d) Decreasing the amount of inventory on hand and increasing sales.

(LO 3)

12. Carlos Company had beginning inventory of $80,000, ending inventory of $110,000, cost of goods sold of $285,000, and sales of $475,000. Carlos's days in inventory is:

(a) 73 days.

(b) 121.7 days.

(c) 102.5 days.

(d) 84.5 days.

(LO 3)

13. Norton Company purchased 1,000 widgets and has 200 widgets in its ending inventory at a cost of $91 each and a current replacement cost of $80 each. The ending inventory under lower- of-cost-or-market is:

(a) $91,000.

(b) $80,000.

(c) $18,200.

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(d) $16,000.

(LO 3)

14. The LIFO reserve is:

(a) the difference between the value of the inventory under LIFO and the value under FIFO.

(b) an amount used to adjust inventory to the lower-of-cost-or-market.

(c) the difference between the value of the inventory under LIFO and the value under average-cost.

(d) an amount used to adjust inventory to historical cost.

(LO 4)

*15. In a perpetual inventory system:

(a) LIFO cost of goods sold will be the same as in a periodic inventory system.

(b) average costs are based entirely on unit-cost simple averages.

(c) a new average is computed under the average-cost method after each sale.

(d) FIFO cost of goods sold will be the same as in a periodic inventory system.

(LO 5)

*16. Fran Company's ending inventory is understated by $4,000. The effects of this error on the current year's cost of goods sold and net income, respectively, are:

(a) understated and overstated.

(b) overstated and understated.

(c) overstated and overstated.

(d) understated and understated.

(LO 5)

*17. Harold Company overstated its inventory by $15,000 at December 31, 2016. It did not correct the error in 2016 or 2017. As a result, Harold's stockholders' equity was:

(a) overstated at December 31, 2016, and understated at December 31, 2017.

(b) overstated at December 31, 2016, and properly stated at December 31, 2017.

(c) understated at December 31, 2016, and understated at December 31, 2017.

(d) overstated at December 31, 2016, and overstated at December 31, 2017.

SOLUTION

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1. (d) A physical inventory is usually taken when a limited number of goods are being sold or received, and at the end of the company's �iscal year. Choice (a) is incorrect because a physical inventory count is usually taken when the company has the least, not greatest, amount of inventory. Choices (b) and (c) are correct, but (d) is the better answer.

2. (a) Goods held on consignment should not be included because another company has title (ownership) to the goods. The other choices are incorrect because (b) goods shipped on consignment to another company and (c) goods in transit from another company shipped FOB shipping point should be included in a company's ending inventory. Choice (d) is incorrect because (a) is not included in the physical inventory.

3. (b) The inventory held on consignment by Rogers should be included in Railway's inventory balance at cost ($35,000). The purchased goods of $13,000 should not be included in inventory until January 3 because the goods are shipped FOB destination. Therefore, the correct amount of inventory is $215,000 ($180,000+$35,000), not (a) $230,000, (c) $228,000, or (d) $193,000.

4. (c) Under FIFO, ending inventory will consist of 5,000 units from the Nov. 8 purchase and 4,000 units from the June 19 purchase. Therefore, ending inventory is (5,000×$13)+(4,000×$12)=$113,000, not (a) $99,000, (b) $108,000, or (d) $117,000.

5. (d) Under LIFO, ending inventory will consist of 8,000 units from the inventory at Jan. 1 and 1,000 units from the June 19 purchase. Therefore, ending inventory is (8,000×$11)+(1,000×$12)=$100,000, not (a) $113,000, (b) $108,000, or (c) $99,000.

6. (d) Under the average-cost method, total cost of goods available for sale needs to be calculated in order to determine average cost per unit. The total cost of goods available is $430,000=(5,000×$8)+(15,000×$10)+ (20,000×$12). The average cost per unit=($430,000/40,000 total units available for sale)=$10.75. Therefore, ending inventory is ($10.75×7,000)=$75,250, not (a) $84,000, (b) $70,000, or (c) $56,000.

7. (c) In periods of rising prices, LIFO will produce lower net income than FIFO, not (a) higher than FIFO or (b) the same as FIFO. Choice (d) is incorrect because in periods of rising prices, LIFO will produce lower net income than average-cost. LIFO therefore charges the highest inventory cost against revenues in a period of rising prices.

8. (b) Cost of goods available for sale consists of beginning inventory and cost of goods purchased, not (a) ending inventory or (c) cost of goods sold. Therefore, choice (d) is also incorrect.

9. (d) Perpetual vs. periodic inventory system is not one of the factors that affect the selection of an inventory costing method. The other choices are incorrect because (a) tax effects, (b) balance sheet effects, and (c) income statement effects all affect the selection of an inventory costing method.

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10. (a) Conservatism means to use the lowest value for assets and revenues when in doubt. The other choices are incorrect because (b) historical cost means that companies value assets at the original cost, (c) materiality means that an amount is large enough to affect a decision- maker, and (d) economic entity means to keep the company's transactions separate from the transactions of other entities.

11. (d) Decreasing the amount of inventory on hand will cause the denominator to decrease, causing inventory turnover to increase. Increasing sales will cause the numerator of the ratio to increase (higher sales means higher COGS), thus causing inventory turnover to increase even more. The other choices are incorrect because (a) increasing the amount of inventory on hand causes the denominator of the ratio to increase while the numerator stays the same, causing inventory turnover to decrease; (b) keeping the amount of inventory on hand constant but increasing sales will cause inventory turnover to increase because the numerator of the ratio will increase (higher sales means higher COGS) while the denominator stays the same, which will result in a lesser inventory increase than decreasing amount of inventory on hand and increasing sales; and (c) keeping the amount of inventory on hand constant but decreasing sales will cause inventory turnover to decrease because the numerator of the ratio will decrease (lower sales means lower COGS) while the denominator stays the same.

12. (b) Carlos's days in inventory=365/Inventory turnover=365/[$285,000/($80,000+$110,000)/2)]=121.7 days, not (a) 73 days, (c) 102.5 days, or (d) 84.5 days.

13. (d) Under the LCM basis, “market” is de�ined as the current replacement cost. Therefore, ending inventory would be valued at 200 widgets×$80 each=$16,000, not (a) $91,000, (b) $80,000, or (c) $18,200.

14. (a) The LIFO reserve is the difference in ending inventory value under LIFO and FIFO. The other choices are therefore incorrect.

15. * (d) FIFO cost of goods sold is the same under both a periodic and a perpetual inventory system. The other choices are incorrect because (a) LIFO cost of goods sold is not the same under a periodic and a perpetual inventory system; (b) average costs are based on a moving average of unit costs, not an average of unit costs; and (c) a new average is computed under the average-cost method after each purchase, not sale.

16. * (b) Because ending inventory is too low, cost of goods sold will be too high (overstated) and since cost of goods sold (an expense) is too high, net income will be too low (understated). Therefore, the other choices are incorrect.

17. * (b) Stockholders' equity is overstated by $15,000 at December 31, 2016, and is properly stated at December 31, 2017. An ending inventory error in one period will have an equal and opposite effect on cost of goods sold and net income in the next period; after two years, the errors have offset each other. The other choices are incorrect because

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stockholders' equity (a) is properly stated, not understated, at December 31, 2017; (c) is overstated, not understated, by $15,000 at December 31, 2016, and is properly stated, not understated, at December 31, 2017; and (d) is properly stated at December 31, 2017, not overstated.

PRACTICE EXERCISES

Determine the correct inventory amount.

(LO 1)

1. Mika Sorbino, an auditor with Martinez CPAs, is performing a review of Sergei Company's inventory account. Sergei's did not have a good year and top management is under pressure to boost reported income. According to its records, the inventory balance at year-end was $650,000. However, the following information was not considered when determining that amount.

1. Included in the company's count were goods with a cost of $200,000 that the company is holding on consignment. The goods belong to Bosnia Corporation.

2. The physical count did not include goods purchased by Sergei with a cost of $40,000 that were shipped FOB shipping point on December 28 and did not arrive at Sergei's warehouse until January 3.

3. Included in the inventory account was $15,000 of of�ice supplies that were stored in the warehouse and were to be used by the company's supervisors and managers during the coming year.

4. The company received an order on December 28 that was boxed and was sitting on the loading dock awaiting pick-up on December 31. The shipper picked up the goods on January 1 and delivered them on January 6. The shipping terms were FOB shipping point. The goods had a selling price of $40,000 and a cost of $30,000. The goods were not included in the count because they were sitting on the dock.

5. On December 29, Sergei shipped goods with a selling price of $80,000 and a cost of $60,000 to Oman Sales Corporation FOB shipping point. The goods arrived on January 3. Oman Sales had only ordered goods with a selling price of $10,000 and a cost of $8,000. However, a Sergei's sales manager had authorized the shipment and said that if Oman wanted to ship the goods back next week, it could.

6. Included in the count was $30,000 of goods that were parts for a machine that the company no longer made. Given the high-tech nature of Sergei's products, it was unlikely that these obsolete parts had any other use. However, management would prefer to keep them on the books at cost, “since that is what we paid for them, after all.”

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INSTRUCTIONS

Prepare a schedule to determine the correct inventory amount. Provide explanations for each item above, saying why you did or did not make an adjustment for each item.

SOLUTION

1. Ending inventory—as reported $650,000  1. Subtract from inventory: The goods belong to Bosnia Corporation. Sergei is merely holding them for Bosnia.

(200,000)

2. Add to inventory: The goods belong to Sergei when they were shipped. 40,000  3. Subtract from inventory: Of�ice supplies should be carried in a separate account. They are not considered inventory held for resale.

(15,000)

4. Add to inventory: The goods belong to Sergei until they are shipped (Jan. 1).

30,000 

5. Add to inventory: Oman Sales ordered goods with a cost of $8,000. Sergei should record the corresponding sales revenue of $10,000. Sergei's decision to ship extra “unordered” goods does not constitute a sale. The manager's statement that Oman could ship the goods back indicates that Sergei knows this overshipment is not a legitimate sale. The manager acted unethically in an attempt to improve Sergei's reported income by overshipping.

52,000 

6. Subtract from inventory: GAAP require that inventory be valued at the lower-of-cost-or-market. Obsolete parts should be adjusted from cost to zero if they have no other use.

(30,000)

Correct inventory $527,000 

Determine LCM valuation.

(LO 3)

2. Creve Couer Camera Inc. uses the lower-of-cost-or-market basis for its inventory. The following data are available at December 31.

Units Cost per Unit Market per Unit

Cameras: Minolta  5 $160 $156 Canon  7  145  153 Light Meters: Vivitar 12  120  114

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Units Cost per Unit Market per Unit

Kodak 10  130  142

INSTRUCTIONS

What amount should be reported on Creve Couer Camera's �inancial statements, assuming the lower-of-cost-or-market rule is applied?

SOLUTION

2.

Cost per Unit

Market per Unit

Lower-of-Cost- or-Market

Units Inventory at Lower-of- Cost-or-Market

Cameras: Minolta $160 $156 $156  5 $  780 Canon  145  153  145  7  1,015 Light Meters:

Vivitar  120  114  114 12  1,368 Kodak  130  142  130 10  1,300 Total $4,463

PRACTICE PROBLEMS

Compute inventory and cost of goods sold using three cost �low methods in a periodic inventory system.

(LO 2)

1. Englehart Company has the following inventory, purchases, and sales data for the month of March.

Inventory: March 1 200 units @ $4.00 $  800 Purchases: March 10 500 units @ $4.50 2,250 March 20 400 units @ $4.75 1,900 March 30 300 units @ $5.00 1,500

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Sales: March 15 500 units March 25 400 units

The physical inventory count on March 31 shows 500 units on hand.

INSTRUCTIONS

Under a periodic inventory system, determine the cost of inventory on hand at March 31 and the cost of goods sold for March under (a) the �irst-in, �irst-out (FIFO) method; (b) the last-in, �irst-out (LIFO) method; and (c) the average-cost method. (For average-cost, carry cost per unit to three decimal places.)

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SOLUTION

1. The cost of goods available for sale is $6,450:

Inventory: March 1 200 units @ $4.00 $  800 Purchases: March 10 500 units @ $4.50 2,250 March 20 400 units @ $4.75 1,900 March 30 300 units @ $5.00 1,500  Total cost of goods available for sale $6,450

(a)

FIFO Method

Ending inventory:

Date Units Unit Cost Total Cost

Mar. 30 300 $5.00 $1,500 Mar. 20 200  4.75    950 $2,450 Cost of goods sold: $6,450 − $2,450 = $4,000

(b)

LIFO Method

Ending inventory:

Date Units Unit Cost Total Cost

Mar.  1 200 $4.00 $  800 Mar. 10 300  4.50  1,350 $2,150 Cost of goods sold: $6,450 − $2,150 = $4,300

(c)

Average-Cost Method

Weighted-average unit cost: $6,450 ÷ 1,400 = $4.607 Ending inventory: 500 × $4.607 = $2,303.50 Cost of goods sold: $6,450 − $2,303.50 = $4,146.50

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Compute inventory and cost of goods sold using three cost �low methods in a perpetual inventory system.

(LO 4)

*2 Practice Problem 1 showed cost of goods sold computations under a periodic inventory system. Now let's assume that Englehart Company uses a perpetual inventory system. The company has the same inventory, purchases, and sales data for the month of March as shown earlier:

Inventory: March 1 200 units @ $4.00 $  800 Purchases: March 10 500 units @ $4.50 2,250 March 20 400 units @ $4.75 1,900 March 30 300 units @ $5.00 1,500 Sales: March 15 500 units March 25 400 units

The physical inventory count on March 31 shows 500 units on hand.

INSTRUCTIONS

Under a perpetual inventory system, determine the cost of inventory on hand at March 31 and the cost of goods sold for March under (a) FIFO, (b) LIFO, and (c) moving-average cost.

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SOLUTION

2. The cost of goods available for sale is $6,450, as follows.

Inventory:   200 units @ $4.00 $  800 Purchases: March 10   500 units @ $4.50 2,250 March 20   400 units @ $4.75 1,900 March 30   300 units @ $5.00  1,500 Total: 1,400 $6,450

Under a perpetual inventory system, the cost of goods sold under each cost �low method is as follows.

(a)

WileyPLUS Brief Exercises, DO IT! Exercises, Exercises, Problems, and many additional resources are available for practice in WileyPLUS.

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NOTE: All asterisked Questions, Exercises, and Problems relate to material in the appendices to the chapter.

QUESTIONS 1. “The key to successful business operations is effective inventory management.” Do you agree? Explain.

2. An item must possess two characteristics to be classi�ied as inventory. What are these two characteristics?

3. What is just-in-time inventory management? What are its potential advantages?

4. Your friend Will Juritz has been hired to help take the physical inventory in Byrd's Hardware Store. Explain to Will what this job will entail.

5. (a) Bonita Company ships merchandise to Myan Corporation on December 30. The merchandise reaches the buyer on January 5. Indicate the terms of sale that will result in the goods being included in (1) Bonita's December 31 inventory and (2) Myan's December 31 inventory.

(b) Under what circumstances should Bonita Company include consigned goods in its inventory?

6. Nona Hat Shop received a shipment of hats for which it paid the wholesaler $2,940. The price of the hats was $3,000, but Nona was given a $60 cash discount and required to pay freight charges of $75. What amount should Nona include in inventory? Why?

7. What is the primary basis of accounting for inventories?

8. Ken McCall believes that the allocation of cost of goods available for sale should be based on the actual physical �low of the goods. Explain to Ken why this may be both impractical and inappropriate.

9. What is the major advantage and major disadvantage of the speci�ic identi�ication method of inventory costing?

10. “The selection of an inventory cost �low method is a decision made by accountants.” Do you agree? Explain. Once a method has been selected, what accounting requirement applies?

11. Which assumed inventory cost �low method:

(a) usually parallels the actual physical �low of merchandise?

(b) divides cost of goods available for sale by total units available for sale to determine a unit cost?

(c) assumes that the latest units purchased are the �irst to be sold?

12. In a period of rising prices, the inventory reported in Short Company's balance sheet is close to the current cost of the inventory, whereas King Company's inventory is considerably below its current cost. Identify the inventory cost �low method used by each company. Which company probably has been reporting the higher gross pro�it?

13. Mamosa Corporation has been using the FIFO cost �low method during a prolonged period of in�lation. During the same time period, Mamosa has been paying out all of its net income as dividends. What adverse effects may result from this policy?

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14. Oscar Geer, a mid-level product manager for Theresa's Shoes, thinks his company should switch from LIFO to FIFO. He says, “My bonus is based on net income. If we switch it will increase net income and increase my bonus. The company would be better off and so would I.” Is he correct? Explain.

15. Discuss the impact the use of LIFO has on taxes paid, cash �lows, and the quality of earnings ratio relative to the impact of FIFO when prices are increasing.

16. Hank Artisan is studying for the next accounting midterm examination. What should Hank know about (a) departing from the cost basis of accounting for inventories and (b) the meaning of “market” in the lower-of-cost-or-market method?

17. Jackson Music Center has �ive TVs on hand at the balance sheet date that cost $400 each. The current replacement cost is $350 per unit. Under the lower-of-cost-or-market basis of accounting for inventories, what value should Jackson report for the TVs on the balance sheet? Why?

18. What cost �low assumption may be used under the lower-of-cost-or-market basis of accounting for inventories?

19. Why is it inappropriate for a company to include freight-out expense in the Cost of Goods Sold account?

20. Tilton Company's balance sheet shows Inventory $162,800. What additional disclosures should be made?

21. Under what circumstances might inventory turnover be too high—that is, what possible negative consequences might occur?

22. What is the LIFO reserve? What are the consequences of ignoring a large LIFO reserve when analyzing a company?

23. “When perpetual inventory records are kept, the results under the FIFO and LIFO methods are the same as they would be in a periodic inventory system.” Do you agree? Explain.

24. How does the average-cost method of inventory costing differ between a perpetual inventory system and a periodic inventory system?

25. Albert Company discovers in 2017 that its ending inventory at December 31, 2016, was $5,000 understated. What effect will this error have on (a) 2016 net income, (b) 2017 net income, and (c) the combined net income for the 2 years?

BRIEF EXERCISES

Identify items to be included in taking a physical inventory.

(LO 1), C

BE6-1 Peete Company identi�ies the following items for possible inclusion in the physical inventory. Indicate whether each item should be included or excluded from the inventory taking.

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(a) 900 units of inventory shipped on consignment by Peete to another company.

(b) 3,000 units of inventory in transit from a supplier shipped FOB destination.

(c) 1,200 units of inventory sold but being held for customer pickup.

(d) 500 units of inventory held on consignment from another company.

Compute ending inventory using FIFO and LIFO.

(LO 2), AP

BE6-2 In its �irst month of operations, McLanie Company made three purchases of merchandise in the following sequence: (1) 300 units at $6, (2) 400 units at $8, and (3) 500 units at $9. Assuming there are 200 units on hand at the end of the period, compute the cost of the ending inventory under (a) the FIFO method and (b) the LIFO method. McLanie uses a periodic inventory system.

Compute the ending inventory using average-cost.

(LO 2), AP

BE6-3 Data for McLanie Company are presented in BE6-2. Compute the cost of the ending inventory under the average-cost method. (Round the cost per unit to three decimal places.)

Explain the �inancial statement effect of inventory cost �low assumptions.

(LO 2), C

BE6-4 The management of Milque Corp. is considering the effects of various inventory-costing methods on its �inancial statements and its income tax expense. Assuming that the price the company pays for inventory is increasing, which method will:

(a) provide the highest net income?

(b) provide the highest ending inventory?

(c) result in the lowest income tax expense?

(d) result in the most stable earnings over a number of years?

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Explain the �inancial statement effect of inventory cost �low assumptions.

(LO 2), AP

BE6-5 In its �irst month of operation, Hoffman Company purchased 100 units of inventory for $6, then 200 units for $7, and �inally 140 units for $8. At the end of the month, 180 units remained. Compute the amount of phantom pro�it that would result if the company used FIFO rather than LIFO. Explain why this amount is referred to as phantom pro�it. The company uses the periodic method.

Identify the impact of LIFO versus FIFO.

(LO 2), C

BE6-6 For each of the following cases, state whether the statement is true for LIFO or for FIFO. Assume that prices are rising.

(a) Results in a higher quality of earnings ratio.

(b) Results in higher phantom pro�its.

(c) Results in higher net income.

(d) Results in lower taxes.

(e) Results in lower net cash provided by operating activities.

Determine the LCM valuation.

(LO 3), AP

BE6-7 Wahlowitz Video Center accumulates the following cost and market data at December 31.

Inventory Categories Cost Data Market Data

Cameras $12,500 $13,400 Camcorders   9,000   9,500 DVDs  13,000  12,200

Compute the lower-of-cost-or-market valuation for the company's inventory.

Compute inventory turnover and days in inventory.

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(LO 3), AP

BE6-8 Suppose at December 31 of a recent year, the following information (in thousands) was available for sunglasses manufacturer Oakley, Inc.: ending inventory $155,377, beginning inventory $119,035, cost of goods sold $349,114, and sales revenue $761,865. Calculate the inventory turnover and days in inventory for Oakley, Inc. (Round inventory turnover to two decimal places.)

Determine ending inventory using LIFO reserve.

(LO 3), AP

BE6-9 Winnebago Industries, Inc. is a leading manufacturer of motor homes. Suppose Winnebago reported ending inventory at August 29, 2017, of $46,850,000 under the LIFO inventory method. In the notes to its �inancial statements, assume Winnebago reported a LIFO reserve of $30,346,000 at August 29, 2017. What would Winnebago Industries' ending inventory have been if it had used FIFO?

Apply cost �low methods to perpetual inventory records.

(LO 4), AP

*BE6-10 Loggins Department Store uses a perpetual inventory system. Data for product E2-D2 include the following purchases.

Date Number of Units Unit Price

May  7 50 $10 July 28 30  15

On June 1, Loggins sold 25 units, and on August 27, 30 more units. Compute the cost of goods sold using (a) FIFO, (b) LIFO, and (c) average-cost. (Round the cost per unit to three decimal places.)

Determine correct �inancial statement amount.

(LO 5), AN

*BE6-11 Fennick Company reports net income of $92,000 in 2017. However, ending inventory was understated by $7,000. What is the correct net income for 2017? What effect, if any, will this error have on total assets as

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reported in the balance sheet at December 31, 2017?

DO IT! EXERCISES

Apply rules of ownership to determine inventory cost.

(LO 1), AN

Do IT! 6-1 Sheldon Company just took its physical inventory on December 31. The count of inventory items on hand at the company's business locations resulted in a total inventory cost of $300,000. In reviewing the details of the count and related inventory transactions, you have discovered the following items that had not been considered.

1. Sheldon has sent inventory costing $28,000 on consignment to Rich�ield Company. All of this inventory was at Rich�ield's showrooms on December 31.

2. The company did not include in the count inventory (cost, $20,000) that was sold on December 28, terms FOB shipping point. The goods were in transit on December 31.

3. The company did not include in the count inventory (cost, $13,000) that was purchased with terms of FOB shipping point. The goods were in transit on December 31.

Compute the correct December 31 inventory.

Compute cost of goods sold under different cost �low methods.

(LO 2), AP

Do IT! 6-2 The accounting records of Ohm Electronics show the following data.

Beginning inventory 3,000 units at $5 Purchases 8,000 units at $7 Sales 9,400 units at $10

Determine cost of goods sold during the period under a periodic inventory system using (a) the FIFO method, (b) the LIFO method, and (c) the average-cost method. (Round unit cost to three decimal places.)

Compute inventory value under LCM.

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(LO 3), AP

Do IT! 6-3a Jeri Company sells three different categories of tools (small, medium and large). The cost and market value of its inventory of tools are as follows.

Cost Market

Small $ 64,000 $ 61,000 Medium  290,000  260,000 Large  152,000  167,000

Determine the value of the company's inventory under the lower-of-cost-or-market approach.

Compute inventory turnover and assess inventory level.

(LO 3), AN

Do IT! 6-3b Early in 2017, Fedor Company switched to a just-in-time inventory system. Its sales and inventory amounts for 2016 and 2017 are shown below.

2016 2017

Sales revenue $3,120,000 $3,713,000 Cost of goods sold 1,200,000 1,425,000 Beginning inventory 170,000 210,000 Ending inventory 210,000 90,000

Determine the inventory turnover and days in inventory for 2016 and 2017. Discuss the changes in the amount of inventory, the inventory turnover and days in inventory, and the amount of sales across the 2 years.

EXERCISES

Determine the correct inventory amount.

(LO 1), AN

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E6-1 Umatilla Bank and Trust is considering giving Pohl Company a loan. Before doing so, it decides that further discussions with Pohl's accountant may be desirable. One area of particular concern is the Inventory account, which has a year-end balance of $275,000. Discussions with the accountant reveal the following.

1. Pohl sold goods costing $55,000 to Hemlock Company FOB shipping point on December 28. The goods are not expected to reach Hemlock until January 12. The goods were not included in the physical inventory because they were not in the warehouse.

2. The physical count of the inventory did not include goods costing $95,000 that were shipped to Pohl FOB destination on December 27 and were still in transit at year-end.

3. Pohl received goods costing $25,000 on January 2. The goods were shipped FOB shipping point on December 26 by Yanice Co. The goods were not included in the physical count.

4. Pohl sold goods costing $51,000 to Ehler of Canada FOB destination on December 30. The goods were received in Canada on January 8. They were not included in Pohl's physical inventory.

5. Pohl received goods costing $42,000 on January 2 that were shipped FOB destination on December 29. The shipment was a rush order that was supposed to arrive December 31. This purchase was included in the ending inventory of $275,000.

Instructions

Determine the correct inventory amount on December 31.

Determine the correct inventory amount.

(LO 1), AN

E6-2 Farley Bains, an auditor with Nolls CPAs, is performing a review of Ryder Company's Inventory account. Ryder did not have a good year, and top management is under pressure to boost reported income. According to its records, the inventory balance at year-end was $740,000. However, the following information was not considered when determining that amount.

1. Included in the company's count were goods with a cost of $228,000 that the company is holding on consignment. The goods belong to Nader Corporation.

2. The physical count did not include goods purchased by Ryder with a cost of $40,000 that were shipped FOB shipping point on December 28 and did not arrive at Ryder's warehouse until January 3.

3. Included in the Inventory account was $17,000 of of�ice supplies that were stored in the warehouse and were to be used by the company's supervisors and managers during the coming year.

4. The company received an order on December 29 that was boxed and was sitting on the loading dock awaiting pick-up on December 31. The shipper picked up the goods on January 1 and delivered them on January 6. The shipping terms were FOB shipping point. The goods had a selling price of $40,000 and a cost of $29,000. The goods were not included in the count because they were sitting on the dock.

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5. Included in the count was $50,000 of goods that were parts for a machine that the company no longer made. Given the high-tech nature of Ryder's products, it was unlikely that these obsolete parts had any other use. However, management would prefer to keep them on the books at cost, “since that is what we paid for them, after all.”

Instructions

Prepare a schedule to determine the correct inventory amount. Provide explanations for each item above, stating why you did or did not make an adjustment for each item.

Identify items in inventory.

(LO 1), K

E6-3 Gato Inc. had the following inventory situations to consider at January 31, its year-end.

(a) Goods held on consignment for Steele Corp. since December 12.

(b) Goods shipped on consignment to Logan Holdings Inc. on January 5.

(c) Goods shipped to a customer, FOB destination, on January 29 that are still in transit.

(d) Goods shipped to a customer, FOB shipping point, on January 29 that are still in transit.

(e) Goods purchased FOB destination from a supplier on January 25 that are still in transit.

(f) Goods purchased FOB shipping point from a supplier on January 25 that are still in transit.

(g) Of�ice supplies on hand at January 31.

Instructions

Identify which of the preceding items should be included in inventory. If the item should not be included in inventory, state in what account, if any, it should have been recorded.

Compute inventory and cost of goods sold using periodic FIFO, LIFO, and average- cost.

(LO 2), AP

E6-4 Mather sells a snowboard, EZslide, that is popular with snowboard enthusiasts. Below is information relating to Mather's purchases of EZslide snowboards during September. During the same month, 102 EZslide snowboards were sold. Mather uses a periodic inventory system.

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Date Explanation Units Unit Cost Total CostDate Explanation Units Unit Cost Total Cost

Sept.  1  Inventory  12 $100 $ 1,200 Sept. 12  Purchases  45  103   4,635 Sept. 19  Purchases  50  104   5,200 Sept. 26  Purchases  20  105   2,100  Totals 127 $13,135

Instructions

Compute the ending inventory at September 30 and the cost of goods sold using the FIFO, LIFO, and average- cost methods. (For average-cost, round the average unit cost to three decimal places.) Prove the amount allocated to cost of goods sold under each method.

Calculate inventory and cost of goods sold using FIFO, average-cost, and LIFO in a periodic inventory system.

(LO 2), AP

E6-5 Rusthe Inc. uses a periodic inventory system. Its records show the following for the month of May, in which 74 units were sold.

Date Explanation Units Unit Cost Total Cost

May  1    Inventory 30 $ 9 $270      15 Purchase 25  10  250      24 Purchase 38   11  418 Total 93 $938

Instructions

Calculate the ending inventory at May 31 using the (a) FIFO, (b) LIFO, and (c) average-cost methods. (For average-cost, round the average unit cost to three decimal places.) Prove the amount allocated to cost of goods sold under each method.

Calculate cost of goods sold using speci�ic identi�ication and FIFO periodic.

(LO 2), AN

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E6-6 On December 1, Premium Electronics has three DVD players left in stock. All are identical, all are priced to sell at $85. One of the three DVD players left in stock, with serial #1012, was purchased on June 1 at a cost of $52. Another, with serial #1045, was purchased on November 1 for $48. The last player, serial #1056, was purchased on November 30 for $40.

Instructions (a) Calculate the cost of goods sold using the FIFO periodic inventory method, assuming that two of the three

players were sold by the end of December, Premium Electronics' year-end.

(b) If Premium Electronics used the speci�ic identi�ication method instead of the FIFO method, how might it alter its earnings by “selectively choosing” which particular players to sell to the two customers? What would Premium's cost of goods sold be if the company wished to minimize earnings? Maximize earnings?

(c) Which inventory method, FIFO or speci�ic identi�ication, do you recommend that Premium use? Explain why.

Compute inventory and cost of goods sold using periodic FIFO, LIFO, and average- cost.

(LO 2), AP

E6-7 Jeters Company reports the following for the month of June.

Date Explanation Units Unit Cost Total Cost

June  1    Inventory 120 $5 $  600      12 Purchase 370  6  2,220      23 Purchase 200  7  1,400      30 Inventory 230

Instructions (a) Compute the cost of the ending inventory and the cost of goods sold under (1) FIFO, (2) LIFO, and (3)

average-cost. (Round average unit cost to three decimal places.)

(b) Which costing method gives the highest ending inventory? The highest cost of goods sold? Why?

(c) How do the average-cost values for ending inventory and cost of goods sold relate to ending inventory and cost of goods sold for FIFO and LIFO?

(d) Explain why the average cost is not $6.

Evaluate impact of LIFO and FIFO on cash �lows and earnings quality.

(LO 2), AP

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E6-8 The following comparative information is available for Rose Company for 2017.

LIFO FIFO

Sales revenue $86,000 $86,000 Cost of goods sold 38,000 29,000 Operating expenses (including depreciation) 27,000 27,000 Depreciation 10,000 10,000 Cash paid for inventory purchases 32,000 32,000

Instructions (a) Determine net income under each approach. Assume a 30% tax rate.

(b) Determine net cash provided by operating activities under each approach. Assume that all sales were on a cash basis and that income taxes and operating expenses, other than depreciation, were on a cash basis.

(c) Calculate the quality of earnings ratio under each approach and explain your �indings. (Round answer to two decimal places.)

Determine LCM valuation.

(LO 3), AP

E6-9 Digital Camera Shop Inc. uses the lower-of-cost-or-market basis for its inventory. The following data are available at December 31.

Units Cost per Unit Market per Unit

Cameras Minolta  5 $170 $158 Canon  7  145  152 Light Meters Vivitar 12  125  114 Kodak 10  120  135

Instructions

What amount should be reported on Digital Camera Shop's �inancial statements, assuming the lower-of-cost-or- market rule is applied?

Determine LCM valuation.

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(LO 3), AP

E6-10 Tascon Corporation sells coffee beans, which are sensitive to price �luctuations. The following inventory information is available for this product at December 31, 2017.

Coffee Bean Units Unit Cost Market

Coffea arabica 13,000 bags $5.60 $5.55 Coffea robusta  5,000 bags  3.40  3.50

Instructions

Calculate Tascon's inventory by applying the lower-of-cost-or-market basis.

Compute inventory turnover, days in inventory, and gross pro�it rate.

(LO 3), AP

E6-11 Suppose this information is available for PepsiCo, Inc. for 2015, 2016, and 2017.

(in millions) 2015 2016 2017

Beginning inventory $ 1,926 $ 2,290 $ 2,522 Ending inventory 2,290 2,522 2,618 Cost of goods sold 18,038 20,351 20,099 Sales revenue 39,474 43,251 43,232

Instructions (a) Calculate the inventory turnover for 2015, 2016, and 2017. (Round to one decimal place.)

(b) Calculate the days in inventory for 2015, 2016, and 2017.

(c) Calculate the gross pro�it rate for 2015, 2016, and 2017.

(d) Comment on any trends observed in your answers to parts (a), (b), and (c).

Calculate inventory turnover, days in inventory, and gross pro�it rate.

(LO 3), AP

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E6-12 The following information is available for Zoe's Activewear Inc. for three recent �iscal years.

2017 2016 2015

Inventory $  553,000 $  568,000 $  332,000 Net sales 1,948,000 1,725,000 1,311,000 Cost of goods sold 1,552,000 1,288,000 947,000

Instructions (a) Calculate the inventory turnover, days in inventory, and gross pro�it rate for 2017 and 2016.

(b) Based on the ratios calculated in part (a), did Zoe's liquidity and pro�itability improve or deteriorate in 2017?

Compute inventory turnover and determine the effect of the LIFO reserve on current ratio.

(LO 3), AP

E6-13 Deere & Company is a global manufacturer and distributor of agricultural, construction, and forestry equipment. Suppose it reported the following information in its 2017 annual report.

(in millions) 2017 2016

Inventories (LIFO) $ 2,397 $3,042 Current assets 30,857 Current liabilities 12,753 LIFO reserve 1,367 Cost of goods sold 16,255

Instructions (a) Compute Deere's inventory turnover and days in inventory for 2017. (Round inventory turnover to 2

decimal places.)

(b) Compute Deere's current ratio using the 2017 data as presented, and then again after adjusting for the LIFO reserve.

(c) Comment on how ignoring the LIFO reserve might affect your evaluation of Deere's liquidity.

Calculate inventory and cost of goods sold using three cost �low methods in a perpetual inventory system.

(LO 4), AP

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*E6-14 Inventory data for Jeters Company are presented in E6-7.

Instructions (a) Calculate the cost of the ending inventory and the cost of goods sold for each cost �low assumption, using a

perpetual inventory system. Assume a sale of 410 units occurred on June 15 for a selling price of $8 and a sale of 50 units on June 27 for $9. (Note: For the moving-average method, round unit cost to three decimal places.)

(b) How do the results differ from E6-7?

(c) Why is the average unit cost not $6 [($5+$6+$7)÷3=$6]?

Apply cost �low methods to perpetual records.

(LO 4), AP

*E6-15 Information about Mather is presented in E6-4. Additional data regarding the company's sales of EZslide snowboards are provided below. Assume that Mather uses a perpetual inventory system.

Date Units

Sept.  5 Sale   8 Sept. 16 Sale  48 Sept. 29 Sale  46 Totals 102

Instructions

Compute ending inventory at September 30 using FIFO, LIFO, and moving-average. (Note: For moving-average, round unit cost to three decimal places.)

Determine effects of inventory errors.

(LO 5), AN

*E6-16 Dowell Hardware reported cost of goods sold as follows.

2017 2016

Beginning inventory $ 30,000 $ 20,000

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2017 2016

Cost of goods purchased 175,000 164,000 Cost of goods available for sale 205,000 184,000 Less: Ending inventory 37,000 30,000 Cost of goods sold $168,000 $154,000

Dowell made two errors:

1. 2016 ending inventory was overstated by $2,000.

2. 2017 ending inventory was understated by $5,000.

Instructions

Compute the correct cost of goods sold for each year.

Prepare correct income statements.

(LO 5), AN

*E6-17 Sheen Company reported these income statement data for a 2-year period.

2017 2016