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Chapter 8: Question 11Q (page 421)

Specific identification is sometimes said to be the ideal method of assigning a cost to inventory and to the cost of goods sold. Briefly indicate the arguments for and againstthis method of inventory valuation.

Short Answer

Expert verified

Special identification is a method of valuing inventory at a specific cost for each specific item. This is an ideal method with several difficulties.

Step by step solution

01

Arguments for the special identification method

The major argument for the special identification method is that it is the ideal method of valuing inventory. This is because it is the only method through which the actual cot can match with actual revenue. Thus under this method, the physical flow of goods matches the cost flow of goods.

02

Arguments against special identification method

One of the arguments against the special identification method is that the reported income can be manipulated by showing higher costs or lower costs. This may lead to tax evasion or other malpractices.

Another problem with this method is the arbitrary issue. This arbitrary issue is due to the difficulty of allocating indirect expenses to inventory.

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Most popular questions from this chapter

Accounting, Analysis, and Principles

Englehart Company sells two types of pumps. One is large and is for commercial use. The other is smaller and is used in residentialswimming pools. The following inventory data is available for the month of March.

Price per

Units Unit Total

Residential Pumps

Inventory at Feb. 28: 200 \( 400 \) 80,000

Purchases:

March 10 500 \( 450 \)225,000

March 20 400 \( 475 \)190,000

March 30 300 \( 500 \)150,000

Sales:

March 15 500 \( 540 \)270,000

March 25 400 \( 570 \)228,000

Inventory at March 31: 500

Commercial Pumps

Inventory at Feb. 28: 600 \( 800 \)480,000

Purchases:

March 3 600 \( 900 \)540,000

March 12 300 \( 950 \)285,000

March 21 500 \(1,000 \)500,000

Sales:

March 18 900 \(1,080 \)972,000

March 29 600 \(1,140 \)684,000

Inventory at March 31: 500

Accounting

(a) Assuming Englehart uses a periodic inventory system, determine the cost of inventory on hand at March 31 and thecost of goods sold for March under first-in, first-out (FIFO).

(b) Assume Englehart uses dollar-value LIFO and one pool, consisting of the combination of residential and commercialpumps. Determine the cost of inventory on hand at March 31 and the cost of goods sold for March. Assume Englehart鈥檚initial adoption of LIFO is on March 1. Use the double-extension method to determine the appropriate price indices.

(Hint:The price index for February 28/March 1 should be 1.00.) (Round the index to three decimal places.)

Analysis

(a) Assume you need to compute a current ratio for Englehart. Which inventory method (FIFO or dollar-value LIFO) doyou think would give you a more meaningful current ratio?

(b) Some of Englehart鈥檚 competitors use LIFO inventory costing and some use FIFO. How can an analyst compare theresults of companies in an industry, when some use LIFO and others use FIFO?

Principles

Can companies change from one inventory accounting method to another? If a company changes to an inventory accounting methodused by most of its competitors, what are the trade-offs in terms of the conceptual framework discussed in Chapter 2 of the textbook?

Question:Stallman Company took a physical inventory on December 31 and determined that goods costing \(200,000 were on hand. Not included in the physical count were \)25,000 of goods purchased from Pelzer Corporation, f.o.b. shipping point, and \(22,000 of goods sold to Alvarez Company for \)30,000, f.o.b. destination. Both the Pelzer purchase and the Alvarez sale werein transit at year-end. What amount should Stallman report as its December 31 inventory?

Colin Davis Machine Company maintains a general ledger account for each class of inventory, debiting such accounts for increases during the period and crediting them for decreases. The transactions below relate to the Raw Materials inventory account, which is debited for materials purchased and credited for materials requisitioned for use.

1. An invoice for \(8,100, terms f.o.b. destination, was received and entered January 2, 2017. The receiving report shows that the materials were received December 28, 2016.

2. Materials costing \)28,000, shipped f.o.b. destination, were not entered by December 31, 2016, 鈥渂ecause they were in a railroad car on the company鈥檚 siding on that date and had not been unloaded.鈥�

3. Materials costing \(7,300 were returned to the supplier on December 29, 2016, and were shipped f.o.b. shipping point. The return was entered on that date, even though the materials are not expected to reach the supplier鈥檚 place of business until January 6, 2017.

4. An invoice for \)7,500, terms f.o.b. shipping point, was received and entered December 30, 2016. The receiving report shows that the materials were received January 4, 2017, and the bill of lading shows that they were shipped January 2, 2017.

5. Materials costing $19,800 were received December 30, 2016, but no entry was made for them because 鈥渢hey were ordered with a specified delivery of no earlier than January 10, 2017.鈥�

Instructions -

Prepare correcting general journal entries required at December 31, 2016, assuming that the books have not been closed.

Hull Company鈥檚 record of transactions concerning part X for the month of April was as follows.

Purchases Sales

April 1 (balance on hand) 100 @ $5.00 April 5 300

4 400 @ 5.10 12 200

11 300 @ 5.30 27 800

18 200 @ 5.35 28 150

26 600 @ 5.60

30 200 @ 5.80

Instructions

(a) Compute the inventory at April 30 on each of the following bases. Assume that perpetual inventory records are kept inunits only. Carry unit costs to the nearest cent.

(1) First-in, first-out (FIFO).

(2) Last-in, first-out (LIFO).

(3) Average cost.

(b) If the perpetual inventory record is kept in dollars, and costs are computed at the time of each withdrawal, what amountwould be shown as ending inventory in (1), (2), and (3) above? (Carry average unit costs to four decimal places.)

The following example was provided to encourage the use of the LIFO method. In a nutshell, LIFO subtracts inflation from inventory costs, deducts it from taxable income, and records it in a LIFO reserve account on the books. The LIFO benefit grows as inflation widens the gap between current-year and past-year (minus inflation) inventory costs.

This gap is:

With LIFO Without LIFO

Revenues \(3,200,000 \)3,200,000

Cost of goods sold 2,800,000 2,800,000

Operating expenses 150,000 150,000

Operating income 250,000 250,000

LIFO adjustment 40,000 0

Taxable income \( 210,000 \) 250,000

Income taxes @ 36% \( 75,600 \) 90,000

Cash flow \( 174,400 \) 160,000

Extra cash \( 14,400 0

Increased cash flow 9% 0%

Instructions

(a) Explain what is meant by the LIFO reserve account.

(b) How does LIFO subtract inflation from inventory costs?

(c) Explain how the cash flow of \)174,400 in this example was computed. Explain why this amount may not be correct.

(d) Why does a company that uses LIFO have extra cash? Explain whether this situation will always exist.
See all solutions

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