SHIPPING TERMS AND TRANSFER OF TITLE
1. The seller pays shipping costs when merchandise is shipped FOB destination point. Miller Wholesalers pays the freight bill and is responsible for the merchandise until it gets to Michael’s warehouse.
2. The inventory should not be included as an asset on Michael’s December 31, 2010, balance sheet because the terms of shipment indicate that the merchandise does not legally belong to Michael until it arrives, and this is after the end of the year. Likewise, Miller should not include the sale on its 2010 income statement, since the goods are not considered sold until they reach the buyer’s business.
3. If the terms of shipment were FOB shipping point, the answers to both questions in part (2) above would change. Under these terms, the inventory belongs to Michael as soon as it is shipped, and because this is on December 23, 2010, the asset should be recognized on the year-end balance sheet. Similarly, Miller would record a sale in 2010.
LO 8 EXERCISE 5-13 INVENTORY ERRORS
Balance Sheet Income Statement
Retained Cost of Net
Inventory Earnings Goods Sold Income
1. U U O U
2. O O U O
3. U U O U
Hint: To summarize, if ending inventory is understated, then cost of goods sold is overstated, but both net income and retained earnings will be understated. On the other hand, if ending inventory is overstated, then cost of goods sold will be understated, but both net income and retained earnings will be overstated.
LO 7 PROBLEM 5-3 EVALUATION OF INVENTORY COSTING METHODS
1. Company B will have the newest costs in inventory because it uses first-in, first-out. Because costs are rising, it will have the lowest costs of goods sold and thus the highest net income.
2. Company C will have the oldest costs in inventory because it uses last-in, first-out. Because costs are rising, it will have the highest cost of goods sold and thus the lowest income before taxes. Company C will pay the least in taxes.
3. This question does not lend itself to an easy answer. LIFO matches the most recent costs with the most recent revenue and thus may be a better indicator of future potential to investors. Inventory profits are not a major concern with LIFO as they are with FIFO, because the newer (most recent) costs are assigned to cost of sales.
4. Company C would have the oldest costs in inventory because it uses LIFO. Because costs are falling, it will have the lowest cost of goods sold and the highest net income.
Company B will have the newest costs in inventory because it uses FIFO. Because costs are falling, it will have the highest cost of goods sold and the lowest income before taxes. Company B will pay the least in taxes.
The answer to part (3) is still not easy. There are advantages and disadvantages in all methods. The important point is to choose one method and stay with it for consistency.
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