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Inventory method and issues

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Problem 8.7A

Between The Ears (BTE. com) is a popular Internet music store. During the current year, the company's cost of goods available for sale amounted to $ 462,000. The retail sales value of this mer-chandise amounted to $ 840,000. Sales for the year were $ 744,000.


A. Using the retail method, estimate (1) the cost of goods sold during the year and (2) the inventory at the end of the year.

B. At year- end, BTE. com takes a physical inventory. The general manager walks through the warehouse counting each type of product and reading its retail price into a tape recorder. From the recorded information, another employee prepares a schedule listing the entire end-ing inventory at retail sales prices. The schedule prepared for the current year reports ending inventory at $ 84,480 at retail sales prices.

1. Use the cost ratio computed in part a to reduce the inventory counted by the general manager from its retail value to an estimate of its cost.

2. Determine the estimated shrinkage losses (measured at cost) incurred by BTE. com during the year.

3. Compute BTE. com's gross profit for the year. (Include inventory shrinkage losses in the cost of goods sold.)

C. What controls might implement to reduce inventory shrinkage?

Estimated ending inventory (part a) = $52,800

Problem 8.8A

Wal-Mart uses LIFO to account for its inventories. Recent financial statements were used to compile the following information (dollar figures are in millions):

Average inventory (throughout the year) $34,433
Current Assets (at year end) $47,585
Current liabilities (at year end) $58,454
Net sales $374,526
Cost of Goods sold $286,515
Gross profit $92,284

Average time required to collect outstanding receivables 3.2 days


A. Using the information provided, compute the following measures based upon the LIFO method:

1. Inventory turnover
2. Current Ratio
3. Gross profit rate

B. Assuming cost of goods sold would be lower under FIFO, what circumstances must the company have encountered to cause this situation? (Were replacement costs, on average, rising or falling?)

C. How would you expect these ratios to differ (i.e., what direction) had the company used FIFO instead of LIFO?

D. Explain why the average number of days required by Wal-Mart to collect its accounts receivable is so low.

Problem 8.3

Avery Frozen Foods owe the bank $50,000 on a line of credit. Terms of the agreement specify that Avery must maintain a minimum current ration of 1.2 to 1, or the entire outstanding balance becomes immediately de in full. To date, the company has complied with the minimum requirement. However, management has just learned that a failed warehouse freezer has ruined thousands of dollars of frozen foods inventory. If the company records this loss its current ratio will drop to approximately 0.8 to 1.

Whether any or all of this loss may be covered by insurance currently is in dispute and will not be known for at least 90 days---perhaps much longer. There are several reasons why the insurance company may have no liability.

In trying to decide how to deal with the bank, management is considering the following options: (1) postpone recording the inventory loss until the dispute with the insurance company is resolved, (2) increase the current ration to 1.2 to 1 by making a large purchase of inventory on account, (3) explain to the bank what has happened, and request that it be flexible until things get back to normal.


A. Given the company hopes for at least partial reimbursement from the insurance company, is it really unethical for management to postpone recording the inventory loss in the financial statements it submits to the bank?

B. Is it possible to increase the company's current ratio from 0.8 to 1 to 1.2 to 1 by purchasing more inventory on account? Explain.

C. What approach do you think the company should follow in dealing with the bank?

Solution Summary

The following solution discusses inventory methods and issues.