Chapter 8, Problem 6E

1. a.

To determine

Prepare the journal entry for the loss from the write-down of inventory.

Explanation of Solution

Journal entry:

Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, and expenses.

Lower-of-cost-or-market: The lower-of-cost-or-market (LCM) is a method which requires the reporting of the ending merchandise inventory in the financial statement of a company, at its current market value or at is historical cost price, whichever is less.

Prepare the journal entry for the loss from the write-down of inventory as follows:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Loss from write-down of inventory (2)		$2,400
	Inventory			$2,400
	(To record the loss from write-down of inventory)

Table (1)

• Loss from write-down of inventory is an operating expense account and decreases the stockholders’ equity account by $2,400. Therefore, debit loss from write-down of inventory with $2,400.
• Inventory is an asset account, and it decreases the value of assets by $2,400. Therefore, credit inventory account with $2,400.

Working note:

Calculate the value of replacement cost

$\begin{array}{c}\text{Relacement cost = }\left[\begin{array}{l}\text{Inventory on hand on December 31}\times \\ \text{Replacement cost per unit}\end{array}\right]\\ =28\text{ units}\times \text{\$250}\\ \text{=\$7,000}\end{array}$ (1)

Calculate loss from write-down of inventory

$\begin{array}{c}\begin{array}{l}\text{Loss from }\\ \text{write-down of inventory}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Total cost available for sale }-\\ \text{Replacement cost (1)}\end{array}\right]\\ =\$9,400-\text{\$7,000}\\ \text{=\$2,400}\end{array}$ (2)

1. b.

To determine

Prepare the journal entries to record the sales revenue and cost of goods sold (FIFO).

Explanation of Solution

Prepare the journal entries to record the sales revenue and cost of goods sold as follows:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash (3)		$5,250
	Sales revenue			$5,250
	(To record the loss from write-down of inventory)

Table (1)

• Cash is an asset account, and it increases the value of assets by $5,250. Therefore, debit the cash account with $5,250.
• Sales revenue is a revenue account and increases the stockholders’ equity account by $5,250. Therefore, credit the sales account with $5,250.

Working note:

Calculate the value of sales revenue

$\begin{array}{c}\text{Sales revenue = Number of units sold}\times \text{Retail price per unit}\\ \text{=15 units }\times \$350\\ =\$5,250\end{array}$ (3)

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (4)		$3,750
	Inventory			$3,750
	(To record the cost of goods sold incurred)

Table (1)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $3,750. Therefore, debit cost of goods account with $3,750.
• Inventory is an asset account, and it decreases the value of assets by $3,750. Therefore, credit inventory account with $3,750.

Working note:

Calculate the value of cost of goods sold (lower-of-cost-or-market)

$\begin{array}{c}\text{Cost of goods sold = Number of units sold}\times \text{Replacement cost per unit}\\ \text{=15 units }\times \$250\\ =\$3,750\end{array}$ (4)

2.

To determine

Prepare the journal entries for the shrinkage loss under FIFO and LIFO method, and explain the cost flow assumption that gives the lowest net income for the period.

Explanation of Solution

Prepare the journal entries for the shrinkage loss under FIFO and LIFO method as follows:

a. Shrinkage loss under FIFO method

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (6)		$1,200
	Inventory			$1,200
	To record the shrinkage loss  incurred under FIFO method)

Table (1)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $1,200. Therefore, debit cost of goods account with $1,200.
• Inventory is an asset account, and it decreases the value of assets by $1,200. Therefore, credit inventory account with $1,200.

Working note:

Calculate the units of shrinkage loss

$\begin{array}{c}\text{Shrinkage loss unit = }\left(\begin{array}{l}\text{Total available sales unit}-\\ \text{Number of physical inventory finds }\end{array}\right)\\ =28\text{ units}-\text{ 25 units}\\ \text{=3 units}\end{array}$ (5)

$\begin{array}{c}\text{Shrinkage loss under FIFO= Shrinkage loss units}\times \text{ Cost per unit under FIFO }\\ \text{=3 units }\times \$400\\ =\$1,200\end{array}$ (6)

b. Shrinkage loss under LIFO method

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (6)		$930
	Inventory			$930
	(To record the shrinkage loss  incurred under LIFO method)

Table (1)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $930. Therefore, debit cost of goods account with $930.
• Inventory is an asset account, and it decreases the value of assets by $930. Therefore, credit inventory account with $930.

Working note:

$\begin{array}{c}\text{Shrinkage loss under LIFO= Shrinkage loss units}\times \text{ Cost per unit under LIFO }\\ \text{=3 units }\times \$310\\ =\$930\end{array}$ (6)

c. Explain the cost flow assumption that gives the lowest net income for the period as follows:

LIFO produces the lowest net income because, under the LIFO method, the costs of the last purchased items are considered as the cost of goods sold for the items which are sold first. When the inventory costs are rising, LIFO method would produce the higher cost of goods sold, because of the increased purchase price of the last item. The higher cost of goods sold reduces the value of net income, at the same time the lower amount of net income produces less income tax expense. Hence, LIFO method gives the lowest net income.