Question

How is merchandising inventory valued when using the lower-of-cost-or-market rule? a)

ABC Company paid $3,000 for its merchandise inventory. At the end of the accounting period, the merchandise inventory can now be replaced for $2,700 and this decline appears to be permanent. Write the journal entry to write down the inventory to LCM:

What are the effects of merchandise inventory errors on the financial statements? Fill in the blanks below with “understated” or “overstated”:

a) If the ending merchandise inventory is overstated, then cost of goods sold is _____________, and the net income is _______________.

b) If the ending merchandise inventory is understated, then cost of goods sold is ____________, and the net income is _______________.

How do we use inventory turnover and days’ sales in inventory to evaluate business performance?

a) What are the formulas for inventory turnover and days’ sales in inventory?

b) Calculate the inventory turnover and days’ sales in inventory based on the information below (show work):

Cost of goods sold $11,000

Beginning merchandise inventory 4,000

Ending merchandise inventory 3,000

Answer 1

1)

The inventory is reduced in value by $300 (ie $3,000 - $2,700 )

Journal entry is

Cost of good sold (Debit) $300

to Merchandise Inventory (Credit) $300

2)

a) Cost of goods sold is Understated and net income is overstated

b) Cost of goods sold is Overstated and net income is understated

3)

In simple terms, inventory turnover ratio means how many times of average inventory is sold during a year. For example if the average inventory is $2,000 and Cost of goods sold is $40,000, inventory turnover ratio is 20. ie $40,000 Cost of goods sold is 20 time of $2,000 average inventory.

Day sales in inventory means within how many days the average inventory is sold during the year.

The evaluating the business performance through inventory turnover ratio, one should check whether the inventory turnover is more or less. If inventory turnover is more then the performance of the business is effective and vice versa.

a)

Inventory turnover ratio = Cost of goods sold / Average Inventory

Average Inventory = ( Beginning merchandise + Ending merchandise ) / 2

Day sales in inventory = (Average Inventory X 365 days) / Cost of goods sold

b)

Average Inventory = ( Beginning merchandise + Ending merchandise ) / 2

= ( $4,000 + $3,000 ) / 2

= $3,500

Inventory turnover ratio = Cost of goods sold / Average Inventory

= $11,000 / $3,500

= 3.14

Day sales in inventory = (Average Inventory X 365 days) / Cost of goods sold

= ( $3,500 X 365 days ) / $11,000

= 116 days