Accounting 350

Monday, February 10
Student Groups
 Net Sales
Sales net of returns and discounts
Sales net of cash discounts and sales returns
Once a sale is made, the firm needs to estimate the amount they will ultimately receive in cash.
Cash discounts: a discount offered to customers if they pay within a short window. This encourages customers to pay
more quickly, providing the firm with cash and reducing the likelihood of non payment. Note: A firm can either use the
gross or net method of accounting for cash discounts. The difference is whether management expects customers to take
the discount or not. For simplicity we will just use the gross method that assumes that customers will not take the
discount (pay full price).
Sales returns: It is common practice to allow customers to return merchandise and receive a refund. The firm should
estimate the amount of future returns and refunds. This creates a “refund liability”
 Example
During January, a firm recorded credit sales for $1,000,000 with terms 2/10, n30. The inventory cost the firm $700,000.
During January, the firm collected $750,000 from customers, net of cash discounts of $14,000 and the firm does not
expect any further cash discounts to be taken. In addition, during January, 6% of the goods sold were returned for a full
refund and at the end of the month, the firm expected an additional 4% of the goods sold to be returned in the future.

Prepare the entries to record the transactions and determine the net sales for January.
 Accounts Receivable Example
Credit Sales Dr Cr Cash collections Dr Cr

Sales returns Dr Cr Future Sales returns Dr Cr

Accounts receivable Net sales

EXERCISE 7-6
Harwell manufactures automobile tires. On July 15, 2024, the company sold 1,000 tires to Nixon for $50 each. The terms of the s
were 2/10, n/30. Harwell uses the gross method of accounting for cash discounts.

Prepare the journal entries to record the sale on July 15 (ignore cost of goods) and collection on July 23, 2024.
Prepare the journal entries to record the sale on July 15 (ignore cost of goods) and collection on August 15, 2024.
 CASH DISCOUNTS
July 15 Dr. Cr.

Payment on July 23 Dr. Cr. Payment onAugust 15 Dr. Cr.

NOTE: THE SALE OCCURS ON JULY 15 AND PAYMENT IS EITHER MADE ON JULY 23 OR ON AUGUST 15
EXERCISE 7-8
Halifax Manufacturing allows its customers to return merchandise for any reason up to 90 days after delivery and
receive a credit to their accounts. All of Halifax’s sales are for credit (no cash is collected at the time of sale). The
company began 2024 with a refund liability of $300,000. During 2024, Halifax sold merchandise on account for
$11,500,000. Halifax’s merchandise costs are 65% of merchandise selling price. Also during the year, customers
returned $450,000 in sales for credit, with $250,000 of those being returns of merchandise sold prior to 2024, and
the rest being merchandise sold during 2024. Sales returns, estimated to be 4% of sales, are recorded as an adjusting
entry at the end of the year.
Prepare entries to record (a) actual returns in 2024 of merchandise that was sold prior to 2024; (b) actual returns in
2024 of merchandise that was sold during 2024; and (c) adjust the refund liability to its appropriate balance at year-
end.
What is the amount of the year-end refund liability after the adjusting entry is recorded?
 SALES RETURNS
2024 Returns of Prior Sales Dr. Cr. 2024 Returns of 2024 Sales Dr. Cr.

Year-end refund liability End of year adjustment Dr. Cr.

EXERCISE 7-9
RIGHT OF RETURN DOES NOT EXPIRE
Halifax Manufacturing allows its customers to return merchandise for any reason and receive a credit to their
accounts. All of Halifax’s sales are for credit (no cash is collected at the time of sale). The company began 2024 with
a refund liability of $300,000. During 2024, Halifax sold merchandise on account for $11,500,000. Halifax’s
merchandise costs are 65% of merchandise selling price. Also during the year, customers returned $450,000 in sales
for credit, with $250,000 of those being returns of merchandise sold prior to 2024, and the rest being merchandise
sold during 2024. Sales returns, estimated to be 4% of sales, are recorded as an adjusting entry at the end of the year.
Prepare entries to record (a) actual returns in 2024 of merchandise that was sold prior to 2024; (b) actual returns in
2024 of merchandise that was sold during 2024; and (c) adjust the refund liability to its appropriate balance at year-
end.
What is the amount of the year-end refund liability after the adjusting entry is recorded?
 SALES RETURNS (NO EXPIRATION)
2024 Returns of Prior Sales Dr. Cr. 2024 Returns of 2024 Sales Dr. Cr.
Refund liability $250,000 Sales returns $200,000
Accounts receivable $250,000 Accounts receivable 200,000
Inventory 162,500 Inventory 130,000
Inventory-estimated returns 162,500 Cost of goods sold 130,000

Year-end refund liability End of year adjustment Dr. Cr.

Accounts Receivable
What is a bad debt?
 Allowance for bad debts
• Does a firm generally collect the amount due from all of its customers?
• What type of an account is the “allowance for uncollectible accounts”?
• Why is it important to set up an allowance for future uncollectible?
• What is a “write-off” and why does it occur?
 Accounts Receivable and Allowance for
uncollectible accounts (ignore for now sales
discounts and returns)

Accounts receivable Allowance

Beginning balance Beginning balance

Credit Sales
Bad debt expense
- Cash collections
- Write offs
- Write offs
Ending balance
Ending balance
 EXERCISE 7-12
Johnson calculates its allowance for uncollectible accounts as 10% of its ending balance in gross accounts
receivable. The allowance for uncollectible accounts had a credit balance of $30,000 at the beginning of
2024. No previously written-off accounts receivable were reinstated during 2024. At 12/31/24, gross
accounts receivable totaled $500,000, and prior to recording the adjusting entry to recording the adjusting
entry to recognize bad debts for 2024, the allowance for doubtful accounts had a debit balance of $55,000.

1. What was the balance in gross accounts receivable as of 12/31/23?

2. What journal entry should Johnson record to recognize bad debt expense in 2024?
3. Assume that Johnson made no other adjustment of the allowance for uncollectible accounts during 2024.
Determine the amount of accounts receivable written off during 2024.
 EXERCISE 7-12
1

2 2 Dr. Cr

3
 EXERCISE 7-14
AGING METHOD
Dhaliwal categorizes its accounts receivable into three age groups for purposes of estimating its allowance for uncollectible
accounts.

Estimated
Balance
Uncollectible %
Accounts not yet due $180,000 10%
Accounts 1-45 days past due $25,000 20%
Accounts more than 45 days past due $10,000 30%

Before recording any adjustments, Dhaliwal has a debit balance of $45,000 in its allowance for uncollectible accounts.

1. Estimate the appropriate 12/31/24 balance for Dhaliwal’s allowance for uncollectible accounts.
2. What journal entry should Dhaliwal record to adjust its allowance of uncollectible accounts?
 EXERCISE 7-14
Estimated Estimated
1 Balance
Uncollectible % Uncollectible $
Accounts not yet due $180,000 10%
Accounts 1-45 days past due $25,000 20%
Accounts more than 45 days past due $10,000 30%
Total $215,000

Allowance

2 Dr Cr
What do you do if you collect a receivable that you have already written off?

• Reinstate the accounts receivable by reversing the write-off entry

• Dr. Accounts receivable, Cr. Allowance for doubtful accounts
• Record the collection of the cash.
• Dr. Cash, Cr. Accounts receivable
 EXERCISE 7-16
Rocky Cookie offers credit terms to its customers. At the end of 2024, accounts receivable totaled $625,000. The
allowance for uncollectible accounts had a credit balance of $32,000 at the beginning of 2024 and $21,000 in
receivables were written off during the year as uncollectible. Also, $1,200 in cash was received in December from a
customer from a customer whose account previously had been written off. The company estimates bad debts by
applying a percentage of 10% to accounts receivable at the end of the year.

1. Prepare the journal entries to record the write-off of receivables, the collection of $1,200 for previously written off
receivables, and the year-end adjusting entry for bad debt expense.
2. How would accounts receivable be shown in the 2024 year-end balance sheet?
 EXERCISE 7-16
Write off of receivables Dr Cr Collection of $1,200 Dr Cr

Allowance

Y-E Adjusting entry Dr Cr Balance Sheet Presentation

Accounting 350
Wednesday, February 12
Accounts and Notes Receivable
 EXERCISE 7-14
AGING METHOD
Dhaliwal categorizes its accounts receivable into three age groups for purposes of estimating its allowance for uncollectible
accounts.

Estimated
Balance
Uncollectible %
Accounts not yet due $180,000 10%
Accounts 1-45 days past due $25,000 20%
Accounts more than 45 days past due $10,000 30%

Before recording any adjustments, Dhaliwal has a debit balance of $45,000 in its allowance for uncollectible accounts.

1. Estimate the appropriate 12/31/24 balance for Dhaliwal’s allowance for uncollectible accounts.
2. What journal entry should Dhaliwal record to adjust its allowance of uncollectible accounts?
 EXERCISE 7-14
Estimated Estimated
1 Balance
Uncollectible % Uncollectible $
Accounts not yet due $180,000 10%
Accounts 1-45 days past due $25,000 20%
Accounts more than 45 days past due $10,000 30%
Total $215,000

Allowance

2 Dr Cr
EXERCISE 7-14
Estimated Estimated
1 Balance
Uncollectible % Uncollectible $
Accounts not yet due $180,000 10% $18,000
Accounts 1-45 days past due $25,000 20% $5,000
Accounts more than 45 days past due $10,000 30% $3,000
Total $26,000

2 Dr Cr
Bad debt expense $71,000
Allowance for bad debts $71,000
What do you do if you collect a receivable that you have already written off?

• Reinstate the accounts receivable by reversing the write-off entry

• Dr. Accounts receivable, Cr. Allowance for doubtful accounts
• Record the collection of the cash.
• Dr. Cash, Cr. Accounts receivable
EXERCISE 7-16
Rocky Cookie offers credit terms to its customers. At the end of 2024, accounts receivable totaled $625,000. The
allowance for uncollectible accounts had a credit balance of $32,000 at the beginning of 2024 and $21,000 in
receivables were written off during the year as uncollectible. Also, $1,200 in cash was received in December from a
customer whose account previously had been written off. The company estimates bad debts by applying a percentage of
10% to accounts receivable at the end of the year.

1. Prepare the journal entries to record the write-off of receivables, the collection of $1,200 for previously written off
receivables, and the year-end adjusting entry for bad debt expense.
2. How would accounts receivable be shown in the 2024 year-end balance sheet?
 EXERCISE 7-16
Write off of receivables Dr Cr Collection of $1,200 Dr Cr

Allowance

Y-E Adjusting entry Dr Cr Balance Sheet Presentation

 EXERCISE 7-16
Write off of receivables Dr Cr Collection of $1,200 Dr Cr
Allowance $21,000 Accounts receivable $1,200
Allowance $1,200
Accounts receivable $21,000
Cash $1,200
Accounts receivable $1,200

Y-E Adjusting entry Dr Cr

Balance Sheet Presentation
Bad debt expense $50,300 Accounts receivable $625,000
Allowance $50,300 Allowance 62,500
Net accounts receivable $562,500
Notes Receivable
How does a note differ from accounts receivable?
Longer term, carries interest

Notes receivable differ from accounts receivable because they have a longer maturity
Because of the longer maturity they generate interest
The interest could be explicit (stated) or implicit (noninterest bearing).
What is an implicit interest rate
Sometimes the interest rate is not explicitly stated in the note. Instead, the note simply states that a
lump-sum payment is due on a specific date.
Even though the note does not state an interest rate, the seller is providing financing for the buyer and
needs to separate sales revenue from financing revenue.
Example
Explicit interest rate
On April 1, Y1, ZXX sold merchandise to a customer for $500,000. The merchandise is recorded on ZXX’s
books at a cost of $300,000. The customer signed a note that agreed to pay ZXX interest at 5% and
principal on March 31, Y2.

Prepare journal entries to record the sale of the merchandise on April 1, the interest accrual on December
31, Y1, and the payment of the principal and interest on March 31, Y2
Notes receivable - Explicit interest rate
Sale on April 1 Dr Cr
Dec 31 Accrual Dr Cr

Interest revenue =

Payment on March 31 Dr Cr
Notes receivable - Explicit interest rate
Sale on April 1 Dr Cr
Notes receivable $500,000 Dec 31 Accrual Dr Cr
Sales revenue $500,000 Interest receivable 18,750
Cost of goods sold 300,000 Interest revenue 18,750
Inventory 300,000

Interest revenue = $500,000 x 5% x 9/12 = $18,750

Payment on March 31 Dr Cr
Cash 525,000
Notes receivable 500,000
Interest receivable 18,750
Interest revenue 6,250
Example
Implicit interest rate
On April 1, Y1, ZXX sold merchandise to a customer that is recorded on ZXX’s books at a cost of
$300,000. The customer signed a note that agreed to pay ZXX $500,000 on March 31, Y2. The fair value
of the merchandise sold is $475,000.

1. Prepare journal entries to record the sale of the merchandise on April 1, the interest accrual on
December 31, Y1, and the payment of the principal and interest on March 31, Y2.
2. What is the effective interest rate on this note?
Notes receivable - Implicit interest rate
Sale on April 1 Dr Cr Dec 31 Accrual Dr Cr
Notes receivable 500,000 Notes receivable discount 18,750
Sales revenue 475,000 Interest revenue 18,750
Notes receivable 25,000
discount
Cost of goods sold 300,000
Inventory 300,000
Interest revenue = $25,000 x 9/12 = $18,750

Payment on March 31 Dr Cr Effective interest rate = $25,000÷$475,000 = 5.26%

Cash 500,000
Notes receivable discount 6,250
Notes receivable 500,000
Interest revenue 6,250
Notes receivable - Implicit interest rate
Sale on April 1 Dr Cr Dec 31 Accrual Dr Cr
Notes receivable 500,000 Notes receivable discount 18,750
Sales revenue 475,000 Interest revenue 18,750
Notes receivable 25,000
discount
Cost of goods sold 300,000
Inventory 300,000
Interest revenue = $25,000 x 9/12 = $18,750

Payment on March 31 Dr Cr Effective interest rate = $25,000÷$475,000 = 5.26%

Cash 500,000
Notes receivable discount 6,250
Notes receivable 500,000
Interest revenue 6,250
 EXERCISE 7-19
On June 30, 2024, the Esquire Co. sold some merchandise to a customer for $30,000. In payment,
Esquire agreed to accept a 6% note requiring the payment of interest and principal on March 31, 2025.

1. Prepare the journal entries to record the sale of merchandise (omit any entry that might be required for
the cost of goods sold), the December 31, 2024 interest accrual, and the March 31, 2025 collection.
2. If the December 31adjusting entry is not prepared, by how much would income before income taxes be
over- or understated in 2024 and 2025?
EXERCISE 7-19
June 30, 2024 Dr. Cr. December 31, 2024 Dr. Cr.

March 31, 2025 Dr. Cr.

IF THE ACCRUAL IS NOT MADE ON DECEMBER 31, 2024 THEN:

EXERCISE 7-19
June 30, 2024 Dr. Cr. December 31, 2024 Dr. Cr.
Notes receivable 30,000 Interest receivable 900
Sales revenue 30,000 Interest revenue 900

March 31, 2025 Dr. Cr.

Cash 31,350
Interest revenue 450
Interest receivable 900
Notes receivable 30,000

IF THE ACCRUAL IS NOT MADE ON DECEMBER 31, 2024 THEN:

 EXERCISE 7-20
On June 30, 2024, the Esquire Co. sold some merchandise to a customer and accepted a non interest
bearing note in exchange. The note requires payment of $30,000 on March 31, 2025. The fair value of the
merchandise exchanged is $28,200. Esquire views the financing component of this contract as significant.

1. Prepare the journal entries to record the sale of merchandise (omit any entry that might be required for
the cost of goods sold), the December 31, 2024 interest accrual, and the March 31, 2025 collection.
2. What is the effective interest rate of the note?
EXERCISE 7-20
December 31, 2024 Dr. Cr.
June 30, 2024 Dr. Cr.

Effective Interest Rate

March 31, 2025 Dr. Cr.
 EXERCISE 7-20
December 31, 2024 Dr. Cr.
June 30, 2024 Dr. Cr.
Note receivable discount 1,200
Notes receivable 30,000
Interest revenue 1,200
Sales revenue 28,200
Note receivable discount 1,800

March 31, 2025 Dr. Cr. Effective Interest Rate

Note receivable discount 600 Interest for 9 months $1,800
Interest revenue 600 Sales price 28,200
Cash 30,000 9 - month interest rate 6.383%
Note receivable 30,000 Annualization factor 12/9
Annualized rate 8.511%
 EXERCISE 7-22
On January 1, 2024, the Apex Co. exchanged some shares of common stock it had been holding as an investment for a
note receivable. The note principal and interest is due on January 1, 2025. The 2024 income statement reported $2,200 in
interest revenue from this note and a $6,000 gain on sale of investment in stock. The stock’s book value was $16,000.
The company’s fiscal year ends on December 31.
1. What is the note’s effective interest rate?
2. Reconstruct the journal entries to record the sale of the stock on January 1, 2024, and the adjusting entry to record
interest revenue at the end of 2024. The company records adjusting entries only at year-end.
EXERCISE 7-22
January 1, 2024 Dr. Cr. December 31, 2024 Dr. Cr.

Effective Interest Rate

EXERCISE 7-22
January 1, 2024 Dr. Cr. December 31, 2024 Dr. Cr.
Investments 16,000 Interest receivable 2,200
Gain on sale of investments 6,000 Interest revenue 2,200
Note receivable 22,000

Effective Interest Rate

Annual interest charge 2,200
Book value of note 1/1/24 22,000
Annual interest rate 10%
Accounting 350
Monday February 17
Notes receivable & secured borrowing
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 EXERCISE 7-22
On January 1, 2024, the Apex Co. exchanged some shares of common stock it had been holding as an investment for a
note receivable. The note principal and interest is due on January 1, 2025. The 2024 income statement reported $2,200 in
interest revenue from this note and a $6,000 gain on sale of investment in stock. The stock’s book value was $16,000.
The company’s fiscal year ends on December 31.
1. What is the note’s effective interest rate?
2. Reconstruct the journal entries to record the sale of the stock on January 1, 2024, and the adjusting entry to record
interest revenue at the end of 2024. The company records adjusting entries only at year-end.
EXERCISE 7-22
January 1, 2024 Dr. Cr. December 31, 2024 Dr. Cr.

Effective Interest Rate

 GENERATING CASH FROM
RECEIVABLES
What if receivables are due in 30 days, but you need cash right away?
Borrow the money and use the
receivables as collateral
Text Example

December 1, 2024 Dr. Cr.

Questions:
1. What is collateral?
2. Why does the dollar value of receivables assigned as collateral exceed the amount borrowed?
3. Why is the financing expense recognized immediately?
Text Example Continued

December 31, 2024 Dr. Cr.

Questions:
1. Does the interest expense depend on the amount collected?
2. What would be the interest expense for January 2025?
EXAMPLE
On April 1, Y1, XXZ had outstanding accounts receivable of $900,000. On that day XXZ borrowed $600,000 from a
Finance Corporation and signed a promissory note. Interest at 8% is payable monthly. The company assigned specific
receivables totaling $900,000 as collateral for the loan. The finance company assigns a finance fee equal to 1.6% of the
accounts receivable assigned.

Prepare the journal entry to record the borrowing on the books of XXZ and the accrual of interest on April 30, Y1
ASSIGNING RECEIVABLES
April 1,2024 Dr. Cr. April 30, 2024 Dr. Cr.
EXERCISE 7-23
On June 30, 2024, the High Five Surfboard Co. had outstanding accounts receivable of $600,000.
On July 1, 2024, the company borrowed $450,000 from the Equitable Finance Corporation and
signed a promissory note. Interest at 10% is payable monthly. The company assigned specific
receivables totaling $600,000 as collateral for the loan. Equitable Finance charges a finance fee
equal to 1.8% of the accounts receivable assigned.

Prepare the journal entry to record the borrowing on the books of High Five Surfboard.
EXERCISE 7-23
July 1, 2024 Dr. Cr.
Discounting a note receivable
What does it mean to discount a note receivable?
A note receivable has a longer term than an accounts receivable and generally includes interest.

• With a note, you are entitled to receive the face value and the interest at a specific time
in the future.

• If you need cash right away, you will take the note to the financial institution and they
will give you less than the amount you will receive in the future (you will receive a
“discounted” amount.

• The amount of the discount depends on the “discount rate” the financial institution
charges.
Textbook Example Time Line

9 Months

12/31/24 9/30/25
Note Originates Note Matures

3 Months 6 Months
12/31/24 3/31/25 9/30/25
Note Originates Note is discounted Note Matures
Textbook Example Calculations

Dr. Cr.

How much cash will Stridewell Receive?

Textbook Example Entry for Discounting

Dr. Cr.

$200,000 x 10% x 3/12

Dr. Cr.
 NOTE DISCOUNT EXAMPLE
SC obtained a $400,000 note receivable from a customer on January 1, 2023. The note, along with interest at 8% is due
on December 31, 2023. On April 1, 2023 SC discounted the note a the Bank. The bank’s discount rate is 9%.
Prepare the journal entries SC should record on April 1, 2023.

How much cash will SC Receive?

4/1/23 Dr. Cr. 4/1/23 Dr. Cr.

EXERCISE 7-27
DISCOUNTING A NOTE RECEIVABLE
Selkirk obtained a $15,000 note receivable from a customer on January 1 2024. The note, along with
interest at 10%, is due on July 1, 2024. On February 28, 2024, Selkirk discounted the note at Unionville
bank. The bank’s discount rate is 12%.
Prepare the journal entries required on February 28, 2024, to accrue interest and to record the
discounting (round all calculations to the nearest dollar) for Selkirk. Assume that the discounting is
accounted for as a sale.
EXERCISE 7-27
February 28 2024 Dr. Cr.

Cash Received from Discounting Note

February 28 2024 Dr. Cr.

ACCOUNTING 350
WEDNESDAY, FEBRUARY 19
FACTORING (SELLING) ACCOUNTS RECEIVABLE
Factoring
FACTORING: A FIRM ESSENTIALLY SELLS RECEIVABLES
TO A “FACTOR” FOR CASH
To generate immediate cash from receivables, a firm could sell the receivables to a third party.
This process is called “factoring” and the third party is called the “factor”. The factor pays cash up front
and then receives (collects) the receivables. Because the company doing the factoring is selling the
receivables, it no longer collects the receivables (but it still has the ability to accept sales returns).
The factor (who buys the receivables) typically withholds some of the funds to protect against sales
returns.
The factor also charges a fee for their service that they deduct up front from the amount paid.
The company that sells the receivables records a loss based on the difference between the book value of
the receivables sold, and the amount received plus the receivable from the factor.
Note the difference between selling the receivables and using the receivables as collateral for a loan.
RECOURSE: WHO BEARS THE RISK OF UNCOLLECTIBLE
ACCOUNTS?
Question: Does the factor have any “recourse” if the receivables they buy are not collected?
Answer: It depends on the contract (sales agreement).
If the contract does not specify recourse, the buyer accepts all of the risk from the possible collection of
the receivables.
If the contract allows for recourse, the seller of the receivables is liable if a customer ultimately fails to
pay.
This means that the seller of the receivables needs to record a recourse liability.
In reality, the price the seller receives from the factoring agreement depends on the recourse clause. We
will just focus on the accounting for recourse and non recourse arrangements.
Textbook Example Factoring without Recourse

Dr. Cr.
FACTORING WITHOUT RECOURSE EXAMPLE
CB transferred $180,000 of accounts receivable to FC. The transfer was made without recourse. FC remits 80% of the
factored amount to CB and retains 20%. When FC collects the receivables, it will remit to CB the retained amount
(which CB estimates has a fair value of $25,000) less a 3% fee (3% of the factored amount).

Dr. Cr.
EXERCISE 7-24
FACTORING WITHOUT RECOURSE
Mountain High Ice Cream transferred $60,000 of accounts receivable to the Prudential Bank. The
transfer was made without recourse. Prudential remits 90% of the factored amount to Mountain High and
retains 10%. When the bank collects the receivables, it will remit to Mountain High the retained amount
(which Mountain High estimates has a fair value of $5,000) less a 2% fee (2% of the total factored
amount).
Prepare the journal entry to record the transfer on the books of Mountain High assuming that the sale
criteria are met.
EXERCISE 7-24
Dr. Cr.
Textbook Example of Factoring with Recourse
Now let’s assume that the sale of the receivables is made with recourse. The seller
estimates that the fair value of the recourse obligation is $5,000.

Dr. Cr.
FACTORING WITH RECOURSE EXAMPLE
CB transferred $180,000 of accounts receivable to FC. The transfer was made with recourse. FC remits 80% of the
factored amount to CB and retains 20%. When FC collects the receivables, it will remit to CB the retained amount
(which CB estimates has a fair value of $25,000) less a 3% fee (3% of the factored amount). CB expects a recourse
obligation of $10,000.

Dr. Cr.
EXERCISE 7-25
FACTORING WITH RECOURSE
Mountain High Ice Cream transferred $60,000 of accounts receivable to the Prudential Bank. The
transfer was made with recourse. Prudential remits 90% of the factored amount to Mountain High and
retains 10%. When the bank collects the receivables, it will remit to Mountain High the retained amount
(which Mountain High estimates has a fair value of $5,000). Mountain High anticipates a $3,000
recourse obligation. The bank charges a 2% fee (2% of $60,000), and requires that amount to be paid at
the start of the factoring arrangement.

Prepare the journal entry to record the transfer on the books of Mountain High assuming that the sale
criteria are met.
EXERCISE 7-25
Dr. Cr.
Inventory
WHAT IS INVENTORY?
GOODS THAT WE OWN THAT WE INTEND TO SELL TO CUSTOMERS

Inventory is an asset that must be expressed in the balance sheet in dollars.

Questions:

Which items do you include in inventory?

How do you value inventory if prices have been changing over time?
 WHY IS INVENTORY SO IMPORTANT?
INVENTORY VS COST OF GOODS SOLD

Retail irm $

Beginning Inventory
Available to sell
+ Purchases

Sold - Cost of goods sold Expense on the income statement

Left Ending Inventory Asset on the balance sheet

f
 MEASURING WHAT’S LEFT TELLS US WHAT WAS USED

Retail irm $

Beginning Inventory
Available to sell
+ Purchases

- Ending inventory Asset on the balance sheet

Left

Used Cost of goods sold Expense on the income statement

f
WHAT UNITS DO WE INCLUDED IN INVENTORY?
OWNERSHIP VERSUS POSSESSION

Start by picturing a warehouse and assume that we are able to count everything in the warehouse.

Question 1: Does the firm own all of the inventory in the warehouse?

Question 2: What are you missing if you only consider items in the warehouse?

Consignment: Goods owned by one party, but held (in the possession of another)

Goods in transit:

FOB shipping point (ownership transfers when goods are shipped, goods in transit belong to the buyer)

FOB destination (ownership transfers when goods arrive, good in transit belong to the seller).
EXAMPLE
At year-end MON Corp. had 900,000 units on hand in it warehouse. In addition, you are provided with
the following information:

Units
90 Units not in the warehouse held on consignment by FED
130 Held in the warehouse on consignment for GHI
85 Incoming goods in transit shipped FOB destination
122 Incoming goods in transit shipped FOB shipping point
33 Outgoing goods in transit shipped FOB destination
64 Outgoing goods in transit shipped FOB shipping point

How many units should MON report in its inventory as of the end of the year?
HOW MANY UNITS SHOULD BE INCLUDED IN INVENTORY?

Description Units
EXERCISE 8-7
GOODS IN TRANSIT, CONSIGNMENT

The December 31, 2024, year-end inventory balance of the Almond Corp. is $210,000. You have been asked to review
the following transactions to determine if they have been correctly recorded.

1. Goods shipped to Almond f.o.b. destination on December 26, 2024, were received on January 2, 2025. The
invoice cost of $30,000 is included in the preliminary inventory balance.
2. At year-end, Almond held $14,000 of inventory on consignment from the Hardgrove Company. The inventory
is included in the preliminary inventory balance.
3. On December 29, inventory costing $6,000 was shipped to a customer f.o.b. shipping point and arrived at the
customer’s location on January 3, 2025. The inventory is not included in the preliminary inventory balance.
4. At year-end, Almond had inventory costing $15,000 on consignment with the Juniper Corporation. The
inventory is not included in the preliminary inventory balance
Determine the correct inventory amount to be reported on Almond’s 2024 balance sheet.
 EXERCISE 8-7
Description $

Preliminary balance

Correct Inventory
Accounting 350
Monday February 24
INVENTORY COSTING METHODS
INVENTORY COSTING
OVER TIME FIRMS BUY AND SELL INVENTORY. THE UNIT COST CHANGES OVER TIME.

Question: If the units are identical, but have different costs because they were purchased or produced at
different times, which costs should be in inventory (balance sheet) and which costs should be in cost of
goods sold (income statement)?

We could identify which units are sold and which are in inventory, but generally, we will make a
simplifying assumption to allocate costs.
 ALLOCATION OF COSTS BETWEEN INVESTORS AND COST
OF GOODS SOLD

Firm $

Beginning Inventory
Available to sell
+ Purchases/production

Sold - Cost of goods sold Expense on the income statement

Left Ending Inventory Asset on the balance sheet

COST ALLOCATION ASSUMPTIONS/METHODS
EACH ONE IS ALLOWABLE AND USED IN THE U.S.

LIFO: Current costs charged to cost of goods sold leading to lower gross profit and lower ending inventory (old costs). US
tax law allows firms to use LIFO to reduce their tax liability. Most other countries do not allow the use of LIFO. Potential
for LIFO liquidation.

FIFO: Current costs in ending inventory and older costs are charged to costs of goods sold.
Weighted average: Determines an average cost of goods acquired and allocates cost to inventory and cost of goods sold
based on the average.
PERPETUAL VS PERIODIC INVENTORY SYSTEMS
A perpetual system continually updates the inventory records each time a transaction takes place (purchase
or sale)
A periodic system calculates inventory at the end of the period based on the purchases and sales that took
place during the period.
The units are hopefully the same, but the allocation of costs between cost of goods sold and inventory
could be different.
EXERCISES 8-13
PERIODIC INVENTORY
Activity for the month of August, 2024

Date Transaction
1 Inventory on hand - 2,000 units; cost $5.30 each
8 Purchased 8,000 units for $5.50 each
14 Sold 6,000 units for $12.00 each
18 Purchased 6,000 units for $5.60 each
25 Sold 7,000 units for $11 each
28 Purchased 4,000 units for $5.80 each
31 Inventory on hand - 7,000 units

Determine the amounts of inventory the firm would report on its balance sheet at the end of August and the cost o
goods sold in August assuming the firm used FIFO, LIFO or average cost.
SUMMARY
Date Transaction Sales Revenue Units Price/unit Total
8/14/24 6,000 $12 $72,000
1 Inventory on hand - 2,000 units; cost $5.30 each
8/25/24 7,000 $11 $77,000
8 Purchased 8,000 units for $5.50 each
Total sales 13,000 $149,000
14 Sold 6,000 units for $12.00 each
18 Purchased 6,000 units for $5.60 each Available for Sale Units Price/unit Total
25 Sold 7,000 units for $11 each Beginning inventory 2,000 $5.30 $10,600
28 Purchased 4,000 units for $5.80 each 8/8/24 8,000 5.50 44,000
31 Inventory on hand - 7,000 units 8/18/24 6,000 5.60 33,600
8/28/24 4,000 5.80 23,200
Available for Sale 20,000 $111,400
EXERCISE 8-13
PERIODIC INVENTORY SYSTEM
LIFO Sold Units Price/unit Total
8/28/24 4,000 $5.80 $23,200
8/18/24 6,000 $5.60 $33,600
8/8/24 3,000 $5.50 $16,500
Available for Sale Units Price/unit Total
Total 13,000 $73,300
Beginning inventory 2,000 $5.30 $10,600
8/8/24 8,000 5.50 44,000 LIFO Ending Inventory Units Price/unit Total
8/18/24 6,000 5.60 33,600 Beginning inventory 2,000 $5.30 $10,600
8/28/24 4,000 5.80 23,200 8/8/24 5,000 $5.50 $27,500
Available for Sale 20,000 $111,400 Total 7,000 $38,100

FIFO Sold Units Price/unit Total FIFO Inventory Units Price/unit Total
Beginning inventory 2,000 $5.30 $10,600 8/28/24 4,000 $5.80 $23,200
8/8/24 8,000 $5.50 $44,000 8/18/24 3,000 $5.60 $16,800
8/18/24 3,000 $5.60 $16,800 Total 7,000 $40,000
Total 13,000 $71,400
Average cost = $111,400 ÷ 20,000 units = $5.57 per unit. Cost of goods sold = 13,000 x $5.57 = $72,310.
Inventory = 7,000 x $5.57 = $38,900
EXERCISE 8-14
THE FIRM USES A PERPETUAL INVENTORY SYSTEM
Activity for the month of August, 2024

Date Transaction
1 Inventory on hand - 2,000 units; cost $5.30 each
8 Purchased 8,000 units for $5.50 each
14 Sold 6,000 units for $12.00 each
18 Purchased 6,000 units for $5.60 each
25 Sold 7,000 units for $11 each
28 Purchased 4,000 units for $5.80 each
31 Inventory on hand - 7,000 units

Determine the amounts of inventory the firm would report on its balance sheet at the end of August and the cost o
goods sold in August assuming the firm used FIFO or average cost.
EXERCISE 8-14 FIFO Sold Units Price/unit
2,000 @ $5.30
Total

PERPETUAL INVENTORY SYSTEM 8/14/24 6,000 $32,600

4,000 @ $5.50
4,000 @ $5.50
8/25/24 7,000 38,800
Date Transaction 3,000 @ $5.60
1 Inventory on hand - 2,000 units; cost $5.30 each Total 13,000 $71,400
8 Purchased 8,000 units for $5.50 each
14 Sold 6,000 units for $12.00 each FIFO Inventory Units Price/unit Total
18 Purchased 6,000 units for $5.60 each 8/28/24 4,000 $5.80 $23,200
25 Sold 7,000 units for $11 each 8/18/24 3,000 $5.60 $16,800
Total 7,000 $40,000
28 Purchased 4,000 units for $5.80 each
31 Inventory on hand - 7,000 units
Weighted Average Units Price/unit Total
[(2,000 x $5.30) + (8,000 x $5.50)] ÷ 10,000 = $5.46
8/14/24 6,000 $5.46 $32,760
8/25/24 7,000 $5.544 $38,808
[(6,000 x $5.60) + (4,000 x $5.460] ÷ 10,000 = $5.544
13,000 $71,368
SUMMARY
Periodic LIFO Periodic FIFO Periodic Average
Sales revenue $149,000 Sales revenue $149,000 Sales revenue $149,000
Cost of goods sold 73,300 Cost of goods sold 71,400 Cost of goods sold 72,310
Gross profit 75,700 Gross profit 77,600 Gross profit 76,590

Perpetual FIFO Perpetual Average

Sales revenue $149,000 Sales revenue $149,000
Cost of goods sold 71,400 Cost of goods sold 71,568
Gross profit 77,600 Gross profit 77,437
EXERCISE 8-16
Periodic inventory FIFO vs LIFO
Date Units Cost/Unit
Beginning inventory 600 $80
Purchases
January 15 1,000 $95
January 21 800 $100
Sales
January 5 400 $120
January 22 800 $130
January 29 400 $135
Ending inventory 800

1. Which method will result in the highest cost of goods sold figure for January 2024? Why? Which method will result
in the highest ending inventory balance? Why?
2. Compute cost of goods sold for January and the ending inventory using both the FIFO and LIFO methods?
3. Now assume that inventory costs were declining during January. The inventory purchased on January 15 had a cost of
$70 and the inventory purchased on January 21 had a cost of $65. Repeat 1 and 2.
 EXERCISE 8-16 PART 2
Date Units Cost/Unit FIFO Sold Units Price/unit Total
Beginning inventory 600 $80 Beginning 600 $80 $48,000
Purchases 1/15 1,000 $95 95,000
Total 1,600 $143,000
January 15 1,000 $95
January 21 800 $100
Sales FIFO Inventory Units Price/unit Total
1/21 800 $100 $80,000
January 5 400 $120
January 22 800 $130 Total $80,000
January 29 400 $135
Ending inventory 800

LIFO Sold Units Price/unit Total

LIFO Ending Inventory Units Price/unit Total
1/21 800 $100 $80,000
Beginning 600 $80 $48,000
1/15 800 $95 76,000
1/15 200 $95 19,000
Total $67,000
Total 1,600 $156,000
 EXERCISE 8-16 PART 3
Date Units Cost/Unit FIFO Sold Units Price/unit Total
Beginning inventory 600 $80
Purchases
January 15 1,000 $70
January 21 800 $65
Sales FIFO Inventory Units Price/unit Total

January 5 400 $120

January 22 800 $130
January 29 400 $135
Ending inventory 800

LIFO Sold Units Price/unit Total

LIFO Ending Inventory Units Price/unit Total
 EXERCISE 8-16 PART 3
Date Units Cost/Unit FIFO Sold Units Price/unit Total
Beginning inventory 600 $80 Beginning 600 $80 48,000
Purchases January 15 1,000 $70 $70,000
Total 1,600 $118,000
January 15 1,000 $70
January 21 800 $65
Sales FIFO Inventory Units Price/unit Total
January 21 800 $65 $52,000
January 5 400 $120
January 22 800 $130
January 29 400 $135
Ending inventory 800

LIFO Sold Units Price/unit Total

LIFO Ending Inventory Units Price/unit Total
January 21 800 $65 $52,000
January 15 200 $70 $14,000
January 15 800 $70 56,000
Beginning 600 $80 48,000
Total 1,600 $108,000
Total 800 $62,000
LIFO Reserve and LIFO Liquidation
LIFO Liquidation and the LIFO Reserve
LIFO Inventory values can be very low due to “old” costs
• LIFO inventory consists of “LIFO layers”
• As long as the inventory grows, old cost layers remain.
• If costs have been increasing over time, this could lead to very old, low costs in LIFO layers and low
inventory values.
• Because FIFO leaves current (higher) costs in inventory, FIFO inventory values can be larger than LIFO
inventory values.
• The difference is referred to as the LIFO Reserve.
• Once the inventory is sold (liquidated) those old costs are charged to income leading to a LIFO
liquidation profit.
Exercise 8-19
LIFO Reserve
To more efficiently manage its inventory, Telnex maintains its internal inventory records using FIFO under a perpetual
inventory system. The following information relates to its inventory during the year.

Date Activity Units Price/cost per unit

Jan 1 Beginning Inventory 20,000
Feb 12 Purchase 70,000 $12.50
Apr 30 Sale 50,000 $20.00
Jul 22 Purchase 50,000 $12.80
Sep 9 Sale 70,000 $20.00
Nov 17 Purchase 40,000 $13.20
Dec 31 Ending inventory 60,000
1. Determine the amount Telnex would calculate internally for ending inventory and cost of goods sold using FIFO
under a perpetual inventory system. Beginning inventory under FIFO was 20,000 units with a unit cost of $12.20.
2. Determine the amount Telnex would report externally for ending inventory and cost of goods sold using LIFO
under a periodic inventory system. Beginning inventory under LIFO was 20,000 with a unit cost of $11.70.
3. Determine the amount Telnex would report for its LIFO reserve at the end of the year.
4. Record the year-end adjustment for the LIFO reserve. The balance of the LIFO reserve at the beginning of the year
was $10,000.
 EXERCISE 8-19
FIFO Sold Units Price/unit Total
Date Activity Units Price/cost per unit
Beginning 20,000 $12.20 $244,000
Jan 1 Beginning Inventory 20,000
Feb 12 30,000 $12.50 375,000
Feb 12 Purchase 70,000 $12.50
Feb 12 40,000 $12.50 500,000
Apr 30 Sale 50,000 $20.00
Jul 22 30,000 $12.80 384,000
Jul 22 Purchase 50,000 $12.80
Total 120,000 $1,503,000
Sep 9 Sale 70,000 $20.00
Nov 17 Purchase 40,000 $13.20
Dec 31 Ending inventory 60,000 FIFO Inventory Units Price/unit Total
Nov 17 40,000 $13.20 $528,000
Jul 22 20,000 $12.80 256,000
Total 60,000 $784,000

LIFO Sold Units Price/unit Total LIFO Ending Inventory Units Price/unit Total
Nov 17 40,000 $13.20 $528,000 Beginning 20,000 $11.70 $234,000
Jul 22 50,000 $12.80 640,000 Feb 12 40,000 $12.50 500,000
Feb 12 30,000 $12.50 375,000 $734,000
120,000 $1,543,000
EXERCISE 8-19 LIFO RESERVE
LIFO Reserve

FIFO Inventory $784,000

LIFO Inventory 734,000

LIFO Reserve 50,000

Account Dr. Cr.

Cost of goods sold $40,000
Inventory $40,000

Target reserve = $50,000

Beginning Reserve = $10,000
Adjustment = $40,000
ACCOUNTING 350
WEDNESDAY FEBRUARY 26
DOLLAR VALUE LIFO
EXERCISE 8-19 LIFO RESERVE
LIFO Reserve

FIFO Inventory $784,000

LIFO Inventory 734,000

LIFO Reserve 50,000

Account Dr. Cr.

Cost of goods sold $40,000
Inventory $40,000

Target reserve = $50,000

Beginning Reserve = $10,000
Adjustment = $40,000
Exercise 8-22
LIFO Liquidation
The MegaMart Co. began 2024 with inventory of 10,000 units at a cost of $7 per unit. During 2024,
50,000 units were purchased for $8.50 each. Sales for the year totaled 54,000 units leaving 6,000 units on
hand at the end of 2024. MegaMart uses a periodic inventory system and the LIFO inventory cost method.

1. Calculate cost of goods sold for 2024.

2. From a financial reporting perspective, what problem is created by the use of LIFO in this situation?
 EXERCISE 8-22
LIFO Cost of Goods Sold Units Price/unit Total

Does the cost of goods sold reflect the firm’s economic profit?
 Exercise 8-23
LIFO Liquidation
The Churchill Corp. uses a periodic inventory system and the LIFO inventory cost method for its one product. Beginning
inventory of 20,000 consisted of the following, listed in chronological order of acquisition.

12,000 units at a cost of $8.00 per unit = $96,000

8,000 units at a cost of $9.00 per unit = 72,000

During 2024, inventory quantity declined by 10,000 units. All units purchased during 2024 cost $12.00 per unit.

Calculate the before-tax LIFO liquidation profit or loss the company would report in a disclosure note, assuming the
amount determined is material.
 EXERCISE 8-23
Cost of Goods Sold Units Price/unit Total

LIFO Liquidation profit

DOLLAR VALUE LIFO
What is Dollar Value LIFO?
LIFO layers based on dollars instead of units
It is often difficult to define a “unit”. Firms can change product size or the type of product they sell. For example, Del
Monte might switch from a 16 oz can to a 20 oz can, or Del Monte might shift from canned peaches to low-sugar canned
peaches.
Dollar value LIFO groups inventory into “cost pools”.
Cost pools consist of products whose prices tend to be a function of the same underlying economic factors, i.e., they
move together.
This reduces the probability of LIFO liquidation. Why is this the case and why is this desirable?
The key is to separate price (cost) changes from quantity changes.
Keep in mind that you are combining different products, so the concept of a “unit” no longer applies.
Dollar value LIFO procedure
Steps to calculate inventory value

1. Define Cost Pool

2. Define a Base Year
3. Calculate the “value” of your ending inventory based on current costs.
4. Define a cost index - costs relative to base year
5. Use the index to calculate a base year value for your inventory
6. Changes in the base year value of inventory create inventory layers.
7. Use the cost index for the “layer” year to determine the inventory value
 Text Example
On January 1, 2024, Jolly adopted the dollar-value LIFO method. The inventory value on this date was $500,000.

Date Ending Inventory (year-end costs) Cost index

12/31/24 $556,500 1.05
12/31/25 $596,200 1.1
12/31/26 $615,250 1.15
12/31/27 $720,000 1.25
The cost index means that the cost of the inventory increased by 5% during 2024. If the inventory at the end of the year is 5%
higher than at the beginning of the year, the value at 1/1/24 costs would be $556,500 ÷ 1.05 = $530,000. This would create 2
different layers of costs. There is the $500,000 layer from 1/1/24 and a $30,000 layer created on 12/31/24. The $30,000 layer
should be valued at 12/31/24 prices = $30,000 x 1.05 = $31,500.

Base Year Acquisition

Date Year-End Cost Base Year DVL
Layers Year Layers

12/31/24 556,500
 Text Example Continued
Date Ending Inventory (year-end costs) Cost index
12/31/24 $556,500 1.05
12/31/25 $596,200 1.1
12/31/26 $615,250 1.15
12/31/27 $720,000 1.25

Base Year Acquisition

Date Y-E Cost Base Year DVL
Layers Year Layers

12/31/24 556,500

12/31/25 $596,200
 Text Example Continued
Date Ending Inventory (year-end costs) Cost index
12/31/25 $596,200 1.1
12/31/26 $615,250 1.15
12/31/27 $720,000 1.25

Base Year Acquisition

Date Y-E Cost Base Year DVL
Layers Year Layers

12/31/25 $596,200

12/31/26 $615,250
 Text Example Continued
Date Ending Inventory (year-end costs) Cost index
12/31/26 $615,250 1.15
12/31/27 $720,000 1.25

Base Year Acquisition

Date Y-E Cost Base Year DVL
Layers Year Layers

12/31/26 $615,250

12/31/27 $720,000
 Problem 8-14
Dollar Value LIFO
A company uses the dollar-value LIFO method of computing inventory. An external price index is used to convert ending
inventory to base year. The company began operations on January 1, 2024, with an inventory of $150,000. Year-end
inventories at year-end costs and cost indexes for its one inventory pool were as follows:

Year Ended Ending Inventory at

Cost Index
December 31 Year-End Costs

2024 $200,000 1.08

2025 245,700 1.17

2026 235,980 1.14

2027 228,800 1.1

Calculate inventory amounts at the end of each year.

 PROBLEM 8-14
Acquisition Year
Date Y-E Cost Base Year Cost Base Year Layers DVL
Layers

12/31/24 $200,000

12/31/25 $245,700

12/31/26 $235,980

12/31/27 $228,800
 Exercise 8-27
Dollar Value LIFO
Mercury Company has only one inventory pool. On December 31, 2024, Mercury adopted the dollar-value LIFO inventory
method. The inventory on that date using the dollar-value LIFO method was $200,000. Inventory data are as follows:

Ending Inventory at Year- Ending Inventory at Base

Year
end Costs Year Costs
2025 $231,000 $220,000
2026 299,000 260,000
2027 300,000 250,000

Compute the inventory at December 31, 2025, 2026, and 2027, using the dollar-value LIFO method.
 EXERCISE 8-27
Acquisition Year
Date Y-E Cost Base Year Cost Base Year Layers DVL
Layers

12/31/25 $231,000

12/31/26 $299,000

12/31/27 $300,000
LOWER OF COST OR MARKET
 LOWER OF COST OR MARKET
IF THE VALUE OF INVENTORY DECLINES, THE FIRM NEEDS TO WRITE-DOWN THE INVENTORY TO THE
CURRENT VALUE AND RECOGNIZE THE LOSS

Inventory held by a firm can decline for several reasons

Obsolescence
Change in fashion and taste
Change in taxes and other laws and regulations
GAAP requires firms to recognize the loss when the value declines. The market is an estimate of what the firm would
receive if it sold the inventory.
GAAP does not allow firms to recognize a gain when the value increases (firms need to sell the item for the higher price
to realize the gain)
 WRITE-DOWN OF INVENTORY
ASSUME THAT THE HISTORICAL COST (BOOK VALUE) OF INVENTORY = $100,000, BUT THE CURRENT
MARKET VALUE = $70,000

Account Dr. Cr.

Cost of goods sold $30,000
Inventory $30,000
HOW DO YOU ESTIMATE THE MARKET VALUE?
Ceiling: Net realizable value

Floor: Net realizable value less normal profit margin

Between ceiling and floor: Replacement cost

 EXERCISE 9-5
The inventory of Royal Decking consisted of five products. Information about the ending inventory is as follows:

Product Cost Replacement cost Selling Price

A $40 $35 $60
B 80 70 100
C 40 55 80
D 100 70 130
E 20 28 30

Costs to sell consist of a sales commission equal to 10% of selling price and shipping costs equal to 5% of cost. The
normal profit is 30% of selling price.

What unit value should Royal Decking use for each of its products when applying the lower of cost or market (LCM)
rule to units of ending inventory?
 EXERCISE 9-5
Replacement Selling Sales Shipping Net Realizable Normal
Product Cost
cost Price Commission Cost Value Profit Margin
A $40 $35 $60
B 80 70 100
C 40 55 80
D 100 70 130
E 20 28 30

Replacement Net Realizable

Product NRV - NPM “Market” Cost LCM
cost Value
A $35
B 70
C 55
D 70
E 28
 Accounting 350
Monday, March 3
Other Inventory Issues
LOWER OF COST OR MARKET
BASIC RULE
ESTIMATING THE MARKET VALUE
Ceiling: Net realizable value

Floor: Net realizable value less normal profit margin

Between ceiling and floor: Replacement cost

 EXERCISE 9-5
The inventory of Royal Decking consisted of five products. Information about the ending inventory is as follows:

Product Cost Replacement cost Selling Price

A $40 $35 $60
B 80 70 100
C 40 55 80
D 100 70 130
E 20 28 30

Costs to sell consist of a sales commission equal to 10% of selling price and shipping costs equal to 5% of cost. The
normal profit is 30% of selling price.
What unit value should Royal Decking use for each of its products when applying the lower of cost or market (LCM)
rule to units of ending inventory?
 EXERCISE 9-5
Cos Replacement Selling Sales Shipping Net Normal
Product Realizable
t cost Price Commission Cost Profit Margin
Value
A $40 $35 $60
B 80 70 100
C 40 55 80
D 100 70 130
E 20 28 30

Replacement Net Realizable

Product NRV - NPM “Market” Cost LCM
cost Value
A $35
B 70
C 55
D 70
E 28
 PROBLEM 9-3
Forester Company has five products in its inventory. Information about the ending inventory follows.

Replacement Selling
Product Quantity Cost
cost Price
A 1,000 $10 $12 $16
B 800 15 11 18
C 600 3 2 8
D 200 7 4 6
E 600 14 12 13
The cost to sell for each product consists of a 15 percent sales commission. The normal profit for each product is 40 percent
of the selling price.

1. Determine the carrying value of inventory, assuming the LCM rule is applied to individual products.
2. Determine the carrying value of inventory, assuming the LCM rule is applied to the entire inventory.
3. Assuming inventory write-downs are common for Forester, record any necessary year-end adjusting entry on the
amount calculated in requirement 2.
 PROBLEM 9-3
Replacement Selling Sales Net Realizable Normal
Product Quantity Cost
cost Price Commission Value Profit Margin
A 1,000 $10 $12 $16
B 800 15 11 18
C 600 3 2 8
D 200 7 4 6
E 600 14 12 13

Replacement Net Realizable

Product NRV - NPM Market Cost LCM
cost Value
A $12
B 11
C 2
D 4
E 12
 PROBLEM 9-3
Market Cost Total
Product Quantity Market Cost LCM
Inventory Inventory LCM
A 1,000 $12 $10 $10
B 800 $11 15 $11
C 600 $3.6 3 $3
D 200 $4 7 $4
E 600 $11.05 14 $11.05
Total

Inventory as a Whole Dr. Cr.

Inventory $
Cost of goods sold
Total Cost Inventory Inventory
Total Market Inventory
Individual items Dr. Cr.
LCM Individual Items
Cost of goods sold
Inventory
THE RETAIL METHOD
 WHAT IS THE RETAIL METHOD?
• Generally used by high volume retail firms
• Allows them to use sales prices to estimate inventory values and cost of goods sold
• Can reduce record-keeping costs
• While there are variations on the retail method, we will concentrate on the conventional method
• Markdowns are ignored in calculating the cost-retail percentage
• This approximates lower of cost or market
• Under this methodology the firm tracks purchases and sales and uses the cost to retail percentage to
estimate the cost of goods sold.
 Wal Mart

Walmart U.S. Segment - Inventories are primarily accounted for under the retail inventory method of
accounting ("RIM") to determine inventory cost, using the last-in, first-out ("LIFO") valuation method.
RIM generally results in inventory being valued at the lower of cost or market as permanent markdowns are
immediately recorded as a reduction of the retail value of inventory.

Kohls
Merchandise inventories are valued at the lower of cost or market using the retail inventory method (“RIM”).
Under RIM, the valuation of inventory at cost and the resulting gross margins are calculated by applying a
cost-to-retail ratio to the retail value of inventory. RIM is an averaging method that has been widely used in
the retail industry due to its practicality. The use of RIM will result in inventory being valued at the lower of
cost or market since permanent markdowns are taken as a reduction of the retail value of inventories. We
would record an additional reserve if the future estimated selling price is less than cost
 TEXT EXAMPLE
Cost Retail

Beginning Inventory $99,200 $160,000

Plus: Net purchases 305,280 470,000

Net Markups 10,000

Net Markdowns -8,000

Net Sales -434,000

Dtermine the ending inventory and cost of goods sold using the conventional retail method.
TEXT EXAMPLE
Cost Retail
 EXERCISE 9-14
CONVENTIONAL RETAIL INVENTORY METHOD
Campbell uses the retail method to value its inventory. The following information is available for the year:

Cost Retail
Beginning inventory $190,000 $280,000
Purchases 600,000 840,000
Freight In 8,000
Net markups 20,000
Net markdowns 4,000
Net sales 800,000

Determine ending inventory and cost of goods sold by applying the conventional retail method using the information provided
TEXT EXAMPLE
Cost Retail
PURCHASE COMMITMENTS
WHAT IS A PURCHASE COMMITMENT?
• A contractual agreement to purchase a certain amount of inventory at a fixed price at a future date
• Allows the firm to lock-in the price of the goods and protect against future price increases
• The firm is exposed to the risk that prices could decline. In that case, the firm is forced to purchase
goods at a higher than market price
• In that case, the firm needs to separate the loss from the decision to enter into the commitment from the
value of the inventory
• Note: Firms can hedge the risk by entering into other contracts. Hedging contracts are covered in
Accounting 450 (Advanced Accounting)
 TEXT EXAMPLE
In July 2024 Lassiter signed 2 purchase commitments. Lassiter uses a 12/31 year-end

Amount Date
Commitment A $500,000 November 15, 2024
Commitment B $600,000 February 15, 2025

Contract A - Commitment to purchase $500,000 on November 15, 2024

Case 1: The market value of the inventory when Lassiter buys the inventory is greater than or equal to $500,000.
Purchase Dr Cr

Case 2: The market value of the inventory when Lassiter buys the inventory is $425,000

Purchase Dr Cr
 TEXT EXAMPLE
Amount Date
Commitment B $600,000 February 15, 2025
Contract B - Commitment to purchase $600,000 on February 15, 2025
Assume that at December 31, 2024 the market price of the inventory for Contract B is $540,000. The firm
should record the estimated loss from the commitment.

December 31, 2024 Dr Cr

 TEXT EXAMPLE
Amount Date
Commitment B $600,000 February 15, 2025
Contract B - Commitment to purchase $600,000 on February 15, 2025
Case 1: The market value of the inventory when Lassiter buys the inventory is greater than or equal to $540,000

Dr Cr

Case 2: The market value of the inventory when Lassiter buys the inventory is $510,000

Dr Cr
EXERCISE 9-31
In March 2024, the Metal Tool Company signed two purchase commitments. The first commitment
requires Metal to purchase inventory for $100,000 by June 15, 2024. The second commitment requires the
company to purchase inventory for $150,000 by August 20, 2024. The company’s fiscal year-end is June
30. Metal uses a periodic inventory system.
The first commitment is exercised on June 15, 2024 when the market price of the inventory purchased was
$85,000. The second commitment was exercised on August 20, 2024, when the market price of the
inventory purchased was $120,000.

Prepare the journal entries required on June 15, June 30, and August 20, 2024 to account for the two
purchase commitments. Assume that the market price of the inventory related to the outstanding purchase
commitments was $140,000 at June 30.
 EXERCISE 9-31
June 15, 2024 Dr. Cr. June 30, 2024 Dr. Cr.

August 20, 2024 Dr. Cr.

ACCOUNTING 350
WEDNESDAY, MARCH 5
CORRECTIONS OF ERRORS AND ESTIMATES
FINAL EXAM SCHEDULE
Tuesday, March 18, 2025

10:15 - 12:15

285 Lillis
INVENTORY ERRORS
WHAT IS THE FINANCIAL STATEMENT IMPACT OF AN INVENTORY ERROR?

WHY DO FIRMS CARE SO MUCH ABOUT THE YEAR-END INVENTORY COUNT?

Y1 $ Y2 $
Beginning Inventory Beginning Inventory
+ Purchases + Purchases
- Ending inventory - Ending inventory
Cost of goods sold Cost of goods sold

An error in the inventory of Y1 affects the cost of goods sold (profit) of Y1 and Y2
EXERCISE 9-25
During 2024, WMC discovered that its ending inventories reported in its financial statements were
misstated by the following material amounts:
2022 understated by $120,000
2023 overstated by $150,000
WMC uses a periodic inventory system and the FIFO cost method.
1. Determine the effect of these errors on retained earnings at January 1, 2024, before any adjustments.
2. Prepare a journal entry to correct the errors.
3. What other step(s) would be taken in connection with the correction of the errors?
 EXERCISE 9-25
2022 $ 2023 $
Beginning Inventory Beginning Inventory U $120,000
+ Purchases + Purchases
- Ending inventory U $120,000 - Ending inventory O $150,000
Cost of goods sold Cost of goods sold

Correction of error
Dr. Cr.
1/1/24
Accounting Changes and Errors
 Overview
Types of changes and errors
Change in Accounting Principle (Change from LIFO to FIFO)
Retrospectively recast all prior year financial statements
Mandated Change in Accounting Principle (Revenue Recognition)
Modified retrospective (apply new approach in current period, and adjust retained earnings for the
effect on past periods).
Change in Accounting Estimate (Extend useful life of an asset)
Incorporate the change in revenues and expenses from that point forward
Correction of an Error (Oops)
Prior period adjustment to retained earnings
Incorporate the change in revenues and expenses from that point forward
Change in Accounting Estimate
 Exercise 20-12
Change in accounting estimate
Boylan Engineering Group receives royalties on a technical manual written by two of its engineers and sold to William B.
Irving Publishing, Inc. Royalties are 10% of net sales, receivable on October 1 for sales in January through June and on
April 1 for sales in July through December of the prior year. Sales of the manual began in July 2023, and Boylan accrued
royalty revenue of $31,000 at December 31, 2023 as follows:

Receivable-royalty revenue 31,000

Royalty revenue 31,000

Boylan received royalties of $36,000 on April 1, 20214, and $40,000 on October 1, 2024. Irving indicated to Boylan on
December 31 that book sales subject to royalties for the second half of 2024 are expected to be $500,000.

1. Prepare any journal entries Boylan should record during 2024 related to royalty revenue.
2. What is the amount of the adjustment, if any, that should be made to retained earnings in the 2023 financial statements?
EXERCISE 20-12
April 1, 2024 Dr. Cr.

October 1, 2024 Dr. Cr.

December 31, 2024 Dr. Cr.

 Exercise 20-13
The Commonwealth of Virginia filed suit in October 2022, against Northern Timber Corporation seeking
civil penalties and injunctive relief for violations of environmental laws regulating forest conservation. When
the financial statements were issued in 2023, Northern had not reached a settlement with state authorities, but
legal counsel advised Northern Timber that it was probable the ultimate settlement would be $1,000,000 in
penalties. The following entry was recorded:

Loss-litigation 1,000,000
Liability-litigation 1,000,000

Late in 2024, a settlement was reached with state authorities to pay a total of $600,000 to cover the cost of
the violations.
1. Prepare any journal entry(s) related to the change.
2. Is Northern required to revise prior years’ financial statements as a result of the change?
3. Is Northern required to provide a disclosure note to report the change?
 EXERCISE 20-13
Revise Estimate in 2024 Dr. Cr.
 Exercise 20-17
Wardell purchased a mini computer on January 1, 2022 at a cost of $40,000. The computer has been
depreciated using the straight-line method over an estimated five-year useful life with an estimated residual
value of $4,000. On January 1, 2024, the estimate of useful life was changed to a total of 10 years, and the
estimate of residual value was changed to $900.

1. Prepare the appropriate adjusting entry for depreciation in 2024 to reflect the revised estimate.
 EXERCISE 20-17
Book Value on 1/1/24 2024 Depreciation

Dr. Cr.
 EXAMPLE PROBLEM

On January 1, Y1 a firm purchases a fleet of trucks for $200,000. The firm expects to use them for four years
and then dispose of them for $20,000. On January 1, Y4, management altered the expected life and residual
value assumptions such that they now expect to use the trucks for a total of six years, i.e., through Y6, and to
dispose of the trucks at that time for $35,000.
1. How much depreciation expense should the firm record in Y4?
2. What is the book value of the trucks at 12/31/Y4?
 EXAMPLE PROBLEM
Book Value on 1/1/Y4 Y4 Depreciation

12/31/Y4 Book Value

12/31/Y4 Depreciation Entry Dr. Cr.
Correction of an Error
 Errors vs. Changes in Estimates
Mistakes vs Revisions based on new information
Errors are mistakes not changes in estimates based on updated information.
They may code journal entries incorrectly, i.e., use either the wrong accounts or the wrong amounts
They may fail to record adjusting entries
If they try to fix the problem in the current period, the firm essentially doubles the error by introducing
misstatements into the current period
As a result, they should just adjust retained earnings for the effect of the error and correct the balance sheet
amounts
 Exercise 20-23
Below are three independent and unrelated errors.
a. On December 31, 2023 Wolfe-Bache failed to accrue salaries expense of $1,800. In January 2024 when
it paid employees for the December 27-31 workweek, Wolfe-Bache made the following entry:
Dr. Salaries Expense $2,520
Cr. Cash $2,520
b. On the last day of 2023, Midwest Importers received a $90,000 prepayment from a tenant for 2024 rent
of a building. Midwest recorded the receipt as rent revenue. The error was discovered midway through
2024.
c. At the end of 2023, Dinkins-Lowery Corporation failed to accrue interest of $8,000 on a note receivable.

1. What would be the effect of each error on the income statement and the balance sheet in the 2023
financial statements?
2. Prepare any journal entries each company should record in 2024 to correct the errors.
 Exercise 20-23
A Dr. Cr. B Dr. Cr.

C Dr. Cr.
CURRENT LIABILITIES
 CURRENT LIABILITIES
OBLIGATIONS TO BE RESOLVED WITHIN THE NEXT YEAR
✤ Definition: An obligation to make payments or deliver services in the future resulting from a past transaction or event
✤ Current: Due within one year

Examples
Accounts payable
Accrued expenses
Deferred revenue (advance payments & deposits)
Short-term notes payable
Current portion of long-term notes payable
Operating right-of-use assets—net N 3,220 2,878
Long-term financing receivables (net of allowances of $27 in 2023 and $28 in 2022) L 5,766 5,806
Prepaid pension assets V 7,506 8,236
Deferred costs C 842 866
Deferred taxes H 6,656 6,256
Goodwill O 60,178 55,949
Intangible assets—net O 11,036 11,184
Investments and sundry assets IBM 1,626 1,617
Total assets $ 135,241 $ 127,243
Liabilities and equity
Current liabilities
Taxes H $ 2,270 $ 2,196
Short-term debt J&P 6,426 4,760
Accounts payable 4,132 4,051
Compensation and benefits 3,501 3,481
Deferred income 13,451 12,032
Operating lease liabilities N 820 874
Other accrued expenses and liabilities 3,521 4,111
Total current liabilities 34,122 31,505
Long-term debt J&P 50,121 46,189
Retirement and nonpension postretirement benefit obligations V 10,808 9,596
Deferred income 3,533 3,499
Operating lease liabilities N 2,568 2,190
Other liabilities Q 11,475 12,243
Total liabilities 112,628 105,222
Commitments and Contingencies R
Equity S
IBM stockholders' equity
Common stock, par value $.20 per share, and additional paid-in capital 59,643 58,343
Shares authorized: 4,687,500,000
Shares issued (2023—2,266,911,160; 2022—2,257,116,920)
Retained earnings 151,276 149,825
Treasury stock, at cost (shares: 2023—1,351,897,514; 2022—1,351,024,943) (169,624) (169,484)
Accumulated other comprehensive income/(loss) (18,761) (16,740)
Total IBM stockholders' equity 22,533 21,944
Noncontrolling interests A 80 77
Total equity 22,613 22,021
Total liabilities and equity $ 135,241 $ 127,243

Amounts may not add due to rounding.

The accompanying notes are an integral part of the financial statements.
Property, plant and equipment, net 8,665.5 7,387.1
Operating lease, right-of-use asset 9,286.2 8,412.6
Deferred income taxes, net 1,766.7 1,769.8
Other long-term assets 617.0 546.5
Other intangible assets 100.9 120.5
Goodwill 3,315.7 3,218.3
TOTAL ASSETS Starbucks $ 31,339.3 $ 29,445.5
LIABILITIES AND SHAREHOLDERS’ EQUITY/(DEFICIT)
Current liabilities:
Accounts payable $ 1,595.5 $ 1,544.3
Accrued liabilities 2,194.7 2,145.1
Accrued payroll and benefits 786.6 828.3
Current portion of operating lease liability 1,463.1 1,275.3
Stored value card liability and current portion of deferred revenue 1,781.2 1,700.2
Short-term debt — 33.5
Current portion of long-term debt 1,248.9 1,818.6
Total current liabilities 9,070.0 9,345.3
Long-term debt 14,319.5 13,547.6
Operating lease liability 8,771.6 7,924.8
Deferred revenue 5,963.6 6,101.8
Other long-term liabilities 656.2 513.8
Total liabilities 38,780.9 37,433.3
Shareholders’ deficit:
Common stock ($0.001 par value) — authorized, 2,400.0 shares; issued and
outstanding, 1,133.5 and 1,142.6 shares, respectively 1.1 1.1
Additional paid-in capital 322.6 38.1
Retained deficit (7,343.8) (7,255.8)
Accumulated other comprehensive income/(loss) (428.8) (778.2)
Total shareholders’ deficit (7,448.9) (7,994.8)
Noncontrolling interests 7.3 7.0
Total deficit (7,441.6) (7,987.8)
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY/(DEFICIT) $ 31,339.3 $ 29,445.5

See Notes to Consolidated Financial Statements.

 DEBT EXAMPLE PROBLEM
On November 1, Y1, Quantum borrowed $16 million cash by signing a 4-year, 12% promissory note.
Interest is payable annually on October 31. The principal on the loan is due in four equal payments of $4
million each October 31. Quantum’s fiscal period is the calendar year.
1. Prepare the journal entry for the issuance of the note by Quantum.
2. Prepare the appropriate adjusting entry for the note by Quantum on December 31, Y1.
3. Prepare the journal entry for the payment due on October 31, Y2.

How much should Quantum show as a current liability at 12/31/Y1?

 DEBT EXAMPLE PROBLEM
November 1, Y1 Dr Cr December 31, Y1 Dr Cr

October 31,Y2 Dr Cr

Current liability (12/31/Y1) =

UNEARNED REVENUE EXAMPLE PROBLEM
On October 1, Y1, Quantum received $3,600,000 in advance payments from customers for 3-year contracts.
Quantum expects to deliver the service equally over the 3 years and uses a December 31, fiscal year-end.

1. Prepare the journal entry for the receipt of the $3,600,000 on 10/1/Y1
2. Prepare the appropriate adjusting entry on December 31, Y1.

How much should Quantum show as a current liability at 12/31/Y1?

How much should Quantum show as a concurrent liability at 12/31/Y1?
UNEARNED REVENUE EXAMPLE PROBLEM
October 1, Y1 Dr Cr December 31, Y1 Dr Cr

Current liability (12/31/Y1) =

Concurrent liability (12/31/Y1) =