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Curriculum Center Browse Bibliography Build EPacket Pricing Structure Distribution Process Management Control in Nonprofit Organizations
 
Joanne Gotsinas (B)
Author(s):
Anthony, Robert N.
Functional Area(s):
   Financial Accounting
Setting(s):
   For Profit
Difficulty Level: Intermediate
Pages: 2
Teaching Note: Available. 
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First Page and the Assignment Questions:

Because an earlier visit with the accounting instructor [see Joanne Gotsinas (A )] had cleared up some puzzling matters, Ms. Gotsinas decided to prepare a new list of problems as a basis for a second discussion. As before, she knew that the instructor expected that tentative answers to these questions be worked out prior to the meeting. The instructor also wanted her to use numbers of her own choosing to illustrate the issues she was raising, and to illustrate her tentative answers with simple numerical illustrations whenever possible. The list follows:

  1. Evidently, there are three ways of handling purchase discounts: They can be deducted from the cost of the purchased goods, they can be reported as other income, or purchase discounts not taken can be reported as an expense of the period. But isn’t the effect on net income the same under all these methods? If so, why argue about which is preferable?
  2. It is said that the perpetual inventory method identifies the amount of inventory shrinkage from pilferage, spoilage, and the like, an amount that is not revealed by the periodic inventory method. Having identified this shrinkage amount, however, how should it be recorded in the accounts?
  3. People have said that the LIFO method assumes that the goods purchased last are sold first. If this is so, the assumption is clearly unrealistic because companies ordinarily sell their oldest merchandise first. Can a method based on such an unrealistic assumption be supported, other than as a tax gimmick?
  4. A certain automobile dealer bases its selling prices on the actual invoice cost of each automobile. In a given model year, the invoice cost for similar automobiles may be increased once or twice to reflect increased manufacturing costs. Would this automobile dealer be wrong if it used the LIFO method? By contrast, a certain hardware dealer changes its selling prices whenever the wholesale price of its goods changes as reported in wholesalers’ price lists. Would this hardware dealer be wrong if it used the FIFO method?
  5. Are the following generalizations valid?
    1. The difference between LIFO and FIFO is relatively small if inventory turnover is relatively high.
    2. The average cost method will result in net income that is somewhere between that produced by the LIFO method and that produced by the FIFO method.
    3. If prices rise in one year and fall by an equal amount the next year, the total income for the two years is the same under the FIFO method as under the LIFO method.
  6. If the LIFO method is used and prices are rising, ending inventory will normally be significantly below prevailing market prices. Therefore, what justification is there for applying the lower-of-cost-or-market rule to LIFO inventories? . . .

Assignment

  1. Give your “tentative answers” to each of the above issues. Illustrate the issue and your answer, whenever possible, with a numerical example.