Inventory Analysis and Depreciation Methods

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Assessment 6
Inventory Analysis and Depreciation Methods
Overview
Complete a problem involving inventory analysis and a problem involving the use of depreciation methods.
Note: Some of the assessments in this course build upon each other, so you are strongly encouraged to complete them in the order in which they are
presented.
Businesses need to determine the optimum level of inventory, as well as the value of assets such as property, plant, and equipment, for strategic
management and planning purposes.
By successfully completing this assessment, you will demonstrate your proficiency in the following course competencies and assessment criteria:
Competency 3: Integrate accounting theories, models, and practices across the organization.
Analyze the effects of LIFO and FIFO inventory methods on an income statement.
Competency 4: Integrate accounting analyses into general business management planning and decision making.
Apply average cost, FIFO, LIFO, and specific identification inventory methods to a summarized income statement.
Record depreciation transactions pertaining to equipment.
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Context
When a company owns inventory, it has to decide how to consistently value the inventory sold and on hand. Four inventory valuation methods are
available to help the organization effectively value its inventory. These valuation methods are based on the systematic cash flow of adding and removing
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inventory, and each has its advantages and disadvantages. When selecting an inventory method, management should select the method that best
reflects their operations. Once an inventory valuation method is selected, it must be applied consistently from year to year.
The four inventory valuation methods are described below:
Average cost: An average cost is calculated based the total costs for the inventory on hand.
First in, first out (FIFO): This method assumes that inventory is used in the order it is received.
Last in, first out (LIFO): This method assumes that the newest inventory is always used first.
Specific identification: Under this method, the costs and selling price are specified for one particular item. This method is appropriate when each
item has a unique identifying characteristic.
When a company purchases a long-term asset such as equipment, the cost of the long-term asset is capitalized. This means the asset will benefit more
than one accounting period, so the original cost of the asset is allocated to the accounting periods it benefits. This allocation results in an expense that is
recorded over several periods known as depreciation expense. Depreciation is used in accounting to estimate the cost of the fixed asset that is allocated
to each period. There are a variety of depreciation methods available to estimate depreciation expense.
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Questions to Consider
To deepen your understanding, you are encouraged to consider the questions below and discuss them with a fellow learner, a work associate, an
interested friend, or a member of the business community.
What are the acceptable inventory valuation methods under the U.S. Generally Accepted Accounting Principles (GAAP)?
How does each affect the valuation of inventory?
How does each affect cost of goods sold?
What elements might organizational leaders consider when selecting which inventory valuation method to adopt?
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Resources
Suggested Resources
The resources provided here are optional. You may use other resources of your choice to prepare for this assessment; however, you will need to ensure
that they are appropriate, credible, and valid. They provide helpful information about the topics in this unit. The MBA-FP6014 – Financial Accounting
Library Guide can help direct your research. The Supplemental Resources and Research Resources, both linked from the left navigation menu in your
courseroom, provide additional resources to help support you.
The following resources are assessment specific templates for completing the assessment.
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Assessment 6, Problem 1 Template.
The following resources provide relevant financial accounting methods and practices.
Doran, D. T. (2012). Financial reporting standards: A decision-making perspective for non-accountants. New York, NY: Business Experts Press.
Chapter 3, “Inventory and Cost of Goods Sold,” pages 58-88
Chapter 4, “Operational Assets,” pages 89-124
Libby, R., Libby, P., & Hodge, F. (2017). Financial accounting (9th ed.). New York, NY: Irwin. – Available from the bookstore
Chapter 7, “Reporting and Interpreting Cost of Goods Sold and Inventory,” pages 326–357.
Chapter 8, “Reporting and Interpreting Property, Plant, and Equipment; Natural Resources; and Intangibles,” pages 380–419.
Assessment Instructions
Note: Some of the assessments in this course build upon each other, so you are strongly encouraged to complete them in the order in which they are
presented.
For this assessment, complete Problems 1 and 2. You may use Word or Excel to complete the assessments throughout this course, but you will find
Excel to be most helpful for creating spreadsheets. Tutorials for using Excel are provided in the Supplemental Resources in the left navigation menu. If
you use Excel, submit the assessment in one Excel document, using separate tabs for each spreadsheet.
To complete the first problem, you may choose to use the Assessment 6, Problem 1 Template linked in the Suggested Resources under the Capella
Resources heading.
Problem 1: The Effects of Different Cost Flow Assumptions for Inventory
At the end of January 2011, the records of Sheldon and Blair showed the following for a particular item that sold at $20 per unit:
Problem 1, Table 1: Records of Sheldon and Blair
Transactions Units Total Amount
Inventory, January 1, 2011 500 @ $6.00 $3,000
Purchase, January 12 600 @ $7.00 $4,200
Purchase, January 26 200 @ $7.10 $1,420
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Transactions Units Total Amount
Sale (400 units sold for $20 each)
Sale (300 units sold for $20 each)
Based on the information provided in the table above, complete the following. An optional template, Assessment 6, Problem 1 Template, is
provided in the Suggested Resources under the Capella Resources heading.

  1. Assuming the use of a periodic inventory system, prepare a summarized income statement through gross profit for the month of January under
    each method of inventory listed below. Show the inventory computations for each method in detail.
    a. Average cost. (Round the average cost per unit to the nearest cent.)
    b. First in, first out (FIFO).
    c. Last in, first out (LIFO).
    d. Specific identification. (Assume that the first sale was selected from the beginning inventory and the second sale was selected from the
    January 12 purchase.)
  2. Of FIFO and LIFO, which method would result in the higher pretax income? Which would result in the higher EPS?
  3. Of FIFO and LIFO, which method would result in the lower income tax expense? Explain, assuming a 35 percent average tax rate.
  4. Of FIFO and LIFO, which method would produce the more favorable cash flow? Explain.
    Problem 2: The Effects of Differing Depreciation Methods
    Total Workout, Inc. purchased three ï¬ï¿½tness machines from Ace Used Equipment at the beginning of the year. All three were used machines that
    had to be overhauled and installed before they were put into use. The costs of the machines and their renovation and installation are shown in Table 1
    below:
    Problem 2, Table 1: Equipment Costs
    Account Machine A Machine B Machine C
    Amount paid for asset $21,000 $30,750 $8,000
    Installation cost $500 $1,000 $200
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    Account Machine A Machine B Machine C
    Renovation costs prior to use $2,000 $1,000 $1,500
    By the end of the first year, each machine had been operating 4,800 hours. Depreciation estimates are shown in Table 2 below:
    Problem 2, Table 2: Equipment Depreciation
    Machine Life Residual Value Depreciation Method
    A 5 years $1,000 Straight-line
    B 60,000 hours $2,000 Units-of-production
    C 4 years $1,500 Double-declining balance
    Using the data provided above, complete the following:
  5. Compute the cost of each machine.
  6. Give the entry to record depreciation expense at the end of the first year, using all three depreciation methods listed in Table 2.
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    Inventory Analysis and Depreciation Methods Scoring Guide
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Sample Solution

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