P7–8.

Req. 1

A change that increases beginning inventory will decrease net income while a change that increases ending inventory will increase net income. Impact on GM net income (in millions) Change in ending inventory $2,077.1 Change in beginning inventory (1,784.5) Increase in pretax income 292.6 Increase in taxes (30%) (87.8) Increase in net income $ 204.8

Use of FIFO would result in an increase of $204.8 million in GM reported net income. The change would result in an increase in income taxes because the LIFO conformity rule precludes use of LIFO for tax purposes if a method other than LIFO were used for financial reporting. Reported net income $320.5 Increase 204.8 FIFO net income $525.3

Req. 2

If FIFO had been used, the ending inventory would have been $2,077.1 million higher. Instead LIFO was used and the $2,077.1 million was allocated to cost of goods sold in earlier accounting periods (including the current year). Thus, the cumulative difference between LIFO pretax income and FIFO pretax income was $2,077.1 million, or a difference of $1,454 million after taxes ($2,077.1 x .7). Therefore, retained earnings on a FIFO basis would have been $16,794 million (i.e., $15,340 + $1,454).

Req. 3

The reduction in taxes (compared to FIFO) was $87.8 million (calculated in Req. 1).

McGraw-Hill/Irwin Financial Accounting, 6/e ? The McGraw-Hill Companies, Inc., 2009 7-37

P7–9.

Req. 1 2009 2010 2011 2012

Sales revenue $2,025,000 $2,450,000 $2,700,000 $2,975,000 Cost of goods sold 1,505,000 1,649,000* 1,760,000* 2,113,000 Gross profit 520,000 801,000 940,000 862,000 Expenses 490,000 513,000 538,000 542,000 Pretax income 30,000 288,000 402,000 320,000 Income tax expense (30%) 9,000 86,400 120,600 96,000 Net income $ 21,000 $ 201,600 $ 281,400 $ 224,000

*There was an overstatement of the ending inventory in 2010 by $22,000; this caused cost of goods sold for 2010 to be understated and 2010 net income to be overstated. Similarly, because this error was carried over automatically to 2011 as the beginning inventory, cost of goods sold for 2011 was overstated and 2011 net income understated. The amounts for 2009 and 2012 were not affected. This is called a self-correcting or counterbalancing error. Cumulative net income for the four-year period was not affected.

Req. 2 2009 2010 2011 2012

Gross profit ratio (gross profit ÷ sales): Before correction: $520,000 ÷ $2,025,000 = .26 $823,000 ÷ $2,450,000 = .34 $918,000 ÷ $2,700,000 = .34 $862,000 ÷ $2,975,000 = .29

After correction: No change .26 $801,000 ÷ $2,450,000 = .33 $940,000 ÷ $2,700,000 = .35 No change .29

Req. 3

The effect of the error on income tax expense was: 2010 2011 Income tax expense reported $93,000 $114,000 Correct income tax expense 86,400 120,600 Income tax expense overstatement (understatement) $ 6,600 $(6,600)

McGraw-Hill/Irwin 7-38 ? The McGraw-Hill Companies, Inc., 2009 Solutions Manual

P7–10. (Supplement A)

Req. 1 Pretax operating profit (loss) for the current year had FIFO accounting been

employed instead of LIFO.

Difference in beginning inventory* (LIFO to FIFO) $2,076 Less: Difference in ending inventory* (LIFO to FIFO) 2,226 Difference in cost of goods sold (LIFO to FIFO) $ (150) Difference in Pretax Net Income = $150 increase

(*The differences are the beginning and ending LIFO Reserve.)

Req. 2 Since prices are rising, LIFO liquidations increase net income before taxes.

The change in pretax operating profit during the current year is given in the footnote as $23 million. As a consequence, net income before taxes would be $23 million lower had there been no inventory quantity reduction.

McGraw-Hill/Irwin Financial Accounting, 6/e ? The McGraw-Hill Companies, Inc., 2009 7-39

P7–11. (Supplement B) (a) Cash (+A) ........................................................................... Sales (+R, +SE) ............................................................. (b) (c) (d) (e) (f) (g) (h) (i)

Cost of goods sold (+E, ?SE) .............................................. Inventory (?A) ................................................................. Sales returns and allowances (+XR, ?R, ?SE) ................... Cash (?A) ....................................................................... Inventory (+A) ...................................................................... Cost of goods sold (+E, ?SE) ......................................... Inventory (+A) ..................................................................... Accounts payable (+L) ................................................... Inventory (+A) ..................................................................... Accounts payable (+L) ................................................... Store equipment (+A) .......................................................... Cash (?A) ....................................................................... Office supplies (Prepaid expense, +A) ............................... Cash (?A) ....................................................................... Inventory (+A) ..................................................................... Cash (?A) ....................................................................... Accounts payable (?L) ........................................................ Cash (?A) ....................................................................... Accounts payable (?L) ........................................................ Cash (?A) ($127,500 x 0.97) .......................................... Inventory (?A) ($127,500 x 0.03)....................................

277,000

277,000

136,000

136,000 1,700

1,200

5,300

1,700 1,200

5,300

127,500

127,500 2,100

650

350

5,300

2,100

650

350

5,300

127,500

123,675 3,825

McGraw-Hill/Irwin 7-40 ? The McGraw-Hill Companies, Inc., 2009 Solutions Manual