ACC541 ACC/541 DQs Week 2 - 19457

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Steel Company, a wholesaler that has been in business for two years, purchases its inventories from various suppliers. During the two years, each purchase has been at a lower price than the previous purchase. Steel uses the lower of FIFO cost or market method to value inventories.


The original cost of the inventories is above replacement cost and below the net realizable value. The net realizable value less the normal profit margin is below the replacement cost.


a) Briefly compare and contrast two of the following inventory valuation methods: (1) first in–first out (FIFO); (2) last in–first out (LIFO), or (3) weighted average. Explain the benefits of each inventory valuation method you selected and how the inventory is valued. Keep it brief, but to the point.

b) In general, what criteria should be used to determine which costs should be included in inventory? I am referring to costs that would be added to the purchase price when inventory or materials are purchased.

c) In general, why is the lower of cost or market rule used to report inventory?

d) At what amount should Steel’s inventories be reported on the balance sheet? Explain the application of the lower of cost or market rule in this situation.

October 10, 2010, Mason Engineering Company completed negotiations on a contract for the purchase of new equipment. Under the terms of the agreement, the equipment may be purchased now or Mason may wait until January 10, 2011, to make the purchase. The cost of the equipment is $400,000. It will be financed by a note bearing interest at the market rate of interest. Straight-line depreciation over a ten-year life will be used for book purposes. A double-declining balance over seven years will be used for tax purposes. (One-half year’s depreciation will be taken in the year of purchase regardless of the date of purchase.)


a. Briefly discuss the financial statement impacts of postponing the purchase of the equipment. Would the market price of the firm’s common stock be affected by any or all of these impacts? Do not assume in your discussion that the postponement will affect revenues or any operating costs, other than depreciation.

b. If the purchase of equipment is postponed briefly discuss how cash flow maybe impacted.

c. Efficient markets assume that stockholder wealth is affected by the amount and timing of cash flows. Which alternate should be considered as more favorable - purchasing before year-end or waiting until the next year? Why?

Jay Manufacturing, Inc. began operations five years ago producing probos, a new type of instrument it hoped to sell to doctors, dentists, and hospitals. The demand for probos far exceeded initial expectations, and the company was unable to produce enough probos to meet that demand. The company was manufacturing probos on equipment it built at the start of its operations, but to meet demand more efficient equipment was needed. Company management decided to design and build the equipment because equipment that was currently available on the market was unsuitable for producing probos.


In 2010, a section of the plant was devoted to development of the new equipment and a special staff of personnel was hired. Within six months a machine was developed at a cost of $170,000 that increased production and reduced labor cost substantially. Sparked by the success of the new machine, the company built three more machines of the same type at a cost of $80,000 each.


a. In addition to satisfying a need that outsiders cannot meet within the desired time, what other reasons might cause a firm to construct fixed assets for its own use?

b. In general, what costs should be capitalized for a self-constructed asset?

c. Discuss the proprietary (give pros and cons) of including in the capitalized cost of self-constructed assets:

i. The increase in overhead caused by the self-construction of fixed assets.

ii. A proportionate share of overhead on the same basis as that applied to goods manufactured for sale. Take into consideration whether or not the company is at full capacity.

d. Discuss the proper accounting treatment of the $90,000 ($170,000 – $80,000) by which the cost of the first machine exceeded the cost of the subsequent machines.

Kallus Corp. is an industry leader in the manufacture of toys. Each year, its design staff comes up with new ideas that are a great success. As a result, Kallus sales and profits consistently exceed those of other toy manufacturers. Over the past ten years, Kallus has earned average net profits of $189 million compared to $122 million for the typical company in the toy industry.


Answer (briefly) the following questions:

a. Does Kallus have goodwill? Explain.

b. Is goodwill an asset? Explain. (Does it meet the definition of an asset found in SFAC No. 6?)

c. If you believe Kallus has goodwill, how would you go about measuring it? Explain.

d. Should Kallus Corp. report goodwill in the balance sheet? Why or why not?


Solution Description

a) Briefly compare and contrast two of the following inventory valuation methods: (1) first in–first out (FIFO); (2) last in&nd