Chapter 8, Problem 4AP

a.

To determine

Prepare the journal entries for the shrinkage loss under (1) average cost method and (2) LIFO method.

Explanation of Solution

Journal entry:

Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, and expenses.

First-in-First-Out (FIFO): In this method, items purchased initially are sold first. So, the value of the ending inventory consist the recent cost for the remaining unsold items.

Last-in-First-Out (LIFO): In this method, items purchased recently are sold first. So, the value of the ending inventory consist the initial cost for the remaining unsold items.

Average Cost method: In this method, the inventories are priced at the average rate of goods available for sales.

Prepare the journal entries for the shrinkage loss under FIFO and LIFO method as follows:

1. Shrinkage loss under average cost method

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (3)		$1,208
	Inventory			$1,208
	(To record the shrinkage loss  incurred under average cost method)

Table (1)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $1,208. Therefore, debit cost of goods account with $1,208.
• Inventory is an asset account, and it decreases the value of assets by $1,208. Therefore, credit inventory account with $1,208.

Working note:

Calculate the units of shrinkage loss

$\begin{array}{c}\text{Shrinkage loss unit = }\left(\begin{array}{l}\text{Total available sales unit}-\\ \text{Number of physical inventory on the hand }\end{array}\right)\\ =350\text{ units}-\text{ 310 units}\\ \text{= 40 units}\end{array}$ (1)

Calculate the average cost per unit

$\begin{array}{c}\begin{array}{l}\text{Average cost }\\ \text{per unit }\end{array}\}\text{= }\frac{\text{Total cost of units}}{\text{Total Number of units}}\\ =\frac{\$10,570}{\text{350 units}}\\ =\$30.2\end{array}$ (2)

Calculate the value of shrinkage loss under average cost method

$\begin{array}{c}\begin{array}{l}\text{Shrinkage loss under}\\ \text{ Average cost method}\end{array}\}\text{= Shrinkage loss units (1)}\times \text{ Average cost per unit (2) }\\ \text{=40 units }\times \$30.2\\ =\$1,208\end{array}$ (3)

2. Shrinkage loss under LIFO method

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (4)		$1,560
	Inventory			$1,560
	(To record the shrinkage loss  incurred under LIFO method)

Table (2)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $1,560. Therefore, debit cost of goods account with $1,560.
• Inventory is an asset account, and it decreases the value of assets by $1,560. Therefore, credit inventory account with $1,560.

Working note:

$\begin{array}{c}\text{Shrinkage loss under LIFO= Shrinkage loss units (1)}\times \text{ Cost per unit under LIFO }\\ \text{=40 units }\times \$39\\ =\$1,560\end{array}$ (4)

b.

To determine

Prepare the journal entries to record (1) shrinkages losses under FIFO and (2) loss from write-down inventory under lower-of-cost-or market.

Explanation of Solution

Lower-of-cost-or-market: The lower-of-cost-or-market (LCM) is a method which requires the reporting of the ending merchandise inventory in the financial statement of a company, at its current market value or at is historical cost price, whichever is less.

Prepare the journal entries to record (1) shrinkages losses under FIFO and (2) loss from write-down inventory under lower-of-cost-or market as follows:

(1) Shrinkages losses under FIFO:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (5)		$1,000
	Inventory			$1,000
	(To record the shrinkage loss  incurred under FIFO method)

Table (2)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $1,000. Therefore, debit cost of goods account with $1,000.
• Inventory is an asset account, and it decreases the value of assets by $1,000. Therefore, credit inventory account with $1,000.

Working note:

$\begin{array}{c}\text{Shrinkage loss under LIFO= Shrinkage loss units (1)}\times \text{ Cost per unit under LIFO }\\ \text{=40 units }\times \$25\\ =\$1,000\end{array}$ (5)

(2) Loss from write-down inventory under lower-of-cost-or market

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (2)		$3,370
	Inventory			$3,370
	(To record the loss from write-down of inventory)

Table (1)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $3,370. Therefore, debit cost of goods account with $3,370.
• Inventory is an asset account, and it decreases the value of assets by $3,370. Therefore, credit inventory account with $3,370.

Working note:

Calculate the value of replacement cost

$\begin{array}{c}\text{Relacement cost = }\left[\begin{array}{l}\text{Inventory on hand on December 31}\times \\ \text{Replacement cost per unit}\end{array}\right]\\ =310\text{ units}\times \text{\$20}\\ \text{=\$6,200}\end{array}$ (6)

Calculate loss from write-down of inventory

$\begin{array}{c}\begin{array}{l}\text{Loss from }\\ \text{write-down of inventory}\end{array}\}\text{ = }\left[\begin{array}{l}\left(\begin{array}{l}\text{Total cost available for sale}-\\ \text{Shrinkage loss under FIFO (5)}\end{array}\right)-\\ \text{Replacement cost (6)}\end{array}\right]\\ =\left[\left(\$10,570-\$1,000\right)-\text{\$6,200}\right]\\ \text{=\$9,570}-\$6,200\\ =\$3,370\end{array}$ (6)

c.

To determine

Explain whether company M has used the hidden camera to entrap its client or not.

Explanation of Solution

Explain whether company M has used the hidden camera to entrap its client or not as follows:

No, company M has not used the hidden camera to entrap its client because, company M uses the hidden camera to watch the activities of employees, and it helps to reduce the shrinkage losses of inventory and protects from the fraudulent activities. Hence, company M has not used the hidden camera to entrap its client.