Chapter 9 Inventories

P9-7 Inventory alternatives

Princess Retail Stores started doing business on January 1, 2005. The following data reflect its inventory purchases and sales during the year:

Required

1. Compute gross margin and cost of ending inventory using the periodic FIFO cost flow assumption.
2. Compute the gross margin and cost of ending inventory using the periodic LIFO cost flow assumption. Compute the dollar amount of the LIFO reserve. Using this additional disclosure, how might an analyst estimate the cost of goods sold of Princess under the FIFO method based only on publicly available information? Show calculations.
3. Under historical cost accounting, gross margin is calculated as current output price minus historical input price, for analytical convenience, we can break the gross margin into two components:
   1. “True” operating margin = current output price – current input price, and
   2. Inventory profits = current input price – historical input price.
4. The following are excerpts from a recent top management meeting at Princess Retail Stores. Your assignment is to clearly provide guidelines to the top management team on each of the issues raised in the meeting. Show calculations where necessary.
   1. “I am most concerned about appropriately matching revenues and expenses. I suggest that we look for an inventory accounting method that achieves this objective both during inflationary and deflationary times.” (Frances Iyer, Chairman)
   2. “Frances, I think the choice is obvious. What other method can achieve better matching of revenues and expenses than the specific identification method? By choosing this method, we would send a clear signal to the stock market that we are not playing any earnings management games.” (Sandra Kang, VP Investor Relations)
   3. “I would like to maximize our current profits. What inventory method might help us achieve this most important goal and why?” (Antonia Iyer, CEO)
   4. “Antonia, I know you can’t stop thinking about your earnings-based bonus. My primary objective is to minimize the present value of future income tax outflows.” (Juanita King, CFO)
   5. “I would like to have our cake and eat it too. Why don’t we follow Juanita’s suggestion for income tax accounting and follow Antonia’s idea for external financial reporting?” (B.T. Kang, VP Operations)