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Q3CA

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Intermediate Accounting (Kieso)
Found in: Page 436

Short Answer

George Solti, the controller for Garrison Lumber Company, has recently hired you as assistant controller. He wishes to determine your expertise in the area of inventory accounting and therefore asks you to answer thefollowing unrelated questions.

(a) A company is involved in the wholesaling and retailing of automobile tires for foreign cars. Most of the inventory is imported,and it is valued on the company’s records at the actual inventory cost plus freight-in. At year-end, the warehousing costs areprorated over cost of goods sold and ending inventory. Are warehousing costs considered a product cost or a period cost?

(b) A certain portion of a company’s “inventory” is composed of obsolete items. Should obsolete items that are not currentlyconsumed in the production of “goods or services to be available for sale” be classified as part of inventory?

(c) A company purchases airplanes for sale to others. However, until they are sold, the company charters and services theplanes. What is the proper way to report these airplanes in the company’s financial statements?

(d) A company wants to buy coal deposits but does not want the financing for the purchase to be reported on its financialstatements. The company therefore establishes a trust to acquire the coal deposits. The company agrees to buy the coalover a certain period of time at specified prices. The trust is able to finance the coal purchase and pay off the loan as itis paid by the company for the minerals. How should this transaction be reported?

Warehousing cost is a product cost retailing and period cost for wholesaling. Obsolete item is a part of the inventory. Inventory used for temporary services still be counted as inventory. Financing through trust is a kind of consignment sale.

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Step by Step Solution

Step1: Product cost and period cost

Product costs are the direct expense of making the product ready for sale. Period costs are the indirect expenses for making sales. In the given question, as the company is involved in the wholesaling and retailing, the warehousing cost would differ in each type of sales. For wholesale, the warehousing cost is the period cost because the product has already been manufactured, and there is no importance of the warehouse after the manufacturing process.

For retail sales, warehousing cost is the product cost. The reason is that, for retailers, finished goods are the only inventory, and warehousing plays a role in making those inventory ready to sell.

Step 2: Obsolete items in inventory

A company may adopt any inventory valuation method. Under the LIFO method, a LIFO liquidation problem occurs, which leads to the earliest inventory in the pool remaining unsold. This unsold inventory may become obsolete but remains a part of the inventory and must be classified as such.

Step 3: Chartering Airplanes held for resale

The primary purpose of the goods is to categorize goods into inventory or assets. In the given case, the airplane was acquired for resale purposes. So this is the primary reason. However, if the plane has been used for charter services, whether this service is temporary or for the long term must be determined.

This plane must be categorized under fixed assets for long-term purposes, and depreciation should be charged on it. For providing temporary services, the airplane is still considered an inventory.

Step 4: Financing through trust

Financing through trust cannot be recorded in the financial statement as there is no link between trust and the company. As the company is acquiring coal through trust, this can be a consignment sale.

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