A $9,250 Choice: How Expected Credit Losses and the Inventory Costing Method Shape a Kayak Maker's Reported Margin
Student Name
American College of Education
ACCT5003: Financial Accounting: Reporting and Impact Analysis
Module 2 Assignment
Instructor Name
July 10, 2028
The Year in Brief
Brackwater Paddle Works, Inc., the composite kayak maker from Module 1, finished its first full year on December 31, 2026. It sold 3,300 kayaks at an average price of $430, for sales of $1,419,000, about $980,000 of it to dealers on credit with 60-day terms and the rest online for cash. Resin prices rose through the year, so each production batch cost more than the one before. Two measurement questions now shape the reported margin: how much of the $210,000 owed by dealers at year-end will actually be collected, and which cost to assign to the kayaks sold and those still on hand.
Receivables and the Expected Credit Loss Allowance
Under the current credit loss standard, which applies to trade receivables, a company records an allowance for the credit losses it expects over the life of its receivables, based on past experience, current conditions and reasonable forecasts, rather than waiting until a loss is probable (Financial Accounting Standards Board [FASB], 2016). Brackwater has no history of its own, so it used loss rates from its industry trade association's dealer credit survey, adjusted upward for a softer retail outlook. It aged its $210,000 of dealer receivables: $150,000 current, $38,000 overdue by 1 to 30 days, $14,000 overdue by 31 to 60 days and $8,000 overdue by more than 60 days. Applying expected loss rates of 1, 4, 12 and 40 percent gives an allowance of $1,500, $1,520, $1,680 and $3,200, a total of $7,900.
During the year, one small dealer filed for bankruptcy owing $6,000, which was written off. Credit loss expense for the year is therefore $13,900: the $6,000 written off plus the $7,900 needed to establish the year-end allowance. Net receivables are reported at $202,100. Days sales outstanding on dealer sales, receivables divided by daily credit sales, is about 78 days against 60-day terms, which suggests that dealers are paying slowly and that the allowance deserves quarterly review. An allowance is a forecast written into the balance sheet, and like any forecast it should be tested against what actually happens.
Inventory Cost Layers
Brackwater produced four batches during the year, each with a higher cost per kayak as resin prices rose: 800 kayaks at $330, 1,200 at $350, 1,000 at $375 and 600 at $390, a total of 3,600 kayaks costing $1,293,000. It sold 3,300, leaving 300 in inventory at year-end. Under first-in, first-out costing, the kayaks sold are assumed to come from the earliest batches, so ending inventory consists of the last 300 kayaks at $390, $117,000, and cost of goods sold is $1,176,000. Under weighted-average costing, every kayak carries the average cost of all production, $1,293,000 divided by 3,600 or about $359.17, so ending inventory is $107,750 and cost of goods sold is $1,185,250.
The difference in cost of goods sold, $9,250, flows directly to gross profit. Under FIFO, gross profit is $243,000, a gross margin of 17.1 percent; under weighted average, it is $233,750, or 16.5 percent. At the assumed 24 percent tax rate, FIFO also produces about $2,220 more tax. Last-in, first-out costing, permitted under U.S. rules, would lower gross profit further, to $225,000, but it would require the company to use the same method for tax and financial reporting and would leave inventory on the balance sheet at the oldest, lowest costs.
Lower of Cost and Net Realizable Value
Inventory measured under FIFO or weighted average must be written down when its net realizable value, the expected selling price less costs to complete and sell, falls below cost (FASB, 2015). Most of Brackwater's kayaks will sell for about $430 less $25 of selling costs, well above cost. But 40 of the 300 kayaks on hand are in a color the company discontinued in November, which dealers will take only at a clearance price that yields net realizable value of about $300. Under FIFO, those kayaks carry a cost of $390, so the write-down is $3,600. Under weighted average, they carry about $359.17, so the write-down is about $2,370. The write-down is recorded as part of cost of goods sold, narrowing the gap between the methods slightly, to about $8,020.
Which Method, and Why It Matters
Both FIFO and weighted average are acceptable, and the choice does not change the kayaks, the cash spent or the company's economic performance. It changes when rising costs appear in the income statement. FIFO reports a higher margin while prices rise and keeps inventory on the balance sheet closer to current cost; weighted average smooths the effect of individual batch costs. Research on managers' reporting choices shows that they care a great deal about reported numbers: in a survey of more than 400 financial executives, Graham et al. (2005) found that many would give up some economic value to smooth reported earnings or meet benchmarks, which is a reason for readers to understand the effect of accounting choices rather than take reported margins at face value.
The paper recommends weighted average for Brackwater. The company's production is continuous, its batches are mixed in the warehouse and a single average cost is simpler to maintain and closer to how its managers actually think about unit cost. Its lender, which tests gross margin in the loan agreement, should be told which method is used and what the margin would be under the alternative. Once chosen, the method must be applied consistently; switching later to report a better margin would require justification as a preferable method and retrospective restatement.
The Entries Behind the Numbers
Each measurement becomes an entry in the ledger. When the bankrupt dealer's $6,000 balance was written off in September, Brackwater had not yet established an allowance, so it debited credit loss expense and credited accounts receivable for $6,000. At year-end, it debited credit loss expense and credited the allowance for credit losses, a contra-asset account, for $7,900, which reduces net receivables without removing any individual dealer's balance from the ledger. If a dealer later pays an amount previously written off, the company reinstates the receivable and records the cash, and the allowance estimate for the next period reflects the recovery.
For inventory, the periodic weighted-average method assigns cost at year-end: the $1,293,000 of production cost is split between cost of goods sold and ending inventory using the $359.17 average. The write-down for the discontinued color is then recorded as a debit to cost of goods sold and a credit to inventory of about $2,370, which becomes the new cost basis of those 40 kayaks. Under U.S. rules, the write-down is not reversed if clearance prices later recover; any gain appears only when the kayaks are sold.
Summary of Effects
Under the recommended approach, Brackwater reports net receivables of $202,100 after a $7,900 allowance, credit loss expense of $13,900, ending inventory of about $105,380 after the write-down and gross profit of about $231,380, a margin of 16.3 percent. Had it chosen FIFO, gross profit would have been about $239,400. The difference is not large relative to sales, but for a company near a lender's margin test, a margin reported under one method rather than another could decide whether a covenant is met, which is why the choice and its effect belong in the notes.
References
Financial Accounting Standards Board. (2015). Inventory (Topic 330): Simplifying the measurement of inventory (Accounting Standards Update No. 2015-11).
Financial Accounting Standards Board. (2016). Financial instruments: Credit losses (Topic 326): Measurement of credit losses on financial instruments (Accounting Standards Update No. 2016-13).
Graham, J. R., Harvey, C. R., & Rajgopal, S. (2005). The economic implications of corporate financial reporting. Journal of Accounting and Economics, 40(1-3), 3-73. https://doi.org/10.1016/j.jacceco.2005.01.002
How this ACCT 5003 Module 2 example is structured
ACCT 5003 Module 2 typically works through receivables, inventory and the costing choice behind reported margin; your classroom's instructions decide the methods and whether journal entries are required. This example treats receivables first, with the allowance built from an aging schedule under the current credit loss standard, then inventory, with every calculation shown for two costing methods. A section compares the effect on gross margin, taxes and the balance sheet, and the conclusion explains which method the company should choose and why the choice deserves disclosure.
ACCT5003 Module 2 questions, answered
What does ACCT5003 Module 2 usually ask for?
ACCT5003 Module 2 typically asks students to measure receivables and inventory and to analyze how the choice of inventory costing method affects reported margin. Many sections expect calculations for more than one method and an explanation of the financial statement effects. Your classroom's instructions decide the methods and format.
How is an allowance for credit losses calculated?
A common approach ages receivables by how long they are overdue and applies an expected loss rate to each group, based on history, current conditions and forecasts. The allowance is the sum, and credit loss expense for the year equals write-offs plus the change needed to reach the ending allowance.
How do FIFO and weighted average differ when costs rise?
FIFO assigns older, lower costs to goods sold and newer costs to ending inventory, so it reports a higher margin while costs rise. Weighted average assigns the same average cost to all units, producing a margin between FIFO and LIFO.
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