Concept explainers
Analyzing the Effects of Four Alternative Inventory Costing Methods
Scrappers Supplies tracks the number of units purchased and sold throughout each accounting period but applies its inventory costing method at the end of each period, as if it uses a periodic inventory system. Assume its accounting records provided the following information at the end of the annual accounting period, December 31.
Transactions | Units | Unit Cost |
Beginning inventory, January 1 Transactions during the year: | 200 | $30 |
a. Purchase on account, March 2 | 300 | 32 |
b. Cash sale, April 1 ($46 each) | (350) | |
c. Purchase on account, June 30 | 250 | 36 |
d. Cash sale, August 1 ($46 each) | (50) |
TIP: Although the purchases and sales are listed in chronological order, Scrappers determines the cost, of goods sold after all of the purchases have occurred.
Required:
- 1. Compute the cost of goods available for sale, cost of ending inventory, and cost of goods sold at December 31 under each of the following inventory costing methods:
- a. Last-in, first-out.
- b. Weighted average cost.
- c. First-in, first-out.
- d. Specific identification, assuming that the April 1 sale was selected one-fifth from the beginning inventory and four-fifths from the purchase of March 2. Assume that the sale of August 1 was selected from the purchase of June 30.
- 2. Of the four methods, which will result in the highest gross profit? Which will result in the lowest income taxes?
The cost of goods available for sale.
Explanation of Solution
Determine cost of goods available for sale.
Date | Particulars | Units ($) | Unit cost($) | Total cost($) |
(a) | (b) | (c = a × b) | ||
January 1 | Beginning inventory | 200 | 30 | 6,000 |
March 2 | Purchased | 300 | 32 | 9,600 |
June 30 | Purchased | 250 | 36 | 9,000 |
Total | 750 | $24,600 | ||
Less: Goods sold | 400 | |||
Ending inventory | 350 |
Table (1)
Therefore, the cost of goods sold available for sale for 750 units of inventory is $24,600.
Requirement 1.(a)
The ending inventory and the cost of goods sold under LIFO.
Explanation of Solution
In Last-in-First-Out method, the cost of last purchased items is sold first. The value of the closing stock consists the initial purchased items.
Determine the amount of cost of goods sold.
Date | Particulars | Units | Unit cost($) | Total cost($) |
(a) | (b) | (c = a × b) | ||
June 30 | Purchased | 250 | 36 | 9,000 |
March 2 | Purchased | 150 | 32 | 4,800 |
Cost of goods sold | 400 | $13,800 |
Table (2)
Determine ending inventory under LIFO method.
Date | Particulars | Units | Unit cost($) | Total cost($) |
(a) | (b) | (c = a × b) | ||
January 1 | Beginning inventory | 200 | 30 | 6,000 |
March 2 | Purchased | 150 | 32 | 4,800 |
Ending inventory | 350 | $10,800 |
Table (3)
Hence, the cost of goods sold under LIFO is $13,800 and the value of ending inventory is $10,800.
Requirement 1.(b)
The ending inventory and the cost of goods sold under weighted average-cost method.
Explanation of Solution
In Average Cost Method the cost of inventory is priced at the average rate of the goods available for sale. Following is the mathematical representation:
Determine cost of ending inventory under average-cost method.
Date | Particulars | Units | Unit cost($) | Total cost($) |
(a) | (b) | (c = a × b) | ||
January 1 | Beginning inventory | 200 | 30 | 6,000 |
March 2 | Purchased | 300 | 32 | 9,600 |
June 30 | Purchased | 250 | 36 | 9,000 |
Cost of goods available for sale | 750 | 24,600 | ||
Less: Ending inventory | 350 | 32.8 | 11,480 | |
Cost of goods sold | 400 | $13,120 |
Table (4)
Working note:
Determine weighted average unit cost.
Hence, the cost of goods sold under weighted average-cost method is $13,120 and the value of ending inventory is $11,480.
Requirement 1.(c)
The ending inventory and the cost of goods sold under FIFO.
Explanation of Solution
In First-in-First-Out method, the cost of initial purchased items is sold first. The value of the ending inventory consists the recent purchased items.
Determine the amount of cost of goods sold.
Date | Particulars | Units | Unit cost($) | Total cost($) |
(a) | (b) | (c = a × b) | ||
January 1 | Beginning inventory | 200 | 30 | 6,000 |
March 2 | Purchased | 200 | 32 | 6,400 |
Cost of goods sold | 400 | $12,400 |
Table (5)
Determine ending inventory under FIFO method.
Date | Particulars | Units | Unit cost($) | Total cost($) |
(a) | (b) | (c = a × b) | ||
March 2 | Purchased | 100 | 32 | 3,200 |
June 30 | Purchased | 250 | 36 | 9,000 |
Ending inventory | 350 | $12,200 |
Table (6)
Hence, the cost of goods sold under FIFO is $12,400 and the value of ending inventory is $12,200.
Requirement 1.(d)
The ending inventory and the cost of goods sold under specific identification method.
Explanation of Solution
Specific identification method can be said as identifying the items precisely which are being sold and those which are being stored as closing inventory. The companies are required to keep perfect records of the original cost of each and every individual items of the inventory.
Determine the amount of cost of goods sold.
Date | Particulars | Units | Unit cost($) | Total cost($) |
(a) | (b) | (c = a × b) | ||
January 1 | Beginning inventory | 70 | 30 | 2,100 |
March 2 | Purchased | 280 | 32 | 8,960 |
June 30 | Purchased | 50 | 36 | 1,800 |
Cost of goods sold | 400 | $12,860 |
Table (7)
Determine ending inventory under FIFO method.
Date | Particulars | Units | Unit cost($) | Total cost($) |
(a) | (b) | (c = a × b) | ||
January 1 | Beginning inventory | 130 | 30 | 3,900 |
March 2 | Purchased | 20 | 32 | 640 |
June 30 | Purchased | 200 | 36 | 7,200 |
Ending inventory | 350 | $11,740 |
Table (8)
Hence, the cost of goods sold under specific identification method is $12,860 and the value of ending inventory is $11,740.
Requirement 3.
The method of inventory costing results highest in gross profit and minimizes income taxes.
Explanation of Solution
- FIFO method provides a lower cost of goods sold and a higher gross profit than in LIFO.
- By comparing the three inventory method, it is found that the use of LIFO method will minimizes the income taxes because it reports less taxable income as a result of using higher unit costs (in this case) to calculate cost of goods sold.
- A higher Cost of Goods Sold means less Income from Operations. Therefore it reduce tax amount.
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Chapter 7 Solutions
Fundamentals Of Financial Accounting
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