Financial Accounting, 8th Edition
Financial Accounting, 8th Edition
8th Edition
ISBN: 9780078025556
Author: Robert Libby, Patricia Libby, Daniel Short
Publisher: McGraw-Hill Education
Question
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Chapter 7, Problem 3P

1. (a), (b), (c) and (d)

To determine

Prepare an income statement through gross profit for the month of January under the following methods:

  1. a.  Average cost,
  2. b. FIFO,
  3. c. LIFO,
  4. d. Specific identification method.

1. (a), (b), (c) and (d)

Expert Solution
Check Mark

Answer to Problem 3P

COMPANY D
Partial Income Statement
For the Month Ended January 31, 2014
ParticularsAverage costFIFOLIFOSpecific Identification
(a)(b)(c)(d)
Sales revenue (1)$9,920 $9,920 $9,920 $9,920
Less: Cost of goods sold Table (2)3,5653,0854,0403,250.10
Gross profit$6,355 $6,835 $5,880 $6,669.90

Table (1)

Explanation of Solution

Periodic Inventory System:

Periodic inventory system is a system, in which the inventory is updated in the accounting records on a periodic basis such as at the end of each month, quarter or year. In other words, it is an accounting method which is used to determine the amount of inventory at the end of each accounting period.

First-in-First-Out:

In First-in-First-Out method, the costs of the initially purchased items are considered as cost of goods sold, for the items which are sold first. The value of the ending inventory consists of the recent purchased items.

Last-in-Last-Out:

In Last-in-First-Out method, the costs of last purchased items are considered as the cost of goods sold, for the items which are sold first. The value of the closing stock consists of the initial purchased items.

Weighted-average cost method:

Under Weighted average cost method, the company calculates a new average cost after every purchase is made. It is determined by dividing the cost of goods available for sale by the units on hand.

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.

Cost of goods sold:

Cost of goods sold is the accumulate total of all direct cost incurred in manufacturing the goods or the products which has been sold during a period. Cost of goods sold involves direct material, direct labor, and manufacturing overheads.

Income statement:

The income statement is a financial statement that shows the net income earned or net loss suffered by a company through reporting all the revenues earned, and expenses incurred by the company over a specific period of time. An income statement is also known as an operation statement, an earnings statement, a revenue statement, or a profit and loss statement. The net income is the excess of revenue over expenses.

Working notes:

Determine the amount of sales revenue:

Salesrevenue=Unitssold×Salesperunit=(370Units+250Units)×$16=$9,920 (1)

Determine the cost of goods sold under each method:

ParticularsUnitsAverage costFIFOLIFOSpecific Identification
Beginning inventory500$2,365 $2,365 $2,365 $2,365
Add: Purchases (net)7604,8804,8804,8804,880
Goods available for sale Table (3)1,2607,2457,2457,2457,245
Less: Ending inventory6403,680 (2)4,160 Table (4)3,205 Table (5)3,994.90 Table (6)
Cost of goods sold620$3,565 $3,085 $4,040 $3,250.10

Table (2)

Determine the goods available for sale:

DateParticularsUnits ($)Unit cost ($)Total cost ($)
(a)(b)(c = a × b)
January 1, 2014Beginning inventory5004.732,365
January 12, 2014Purchased60063,600
January 26, 2014Purchased16081,280
Total1,260$7,245
Less: Goods sold620
Ending inventory640

Table (3)

Determine the amount of ending inventory under average cost:

EndingInventory=[Units of ending invenotry×average cost per unit]=640units×[$7,2451,260Units]=640units×$5.75=$3,680 (2)

Determine the amount of ending inventory under FIFO:

DateParticularsUnitsUnit cost ($)Total cost ($)
(a)(b)(c = a × b)
January 12, 2014 Purchased48062,880
January 26, 2014Purchased16081,280
Ending inventory640$4,160

Table (4)

Determine the amount of ending inventory under LIFO:

DateParticularsUnitsUnit cost ($)Total cost ($)
(a)(b)(c = a × b)
January 12, 2014 Purchased1406840
January 26, 2014Purchased5004.732,365
Ending inventory640$3,205

Table (5)

Determine the amount of ending inventory under specific identification method:

DateParticularsUnitsUnit cost ($)Total cost ($)
(a)(b)(c = a × b)
January 1, 2014Beginning balance1304.73614.9
January 12, 2014Purchased35062,100
January 26, 2014Purchased16081,280
Ending inventory2,150$3,994.9

Table (6)

Conclusion

Therefore, the income statement is prepared through gross profit for the month of January.

2.

To determine

Describe the method that results in the higher pretax income and higher EPS.

2.

Expert Solution
Check Mark

Explanation of Solution

First-in-First-Out:

In First-in-First-Out method, the costs of the initially purchased items are considered as cost of goods sold, for the items which are sold first. The value of the ending inventory consists of the recent purchased items.

The FIFO method reports a higher pretax income than LIFO method. This is due to the following:

  • The rise in price.
  • FIFO allocates the lower unit costs to the cost of goods sold.

Similarly, for the EPS amount the FIFO method reports a higher EPS amount than LIFO method. This is because it produces a higher pretax income than LIFO.

3.

To determine

Describe the method that results in the lower income tax expense, assuming a 30% average tax rate.

3.

Expert Solution
Check Mark

Answer to Problem 3P

LIFO results in the lower income tax expense. This is because LIFO reports a lower pretax income than FIFO method.  The LIFO will derive lesser income tax than FIFO method by $286.5.

Explanation of Solution

Last-in-Last-Out:

In Last-in-First-Out method, the costs of last purchased items are considered as the cost of goods sold, for the items which are sold first. The value of the closing stock consists of the initial purchased items.

Determine the amount of income tax:

Income tax expenses=[Gross profit of FIFOGross profit of LIFO]×30%=($6,835$5,880)×30%=$286.5

4.

To determine

Explain the method that produces the most favorable cash flow.

4.

Expert Solution
Check Mark

Explanation of Solution

The LIFO method produces the most favorable cash flow by $286.5. This is because Under LIFO method the income tax expenses paid for the current year would be less than that of the FIFO method.

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Chapter 7 Solutions

Financial Accounting, 8th Edition

Ch. 7 - Explain briefly the application of the LCM concept...Ch. 7 - Prob. 12QCh. 7 - Consider the following information: ending...Ch. 7 - The inventory costing method selected by a company...Ch. 7 - Which of the following is not a component of the...Ch. 7 - Consider the following information: beginning...Ch. 7 - Consider the following information: beginning...Ch. 7 - An increasing inventory turnover ratio a....Ch. 7 - If the ending balance in accounts payable...Ch. 7 - Prob. 8MCQCh. 7 - Which inventory method provides a better matching...Ch. 7 - Which of the following is false regarding a...Ch. 7 - Prob. 1MECh. 7 - Recording the Cost of Purchases for a Merchandiser...Ch. 7 - Identifying the Cost of Inventories for a...Ch. 7 - Inferring Purchases Using the Cost of Goods Sold...Ch. 7 - Prob. 5MECh. 7 - Matching Inventory Costing Method Choices to...Ch. 7 - Reporting Inventory under Lower of Cost or Market...Ch. 7 - Determining the Effects of Inventory Management...Ch. 7 - Prob. 9MECh. 7 - Prob. 1ECh. 7 - Inferring Missing Amounts Based on Income...Ch. 7 - Prob. 3ECh. 7 - Inferring Merchandise Purchases Abercrombie and...Ch. 7 - Prob. 5ECh. 7 - Prob. 6ECh. 7 - Prob. 7ECh. 7 - Prob. 8ECh. 7 - Prob. 9ECh. 7 - Evaluating the Choice among Three Alternative...Ch. 7 - Prob. 11ECh. 7 - Prob. 12ECh. 7 - Prob. 13ECh. 7 - Prob. 14ECh. 7 - Prob. 15ECh. 7 - Prob. 16ECh. 7 - Prob. 17ECh. 7 - Prob. 18ECh. 7 - Prob. 19ECh. 7 - (Chapter Supplement A) Analyzing the Effects of a...Ch. 7 - (Chapter Supplement B) FIFO and LIFO Cost of Goods...Ch. 7 - Prob. 22ECh. 7 - Prob. 1PCh. 7 - Prob. 2PCh. 7 - Prob. 3PCh. 7 - Prob. 4PCh. 7 - Evaluating the LIFO and FIFO Choice When Costs Are...Ch. 7 - Prob. 6PCh. 7 - Evaluating the Effects of Manufacturing Changes on...Ch. 7 - Evaluating the Choice between LIFO and FIFO Based...Ch. 7 - Prob. 9PCh. 7 - (Chapter Supplement A) Analyzing LIFO and FIFO...Ch. 7 - Prob. 1APCh. 7 - Prob. 2APCh. 7 - Evaluating the UFO and FIFO Choice When Costs Are...Ch. 7 - Prob. 4APCh. 7 - Prob. 1CPCh. 7 - Prob. 2CPCh. 7 - Prob. 3CPCh. 7 - Prob. 4CPCh. 7 - Using Financial Reports: Interpreting Effects of...Ch. 7 - Making a Decision as a Financial Analyst: Analysis...Ch. 7 - Evaluating an Ethical Dilemma: Earnings, Inventory...Ch. 7 - Prob. 1CC
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