Questions on Inventory Costing

1200 WordsAug 18, 20155 Pages
Due to a clerical error, a company overstated by $50,000 the amount of inventory on hand at the end of the year. Will net income for the year be overstated or understated? Identify the two accounts on the year-end balance sheet that will be in error and indicate whether they will be understated or overstated. Error: The ending inventory is overstated by $50,000. Effect on net income: When the ending inventory is overstated, then, the cost of goods sold expense will be understated as the ending inventory is deducted from the goods available for sale to calculate the cost of the goods sold expense. As the cost of goods sold expense is understated, the net income for that period will be overstated. Name of the two accounts on the year…show more content…
The companies use the following methods to value ending inventory: Company A—weighted average cost Company B—first-in, first-out (FIFO) Company C—last-in, first-out (LIFO) Required 1. Which of the three companies will report the highest net income? Explain your answer. Company B will earn the highest net income in this situation. Under the present scenario, the prices of the inventories are rising, and company B is following the FIFO inventory method. Under FIFO inventory method, the earlier acquired goods are assigned to sale first. Since the prices of the inventories are rising, the earlier acquired inventories will be low priced. As a result, the cost of goods sold of B Company will be least among these three companies. Thus, the net income of B Company will be highest in the current scenario. 2. Which of the three companies will pay the least in income taxes? Explain your answer. Company C will pay the least amount in income tax. Under the present scenario, the prices of the inventories are rising, and company C is following the LIFO inventory method. Under LIFO inventory method, the latest acquired goods are assigned to sale first. Since the prices of the inventories are raising, the latest acquired inventories will be high priced. As a result, the cost of goods sold of C Company will be the highest among these three companies, and he net income will be the least. Thus, income tax expense would be least.
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