Chapter 5, Problem 21E

a.

To determine

Prepare income statement using FIFO and LIFO.

Explanation of Solution

Income statement:  The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Prepare income statement using FIFO as follows:

Company W
Income Statements (FIFO)
For the Year Ended December 31, XXXX
Particulars	Amount
Sales revenue (1)	$175,000
Less: Cost of Goods Sold Table (2)	($104,300)
Gross Margin	$70,700
Less: Operating Expenses	($21,000)
Income Before Tax	$49,700
Less: Income Tax Expense (3)	($14,910)
Net Income	$34,790

Table (1)

Working note 1: Calculate the sales revenue.

$\begin{array}{c}\text{Sales revenue}=\left(\begin{array}{l}\text{Units of inventory}\\ \text{ to be sold}\end{array}\right)\times \left(\begin{array}{l}\text{Sale price}\\ \text{ per unit}\end{array}\right)\\ =3,500\text{ units}\times \text{\$50 per unit}\\ \text{=\$175,000}\end{array}$

Working note 2: Calculate cost of goods sold amount under FIFO:

Computation of cost of goods sold
Particulars	Unit	Unit cost	Total cost
Purchases:
January 1	300	$25	$7,500
April 1	2,800	$30	$84,000
October 1	400	$32	$12,800
Cost of goods sold	3,500		$104,300

Table (2)

Working note 3: Calculate income tax expense amount:

$\begin{array}{c}\text{Income tax expenses}=\left[\begin{array}{l}\text{sales}-\text{cost of goods}\\ \text{sold}-\text{operating expense}\end{array}\right]\times \frac{\text{30}}{100}\\ =\$175,000-\$104,300-\$21,000\times \frac{\text{30}}{100}\\ =\$49,700\times \frac{\text{30}}{100}\\ =\$14,910\end{array}$

Prepare income statement using LIFO as follows:

Company W
Income Statements (LIFO)
For the Year Ended December 31, XXXX
Particulars	Amount
Sales revenue (4)	$175,000
Less: Cost of Goods Sold Table (4)	($107,000)
Gross Margin	$68,000
Less: Operating Expenses	($21,000)
Income Before Tax	$47,000
Less: Income Tax Expense (6)	($14,100)
Net Income	$32,900

Table (3)

Working note 4: Calculate the sales revenue.

$\begin{array}{c}\text{Sales revenue}=\left(\begin{array}{l}\text{Units of inventory}\\ \text{ to be sold}\end{array}\right)\times \left(\begin{array}{l}\text{Sale price}\\ \text{ per unit}\end{array}\right)\\ =3,500\text{ units}\times \text{\$50 per unit}\\ \text{=\$175,000}\end{array}$

Working note 5: Calculate cost of goods sold amount under LIFO:

Computation of cost of goods sold
Particulars	Unit	Unit cost	Total cost
Purchases:
October 1	1,000	$32	$32,000
April 1	2,500	$30	$75,000
Cost of goods sold	3,500		$107,000

Table (4)

Working note 6: Calculate income tax expense amount:

$\begin{array}{c}\text{Income tax expenses}=\left[\begin{array}{l}\text{Sales}-\text{Cost of goods}\\ \text{sold}-\text{Operating expense}\end{array}\right]\times \frac{\text{30}}{100}\\ =\left[\$175,000-\$107,000-\$21,000\right]\times \frac{\text{30}}{100}\\ =\$47,000\times \frac{\text{30}}{100}\\ =\$14,100\end{array}$

b.

To determine

Ascertain the amount of income tax that would be saved by Company W if it changes the cost flow method.

Explanation of Solution

Income Tax Expenses: The expenses which are related to the taxable income of the individuals and business entities for an accounting period, and are recognized by them for the purpose of federal government and state government tax are called as income tax expenses.

• The amount of income tax that paid by Company W under FIFO cost method is $14,910.
• The amount of income tax that paid by Company W under LIFO cost method is $14,100.

The income tax saved by Company W is calculated as follows:

$\begin{array}{c}\begin{array}{l}\text{Income tax saved }\\ \text{by Company W}\end{array}\}=\left(\begin{array}{l}\text{Tax expense under}\\ \text{ FIFO}\text{}\text{ method}\end{array}\right)-\left(\begin{array}{l}\text{Tax expense under }\\ \text{LIFO}\text{}\text{ method }\end{array}\right)\\ =\$14,910-\$14,100\\ =\$810\end{array}$

Thus, Company W would save $810 if it changes the cost flow method from FIFO method to LIFO method.

c.

To determine

Ascertain the cash flow from operating activities under FIFO and LIFO.

Explanation of Solution

Cash flows from operating activities:  This section of cash flow statement provides information about the cash received or cash paid in day-to-day operating activities of a company.

Ascertain the cash flow from operating activities under FIFO and LIFO as follows:

Company W
Cash Flows from Operating Activities
Particulars	FIFO	LIFO
Cash Flows From Operating Activities:
Cash Inflow from Customers	$175,000	$175,000
Less: Cash Outflow for Inventory (7)	($116,000)	($116,000)
Cash Outflow for Operating Expense	($21,000)	($21,000)
Cash Outflow for Income Tax Expense	($14,910)	($14,100)
Net Cash Flow from Operating Activities	$23,090	$23,900

Table (5)

Working note 7: Calculate cash outflow for Inventory amount:

$\begin{array}{c}\text{Cash paid for inventory}=\left[\begin{array}{l}\text{Purchased made on April 1}+\\ \text{Purchased made on october 1}\end{array}\right]\\ =\$84,000+\$32,000\\ =\$116,000\end{array}$

d.

To determine

Describe why cash flow from operating activities is lower under FIFO when that cost flow method produced the higher gross margin.

Explanation of Solution

The cash flow from operating activities is lower under FIFO method because more amount of income tax has to be paid on the amount of income before tax reported under FIFO. Thus, more amounts of cash have been expensed for operating activities that lowers the net cash flow from operating activities.