Chapter 5, Problem 3PSA

To determine

Inventory:

Inventory refers to the stock or goods which will be sold in the near future and thus is an asset for the company. It comprises of the raw materials which are yet to be processed, the stock which is still going through the process of production and it also includes completed products that are ready for sale. Thus inventory is the biggest and the important source of income and profit for the business.

Perpetual Inventory System:

In perpetual inventory system there is a continuous recording of transactions as and when they take place that is purchase and sale transactions are recorded whenever they occur.

Cost of Goods Available for Sale:

It basically includes the cost of inventory which is ready for sale within an accounting period. It mainly includes the cost of beginning inventory as well as the stock purchased in that year and the production within that period (if any).

Cost of Goods Sold:

Cost of goods sold is the total expenses or the cost incurred by the business during the process of manufacturing of goods and is directly related to the production. It generally includes the cost of raw material, labor and other manufacturing support costs.

Gross Profit:

The profit made after subtracting or debiting the costs related to the goods sold from the total revenue earned or made through sales in a fiscal year is the gross profit.

First in First out:

In case of first in, first out method, also known as FIFO method, the inventory which was bought first will also be the first one to be taken out.

Last in First out:

In case of last in, first out, also known as LIFO method, the inventory which was bought in the last will be taken out first.

Weighted Average Cost Method:

In this method the weighted average cost is evaluated after any purchases have been made and transactions are recorded as when purchase or sales take place.

Specific Identification Method:

Under this method, there is a continuous tracking of the inventory and the inventory cost at the time of purchase on the basis of unique identity which thus helps in the valuation of the ending inventory as well as the cost of goods sold. This method is used generally when the company is involved in limited expensive goods which are easily identifiable.

To compute: 1. Cost of goods available for sale and number of units available for sale.
2. Number of units in ending inventory.
3. Cost of ending inventory under the following methods

(a) FIFO
(b)LIFO
(c) Weighted average
(d) Specific identification

4. Gross profit for each of the four methods in part
5. The inventory costing method suitable incase of bonus earned on gross profit.

Explanation of Solution

Solution:

Given info,

Date	Particulars	Units acquired	Cost per unit ($)	Units sold	Retail price per unit ($)
Jan 1	Beginning inventory	600	45
Feb 10	Purchase	400	42
Mar 13	Purchase	200	27	800	75
Mar 15	Sales
Aug 21	Purchase	100	50
Sept 5	Purchase	500	46	600	75
Sept 10	Sales
	Total	1,800		1,400
Table (1)

Given,
The ending inventory has,
100 units are from Feb 10,
50 units are from August 21 and
250 units are from September 5.

1.

Cost of goods available for sale

Formula to calculate Cost of goods available for sale is,

$\text{Cost}\text{of}\text{goods}\text{available}\text{for}\text{sale}=\text{Beginning}\text{inventory}-\text{Purchases}$

Cost and units of goods available for sale:

Particulars	Number of units $$	Cost per unit ($)	Amount ($) $\left(\left(\text{Number}\text{of}\text{units}\right)\times \left(\text{Cost}\text{per}\text{unit}\right)\right)$
Beginning Inventory $\left(A\right)$	600	45	27,000
Purchases:
Feb 10	400	42	16,800
March 13	200	27	5,400
August 21	100	50	5,000
September 5	500	46	23,000
Total Purchases $\left(B\right)$	1,200		50,200
Available for sale $\left(A+B\right)$	1,800		77,200
Table (2)

The cost of goods available for sale is $77,200 and the number of units available for sale is 1,800 units.

2.

Number of units in ending inventory

Particulars	Number of units
Number of units available for sale (given)	1,800
Less: units sold (given)	1,400
Number of units in ending inventory	400
Table (3)

The number of units in ending inventory is 400 units.

(a)

First in, First out method (FIFO)

Ending inventory

Cost of goods sold

Formula to calculate cost of goods sold is,

$\mathrm{Cos}tofgoodssold=\mathrm{Cos}tofgoodsavailableforsale-\mathrm{Cos}tofendinginventory$

Substitute $77,200 for cost of goods available for sale (calculated in part (1)) and $18,400 for cost of ending inventory (as calculated above in the table) in the above formula.

$\begin{array}{c}\mathrm{Cos}tofgoodssold=\$77,200-\$18,400\\ =\$58,800\end{array}$

Under FIFO method, the amount of ending inventory is $18,400 and cost of goods sold is $58,800.

(b)
Last in, first out method (LIFO)

Ending inventory

Cost of goods sold

Formula to calculate cost of goods sold is,

$\mathrm{Cos}tofgoodssold=\mathrm{Cos}tofgoodsavailableforsale-\mathrm{Cos}tofendinginventory$

Substitute $77,200 for cost of goods available for sale (calculated in part (1)) and $18,000 for cost of ending inventory (as calculated above in the table) in the above formula.

$\begin{array}{c}\mathrm{Cos}tofgoodssold=\$77,200-\$18,000\\ =\$59,200\end{array}$

Under FIFO method, the amount of ending inventory is $18,000 and cost of goods sold is $59,200.

(c)

Weighted average method

Ending inventory

Working notes:

Calculation of weighted average cost per unit,

$WeightedAverage\mathrm{Cos}tperunit=\frac{\mathrm{Cos}tofgoodsavailableforsale}{Numberofunitsavailable}$

$\begin{array}{c}Weightedaverage\cos tperunit(asonMarch13)=\left(\frac{\$27,000+\$16,800}{600units+400units}\right)\\ =\left(\frac{\$43,800}{1,000}\right)\\ =\$43.8perunit\end{array}$

$\begin{array}{c}Weightedaverage\cos tperunit(asonMarch15)=\left(\frac{\$43,800+\$5,400}{1,000units+200units}\right)\\ =\left(\frac{\$49,200}{1,200}\right)\\ =\$41perunit\end{array}$

$\begin{array}{c}Weightedaverage\cos tperunit(asonAugust12)=\left(\frac{\$16,400+\$5,000}{400units+100units}\right)\\ =\left(\frac{\$21,400}{500}\right)\\ =\$42.8perunit\end{array}$

$\begin{array}{c}Weightedaverage\cos tperunit(asonSept5)=\left(\frac{\$21,400+\$23,000}{500units+500units}\right)\\ =\left(\frac{\$44,400}{1,000}\right)\\ =\$44.4perunit\end{array}$

Cost of goods sold

Formula to calculate cost of goods sold is,

$\mathrm{Cos}tofgoodssold=\mathrm{Cos}tofgoodsavailableforsale-\mathrm{Cos}tofendinginventory$

Substitute $77,200 for cost of goods available for sale (calculated in part (1)) and $17,760 for cost of ending inventory (as calculated above in the table) in the above formula.

$\begin{array}{c}\mathrm{Cos}tofgoodssold=\$77,200-\$17,760\\ =\$59,440\end{array}$

Under weighted average method, the amount of ending inventory is $17,760 and cost of goods sold is $59,440.

(d)

Specific identification method

Cost of Ending Inventory

Date of Purchase	Number of units (A)	Cost per unit ($) (B)	Amount ($) $\left(\left(A\right)\times \left(B\right)\right)$
Feb 10	100	42	4,200
August 21	50	50	2,500
September 5	250	46	11,500
Cost of Ending Inventory	18,200
Table (10)

Cost of goods sold

Formula to calculate cost of goods sold is,

$\mathrm{Cos}tofgoodssold=\mathrm{Cos}tofgoodsavailableforsale-\mathrm{Cos}tofendinginventory$

Substitute $77,200 for cost of goods available for sale (calculated in part (1)) and $18,200 for cost of ending inventory (calculated above in the table) in the above formula.

$\begin{array}{c}\mathrm{Cos}tofgoodssold=\$77,200-\$18,200\\ =\$59,000\end{array}$

The cost of ending inventory is $18,200 and the cost of goods sold is $59,000.

(4)

Sales are $105,000 (working notes).
Cost of goods sold in case of FIFO is $58,800. (Calculated in part (3(a))
Cost of goods sold in case LIFO is $59,200. (Calculated in part (3(b))
Cost of goods sold in case of weighted average is $59,440 and (Calculated in part (3(c))
Cost of goods sold in case of specific identification is 59,000. (Calculated in part (3(d))

Gross Profit

Formula to calculate gross profit is,

$\begin{array}{l}\text{Gross}\text{Profit}=\text{Sales}-\text{Cost}\text{of}\text{goods}\text{sold}\\ \end{array}$

Particulars	FIFO ($)	LIFO ($)	Weighted average ($)	Specific identification ($)
Sales(working notes)	105,000	105,000	105,000	105,000
Less: Cost of goods sold	58,800	59,200	59,440	59,000
Gross profit	46,200	45,800	45,560	46,000
Table (11)

Working notes:

Calculation of sales,

$\begin{array}{c}\text{Sales}\text{as}\text{on}\text{March}15=\text{Number}\text{of}\text{units}\text{sold}\times \text{cost}\text{per}\text{unit}\\ =800\times \$75\\ =\$60,000\end{array}$

$\begin{array}{c}\text{Sales}\text{as}\text{on}\text{September}\text{5}=\text{Number}\text{of}\text{units}\text{sold}\times \text{cost}\text{per}\text{unit}\\ =600\times \$75\\ =\$45,000\end{array}$

$\begin{array}{c}\text{Sales}=\text{Sales}\text{as}\text{on}\text{march}15+\text{Sales}\text{as}\text{on}\text{september}5\\ =\$60,000+\$45,000\\ =\$105,000\end{array}$

The gross profit in case of FIFO it is $46,200, of LIFO it is $45,800, of weighted average it is $45,560 and of specific identification it is $46,000.

5.

FIFO inventory method resulted in highest gross profit that is $46,200 as compared to other four methods. The bonus will be more on the highest gross profit made by the company and herein it is the FIFO method which resulted in the highest gross profit.

Thus, the FIFO method is the best to earn more bonus on the gross profit.