Chapter 5, Problem 3PSB

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.

Given info,

Date	Particulars	Units acquired	Cost per unit ($)	Units sold	Retail price per unit ($)
May 1	Beginning inventory	150	300
May 6	Purchase	350	350
May 9	Sales			800	75
May 17	Purchase	80	450
May 25	Purchase	100	458
May 30	Sales			600	75
	Total	680		480

The ending inventory has,
70 units are from May 1,
50 units are from May 6 and
80 units are from May 17.

Explanation of Solution

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 $\left(A\right)$	150	300	45,000
Purchases:
May 6	350	350	122,500
May 17	80	450	36,000
May 25	100	458	45,800
Total Purchases $\left(B\right)$	530		204,300
Available for sale $\left(A+B\right)$	680		249,300

Table (1)

The cost of goods available for sale is $249,300 and the number of units available for sale is 680 units.

2.

Number of units in ending inventory

Particulars	Number of units
Number of units available for sale (given)	680
Less: units sold (given)	480
Number of units in ending inventory	200

Table (2)

The number of units in ending inventory is 200 units.

3.

(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 $249,300 for cost of goods available for sale (calculated in part (1)) and $24,000 for cost of ending inventory (as calculated above in the table) in the above formula.

$\begin{array}{c}\mathrm{Cos}tofgoodssold=\$249,300-\$88,800\\ =\$160,500\end{array}$

Under FIFO method, the amount of ending inventory is $88,800 and cost of goods sold is $160,500.

(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 $249,300 for cost of goods available for sale (calculated in part (1)) and $62,500 for cost of ending inventory (as calculated above in the table) in the above formula.

$\begin{array}{c}\mathrm{Cos}tofgoodssold=\$249,300-\$62,500\\ =\$186,800\end{array}$

Under LIFO method, the amount of ending inventory is $62,500 and cost of goods sold is $186,800.

(c)

Weighted average method

Ending inventory

Working Notes:

Calculation of weighted average cost per unit:

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

$\begin{array}{c}Weightedaverage\cos tperunit(asonMay6)=\left(\frac{\$300\times 150+\$350\times 350}{150units+350units}\right)\\ =\left(\frac{\$167,500}{500}\right)\\ =\$335perunit\end{array}$

$\begin{array}{c}Weightedaverage\cos tperunit(asonMay17)=\left(\frac{\$335\times 320+\$450\times 80}{320units+80units}\right)\\ =\left(\frac{\$143,200}{400}\right)\\ =\$358perunit\end{array}$

$\begin{array}{c}Weightedaverage\cos tperunit(asonMay25)=\left(\frac{\$358\times 400+\$458\times 100}{400units+100units}\right)\\ =\left(\frac{\$189,000}{500}\right)\\ =\$378perunit\end{array}$

Cost of goods sold

Formula to calculate cost of goods sold is,

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

Substitute $249,300 for cost of goods available for sale (calculated in part (1)) and $75,600 for cost of ending inventory (as calculated above in the table) in the above formula.

$\begin{array}{c}\mathrm{Cos}tofgoodssold=\$249,300-\$75,600\\ =\$173,700\end{array}$

Under weighted average method, the amount of ending inventory is $75,600 and cost of goods sold is $173,700.

(d)

Specific identification method

Ending Inventory

Date of Purchase	Number of units (A)	Cost per unit ($) (B)	Amount ($) $\left(\left(A\right)\times \left(B\right)\right)$
May 1	70	300	21,000
May 6	50	350	17,500
May 17	80	450	36,000
Cost of Ending Inventory			74,500

Table (6)

Cost of goods sold

Formula to calculate cost of goods sold is,

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

Substitute $249,300 for cost of goods available for sale (calculated in part (1)) and $74,500 for cost of ending inventory (calculated above in the table) in the above formula.

$\begin{array}{c}\mathrm{Cos}tofgoodssold=\$249,300-\$74,500\\ =\$174,800\end{array}$

Conclusion

The cost of ending inventory is $74,500 and the cost of goods sold is $174,500.

4.

Sales are $636,000 (working notes).
Cost of goods sold in case of FIFO is $160,500. (Calculated in part (3(a))
Cost of goods sold in case LIFO is $186,800. (Calculated in part (3(b))
Cost of goods sold in case of weighted average is $173,700 and (Calculated in part (3(c))
Cost of goods sold in case of specific identification is $174,800. (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)	$636,000	$636,000	$636,000	$636,000
Less: Cost of goods sold	$160,500	$186,800	$173,700	$174,800
Gross profit	$475,500	$449,200	$462,300	$461,200

Table (7)

Working notes:

Calculation of sales

$\begin{array}{c}\text{Sales}\text{as}\text{on}\text{May}\text{9}=\text{Number}\text{of}\text{units}\text{sold}\times \text{cost}\text{per}\text{unit}\\ =180\times \$1,200\\ =\$216,000\end{array}$

$\begin{array}{c}\text{Sales}\text{as}\text{on}\text{May}\text{30}=\text{Number}\text{of}\text{units}\text{sold}\times \text{cost}\text{per}\text{unit}\\ =300\times \$1,400\\ =\$420,000\end{array}$

$\begin{array}{c}\text{Sales}=\text{Sales}\text{as}\text{on}\text{May}9+\text{Sales}\text{as}\text{on}\text{May}30\\ =\$216,000+\$420,000\\ =\$636,000\end{array}$

The gross profit in case of FIFO it is $475,500, of LIFO it is $449,200, of weighted average it is $462,300 and of specific identification it is $461,200.

5.

Preferred method:

FIFO inventory method resulted in highest gross profit that is $475,500 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 First in, first out inventory costing method is suitable so to earn more amount of bonus on gross profit.