Chapter 5, Problem 4PSB

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.

Periodic inventory system: In periodic inventory system the changes in the stock items are reported periodically unlike recording as and when purchases or sales take place.

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.

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.

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.

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.

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 3.
5. The inventory costing method suitable incase of bonus earned on gross profit.

Answer to Problem 4PSB

Solution:

Given info,
Units available for sale are 680 units.
Units of goods sold are 480 units.

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:

Explanation of Solution

• As per gross profit approach the FIFO method is the best to earn more profits or bonus.
• 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.

Conclusion

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

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

The number of units in ending inventory is 200 units.

3.

(a)

First in first out method (FIFO)

Cost of ending inventory

Particulars	Amount ($)
Most recent cost; May 25:
100 units @ $458 per unit	45,800
Next most recent cost; May 17:
80 units @ $450 per unit	36,000
Next most recent cost; May 6:
20 units @ $350 per unit	7,000
Total cost of the ending inventory	88,800

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 $88,800 for cost of ending inventory (as calculated above in the table) in the above formula,

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

(b)

Last in first out method (LIFO)

Cost of ending inventory

Particulars	Amount ($)
Earliest cost; May 1:
150 units @ $300 per unit	45,000
Next earliest cost; May 6:
50 units @ $350 per unit	17,500
Total cost of the ending inventory	62,500

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,

$\begin{array}{c}\mathrm{Cos}tofgoodssold=\$249,3000-\$62,500\\ =\$186,800\end{array}$

(c)

Weighted average method

Cost of ending inventory

Formula to calculate cost of ending inventory is,

$\mathrm{Cos}tofendinginventory=\left(\begin{array}{l}Unitsinendinginventory\\ \times weightedaverage\cos tperunit\end{array}\right)$

Substitute 200 units for units in ending inventory (calculated in the (2) part) and $366.62 for weighted average cost per unit (working notes).in the above formula.

$\begin{array}{c}\mathrm{Cos}tofendinginventory=200\times \$366.62\\ =\$73,324\end{array}$

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 the part (1)) and $73,324 for cost of ending inventory (as calculated above) in the above formula,

$\begin{array}{c}\mathrm{Cos}tofgoodssold=\$249,300-\$73,324\\ =\$175,976\end{array}$

Working Notes:

Calculation of weighted average cost per unit:

$Weightedaverage\mathrm{Cos}tperunit=\frac{\mathrm{Cos}tofgoodsavailableforsale}{Numberofunitsavailable}$$\begin{array}{c}Weightedaverage\cos tperunit=\frac{\$249,300}{680}\\ =\$366.62perunit\end{array}$

(d)

Specific identification method

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

Cost of ending inventory

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

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,

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

Under FIFO method, the cost of ending inventory is $88,800 and the cost of goods sold is $160,500.
Under LIFO method, the cost of ending inventory is $62,500 and the cost of goods sold is $186,800.
Under weighted average method, the cost of ending inventory is $73,324 and the cost of goods sold is $175,976.
Under specific identification, 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 $31,800. (Calculated in part (3(a))
Cost of goods sold in case LIFO is $33,400. (Calculated in part (3(b))
Cost of goods sold in case of weighted average is $32,960 and (Calculated in part (3(c))
Cost of goods sold in case of specific identification is 32,540. (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	$175,976	$174,800
Gross profit	$475,500	$449,200	$460,024	$461,200

Working notes:

Calculation of sales

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

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

$\begin{array}{c}\text{Sales}=\text{Sales}\text{as}\text{on}May9+\text{Sales}\text{as}\text{on}May30\\ \text{=\$216,000+\$420,000}\\ \text{=\$636,000}\\ \end{array}$

The gross profit in case of FIFO it is $475,500, of LIFO it is $449,200, of weighted average it is $460,024 and of specific identification it is $461,200.

5.

FIFO inventory method resulted in highest gross profit that is $475,500 as compared to other four methods.