Chapter 5, Problem 6BE

a. 1

To determine

Record the given transactions in general journal form and post it to T-accounts using the FIFO method.

Explanation of Solution

Journal:

Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system of Accounting.

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.

Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

Ledger:

Ledger is the book, where the debit and credit entries recorded in the journal book are transferred to their relevant accounts. The entire accounts of the company are collectively called the ledger.

First-in-First-Out:

In First-in-First-Out method, the costs of the initially purchased items are considered as cost of goods sold, for the items which are sold first. The value of the ending inventory consists of the recent purchased items.

Record the given transactions in general journal form using FIFO as follows:

Journal
Date	Account Title and Explanation	Post	Debit	Credit
		Ref.	($)	($)
April 1	Merchandise Inventory Table (2)		84,000
	Cash			84,000
	(To record the purchase of inventory)
October 1	Merchandise Inventory Table (2)		32,000
	Cash			32,000
	(To record the purchase of inventory)
	Cash Table (2)		175,000
	Sales Revenue			175,000
	(To record the sales made)
	Cost of Goods Sold Table (3)		104,300
	Merchandise Inventory			104,300
	(To record the cost of goods sold)
	Operating Expenses		21,000
	Cash			21,000
	(To record the operating expenses incurred)
	Income Tax Expense (1)		14,910
	Cash			14,910
	(To record the income tax expenses incurred)

Table (1)

Working notes:

Calculate total purchase:

Particular	Unit	Unit cost	Total cost
Purchases:
January 1	300	$25	$7,500
April 1	2,800	30	84,000
October 1	1,000	32	32,000
Goods Available for Sale	4,100		$123,500
Less: Cost of goods sold	3,500	50	175,000
Ending inventory	600

Table (2)

Calculate cost of goods sold amount under FIFO:

Particular	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 (3)

Calculate income tax expense amount:

$\begin{array}{c}\text{Income tax expenses}=\left[\begin{array}{l}\text{sales}-\text{cost of goods}\\ \text{sold}-\text{operating expense}\end{array}\right]\times \frac{\text{30}}{100}\\ =\$175,000-\$104,300-\$21,000\times \frac{\text{30}}{100}\\ =\$49,700\times \frac{\text{30}}{100}\\ =\$14,910\end{array}$ (1)

Post the given transactions to T-accounts using FIFO as follows:

Cash
Bal	36,000
Year 2	175,000	1-Apr	84,000
		1-Oct	32,000
		Year 2	21,000
		Year 2	14,910
Bal.	59,090

Sales revenue
		Year 2	175,000
		Bal.	175,000

Merchandise Inventory
Bal	7,500
1-Apr	84,000
1-Oct	32,000	Year 2	104,300
Bal.	19,200

Cost of goods sold
Year 2	104,300
Bal.	104,300

Common stock
		Bal	20,000
		Bal.	20,000

Retained earnings
		Bal	23,500
		Bal.	23,500

Operating expenses
Year 2		21,000
Bal.		21,000
Income tax expenses
Year 2	14,910
Bal.	14,910

a. 2

To determine

Record the given transactions in general journal form and post it to T-accounts using the LIFO method.

Explanation of Solution

Last-in-Last-Out:

In Last-in-First-Out method, the costs of last purchased items are considered as the cost of goods sold, for the items which are sold first. The value of the closing stock consists of the initial purchased items.

Record the given transactions in general journal form using LIFO as follows:

Journal
Date	Account Title and Explanation	Post	Debit	Credit
		Ref.	($)	($)
April 1	Merchandise Inventory Table (2)		84,000
	Cash			84,000
	(To record the purchase of inventory)
October 1	Merchandise Inventory Table (2)		32,000
	Cash			32,000
	(To record the purchase of inventory)
	Cash Table (2)		175,000
	Sales Revenue			175,000
	(To record the sales made)
	Cost of Goods Sold Table (5)		107,000
	Merchandise Inventory			107,000
	(To record the cost of goods sold)
	Operating Expenses		21,000
	Cash			21,000
	(To record the operating expenses incurred)
	Income Tax Expense (2)		14,100
	Cash			14,100
	(To record the income tax expenses incurred)

Table (4)

Working notes:

Calculate cost of goods sold amount under LIFO:

Particular	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 (5)

Calculate income tax expense amount:

$\begin{array}{c}\text{Income tax expenses}=\left[\begin{array}{l}\text{sales}-\text{cost of goods}\\ \text{sold}-\text{operating expense}\end{array}\right]\times \frac{\text{30}}{100}\\ =\$175,000-\$107,000-\$21,000\times \frac{\text{30}}{100}\\ =\$47,000\times \frac{\text{30}}{100}\\ =\$14,100\end{array}$ (2)

Post the given transactions to T-accounts using LIFO as follows:

Cash
Bal	36,000
Year 2	175,000	1-Apr	84,000
		1-Oct	32,000
		Year 2	21,000
		Year 2	14,100
Bal.	59,900

Sales revenue
		Year 2	175,000
		Bal.	175,000

Merchandise Inventory
Bal	7,500
1-Apr	84,000
1-Oct	32,000	Year 2	107,000
Bal.	16,500

Cost of goods sold
Year 2	107,000
Bal.	107,000

Common stock
		Bal	20,000
		Bal.	20,000

Retained earnings
		Bal	23,500
		Bal.	23,500

Operating expenses
Year 2		21,000
Bal.		21,000
Income tax expenses
Year 2	14,100
Bal.	14,100

b.

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

Table (6)

Prepare income statement using LIFO as follows:

Company B
Income Statements (FIFO)
For the Year Ended December 31, Year 2
Particulars	$
Sales Table (2)	$175,000
Less: Cost of Goods Sold Table (5)	107,000
Gross Margin	68,000
Less: Operating Expenses	21,000
Income Before Tax	47,000
Less: Income Tax Expense (1)	14,100
Net Income	$32,900

Table (7)

c.

To determine

Ascertain the amount of income tax that Company B would save if it changed cost flow method.

Explanation of Solution

• The amount of income tax that Company B would be saved is $810$\left(\text{\$14,910}-\text{\$14,100}\right)$.

d.

To determine

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

Explanation of Solution

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

Company B
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 (3)	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 (8)

Working notes:

Calculate cash outflow for Inventory amount:

$\begin{array}{c}\text{Cash paid for inventory}=\left[\begin{array}{l}\text{Purchased made on April 1}+\\ \text{Purchased made on october 1}\end{array}\right]\\ =\$84,000+\$32,000\\ =\$116,000\end{array}$ (3)

e.

To determine

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

Explanation of Solution

Under FIFO, the taxable income would be greater. Hence, more amount of income tax must be paid on the higher amount of income before tax reported. Thus, when the amount of cash used for operating activities increase, it would result in lower net cash flow from operating activities.