Chapter 7, Problem 7.1CP

Analyzing the Effects of Four Alternative Inventory Costing Methods

Scrappers Supplies tracks the number of units purchased and sold throughout each accounting period but applies its inventory costing method at the end of each period, as if it uses a periodic inventory system. Assume its accounting records provided the following information at the end of the annual accounting period, December 31.

Transactions	Units	Unit Cost
Beginning inventory, January 1 Transactions during the year:	200	$30
a. Purchase on account, March 2	300	32
b. Cash sale, April 1 ($46 each)	(350)
c. Purchase on account, June 30	250	36
d. Cash sale, August 1 ($46 each)	(50)

TIP: Although the purchases and sales are listed in chronological order, Scrappers determines the cost, of goods sold after all of the purchases have occurred.

Required:

1. 1. Compute the cost of goods available for sale, cost of ending inventory, and cost of goods sold at December 31 under each of the following inventory costing methods:
   1. a. Last-in, first-out.
   2. b. Weighted average cost.
   3. c. First-in, first-out.
   4. d. Specific identification, assuming that the April 1 sale was selected one-fifth from the beginning inventory and four-fifths from the purchase of March 2. Assume that the sale of August 1 was selected from the purchase of June 30.
2. 2. Of the four methods, which will result in the highest gross profit? Which will result in the lowest income taxes?

To determine

The cost of goods available for sale.

Explanation of Solution

Determine cost of goods available for sale.

Date	Particulars	Units ($)	Unit cost($)	Total cost($)
		(a)	(b)	(c = a × b)
January 1	Beginning inventory	200	30	6,000
March 2	Purchased	300	32	9,600
June 30	Purchased	250	36	9,000
	Total	750		$24,600
	Less: Goods sold	400
	Ending inventory	350

Table (1)

Conclusion

Therefore, the cost of goods sold available for sale for 750 units of inventory is $24,600.

To determine

The ending inventory and the cost of goods sold under LIFO.

Explanation of Solution

In Last-in-First-Out method, the cost of last purchased items is sold first. The value of the closing stock consists the initial purchased items.

Determine the amount of cost of goods sold.

Date	Particulars	Units	Unit cost($)	Total cost($)
		(a)	(b)	(c = a × b)
June 30	Purchased	250	36	9,000
March 2	Purchased	150	32	4,800
	Cost of goods sold	400		$13,800

Table (2)

Determine ending inventory under LIFO method.

Date	Particulars	Units	Unit cost($)	Total cost($)
		(a)	(b)	(c = a × b)
January 1	Beginning inventory	200	30	6,000
March 2	Purchased	150	32	4,800
	Ending inventory	350		$10,800

Table (3)

Conclusion

Hence, the cost of goods sold under LIFO is $13,800 and the value of ending inventory is $10,800.

To determine

The ending inventory and the cost of goods sold under weighted average-cost method.

Explanation of Solution

In Average Cost Method the cost of inventory is priced at the average rate of the goods available for sale. Following is the mathematical representation:

$\text{Weighted-average Cost}=\frac{\text{Total Cost of Goods Available For Sale}}{\text{Total Number of Units Available For Sale}}$

Determine cost of ending inventory under average-cost method.

Date	Particulars	Units	Unit cost($)	Total cost($)
		(a)	(b)	(c = a × b)
January 1	Beginning inventory	200	30	6,000
March 2	Purchased	300	32	9,600
June 30	Purchased	250	36	9,000
	Cost of goods available for sale	750		24,600
	Less: Ending inventory	350	32.8	11,480
	Cost of goods sold	400		$13,120

Table (4)

Working note:

Determine weighted average unit cost.

$\begin{array}{c}\begin{array}{c}\text{Weighted}\\ \text{average}\text{unit}\text{cost}\end{array}\}=\frac{\left(\begin{array}{l}\text{Cost}\text{of}\text{goods}\\ \text{available}\text{for}\text{sale}\end{array}\right)}{\left(\begin{array}{l}\text{Total}\text{units}\\ \text{available}\text{for}\text{sales}\end{array}\right)}\\ =\frac{\$24,600}{750}\\ =\$32.8\text{per unit}\end{array}$

Conclusion

Hence, the cost of goods sold under weighted average-cost method is $13,120 and the value of ending inventory is $11,480.

To determine

The ending inventory and the cost of goods sold under FIFO.

Explanation of Solution

In First-in-First-Out method, the cost of initial purchased items is sold first. The value of the ending inventory consists the recent purchased items.

Determine the amount of cost of goods sold.

Date	Particulars	Units	Unit cost($)	Total cost($)
		(a)	(b)	(c = a × b)
January 1	Beginning inventory	200	30	6,000
March 2	Purchased	200	32	6,400
	Cost of goods sold	400		$12,400

Table (5)

Determine ending inventory under FIFO method.

Date	Particulars	Units	Unit cost($)	Total cost($)
		(a)	(b)	(c = a × b)
March 2	Purchased	100	32	3,200
June 30	Purchased	250	36	9,000
	Ending inventory	350		$12,200

Table (6)

Conclusion

Hence, the cost of goods sold under FIFO is $12,400 and the value of ending inventory is $12,200.

To determine

The ending inventory and the cost of goods sold under specific identification method.

Explanation of Solution

Specific identification method can be said as identifying the items precisely which are being sold and those which are being stored as closing inventory. The companies are required to keep perfect records of the original cost of each and every individual items of the inventory.

Determine the amount of cost of goods sold.

Date	Particulars	Units	Unit cost($)	Total cost($)
		(a)	(b)	(c = a × b)
January 1	Beginning inventory	70	30	2,100
March 2	Purchased	280	32	8,960
June 30	Purchased	50	36	1,800
	Cost of goods sold	400		$12,860

Table (7)

Determine ending inventory under FIFO method.

Date	Particulars	Units	Unit cost($)	Total cost($)
		(a)	(b)	(c = a × b)
January 1	Beginning inventory	130	30	3,900
March 2	Purchased	20	32	640
June 30	Purchased	200	36	7,200
	Ending inventory	350		$11,740

Table (8)

Conclusion

Hence, the cost of goods sold under specific identification method is $12,860 and the value of ending inventory is $11,740.

To determine

The method of inventory costing results highest in gross profit and minimizes income taxes.

Explanation of Solution

• FIFO method provides a lower cost of goods sold and a higher gross profit than in LIFO.
• By comparing the three inventory method, it is found that the use of LIFO method will minimizes the income taxes because it reports less taxable income as a result of using higher unit costs (in this case) to calculate cost of goods sold.
• A higher Cost of Goods Sold means less Income from Operations. Therefore it reduce tax amount.