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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Communication

Golden Eagle Company began operations on April 1 by selling a single product. Data on purchases and sales for the year are as follows:

images

Sales
April 16,000 units
May 16,000
June 20,000
July 24,000
August 28,000
September 28,000
October 18,000
November 10,000
December 8,000
Total units 168,000
Total sales $10,000,000

The president of the company, Connie Kilmer, has asked for your advice on which inventory cost flow method should be used for the 32,000-unit physical inventory that was taken on December 31. The company plans to expand its product line in the future and uses the periodic inventory system.

Write a brief memo to Ms. Kilmer comparing and contrasting the LIFO and FIFO inventory cost flow methods and their potential impacts on the company’s financial statements.

To determine

Periodic Inventory System:

Periodic inventory system is a system, in which the inventory is updated in the accounting records on a periodic basis such as at the end of each month, quarter or year. In other words, it is an accounting method which is used to determine the amount of inventory at the end of each accounting period.

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.

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.

To prepare: the memo to Ms. CK of GE Company.

Explanation

From:

XYZ

To:

Ms. CK

President

GE Company.

Re: Comparison of LIFO and FIFO inventory methods.

Dear Ms. K,

LIFO (Last in first out) and FIFO (First in first out) are two alternate methods of applied for calculating cost of units that are sold and for cost of units that are remaining in the ending inventory at the end of the year in balance sheet.

The LIFO method is viewed as the best method for replicating the operational performance of the business by depicting the income from operations. The reason is that LIFO method matches the most current cost of inventory purchases against existing sales of the company.

The cost of ending inventory under LIFO is shown as below:

Ending Inventory
31,000 Units at $36.60 $ 1,134,600
1,000 Units at $39.00 $ 39,000
32,000 $ 1,173,600

Table (1)

The cost of merchandise sold is calculated as below:

Cost of merchandise sold (LIFO)
Particulars Amount ($)
Cost of merchandise available for sale 8,148,000
Less: Ending Inventory 1,173,600
Cost of merchandise sold 6,974,400

Table (2)

The gross profit is calculated as under:

Gross profit (LIFO)
Particulars Amount ($)
Sales 10,000,000
Less: Cost of merchandise sold 6,974,400
Gross Profit 3,025,600

Table (3)

From the above calculations, the gross profit of $3,025,600 reflects the matching of most current cost of purchases of the product of $6,974,400 against the sales of $10,000,000. As it is seen, the matching of cost with the existing sales inclines to minimize the effect of trends of prices fluctuation on the outcome of the business operations in the current year. In the period of rising prices, as in this scenario of GE Company, the LIFO method would be beneficial for the company as it will result in less net income that FIFO method, because taxes are being levied on net income of the company...

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