Chapter 7, Problem 7E

Analyzing and Interpreting the Financial Statement Effects of FIFO, LIFO, and Weighted Average Cost

Scoresby Inc. tracks the number of units purchased and sold throughout each year but applies its inventory costing method at the end of the year, 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
a. Inventory, Beginning For the year:	3,000	$8
b. Purchase, March 5	9,500	9
c. Purchase, September 19	5,000	11
d. Sale, April 15 (sold for $29 per unit)	4,000
e. Sale, October 31 (sold for $31 per unit)	8,000
f. Operating expenses (excluding income tax expense), $250,000

Required:

1. 1. Calculate the number and cost of goods available for sale.
2. 2. Calculate the number of units in ending inventory.
3. 3. Compute the cost of ending inventory and cost of goods sold under (a) FIFO, (b) LIFO, and (c) weighted average cost.
4. 4. Prepare an income statement that shows the FIFO method in one column, the LIFO method in another column, and the weighted average method in a final column. Include the following line items in the income statement: Sales, Cost of Goods Sold, Gross Profit, Operating Expenses, and Income from Operations.
5. 5. Compare the Income from Operations and the ending inventory amounts that would be reported under the three methods. Explain the similarities and differences.
6. 6. Which inventory costing method minimizes income taxes?

To determine

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)
a.	Beginning inventory	3,000	8	24,000
b.	Purchased	9,500	9	85,500
c.	Purchased	5,000	11	55,000
	Total	17,500		$164,500

Table (1)

Conclusion

Therefore, the cost of goods sold available for sale for 17,500 units of inventory is $164,500.

To determine

Calculate the number of units in ending inventory.

Explanation of Solution

Number of units in ending inventory:

$\begin{array}{c}\begin{array}{l}\text{Number of units in}\\ \text{ending inventory}\end{array}\}=\left(\begin{array}{l}\text{Total units available for sale}\\ -\text{ Total units of sales}\end{array}\right)\\ =\left(17,500-12,000\right)\\ =5,500\text{ units}\end{array}$

Conclusion

Therefore, the number of units in ending inventory is 5,500 units.

To determine

Calculate the cost 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 consist the recent purchased items.

Calculate ending inventory and cost of goods sold under FIFO method.

Determine the amount of cost of goods sold.

Date	Particulars	Units	Unit cost ($)	Total cost ($)
		(a)	(b)	(c = a × b)
a.	Beginning inventory	3,000	8	24,000
b.	Purchased	9,000	9	81,000
	Cost of goods sold	900		$105,000

Table (2)

Determine ending inventory under FIFO method.

Date	Particulars	Units	Unit cost ($)	Total cost ($)
		(a)	(b)	(c = a × b)
b.	Purchased	500	9	4,500
c.	Purchased	5,000	11	55,000
	Ending inventory	5,500		$59,500

Table (3)

Conclusion

Hence, the cost of goods sold under FIFO is $105,000 and the value of ending inventory is $56,500.

To determine

Calculate the cost 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 consist the initial purchased items.

Determine the amount of cost of goods sold.

Date	Particulars	Units	Unit cost ($)	Total cost ($)
		(a)	(b)	(c = a × b)
c.	Purchased	5,000	11	55,000
b.	Purchased	7,000	9	63,000
	Cost of goods sold	12,000		$118,000

Table (4)

Determine ending inventory under LIFO method.

Date	Particulars	Units	Unit cost ($)	Total cost ($)
		(a)	(b)	(c = a × b)
a.	Beginning inventory	3,000	8	24,000
b.	Purchased	2,500	9	22,500
	Ending inventory	5,500		$46,500

Table (5)

Conclusion

Hence, the cost of goods sold under LIFO is $118,000 and the value of ending inventory is $46,500.

To determine

Determine the ending inventory and the cost of goods sold under 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)
a.	Beginning inventory	3,000	8	24,000
b.	Purchased	9,500	9	85,500
c.	Purchased	5,000	11	55,000
	Cost of goods available for sale	17,500		164,500
	Less: Ending inventory	5,500	9.4	51,700
	Cost of goods sold			$112,800

Table (6)

Determine cost of goods sold under average cost method.

$\begin{array}{c}\text{Cost of goods sold = }\left(\begin{array}{l}\text{Number of units sold}\times \\ \text{Weighted average unit cost}\end{array}\right)\\ =\left(12,000\times \$9.4\right)\\ =\$112,800\end{array}$

Working note:

Determine weighted average unit cost.

$\begin{array}{c}\begin{array}{c}\text{Weighted}\\ \text{average}\text{unit}\text{cost}\end{array}\}=\frac{\left(\begin{array}{l}\text{Cost}\text{of}\text{goods}\\ \text{available}\text{for}\text{sale}\end{array}\right)}{\left(\begin{array}{l}\text{Total}\text{units}\\ \text{available}\text{for}\text{sales}\end{array}\right)}\\ =\frac{\$164,500}{17,500}\\ =\$9.4\text{per unit}\end{array}$

Conclusion

Hence, the cost of goods sold under weighted average cost method is $112,800 and the value of ending inventory is $51,700.

To determine

Prepare an income statement.

Explanation of Solution

Prepare an income statement.

Particulars	FIFO	LIFO	Weighted Average
Sales Revenue	364,000	364,000	364,000
Cost of Goods Sold	105,000	118,000	112,800
Gross Profit	259,000	246,000	251,200
Operating Expenses	250,000	250,000	250,000
Income (Loss) from Operations	$9,000	$ (4,000)	$1,200

Table (7)

Working Note:

Calculate the amount of sales revenue:

$\begin{array}{c}\text{Sales revenue}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Number of units sold on April 15 }\\ \times \text{Sales per unit }\end{array}\right)\\ \text{+}\left(\begin{array}{l}\text{ Number of units sold on September 19 }\\ \times \text{Sales per unit }\end{array}\right)\end{array}\right]\\ =\left[\begin{array}{l}\left(\text{4,000}\times \$29\right)\\ \text{+}\left(\text{8,000}\times \$31\right)\end{array}\right]\\ =\left[\$116,000\text{ +\$248,000}\right]\\ =\$364,000\end{array}$

Conclusion

Therefore, the income/loss from operation for FIFO is $9,000, LIFO is $(4,000) and weighted average method is $1,200.

To determine

Compare the income from operations and ending inventory amount reported in three methods.

Explanation of Solution

Compare the income from operations and ending inventory amount reported in three methods.

Comparison of Amounts
Particulars	FIFO	LIFO	Weighted Average
Income from Operations	9,000	(4,000)	1,200
Ending Inventory	59,500	46,500	51,700

Table (8)

To determine

Explain the similarities and differences.

Explanation of Solution

• From the above table, it clearly shows the income from operation under three methods.
• The differences in inventory have a dollar–for–dollar effect on income from operations.
• The method with the highest ending inventory always has the highest Income from operations.
• In most cases, the weighted average method falls between the FIFO and LIFO methods. 

To determine

Determine the method of inventory costing minimizes income taxes.

Explanation of Solution

• 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.