Chapter 7, Problem 8P

1 a.

To determine

Calculate the gross profit for each year under periodic method using FIFO method.

Explanation of Solution

Gross margin (gross profit): Gross margin is the amount of revenue earned from goods sold over the costs incurred for the goods sold.

FIFO: In First-in-First-Out method, items purchased initially are sold first. So, the value of the ending inventory consist the recent cost for the remaining unsold items.

Compute the gross profit for each year:

Particulars	2015	2016	2017	2018
Sales	$400,000	$550,000	$750,000	$600,000
Less: Cost of goods sold (2)	($160,000)	($215,500)	($286,500)	($222,500)
Gross profit	$240,000	$334,500	$463,500	$377,500

Table (1)

Thus, the gross profit for 2015, 2016, 2017, and 2018 are $240,000, $334,500, $463,500, and $377,500 respectively.

Working note 1: Determine the ending inventory:

Computation of cost of ending inventory
Particulars	2015	2016	2017	2018
Total production (A)	$200,000	$234,000	$247,000	$240,500
Units purchased (B)	100,000	120,000	130,000	130,000
Per unit cost $\left(\text{C}\right)=\left(\text{A}\right)/\left(\text{B}\right)$	$2.00	$1.95	$1.90	$1.85
Units in ending inventory (D)	20,000	30,000	10,000	20,000
Cost of ending inventory $\left(\text{E}\right)=\left(\text{D}\right)\times \left(\text{C}\right)$	$40,000	$58,500	$19,000	$37,000

Table (2)

Working note 2: Determine the cost of goods sold:

Particulars	2015	2016	2017	2018
Beginning inventory	$0	$40,000	$58,500	$19,000
Add: Units purchased	$200,000	$234,000	$247,000	$240,500
Goods available for sale	$200,000	$274,000	$305,500	$259,500
Less: Ending inventory (1)	($40,000)	($58,500)	($19,000)	($37,000)
Cost of goods sold	$160,000	$215,500	$286,500	$222,500

Table (3)

1 b.

To determine

Calculate the gross profit for each year under periodic method using LIFO method.

Explanation of Solution

LIFO: In Last-in-First-Out method, items purchased recently are sold first. So, the value of the ending inventory consist the initial cost for the remaining unsold items.

Compute the gross profit for each year:

Particulars	2015	2016	2017	2018
Sales	$400,000	$550,000	$750,000	$600,000
Cost of goods sold (6)	($160,000)	($214,500)	($285,500)	($222,000)
Gross profit	$240,000	$335,500	$464,500	$378,000

Table (4)

Thus, the gross profit for 2015, 2016, 2017, and 2018 are $240,000, $335,500, $464,500, and $378,000 respectively.

Working note 3: Determine the ending inventory:

Computation of cost of ending inventory
Particulars	2015	2016	2017	2018
Total production	$200,000	$234,000	$247,000	$240,500
Units purchased	100,000	120,000	130,000	130,000
Per unit cost	$2.00	$1.95	$1.90	$1.85
Units in ending inventory	20,000	30,000	10,000	20,000
Cost of ending inventory	$40,000	$59,500	$20,000	$38,500

Table (5)

Working note 4: Calculate ending inventory for the year 2016:

$\begin{array}{c}\begin{array}{l}\text{Ending inventory}\\ \text{ for the year 2016}\end{array}\}\text{ = }\left(\begin{array}{l}\text{Units in ending inventory }\\ \text{for 2016}\times \text{ Average unit for 2016}\end{array}\right)+\left(\begin{array}{l}\text{Units in ending inventory }\\ \text{for 2015}\times \text{ Average unit for 2015}\end{array}\right)\\ =\left(\text{20,000}\times \text{ \$2}\text{.00}\right)+\left(\text{10,000}\times \text{ \$1}\text{.95}\right)\\ =\$40,000+\$19,500\\ =\$58,500\end{array}$

Working note 5: Calculate ending inventory for the year 2016:

$\begin{array}{c}\begin{array}{l}\text{Ending inventory}\\ \text{ for the year 2018}\end{array}\}\text{ = }\left(\begin{array}{l}\text{Units in ending inventory }\\ \text{for 2017}\times \text{ Average unit for 2017}\end{array}\right)+\left(\begin{array}{l}\text{Units in ending inventory }\\ \text{for 2015}\times \text{ Average unit for 2018}\end{array}\right)\\ =\left(\text{10,000}\times \text{ \$2}\text{.00}\right)+\left(\text{10,000}\times \text{ \$1}\text{.85}\right)\\ =\$20,000+\$18,500\\ =\$38,500\end{array}$

Working note 6: Determine the cost of goods sold:

Particulars	2015	2016	2017	2018
Beginning inventory	$0	$40,000	$58,500	$20,000
Add: Units purchased	$200,000	$234,000	$247,000	$240,500
Goods available for sale	$200,000	$274,000	$305,500	$260,500
Less: Ending inventory	($40,000)	($59,500)	($20,000)	($38,500)
Cost of goods sold	$160,000	$214,500	$285,500	$222,000

Table (6)

1 c.

To determine

Calculate the gross profit for each year under periodic method using average cost method.

Explanation of Solution

Average cost method: Under average cost method, company calculates a new average after every purchase. It is determined by dividing the cost of goods available for sale by the units on hand.

Compute the gross profit for each year:

Particulars	2015	2016	2017	2018
Sales	$400,000	$550,000	$750,000	$600,000
Cost of goods sold (7)	($160,000)	($215,290)	($286,600)	($222,530)
Gross profit	$240,000	$334,710	$463,400	$377,470

Table (7)

Thus, the gross profit for 2015, 2016, 2017, and 2018 are $240,000, $334,710, $463,400, and $377,470 respectively.           

Working note 7: Determine the cost of goods sold:

Table (8)

2.

To determine

Discuss the reasons whether the company’s return on assets would be higher under FIFO or LIFO.

Explanation of Solution

In FIFO method, net income and total assets are higher than in LIFO (assuming rising costs). But, the net income is different by the annual difference between the two methods, while assets are different by the lifetime difference. Since, the LIFO denominator would be reduced by a larger amount than LIFO numerator, the ratio would be higher under LIFO method.