Chapter 5, Problem 6AE

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)		70,000
	Cash			70,000
	(To record the purchase of inventory)
October 1	Merchandise Inventory Table (2)		22,800
	Cash			22,800
	(To record the purchase of inventory)
	Cash Table (2)		243,000
	Sales Revenue			243,000
	(To record the sales made)
	Cost of Goods Sold Table (3)		93,400
	Merchandise Inventory			93,400
	(To record the cost of goods sold)
	Operating Expenses		41,500
	Cash			41,500
	(To record the operating expenses incurred)
	Income Tax Expense (1)		32,430
	Cash			32,430
	(To record the income tax expenses incurred)

Table (1)

Working notes:

Calculate total purchase:

Particular	Unit	Unit cost	Total cost
Purchases:
January 1	400	$30	$12,000
April 1	2,000	35	70,000
October 1	600	38	22,800
Goods Available for Sale	3,000		$104,800
Less: Cost of goods sold	2,700	90	243,000
Ending inventory	300

Table (2)

Calculate cost of goods sold amount under FIFO:

Particular	Unit	Unit cost	Total cost
Purchases:
January 1	400	$30	$12,000
April 1	2,000	35	70,000
October 1	300	38	11,400
Cost of goods sold	2,700		93,400

Table (3)

Calculate income tax expense amount:

$\begin{array}{c}\text{Income tax expenses}=\left[\begin{array}{l}\text{sales}-\text{cost of goods}\\ \text{sold}-\text{operating expense}\end{array}\right]\times \frac{\text{30}}{100}\\ =\$243,000-\$93,400-\$41,500\times \frac{\text{30}}{100}\\ =\$108,100\times \frac{\text{30}}{100}\\ =\$32,430\end{array}$ (1)

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

Cash
Bal	75,000
Year 2	243,000	1-Apr	70,000
		1-Oct	22,800
		Year 2	41,500
		Year 2	32,430
Bal.	151,270

Sales revenue
		Year 2	243,000
		Bal.	243,000

Merchandise Inventory
Bal	12,000
1-Apr	70,000
1-Oct	22,800	Year 2	93,400
Bal.	11,400

Cost of goods sold
Year 2	93,400
Bal.	93,400

Common stock
		Bal	50,000
		Bal.	50,000

Retained earnings
		Bal	37,000
		Bal.	37,000

Operating expenses
Year 2		41,500
Bal.		41,500
Income tax expenses
Year 2	32,430
Bal.	32,430

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)		70,000
	Cash			70,000
	(To record the purchase of inventory)
October 1	Merchandise Inventory Table (2)		22,800
	Cash			22,800
	(To record the purchase of inventory)
	Cash Table (2)		243,000
	Sales Revenue			243,000
	(To record the sales made)
	Cost of Goods Sold Table (5)		93,400
	Merchandise Inventory			93,400
	(To record the cost of goods sold)
	Operating Expenses		41,500
	Cash			41,500
	(To record the operating expenses incurred)
	Income Tax Expense (2)		32,430
	Cash			32,430
	(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	600	$38	$22,800
April 1	2,000	35	70,000
January 1	100	30	3,000
Cost of goods sold	2,700		95,800

Table (5)

Calculate income tax expense amount:

$\begin{array}{c}\text{Income tax expenses}=\left[\begin{array}{l}\text{sales}-\text{cost of goods}\\ \text{sold}-\text{operating expense}\end{array}\right]\times \frac{\text{30}}{100}\\ =\$243,000-\$95,800-\$41,500\times \frac{\text{30}}{100}\\ =\$105,700\times \frac{\text{30}}{100}\\ =\$31,710\end{array}$ (2)

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

Cash
Bal	75,000
Year 2	243,000	1-Apr	70,000
		1-Oct	22,800
		Year 2	41,500
		Year 2	31,710
Bal.	151,990

Sales revenue
		Year 2	243,000
		Bal.	243,000

Merchandise Inventory
Bal	12,000
1-Apr	70,000
1-Oct	22,800	Year 2	95,800
Bal.	9,000

Cost of goods sold
Year 2	95,800
Bal.	95,800

Common stock
		Bal	50,000
		Bal.	50,000

Retained earnings
		Bal	37,000
		Bal.	37,000

Operating expenses
Year 2		41,500
Bal.		41,500
Income tax expenses
Year 2	31,710
Bal.	31,710

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 P
Income Statements (FIFO)
For the Year Ended December 31, Year 2
Particulars	$
Sales Table (2)	$243,000
Less: Cost of Goods Sold Table (3)	93,400
Gross Margin	149,600
Less: Operating Expenses	41,500
Income Before Tax	108,100
Less: Income Tax Expense (1)	32,430
Net Income	$75,670

Table (5)

Prepare income statement using LIFO as follows:

Company P
Income Statements (LIFO)
For the Year Ended December 31, Year 2
Particulars	$
Sales Table (2)	$243,000
Less: Cost of Goods Sold Table (5)	95,800
Gross Margin	147,200
Less: Operating Expenses	41,500
Income Before Tax	105,700
Less: Income Tax Expense (2)	31,710
Net Income	$73,990

Table (6)

c.

To determine

Ascertain the amount of income tax that Company P Would pay using each cost flow method.

Explanation of Solution

• The amount of income tax that Company P would pay under FIFO cost method is $32,430.
• The amount of income tax that Company P would pay under LIFO cost method is $31,710.

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 P
Cash Flows from Operating Activities
Particulars	FIFO	LIFO
Cash Flows From Operating Activities:
Cash Inflow from Customers	$243,000	$243,000
Less: Cash Outflow for Inventory (3)	92,800	92,800
Cash Outflow for Operating Expense	41,500	41,500
Cash Outflow for Income Tax Expense	32,430	31,710
Net Cash Flow from Operating Activities	$76,270	$76,990

Table (7)

Working notes:

Calculate cash outflow for Inventory amount:

$\begin{array}{c}\text{Cash paid for inventory}=\left[\begin{array}{l}\text{Purchased made on April 1}+\\ \text{Purchased made on october 1}\end{array}\right]\\ =\$70,000+\$22,800\\ =\$92,800\end{array}$ (3)

e.

To determine

Describe why does the cash flow from operating activities differs between FIFO and LIFO.

Explanation of Solution

Due to the difference in the amount of income tax paid under the two methods, the cash flow from operating activities differs between FIFO and LIFO. Under FIFO, the taxable income would be greater. Hence the amount of income tax paid would be higher which cause a greater cash flow for tax expense.