Chapter 6, Problem 51E

Inventory Costing Methods

On June 1, Welding Products Company had a beginning inventory of 210 cases of welding rods that had been purchased for S88 per case. Welding Products purchased 1,150 cases at a cost of

$95 per case on June 3. On June 19, the company purchased another 950 cases at a cost of $112 per case. Sales data for the welding rods are:

Welding Products uses a perpetual inventory system, and the sales price of the welding rods was $130 per case.

Required:

1. Compute the cost of ending inventory and cost of goods sold using the FIFO method.

2. Compute the cost of ending inventory and cost of goods sold using the LIFO method.

3. Compute the cost of ending inventory and cost of goods sold using the average cost method.

( Note: Use four decimal places for per-unit calculations and round all other numbers to the nearest dollar.)

4. CONCEPTUAL CONNECTION Assume that operating expenses are $21,600 and Welding

Products has a 30% tax rate. How much will the cash paid for income taxes differ among the three inventory methods?

5. CONCEPTUAL CONNECTION Compute Welding Products' gross profit ratio (rounded to two decimal places) and inventory turnover ratio (rounded to three decimal places) under each of the three inventory costing methods. How would the choice of inventory costing method affect these ratios?

To determine

(a)

Inventory costing methods:

FIFO, LIFO and average cost method, are those method which used for calculation of closing inventory and cost of goods sold.

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

Answer to Problem 51E

Particular	$\text{ FIFO \$}$
Cost of goods sold	$195490$
Closing inventory value	$38640$

Explanation of Solution

The given information is as follows:

Total available units are:

$\text{Opening inventory}=21\text{0 cases @ \$88 each}$

$\begin{array}{c}\text{Purchases}=1150\text{ cases @ \$95 each}\\ \text{Purchases}=950\text{ cases @ \$112 each}\end{array}$

$\text{Total Purchased cases = 2100}$

$\begin{array}{c}\text{Total available cases = 210+2100}\\ \text{= 2310 units}\end{array}$

$\text{Sales}=1965\text{ cases}$

$\begin{array}{c}\text{Closing inventory }=\text{Beginning inventory + Purchase}-\text{Sales}\\ \text{=210}+2100-1965\\ =345\text{ cases}\end{array}$

Calculation of Closing Inventory as per FIFO Method:

Under this method, which material purchased first, issued first for production. However closing inventory includes last purchased materials in stock. Due to latest purchase in closing inventory, higher value of latest purchase effects cost of goods sold as lower and profit margin will be high.

	Closing inventory	Cost of Goods sold
		$\text{210 cases @ \$88}=\text{\$18480}$
		$\text{780 cases @ \$95}=\text{\$74100}$
		$\text{370 cases @ \$95}=\text{\$35150}$
	$\text{345 cases @ \$112}=\text{\$38640}$	$\text{605 cases @ \$112}=\text{\$67760}$
Total	$\text{345 cases @ \$112}=\text{\$38640}$	$\text{1965 cases = \$195490}$

To determine

(b)

Inventory costing methods:

FIFO, LIFO and average cost method, are those method which used for calculation of closing inventory and cost of goods sold.

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

Answer to Problem 51E

Particular	$\text{LIFO \$}$
Cost of goods sold	$202825$
Closing inventory value	$31305$

Explanation of Solution

The given information is as follows:

The given information is as follows:

Total available units are:

$\text{Opening inventory}=21\text{0 cases @ \$88 each}$

$\begin{array}{c}\text{Purchases}=1150\text{ cases @ \$95 each}\\ \text{Purchases}=950\text{ cases @ \$112 each}\end{array}$

$\text{Total Purchased cases = 2100}$

$\begin{array}{c}\text{Total available cases = 210+2100}\\ \text{= 2310 units}\end{array}$

$\text{Sales}=1965\text{ cases}$

$\begin{array}{c}\text{Closing inventory }=\text{Beginning inventory + Purchase}-\text{Sales}\\ \text{=210}+2100-1965\\ =345\text{ cases}\end{array}$

Calculation of closing inventory as per LIFO Method:

Under this method, which material purchased last, issued first for production. However closing inventory includes earliest purchased material in stock. Due to earliest purchase material in stock, lower value of earliest purchased effects cost of goods sold as high and profit margin will be lower.

	Ending Inventory	Cost of Goods sold
		$\text{990 cases @ \$95}=\text{\$94050}$
	$\text{210 cases @ \$88}=\text{\$18480}$	$\text{950 cases @ \$112}=\text{\$106400}$
	$\text{135 cases @ \$95}=\text{\$12825}$	$\text{25 cases @ \$95}=\text{\$2375}$
Total	$\text{345 cases}=\text{\$31305}$	$\text{1965 cases = \$202825}$

To determine

(c)

Inventory costing methods:

FIFO, LIFO and average cost method, are those method which used for calculation of closing inventory and cost of goods sold.

The cost of ending inventory and the cost of goods sold using the average cost method.

Answer to Problem 51E

Particular	$\text{Average cost \$}$
Cost of goods sold	$197239$
Closing inventory value	$36891$

Explanation of Solution

The given information is as follows:

The given information is as follows:

Total available units are:

$\text{Opening inventory}=21\text{0 cases @ \$88 each}$

$\begin{array}{c}\text{Purchases}=1150\text{ cases @ \$95 each}\\ \text{Purchases}=950\text{ cases @ \$112 each}\end{array}$

$\text{Total Purchased cases = 2100}$

$\begin{array}{c}\text{Total available cases = 210+2100}\\ \text{= 2310 units}\end{array}$

$\text{Sales}=1965\text{ cases}$

$\begin{array}{c}\text{Closing inventory }=\text{Beginning inventory + Purchase}-\text{Sales}\\ \text{=210}+2100-1965\\ =345\text{ cases}\end{array}$

Calculation of closing inventory as per weighted average method:

Under this method, average cost per unit of inventory is calculated and closing inventory value is to be calculated on that basis. Average cost of inventory is changed on purchase high or low. However we follow indirect method of average cost to calculate closing inventory.

As the fist two sales are done only from two purchases and beginning inventory and the third sale is done including all purchases. Hence, there will requirement of two average cost for computing the cost of goods sold.

$\begin{array}{c}\text{Weighted average cost per unit}=\text{Cost of Goods available for sale}÷\text{Units available for sale}\\ \text{=}\left\{\left(210\text{ cases}\times \$88\right)+\left(\text{1150 cases}\times \$92\right)\right\}÷1360\\ =\left(\$18480+\$109250\right)÷1360\\ =\$93.92\end{array}$

$\begin{array}{c}\text{Weighted average cost per unit}=\text{Cost of Goods available for sale}÷\text{Units available for sale}\\ \text{=}\left\{\left(\left(210+1150-990\right)\text{ cases}\times 93.92\right)+\left(\text{950 cases}\times 112\right)\right\}÷1320\\ =\left(\$34750+\$106400\right)÷1320\\ =\$106.93\end{array}$

	Closing inventory	Cost of Goods sold
		$\text{990 cases @ \$93}\text{.92}=\text{\$92980}$
	$\text{345 cases @ \$106}\text{.93}=\$36891$	$\text{975 cases @ \$106}\text{.93}=\text{\$104259}$
Total	$\text{345 cases @ \$106}\text{.93}=\$36891$	$\text{1365 cases}=\text{\$197239}$

To determine

(d)

Inventory costing methods:

FIFO, LIFO and average cost method, are those method which used for calculation of closing inventory and cost of goods sold.

The cash paid for income as per three inventory costing methods.

Answer to Problem 51E

	FIFO $\left(\$\right)$	LIFO $\left(\$\right)$	Average Cost $\left(\$\right)$
Profit/ Loss before tax	$38360.00$	$31025.00$	$36611.00$
Income Tax Expense	$11508.00$	$9308.00$	$10983.00$
Net Income	$26852.00$	$21717.00$	$25628.00$

Explanation of Solution

The available information by calculating in the above parts as:

Particular	$\text{ FIFO \$}$	$\text{LIFO \$}$	$\text{Average cost \$}$
Cost of goods sold	$195490$	$202825$	$197239$
Closing inventory value	$38640$	$31305$	$36891$

The computation of income before taxes, income tax expenses and net income as per three inventory costing methods are:

$$

	FIFO $\left(\$\right)$	LIFO $\left(\$\right)$	Average Cost $\left(\$\right)$
Sales	$255450.00$	$255450.00$	$255450.00$
Less: COGS	$195490.00$	$202825.00$	$197239.00$
Gross Profit	$59960.00$	$52625.00$	$58211.00$
Less: Operating Expenses	$21600.00$	$21600.00$	$21600.00$
Profit/ Loss before tax	$38360.00$	$31025.00$	$36611.00$
Less: Income Tax $\left(30\%\right)$	$11508.00$	$9308.00$	$10983.00$
Net Income	$26852.00$	$21717.00$	$25628.00$

The lowest cash paid for income is in LIFO method.

To determine

(e)

Gross profit margin ratio:

The gross margin ratio is a type of profitability ratio which is used to measure the returns and earning after direct expenses and compute the ratio in respect to the sales of the business.

Inventory Turnover ratio:

The ratio which measures the efficiency of the company in managing their inventory by diving the cost of goods sold by the average inventory.

The gross margin ratio and inventory turnover ratio.

Answer to Problem 51E

Particulars	FIFO	LIFO	Average Cost
Gross Profit Ratio	$23.47\%$	$20.60\%$	$22.79\%$
Inventory Turnover Ratio	$3.422$	$4.074$	$3.562$

Explanation of Solution

The available information by calculating in the above parts as:

Particular	$\text{ FIFO \$}$	$\text{LIFO \$}$	$\text{Average cost \$}$
Cost of goods sold	$195490$	$202825$	$197239$
Closing inventory value	$38640$	$31305$	$36891$

The formula for computing the gross profit margin is:

$\text{Gross Profit Ratio}=\frac{\text{Gross Profit}}{\text{Sales}}\times 100$

The formula for computing inventory turnover ratio is:

$\text{Inventory Turnover ratio}=\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}$

Particulars	FIFO	LIFO	Average Cost
Sales $\left(\text{Units sold}\times \$130\right)$ $\left(1\right)$	$255450.00$	$255450.00$	$255450.00$
Less: Cost of goods sold $\left(2\right)$	$195490.00$	$202825.00$	$197239.00$
Gross Profit $\left(3\right)$	$59960.00$	$52625.00$	$58211.00$
Opening Inventory $\left(4\right)$	$18480$	$18480$	$18480$
Closing Inventory $\left(5\right)$	$38640$	$31305$	$36891$
Average Inventory $\left(6\right)=\left(4+5\right)÷2$	$\$28560$	$\$24893$	$\$27686$
Gross Profit Ratio $\left(3÷2\right)\times 100$	$23.47\%$	$20.60\%$	$22.79\%$
Inventory Turnover Ratio $\left(2÷6\right)$	$3.422$	$4.074$	$3.562$

By analyzing the above table, it can be said that FIFO has the highest gross margin ratio and LIFO has the highest inventory turnover ratio.