Chapter 7, Problem 12E

Alternative Inventory Methods Park Company’s perpetual inventory records indicate the following transactions in the month of June:

Required:

1. 1. Compute the cost of goods sold for June and the inventory at the end of June using each of the following cost flow assumptions:
   1. a. FIFO
   2. b. LIFO
   3. c. Average cost (Round unit costs to 3 decimal places and other amounts to the nearest dollar.)
2. 2. Next Level Why are the cost of goods sold and ending inventory amounts different for each of the three methods? What do these amounts tell us about the purchase price of inventory during the year?
3. 3. Next Level Which method produces the most realistic amount for net income? For inventory? Explain your answer.
4. 4. Next Level If Park uses IFRS, which of the previous alternatives would be acceptable and why?

To determine

Calculate the ending inventories and the cost of goods sold for the month of June using FIFO method under perpetual system.

Explanation of Solution

Perpetual inventory system: The method or system of maintaining, recording, and adjusting the inventory perpetually throughout the year, is referred to as perpetual inventory system.

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 ending inventory and cost of goods sold for June using FIFO method:

Date	Particulars	Cost of goods sold			Inventory Balance
		Units	Cost per unit	Amount	Units	Cost per unit	Amount
June
01	Beginning inventory				200	$3.20	$640
03					200	$3.20	$640
	Purchase				200	$3.50	$700
							$1,340
06	Sale (300) units	200	$3.20	$640	100	$3.50	$350
		100	$3.50	$350
							$2,350
17					100	$3.50	$350
	Purchase				250	$3.60	$900
							$1,250
21	Sale (200) units	100	$3.50	$350	150	$3.60	$540
		100	$3.60	$360
							$540
24					150	$3.60	$540
	Purchase				300	$3.65	$1,095
							$1,635
27	Sale (150) units	150	$3.60	$540	300	$3.65	$1,095
	Total	650		$2,240	300		$1,095

Table (1)

Thus, under FIFO cost method the cost of goods sold is $2,240 and the ending inventory in units are 300 and in dollars are $1,095.

To determine

Calculate the ending inventories and the cost of goods sold for the month of June using LIFO method under perpetual system.

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 ending inventory and cost of goods sold for June:

Date	Particulars	Cost of goods sold			Inventory Balance
		Units	Cost per unit	Amount	Units	Cost per unit	Amount
June
1	Beginning inventory				200	$3.20	$640.00
3					200	$3.20	$640.00
	Purchase				200	$3.50	$700.00
							$1,340.00
6	Sale (300) units	200	$3.50	$700.00	100	$3.20	$320.00
		100	$3.20	$320.00
17					100	$3.20	$320.00
	Purchase				250	$3.60	$900.00
							$1,220.00
21	Sale (200) units	200	$3.60	$720.00	100	$3.20	$320.00
					50	$3.60	$180.00
							$500.00
24					100	$3.20	$320.00
					50	$3.60	$180.00
	Purchase				300	$3.65	$1,095.00
							$1,595.00
27	Sale (150) units	150	$3.65	$547.50	100	$3.20	$320.00
					50	$3.60	$180.00
					150	$3.65	$547.50
	Total	650		$2,287.50	300		$1,047.50

Table (2)

Thus, under LIFO cost method the cost of goods sold is $2,287.50 and the ending inventory in units are 300 and in dollars are $1,047.50.

To determine

Calculate the ending inventories and the cost of goods sold for the month of June 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.

Calculate the ending inventories and the cost of goods sold for the month of June:

Date	Particulars	Cost of goods Sold	Ending inventory
June
01	Beginning inventory		$200\text{ units at }\$3.20=\$640$
03	Purchase of 200 units		$\begin{array}{r}\hfill \begin{array}{l}\text{200 units at \$3}\text{.20}\\ \text{200 units at \$3}\text{.50}\end{array}\}\text{ = }\{\text{\$1,340}\left(\begin{array}{l}\text{400 units }\\ \text{at \$3}\text{.35}\end{array}\right)\end{array}$
06	Sale of 300 units	$\left(\begin{array}{l}300\text{ units at}\\ \$3.35=\$1,005\end{array}\right)$	$\left(100\text{ units }\times \$3.35=\$335\right)$
17	Purchase of 250 units		$\begin{array}{r}\hfill \begin{array}{l}\text{100 units at \$3}\text{.35}\\ \text{250 units at \$3}\text{.60}\end{array}\}\text{ = }\{\text{\$1,235}\left(\begin{array}{l}\text{350 units }\\ \text{at \$3}\text{.529}\end{array}\right)\end{array}$
21	Sale of 150 units	$\left(\begin{array}{l}200\text{ units at}\\ \$3.529=\$706\end{array}\right)$	$150\text{ units}\times \$3.529=\$529$
24	Purchase of 300 units		$\begin{array}{r}\hfill \begin{array}{l}\text{150 units at \$3}\text{.529}\\ 300\text{ units at \$3}\text{.65}\end{array}\}\text{ = }\{\text{\$1,624}\left(\begin{array}{l}\text{450 units }\\ \text{at \$3}\text{.609}\end{array}\right)\end{array}$
27	Sale of 150 units	$\left(\begin{array}{l}150\text{ units at}\\ \$3.609=\$541\end{array}\right)$	$300\text{ units at }\$3.609=\$1,083$
	Total Cost of goods sold	$2,252

Table (3)

Thus, under average cost method the cost of goods sold is $2,252 and the ending inventory in units are 300 and in dollars are $1,083.

To determine

Explain the reasons behind the difference in cost of goods sold and ending inventory among three methods. Identify the trend of purchase prices of inventory during the year.

Explanation of Solution

The unit costs of and closing inventory and cost of goods sold are different for each cost flow assumption and such variances arise due to different unit costs that are allocated to cost of goods sold and closing inventory. The use of FIFO method leads to lower cost of goods sold, although the use of LIFO method leads to higher cost of goods sold. Hence, the amounts reveal an upward trend in the purchase price of inventory.

To determine

Identify the method that produces accurate amount of net income and inventory and explain the same.

Explanation of Solution

LIFO provides the most accurate amount of net income because the current costs are matched against the revenues.

FIFO reflects the accurate amount of inventory because it values the inventory at the recent prices in the balance sheet.

To determine

Identify the alternative that would be acceptable by Company P, if it follows IFRS and also explain the reasons.

Explanation of Solution

International Financial Reporting Standards (IFRS): IFRS are a set of international accounting standards which are framed, approved, and published by IASB for the preparation and disclosure of international financial reports.

If Company P follows IFRS, it might value its inventory in FIFO, average or specific identification method. Since, LIFO method is not consistent with the physical flow of inventory and this method is also not applicable to inventory under IFRS. Moreover, there are no tax incentives for a company to use the LIFO method in most of the countries.