Chapter 7, Problem 14E

Analyzing and Interpreting the Effects of the LIFO/FIFO Choice on Inventory Turnover Ratio

Simple Plan Enterprises uses a periodic inventory system. Its records showed the following:

Inventory, December 31, using FIFO → 38 Units @$14 = $532

Inventory, December 31, using UFO → 38 Units @ $10 = $380

Required:

1. 1. Compute the number and cost of goods available for sale, the cost of ending inventory, and the cost of goods sold under FIFO and LIFO.
2. 2. Compute the inventory turnover ratio under the FIFO and LIFO inventory costing methods (show computations).
3. 3. Based on your answer to requirement 2, explain whether analysts should consider the inventory costing method when comparing companies’ inventory turnover ratios.

To determine

To Compute: The number of units and cost of goods available for sale and cost of ending inventory and the cost of goods sold under FIFO and LIFO.

Explanation of Solution

Determine cost of goods available for sale _FIFO.

Date	Particulars	Units ($)	Unit cost ($)	Total cost ($)
		(a)	(b)	(c = a × b)
December 31	Beginning inventory	38	14	532
January 9	Purchased	50	15	750
January 20	Purchased	100	16	1,600
	Total	188		$2,882

Table (1)

Therefore, the cost of goods sold available for sale under FIFO for 188 units of inventory is $2,882.

Determine cost of goods available for sale _LIFO.

Date	Particulars	Units ($)	Unit cost ($)	Total cost ($)
		(a)	(b)	(c = a × b)
December 31	Beginning inventory	38	10	380
January 9	Purchased	50	15	750
January 20	Purchased	100	16	1,600
	Total	188		$2,730

Table (2)

Therefore, the cost of goods sold available for sale under LIFO for 188 units of inventory is $2,882.

Calculate the number of units in ending inventory:

$\begin{array}{c}\begin{array}{l}\text{Number of units in}\\ \text{ending inventory}\end{array}\}=\left(\begin{array}{l}\text{Total units available for sale}\\ -\text{ Total units of sales}\end{array}\right)\\ =\left(188-136\right)\\ =52\text{ units}\end{array}$

Therefore, the number of units in ending inventory is 52 units.

In First-in-First-Out method, the cost of initial purchased items is sold first. The value of the ending inventory consists the recent purchased items.

Determine the amount of cost of goods sold.

Date	Particulars	Units	Unit cost ($)	Total cost ($)
		(a)	(b)	(c = a × b)
December 31	Beginning inventory	38	14	532
January 9	Purchased	50	15	750
January 20	Purchased	48	16	768
	Cost of goods sold	136		$2,050

Table (3)

Determine ending inventory under FIFO method.

Date	Particulars	Units	Unit cost ($)	Total cost ($)
		(a)	(b)	(c = a × b)
	Ending inventory	52	16	832
	Ending inventory			$832

Table (4)

Hence, the cost of goods sold under FIFO is $2,050 and the value of ending inventory is $832.

In Last-in-First-Out method, the cost of last purchased items is sold first. The value of the closing stock consists the initial purchased items.

Determine the amount of cost of goods sold.

Date	Particulars	Units	Unit cost ($)	Total cost ($)
		(a)	(b)	(c = a × b)
January 20	Purchased	100	16	1,600
January 9	Purchased	36	15	540
	Cost of goods sold	136		$2,140

Table (5)

Determine ending inventory under LIFO method.

Date	Particulars	Units	Unit cost ($)	Total cost ($)
		(a)	(b)	(c = a × b)
December 31	Beginning inventory	38	10	380
January 9	Purchased	14	15	210
	Ending inventory			$590

Table (6)

Hence, the cost of goods sold under LIFO is $2,140 and the value of ending inventory is $590.

To determine

To Compute: The inventory turnover ratio under FIFO and LIFO inventory costing method.

Answer to Problem 14E

Inventory Costing Method	Inventory Turnover Ratio
FIFO	3.01
LIFO	4.41

Explanation of Solution

Inventory Turnover: The comparison between the average number of time of sales and the average level of inventory during a period is called as Inventory Turnover. In other words, it is the ratio between the Cost of Goods Sold and Average Inventory.

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

$\text{Average Inventory = }\frac{\text{Beginning Inventory + Ending Inventory}}{2}$

Calculate the inventory turnover ratio under FIFO:

Step 1: Calculate the average inventory.

$\begin{array}{c}\text{Average Inventory =}\left[\frac{\left(\begin{array}{l}\text{Beginning Inventory}\\ \text{ + Ending Inventory}\end{array}\right)}{2}\right]\\ \text{=}\left[\frac{\left(\text{\$532+\$832 }\right)}{2}\right]\\ =\left[\frac{\$1,364}{2}\right]\\ =\$682\end{array}$

Step 2: Calculate the inventory turnover ratio.

$\begin{array}{c}\text{Inventory Turnover Ratio}=\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}\\ =\frac{\$2,050}{\text{\$s682}}\\ =3.0\text{ Times}\end{array}$

Calculate the inventory turnover ratio under LIFO:

Step 1: Calculate the average inventory.

$\begin{array}{c}\text{Average Inventory =}\left[\frac{\left(\begin{array}{l}\text{Beginning Inventory}\\ \text{ + Ending Inventory}\end{array}\right)}{2}\right]\\ \text{=}\left[\frac{\left(\text{\$380+\$590 }\right)}{2}\right]\\ =\left[\frac{\$1,212}{2}\right]\\ =\$485\end{array}$

Step 2: Calculate the inventory turnover ratio.

$\begin{array}{c}\text{Inventory Turnover Ratio}=\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}\\ =\frac{\$2,140}{\$485}\\ =4.4\text{Times}\end{array}$

To determine

To Explain: Whether analysts consider the inventory costing method when comparing companies inventory turnover ratios.

Explanation of Solution

• The inventory costing method present a major difference in the inventory turnover ratio.
• If analysts compare the inventory turnover ratio across companies, they must take this into account before deciding whether one company has better inventory management than another. 
• If they are comparing the same company over time, it is not as important provided the company is consistent in the method it uses.