Concept explainers
1. (a), (b), (c) and (d)
Prepare an income statement through gross profit for the month of January under the following methods:
- a. Average cost,
- b. FIFO,
- c. LIFO,
- d. Specific identification method.
1. (a), (b), (c) and (d)

Explanation of Solution
Periodic Inventory System:
Periodic inventory system is a system, in which the inventory is updated in the accounting records on a periodic basis such as at the end of each month, quarter or year. In other words, it is an accounting method which is used to determine the amount of inventory at the end of each accounting period.
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.
Last-in-First-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.
Weighted-average cost method:
Under Weighted average cost method, the company calculates a new average cost after every purchase is made. It is determined by dividing the cost of goods available for sale by the units on hand.
Specific identification method:
This method can be said as identifying the items precisely which are being sold and those which are being stored as closing inventory. The companies are required to keep perfect records of the original cost of each and every individual items of the inventory.
Cost of goods sold:
Cost of goods sold is the accumulate total of all direct cost incurred in manufacturing the goods or the products which has been sold during a period. Cost of goods sold involves direct material, direct labor, and manufacturing
Income statement:
The income statement is a financial statement that shows the net income earned or net loss suffered by a company through reporting all the revenues earned, and expenses incurred by the company over a specific period of time.
Prepare an income statement through gross profit for the month of January under the following methods:
COMPANY D | ||||
Partial Income Statement | ||||
For the Month Ended January 31, (current year) | ||||
Particulars | Average cost | FIFO | LIFO | Specific Identification |
(a) | (b) | (c) | (d) | |
Sales revenue (1) | $9,920 | $9,920 | $9,920 | $9,920 |
Less: Cost of goods sold Table (2) | 3,565 | 3,085 | 4,040 | 3,250.10 |
Gross profit | $6,355 | $6,835 | $5,880 | $6,669.90 |
Table (1)
Working notes:
(1) Compute the amount of sales revenue:
Compute the cost of goods sold under each method:
Particulars | Units | Average cost | FIFO | LIFO | Specific Identification |
Beginning inventory | 500 | $2,365 | $2,365 | $2,365 | $2,365 |
Add: Purchases (net) | 760 | 4,880 | 4,880 | 4,880 | 4,880 |
Goods available for sale Table (3) | 1,260 | 7,245 | 7,245 | 7,245 | 7,245 |
Less: Ending inventory | 640 | 3,680 (2) | 4,160 Table (4) | 3,205 Table (5) | 3,994.90 Table (6) |
Cost of goods sold | 620 | $3,565 | $3,085 | $4,040 | $3,250.10 |
Table (2)
Compute the goods available for sale:
Date | Particulars | Units ($) | Unit cost ($) | Total cost ($) |
(a) | (b) | (c = a × b) | ||
January 1 | Beginning inventory | 500 | 4.73 | 2,365 |
January 12 | Purchased | 600 | 6 | 3,600 |
January 26 | Purchased | 160 | 8 | 1,280 |
Total | 1,260 | $7,245 | ||
Less: Goods sold | 620 | |||
Ending inventory | 640 |
Table (3)
Compute the amount of ending inventory under average cost:
Compute the amount of ending inventory under FIFO:
Date | Particulars | Units | Unit cost ($) | Total cost ($) |
(a) | (b) | (c = a × b) | ||
January 12 | Purchased | 480 | 6 | 2,880 |
January 26 | Purchased | 160 | 8 | 1,280 |
Ending inventory | 640 | $4,160 |
Table (4)
Compute the amount of ending inventory under LIFO:
Date | Particulars | Units | Unit cost ($) | Total cost ($) |
(a) | (b) | (c = a × b) | ||
January 12 | Purchased | 140 | 6 | 840 |
January 26 | Purchased | 500 | 4.73 | 2,365 |
Ending inventory | 640 | $3,205 |
Table (5)
Compute the amount of ending inventory under specific identification method:
Date | Particulars | Units | Unit cost ($) | Total cost ($) |
(a) | (b) | (c = a × b) | ||
January 1 | Beginning balance | 130 | 4.73 | 614.9 |
January 12 | Purchased | 350 | 6 | 2,100 |
January 26 | Purchased | 160 | 8 | 1,280 |
Ending inventory | 640 | $3,994.9 |
Table (6)
2.
Describe the method that results in the higher pre-tax income and higher EPS.
2.

Explanation of Solution
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.
The FIFO method reports a higher pre-tax income than LIFO method. This is due to the following:
- The rise in price.
- FIFO allocates the lower unit costs to the cost of goods sold.
Similarly, for the EPS amount the FIFO method reports a higher EPS amount than LIFO method. This is because it produces a higher pretax income than LIFO.
3.
Describe the method that results in the lower income tax expense. Assume that the average tax rate is 30%.
3.

Answer to Problem 3P
LIFO results in the lower income tax expense. This is because LIFO reports a lower pretax income than FIFO method. The LIFO will derive lesser income tax than FIFO method by $286.5.
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.
Compute the amount of income tax:
4.
Determine the method that produces the most favorable
4.

Explanation of Solution
The LIFO method produces the most favorable cash flow by $286.5. This is because Under LIFO method the income tax expenses paid for the current year would be less than that of the FIFO method.
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Chapter 7 Solutions
FINANCIAL ACCOUNTING W/CONNECT PKG
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