Chapter 8, Problem 1BP

a.

To determine

Prepare the journal entries to record cost of goods sold under (1) specific identification method, (2) average-cost method, (3) FIFO method, and (4) LIFO method, and discuss the financial reporting differences that may arise from choosing the FIFO method over the LIFO method.

Explanation of Solution

Journal entry:

Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

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, and expenses.

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.

First-in-First-Out (FIFO): In this method, items purchased initially are sold first. So, the value of the ending inventory consist the recent cost for the remaining unsold items.

Last-in-First-Out (LIFO): In this method, items purchased recently are sold first. So, the value of the ending inventory consist the initial cost for the remaining unsold items.

Average Cost method: In this method, the inventories are priced at the average rate of goods available for sales.

Prepare the journal entries to record cost of goods sold under specific identification method as follows:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (1)		$14,800
	Inventory			$14,800
	(To record the cost of goods sold incurred)

Table (1)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $14,800. Therefore, debit cost of goods account with $14,800.
• Inventory is an asset account, and it decreases the value of assets by $14,800. Therefore, credit inventory account with $14,800.

Working note:

Calculate the value of cost of goods sold under separate identification method

Table (2)

(1)

Prepare the journal entries to record cost of goods sold under average cost method as follows:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (3)		$15,050
	Inventory			$15,050
	(To record the cost of goods sold incurred)

Table (3)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $15,050. Therefore, debit cost of goods account with $15,050.
• Inventory is an asset account, and it decreases the value of assets by $15,050. Therefore, credit inventory account with $15,050.

Working note:

Calculate average cost per unit

$\begin{array}{c}\begin{array}{l}\text{Average cost }\\ \text{on January 15 }\end{array}\}\text{= }\frac{\left(\begin{array}{l}\text{Total cost of units purchased on December 12 + }\\ \text{Total cost of units purchased on January 16}\end{array}\right)}{\left(\begin{array}{l}\text{Number of units purchased on December 12 + }\\ \text{Number of units purchased on January 16}\end{array}\right)}\\ =\frac{\$8,000\text{+ \$26,400}}{\text{400 units}\text{+ 1,200 units}}\\ =\frac{\text{\$34,400}}{\text{1,600 units}}\\ =\$21.5\end{array}$ (2)

Calculate the value of cost of goods sold under average cost method

Table (4)

(3)

Prepare the journal entries to record cost of goods sold under FIFO method as follows:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (4)		$14,600
	Inventory			$14,600
	(To record the cost of goods sold incurred)

Table (5)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $14,600. Therefore, debit cost of goods account with $14,600.
• Inventory is an asset account, and it decreases the value of assets by $14,600. Therefore, credit inventory account with $14,600.

Working note:

Calculate the value of cost of goods sold under FIFO assets

Table (6)

(4)

Prepare the journal entries to record cost of goods sold under LIFO method as follows:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cost of goods sold (5)		$15,400
	Inventory			$15,400
	(To record the cost of goods sold incurred)

Table (7)

• Cost of goods sold is an operating expense account and decreases the stockholders’ equity account by $15,400. Therefore, debit cost of goods account with $15,400.
• Inventory is an asset account, and it decreases the value of assets by $15,400. Therefore, credit inventory account with $15,400.

Working note:

Calculate the value of cost of goods sold under LIFO assets

Table (8)

(5)

b.

To determine

Prepare the subsidiary ledger record for Company under the four inventory method valuation.

Explanation of Solution

Subsidiary ledger:

Subsidiary ledger refers to the ledger that provides the detailed information of the account already recorded in the general ledger such as accounts receivable subsidiary ledger and accounts payable subsidiary ledger.

Prepare the subsidiary ledger record for Company under the four inventory method valuation as follows:

(1) Specific identification method:

	PURCHASED			SOLD			BALANCE
Date	Units	Unit Cost	Total	Units	Unit Cost	Cost of Goods Sold	Units	Unit Cost	Balance
Dec 12	400	20	8,000				400	20	8,000
Jan 16	1,200	22	26,400				400	20
							1,200	22	34,400
Jan 22				300	20		100	20
				400	22	14,800	800	22	19,600

Table (9)

(2) Average-cost method:

	PURCHASED			SOLD			BALANCE
Date	Units	Cost	Total	Units	Cost	Cost of Goods Sold	Units	Cost	Balance
Dec 12	400	20	8,000				400	20.00	8,000
Jan 16	1,200	22	26,400				1,600	21.50	34,400
Jan 22				700	$   21.50	$ 15,050	900	21.50	19,350

Table (10)

(3) First-in, first-out (FIFO) method:

	PURCHASED			SOLD			BALANCE
Date	Units	Unit Cost	Total	Units	Unit Cost	Cost of Goods Sold	Units	Unit Cost	Balance
Dec 12	400	20	8,000				400	20	$ 8,000
Jan 16	1,200	22	26,400				400	20
							1,200	22	34,400
Jan 22				400	20
				300	22	14,600	900	22	19,800

Table (11)

(4) Last-in, first-out (LIFO) method:

	PURCHASED			SOLD			BALANCE
Date	Units	Unit Cost	Total	Units	Unit Cost	Cost of Goods Sold	Units	Unit Cost	Balance
Dec 12	400	20	8,000				400	20	8,000
Jan 16	1,200	22	26,400				400	20
							1,200	22	34,400
Jan 22				700	22	15,400	400	20
							500	22	19,000

Table (12)

c.

To determine

Explain whether the inventory valuation method gives lowest cost of goods sold or not, and the valuation method that gives highest cost of goods sold for the tax purposes.

Explanation of Solution

Explain whether the inventory valuation method gives lowest cost of goods sold or not, and the valuation method that gives highest cost of goods sold for the tax purposes as follows:

In this case, the cost of goods sold under FIFO and LIFO is $14,600, and $15,400 respectively. Hence, the LIFO method has highest cost of goods sold whereas the FIFO method has the lowest cost of goods sold.

The inventory method that would be preferable for financial statements is FIFO, because FIFO method would produce higher net income, lower cost of goods sold, and higher ending inventory (total assets). At the same time, the higher amount of net income produces the more income tax expense, so LIFO method is preferred for income tax reporting. When a company uses LIFO method it would produce lower amount of tax obligation and higher amount of cash inflow.