Chapter 8, Problem 8.1DCOMP

Case D. Stewart Company reports the following inventory record for November:

INVENTORY
Date	Activity	# of Units	Cost/Unit
November 1	Beginning balance	100	$16
November 4	Purchase	300	19
November 7	Sale (@ $50 per unit)	200
November 13	Purchase	500	21
November 22	Sale (@ $50 per unit)	500

Selling, administrative, and depreciation expenses for the month were $16,000. Stewart’s tax rate is 30 percent.

1. 1. Calculate the cost of ending inventory and the cost of goods sold under each of the following methods:
   1. a. First-in. first-out.
   2. b. Last-in. first-out.
   3. c. Weighted average (round unit cost to the nearest penny).
2. 2. Based on your answers in requirement (1):
   1. a. What is the gross profit percentage under the FIFO method?
   2. b. What is net income under the LIFO method?
   3. c. Which method would you recommend to Stewart for tax and financial reporting purposes? Explain your recommendation.
3. 3. Stewart applied the lower of cost or market method to value its inventory for reporting purposes at the end of the month. Assuming Stewart used the FIFO method and that inventory had a market replacement value of $19.50 per unit, what would Stewart report on the balance sheet for inventory? Why?

To determine

Calculate the cost of ending inventory, and cost of goods sold under First-in, first-out (FIFO) method.

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.

Calculate the Cost of goods available for sales.

Date	Particulars	Units (a)	Unit Cost (in $) (b)	Total Cost (in $)$\left(\text{c}\right)=\left(\text{a}\right)\times \left(\text{b}\right)$
November 1	Beginning inventory	100	16	1,600
November 4	Purchase	300	19	5,700
November 13	Purchase	500	21	10,500
	Total	900		$17,800

Table (1)

Calculate the cost of goods sold.

Date	Particulars	Units (a)	Unit Cost (in $) (b)	Total Cost (in $) $\left(\text{c}\right)=\left(\text{a}\right)\times \left(\text{b}\right)$
November 7	Sales	100	16	1,600
		100	19	1,900
November 22	Sales	200	19	3,800
		300	21	6,300
	Total	700		$13,600

Table (2)

Calculate the Cost of Ending Inventory.

Date	Units (a)	Unit Cost (in $) (b)	Total Cost (in $) $\left(\text{c}\right)=\left(\text{a}\right)\times \left(\text{b}\right)$
November 13	200	21	4,200
Total	200		$4,200

Table (3)

Hence, the cost of ending inventory, and cost of goods sold under First-in, first-out (FIFO) method is $4,200, and $13,600 respectively.

To determine

Calculate the cost of ending inventory, and cost of goods sold under Last-in, first-out (LIFO) method.

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.

Calculate the Cost of goods available for sales.

Date	Particulars	Units (a)	Unit Cost (in $) (b)	Total Cost (in $)$\left(\text{c}\right)=\left(\text{a}\right)\times \left(\text{b}\right)$
November 1	Beginning inventory	100	16	1,600
November 4	Purchase	300	19	5,700
November 13	Purchase	500	21	10,500
	Total	900		$17,800

Table (4)

Calculate the cost of goods sold.

Date	Particulars	Units (a)	Unit Cost (in $) (b)	Total Cost (in $) $\left(\text{c}\right)=\left(\text{a}\right)\times \left(\text{b}\right)$
November 7	Sales	200	21	4,200
November 22	Sales	300	21	6,300
		200	19	3,800
	Total	700		$14,300

Table (5)

Calculate the Cost of Ending Inventory.

Date	Units (a)	Unit Cost (in $) (b)	Total Cost (in $) $\left(\text{c}\right)=\left(\text{a}\right)\times \left(\text{b}\right)$
November 1	100	16	1,600
November 4	100	19	1,900
Total	200		$3,500

Table (6)

Hence, the cost of ending inventory, and cost of goods sold under Last-in, first-out (LIFO) method is $3,500, and $14,300 respectively.

To determine

Calculate the cost of ending inventory, and cost of goods sold under weighted average method.

Explanation of Solution

Weighted-average cost method:

Under average cost method inventories are priced at the average of all available inventories. Average cost is the quotient of total cost of goods available for sale and total units available for sale.

$\text{Weighted-average Cost}=\frac{\text{Total Cost of Goods Available For Sale}}{\text{Total number of units Available for Sale}}$

Calculate the Weighted-average cost.

$\begin{array}{c}\text{Weighted-average Cost}=\frac{\text{Total Cost of Goods Available For Sale}}{\text{Total number of units Available for Sale}}\\ =\frac{\$17,800}{\text{900 Units}}\\ =\$19.78\end{array}$

Calculate the amount of Ending Inventory.

$\begin{array}{c}\text{Cost of Ending inventory}=\left(\begin{array}{l}\text{Number of units in Ending inventory }\left(1\right)\\ \times \text{Weighted-average cost per unit}\end{array}\right)\\ =200\text{units}\times \$19.78\\ \text{=}\text{\$3,956}\end{array}$

Calculate the Cost of goods sold.

$\begin{array}{c}\text{Cost of goods sold}=\text{Cost of goods available for sale}-\text{Ending inventory}\\ =\$17,800-\$3,956\\ =\$13,844\end{array}$

Working Note:

Calculate the number of units in ending inventory.

$\begin{array}{c}\text{Ending inventory = }\left(\begin{array}{l}\text{Total units of goods available for sale}-\\ \text{Total units of sales}\end{array}\right)\\ =900\text{units}-700\text{units}\\ =200\text{units}\end{array}$ (1)

Hence, the cost of ending inventory, and cost of goods sold under weighted average method is $3,956, and $13,844 respectively.

To determine

Calculate the gross profit percentage under the FIFO method.

Explanation of Solution

Gross Profit Rate:

Gross is the financial ratio that shows the relationship between the gross profit and net sales. It represents gross profit as a rate of net sales. Gross Profit is the difference between the net sales revenue, and the cost of goods sold. It can be calculated by using the following formula:

$\boxed{\text{Gross profit percentage =}\frac{\text{Gross profit}}{\text{Net sales}}\times 100}$

Calculate gross profit percentage:

$\begin{array}{c}\text{Gross profit percentage}=\frac{\text{Gross profit}}{\text{Net sales}}\times 100\\ =\frac{\$21,400}{\$35,000}\times 100\\ =61.14\%\end{array}$

Working Note:

Calculate the gross profit.

$\begin{array}{c}\text{Gross profit=Sales revenue}-\text{Cost of goods sold}\\ \text{=}\left[\left(\text{Number of units sold}\times \text{Sale price per unit}\right)-\text{Cost of goods sold}\right]\\ =\left[\left(700\text{units}\times \text{\$50}\right)-\$13,600\right]\\ \text{=\$35,000}-\$13,600\end{array}$

$=\$21,400$

Hence, the gross profit percentage under the FIFO method is 61.14%.

To determine

Ascertain the net income under the LIFO method.

Explanation of Solution

Net Income:

Net income is the sum total of all the revenues generated in a particular accounting period after deducting cost of goods sold and expenses and losses, such as rent expense, depreciation of that particular accounting period.

Determine the net income under the LIFO method.

Sales revenue	$35,000
Less:  Cost of goods sold	14,300
Gross profit	20,700
Less:  Operating expenses	16,000
Pretax income	4,700
Less:  Income tax expense	1,410
Net income	$3,290

Table (7)

Hence, the net income under the LIFO method is $3,290.

To determine

Identify the method which would be recommended to Company S for tax and financial reporting purposes and to explain it.

Explanation of Solution

The method which would be recommended to Company S for tax and financial reporting purposes is the Last-in, first-out (LIFO) method. The prices of the inventories are increasing. When the prices increase, under LIFO method, the cost of goods sold will be increased, which results in the decreased net income. Due to this decreased net income, the amount of tax payable will also be less. Hence, for tax purposes, LIFO method is the best inventory method. The LIFO Conformity Rule indicates that when a company adopts the LIFO method for tax purposes, it must use the same LIFO method for financial reporting purposes also, even if it reports the lowest net income.

Therefore, the method which would be recommended to Company S for tax and financial reporting purposes is the LIFO method.

To determine

Ascertain the amount of inventory that would be reported on the balance sheet of Company S and to discuss the reason behind it.

Explanation of Solution

Lower-of-cost-or-market:

The lower-of-cost-or-market (LCM) is a method which requires the reporting of the ending merchandise inventory in the financial statement of a company, at its current market value (market) or at its historical cost price, whichever is less.

Compute the amount of ending inventory using lower-of-cost-or-market method:

Quantity (Units)	Cost Price		Market Price		Lower-of-cost-or-market (LCM)
	Rate per unit	Total cost ($)	Rate per unit	Total cost ($)
200	21	4,200	19.50	3,900	3,900

Table (8)

Hence, the amount of inventory that would be reported on the balance sheet of Company S is $3,900, as the market value of ending inventory ($3,900) is lower than the FIFO cost of the ending inventory ($4,200). This difference amount of $300 $\left(\$4,200-\$3,900\right)$ would increase the cost of goods sold, which in turn decreases the net income of the company for the month.