Question

Evaluating Four Alternative Inventory Methods Based on Income and Cash Flow (AP7-2) At the end of January of the current year, the records of Donner Company showed the following for a particular item that sold at $16 per unit: Amount Units Transactions $2.365 500 Inventory, January 1 Purchase, January 12 Purchase, January 26 3,600 600 1,280 160 (370) Sale (250) Sale Required 1. Assuming the use of a periodic inventory system, prepare a summarized income statement through gross profit for the month of January under each method of inventory: (a) average cost (round the average cost per unit to the nearest cent), (b) FIFO, (c) LIFO, and (d) specific identification. For specific identification, assume that the first sale was selected from the beginning inventory and the second sale was selected from the January 12 purchase. Show the inventory computations in detail. 2. Between FIFO and LIFO, which method results in the higher pretax income? Which method results in the higher EPS? 3. Between FIFO and LIFO, which method results in the lower income tax expense? Explain, assuming a 30 percent average tax rate. 4. Between FIFO and LIFO, which method produces the more favorable cash flow? Explain. ring and Internreting Income Maninulation under the LIFO Inventory Method

Answer 1

FIFO METHOD
		COST OF GOODS AVAILABLE FOR SALE			COST OF GOODS SOLD			ENDING INVENTORY
Date	Particulars	Units	Rate	Total	Units	Rate	Total	Units	Rate	Total
Jan, 01	Beginning inventory	500	$                           4.73	$                          2,365
Purchases
Jan, 12	Purchases	600	$                           6.00	$                          3,600
Jan, 26	Purchases	160	$                           8.00	$                          1,280
	Goods Avaiable for sold	1260		$                          7,245
	Sales (370 + 250)	620			500	$               4.73	$             2,365
					120	$               6.00	$                 720	480	$           6.00	$             2,880
								160	$           8.00	$             1,280
	TOTAL	3140		$14,490	620		$3,085	640		$4,160
LIFO METHOD
		COST OF GOODS AVAILABLE FOR SALE			COST OF GOODS SOLD			ENDING INVENTORY
Date	Particulars	Units	Rate	Total	Units	Rate	Total	Units	Rate	Total
Jan, 01	Beginning inventory	500	$                           4.73	$                          2,365
Purchases
Jan, 12	Purchases	600	$                           6.00	$                          3,600
Jan, 26	Purchases	160	$                           8.00	$                          1,280
		1260		$                          7,245
	Sales (370 + 250)	620			160	$               8.00	$             1,280
					460	$               6.00	$             2,760	140	$           6.00	$                 840
								500	$           4.73	$             2,365
	TOTAL	3140		$14,490	620		$4,040	640		$3,205
AVERAGE COST
		COST OF GOODS AVAILABLE FOR SALE			COST OF GOODS SOLD			ENDING INVENTORY
Date	Particulars	Units	Rate	Total	Units	Rate	Total	Units	Rate	Total
Jan, 01	Beginning inventory	500	$                           4.73	$                          2,365
Purchases
Jan, 12	Purchases	600	$                           6.00	$                          3,600
Jan, 26	Purchases	160	$                           8.00	$                          1,280
		1260	$                           5.75	$                          7,245
	Sales (370 + 250)	620			620	$               5.75	$             3,565	640	$           5.75	$             3,680
	TOTAL	3140		$14,490	620		$3,565	640		$3,680
SPECIFIC IDENTIFICATION
		COST OF GOODS AVAILABLE FOR SALE			COST OF GOODS SOLD			ENDING INVENTORY
Date	Particulars	Units	Rate	Total	Units	Rate	Total	Units	Rate	Total
Jan, 01	Beginning inventory	500	$                           4.73	$                          2,365	370	$               6.39	$             2,365	130	$         18.19	$             2,365
Jan, 12	Purchases	600	$                           6.00	$                          3,600	250	$               6.00	$             1,500	350	$           6.00	$             2,100
Jan, 26	Purchases	160	$                           8.00	$                          1,280	0	$                    -	$                    -	160	$           8.00	$             1,280
	TOTAL	1260		$7,245	620		$3,865	640		$5,745
Answer = 1)
	INCOME STATEMETN	Average method	FIFO	LIFO	Spec Ident
	Sales Revenue (620 Units X $ 16)	$                        9,920	$                        9,920	$                          9,920	$                   9,920
	Less: Cost of Sales	$                        3,565	$                        3,085	$                          4,040	$                   3,865
	Gross Profit	$                        6,355	$                        6,835	$                          5,880	$                   6,055
Answer = 2)	Answer = FIFO method have higher pretax income and FIFO mehtod have highet EPS
Answer = 3)	Answer = LIFO method (Because the lifo mehtod have the highet cost of goods sold)
Answer = 4)	Answer = LIFO Method ( Because LIFO method will produce lower income and lower income tax expenses)