Question

Ernst Company sells electronics products. The company uses the perpetual inventory system. The following information relates to one of their electronics products for July 2020. Units Beginning inventory Jul 1 20 units @ $2,000/ unit Purchases Jul 8 10 units @$1,800/unit Jul 20 20 units @$1,700/unit The company sold the units at $2,200 per unit on the following dates. Sales Jul 10 Jul 25 15 units 22 units For specific identification method, units sold consist of 20 units from the beginning inventory and 17 units from the Jul 20 purchases. Required: (a) Compute the cost of inventory on hand at 31 July and the cost of goods sold for July 2020 under: (i) FIFO method. Specific identification method. (20 marks) (b) Explain the effects of the FIFO method on the value of ending inventory and profit for July 2020. (10 marks) Due to Covid-19, the company has not been performing well. Thus, the CEO asked the accountant to change the inventory method to report better financial performance. The CEO explained that the accounting standards allow companies to change inventory methods. The CEO added that the accountant can always switch back the inventory method when things return to normal after Covid-19. Explain whether you agree or disagree with the CEO to change the inventory method for earnings management purpose. You should also discuss the impacts on the users of the financial statements. (15 marks)

Answer 1

(a) Calculation of Cost of Invetntory and Cost of Goods Sold.

Specific Identification method :

We have been provided that 20 units are sold from opening inventory while the balance 17 were sold from July 20 purchase hence closing stock of 13 unit will compose of 10 unit from July 8 purchase and 3 unit from July 20 purchase :

Particulars	Qty	Per Unit	Total (USD)
Jul 8	10	1,800	18,000
Jul 20	3	1,700	5,100
Closing Stock	13	1,777	23,100

Cost of Goods Sold
From Opening Balance	20	2,000	40,000
From July 20 Purchase	17	1,700	28,900
Total Cost of goods sold	37	1,862	68,900

Under FIFO Method :
FIFO method means first in first out.FIFO Method :

The closing balance is 13 quantity which will be out of last purchase since last purchase was for 20 units

Particulars	Qty	Per Unit	Total (USD)
Closing Balance	13	1,700	22,100

The first sale is of 15 unit which will be from opening stock. Next sale is 22 unit, where 5 units which are remained from opening balance, 10 unit from purchase made on 8th July and balance 7 units from July 20 purchase

Cost of Goods Sold
From Opening Balance	15	2,000	30,000
From Opening Balance	5	2,000	10,000
From Jul 8 Purchase	10	1,800	18,000
From Jul 20 Purchase	7	1,700	11,900
Total	37		69,900

(b) Impact of FIFO on closing inventory & Profit

Under specific identification method the closing inventory value is 23,100 while under FIFO it is 22,100 so inventory value is lower by 1,000.

The corollary impact is the cost of goods sold is higher in case of FIFO by 1,000 hence the profit will be lower by 1,000 under FIFO as compared to specific identification method

(c) Change in inventory method :

Change in inventory valuation method is change in accounting policy. Change in accounting policy should be adopted only if it results in the financial statements providing reliable and more relevant information about the effects of transactions.

The suggestion of CEO is not acceptable as company is not intending to apply consistent policy for inventory valuation whereas the criteria specified by CEO is on the base of better financial performance which should not be the criteria to change accounting policy.