Question

The following information applies for Backes Corp as of December 1st, 2013.

Beginning inventory 4,000 units costing $13.00/unit Sales during 2013 60,000 units sold for $70.00/unit Purchases during 2013 100,000 units costing $45.00/unit Backes values their inventory using the periodic LIFO method. The company can buy an additional 5,000 units at $60/unit before December 31st.

a. Calculate the cost of goods sold and gross margin without the additional purchase.

b. Calculate the cost of goods sold and gross margin with the additional purchase of 5,000 units.

c. Backes releases their income statement on December 31, 2013. If they wish to reduce their taxes, should Backes make the additional purchase before year-end?

Answer 1

Sales Less: Cost of Goods sold Gross Profit Amount $4,200,000 (2,700,000) Note 1 $ 1,500,000 Gross Margin = Gross Profit/Sales 36% Note 1 13 Opening Stock Add: Purchases Less: Sales/COS* Units Unit Price 4,000 100,000 (60,000) Amount Remarks 52,000 45 4,500,000 45 $ (2,700,000) Units purchased latest are sold first under LIFO I, e out of 100,000 units @45 1,852,000 Clsoing Stock is values at the earliest purchases under LIFO Closing stock 44,000

45 Amount 1,800,000 Closing Stock Units Unit Price 40,000 units out of 100,000 40,000 $ units purchased 4,000 units out of Opening 4,000 $ inventory 44,000 52,000 1,852,000 Sales Less: Cost of Goods sold Gross Profit Amount $4,200,000 (2,775,000) Note 2 $ 1,425,000 Gross Margin = Gross Profit/Sales 34%

Note 2 Remarks Opening Stock Add: Purchases Add: Additional Purchases in Dec Less: Sales/Cos* Units 4,000 100,000 5,000 Unit Price $ $ $ Amount 52,000 4,500,000 300,000 (5,000) $ (55,000) $ 49,000 (300,000) Units purchased latest are sold first under LIFO i,e 5,000 units @60 and 55,000 units out of (2,475,000) 100,000 units purchased a @$45 2,077,000 Cisoing Stock is values at the earliest purchases under LIFO Closing stock Unit Price $ Amount 2,025,000 45 Clsoing Stock Units 45,000 units out of 100,000 45,000 units purchased 4,000 units out of Opening 4,000 inventory 49,000 $ 13 52,000 2,077,000

Yes, if the company wish to decrease their taxes they should make the additional purchases before the year end. It can be seen that, Gross profit is lesser if the company make additional purchases of 5,000 units before year end which results in lower taxes. This has happened because the company is valuing its inventory at LIFO in which the latest purchases which are generally at higher prices are charged to Cost of sales earler and hence results in lesser Gross profit and consequently lesser taxes.