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Chapter 8: Question 15Q (page 421)

As compared with the FIFO method of costing inventories, does the LIFO method result in a larger or smaller net income in a period of rising prices? What is the comparative effect on net income in a period of falling prices?

Short Answer

Expert verified

In case of rising price trend, FIFO is a suitable method, and in case of falling price, trend LIFO is suitable.

Step by step solution

01

FIFO vs. LIFO in case of rising prices

FIFO is based on the historic cost method. So the issued inventories are valued at the earliest cost of acquisition. Thus under the FIFO method, the current price rising to tend does not affect the inventory valuation, and the net income is free from the inflation effect.

On the contrary, under the LIFO method, the current cost is used for valuing inventory. Current cost is affected by the rising price trend reflect the inflation effect.

So, the LIFO method is affected the rising price trend.

02

FIFO vs. LIFO in case of falling prices

In case of falling prices, the FIFO may represent a cost lower higher than the current cost level. So under FIFO, inventory can be overvalued in case of a falling price trend.

On the contrary, the LIFO may represent the lover inventory value in case of falling prices as the valuation is done on the current cost level.

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Most popular questions from this chapter

Some of the transactions of Torres Company during August are listed below. Torres uses the periodic inventory method.

August 10 Purchased merchandise on account, \(12,000, terms 2/10, n/30.

13 Returned part of the purchase of August 10, \)1,200, and received

credit on account.

15 Purchased merchandise on account, \(16,000, terms 1/10, n/60.

25 Purchased merchandise on account, \)20,000, terms 2/10, n/30.

28 Paid invo

ice of August 15 in full.

Instructions

(a) Assuming that purchases are recorded at gross amounts and that discounts are to be recorded when taken:

(1) Prepare general journal entries to record the transactions.

(2) Describe how the various items would be shown in the financial statements.

(b) Assuming that purchases are recorded at net amounts and that discounts lost are treated as financial expenses:

(1) Prepare general journal entries to enter the transactions.

(2) Prepare the adjusting entry necessary on August 31 if financial statements are to be prepared at that time.

(3) Describe how the various items would be shown in the financial statements.

(c) Which of the two methods do you prefer and why?

You are asked to travel to Milwaukee to observe and verify the inventory of the Milwaukee branch of one of your clients. You arrive on Thursday, December 30, and find that the inventory procedures have justbeen started. You spot a railway car on the sidetrack at the unloading door and ask the warehouse superintendent, Buck Rogers,how he plans to inventory the contents of the car. He responds, 鈥淲e are not going to include the contents in the inventory.鈥�

Later in the day, you ask the bookkeeper for the invoice on the carload and the related freight bill. The invoice lists the variousitems, prices, and extensions of the goods in the car. You note that the carload was shipped December 24 from Albuquerque,f.o.b. Albuquerque, and that the total invoice price of the goods in the car was \(35,300. The freight bill called for a payment of\)1,500. Terms were net 30 days. The bookkeeper affirms the fact that this invoice is to be held for recording in January.

Instructions

(a) Does your client have a liability that should be recorded at December 31? Discuss.

(b) Prepare a journal entry(ies), if required, to reflect any accounting adjustment required. Assume a perpetual inventory

system is used by your client.

(c) For what possible reason(s) might your client wish to postpone recording the transaction?

Case 3: The Kroger Company

The Kroger Company reported the following data in its annual report (in millions).

January 31, February 1, February 2,

2015 2014 2013

Net sales \(108,465 \)98,375 $96,619

Cost of sales (using LIFO) 85,512 78,138 76,726

Year-end inventories using FIFO 6,933 6,801 6,244

Year-end inventories using LIFO 5,688 5,651 5,146

Instructions

(a) Compute Kroger鈥檚 inventory turnovers for fiscal years ending January 31, 2015, and February 1, 2014, using:

(1) Cost of sales and LIFO inventory.

(2) Cost of sales and FIFO inventory.

(b) Some firms calculate inventory turnover using sales rather than cost of goods sold in the numerator. Calculate Kroger鈥檚 fiscal years ending January 31, 2015, and February 1, 2014, turnover, using:

(1) Sales and LIFO inventory.

(2) Sales and FIFO inventory.

(c) State which method you would choose to evaluate Kroger鈥檚 performance. Justify your choice.

Colin Davis Machine Company maintains a general ledger account for each class of inventory, debiting such accounts for increases during the period and crediting them for decreases. The transactions below relate to the Raw Materials inventory account, which is debited for materials purchased and credited for materials requisitioned for use.

1. An invoice for \(8,100, terms f.o.b. destination, was received and entered January 2, 2017. The receiving report shows that the materials were received December 28, 2016.

2. Materials costing \)28,000, shipped f.o.b. destination, were not entered by December 31, 2016, 鈥渂ecause they were in a railroad car on the company鈥檚 siding on that date and had not been unloaded.鈥�

3. Materials costing \(7,300 were returned to the supplier on December 29, 2016, and were shipped f.o.b. shipping point. The return was entered on that date, even though the materials are not expected to reach the supplier鈥檚 place of business until January 6, 2017.

4. An invoice for \)7,500, terms f.o.b. shipping point, was received and entered December 30, 2016. The receiving report shows that the materials were received January 4, 2017, and the bill of lading shows that they were shipped January 2, 2017.

5. Materials costing $19,800 were received December 30, 2016, but no entry was made for them because 鈥渢hey were ordered with a specified delivery of no earlier than January 10, 2017.鈥�

Instructions -

Prepare correcting general journal entries required at December 31, 2016, assuming that the books have not been closed.

Inventory information for Part 311 of Monique Aaron Corp. discloses the following information for the month of June.

June 1 Balance 300 units @ \(10 June 10 Sold 200 units @ \)24

11 Purchased 800 units @ \(12 15 Sold 500 units @ \)25

20 Purchased 500 units @ \(13 27 Sold 300 units @ \)27

Instructions

(a) Assuming that the periodic inventory method is used, compute the cost of goods sold and ending inventory under(1) LIFO and (2) FIFO.

(b) Assuming that the perpetual inventory method is used and costs are computed at the time of each withdrawal, what is the value of the ending inventory at LIFO?

(c) Assuming that the perpetual inventory method is used and costs are computed at the time of each withdrawal, what is the gross profit if the inventory is valued at FIFO?

(d) Why is it stated that LIFO usually produces a lower gross profit than FIFO?
See all solutions

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