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Chapter 9: Problem 11

The following units of a particular item were available for sale during the year: \(\begin{array}{ll}\text { Beginning inventory } & 20 \text { units at } \$ 45 \\\ \text { Sale } & 15 \text { units at } \$ 80 \\ \text { First purchase } & 31 \text { units at } \$ 47 \\ \text { Sale } & 27 \text { units at } \$ 80 \\\ \text { Second purchase } & 40 \text { units at } \$ 50 \\ \text { Sale } & 35 \text { units at } \$ 80\end{array}\) The firm uses the perpetual inventory system, and there are 14 units of the item on hand at the end of the year. What is the total cost of the ending inventory according to (a) fifo, (b) lifo?

Short Answer

Expert verified
FIFO ending inventory cost is $700, and LIFO ending inventory cost is $630.

Step by step solution

01

Understand FIFO and Calculate Remaining Inventory

In the FIFO (First-In, First-Out) method, the cost of the ending inventory is calculated using the cost of the most recently acquired units. We'll first calculate how many and which units are left at the end of the year. Total units: starting units (20), plus units from first purchase (31), plus units from second purchase (40), totals to 91 units. Units sold: 15 (first sale), 27 (second sale), 35 (third sale), totals to 77 units. Units remaining = 91 - 77 = 14 units. Now we'll allocate these 14 units from the most recent acquisitions in the given order.
02

Calculate Ending Inventory Cost using FIFO

Under FIFO, the remaining 14 units will be taken from the latest purchases: 1. 14 units come from the Second Purchase (40 units at $50 each). Total cost = 14 units * $50 = $700. The total cost of the ending inventory using FIFO is $700.
03

Understand LIFO and Calculate Remaining Inventory

In the LIFO (Last-In, First-Out) method, the cost of the ending inventory is based on the oldest costs. We will use the same number of remaining units calculated earlier. Using the LIFO method, we will value the unacquired units from the earliest availability.
04

Calculate Ending Inventory Cost using LIFO

Under LIFO, the remaining 14 units will be valuated using the oldest cost: 1. 14 units will be taken from the Beginning Inventory (20 units at $45 each). Total cost = 14 units * $45 = $630. Thus, the total cost of the ending inventory according to LIFO is $630.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

FIFO Method
The FIFO method stands for First-In, First-Out. It means the earliest acquired inventories are the first to be used or sold. When calculating the cost of ending inventory using FIFO, you will use the cost price of the most recent purchases. This method is often used when it's assumed that the older stock is used first, aligning with the typical flow of goods in many businesses. FIFO has the benefit of showing lower cost of goods sold during inflationary periods, leading to higher net income.
  • FIFO tends to reflect more realistic inventory value on the balance sheet.
  • Companies that keep their inventory fresh may prefer FIFO.
  • In the exercise, after selling 77 units, 14 units remain, sourced from the last batch purchased.
So, for FIFO, the ending inventory was calculated using the 14 units from the second purchase at $50 each, totaling $700.
LIFO Method
LIFO stands for Last-In, First-Out. Contrary to FIFO, it assumes that the most recently acquired inventory is sold first. This method calculates ending inventory using the cost of the oldest inventory on hand. LIFO can be advantageous during times of rising prices because it creates higher cost of goods sold, lowering taxable income.
  • More suitable for businesses where the last items added are typically sold first.
  • During inflation, it can give a tax advantage by reducing profit on paper.
  • It may yield a lower total value for ending inventory.
In the example, LIFO accounts for the remaining 14 units using the price from the beginning inventory at $45 per unit, leading to an ending inventory cost of $630.
Perpetual Inventory System
The perpetual inventory system involves continuous tracking of inventory as it is acquired and sold. Unlike a periodic system, it updates inventory records instantly with every transaction. This system offers real-time data, helping businesses make informed decisions quickly. They know at any moment exactly how much inventory they have.
  • Efficiently tracks inventory, reducing the likelihood of stockouts or overstock.
  • Requires more sophisticated technology such as barcode scanners or inventory management software.
  • Ideal for businesses with high-volume inventory operations.
In the exercise context, this system simplifies tracking the movement of inventory items as they're bought and sold, crucial for calculating the remaining inventory using FIFO or LIFO accurately.
Ending Inventory Cost
Ending inventory cost refers to the value of the goods that remain unsold at the end of a specific accounting period. It plays a critical role in calculating the cost of goods sold and, subsequently, the company's gross profit. The computation of ending inventory can occur through several methods, including FIFO and LIFO.
  • Provides insights into the cost of unsold stock, affecting financial statements.
  • Reflects on how efficiently a company manages its inventory.
  • Different methods can lead to varying financial results; thus, consistency in chosen methods is vital.
In our exercise, determining the ending inventory using FIFO and LIFO led to costs of $700 and $630, respectively. These values reflect the different approaches to inventory valuation and their resulting impact on reported financial data.

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Most popular questions from this chapter

The merchandise inventory was destroyed by fire on May 17 . The following data were obtained from the accounting records: \(\begin{array}{llr}\text { Jan. 1 } & \text { Merchandise inventory } & \$ 180,000 \\ \text { Jan. 1-May 17 } & \text { Purchases (net) } & 750,000 \\\ & \text { Sales (net) } & 1,250,000 \\ & \text { Estimated gross profit rate } & 35 \%\end{array}\) a. Estimate the cost of the merchandise destroyed. b. Briefly describe the situations in which the gross profit method is useful.

During 2006 , the accountant discovered that the physical inventory at the end of 2005 had been understated by \(\$ 12,800\). Instead of correcting the error, however, the accountant assumed that a \(\$ 12,800\) overstatement of the physical inventory in 2006 would balance out the error. 1\. Are there any flaws in the accountant's assumption? Explain.

The following data were taken from recent annual reports of Apple Computer, Inc., a manufacturer of personal computers and related products, and American Greetings Corporation, a manufacturer and distributor of greeting cards and related products: \begin{tabular}{lrr} & \multicolumn{1}{c}{ Apple } & American Greetings \\ \hline Cost of goods sold & \(\$ 4,139,000,000\) & \(\$ 881,771,000\) \\ Inventory, end of year & \(45,000,000\) & \(278,807,000\) \\ Inventory, beginning of the year & \(11,000,000\) & \(290,804,000\) \end{tabular} a. Determine the inventory turnover for Apple and American Greetings. Round to two decimal places. b. Would you expect American Greetings' inventory turnover to be higher or lower than Apple's? Why?

Onsite Hardware Store currently uses a periodic inventory system. Dana Cogburn, the owner, is considering the purchase of a computer system that would make it feasible to switch to a perpetual inventory system. Dana is unhappy with the periodic inventory system because it does not provide timely information on inventory levels. Dana has noticed on several occasions that the store runs out of good-selling items, while too many poor-selling items are on hand. Dana is also concerned about lost sales while a physical inventory is being taken. Onsite Hardware currently takes a physical inventory twice a year. To minimize distractions, the store is closed on the day inventory is taken. Dana believes that closing the store is the only way to get an accurate inventory count. 1.Will switching to a perpetual inventory system strengthen Onsite Hardware's control over inventory items? Will switching to a perpetual inventory system eliminate the need for a physical inventory count? Explain.

Crazy Rapids Co. sells canoes, kayaks, whitewater rafts, and other boating supplies. During the taking of its physical inventory on December 31,2006 , Crazy Rapids incorrectly counted its inventory as \(\$ 117,800\) instead of the correct amount of \(\$ 119,750\). a. State the effect of the error on the December 31,2006 balance sheet of Crazy Rapids. b. State the effect of the error on the income statement of Crazy Rapids for the year ended December \(31,2006 .\)
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