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Inventory and depreciation methods for low/high net income

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Aardvark Company and Bear Company both began operations on 1/1/11. The companies had identical balance sheets at 1/1/11, consisting of the following items:
Cash $80,000
Merchandise Inventory (3,000 units at $3 each) 9,000
Delivery trucks 75,000
Note payable (10%) 70,000
Common stock 94,000
During 2011, the two companies had identical transactions. All five transactions described below were cash transactions.

Purchase: 3/1/11 (3,400 units at $6 each) $20,400
Purchase: 5/1/11 (7,000 units at $8 each) 56,000
Sales: 8/1/11 (10,000 units at $15 each) 150,000
Selling expenses paid at various dates 21,000
Administrative expenses paid at various dates 17,000

The note is due with interest on 1/1/12. The delivery trucks have a useful life of five years with a total expected salvage value of $15,000. Both companies have a 30% income tax rate, and all income taxes for 2011 will be paid in 2012.

Aardvark Company wishes to report as high a net income as possible.
Bear Company wishes to report as low a net income as possible.

Step 1: Aardvark Company wishes to report as high a net income as possible. Prepare a 2011 income statement for Aardvark. Choose the depreciation method and inventory cost flow assumption that will result in the highest net income.

Step 2: Based on the information given and the 2011 income statement prepared in Step 1, prepare a 12/31/11 balance sheet for Aardvark. Use the same depreciation method and inventory cost flow assumption as in Step 1.

Step 3: Bear Company wishes to report as low a net income as possible. Prepare a 2011 income statement for Bear. Choose the depreciation method and inventory cost flow assumption that will result in the lowest net income.

Step 4: Based on the information given and the 2009 income statement prepared in Step 3, prepare a 12/31/11 balance sheet for Bear. Use the same depreciation method and inventory cost flow assumption as in Step 3.

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Solution Summary

Your tutorial is attached in Excel (click in cells to see computations). It explains the strategy needed to achieve the low and high net income desired. It shows the computations of the four methods to achieve these results and then maps out the multi-step income statement needed to reveal how net income end up with these method choices.

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Your tutorial is attached. It explains the strategy needed to achieve ...

Solution provided by:
Carol Sargent, PhD
Education
  • BSc, University of Virginia
  • MSc, University of Virginia
  • PhD, Georgia State University
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