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# Inventory identification methods

E3: Paul's Farm Store recorded the following purchases and sales of fertilizer during the past year:

Jan. 1 Beginning Inventory 250 cases @ \$23 \$5,750
Feb. 25 Purchase 100 cases @ \$26 2,600
June 15 Purchase 400 cases @ \$28 11,200
Aug. 15 Purchase 100 cases @ \$26 2,600
Oct. 15 Purchase 300 cases @ \$28 8,400
Dec. 15 Purchase 200 cases @ \$30 6,000
Good available for sale 1,350 cases \$36,550
Total sales 1,000 cases
Dec. 31 Ending inventory 350 cases

Assume that Paul's Farm Store sold all of the June 15 purchase and 200 cases each from the January 1 beginning inventory, the October 15 purchase, and the December 15 purchase.

Determine the cost that should be assigned to ending inventory and cost of goods sold under each of the following assumptions: (1) costs are assigned by the specific identification method; (2) costs are assigned by the average-cost method; (3) costs are assigned by the FIFO method; (4) costs are assigned by the LIFO method. What conclusions can be drawn about the effect of each method on the income statement and the balance sheet of Paul's Farm Store? Round your answers to the nearest whole number and assume the periodic inventory system.

E4: During its first year of operation, Bingham Company purchased 5,600 units of a product at \$21 per unit. During the second year, it purchased 6,000 units of the same product at \$24 per unit. During the third year, it purchased 5,000 units at \$30 per unit. Bingham Company managed to have an ending inventory each year of 1,000 units. The company uses the periodic inventory system.

--Prepare cost of goods sold statements that compare the value of ending inventory and the cost of goods sold for each of the three years using (1) the FIFO inventory costing method and (2) the LIFO method. From the resulting data, what conclusions can you draw about the relationships between changes in unit price and changes in the value of ending inventory?

E5: In chronological order, the inventory, purchases, and sales of a single product for a recent month are as follows:

Units Amount
Per Unit
June 1 Beginning inventory 300 \$30
4 Purchase 800 33
8 Sale 400 60
12 Purchase 1,000 36
16 Sale 700 60
20 Sale 500 66
24 Purchase 1,200 39
28 Sale 600 66
29 Sale 400 66

Using the periodic inventory system, compute the cost of ending inventory, cost of goods sold, and gross margin. Use the average-cost, FIFO, and LIFO inventory costing methods. Explain the differences in gross margin produced by the three methods. Round unit costs to cents and totals to dollars.

E6: Using the data in E5 and assuming the perpetual inventory system, compute the cost of ending inventory, cost of goods sold, and gross margin. Use the average-cost, FIFO, and LIFO inventory costing methods. Explain the reasons for the differences in gross margin produced by the three methods. Round units to cents an totals to dollars

E7: During July 20x1, Downes, Inc. sold 250 unit of its product Velt for \$4,000. The following units were available:

Units Cost
Beginning inventory 100 \$2
Purchase 1 40 4
Purchase 2 60 6
Purchase 3 70 8
Purchase 4 80 10
Purchase 5 90 12

A sale of 100 units was made after purchase 1, and sale of 150 units was made after purchase 4. Of the units sold, 100 came from beginning inventory and 150 from purchases 3 and 4.

--Determine goods available for sale and ending inventory in units. Then determine the costs that should be assigned to cost of goods sold and ending inventory under each of the following assumptions: (1) Costs are assigned under the periodic inventory system using (a) the specific identification method, (b) the average-cost method, and (c) the FIFO method, and (d) the LIFO method. (2) Costs are assigned under the perpetual inventory system using (a) the average-cost method, (b) the FIFO method, and (c) the LIFO method. For each alternative, show the gross margin. Round unit cost to cents and totals to dollars.

Periodic Inventory System Perpetual Inventory System
Specific
Identification
Method Average-
Cost
Method First-In,
First-Out
Method Last-In,
First-Out
Method Average-
Cost
Method First-In,
First-Out-
Method Last-In,
First-Out
Method

E8: Lao Products, Inc. sold 120,000 cases of glue at \$40 per case during 20x1. Its beginning inventory consisted of 20,000 cases at a cost of \$24 per case. During 20x1, it purchased 60,000 cases at \$28 per case and later 50,000 cases at \$30 per case. Operating expenses were \$1,100,000, and the applicable income tax rate was 30 percent.

-- Using the periodic inventory system, compute net income using the FIFO method and the LIFO method for costing inventory. Which alternative produces the larger cash flow? The company is considering a purchase of 10,000 cases at \$30 per case just before the year-end. What effect on net income and on cash flow will this proposed purchase have under each method? (HINT: What are the income tax consequences?)

E9: Match each of the descriptions listed below to these inventory-costing methods:

a. Specific identification
b. Average-cost
c. First-in, first-out (FIFO)
d. Last-in, first-out (LIFO)

1. Matches recent costs with recent revenues
2. Assumes that each item of inventory is identifiable
3. Results in the most realistic balance sheet valuation
4. Results in the lowest net income in periods of deflation
5. Results in the lowest net income in periods of inflation
6. Matches the oldest costs with recent revenues
7. Results I the highest net income periods of inflation
8. Results I the highest net income periods of deflation
9. Tends to level out the effects of inflation
10. Is unpredictable as to the effects of inflation

E10: Condensed income statements for Earle Company for two years are shown below.

20x5 20x4
Sales \$126,000 \$105,000
Cost of goods sold 75,000 54,000
Gross margin \$51,000 \$51,000
Operating Expenses 30,000 30,000
Income before income taxes \$21,000 \$21,000

E11: Rasmin Company values its inventory, shown below, at the lower of cost or market. Compute Rasmin's inventory value using (1) the item-by-item method and (2) the major category method.

Per unit
Quantity Cost Market
Category I
Item aa 200 2.00 1.80
Item bb 240 4.00 4.40
Item cc 400 8.00 7.50
Category II
Item dd 300 12.00 13.00
Item ee 400 18.00 18.20

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#### Solution Preview

Inventory Methods

Inventory Methods 2 of 2

E3: Paul's Farm Store recorded the following purchases and sales of fertilizer during the past year:

Jan. 1 Beginning Inventory 250 cases @ \$23 \$5,750
Feb. 25 Purchase 100 cases @ \$26 2,600
June 15 Purchase 400 cases @ \$28 11,200
Aug. 15 Purchase 100 cases @ \$26 2,600
Oct. 15 Purchase 300 cases @ \$28 8,400
Dec. 15 Purchase 200 cases @ \$30 6,000
Good available for sale 1,350 cases \$36,550
Total sales 1,000 cases
Dec. 31 Ending inventory 350 cases

Assume that Paul's Farm Store sold all of the June 15 purchase and 200 cases each from the January 1 beginning inventory, the October 15 purchase, and the December 15 purchase.

Determine the cost that should be assigned to ending inventory and cost of goods sold under each of the following assumptions: (1) costs are assigned by the specific identification method; (2) costs are assigned by the average-cost method; (3) costs are assigned by the FIFO method; (4) costs are assigned by the LIFO method. What conclusions can be drawn about the effect of each method on the income statement and the balance sheet of Paul's Farm Store? Round your answers to the nearest whole number and assume the periodic inventory system.

(1) costs are assigned by the specific identification method

Paul's Farm Store sold all of the June 15 purchase and 200 cases each from the January 1 beginning inventory, the October 15 purchase, and the December 15 purchase.

Therefore, the costs assigned will be as follows:-

Jan. 1 Beginning Inventory 200 cases @ \$23 \$4,600
June 15 Purchase 400 cases @ \$28 \$11,200
Oct. 15 Purchase 200 cases @ \$28 \$5,600
Dec. 15 Purchase 200 cases @ \$30 \$6,000
Total \$27,400

Cost of goods sold = \$27,400

Ending inventory = Good available for sale - Cost of goods sold
= \$36,550 - \$27,400
= \$9,150

(2) costs are assigned by the average-cost method

Under average-cost method under the periodic inventory system, we need to find the average cost of the total inventory on hand, i.e., the beginning inventory plus total purchases during the month. Therefore, the price used to calculate the cost of ending inventory and costs of goods sold can be calculated as follows: -

Average cost = Total inventory cost/Goods available for sale
= \$36,550/1,350 cases
= \$27/case

Cost of goods sold = Sales x average cost
= 1,000x \$27
= \$27,000

Cost of ending inventory = Ending inventory x average cost
= 350 x \$27
= \$9,450

(3) costs are assigned by the FIFO method

Jan. 1 Beginning Inventory 250 cases @ \$23 \$5,750
Feb. 25 Purchase 100 cases @ \$26 2,600
June 15 Purchase 400 cases @ \$28 11,200
Aug. 15 Purchase 100 cases @ \$26 2,600
Oct. 15 Purchase 300 cases @ \$28 8,400
Dec. 15 Purchase 200 cases @ \$30 6,000
Good available for sale 1,350 cases \$36,550
Total sales 1,000 cases
Dec. 31 Ending inventory 350 cases

Using FIFO, units purchased first are assumed to be sold out first. Therefore, the cost of goods sold will be calculated from the beginning inventory.

1,000 units sold
= 250 cases from beginning inventory of at \$23 unit cost
+ 100 cases from Feb. 25 purchases at \$26 unit cost
+ 400 cases from June 15 purchases at \$28 unit cost
+ 100 cases from Aug. 15 purchases at \$26 unit cost
+ 150 cases from Oct. 15 purchases at \$28 unit cost

Cost of goods sold = 250x\$23 + 100x\$26 + 400x\$28 + 100x\$26 + 150x\$28
= \$5,750 + \$2,600 + \$11,200 + \$2,600 + \$4,200
= \$26,350

350 cases of inventory left
= 150 cases from Oct. 15 purchases at \$28 unit cost
+ 200 cases from Dec. 15 purchases at \$30 unit cost

Cost of ending inventory = 150x\$28 + 200x\$30
= \$4,200 + \$6,000
= \$10,200

(4) costs are assigned by the LIFO method

Using LIFO, units purchased last are assumed to be sold first. Therefore, the cost of goods sold will be calculated from the last purchase backward.

Jan. 1 Beginning Inventory 250 cases @ \$23 \$5,750
Feb. 25 Purchase 100 cases @ \$26 2,600
June 15 Purchase 400 cases @ \$28 11,200
Aug. 15 Purchase 100 cases @ \$26 2,600
Oct. 15 Purchase 300 cases @ \$28 8,400
Dec. 15 Purchase 200 cases @ \$30 6,000
Good available for sale 1,350 cases \$36,550
Total sales 1,000 cases
Dec. 31 Ending inventory 350 cases

1,000 units sold
= 200 cases from Dec. 15 purchases at \$30 unit cost
+ 300 cases from Oct. 15 purchases at \$28 unit cost
+ 100 cases from Aug. 15 purchases at \$26 unit cost
+ 400 cases from June 15 purchases at \$28 unit cost

Cost of goods sold = 200x\$30 + 300x\$28 + 100x\$26 + 400x\$28
= \$6,000 + \$8,400 + \$2,600 + \$11,200
= \$28,200

350 cases of inventory left
= 100 cases from Feb. 25 purchases at \$26 unit cost
+ 250 cases from beginning inventory of at \$23 unit cost

Cost of ending inventory = 100x\$26 + 250x\$23
= \$2,600 + \$5,750
= \$8,350

Specific
Identification
Method Average-
Cost
Method First-In,
First-Out
Method Last-In,
First-Out
Method
Cost of goods sold 27,400 27,000 26,350 28,200
Cost of ending inventory 9,150 9,450 10,200 8,350

What conclusions can be drawn about the effect of each method on the income statement and the balance sheet of Paul's Farm Store?

The LIFO method will result in lowest net income for Paul's Farm Store while FIFO will result in the highest net income. For specific identification method and average-cost method, the net income will be similar but still higher than LIFO method. From the result, we can also see that the FIFO method will result in highest inventory in the balance follow by specific identification method, average-cost method, and LIFO method respectively.

E4: During its first year of operation, Bingham Company purchased 5,600 units of a product at \$21 per unit. During the second year, it purchased 6,000 units of the same product at \$24 per unit. During the third year, it purchased 5,000 units at \$30 per unit. Bingham Company managed to have an ending inventory each year of 1,000 units. The company uses the periodic inventory system.

--Prepare cost of goods sold statements that compare the value of ending inventory and the cost of goods sold for each of the three years using (1) the FIFO inventory costing method and (2) the LIFO method. From the resulting data, what conclusions can you draw about the relationships between changes in unit price and changes in the value of ending inventory?

Purchases Beginning Inventory Ending Inventory Sales=Beg. Inv + Pur - End. Inv
Year 1 5,600 units @ \$21 0 1,000 units 4,600 units
Year 2 6,000 units @ \$24 1,000 units 1,000 units 6,000 units
Year 3 5,000 units @ \$30 1,000 units 1,000 units 5,000 units

Using FIFO, units purchased first are assumed to be sold out first. Therefore, the cost of goods sold will be calculated from the beginning inventory.

For Year 1

4,600 units sold
= 4,600 units from Year 1 purchases at \$21 unit cost

Cost of goods sold = 4,600x\$21
= \$96,600

1,000 units of inventory left
= 1,000 units from Year 1 purchases at \$21 unit cost

Cost of ending inventory = 1,000x\$21
= \$21,000

For Year 2

6,000 units sold
= 1,000 units from Year 1 purchases at \$21 unit cost
+ 5,000 units from Year 2 purchases at \$24 unit cost

Cost of goods sold = 1,000x\$21 + 5,000x\$24
= \$21,000 + \$120,000 = \$141,000

1,000 units of inventory left
= 1,000 units from Year 2 purchases at \$24 unit cost

Cost of ending inventory = 1,000x\$24
= \$24,000

For Year 3

5,000 units sold
= 1,000 units from Year 2 purchases at \$24 unit cost
+ 4,000 units from Year 3 purchases at \$30 unit cost

Cost of goods sold = 1,000x\$24 + 4,000x\$30
= \$24,000 + \$120,000 = \$144,000

1,000 units of inventory left
= 1,000 units from Year 3 purchases at \$30 unit cost

Cost of ending inventory = 1,000x\$30
= \$30,000

Cost of goods sold statement (FIFO)

Year 1 Year 2 Year 3
Merchandise inventory, beginning 0 21,000 24,000
Goods available for sale 117,600 165,000 174,000
Less: Merchandise inventory, ending 21,000 24,000 30,000
Cost of goods sold 96,600 141,000 144,000

Using LIFO, units purchased last are assumed to be sold first. Therefore, the cost of goods sold will be calculated from the last purchase backward.

Year 1

4,600 units sold
= 4,600 units from Year 1 purchases at \$21 unit cost

Cost of goods sold = 4,600x\$21
= \$96,600

1,000 units of inventory left
= 1,000 units from Year 1 purchases at \$21 unit cost

Cost of ending inventory = 1,000x\$21
= \$21,000

For Year 2

6,000 units sold
= 6,000 units from Year 2 purchases at \$24 unit cost

Cost of goods sold = 6,000x\$24
= \$144,000

1,000 units of inventory left
= 1,000 units from Year 1 purchases at \$21 unit cost

Cost of ending inventory = 1,000x\$21
= \$21,000

For Year 3

5,000 units sold
= 5,000 units from Year 3 purchases at \$30 unit cost

Cost of goods sold = 5,000x\$30
= \$150,000

1,000 units of inventory left
= 1,000 units from Year 1 purchases at \$21 unit cost

Cost of ending inventory = 1,000x\$21
= \$21,000

Cost of goods sold statement (LIFO)

Year 1 Year 2 Year 3
Merchandise inventory, beginning 0 21,000 21,000