Problem 1: The Effects of Different Cost Flow Assumptions for Inventory

At the end of January 2011, the records of Sheldon and Blair showed the following for a particular item that sold at $20 per unit:

Problem 1, Table 1: Records of Sheldon and Blair

Transactions	Units	Total Amount
Inventory, January 1, 2011	500 @ $6.00	$3,000
Purchase, January 12	600 @ $7.00	$4,200
Purchase, January 26	200 @ $7.10	$1,420
Sale	(400 units sold for $20 each)
Sale	(300 units sold for $20 each)

Based on the information provided in the table above, complete the following. An optional template, Assessment 6, Problem 1 Template, is provided in the Suggested Resources under the Capella Resources heading.

Assuming the use of a periodic inventory system, prepare a summarized income statement through gross profit for the month of January under each method of inventory listed below. Show the inventory computations for each method in detail.

a. Average cost. (Round the average cost per unit to the nearest cent.)

b. First in, first out (FIFO).

c. Last in, first out (LIFO).

d. Specific identification. (Assume that the first sale was selected from the beginning inventory and the second sale was selected from the January 12 purchase.)

Of FIFO and LIFO, which method would result in the higher pretax income? Which would result in the higher EPS?

Of FIFO and LIFO, which method would result in the lower income tax expense? Explain, assuming a 35 percent average tax rate.

Of FIFO and LIFO, which method would produce the more favorable cash flow? Explain.

Template for a summarized income statement through gross profit for the month ended January 31, 2011, under four inventory valuation methods: (a) weighted average, (b) FIFO, (c) LIFO, and (d) specific identification. For Sheldon and Blair.

Learner:

Sheldon and Blair

Partial Income Statement

For the Month Ended January 31, 2011

(a) Weighted Average

(b) FIFO

(c) LIFO

(d) Specific Identification

Sales revenue¹

$14,000

$14,000

$14,000

$14,000

Cost of goods sold²

$3,000

$200

$2,300

($1,120)

Gross profit

$11,000

$13,800

$11,700

$15,120

Template provided:

Sheldon and Blair

Computations

¹Sales revenue:

700 units @ $20 =

$14,000

²Cost of goods sold:

Units

Weighted Average

FIFO

LIFO

Specific Identification

Beginning inventory

500

$3,000

$3,000

$3,000

$3,000

Purchases (net)³

0

$0

$0

$0

$0

Goods available for sale

500

$3,000

$3,000

$3,000

$3,000

Ending inventory⁴

$0

$2,800

$700

$4,120

Cost of goods sold

500

$3,000

$200

$2,300

($1,120)

³Purchases (net)

Purchase, January 12

$0

Purchase, January 26

$0

Totals

0

$0

⁴Ending inventory

(a) Weighted-average cost:

Units

Amount

Beginning inventory

500

@$6

$3,000

Purchases³

0

$0

500

$3,000

Average cost:

$8,620 1,300 units =

6.00

Ending inventory:

600 units $6.63 =

$0

(b) FIFO:

units @ $7.10

units @ $7.00

$2,800

600

$2,800

(c) LIFO:

units @ $6.00

units @ $7.00

$700

600

$700

(d) Specific identification:

units @ $6.00

units @ $7.00

units @ $7.10

$1,420

600

$4,120

Of FIFO and LIFO, which method would result in the higher pretax income? Which would result in the higher EPS?

Of FIFO and LIFO, which method would result in the lower income tax expense? Explain, assuming a 35 percent average tax rate.

FIFO = Gross profit .35

LIFO = Gross profit .35

Of FIFO and LIFO, which method would produce the more favorable cash flow? Explain.

End of worksheet

Template for a summarized income statement through gross profit for the month ended January 31, 2011, under four inventory valuation methods: (a) weighted average, (b) FIFO, (c) LIFO, and (d) specific identification. For Sheldon and Blair.
Learner:
Sheldon and Blair
Partial Income Statement
For the Month Ended January 31, 2011
	(a) Weighted Average		(b) FIFO		(c) LIFO		(d) Specific Identification
Sales revenue1	$14,000		$14,000		$14,000		$14,000
Cost of goods sold2	$3,000		$200		$2,300		($1,120)
Gross profit	$11,000		$13,800		$11,700		$15,120
Sheldon and Blair
Computations
1Sales revenue:
700 units @ $20 =	$14,000
2Cost of goods sold:
	Units		Weighted Average		FIFO		LIFO		Specific Identification
Beginning inventory	500		$3,000		$3,000		$3,000		$3,000
Purchases (net)3	0		$0		$0		$0		$0
Goods available for sale	500		$3,000		$3,000		$3,000		$3,000
Ending inventory4			$0		$2,800		$700		$4,120
Cost of goods sold	500		$3,000		$200		$2,300		($1,120)
3Purchases (net)
Purchase, January 12					$0
Purchase, January 26					$0
Totals	0				$0
4Ending inventory
(a) Weighted-average cost:	Units		Amount
Beginning inventory	500	@$6	$3,000
Purchases3	0		$0
	500		$3,000
Average cost:
$8,620 1,300 units =	6.00
Ending inventory:
600 units $6.63 =	$0
(b) FIFO:			units @ $7.10
			units @ $7.00		$2,800
	600				$2,800
(c) LIFO:			units @ $6.00
			units @ $7.00		$700
	600				$700
(d) Specific identification:			units @ $6.00
			units @ $7.00
			units @ $7.10		$1,420
	600				$4,120
Of FIFO and LIFO, which method would result in the higher pretax income? Which would result in the higher EPS?
Of FIFO and LIFO, which method would result in the lower income tax expense? Explain, assuming a 35 percent average tax rate.
FIFO = Gross profit .35
LIFO = Gross profit .35
Of FIFO and LIFO, which method would produce the more favorable cash flow? Explain.
End of worksheet