Question

QP Corp. sold 4,000 units of its product at \(50 per unit in year 2017 and incurred operating expenses of \)5 per unit in selling the units. It began the year with 700 units in inventory and made successive purchases of its product as follows.

Jan 1	Beginning inventory	700 units @ \(18.00 per unit
Feb 20	Purchases	1,700 units @ \)19.00 per unit
May 16	Purchases	800 units @ \(20.00 per unit
Oct 3	Purchases	500 units @ \)21.00 per unit
Dec 11	Purchases	2,300 units @ $22.00 per unit
	Total	6,000 units

Required

1.Prepare comparative income statements similar to Exhibit 5.8 for the three inventory costing methods of FIFO, LIFO, and weighted average. (Round all amounts to cents.) Include a detailed cost of goods sold section as part of each statement. The company uses a periodic inventory system, and its income tax rate is 40%.

2. How would the financial results from using the three alternative inventory costing methods change if the company had been experiencing declining costs in its purchases of inventory?

3. What advantages and disadvantages are offered by using (a) LIFO and (b) FIFO? Assume the continuing trend of increasing costs.

Short answer

1.

Particular	FIFO	LIFO	Weighted Average
Net income	$61,200	$57,180	59,200

2.Net income reported under the LIFO method will be higher in the situation of declining prices.

3.

Particular	Advantages	Dis-Advantages
LIFO	Lower tax liability	Understated inventory
FIFO	Inventory stated at market value	Higher tax liability

Step-by-step solution

Step-By-Step SolutionStep 1: Comparative Income Statement

The expenses incurred for operating daily business functions are known as operating expenses, which are further helpful for creating revenue from the operations.

Particular	FIFO	LIFO	Weighted Average
Sales	$200,000	$200,000	$200,000
Less: Cost of goods sold	(78,000)	(84,700)	(81,334)
Gross profit	$122,000	$115,300	$118,666
Less: Operating expenses @ $5 per unit	(20,000)	(20,000)	(20,000)
Operating income	$102,000	$95,300	$98,666
Less: Tax expenses @ 40%	(40,800)	(38,120)	(39,466)
Net income	$61,200	$57,180	59,200

Working note:

Calculation of cost of goods sold

(a) FIFO

Particular	Units	X	Per unit	=	Total cost
Jan 1	700	X	$18	=	$12,600
Feb 20	1,700	X	$19	=	$32,300
May 16	800	X	$20	=	$16,000
Oct 3	500	X	$21	=	$10,500
Dec 11	300	X	$22	=	$6,600
Total					$78,000

(b) LIFO

Particular	Units	X	Per unit	=	Total cost
Dec 11	2,300	X	$22	=	$50,600
Oct 3	500	X	$21	=	$10,500
May 16	800	X	$20	=	$16,000
Feb 20	400	X	$19	=	$7,600
Total					$84,700

(c) Weighted Average method

$$\begin{gathered} \mathrm{Cost}\mathrm{of}\mathrm{goods}\mathrm{sold}=\frac{\mathrm{Total}\mathrm{cost}\mathrm{of}\mathrm{goods}\mathrm{available}\mathrm{for}\mathrm{sale}}{\mathrm{Total}\mathrm{units}\mathrm{available}\mathrm{for}\mathrm{sale}}\times \mathrm{Units}\mathrm{sold} \\ =\frac{(700\times \mathrm{\$}18)+(1,700\times \mathrm{\$}19)+(800\times \mathrm{\$}20)+(500\times \mathrm{\$}21)+(2,300\times \mathrm{\$}22)}{6,000}\times 4,000 \\ =\frac{\mathrm{\$}12,600+\mathrm{\$}32,300+\mathrm{\$}16,000+\mathrm{\$}10,500+50,600}{6,000}\times 4,000 \\ =\mathrm{\$}81,334 \end{gathered}$$

Change in the Financial Results If the Company is Experiencing Declining Cost of Inventory

Net benefits generated by the business entity from the business operations after adjusting all the expenses such as operating, selling, administration, and tax expenses are known as net income.

In declining prices, net income reported under LIFO will be higher than the FIFO method because inventory with lower costs will be included in the cost of goods sold under the LIFO method. FIFO’s goods sold will consist of inventory at a higher cost.

Advantages and Disadvantages of Using LIFO and FIFO

Tax liability is a liability account reflecting the amount of tax that a business entity or individual is liable to pay to the taxation authority.

LIFO: Adopting LIFO in increasing prices will report lower income because of the higher cost of goods sold, and lower-income will report lower tax liability.

The disadvantage of using the LIFO method in rising prices is that lower profit will be reported, and the ending inventory of the business entity will be understated.

FIFO: Adopting the FIFO method will report inventory at its market price, and therefore, inventory is not over or understated.

The disadvantage of using the FIFO method under rising prices is that it will report higher income, generating higher tax liability.