Question

Case 1: T J International

T J International was founded in 1969 as Trus Joist International. The firm, a manufacturer of specialty building products, has its headquarters in Boise, Idaho. The company, through its partnership in the Trus Joist MacMillan joint venture, develops and manufactures engineered lumber. This product is a high-quality substitute for structural lumber and uses lower-grade wood and materials formerly considered waste. The company also is majority owner of the Outlook Window Partnership, which is a consortium of three wood and vinyl window manufacturers.

Following is T J International’s adapted income statement and information concerning inventories from its annual report.

T J International

Sales \(618,876,000

Cost of goods sold 475,476,000

Gross profit 143,400,000

Selling and administrative expenses 102,112,000

Income from operations 41,288,000

Other expense 24,712,000

Income before income tax 16,576,000

Income taxes 7,728,000

Net income \) 8,848,000

Inventories.Inventories are valued at the lower of cost or market and include material, labor, and production overhead costs. Inventories consisted of the following:

Current Year Prior Year

Finished goods \(27,512,000 \)23,830,000

Raw materials and

work-in-progress 34,363,00033,244,000

61,875,000 57,074,000

Reduction to LIFO cost (5,263,000) (3,993,000)

\(56,612,000 \)53,081,000

The last-in, first-out (LIFO) method is used for determining the cost of lumber, veneer, Microllamlumber, TJI joists, and open web joists. Approximately 35 percent of total inventories at the end of the current year were valued using the LIFO method. The first-in, first-out (FIFO) method is used to determine the cost of all other inventories.

Instructions

(a) How much would income before taxes have been if FIFO costing had been used to value all inventories?

(b) If the income tax rate is 46.6%, what would income tax have been if FIFO costing had been used to value all inventories ? In your opinion, is this difference in net income between the two methods material? Explain.

(c) Does the use of a different costing system for different types of inventory mean that there is a different physical flow of goods among the different types of inventory? Explain.

Short answer

1) Income before tax $21,839,000

2) Income tax $10,176,974

Different costing systems are adopted for different inventories to match the cost with their physical flow and other inventories’ costs.

Step-by-step solution

income before tax under FIFO costing

With the given data, if the FIFO method has been used, then the ending inventory in the current year would be $5,263,000 higher than the given amount. In such a case, COGS would be lower by $5,263,000. So, the new gross profit would be:

$\begin{array}{c}\mathbf{N}\mathbf{e}\mathbf{w}\mathbf{}\mathbf{g}\mathbf{r}\mathbf{o}\mathbf{s}\mathbf{s}\mathbf{}\mathbf{p}\mathbf{r}\mathbf{o}\mathbf{f}\mathbf{i}\mathbf{t}\mathbf{=}\mathbf{C}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{}\mathbf{g}\mathbf{r}\mathbf{o}\mathbf{s}\mathbf{s}\mathbf{}\mathbf{p}\mathbf{r}\mathbf{o}\mathbf{f}\mathbf{i}\mathbf{t}\mathbf{+}\mathbf{D}\mathbf{e}\mathbf{c}\mathbf{r}\mathbf{e}\mathbf{a}\mathbf{s}\mathbf{e}\mathbf{}\mathbf{i}\mathbf{n}\mathbf{}\mathbf{C}\mathbf{O}\mathbf{G}\mathbf{S}\\ \mathbf{=}\mathbf{\$}\mathbf{143}\mathbf{,}\mathbf{400}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{5}\mathbf{,}\mathbf{263}\mathbf{,}\mathbf{000}\\ \mathbf{=}\mathbf{\$}\mathbf{148}\mathbf{,}\mathbf{663}\mathbf{,}\mathbf{000}\end{array}$

As the gross profit has increased, income before taxes would also increase by the same amount.

$\begin{array}{c}\mathbf{Income}\mathbf{}\mathbf{before}\mathbf{}\mathbf{taxes}\mathbf{=}\mathbf{New}\mathbf{}\mathbf{Gross}\mathbf{}\mathbf{Profit}\mathbf{-}\mathbf{Selling}\mathbf{}\mathbf{and}\mathbf{}\mathbf{administrative}\mathbf{}\mathbf{expenses}\mathbf{-}\mathbf{Other}\mathbf{}\mathbf{expenses}\\ \mathbf{=}\mathbf{\$}\mathbf{148}\mathbf{,}\mathbf{663}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{102}\mathbf{,}\mathbf{112}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{24}\mathbf{,}\mathbf{712}\mathbf{,}\mathbf{000}\\ \mathbf{\$}\mathbf{21}\mathbf{,}\mathbf{839}\mathbf{,}\mathbf{000}\end{array}$

New Income tax

$\begin{array}{c}\mathbf{New}\mathbf{}\mathbf{Income}\mathbf{}\mathbf{tax}\mathbf{=}\mathbf{New}\mathbf{}\mathbf{Income}\mathbf{}\mathbf{before}\mathbf{}\mathbf{taxes}\mathbf{\times }\mathbf{tax}\mathbf{}\mathbf{rate}\\ \mathbf{=}\mathbf{\$}\mathbf{21}\mathbf{,}\mathbf{839}\mathbf{,}\mathbf{000}\mathbf{\times }\frac{\mathbf{46}\mathbf{.}\mathbf{6}}{\mathbf{100}}\\ \mathbf{=}\mathbf{\$}\mathbf{10}\mathbf{,}\mathbf{176}\mathbf{,}\mathbf{974}\end{array}$

$\begin{array}{c}\mathbf{New}\mathbf{}\mathbf{net}\mathbf{}\mathbf{income}\mathbf{=}\mathbf{New}\mathbf{}\mathbf{income}\mathbf{}\mathbf{before}\mathbf{}\mathbf{taxes}\mathbf{-}\mathbf{New}\mathbf{}\mathbf{Income}\mathbf{}\mathbf{tax}\\ \mathbf{=}\mathbf{\$}\mathbf{21}\mathbf{,}\mathbf{839}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{10}\mathbf{,}\mathbf{176}\mathbf{,}\mathbf{974}\\ \mathbf{=}\mathbf{\$}\mathbf{11}\mathbf{,}\mathbf{662}\mathbf{,}\mathbf{026}\end{array}$

There is a big gap between the current given net income and the new computed net income. So the change in net income due to different methods is material.

Different costing systems for different types of inventory

Physical flow may differ for certain types of inventory. But inventory valuation method does not depend on the physical flow of goods. A different costing system may be adopted for the inventories having the same physical flow. Physical flow may be similar for different inventories, but cost flow may differ by adopting the same inventory costing system due to the degree of difference in cost.

For this purpose, different costing systems are used for different inventories, irrespective of their physical flow. The physical flow may match the cost flow of the goods and other inventories.