E9-3. Computing ending inventory under different cost flow
assumptions
(AICPA adapted)
Requirement 1:
Cost of goods sold and the cost of ending inventory under the
FIFO method are computed below.
FIFO
FIFO
January 12
January 30
Units sold
200
100
50
350
@ $16
@ $16
@ $17
Cost of goods sold
$3,200
1,600
850
$5,650
Now we know how many units are no longer in inventory, and
we can compute the ending balance from the units remaining.
Remaining in ending inventory:
FIFO
100 @ $17
100 @ $18
200 Units
$1,700
1,800
$3,500
The cost of ending inventory under FIFO is $3,500. We can
use the same method to find the cost of ending inventory
under LIFO.
Requirement 2:
LIFO
January 12 100 @ $18
100 @ $17
January 30
50 @ $17
100 @ $16
Units sold
350
Cost of goods sold
$1,800
1,700
850
1,600
$5,950
Since Kristen’s Office Supplies, Inc., does not use perpetual
inventory records, we do not need to worry about the dates of
the purchases and sales.
LIFO ending inventory:
1
200 @ $16 = $3,200
Under LIFO, ending inventory is $300 less than it is under
FIFO, or $3,200.
Requirement 3:
Average cost
Beginning inventory
Purchase January 14
Purchase January 29
Units available
300
150
100
550
@ $16
@ $17
@ $18
$4,800
2,550
1,800
$9,150
Average cost per unit = $9,150 ÷ 550 units = $16.636
Ending inventory = 200 units @ $16.636 = $3,327
Cost of goods sold = 350 units @ $16.636 = $5,823
E9-8. Computing inventory under three flow assumptions
(AICPA adapted)
Purchases during 2011 were:
1,500
@ $10.00
=
$15,000
1,200
@
10.50
=
12,600
600
@
11.00
=
6,600
900
@
11.50
=
10,350
4,200
$44,550
To find ending inventory under each of these methods, we
need to compute how many units have been sold. To find this
number, we can sum the purchases (4,200 units) and
beginning inventory (800 units) to find the units available for
sale (5,000). Next, we subtract the units on hand (1,600) from
the units available. This figure (3,400) is the number of units
that have been sold. Now that we know the number of units
sold, we can compute the cost of goods sold under each
method.
Requirement 1:
FIFO
Sold:
800 @ $9
1,500 @ $10
1,100 @ $10.50
3,400
Cost of goods sold
2
$ 7,200
15,000
11,550
$33,750
Since we now know cost of goods sold, and beginning
inventory and purchases were given, we can compute ending
inventory from an analysis of the inventory T-account.
Beginning balance
Purchases
Ending balance
Inventory
$7,200
44,550
$33,750
X
Cost of goods sold
$7,200 + $44,550 - $33,750 = X
X = $18,000
We can use the same procedure for LIFO and weighted
average.
Requirement 2:
LIFO
Sold:
900
600
1,200
700
3,400
@ $11.50
@ $11
@ $10.50
@ $10
Cost of goods sold
$10,350
6,600
12,600
7,000
$36,550
Inventory
Beginning balance
Purchases
$7,200
44,550
$36,550
Ending balance
Cost of goods sold
X
$7,200 + $44,550 - $36,550 = X
X = $15,200
Requirement 3:
Weighted average
Sold:
3,400 @ $10.351
Cost of goods sold
3
$35,190
1
The computation of the weighted average unit price is as follows:
800
1,500
1,200
600
900
@
@
@
@
@
$9
$10
$10.50
$11
$11.50
$7,200
15,000
12,600
6,600
10,350
$51,750
5,000
$10.35
Total inventory cost
Total inventory units
5,000
Weighted average cost per unit
Inventory
Beginning balance
Purchases
$7,200
44,550
$35,190
Ending balance
Cost of goods sold
X
$7,200 + $44,550 - $35,190 = X
X = $16,560
E9-12.
Converting LIFO to FIFO
Requirement 1:
KW Steel Corp.
2011
2010
($ in millions)
Balance sheet
inventories
LIFO reserve
Sales
Cost of Goods sold
Gross margin
Gross margin rate
(Gross margin/sales)
Inventory turnover
(COGS/average
inventory)
$
797.6
378.0
4,284.8
3,427.8
857.0
Waretown Steel
2011
2010
$ 692.7 $ 708.2
334.9
4,029.7
3,226.5
803.2
3,584.2
2,724.0
860.2
20.0%
24.0%
4.6
3.9
4
$ 688.6
3,355.8
2,617.5
738.3
A comparison of the ratios suggests that KW has a lower
gross margin than Waretown, but a better inventory turnover.
Requirement 2:
KW Steel Corp.
Waretown Steel
2011
2010
2011
2010
$ 797.6
$ 692.7 $ 708.2 $ 688.6
378.0
334.9
1,175.6
1,027.6
($ in millions)
Total inventories
LIFO reserve
Inventories restated to FIFO
Sales
Cost of Goods sold—LIFO
Increase in LIFO reserves
Cost of Goods sold—FIFO
Gross margin—FIFO
$ 4,284.8
$ 3,584.2
3,384.7
900.1
2,724.0
860.2
21.0%
24.0%
3.1
3.9
3,427.8
(43.1)
Gross margin rate
(Gross margin/sales)
Inventory turnover
(COGS/average inventory)
KW’s gross profit rate, as restated, is still below Waretown’s,
but the difference is not quite as great. KW’s inventory
turnover has dropped significantly and is now below that of
Waretown. When the LIFO bias is removed from KW’s data,
KW is clearly the weaker of the two companies on the basis of
both ratios.
E9-13. Identifying effects of a LIFO liquidation
Requirement 1:
Sales revenues, 275 @ $1,350
Cost of goods sold:
2011 purchases, 275 @ $675
LIFO gross margin
Gross margin percentage
$ 371,250
185,625
$ 185,625
.50
5
Requirement 2:
Sales revenues, 275 @ $1,350
Cost of goods sold:
2011 purchases, 180 @ $675
2010 purchases, 60 @ $600
2009 purchases, 35 @ $500
275
LIFO gross margin
Gross margin percentage
$ 371,250
121,500
36,000
17,500
175,000
$ 196,250
.529
Requirement 3:
When prices are rising, selling more units than are purchased
results in a gross margin increase. This increase occurs when
older units, having lower costs, are presumed to be sold, thus
mismatching old costs with current period revenues. This is
most easily seen by reference to the gross margin percentage.
Given
Nathan’s pricing formula, the long-run sustainable gross
margin percentage is .50. But with the LIFO liquidation, the
reported margin percentage is .529. This mismatch can be
avoided by purchasing enough inventory in any given year to
avoid liquidating old LIFO layers.
P9-1.
Calculating amounts and ratios under FIFO and LIFO
Requirement 1:
Total purchases—2010
Total sales—2010
Ending inventory—2010
Beginning inventory—2011
Total purchases—2011
Goods available for sale—2011
Total sales—2011
Ending inventory—2011
Units
550
(440)
110
110
530
640
(510)
130
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Ending inventory 2010—FIFO: Units Cost/unit
Total
December 5, 2010
50
$
32 $ 1,600
September 3, 2010
60
31
1,860
Ending inventory 2010—FIFO
110
$ 3,460
Cost of goods sold 2010—FIFO:
Total purchases—2010
Ending inventory 2010—FIFO
Cost of goods sold 2010—FIFO
$15,820
(3,460)
$12,360
Total sales—2010
Cost of goods sold 2010—FIFO
Gross margin—2010
$22,925
(12,360)
$10,565
Ending inventory 2011—FIFO: Units Cost/unit
November 3, 2011
80
$
27
August 20, 2011
50
28
Ending inventory 2011—FIFO
130
Total
$ 2,160
1,400
$ 3,560
Cost of goods sold 2011—FIFO:
Beginning inventory 2011—FIFO
Total purchases—2011
Ending inventory 2011—FIFO
Cost of goods sold 2011—FIFO
$ 3,460
15,510
(3,560)
$15,410
Total sales—2011
Cost of goods sold 2011—FIFO
Gross margin—2011
$26,200
(15,410)
$10,790
Requirement 2:
Ending inventory 2010—LIFO: Units Cost/unit
January 1, 2010
85 $
25
March 15, 2010
25
27
Ending inventory 2010—LIFO
110
7
Total
$ 2,125
675
$ 2,800
Cost of goods sold 2010—LIFO:
Total purchases—2010
Ending inventory 2010—LIFO
Cost of goods sold 2010—LIFO
$15,820
(2,800)
13,020
Total sales—2010
Cost of goods sold 2010—LIFO
Gross margin—2010
$22,925
(13,020)
$ 9,905
Ending inventory 2011—LIFO: Units Cost/unit
January 1, 2010
85 $
25
March 15, 2010
25
27
February 20, 2011
20
31
Ending inventory 2011—LIFO
130
Cost of goods sold 2011—LIFO:
Beginning inventory 2011—LIFO
Total purchases—2011
Ending inventory 2011—LIFO
Cost of goods sold 2011—LIFO
Total
$ 2,125
675
620
$ 3,420
Total sales—2011
Cost of goods sold 2011—LIFO
Gross margin—2011
$26,200
(14,890)
$11,310
$ 2,800
15,510
(3,420)
$14,890
Requirement 3:
In 2010, when prices paid for purchased goods were rising,
FIFO produced a higher gross margin than LIFO because it
allocated the older, lower cost purchases to cost of goods sold.
During 2011, however, prices for purchased items steadily
dropped so LIFO reported a larger gross margin than FIFO
because more recent—and thus lower—costs were allocated
to cost of goods sold.
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P9-6. Choosing a cost flow assumption
Responses to each of the issues raised follow.
a. Use of FIFO will produce both higher income and higher
working capital and, thus, help satisfy the covenants.
b. FIFO would lead to higher income and, hence, higher
bonuses.
c. This is not possible due to the LIFO conformity rule.
d. If firms liquidate LIFO layers when inventory levels are
falling, then they may have to pay taxes on LIFO
liquidations (i.e., cumulative holding gains from inflation).
FIFO cannot solve the problem, since we would have paid
the taxes earlier under FIFO. In terms of present value,
therefore, we are much better off under LIFO which defers
tax payments until liquidation occurs.
e. This is not possible. LIFO ensures better matching, but
FIFO generates a more current inventory value in the
balance sheet.
f. Not necessarily. If securities markets are “efficient,” then
higher income due to a different accounting method does
not ensure a higher stock price, especially when
sophisticated investors can estimate the amount of realized
holding gains in reported FIFO income.
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