The management of Danica Co. asks your help in determining the comparative effects of the FIFO and LIFO inventory cost flow methods. For 2019, the accounting records provide the following data.
| Inventory, January 1 (10,000 units) | $47,000 |
| Cost of 100,000 units purchased | 532,000 |
| Selling price of 84,000 units sold | 735,000 |
| Operating expenses | 140,000 |
Units purchased consisted of 35,000 units at $5.10 on May 10: 35,000 units at $5.30 on August 15; and 30,000 units at $5.60 on November 20. Income taxes are 30%.
Instructions
- Prepare comparative condensed income statements for 2019 under FIFO and LIFO(Show computations of ending inventory)
- Answer the following operations for management.
- Which cost flow method (FIFO or LIFO) produces the most meaningful inventory amount for the balance sheet? Why?
- Which cost flow method (FIFO or LIFO) produces the most meaningful net income? Why?
- Which cost flow method (FIFO or LIFO) is most likely to approximate the actually physical flow of goods? Why?
- How much more cash will be available for management under LIFO than under FIFO? Why?
- How much of the gross profit under FIFO is illusory in comparison with the gross profit under LIFO?
Solution
a.
Danica Co.
Condensed Income Statement
For the year ended December 31, 2019
Condensed Income Statement
For the year ended December 31, 2019
b.
- FIFO method produces the most meaningful inventory amount for the balance sheet because the units are closed at the most recent purchase
- LIFO method produces the most meaningful net income for the balance sheet because the costs are closed at the most recent purchases against the sales
- FIFO method is more likely to approximate the actual physical flow of goods because the oldest goods are usually sold first to minimize damages and expired
- There will be $5,100 additional cash available for management under LIFO than under FIFO because income taxes are $43,380 under LIFO and $48,480 under FIFO
- The illusory profit is $301,600 - $284,600 = $17,000