Effect of cost-flow assumptions on income and tax The Svejk Company is a wholesaler of beer tankards. The table below shows the company’s purchases and sales of its (1 litre) Pilsener Special tankard.

Balance Purchases Sales in inventory 31/12/x5 500 at 4/tankard During x6:

February 300 at 5 April 600 at 7 July 700 at 5.5 August 800 at 7.5 October 500 at 6 Total 1,500 1,400 31/12/x6 600 at ?

Required

(a) Calculate the x6 gross profit and end-x6 inventory for this product line under FIFO, LIFO and WAC cost-flow assumptions. Assume the company uses a perpetual system to keep track of inventory quantities and values. Compare the results. Which method yields the highest gross profit and why?

(b) Assume all three methods are permitted for tax purposes. Would Svejk’s income tax liability for x6 be greater or less if it used LIFO rather than FIFO – and by how much? Assume a 40% tax rate.

(c) On investigating Svejk’s accounting systems, you discover that it uses a perpetual inventory system to keep track of inventory quantities but uses a periodic system to establish the costs of tankards sold during the year. (Under the periodic system, COGS is calculated at year-end:

thus purchases made (and other costs incurred) after the last sale date are included in the COGS calculation.)

Recalculate the x6 gross profit for the Pilsener Special product line under FIFO, LIFO and WAC cost-flow assumptions. Compare the resulting gross profit figures with those you calculated in (a).

Why does gross profit differ between

(a) and

(c) under LIFO and WAC? Under what circumstances would you expect a company to choose the system outlined in (c)?

Check figures:

(a) WAC gross profit 3,375

(c) LIFO gross profit 2,350 AppenedixLO1