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Problem 1: The Effects of Different Cost Flow Assumptions for Inventory At the end of January 2011, the records of Sheldon and Blair showed the

Problem 1: The Effects of Different Cost Flow Assumptions for Inventory

At the end of January 2011, the records of Sheldon and Blair showed the following for a particular item that sold at $20 per unit:

Problem 1, Table 1: Records of Sheldon and Blair
Transactions Units Total Amount
Inventory, January 1, 2011 500 @ $6.00 $3,000
Purchase, January 12 600 @ $7.00 $4,200
Purchase, January 26 200 @ $7.10 $1,420
Sale (400 units sold for $20 each)
Sale (300 units sold for $20 each)

Based on the information provided in the table above, complete the following. An optional template, Assessment 6, Problem 1 Template, is provided in the Suggested Resources under the Capella Resources heading.

Assuming the use of a periodic inventory system, prepare a summarized income statement through gross profit for the month of January under each method of inventory listed below. Show the inventory computations for each method in detail.

a. Average cost. (Round the average cost per unit to the nearest cent.)

b. First in, first out (FIFO).

c. Last in, first out (LIFO).

d. Specific identification. (Assume that the first sale was selected from the beginning inventory and the second sale was selected from the January 12 purchase.)

Of FIFO and LIFO, which method would result in the higher pretax income? Which would result in the higher EPS?

Of FIFO and LIFO, which method would result in the lower income tax expense? Explain, assuming a 35 percent average tax rate.

Of FIFO and LIFO, which method would produce the more favorable cash flow? Explain.

Template for a summarized income statement through gross profit for the month ended January 31, 2011, under four inventory valuation methods: (a) weighted average, (b) FIFO, (c) LIFO, and (d) specific identification. For Sheldon and Blair.
Learner:
Sheldon and Blair
Partial Income Statement
For the Month Ended January 31, 2011
(a) Weighted Average (b) FIFO (c) LIFO (d) Specific Identification
Sales revenue1 $14,000 $14,000 $14,000 $14,000
Cost of goods sold2 $3,000 $200 $2,300 ($1,120)
Gross profit $11,000 $13,800 $11,700 $15,120
Sheldon and Blair
Computations
1Sales revenue:
700 units @ $20 = $14,000
2Cost of goods sold:
Units Weighted Average FIFO LIFO Specific Identification
Beginning inventory 500 $3,000 $3,000 $3,000 $3,000
Purchases (net)3 0 $0 $0 $0 $0
Goods available for sale 500 $3,000 $3,000 $3,000 $3,000
Ending inventory4 $0 $2,800 $700 $4,120
Cost of goods sold 500 $3,000 $200 $2,300 ($1,120)
3Purchases (net)
Purchase, January 12 $0
Purchase, January 26 $0
Totals 0 $0
4Ending inventory
(a) Weighted-average cost: Units Amount
Beginning inventory 500 @$6 $3,000
Purchases3 0 $0
500 $3,000
Average cost:
$8,620 1,300 units = 6.00
Ending inventory:
600 units $6.63 = $0
(b) FIFO: units @ $7.10
units @ $7.00 $2,800
600 $2,800
(c) LIFO: units @ $6.00
units @ $7.00 $700
600 $700
(d) Specific identification: units @ $6.00
units @ $7.00
units @ $7.10 $1,420
600 $4,120
Of FIFO and LIFO, which method would result in the higher pretax income? Which would result in the higher EPS?
Of FIFO and LIFO, which method would result in the lower income tax expense? Explain, assuming a 35 percent average tax rate.
FIFO = Gross profit .35
LIFO = Gross profit .35
Of FIFO and LIFO, which method would produce the more favorable cash flow? Explain.
End of worksheet

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