AAA Hardware uses the LIFO method to value its inventory. Inventory at the begin
ID: 2447058 • Letter: A
Question
AAA Hardware uses the LIFO method to value its inventory. Inventory at the beginning of the year consisted of 15,000 units of the company’s one product. These units cost $16 each. During the year, 65,000 units were purchased at a cost of $19 each and 66,500 units were sold. Near the end of the fiscal year, management is considering the purchase of an additional 7,500 units at $19
What would be the effect of this purchase on income before income taxes? What would be the effect of this purchase on income before income taxes using FIFO method?
AAA Hardware uses the LIFO method to value its inventory. Inventory at the beginning of the year consisted of 15,000 units of the company’s one product. These units cost $16 each. During the year, 65,000 units were purchased at a cost of $19 each and 66,500 units were sold. Near the end of the fiscal year, management is considering the purchase of an additional 7,500 units at $19
What would be the effect of this purchase on income before income taxes? What would be the effect of this purchase on income before income taxes using FIFO method?
Explanation / Answer
Under LIFO method it is assumed that last purchased is first sold.
Inventory at the beginning of the year=15,000 units.@ 16
Purchased during the year=65,000 units @ $19.
Units sold =66,500 .
Cost of goods sold if the purchases is not made =65,000* $19+ 1,500*$16
=$1,259,000.--------------(A)
If the purchases are made then
Cost of goods sold=7.500*19+(66,600 -7,500)*$19.
=$1,263,500-----(B)
There is an increase in cost of goods sold to the extent of (B-A) =$$4,500.
So, this purchase would reduce income before income taxes by $4,500, as the cost of goods sold has increased to the extnet of $4,500.
If FIFO method is used:
Under FIFO method, It is assumed whatever purchased first is sold first.
Therefore cost of goods sold = 15,000 units* $16+(66,500 -15,000) units*$19
=$240,000+$978,500
=$1,218,500
Still there is a stock of 13,500 units @$19. If new purchases are made then they would be in closing stock, making the closing stock as 13500 +7,500 units @$19 per unit. ie., 21,000 units @$19 per unit.
There would be no change in the income before incomes taxes, because always whatever purchsed first is sold first, hence the opening stock is cleared first and then from the purchases of the year, As already the purchases are enough to cover the balance sales of the year, the new purchase proposal will only add the units in the closing stock and no impact on the cost of goods sold and there by no impact on income before income taxes.