Effect of FIFO versus LIFO on income tax expense

Accounting for Inventories

Exercise 5-7A Effect of FIFO versus LIFO on income tax expense

The Brick Company had cash sales of $280,000 for Year 1, its first year of operation. On April 2, the company purchased 210 units of inventory at $390 per unit. On September 1, an additional 160 units were purchased for $425 per unit. The company had 110 units on hand at the end of the year. The company’s income tax rate is 40 percent. All transactions are cash transactions.

Required
a. The preceding paragraph describes five accounting events: (1) a sales transaction, (2) the first purchase of inventory, (3) a second purchase of inventory, (4) the recognition of cost of goods sold expense, and (5) the payment of income tax expense. Show the amounts of each event in horizontal statements models like the following ones, assuming first a FIFO and then a LIFO cost flow.

b. Compute net income using FIFO.
c. Compute net income using LIFO.
d. Explain the difference, if any, in the amount of income tax expense incurred using the two cost flow assumptions.
e. Which method, FIFO or LIFO, produced the larger amount of assets on the balance sheet?

Exercise 5-8A Recording inventory transactions using the perpetual method: intermittent sales and purchases

The following inventory transactions apply to Green Company for Year 2:

• Jan. 1 Purchased 260 units @ $50
• Apr. 1 Sold 130 units @ $85
• Aug. 1 Purchased 390 units @ $56
• Dec. 1 Sold 490 units @ $96

The beginning inventory consisted of 180 units at $48 per unit. All transactions are cash transactions.

Required

a. Record these transactions in general journal format assuming Green uses the FIFO cost flow assumption and keeps perpetual records.

b. Compute cost of goods sold for Year 2.

Exercise 5-9A Effect of cost flow on ending inventory: intermittent sales and purchases

The Hat Store had the following series of transactions for Year 2:

Required

a. Determine the quantity and dollar amount of inventory at the end of the year, assuming The Hat Store uses the FIFO cost flow assumption and keeps perpetual records.

b. Write a memo explaining why The Hat Store would have difficulty applying the weighted-average method on a perpetual basis.

Exercise 5-10A Lower-of-cost-or-market rule: perpetual system

The following information pertains to Hagen Metal Works’ ending inventory for the current year:

Required

a. Determine the value of the ending inventory using the lower-of-cost-or-market rule applied to (1) each individual inventory item and (2) the inventory in aggregate.

b. Prepare any necessary journal entries, assuming the decline in value is immaterial. Hagen Metal Works uses the perpetual inventory system. (Make entries for both methods.)

Exercise 5-11A Lower-of-cost-or-market rule

Brooks Company carries three inventory items. The following information pertains to the ending inventory:

Required

a. Determine the ending inventory that Brooks will report on the balance sheet, assuming that it applies the lower-of-cost-or-market rule to individual inventory items.

b. Prepare the necessary journal entry, assuming the decline in value was immaterial.

Exercise 5-12A Effect of inventory error on financial statements: perpetual system

Stubbs Company failed to count $55,000 of inventory in its Year 1 year-end physical count.

Required

Write a memo explaining how Stubbs Company’s balance sheet will be affected in Year 1. Assume Stubbs uses the perpetual inventory system.