Question

AAA Hardware uses the LIFO method to report its inventory. Inventory at the beginning of the year consisted of 23,000 units of the company’s one product. These units cost $14 each. During the year, 73,000 units were purchased at a cost of $17 each and 80,500 units were sold. Near the end of the fiscal year, management is considering the purchase of an additional 9,000 units at $17. Required: 1. What would be the effect of this purchase on income before income taxes? 2. What would be the effect of this purchase on income before income taxes using FIFO?

Answer 1

1) Under LIFO method the goods purchased last are sold first and cost of good sold represents the current prices of goods. In the given case if additional 9,000 units are not purchased then cost of goods sold would be:-

Cost of goods sold = (73,000 units*$17)+[(80,500-73,000)*$14]

= $1,241,000+$105,000 = $1,346,000

But if additional 9,000 units purchased, then cost of goods sold would be $1,368,500 (i.e. 80,500 units*$17 per unit). (As then all units sold would be only from current purchases (i.e. at $17) not from beginning inventory).

Therefore cost of goods sold will increase from $1,346,000 to $1,368,500 if additional 9,000 units purchased.

Hence income before income taxes would decrease if additional units purchased.

2) Under FIFO method the goods purchased first are sold first which means cost of goods sold would include 23,000 units of beginning inventory at $14 and remaining 57,500 units (80,500-23,000) purchased at $17.

The cost of goods sold would be same even if additional units purchased (Under FIFO Method).

Therefore income before income taxes using FIFO would remain same if additional units purchased.