Question

AP7-3) Page 1864 P7-5 Evaluating the LIFO and FIFO Choice When Costs Are Rising and Falling L07-2,7-3 Income is to be evaluated under four different situations as follows: a. Prices are rising: (1) Situation A: FIFO is used. (2) Situation B: LIFO is used. b. Prices are falling: (1) Situation C: FIFO is used. (2) Situation D: LIFO is used. The basic data common to all four situations are sales, 500 units for $15,000: beginning inventory, 300 units purchases. 400 units: ending inventory. 200 units and operating expenses. $4,000. The following tabulated income statements for each situation have been set up for analytical purposes: PRICES RISING Situation A FIFO Situation B LIFO $15.000 $15.000 PRICES FALLING Situation CFIFO Situation D LIFO $15,000 $15.000 Sales revenue Cost of goods sold: Beginning inventory Purchases Goods available for sale Ending inventory Cost of goods sold Gross profit Expenses Pretax income Income tax expense (30%) Net income 3.300 4.800 8.100 2.400 5.700 9.300 4.000 5.300 1.590 4.000 000 $ 3.710 Required: 1. Complete the preceding tabulation for each situation. In Situations A and B (prices rising), assume the following: beginning inventory, 300 units at $11 - $3.300; purchases, 400 units at $12 - $4.800. In Situations C and D (prices falling), assume the opposite that is, beginning inventory, 300 units at $12 - $3,600: purchases, 400 units at Sll - $4,400. Use periodic inventory procedures. 2. Analyze the relative effects on pretax income and net income as demonstrated by requirement (1) when prices are rising and when prices are falling. 3. Analyze the relative effects on the cash position for each situation. 4. Would you recommend FIFO or LIFO? Explain.

Answer 1

Solution of the above question is as under:

Income Statement
	PRICES RISING ($)		PRICES FALLING ($)
Particulars	Situation A FIFO	Situation B LIFO	Situation C FIFO	Situation D LIFO
Sales Revenue (500 Units)	15000	15000	15000	15000
Cost of Goods Sold:
Beginning Inventory (300 Units)	3300	3300	3600	3600
Purchases (400 Units)	4800	4800	4400	4400
Goods Available for Sale	8100	8100	8000	8000
Less: Ending Inventory (200 Units)	2400	2200	2200	2400
Cost of Goods Sold	5700	5900	5800	5600
Gross Profit	9300	9100	9200	9400
Less: Operating Expenses	4000	4000	4000	4000
Pre-Tax Income	5300	5100	5200	5400
Income Tax Expense (30%)	1590	1530	1560	1620
Net Income	3710	3570	3640	3780

2) When the prices of the goods rise, it is clearly visible from the above table that the Gross Profit and Net Operating Income under FIFO is higher than LIFO. Thus, FIFO usually produce higher gross profit and Net Income than LIFO when the prices of the goods have a rising trend.

Similarly. when the prices of the goods fall, it is clearly visible from the above table that the Gross Profit and Net Operating Income under LIFO is higher than FIFO. Thus, LIFO usually produce higher gross profit and Net Income than FIFO when the prices of the goods has a decreasing trend.

3) When the prices of the goods has a rising trend, Pre-Tax Income and Net Operating Income is higher under FIFO thereby position of Cash is more under FIFO as compared to LIFO and similarly When the prices of the goods has a decreasing trend the position of cash is more under LIFO as compared to FIFO

4)

Recommendation

When the prices of the goods has a rising trend, FIFO is recommended

When the prices of the goods has a falling trend, LIFO is recommended