Evaluating the LIFO and FIFO Choice When Costs Are Rising and Falling (AP7-3)
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 | PRICES FALLING
| ||
| Situation A FIFO | Situation B FIFO | Situation C FIFO | Situation D FIFO |
Sales revenue | $15,000 | $15,000 | $15,000 | $15,000 |
Cost of goods sold: |
|
|
|
|
Beginning inventory | 3,300 | ? | ? | ? |
Purchases | 4,800 | ? | ? | ? |
Goods available for sale | 8,100 | ? | ? | ? |
Ending inventory | 2,400 | ? | ? | ? |
Cost of goods sold | 5,700 | ? | ? | ? |
Gross pro fit | 9,300 | ? | ? | ? |
Expenses | 4,000 | 4,000 | 4,000 | 4.000 |
Pretax income | 5,300 | ? | ? | ? |
Income tax expen se (30% ) | 1,590 | ? | ? | ? |
Net income | $ 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 $11 = $4,400. Use periodic inventory procedures.
2. Analyze the relative effects on pretax income and on net income as demonstrated by requirement 11) 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.
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