Question

AAA Hardware uses the LIFO method to value its inventory. Inventory at the beginning of the year consisted of 10,000 units of the company’s one product. These units cost $15 each. During the year, 60,000 units were purchased at a cost of $18 each and 64,000 units were sold. Near the end of the fiscal year, management is considering the purchase of an additional 5,000 units at $18. Required: 1. What would be the effect of this purchase on income before income taxes? Income before income taxes would be $_________ 2. What would be the effect of this purchase on income before income taxes using FIFO method? Income before income taxes would be $___________"

Answer 1

Answer:

1. Net income decreases by $12,000

2. The amount of net income would be remains the same.

Explanation:

1. Under LIFO method

(i) Before 5,000 units purchased:

sales = 64,000 units

Cost of goods sold = Quantity × Price

                                = (60,000 × $18) + (4,000 × $15)

                                = $1,080,000 + $60,000

                                = $1,140,000

(ii) If 5,000 units purchased at $18 each then,

Cost of goods sold = Quantity × Price

                                = 64,000 × $18

                                = $1,152,000

As the cost of goods increases as a result there will be decrease in the net income before tax under LIFO method.

The amount of net income would be decreased by:

= $1,152,000 - $1,140,000

= $12,000

2. Under FIFO method:

(i) Before 5,000 units purchased:

sales = 64,000 units

Cost of goods sold = Quantity × Price

                                = (10,000 × $15) + (54,000 × $18)

                                = $150,000 + $972,000

                                = $1,122,000

(ii) If 5,000 units purchased at $18 each then,

Cost of goods sold = Quantity × Price

                                = (10,000 × $15) + (54,000 × $18)

                                = $150,000 + $972,000

                                = $1,122,000

As there will be no change in the cost of goods sold, so, there will be no change in the net income before tax under FIFO method.

The amount of net income would be remains the same.