Answer:
Phantom profit = $680
Explanation:
Phantom profits or illusionary profits are used in the context of inventory, during periods of rising costs. It is the difference between profit reported using the historical cost and the profit that would have been reported if the replacement cost was used. To understand this, we need to know the cost of goods sold under both the LIFO and FIFO methods.
Total inventory:
1. 320 units x $5 = $1600
2. 420 units x $6 = $2520
3. 360 units x $7 = $2520
If ending inventory was 400 units, the number of units sold =
Total inventory - ending inventory
(320 + 420 + 360) - 400 = 700 units
FIFO is where by the inventory that first enters the business is the one used first. Common for inventory consisting of perishable goods.
This would be used up as:
1. 320 units x $5 = $1600
2. 380 units x $6 = $2280
Hence, COGS under FIFO = $2280 + $1600 = $3880
LIFO is a method of inventory valuation where the inventory that comes in last is first to be used. This is common in bulk inventory stacked one on top of the other. COGS under this method:
1. 360 units x $7 = $2520
2. 340 units x $6 = $2040
Thus, COGS under LIFO is $2520 + $2040 = $4560
COGS is $4560 when using LIFO and $3880 when using FIFO. Thus, the phantom profit is $4560 - $3880 = $680.
