JOAN HOLTZ

Question 1
The difference in treatment will create
differences in other parts of the Income
Statement, such as the margins
Deduction Other Income Period Expense
Sales Revenue 100,000 100,000 100,000 Assumes the following:
Cost of Goods Sold 60,000 70,000 50,000 Sales Revenue 100,000
Gross Profit 40,000 30,000 50,000 Inventory sold (w/o discounts) 70,000
Gross Profit % 40.00% 30.00% 50.00% Purchase discounts taken 10,000
Operating Expenses 10,000 10,000 10,000 Purchase discounts not taken 10,000
Discounts Not Taken 0 0 10,000 Operating expenses 10,000
Operating Income 30,000 20,000 30,000
Operating Income % 30.00% 20.00% 30.00%
Other Income/(Expense) 0 10,000 0
Income Before Tax 30,000 30,000 30,000
Income Before Tax % 30.00% 30.00% 30.00%
Question 2
Since these inventory amounts are not
related to the sales of the goods which
generated the revenues of the period, they
should be reported as a period expense

Ex.
Inventory shrinkage 100
Merchandising Inventory 100
Question 3
Proponents of LIFO acknowledge that the
assumption is realistic in terms of
representing actual inventory amounts on
hand. However, LIFO is a better
approximation of the companys current
true gross margin, since it reflects the
most current inventory costs versus
revenues.
Question 4
In both cases, the FIFO method would
result in a more accurate figure for the
cost of actual inventories sold and
inventories on-hand. However, LIFO would
better approximate the companys true
gross margin and profitability. So, neither
dealer is strictly wrong. Both methods
have their advantages and disadvantages.
Question 5
a. Yes. Having a high-turnover of items
means that inventory does not last long
before being sold, so the price differences
are likely to be less varied
B. Yes. Since the average cost method
uses the average inventory cost of all
inventory, cost of sales, and therefore net
income, will be somewhere in between the
cost of sales derived from FIFO or LIFO
Question 5
C. No. It will depend on the amount of
goods purchased and sold in the two
years.
Example
In 2008, inventory prices that were 15 rose to 20. In 2009, this inventory
dropped back to 15.
Cost of goods sold
USING LIFO USING FIFO
Beginning Inventory 0 0
Purchased 100 units @ 20 each in 2008
Sold 80 Units in 2008 1600 1600
Purchased 80 units @ 15 each in 2008
Sold 80 Units in 2009 1200 1300
Total cost of goods sold (2008 and 2009) 2800 2900
Question 6
In most cases, using the LIFO method
would result inventories which are valued
at lower than market price. However,
reasons such as deterioration or damage
to inventory on hand will cause its value to
drop even lower than its cost. In line with
the conservatism concept, the value must
be written down to market value.
Question 7
Profit would increase to 740,000 and inventory
cost would decrease to 0.98 per gallon
Pretax Profit = Revenue - Costs Variable costs = 0.7 + 0.2
600,000 = Revenue - 1,000,000 Variable costs = 0.9
Revenue = 1,600,000 Fixed costs = 0.1 * 1,000,000
Revenue per gallon = 1.6 Fixed costs = 100,000
Income @ 1,200,000
Revenue 1,920,000
Variable Costs 1,080,000
Fixed Costs 100,000
Income 740,000
Total manufacturing costs 1,180,000
Inventory cost per gallon 0.98
Question 8
To be consistent with matching concept, the cost of producing the
sales should match the period when the revenue is recognized.
Therefore:
Total costs 1,000,000
Total revenue 1,600,000
Year 1 Year 2 Year 3+
Revenue generated 1,000,000 300,000 300,000
Percentage of total 0.6250 0.1875 0.1875
Costs 625,000 187,500 187,500
62.% percent of total costs, or 625,000, should be reported as cost
of sales in year 1. Advertising and promotions will not affect this
total, since they are not part of costs associated with producing the
inventory