Question

On Jan 1, Bike Mart had a beginning inventory of 20 bicycles which it purchased for $365 each.

During January, the company purchases four more bicycles for $400 each. None were sold in January.

On February 15, the company purchases five more bicycles for $450 each.

Between February 16 and 28, Bike Mart sells 10 of these bicycles.

a.) Calculate Bike Mart’s Ending Inventory Balance (in dollars) at the end of February and Cost of Goods Sold through February using the FIFO Method. (show all work.)

b.) Calculate Bike Mart’s Ending Inventory Balance (in dollars) at the end of February and Cost of Goods Sold through February using the Weighted Average Method. (show all work.)

c.) At the end of February, will Bike Mart’s Net Income (profits) on its Income Statement be higher if it uses the FIFO or Weighted Average Inventory Method? Why?

e.) At the end of February, will Bike Mart’s Inventory Turnover Ratio be higher if it uses the FIFO or Weighted Average Inventory Method? Why?

Answer 1

It is given that,

Beginning inventory = 20 bicycles at $365 each = $7,300

Purchase during January = 4 bicycles at $400 each = $1,600

Purchase during February = 5 bicycles at $450 each = $2,250

Cost of goods available for sale = Beginning inventory + January Purchases + February Purchases = $7,300 + $1,600 + $2,250 = $11,150

Cost of goods sold:

Units sold = 10 bicycles

a) FIFO:
As per FIFO method, the units purchased first are sold first. Therefore, the goods are sold from the beginning inventory. Here, 10 units are sold. The beginning inventory has a balance of 20 units. Therefore, all the 10 units sales are made from the beginning inventory under FIFO method.

Cost of goods sold = Units sold × Unit Cost = 10 × $365 = $3,650

Ending inventory = Cost of goods available for sale - Cost of goods sold = $11,150 - $3,650 = $7,500

b) Weighted Average Method:
As per weighted average method, the weighted average per unit cost of goods available for sale is calculated.

Weighted average inventory per unit = Total Cost of goods available for sale ÷ Total quantity of goods available for sale

Cost of goods available for sale = $11,150

Units available for sale = 20 + 4 + 5 = 29 bicycles

Weighted average inventory per unit = $11,150 ÷ 29 = $384.48275862068

Cost of goods sold = Units sold × Weighted average inventory per unit = 10 × $384.48275862068 = $3,845

Ending inventory = Cost of goods available for sale - Cost of goods sold = $11,150 - $3,845 = $7,305

c) It is the common rule that Sales - Cost of goods sold = Gross profit.
Higher the cost of goods sold, lower will be gross profit. Lower the cost of goods sold, higher will be the gross profit.
Similarly, Net income on Income Statement will be lower if the cost of goods sold is higher and it will be higher if the cost of goods sold is lower.
Under FIFO method the cost of goods sold is $3,650 and under weighted average inventory method, the Cost of goods sold is $3,845.

Therefore, Bike Mart’s Net Income (profits) on its Income Statement will be higher if it uses the FIFO method, because it reported lower cost of goods sold. It's because the unit cost of goods sold under FIFO (from beginning inventory) is less compared to weighted average cost.

e) Inventory turnover ratio is Cost of goods sold divided by Average inventory.

● FIFO method:

Cost of goods sold = $3,650

Beginning inventory = $7,300
Ending inventory = $7,500

Average inventory = ($7,300 + $7,500) ÷ 2 = $7,400

Inventory turnover ratio = Cost of goods sold ÷ Average inventory = $3,650 ÷ $7,400 = 0.49

● Weighted average inventory method:

Cost of goods sold = $3,845

Beginning inventory = $7,300
Ending inventory = $7,305

Average inventory = ($7,300 + $7,305) ÷ 2 = $7,302.5

Inventory turnover ratio = Cost of goods sold ÷ Average inventory = $3,845 ÷ $7,302.5 = 0.52

At the end of February, Bike Mart’s Inventory Turnover Ratio will be higher if it uses Weighted Average Inventory Method. It is because the cost of goods sold under weighted average inventory is higher than under FIFO method. Similarly, the ending inventory is lower under weighted average method as compared to FIFO method. Therefore, the inventory turnover ratio is higher under weighted average method.