Question

You have been given responsibility for overseeing a bank’s small business loans division. The bank has included loan covenants requiring a minimum current ratio of 1.60 in all small business loans. When you ask which inventory costing method the covenant assumes, the previous loans manager gives you a blank look. To explain to him that a company’s inventory costing method is important, you present the following balance sheet information.

Current assets other than inventory	$	20
Inventory		(a	)
Other (noncurrent) assets		127
Total assets	$	(b	)
Current liabilities	$	56
Other (noncurrent) liabilities		64
Stockholders’ equity		(d	)
Total liabilities and stockholders’ equity	$	(c	)

You ask the former loans manager to find amounts for (a), (b), (c), and (d) assuming the company began the year with 5 units of inventory at a unit cost of $13, then purchased 8 units at a cost of $14 each, and finally purchased 6 units at a cost of $18 each. A year-end inventory count determined that 4 units are on hand.

Required:

1. Determine the amount for (a) using FIFO, and then calculate (b) through (d).
2. Determine the amount for (a) using Weighted Average, and then calculate (b) through (d).
3. Determine the amount for (a) using LIFO, and then calculate (b) through (d).
4. Determine the current ratios using (i) FIFO, (ii) Weighted Average, and (iii) LIFO
5. Determine whether the company would be in violation or compliance with the loan covenant if the company were to use (i) FIFO, (ii) Weighted Average, and (iii) LIFO.

Answer 1

1	As per FIFO,Goods purchased first are sold first.
	Hence,ending inventory conist of latest purchases
	Ending inventory of 4 units consist of:
					$
	Final purchase		4 units at $ 18		72
	(a)=Inventory=$ 72
	(b)=Total assets:
					$
	Current assets other than inventory				20
	Inventory				72
	Other (noncurrent) assets				127
	Total assets				219
	(c )=Total liabilities and stockholders’ equity=Total assets=$ 219
	(d)=Stockholder's equity=Total liabilities and stockholders’ equity-Current liabilities-Other liabilities=219-56-64=$ 99
3	Ending inventory=Units in ending inventory*Weighted average cost per unit
	Weighted average cost per unit:
				Units	Rate	Cost
				a	b	a*b
	Beginning inventory			5	13	65
	First purchase			8	14	112
	Second purchase			6	18	108
				19		285
	Weighted average cost per unit=285/19=$15 per unit
	(a)=Inventory=4*15=$ 60
	(b)=Total assets:
					$
	Current assets other than inventory				20
	Inventory				60
	Other (noncurrent) assets				127
	Total assets				207
	(c )=Total liabilities and stockholders’ equity=Total assets=$ 207
	(d)=Stockholder's equity=Total liabilities and stockholders’ equity-Current liabilities-Other liabilities=207-56-64=$ 87
3	As per LIFO,Goods purchased last are sold first.
	Hence,ending inventory conist of earlier purchases
	Ending inventory of 4 units consist of:
					$
	Beginning balance		4 units at $ 13		52
	(a)=Inventory=$ 52
	(b)=Total assets:
					$
	Current assets other than inventory				20
	Inventory				52
	Other (noncurrent) assets				127
	Total assets				199
	(c )=Total liabilities and stockholders’ equity=Total assets=$ 199
	(d)=Stockholder's equity=Total liabilities and stockholders’ equity-Current liabilities-Other liabilities=199-56-64=$ 79