Question

Jim has recently opened a dry fruits wholesale company dedicated to the sale of peanuts, almonds and pistachios. During its first month of activity, the company has made the following transactions:

February 2:                                 KG             PRICE PER KG         AMOUNT

Purchase of Pistachios: 2500                 $12                     $30,000

Purchase of Almonds   4000 $7                       $28,000
Purchase of Peanuts 6000 $5 $30,000

February 3:                               KG             PRICE PER KG         AMOUNT

Purchase of Pistachios:       1500                  $14                     $21,000

Purchase of Almonds:         2000                   $8                      $16,000
Purchas of Peanuts:            2000                   $6                      $12,000

February 6: Sold to several clients:      

                                                   KG              PRICE PER KG         AMOUNT

Pistachios:                            2000                 $22                       $44,000

Almonds:                              2500                 $13                       $32,500

Peanuts:                               3000                  $9                        $27,000

February 6: Sold to Fruits Lovers Inc:

                                           KG               PRICE PER KG       AMOUNT

Pistachios:                      500 $22 $11,000

Almonds:                        1000                  $13                         $13,000

Peanuts:                         1500   $10 $15,000

February 12:                     

                                                KG                   PRICE PER KG AMOUNT

Purchase of Pistachios: 1500 $16 $24,000

Purchase of Almonds: 2000 $10 $20,000

February 13: Sale of peanuts to peanuts lovers Inc...:

                                           KG                    PRICE PER KG             AMOUNT

                                          3500 $10                               $35,000

February 14:  Purchase of Peanuts

                                         KG                       PRICE PER KG                  AMOUNT

                                        6000                      $6                                     $36,000

February 19:  Sold to several clients:

KG PRICE PER KG AMOUNT

  PISTACHIOS: 1000 $23                                  $23,000

  Almonds: 1500 $15                                  $22,500

  Peanuts: 3000 $11                                  $33,000

February 25: Purchased from various suppliers:

                                          KG                     PRICE PER KG                AMOUNT

Pistachios:                      1000                    $15                                $15,000

Almonds:                        1000                    $11                                $11,000

Peanuts:                         1000                     $6                                  $6,000

Besides these transactions, the company has had the following expenses:

Salaries: $3650
Electricity bill: $360
Renting of equipment: $950

Rent of warehouse and office: $1.650

Miscellaneous: $1.250

Jim’s accountant recommended that he should use the average cost method in order to determine the cost of the inventory sold but he is not sure about the consequences it may have on his financial situation.

Relying on your accounting knowledge, Jim asks you the following questions:

1: Why in your opinion did Jim’s accountant recommend the average cost method and what difference is there with the three other methods? Explain the main characteristics of each method of valuation of the inventory and the consequences they may have on the valuation of the inventory and determination of the net income in case of price fluctuation. (20 points)

2: Prepare an Income statement of the company at the end of February using as method of valuation of the inventory the average cost method, FIFO and LIFO for each one of the products sold by Jim, and calculate the balance of the inventory at the end of the month. Explain the calculations. (40 points: 30 points for the calculation and 10 for explanations)

Answer 1

There are three methods of inventory valuation, namely:

1. FIFO (first in first out) - It is a method used for cost flow assumption purposes in the cost of goods sold calculation. The FIFO method assumes that the oldest products in a company’s inventory have been sold first. The costs paid for those oldest products are the ones used in the calculation.

2. LIFO (last in first out) - It is a method used for cost flow assumption purposes in the cost of goods sold calculation. The LIFO method assumes that the most recent products added to a company’s inventory have been sold first. The costs paid for those recent products are the ones used in the calculation.

3. Weighted average method -

Under the weighted average cost method, the weighted average is used to determine the amount that goes into the cost of goods sold and inventory. Weighted average cost per unit is calculated as follows:

Weighted Average Cost Per Unit = Total Cost of Goods in Inventory / Total Units in Inventory

This method is commonly used to determine a cost for units that are indistinguishable from one another and it is difficult to track the individual costs.

Calculation of profit/loss by using weighted average method

PISTACHIOS ALMONDS PEANUTS

DATE	PARTICULARS	KGS	RATE	AMT	KGS	RATE	AMT	KGS	RATE	AMT
feb2	purchase	2500	12	30000	4000	7	28000	6000	5	30000
feb 3	purchase	1500	14	21000	2000	8	16000	2000	6	12000
	total	4000	12.75	51000	6000	7.33	44000	8000	5.25	42000
feb6	cost of sales to clients	-2000	12.75	-25500	-2500	7.33	-18333	-3000	5.25	-15750
feb6	cost of sales to fruit lovers	-500	12.75	-6375	-1000	7.33	-7333	-1500	5.25	-7875
	balance	1500	12.75	19125	2500	7.33	18333	3500	5.25	18375
feb12	purchase	1500	16	24000	2000	10	20000	-	-	-
	total	3000	14.38	43125	4500	8.52	38333	3500	5.25	18375
feb13	cost of sales to peanut lovers	-	-	-				-3500	5.25	-18375
	balance	3000	14.38	43125	4500	8.52	38333	-	-	-
feb14	purchase	-	-	-	-			6000	6	36000
	total	3000	14.38	43125	4500	8.52	38333	6000	6	36000
feb19	cost of sales to several clients	-1000	14.38	-14375	-1500	8.52	-12778	-3000	6	-18000
	balance	2000	14.38	28750	3000	8.52	25556	3000	6	18000
feb25	purchased from various suppliers	1000	15	15000	1000	11	11000	1000	6	6000
	closing balance	3000	14.58	43750	4000	9.14	36556	4000	6	24000

FIFO - in fifo oldest inventory is used first, which will leave out the most expensive inventory in an environment where price is rising. Though FIFO can increase net income by this but that will also increase tax liability.consequences on valuation of inventory in:

LIFO - in fifo newest inventory is used first, which means that the old invnentory which was cheaper would be sold later. In an environment which is in inflation, the cost of goods sold will be high under lifo becasue new inventory is now expensive. Company wouth therefor have less profits and less tax liability.

Average cost - this method would give a balanced report which will not result in undue inflation or deflation in comparison with above methods.

2.

particulars	WAM	FIFO	LIFO
income: revenue from operations total income Expense: COGS other expense: -salary -electricity -rent equipment -rent warehouse =misc total expense	256000 256000 144694 3650 360 950 1650 1250 152554	256000 256000 140000 3650 360 950 1650 1250 147860	256000 256000 150500 3650 360 950 1650 1250 158360

Net profit: 103446 108140 97640