Question

In: Accounting

Jim has recently opened a dry fruits wholesale company dedicated to the sale of peanuts, almonds...

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: Purchase of Pistachios: Purchase of Almonds:
Purchas of Peanuts:
February 3: Purchase of Pistachios: Purchase of Almonds:
Purchas of Peanuts:
February 6: Sold to several clients: Pistachios:
Almonds:
Peanuts:
February 6: Sold to Fruits Lovers Inc.:
Kg Price per Kg 2500 $12
4000 $7
6000 $5
1500 $14 2000 $8 2000 $6
2000 $22 2500 $13 3000 $9
Amount $30,000 $28,000 $30,000
$21,000 $16,000 $12,000
$44,000 $32,500 $27,000

Pistachios: 500 $22 Almonds: 1000 $13 Peanuts: 1500 $10
February 12 Purchase of Pistachios: 1500 $16 Purchase of almonds: 2000 $10
February 13: Sale of peanuts to Peanuts Lovers Inc.: 3500 $10 February 14: Purchase of Peanuts 6000 $6
February 19: Sold to several clients:
Pistachios: 1000 $23 Almonds: 1500 $15 Peanuts: 3000 $11
February 25: Purchased from various suppliers:
Pistachios: 1000 $15 Almonds: 1000 $11 Peanuts: 1000 $6
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
$11,000 $13,000 $15,000
$24,000 $20,000
$35,000 $36,000
$23,000 $22,500 $33,000
$15,000 $11,000 $6,000
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)
3: In order to compare with the records made by his accountant, Jim asks you to prepare the different journal entries for the purchases and sales mentioned above for each one of the 3 different methods used above. (15 points)
4: Jim’s accountant insisted that he should use a perpetual inventory system instead of a periodic inventory system and the average cost method for valuating the inventory. Do you agree with this advice (justify your answer)? Would the balance of the inventory at the end of the month be the same? And the net income? (15 points)
5: Jim would like to know a forecast of the number of days to sell the inventory based on the results of the month of February. Explain your calculation and the steps followed. (10 points: 5 for calculation and 5 for explanation)
6. Jim expects that the prices of the merchandises will dramatically decrease in the next future as a result of the Covid 19 crisis. Which method of valuation of the inventory would you thus recommend to Jim? Explain your answer. (5 points)

Solutions

Expert Solution

Part 2:

Income Statement based on FIFO (First in First Out)

Pistachios Almonds Peanuts Total
Revenue from Sales $        78,000 $        68,000 $        110,000 $   256,000
Cost of goods sold (FIFO) $        44,000 $        36,000 $           60,000 $   140,000
Gross Profit $        34,000 $        32,000 $           50,000 $   116,000
Less: Expenses
Salaries                      -                        -                          -   $        3,650
Electricity Bill                      -                        -                          -   $            360
Renting of Equipment                      -                        -                          -   $            950
Rent of Warehouse and Office                      -                        -                          -   $        1,650
Miscellaneous                      -                        -                          -   $        1,250
Total Expenses                      -                        -                          -   $        7,860
Net Profit $   108,140

Under FIFO basis inventory which is purchased first is sold out first. Therefore, the total quantity of Pistachios sold is 3500 KG which is sold first from Pistachios purchased on 02 February (2500 KG) and then from 03 February (1000 KG). The remaining quantity and its equivalent cost form part of the Closing Inventory. The same is followed for the other two that is Almonds and Peanuts.

The cost of goods sold valuation using a FIFO basis method uses this technique " START FROM FIRST".

Cost of Good Sold Statement (FIFO)-Pistachios
Quantity Price per unit Total COGS
02-Feb                         2,500 $                    12 $                        30,000
03-Feb                         1,000 $                    14 $                        14,000
$                        44,000
Cost of Good Sold Statement (FIFO)-Almonds
Quantity Price per unit Total COGS
02-Feb                         4,000 $                      7 $                        28,000
03-Feb                         1,000 $                      8 $                          8,000
$                        36,000
Cost of Good Sold Statement (FIFO)-Peanuts
Quantity Price per unit Total COGS
02-Feb                         6,000 $                      5 $                        30,000
03-Feb                         2,000 $                      6 $                        12,000
14-Feb                         3,000 $                      6 $                        18,000
$                        60,000

Income Statement based on FIFO (Last in First Out)

Pistachios Almonds Peanuts Total
Revenue from Sales $        78,000 $        68,000 $        110,000 $   256,000
Cost of goods sold (FIFO) $        49,000 $        41,500 $           60,000 $   150,500
Gross Profit $        29,000 $        26,500 $           50,000 $   105,500
Less: Expenses
Salaries                      -                        -                          -   $        3,650
Electricity Bill                      -                        -                          -   $            360
Renting of Equipment                      -                        -                          -   $            950
Rent of Warehouse and Office                      -                        -                          -   $        1,650
Miscellaneous                      -                        -                          -   $        1,250
Total Expenses                      -                        -                          -   $        7,860
Net Profit $      97,640

Under the LIFO basis of Inventory valuation, the inventory which is purchased at last as on the date of sale is sold out first. The total sales of Almond were 5000 KG. Therefore, for sale made on 06 February of 3500 KG adjusts first, purchase made on 03 February of 2000 KG ($16,000), then the remaining 1500 KF is adjusted from a purchase made on 02 February ($10500). The sales made on 19 February is adjusted from the Purchase made last that is on 12 February. The same is followed for the other two that are Pistachios and Peanuts.

The cost of goods sold valuation using a FIFO basis method uses this technique " START FROM LAST".

Cost of Good Sold Statement (LIFO)-Pistachios
Quantity Price per unit Total COGS
03-Feb                         1,500 $                    14 $                        21,000
02-Feb                         1,000 $                    12 $                        12,000
12-Feb                         1,000 $                    16 $                        16,000
$                        49,000
Cost of Good Sold Statement (LIFO)-Almonds
Quantity Price per unit Total COGS
03-Feb                         2,000 $                      8 $                        16,000
02-Feb                         1,500 $                      7 $                        10,500
12-Feb                         1,500 $                    10 $                        15,000
$                        41,500
Cost of Good Sold Statement (LIFO)-Peanuts
Quantity Price per unit Total COGS
03-Feb                         2,000 $                      6 $                        12,000
02-Feb                         2,500 $                      5 $                        12,500
02-Feb                         3,500 $                      5 $                        17,500
14-Feb                         3,000 $                      6 $                        18,000
$                        60,000

Income Statement based on FIFO (Average Cost)

Pistachios Almonds Peanuts Total
Revenue from Sales $        78,000 $        68,000 $        110,000 $   256,000
Cost of goods sold (FIFO) $        48,462 $        41,667 $           61,600 $   151,729
Gross Profit $        29,538 $        26,333 $           48,400 $   104,271
Less: Expenses
Salaries                      -                        -                          -   $        3,650
Electricity Bill                      -                        -                          -   $            360
Renting of Equipment                      -                        -                          -   $            950
Rent of Warehouse and Office                      -                        -                          -   $        1,650
Miscellaneous                      -                        -                          -   $        1,250
Total Expenses                      -                        -                          -   $        7,860
Net Profit $      96,411

Under the Average Cost method of Inventory Valuation, Cost of Goods sold is determined by computing an average value that is,

Cost of Goods Sold of Peanuts

The same is followed for the other two that is Pistachios and Almonds.

Working Note:

Part 3:

The Journal entry for Purchases and Sales would be the same for each of the 3 methods which are as follows:

Date Account Titles and Explanation Debit Credit
$ $
02-Feb Purchase of Pistachios          30,000
Purchase of Almonds          28,000
Purchase of Peanuts          30,000
Cash          88,000
To record the purchase of dry fruits
03-Feb Purchase of Pistachios          21,000
Purchase of Almonds          16,000
Purchase of Peanuts          12,000
Cash          49,000
To record the purchase of dry fruits

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