Question

February 2:                                 KG             PRICE PER KG         AMOUNT

Purchase of Pistachios:          2500                 $12                     $30,000

Purchase of Almonds:            4000                 $7                       $28,000
Purchas 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.

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

Answer 1

The three methods of inventory Valuation includes:

1) Average Cost Method = It is also called weighted Average Cost Method and in this method the stock is valuedbased on the formula

Average Cost = TotalInward Value for the year / Total Inward Quantity for the year.

In case of monthly Average Cost Method, the weighted average cost is determined on monthly basis instead of annual.

2)FIFO Method - Under this method, items that are purchased first are sild first. . Hence Cost of goods sold is based upon cost of materials received first in the period, while the cost of inventory is based upon the cost of material received last in the period. This method is adopted by business when cost of item are decreasing (deflation) and this will result in lower taxable income.

3) LIFO (Last In First Out) Under LIFO system, it is assumed that iitems purchased last are sold first . Hence Cost of goods sold is based upon cost of materials received last in the period, while cost of inventory is based upon the cost of material received first in the period.

This method is adopted by the business when the cost of item are increasing (Inflation) and this will result in lower taxable income.

Here we will calculate Cost of Goods sold in two cases under FIOF and LIFO , so that we will be able to calculate net Income in each case.

FIFO Method

Date	Particulars	Purchases			Issue			Balance
		Quantity	Rate	Amount	Quantity	Rate	Amount	Quantity	Rate	Amount
Feb 2	Purchases	Pistachios = 2500	12	30,000				Pistachios = 2500		30,000
		Almonds = 4,000	7	28,000				Almonds = 4,000		28,000
		Peanuts = 6,000	5	30,000				Peanuts = 6,000		30,000
Feb 3	Purchases	Pistachios = 1500	14	21,000				Pistachios = 4000		51,000
		Almonds = 2,000	8	16,000				Almonds = 6,000		44,000
		Peanuts = 2,000	6	12,000				Peanuts = 8,000		42,000
Feb 6	Sales				Pistachios = 2,000	12	24,000	2,000		27,000
					Almonds = 2500	7	17,500	3500		26,500
					Peanuts = 3000	5	15,000	5,000		27,000
Feb 6	Sales				Pistachios = 500	12	6,000	1500		21,000
					Almonds = 1000	7	7,000	2500		19,500
					Peanuts = 1500	5	7500	3500		19,500
Feb 12	Purchases	Pistachios = 1500	16	24,000				3,000		45,000
		Almonds = 2000	10	20,000				4500		39,500
								3500		19,500
Feb 13	Sales				Peanuts = 3500	1500 kg = 5 per kg 2,000 = 6 per kg	19500	Peanuts = NIL		NIL
Feb 14	Purchases	Peanuts = 6,000	6	36,000				6,000	6	36,000
Feb 19	Sales				Pistachios = 1000	14	14,000	2,000		31,000
					Almonds = 1500	500 = 7 per kg 1000 kg = 8 per kg	11,500	3000		28,000
					Peanuts = 3000	6	18,000	3000		18,000
Feb 25	Purchases	Pistachios = 1000	15	15000				Pistachios = 3000		46,000
		Almonds = 1000	11	11000				Almonds = 4000		39,000
		Peanuts = 1000	6	6000				Peanuts = 4000		24,000
	Total

Sales =

Pistachios = 78,000

Almonds = 68,000

Peanuts = 110,000

Total Sales = 2,56,000

Less:

Cost of Goods Sold = 140,000

Pistachios = 44,000

Almonds = 36,000

Peanuts = 60,000

Less :

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

Rent of warehouse and office: $1.650

Miscellaneous: $1.250

Net Income (Under FIFO Method ) = 111,037.1

Computation of Net Income under LIFO

Sales =

Pistachios = 78,000

Almonds = 68,000

Peanuts = 110,000

Total Sales = 2,56,000

Less:

Cost of Goods Sold = 150,500

Pistachios = (27,000 + 6,000 + 16,000) = 49,000

Almonds = (19,500 + 7,000 + 15,000) = 41,500

Peanuts = (17,000 + 7,500 + 17,500 + 18,000) = 60000

Less :

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

Rent of warehouse and office: $1.650

Miscellaneous: $1.250

Net Income (Under LIFO Method ) = 100,537.1