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)

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)

Answer 1

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
06-Feb	Accounts Receivables	103,500
	Sale of Pistachios		44,000
	Sale of Almonds		32,500
	Sale of Peanuts		27,000
	To record sales of dry fruits to several clients on credit
06-Feb	Accounts Receivables	39,000
	Sale of Pistachios		11,000
	Sale of Almonds		13,000
	Sale of Peanuts		15,000
	To record sales of dry fruits to Fruits Lovers Inc.
12-Feb	Purchase of Pistachios	24,000
	Purchase of Almonds	20,000
	Cash		44,000
	To record the purchase of dry fruits
13-Feb	Accounts Receivables	35,000
	Sale of Peanuts		35,000
	To record sales of dry fruits to Peanuts Lovers Inc.
14-Feb	Purchase of Peanuts	36,000
	Cash		36,000
	To record purchase of peanuts
19-Feb	Accounts Receivables	78,500
	Sale of Pistachios		23,000
	Sale of Almonds		22,500
	Sale of Peanuts		33,000
	To record sales of dry fruits to various clients
25-Feb	Purchase of Pistachios	15,000
	Purchase of Almonds	11,000
	Purchase of Peanuts	6,000
	Cash		32,000
	To record the purchase of dry fruits

Part 4:

Closing Inventory in each of three methods

Calculation of Closing Inventory FIFO
	Pistachios	Almonds	Peanuts
Total Purchases	90,000	75,000	84,000
Total COGS from Income Statement	44,000	36,000	60,000
Closing Inventory	46,000	39,000	24,000

Calculation of Closing Inventory LIFO
	Pistachios	Almonds	Peanuts
Total Purchases	90,000	75,000	84,000
Total COGS from Income Statement	49,000	41,500	60,000
Closing Inventory	41,000	33,500	24,000

Calculation of Closing Inventory Average Cost
	Pistachios	Almonds	Peanuts
Total Purchases	90,000	75,000	84,000
Total COGS from Income Statement	48,462	41,667	61,600
Closing Inventory	41,538	33,333	22,400