Question

This task assesses the following learning outcomes:

• Critically understand the differences between the methods of valuation of the inventory
• Knowing how to properly elaborate an income statement and determine the ending inventory balance.

Submission file format: Excel document with all the answers, clearly identifying all steps, results, journals and including comments besides each answer.

BUSINESS CASE (100 points)

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:             2.500Kg@10$/Kg                                                  $ 25.000

                        Purchase of Almonds:                4.000Kg @ 5$/Kg                                                  $ 20.000

                        Purchas of Peanuts:                    6.000Kg @ 3$/ Kg                                                 $ 18.000

February 3: Purchase of Pistachios:             1.500Kg@12$/Kg                                                  $18.000

                        Purchase of Almonds:                2.000Kg @ 6$/Kg                                                  $ 12.000

                        Purchas of Peanuts:                    2.000Kg @ 4$/ Kg                                                 $ 8.000

February 6: Sold to several clients:

Pistachios:                                      2.000Kg@ 20$/Kg                                                $40.000

Almonds:                                        2.500Kg @ 11$/Kg                                               $ 27.500

Peanuts:                                          3.000Kg @ 7$/ Kg                                                 $ 21.000

February 6: Sold to Fruits Lovers Inc.:

Pistachios:                                      500Kg @20$/Kg.                                                   $ 10.000

Almonds:                                        1.000Kg @ 11$/Kg                                               $ 11.000

Peanuts:                                          1.500Kg @ 8$/ Kg                                                 $ 12.000

February 12 Purchase of Pistachios:            1.500Kg@14$/Kg                          $ 21.000

                        Purchase of almonds:               2.000Kg @ 8$/Kg                          $ 16.000

                       

February 13: Sale of peanuts to Peanuts Lovers Inc.:  3.500Kg @8$/kg     $ 28.000

February 14: Purchase of Peanuts              6.000 Kg @4$/Kg                          $24.000

February 19: Sold to several clients:

Pistachios:                                      1.000Kg@ 21$/Kg.                                               $ 21.000

Almonds:                                        1.500Kg @ 13$/Kg                                               $ 19.500

Peanuts:                                          3.000Kg @ 9$/ Kg                                                 $ 27.000

February 25: Purchased from various suppliers:

Pistachios:                                      1.000Kg@13$/Kg.                                                $ 13.000

Almonds:                                        1.000Kg @ 9$/Kg                                                  $ 9.000

Peanuts:                                          1.000Kg @ 4$/ Kg                                                 $ 4.000

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

Salaries: $3500

Electricity bill: $300

Renting of equipment: $800

Rent of warehouse and office: $1.500

Miscellaneous: $1.200

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)

Answer 1

When the trend of the price is observed the price is highly fluctuating both upwards and downwards in such a situation the best method to calculate the value of inventory is Average cost method.

Difference Weighted Average vs. FIFO vs. LIFO

Each of these disciplines relies on a different method of calculating both the inventory and cost of goods sold, and each system is appropriate for different situations.

.Weighted Average

The weighted average method, which is mainly utilized to assign the average cost of production to a given product, is most commonly employed when inventory items are so intertwined that it becomes difficult to assign a specific cost to an individual unit. This is frequently the case when the inventory items in question are identical to one another. Furthermore, this method assumes a store sells all of its inventories simultaneously.

To use the weighted average model, one divides the cost of the goods that are available for sale by the number of those units still on the shelf. This calculation yields the weighted average cost per unit—a figure that can then be used to assign a cost to both ending inventory and the cost of goods sold. While the weighted average method is a generally accepted accounting principle, this system doesn’t have the sophistication needed to track FIFO and LIFO inventories.

FIFO

The FIFO accounting method relies on a cost flow assumption that removes costs from the inventory account when an item in someone’s inventory has been purchased at varying costs, over time. In other words, under FIFO, the oldest cost of an item in an inventory will be removed first when one of those items is sold. This oldest cost will then be reported on the income statement as part of the cost of goods sold.

LIFO

The LIFO accounting method assumes that the latest items bought are the first items to be sold. With this accounting technique, the costs of the oldest products will be reported as inventory. It should be understood that, although LIFO matches the most recent costs with sales on the income statement, the flow of costs does not necessarily have to match the flow of the physical units.

Generally speaking, FIFO is preferable in times of rising prices, so that the costs recorded are low, and income is higher. Contrarily, LIFO is preferable in economic climates when tax rates are high because the costs assigned will be higher and income will be lower.

main characteristics of each method of valuation of the inventory

• The weighted average method is most commonly employed when inventory items are so intertwined that it becomes difficult to assign a specific cost to an individual unit. it uses the average of total inventory purchased
• The FIFO accounting method relies on a cost flow assumption that removes costs from the inventory account when an item in someone’s inventory has been purchased at varying costs, over time.
• The LIFO accounting method assumes that the latest items bought are the first items to be sold.

consequences they may have on the valuation of the inventory and determination of the net income in case of price fluctuation.