Question

The following transactions occurred for the Levy Company during 2019: Beginning inventory consists of 50 units with a price per unit of $40. Transactions during 2019 (in order) were: 1) Purchased 100 units @ $42 2) Purchased 110 units @ $43 3) Sold 190 units Required: a) Use the above information and compute the ending inventory and cost of goods sold for 2018 assuming is used: periodic LIFO, periodic FIFO, WAC. b) Assume the use of LIFO and a market value of inventory at the end of 2019 of $ 2,800. What is the value of ending inventory to be reported in the balance sheet? What is the value of cost of goods sold to be reported in the income statement? c) Conceptually, how does pretax income using FIFO (in times of rising prices) compare to LIFO pretax income? Explain briefly your answer.

Answer 1

A) Computation of year-end inventory and cost of goods sold for 2018:

1) Using Periodic LIFO Method:

Under LIFO it is assumed that the recent inventories are sold on priority and the earlier units of inventories are given less preference.

Particulars	Units	Rate ($)	Value ($)	Inventory Valuation ($)
Opening Inventory	50	40	2,000	2,000
Add: First Purchase	100	42	4,200	6,200
Add: Second Purchase	110	43	4,730	10,930
Less: Sales (COGS)	190	42.58	-8,090	2,840
Year-end Valuation	70	40.57	2,840	2,840

Calculation of rate of sales using LIFO Method:

= [(110 * 43) + (80 * 42)] / 190 = $ 42.58

Calculation of cost of goods sold = [(110 * 43) + (80 * 42)] = $ 8,090

2) Using Periodic FIFO Method:

Under FIFO it is assumed that the earlier inventories are sold on priority and the earlier units of inventories are cleared only after the older inventories are sold.

Particulars	Units	Rate ($)	Value ($)	Inventory Valuation ($)
Opening Inventory	50	40	2,000	2,000
Add: First Purchase	100	42	4,200	6,200
Add: Second Purchase	110	43	4,730	10,930
Less: Sales (COGS)	190	41.68	-7,920	3,010
Year-end Valuation	70	43	3,010	3,010

Calculation of rate of sales using FIFO Method:

= [(50 * 40) + (100 * 42) + (40 * 43)] / 190 = $ 41.68

Calculation of cost of goods sold = [(50 * 40) + (100 * 42) + (40 * 43)] = $ 7,920

3) Using WAC Method:

Under WAC, the inventory valuation is done on the basis of any change in the units. Meaning thereby, the units are valued on the basis of total costs and total units, whereas the valuation changes as and when there is any movement in the inventory.

Particulars	Units	Rate ($)	Value ($)	Total Units	Total Value	Calculation of WA Rate = Total Value / Total Units	Inventory Valuation ($)
Opening Inventory	50	40	2,000	50	2,000	40	2,000
Add: First Purchase	100	42	4,200	150	6,200	41.33	6,200
Add: Second Purchase	110	43	4,730	260	10,930	42.04	10,930
Less: Sales (COGS)	190	42.04	-7,987	70	2,843	42.04	2,843
Year-end Valuation				70	2,843	42.04	2,843

B) Valuation of inventory in Financial Statements using LIFO Method:

Valuation of inventory - inventories at the end of the Financial Year are valued at the lower of its cost or Net Realizable Value (NRV).

In the given case, the cost of the inventory as per LIFO Method from above is $ 2,840 and the market value (NRV) of the inventory at the end of the year is $ 2,800. Therefore, the inventory would be reported at the NRV of $ 2,800.

Value of year-end inventory to be reported in Balance Sheet = $ 2,800

Value of Cost of Goods Sold (COGS) in the Income Statement = Cost of Goods Sold as per the LIFO valuation and value of written-off inventory

Value of COGS in Income Statement = $ 8,090 + ($ 2,840 - $ 2,800) = $ 8,130

C) Comparison of pre-tax income under FIFO (at the time of rising prices) and LIFO:

Method of Inventory Valuation	Inventory Valuation	Overall impact on pre-tax income
FIFO (at the time of rising prices)	Since FIFO assumes earlier inventories are taken out first, the inventory valuation is always driven by the cost of the inventories purchased later/ held at the end of the period. Therefore, in the event of inflatory market conditions, FIFO method reports higher inventory valuation and lower COGS. Sometimes, the inventory is overstated, leading to reporting of higher unrealized gains as on year-end.	The inventory valuation is higher in such times and the pre-tax income reported is also higher on account of unrealized gains in the form of high inventory valuation. Further, higher pre-tax income would also result into higher taxes for the income which are unrealized.
LIFO	LIFO assumes that the recent inwards of inventory is taken out first and the valuation of inventory at year-end is driven by the inventories purchased earlier.	Under normal circumstances, LIFO method might not represent a true picture of the profitability of the business as the inventory is valued at the outdated prices, which might seem irrelevant as on year-end.
LIFO (at the time of rising prices)	Since LIFO assumes that the latest purchases of inventory is taken out first, the method perfectly matches the recent purchases with the COGS of recent sales at the times of rising prices. Due to this, the COGS reported is higher along with lower inventory valuation under LIFO during inflation.	At the time of inflation, LIFO shows higher COGS and lower inventory valuation leading to lower pre-tax income. Moreover, under inflatory markets, gross margins derived by using LIFO method are better indicator of the profitability, as unrealized gains in inventory are limited and the inventory is valued at the cost of inventory purchased earlier at lower costs.