Question

Duracraft Corporation is nearing the end of its first year of operations. Duracraft made inventory purchases of $926,000 during the year, as follows:

January	1,500 units @	$120.00	$180,000
July	3,000	142.00	426,000
November	2,000	160.00	320,000
Totals	6,500		$926,000

Sales for the year are 6,000 units for $1,800,000 of revenue. Expenses other than cost of goods sold and income taxes total $425,000. The president of the company is undecided about whetehr to adopt the FIFO method or the weighted-average-cost method for inventories. The company uses the periodic inventory system. The income tax rate is 30%.

Required:

1. To aid company decision make, prepare income statements under FIFO and under weighted-average cost.

2. Compare the net income under FIFO with net income under weighted-average cost. Which method produces the higher net income? What causes this difference? Be specific.

Answer 1

1) FIFO Method

Under FIFO method, the goods purchased first are sold first, total units purchased are 6,500 units and units sold are 6,000 units.

Ending Inventory = 6,500 units - 6,000 units = 500 units

Opening Inventory = 0 (as company is in its first year of operations)

Under FIFO, ending Inventory of 500 units will be from units purchased in November at a price of $160.00 per unit.

Ending Inventory = 500 units*$160 = $80,000

Cost of goods sold = Opening Inventory+Purchases-Ending Inventory

= 0+$926,000-$80,000 = $846,000

Income Statement Under FIFO (Amount in $)

Sales Revenue	1,800,000
Less: Cost of goods sold	(846,000)
Gross Profit	954,000
Less: Other Expenses	(425,000)
Income Before Tax	529,000
Less: Income Taxes ($529,000*30%)	(158,700)
Net Income	370,300

Weighted Average Cost

Weighted Average Cost = Total Purchase Cost/Total Units purchased

= $926,000/6,500 units = $142.46154

Ending Inventory = 500 units*$142.46154 = $71,231

Cost of good sold = 6,000 units*$142.46154 = $854,769

Income Statement Under Weighted Average Cost (Amount in $)

Sales Revenue	1,800,000
Less: Cost of goods sold	(854,769)
Gross Profit	945,231
Less: Other Expenses	(425,000)
Income Before Tax	520,231
Less: Income Taxes ($520,231*30%)	(156,069)
Net Income	364,162

2) The net income under FIFO method is higher than net income under weighted average cost. This is because the purchase price of inventory is rising and under FIFO cost of goods sold will be lowest due to lowest cost included in it and this results in higher net income but in weighted average cost method a weighted average cost is used for valuing ending inventory and cost of goods sold.