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Inventories and Cost of Goods Sold Hurley Inc. is a wholesaler of motorcycle parts. The company...

Inventories and Cost of Goods Sold

Hurley Inc. is a wholesaler of motorcycle parts. The company uses a perpetual inventory system, and its fiscal year ends on December 31. Hurley had the following transactions during 2012.

Transactions	Units	Unit Cost
(a) Inventory, Dec 31, 2011	10,000	$8
For the year 2012:
(b) Purchase, Mar 21	30,000	6
(c) Sale, Jun 20 ($13 each)	35,000
(d) Purchase, Aug 19	15,000	5.5
(e) Sale, Nov 20 ($10 each)	12,000

Required:

1. Compute the gross profit, assuming the company uses FIFO.

2. Would your answer above be different under a periodic inventory system, assuming the company continues to use the FIFO inventory costing method? Explain your answers. Calculations are not necessary to answer this requirement.

3. In the most recent annual report, Hurley stated that its inventories are carried at the lower of cost and net realizable value (LCNRV). What effects would this rule have on the company’s financial statements (B/S, I/S, Cash Flow Statement) if the net realizable value of Hurley’s ending inventory drops below cost?

Expert Solution

1.

Under FIFO cost flow assumption, it is assumed that units of inventory purchased earliest are sold first. Therefore, the 35,000 units sold on June 20 will include 10,000 units from inventory at December 31, 2011, and 25,000 units from March 21 purchases.

The 12,000 units sold on November 20, will include 5,000 units remainig from March 21 purchases and 7,000 units from August 19 purchases.

Thus,

Cost of goods sold = (10,000 x $8) + (30,000 x $6) + (7,000 x $5.5) = $298,500

Now calculate gross profit by subtracting cost of goods sold from total sales.

Sales = (35,000 x $13) + (12,000 x $10) = $575,000

And,

Gross profit = Sales - Cost of goods sold = $575,000 - $298,500 = $276,500

2.

No the answer would not be different if the company uses periodic inventory system. Calculation of sales and cost of goods sold is same under both inventory systems when FIFO cost flow assumption is used. Therefore, the amount of gross profit will also remain same under both the inventory systems.

3.

If the net realizable value of of ending inventory drops below cost, the difference between the cost of inventory and the net realizable value would be included in the cost of goods sold. Therefore, the income statement will show a lower gross profit and as a result of lower gross profit, the net income will also decline by the same amount.

In the balance sheet, the inventory will be reported at its net realizable value. Therefore, the inventory balance shown on the balance sheet will decrease and as a result the value of total current assets and total assets will also decrease. Also, as a result of decrease in net income, retained earnings and total stockholders' equity will also decrease by the same amount.

There would be no effect of the drop in net realizable value of inventory on the cash flow statement.

ekkarill92 answered 1 year ago

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