Chapter 7, Problem 15E

Habicht Company was formed in 2018 to produce a single product. The production and sales for the next 4 years were as follows:

Required:

1. 1. Determine the gross profit for each year under each of the following periodic inventory methods:
   1. a. FIFO
   2. b. LIFO
   3. c. Average cost (Round unit costs to 3 decimal places.)
2. 2. Next Level Explain whether the company’s return on assets (net income divided by average total assets) would be higher under FIFO or LIFO.

To determine

Ascertain the gross profit under the periodic inventory system for each year as per the inventory cashflow methods.

Explanation of Solution

First-in-First-Out (FIFO): In this method, items purchased initially are sold first. So, the value of the ending inventory consists the recent cost for the remaining unsold items.

Last-in-First-Out (LIFO): In this method, items purchased recently are sold first. So, the value of the ending inventory consists the initial cost for the remaining unsold items.

1. a)      Calculate the gross profit for the four years under FIFO method:

Particulars	2018	2019	2020	2021
	Amount ($)	Amount ($)	Amount ($)	Amount ($)
Net sales	$400,000	$550,000	$750,000	$600,000
Cost of goods sold
Beginning inventory	$ 0	$ 40,000	$ 58,500	$ 19,000
Add: Production	$ 200,000	$ 234,000	$ 247,000	$ 240,500
Goods available for sale	$ 200,000	$ 274,000	$ 305,500	$ 259,500
Less: Ending inventory	(1) $ 40,000	(2) $ 58,500	(3) $ 19,000	(4) $ 37,000
Cost of goods sold	$ 160,000	$ 215,500	$ 286,500	$ 222,500
Gross Margin	$ 240,000	$ 334,500	$ 463,500	$ 377,500

Table (1)

Working Note (1):

Ending inventory for 2018 is $40,000$\left(20,000\text{ units}\times \text{\$2}\text{.00}\right)$.

Working Note (2):

Ending inventory for 2019 is $58,500$\left(30,000\text{ units}\times \text{\$1}\text{.95}\right)$.

Working Note (3):

Ending inventory for 2020 is $19,000$\left(10,000\text{ units}\times \text{\$1}\text{.90}\right)$.

Working Note (4):

Ending inventory for 2021 is $37,000$\left(20,000\text{ units}\times \text{\$1}\text{.85}\right)$.

1. b)     Calculate the gross profit for the four years under LIFO method:

Particulars	2018	2019	2020	2021
	Amount ($)	Amount ($)	Amount ($)	Amount ($)
Net sales	$400,000	$550,000	$750,000	$600,000
Cost of goods sold
Beginning inventory	$ 0	$ 40,000	$ 59,500	$ 20,000
Add: Production	$ 200,000	$ 234,000	$ 247,000	$ 240,500
Goods available for sale	$ 200,000	$ 274,000	$ 306,500	$ 260,500
Less: Ending inventory	(5) $ 40,000	(6) $ 59,500	(7) $ 20,000	(8) $ 38,500
Cost of goods sold	$ 160,000	$ 214,500	$ 286,500	$ 222,000
Gross Margin	$ 240,000	$ 335,500	$ 463,500	$ 378,000

Table (2)

Working Note (5):

Ending inventory for 2018 is $40,000$\left(20,000\text{ units}\times \text{\$2}\text{.00}\right)$.

Working Note (6):

Ending inventory for 2019 is $59,500$\left[\left(20,000\text{ units}\times \text{\$2}\text{.00}\right)+\left(10,000\text{ units}\times \text{\$1}\text{.95}\right)\right]$.

Working Note (7):

Ending inventory for 2020 is $20,000$\left(10,000\text{ units}\times \text{\$2}\text{.00}\right)$.

Working Note (8):

Ending inventory for 2021 is $38,500$\left[\left(10,000\text{ units}\times \text{\$2}\text{.00}\right)+\left(10,000\text{ units}\times \text{\$1}\text{.85}\right)\right]$.

1. a)      Calculate the gross profit for the four years under Average cost method:

Compute the cost of goods sold for average cost method:

Year	Beginning inventory		Production		Goods available for sale		Average Unit
	Units	Cost	Units	Cost	Units	Cost	Cost
2018	0	$ 0	100,000	$ 200,000	100,000	$ 200,000	$ 2.00
2019	20,000	$ 40,000	120,000	$ 234,000	140,000	$ 274,000	$ 1.957
2020	30,000	$ 58,710	130,000	$ 247,000	160,000	$ 305,710	$ 1.911
2021	10,000	$ 19,110	130,000	$ 240,500	140,000	$ 259,610	$ 1.854

Table (3)

Year	Ending inventory		Cost of goods sold
	Units	Cost	Units	Cost
2018	20,000	$ 40,000	80,000	$ 160,000
2019	30,000	$ 58,710	110,000	$ 215,290
2020	10,000	$ 19,110	150,000	$ 286,600
2021	20,000	$ 37,080	120,000	$ 222,530

Table (4)

Calculate the gross profit for the four years under Average cost method

Particulars	2018	2019	2020	2021
	Amount ($)	Amount ($)	Amount ($)	Amount ($)
Net sales	$400,000	$550,000	$750,000	$600,000
Cost of goods sold
Beginning inventory	$ 0	$ 40,000	$ 58,710	$ 19,110
Add: Production	$ 200,000	$ 234,000	$ 247,000	$ 240,500
Goods available for sale	$ 200,000	$ 274,000	$ 305,710	$ 259,610
Less: Ending inventory	$ 40,000	$ 58,710	$ 19,110	$ 37,080
Cost of goods sold	$ 160,000	$ 215,290	$ 286,600	$ 222,530
Gross Margin	$ 240,000	$ 334,710	$ 463,400	$ 377,470

Table (5)

To determine

Identify would return on asset would be greater under FIFO and LIFO.

Explanation of Solution

The net income and assets are higher under the FIFO method. There is a difference in the net income under both the methods.