Question

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.

2: Prepare an Income statement of the company at the end of February using as method of valuation of the inventory the average cost method, FIFO and LIFO for each one of the products sold by Jim, and calculate the balance of the inventory at the end of the month. Explain the calculations.

3: In order to compare with the records made by his accountant, Jim asks you to prepare the different journal entries for the purchases and sales mentioned above for each one of the 3 different methods used above.

4: Jim’s accountant insisted that he should use a perpetual inventory system instead of a periodic inventory system and the average cost method for valuating the inventory. Do you agree with this advice (justify your answer)? Would the balance of the inventory at the end of the month be the same? And the net income?

5: Jim would like to know a forecast of the number of days to sell the inventory based on the results of the month of February. Explain your calculation and the steps followed.

6. Jim expects that the prices of the merchandises will dramatically decrease in the next future as a result of the Covid 19 crisis. Which method of valuation of the inventory would you thus recommend to Jim? Explain your answer.

Answer 1

Answer to part 1

Jim the accountant recommeneded the average cost method because there are different kinds of inventory with high price differences hence the average cost method will efficate the the measuring of inentory.

There are three other types of processes namely FIFO(First in First out ) , LIFO(Last in First out ) and Weighted Average Method.

In FIFO , we assume the inventory being sold is at the rate of the inventory which was purchased first.

In LIFO , we assume the inventory being sold is at the rate of the inventory which was purchased latest.

In Weighted Average Methoid , we assume the rate of inventory to be the weighted average of the price and number of units.