Question

AAA Hardware uses the LIFO method to report its inventory. Inventory at the beginning of the year consisted of 12,000 units of the company’s one product. These units cost $12 each. During the year, 62,000 units were purchased at a cost of $15 each and 65,000 units were sold. Near the end of the fiscal year, management is considering the purchase of an additional 6,000 units at $15.

Required:
1. What would be the effect of this purchase on income before income taxes?
2. What would be the effect of this purchase on income before income taxes using FIFO?
  

Answer 1

1. Under LIFO method

(i) Before 56000 units purchased:

sales = 65,000 units

Cost of goods sold = Quantity × Price

= (62,000 × $15) + (3000 × $12)

= $930,000 + $36000

= $966,000

(ii) If 65000 units purchased at $15 each then,

Cost of goods sold = Quantity × Price

= 65000 × $15

= 975,000

As the cost of goods increases as a result there will be decrease in the net income before tax under LIFO method.

The amount of net income would be decreased by:

= $975,000 - $966,000

= $9000

2. Under FIFO method:

(i) Before 5,000 units purchased:

sales = 64,000 units

Cost of goods sold = Quantity × Price

= (12,000 × $12) + (53,000 × $15)

= $144,000 + $795000

= $939000

(ii)

Cost of goods sold = Quantity × Price

= (12,000 × $12) + (53,000 × $15)

= $144,000 + 795,000

= 939000

As there will be no change in the cost of goods sold, so, there will be no change in the net income before tax under FIFO method.