Question

Company X and Company Y sell the same product. The cost of this product has been rising steadily throughout the year. Both companies reported the same net income for the year, although Company X used the first-in, first-out method of pricing inventory, while Company Y used the last-in, first-out method.

(a) Which company's valuation of ending inventory in the balance sheet is more likely to approximate replacement cost?
Company ______________________________
(b) Which company reports a cost of goods sold figure in the current year income statement that is more likely to reflect the replacement cost of the units sold?
Company ______________________________
(c) Which company is minimizing income taxes it must pay?
Company ______________________________
(d) Which company would have reported the higher net income if both companies had used the same method of pricing inventory?
Company ______________________________

Answer 1

(a) Company X because its closing inventory will comprise more of the recently purchased goods that can have either same or slightly low replacement value as compared to the old inventory in stock in case of Company Y.

(b) Company Y because it would have sold the latest inventory that would be more likely to reflect the replacement cost of the units sold.

(c) Company Y because cost of goods sold will be high as due to inflation the latest goods purchased and sold would have more value and high cost of goods sold will result in low profits and ultimately, low tax liability.

(d) Company X would have recorded the higher net income due to low cost of goods sold.