Chapter 8: Q1AAP. (page 440)

Accounting, Analysis, and Principles
Englehart Company sells two types of pumps. One is large and is for commercial use. The other is smaller and is used in residentialswimming pools. The following inventory data is available for the month of March.
Price per
Units Unit Total
Residential Pumps
Inventory at Feb. 28: 200 $ 400 $ 80,000
Purchases:
March 10 500 $ 450 $225,000
March 20 400 $ 475 $190,000
March 30 300 $ 500 $150,000
Sales:
March 15 500 $ 540 $270,000
March 25 400 $ 570 $228,000
Inventory at March 31: 500
Commercial Pumps
Inventory at Feb. 28: 600 $ 800 $480,000
Purchases:
March 3 600 $ 900 $540,000
March 12 300 $ 950 $285,000
March 21 500 $1,000 $500,000
Sales:
March 18 900 $1,080 $972,000
March 29 600 $1,140 $684,000
Inventory at March 31: 500
Accounting
(a) Assuming Englehart uses a periodic inventory system, determine the cost of inventory on hand at March 31 and thecost of goods sold for March under first-in, first-out (FIFO).
(b) Assume Englehart uses dollar-value LIFO and one pool, consisting of the combination of residential and commercialpumps. Determine the cost of inventory on hand at March 31 and the cost of goods sold for March. Assume Englehart’sinitial adoption of LIFO is on March 1. Use the double-extension method to determine the appropriate price indices.
(Hint:The price index for February 28/March 1 should be 1.00.) (Round the index to three decimal places.)
Analysis
(a) Assume you need to compute a current ratio for Englehart. Which inventory method (FIFO or dollar-value LIFO) doyou think would give you a more meaningful current ratio?
(b) Some of Englehart’s competitors use LIFO inventory costing and some use FIFO. How can an analyst compare theresults of companies in an industry, when some use LIFO and others use FIFO?
Principles
Can companies change from one inventory accounting method to another? If a company changes to an inventory accounting methodused by most of its competitors, what are the trade-offs in terms of the conceptual framework discussed in Chapter 2 of the textbook?

Short Answer

Expert verified

Under Periodic system

Ending inventory $745,000

COGS $1,705,000

Under dollar value LIFO

Ending inventory$745,200

COGS $1,704,800

The FIFO method is most preferred in analyzing financial performance, and there can be a change in the inventory method with a cost-benefit trade-off.

Step by step solution

Accounting

a. Ending Inventory and COGS using the periodic inventory

Under the periodic inventory system, the inventory received first is utilized first. Thus the ending inventory would always be valued at the cost of the earliest inventory received.

In this case,

The cost of ending inventory for Residential pumps are as follow –

Ending inventory = 500 units

Date	Units	Cost per unit	Amount

March 30	300	$500	$150,000
March 20	200	$475	$95,000
Total			$245,000

$C o s t o f g o o d s s o l d (f o r r e s e d e n t i a l p u m p s) = C o s t o f o p e n i n g i n v e n t o r y + C o s t o f a l l p u r c h a s e s - C o s t o f e n d i n g i n v e n t o r y = $ 80, 000 + ($ 225, 000 + $ 190, 000 + $ 150, 000) - $ 245, 000 = $ 400, 000$

The cost of ending inventory for Commercial pumps is as follows–

Ending inventory = 500 units

Date	Units	Cost per unit	Amount

March 21	500	$1000	$500,000
Total			$500,000

$C o s t o f g o o d s s o l d (f o r c o m m e r c i a l p u m p s) = C o s t o f o p e n i n g i n v e n t o r y + C o s t o f a l l p u r c h a s e s - C o s t o f e n d i n g i n v e n t o r y = $ 480, 000 + ($ 540, 000 + $ 285, 000 + $ 500, 000) - $ 500, 000 = $ 1, 305, 000 T o t a l c o s t o f e n d i n g i n v e n t o r y = C o s t o f e n d i n g i n v e n t o r y o f r e s e d e n t i a l p u m p s + C o s t o f e n d i n g i n v e n t o r y o f C o m m e r c i a l p u m p s = $ 245, 000 + $ 500, 000 = $ 745, 000 T o t a l c o s t o f g o o d s s o l d = C o s t o f g o o d s s o l d f o r r e s e d e n t i a l p u m p s + C o s t o f g o o d s s o l d f o r c o m m e r c i a l p u m p s = $ 400, 000 + $ 1, 305, 000 = $ 1, 705, 000$

Total ending inventory under the periodic method comes out to be $745,000, and the total cost of goods sold amounts to $1,705,000.

b) Ending Inventory and COGS using dollar-value LIFO under one pool

Under the dollar-value LIFO inventory system, the layers of inventory at base cost added every year are converted to current cost using the price index. The sum of all layers at the current cost is the cost of ending inventory.

In this case, the cost of ending inventory and COGS using one pool would be as follows –

Ending inventory

Date	Units	Current year cost	Amount	Base year cost	Amount
Residential pumps
March 30	300	$500	$150,000	$400	$120,000
March 20	200	$475	$95,000	$400	$80,000
Commercial pumps
March 21	500	$1000	$500,000	$800	$400,000
Total			$745,000		$600,000

$P r i c e I n d e x = \frac{E n d i n g i n v e n t o r y c o s t a t c u r r e n t y e a r p r i c e}{E n d i n g i n v e n t o r y c o s t a t b a s e y e a r p r i c e} = \frac{$ 745, 000}{$ 600, 000} = 1.242$

Valuation of ending inventory using dollar-value LIFO

Date	Inventory at base price	Layer	X	Price Index	=	Dollar Value LIFO

1 March	$560,000	$560,000	X	1.242	=	$695,520
31 March	$600,000	$40,000	X	1.242	=	$49,680
Total						$745,200

$C o s t o f g o o d s s o l d = T o t a l o p e n i n g i n e v n t o r y + T o t a l p u r c h a s e s - E n d i n g i n v e n t o r y u s i n f d o l l a r v a l u e L I F O = ($ 80, 000 + $ 480, 000) + ($ 225, 000 + $ 190, 000 + $ 150, 000 + $ 540, 000 + $ 285, 000 + $ 500, 000) - $ 745, 200 = $ 560, 000 + $ 1, 890, 000 - $ 745, 200 = $ 1, 704, 800$

The cost of goods sold and ending inventory using dollar-value LIFO comes out to be $1,704,800 and $745,200, respectively.

Analysis

a) FIFO vs. dollar-value LIFO in computing current ratio

In computing, the current ratio, one of the factors affecting the ratio, is the ending inventory. There are several methods for computing ending inventory that yields different results.

Under the FIFO method, ending inventory is completed at the earliest cost, while under dollar value LIFO, ending inventory is computed at the current price using a price index. In both methods, there remains a difference in amount.

The ending inventory under both methods is almost the same in the given case. However, the FIFO method would be the most preferred method as this method is quite simple and reasonable in computing the ending inventory. Furthermore, the inventory is calculated at the original cost than at the price index value in this method.

So, the preferred method for computing the current ratio would be the FIFO method.

b) Comparing the results under FIFO and LIFO

Under FIFO and LIFO methods, ending inventory is computed at a different rate. So there remains a difference between the FIFO and LIFO methods. But this difference can be reconciled using the LIFO reverse account. LIFO reverse is the difference between the FIFO ending inventory and the LIFO ending inventory.

Using this account, an analyst can compare the results under both methods.

Principles

Yes, a company can change from one inventory method to another with the condition that there should be consistency for the long term. There should not be a frequent change in the inventory method, and there should be full disclosure about the change.

In changing the inventory method, the trade-off in terms of the conceptual framework can be matching principle and cost constrain. A company may lose or gain some inventory value by changing the method. This gain or loss must be matched with the current income, and the cost-benefit trade-off should be properly reported.

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