Exercise-11 (Comparison of FIFO, LIFO and average costing method)

The president of HPL Inc. wants to know the effect of different inventory costing methods on the financial statements. For the purpose of comparison of some popular inventory costing methods, the following data was selected.

  • Cash balance on January 1, 2013: $14,000.
  • Retained earnings January 1, 2013: $20,000.
  • Inventory on January 1, 2013: 8,000 units @ $6.
  • Income tax rate: 30%.

The HPL Inc. sold 10,000 units for $240,000 during the year 2013. The total purchases were 12,000 units @ $8 each and the total operating expenses were $25,000 during this period. A periodic costing method is used.

Required:

  1. Prepare a comparative income statement using FIFO, LIFO and average costing method to show the effect of each on net operating income of HPL Inc.
  2. Show the balances of the following items on December 31, 2013 under FIFO, LIFO and average costing method:
    (i). Inventory
    (ii). Retained earnings
    (iii). Cash

Solution:

(1). Income statement under FIFO, LIFO and average costing method:

exercise-11-icm-img1

*Cost of goods sold:

  • FIFO method: (8,000 units × $6) + (2,000 units × $8) = $64,000
  • LIFO method: (10,000 × $8) = $80,000
  • Average method: 10,000 × [($96,000 + $48,000) / 20,000] = $72,000

(2). The ending balances of inventory, retained earnings and cash:

Units in ending inventory = Units in beginning inventory + Units purchased – Units sold

= 10,000 units + 12,000 units – 10,000 units

= 10,000 units

FIFO method:

i. Inventory:

= 10,000 units × $8

= $80,000

ii. Retained earnings:

= $20,000 + $105,700

= $125,700

iii. Cash:

= Beginning balance + Sales – Purchases – Operating expenses – Income tax

= $14,000 + $240,000 – $96,000 – $25,000 – $45,300

= $87,700

LIFO method:

i. Inventory:

= (2,000 units × $8) + (8,000 units × $6)

= $64,000

ii. Retained earnings:

= $20,000 + $94,500

= $114,500

iii. Cash:

= Beginning balance + Sales – Purchases – Operating expenses – Income tax

= $14,000 + $240,000 – $96,000 – $25,000 – $40,500

= $92,500

Average costing method:

(i). Inventory:

= 10,000 units × $7.2*

= $72,000

*($96,000 + $48,000)/20,000 units

(ii). Retained earnings:

= $20,000 + $100,100

= $120,100

(iii). Cash:

= Beginning balance + Sales – Purchases – Operating expenses – Income tax

= $14,000 + $240,000 – $96,000 – $25,000 – $42,900

= $90,100

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5 Comments on Exercise-11 (Comparison of FIFO, LIFO and average costing method)

  1. mussie

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  5. Vusumzi

    Please help guys.I m doing management accounting for the first time

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    1. The following transactions of Fernglen Limited, a manufacturer of children’s’ tables and chairs
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    APRIL
    01 Stock on hand 600 units @ R220 per unit
    03 Issued to production 350 units
    08 Returned from production to stores 50 units
    17 Purchased from supplier 2000 units @ R230 per unit
    20 Issued to production 800 units
    21 Returned to supplier (purchased on 17 April
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    200 units
    30 Issued to production 800 units
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    (13 marks)

    1.2 Ricey Wholesalers sells 8 000 bags of rice each year. The inventory holding cost of one bag
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    1.2.2 Calculate the number of orders that should be placed per annum. (3 marks)
    (Round off calculations to the nearest whole number.)
    MODULE MANAGEMENT ACCOUNTING
    TOTAL MARKS 60 MARKS
    Question 2 (20 marks)
    The information provided below relates to Prague Enterprises.
    1. The bank balance on 31 May 2018 was R9 000 unfavourable.
    2. Actual and budgeted sales are as follows:
    MONTH AMOUNT
    May 2018 R440 000
    June 2018 R400 000
    July 2018 R480 000
    Cash sales are estimated at 10% of total sales.
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    3. Actual and budgeted purchases for each month are as follows:
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    May 2016 R240 000
    June 2016 R200 000
    July 2016 R220 000
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    4. Rent expense amounts to R19 000 per month, payable monthly. Rent will increase by 10% from
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    5. Variable selling and administrative expenses are estimated at 25% of sales. They are payable
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    6. Insurance amounts to R72 000 per annum payable monthly.
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    Variable production cost per garden bench:
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    – Direct labour
    – Overheads
    R135
    R90
    R45
    Fixed production overheads R127 500
    Selling and administrative expenses:
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    – Sales commission
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