Following is partial information for the income statement of Audio Solutions Company under three different inventory costing methods, assuming the use of a periodic inventory system:

FIFO LIFO Average Cost
Cost of goods sold
Beginning inventory (400 units S28) $11,200 $11,200 11,200
Purchases (475 units $35) 16,625 16,625 16,625
Goods available for sale 17,825
Ending inventory (525 units)
Cost of goods sold

Required:
a. Compute cost of goods sold under the FIFO, LIFO, and average cost inventory costing methods.
b. Prepare an income statement through pretax income for each method. Sales, 307 units; unit sales price, $50; Expenses, $1,680
c. Rank the three methods in order of income taxes paid (favorable cash flow).

The computation is shown below:-

Explanation:

1.                     FIFO    LIFOAverage cost  

Cost of goods sold      

Beginning inventory       $11,200      $11,200  $11,200

(400 units ×  $28))                          

purchases                       $16,625    $16,625   $16,625

(475 units × 35)                  

Goods available for use $27,825    $27,825   $27,825  

Ending inventory             $18,025    $15,575    $16,695

(525 units)  

Cost of goods sold          $9,800    $12,250    $11,130  

under ending inventory = 475 × $35 + 50 × $28    

FIFO = $18,025  

LIFO ending inventory 400 × $28 + 125 × $35

= $15,575  

Average cost = $27,825 ÷ $875    

= 31.8      

Ending inventory = 525 × 31.8

= $16,695

2.                                  FIFO            LIFO         Average

Sales

(307 × $50)                $15,350         $15,350    $15,350

Cost of goods sold     $9,800    $12,250    $11,130

Gross Profit                 $5,550           $3,100      $4,220

Expenses                     $1,680           $1,680      $1,680

Net income                  $3,870           $1,420       $2,540

3. FIFO = 3

LIFO = 2

Average = 1

a. The cost of goods sold under each inventory method is as follows:

                                        FIFO           LIFO      Average Cost

Cost of goods sold      $9,800     $12,250       $11,130

b. Income statement for each method:

                                                  FIFO           LIFO      Average Cost

Sales Revenue (350 units)  $17,500       $17,500          $17,500

Cost of goods sold                 9,800         12,250              11,130

Gross profit                           $7,700        $5,250            $6,370

Operating Expenses               1,680           1,680               1,680

Pretax income                    $6,020        $3,570           $4,690

C. Ranking of methods in order of favorable cash flow with respect to income taxes paid are as follows:

1. LIFO

2. Average Cost

3. FIFO

Data and Calculations:

                                                               FIFO           LIFO      Average Cost

Cost of goods sold:

Beginning inventory (400 units $28) $11,200      $11,200         $11,200

Purchases (475 units $35)                   16,625       16,625           16,625

Goods available for sale  (875)          27,825       27,825          27,825

Ending inventory (525 units)                

Ending inventory under FIFO = $18,025 (475 x $35 + 50 x $28)

Cost of goods sold under FIFO = $9,800 ($27,825 - $18,025)

Ending inventory under LIFO = $15,575 (400 x $28 + 125 x $35)

Cost of goods sold under LIFO = $12,250 ($27,825 - $15,575)

Ending inventory under Average Cost = $16,695 ($27,825/875) x 525)

Cost of goods sold under Average Cost = $11,130 ($27,825 - $16,695)

Cost of goods sold = Cost of goods available for sale - Ending Inventory

Sales revenue = $17,500 ($50 x 350)

Thus, the most favorable inventory method, especially when prices are rising, for income taxes payment purposes, is LIFO (Last-in, First-Out).  The LIFO method takes into consideration the latest cost of goods when determining the cost of goods sold.

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