P7–3.

Req. 1

ATLANTA COMPANY Partial Income Statement

For the Month Ended January 31, 2010

(a) (b) (c) (d) Weighted Specific Average FIFO LIFO Identification

Sales revenue* $10,540 $10,540 $10,540 $10,540 Cost of goods sold** 3,630 3,220 4,040 3,350 Gross profit $ 6,910 $ 7,320 $ 6,500 $ 7,190

Computations:

*620 units @ $17 = $10,540. **Cost of goods sold: Weighted Specific Units Average FIFO LIFO Identification

Beginning inventory 500 $2,500 $2,500 $2,500 $2,500 Purchases (net)*** 760 4,880 4,880 4,880 4,880 Goods available for sale 1,260 7,380 7,380 7,380 7,380 Ending inventory**** 640 3,750 4,160 3,340 4,030 Cost of goods sold 620 $3,630 $3,220 $4,040 $3,350

***Purchases: January 12 600 units @ $6 = $3,600 January 26 160 units @ $8 = 1,280 Totals 760 $4,880

****Ending inventory: a. Weighted-average cost: Units Amount Beginning inventory 500 $2,500 Purchases (per above) 760 4,880 1,260 $7,380 Average cost: $7,380 ÷ 1,260 units = $5.86 Ending inventory: 640 units x $5.86 = $3,750

McGraw-Hill/Irwin Financial Accounting, 6/e ? The McGraw-Hill Companies, Inc., 2009 7-29

P7–3. (continued)

Req. 1 (continued) b. FIFO: 160 units @ $8 = $1,280 480 units @ $6 = 2,880 640 $4,160 c. LIFO: 500 units @ $5 = $2,500 140 units @ $6 = 840 640 $3,340 d. Specific identification: 130 units @ $5 = $ 650 350 units @ $6 = 2,100 160 units @ $8 = 1,280 640 $4,030

Req. 2

FIFO reports a higher pretax income than LIFO because (1) prices are rising and (2) FIFO allocates the old (lower) unit costs to cost of goods sold. For the same reason, FIFO will report a higher EPS amount because it produces a higher pretax income than LIFO.

Req. 3

Because LIFO reports a lower pretax income than FIFO for the reasons given in Requirement (2), the former will derive less income tax by ($7,320 – $6,500) x 30% = $246.

Req. 4

LIFO will provide a more favorable cash flow than FIFO of $246 because less cash will be paid for income tax in the current year than would be paid under FIFO (for the reasons given in Requirements 2 and 3).

McGraw-Hill/Irwin 7-30 ? The McGraw-Hill Companies, Inc., 2009 Solutions Manual

P7–4.

Req. 1

Sales revenue $1,151,500 Cost of goods sold* (42 @ $10,000) + (5 @ $11,500) 477,500 Gross profit 674,000 Expenses 300,000 Pretax income $ 374,000

*Ending inventory (15 @ $11,500) $ 172,500

Req. 2

Sales revenue $1,151,500 Cost of goods sold** (20 @ $8,500)+(27 @ $10,000) 440,000 Gross profit 711,500 Expenses 300,000 Pretax income $ 411,500

**Ending inventory (15 @ $10,000)+(20 @ $11,500) $ 380,000

Req. 3

Pretax income increased by $37,500 because of the decision to purchase the additional units at the end of the year. This decision provided lower cost units to allocate to cost of goods sold, which increased pretax income.

There is evidence of deliberate income manipulation. Although no information is provided as to expected future sales, nor the time to order and receive units, the timing of the purchase of the additional units is suspect because the cost of the equipment will be decreased again during the first quarter of next year.

(Instructional Note–This problem illustrates the way that income can be manipulated under LIFO by buying, or not buying, at year-end. This opportunity to manipulate income is not available under weighted average or FIFO.)

McGraw-Hill/Irwin Financial Accounting, 6/e ? The McGraw-Hill Companies, Inc., 2009 7-31

P7–5.

Req. 1 Prices Rising Prices Falling FIFO LIFO FIFO LIFO

Sales revenue (500 units) $12,000 $12,000 $12,000 $12,000 Cost of goods sold: Beginning inventory (300 units) 3,300 3,300 3,600 3,600 Purchases (400 units) 4,800 4,800 4,400 4,400 Goods available for sale 8,100 8,100 8,000 8,000 Ending inventory (200 units)* 2,400 (a) 2,200 (b) 2,200 (c) 2,400 (d) Cost of goods sold (500 units) 5,700 5,900 5,800 5,600 Gross profit 6,300 6,100 6,200 6,400 Expenses 4,000 4,000 4,000 4,000 Pretax income 2,300 2,100 2,200 2,400 Income tax expense (30%) 690 630 660 720 Net income $1,610 $1,470 $1,540 $1,680

*Inventory computations: (a) FIFO: 200 units @ $12.00 = $2,400 (b) LIFO: 200 units @ $11.00 = 2,200 (c) FIFO: 200 units @ $11.00 = 2,200 (d) LIFO: 200 units @ $12.00 = 2,400

Req. 2

The above tabulation demonstrates that when prices are rising, FIFO gives a higher net income than LIFO. When prices are falling, the opposite effect results. The difference in pretax income (as between FIFO and LIFO) is the same as the difference in cost of goods sold but in the opposite direction. The difference in net income (i.e., after tax) is equal to the difference in cost of goods sold multiplied by one minus the income tax rate.

Req. 3

When prices are rising, LIFO derives a more favorable cash position (than FIFO) equal to the difference in income tax. In contrast, when prices are falling, FIFO derives a more favorable cash position equal to the difference in income tax.

McGraw-Hill/Irwin 7-32 ? The McGraw-Hill Companies, Inc., 2009 Solutions Manual