Chapter 6-2 Group Report

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(1)

FINANCIAL ACCOUNTING

CASE 6-2

Lewis Corporation

Case Analysis

Group

:

2

Members :

Carbonell, Rosario

Carpio, Nathaniel

Zarate, Vic Paulo

(2)

I. TITLE OF THE CASE: Lewis Corporation II. BACKGROUND OF THE CASE

Lewis Corporation had traditionally used the FIFO method of inventory valuation. You are given the information shown in Exhibit 1 on transactions during the year affecting Lewis’s inventory account. (The purchases are in sequence during the year. The company uses a periodic inventory method).

Exhibit 1

2009

Beginning balance purchases

1840 cartons $20.00

600 cartons $20.25

800 cartons $21.00

400 cartons $21.25

200 cartons $21.50

Sales

2820 cartons $34.00

2010

Beginning balance purchases

1020 cartons

700 cartons $21.50

700 cartons $21.50

700 cartons $22.00

1000 cartons $22.25

Sales

3080 cartons $35.75

2011

Beginning balance purchases

1040 cartons

1000 cartons $22.50

700 cartons $22.75

700 cartons $23.00

700 cartons $23.50

Sales

2950 cartons $35.75

III. STATEMENT OF THE PROBLEM

1). Calculate the cost of goods sold and year-end inventory amounts for 2009, 2010, and 2011 using the (a) FIFO, (b) LIFO, and (c) average cost methods.

2). Lewis Corporation is considering switching from FIFO to LIFO to reduce its income tax expense. Assuming a corporate income tax rate of 40 percent, calculate the tax savings this would have made for 2009 to 2011. Would you recommend that Lewis make the change?

(3)

3). Dollar sales for 2012 are expected to drop by approximately 8 percent, as a recession in Lewis’s market is forecasted to continue at least through the first three quarters of the year. Total sales are forecasted to be 2,700 cartons. Lewis will be unable to raise its selling price from the 2011 level of $35.75. However, costs are expected to increase to $24.00 per carton for the whole year. Due to these cost/price pressures, the corporation wishes to lower its investment in inventory by holding only the essential inventory of 400 cartons at any time during the year. What is the effect of remaining on FIFO, assuming Lewis had adopted FIFO in 2009? What is the effect of remaining on LIFO, assuming Lewis had adopted LIFO in 2009? What method would you recommend now?

4).What is the LIFO reserve in 2009? What is the LIFO reserve in 2010? What is the significance of the LIFO reserve number? How much did the LIFO reserve increase in 2010? What is the significance of this increase?

5). Despite continuing inflation in the United States in the 1980s and the early 1990s many companies continued to use FIFO for all or part of their domestic inventories. Why do you believe this was the case?

(4)

IV. ANALYSIS 1. A.) FIFO METHOD

Cost of Goods Sold Ending Inventory

2009

Unit Unit Cost Unit Total Cost Unit Total Cost

Beginning balance purchases 1840 cartons $20.00 1840 $36,800.00 0 $0.00

600 cartons $20.25 600 $12,150.00 0 $0.00 800 cartons $21.00 380 $7,980.00 420 $8,820.00 400 cartons $21.25 400 $8,500.00 200 cartons $21.50 200 $4,300.00 Total 3840 cartons 2820 $56,930.00 1020 $21,620.00 Sales 2820 cartons $34.00

2010 Cost of Goods Sold Ending Inventory

Unit Unit Cost Unit Total Cost Unit Total Cost

Beginning balance purchases 1020 cartons 1020 $21,620.00 0 $0.00

700 cartons $21.50 700 $15,050.00 0 $0.00 700 cartons $21.50 700 $15,050.00 0 $0.00 700 cartons $22.00 660 $14,520.00 40 $880.00 1000 cartons $22.25 1000 $22,250.00 Total 4120 3080 $66,240.00 1040 $23,130.00 Sales 3080 cartons $35.75

2011 Cost of Goods Sold Ending Inventory

Unit Unit Cost Unit Total Cost Unit Total Cost

Beginning balance purchases 1040 cartons $22.24 1040 $23,130.00 0 $0.00

1000 cartons $22.50 1000 $22,500.00 0 $0.00 700 cartons $22.75 700 $15,925.00 0 $0.00 700 cartons $23.00 210 $4,830.00 490 $11,270.00 700 cartons $23.50 700 $16,450.00 Total 4140 2950 $66,385.00 1190 $27,720.00 Sales 2950 cartons $35.75

(5)

B.) LIFO METHOD

Cost of Goods Sold Ending Inventory

2009

Unit Unit Cost Unit Total Cost Unit Total Cost

Beginning balance purchases 1840 cartons $20.00 820 $16,400.00 1020 $20,400.00

600 cartons $20.25 600 $12,150.00 0 $0.00 800 cartons $21.00 800 $16,800.00 0 $0.00 400 cartons $21.25 400 $8,500.00 0 $0.00 200 cartons $21.50 200 $4,300.00 0 $0.00 Total 3840 cartons 2820 $58,150.00 1020 $20,400.00 Sales 2820 cartons $34.00

2010 Cost of Goods Sold Ending Inventory

Unit Unit Cost Unit Total Cost Unit Total Cost

Beginning balance purchases 1020 cartons $20.00 0 $0.00 1020 $20,400.00

700 cartons $21.50 680 $14,620.00 20 $430.00 700 cartons $21.50 700 $15,050.00 0 $0.00 700 cartons $22.00 700 $15,400.00 0 $0.00 1000 cartons $22.25 1000 $22,250.00 0 $0.00 Total 4120 3080 $67,320.00 1040 $20,830.00 Sales 3080 cartons $35.75

2011 Cost of Goods Sold Ending Inventory

Unit Unit Cost Unit Total Cost Unit Total Cost

Beginning balance purchases 1040 cartons $20.03 0 $0.00 1040 $20,830.00

1000 cartons $22.50 850 $19,125.00 150 $3,375.00 700 cartons $22.75 700 $15,925.00 0 $0.00 700 cartons $23.00 700 $16,100.00 0 $0.00 700 cartons $23.50 700 $16,450.00 0 $0.00 Total 4140 2950 $67,600.00 1190 $24,205.00 Sales 2950 cartons $35.75

(6)

C.) AVERAGE COST METHOD

Units

Unit

cost

Cost Total

2009

Beginning balance purchases

1840 cartons

$20.00

$36,800.00

600 cartons

$20.25

$12,150.00

800 cartons

$21.00

$16,800.00

400 cartons

$21.25

$8,500.00

200 cartons

$21.50

$4,300.00

Goods Available for sale

3840 cartons

$20.46

$78,550.00

Sales

2820 cartons

$34.00

$95,880.00

Ending Inventory

1020 cartons

$20.46

$20,864.84

Cost of goods sold

2820 cartons

$20.46

$57,685.16

2010

Beginning balance purchases

1020 cartons

$20.46

$20,864.84

700 cartons

$21.50

$15,050.00

700 cartons

$21.50

$15,050.00

700 cartons

$22.00

$15,400.00

1000 cartons

$22.25

$22,250.00

Goods Available for sale

4120 cartons

$21.51

$88,614.84

Sales

3080 cartons

$35.75 $110,110.00

Ending Inventory

1040 cartons

$21.51

$22,368.80

Cost of goods sold

3080 cartons

$21.51

$66,246.05

2011

Beginning balance purchases

1040 cartons

$21.51

$22,368.80

1000 cartons

$22.50

$22,500.00

700 cartons

$22.75

$15,925.00

700 cartons

$23.00

$16,100.00

700 cartons

$23.50

$16,450.00

Goods Available for sale

4140 cartons

$22.55

$93,343.80

Sales

2950 cartons

$35.75 $105,462.50

Ending Inventory

1190 cartons

$22.55

$26,830.70

Cost of goods sold

2950 cartons

$22.55

$66,513.09

(7)

2.

2009

2010

2011

FIFO

LIFO

FIFO

LIFO

FIFO

LIFO

Sales

95880

95880

110110

110110 105462.5 105462.5

Cost of goods sales

56930

58150

66240

67320

66385

67600

Gross Margin

38950

37730

43870

42790

39077.5

37862.5

Tax (40%)

15580

15092

17548

17116

15631

15145

Net Income

23370

22638

26322

25674

23446.5

22717.5

Savings in TAX

488

432

486

Net Income difference

732

648

729

We would not recommend Lewis Corporation to switch from FIFO to LIFO even if it has a TAX savings. Only because, the TAX savings we got from changing from FIFO to LIFO would not compensate the Net income difference from the two methods. FIFO has more income than LIFO.

(8)

3. FIFO Forecast

2012

Cost of Goods

Sold

Ending

Inventory

Unit

Unit Cost

Unit

Total Cost

Unit

Total

Cost

Beginning balance

1190

$23.29

1190 $27,720.00

0

$0.00

Purchases

1910

$24.00

1510 $36,240.00

400 $9,600.00

Total

3100

Sales

2700

2700 $63,960.00

LIFO Forecast

2012

Cost of Goods

Sold

Ending

Inventory

Unit

Unit Cost

Unit

Total Cost

Unit

Total

Cost

Beginning balance

1190

$20.34

790 $16,068.87

400 $8,136.13

Purchases

1910

$24.00

1910 $45,840.00

0

$0.00

Total

3100

Sales

2700

2700 $61,908.87

400 $8,136.13

2009

2010

2011

2012 - Forecast

FIFO

LIFO

FIFO

LIFO

FIFO

LIFO

FIFO

LIFO

Sales

95880

95880

110110

110110 105462.5 105462.5 96525

96525

Cost of goods sales

56930

58150

66240

67320

66385

67600 63960

61908.87

Gross Margin

38950

37730

43870

42790

39077.5

37862.5 32565

34616.13

Tax (40%)

15580

15092

17548

17116

15631

15145 13026

13846.45

(9)

Since the total sales forecasted for year 2012 is a period of deflation, with FIFO it has lower taxable income and will pay lower taxes than LIFO. For LIFO has higher taxable income and will pay more taxes than FIFO. Therefore, we’ll still recommend FIFO method.

4.

2009

2010

LIFO

Rsrv

Increase

FIFO

LIFO

LIFO Rsrv

FIFO

LIFO

LIFO Rsrv

21620

20400

1220 23130

20830

2300

1080

The significance of the LIFO reserve number was the amount inventory difference as the period goes on. This value must be in the notes to the financial statement to permit the reader to convert the inventory to a FIFO basis. The 1080 increase on 2010 is the amount needed to add to the LIFO inventory amount to convert it to FIFO.

5.

V. ALTERNATIVE COURSES OF ACTION

VI. RECOMMENDATION

Figure

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References

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