Q 20-4 - Horngren'S Financial And Managerial Accounting

Question

Assume that AB Tire Store completed the following perpetual inventory transactions for a line of tires:

May 1          Beginning merchandise inventory           16 tires @ \( 65 each

      11          Purchase                                                     10 tires @ \) 78 each

      23          Sale                                                              12 tires @ \( 88 each

      26          Purchase                                                     14 tires @ \) 80 each

      29          Sale                                                              18 tires @ $ 88 each

 

Requirements

4. Which method results in the largest gross profit, and why?

Step-by-Step Solution

Answer

FIFO method would result in the highest gross profit due to valuing issued inventory (COGS) at the historical prices and yielding the lowest COGS.

Step-by-Step-Solution Step 1: Gross profit under FIFO, LIFO, and Average Method

In the given case, the gross profit computed under each method is as follows –

	Gross Profit
FIFO	$500
LIFO	$350
Weighted Average	$450

The method that has resulted in the highest gross profits is the FIFO method.

Step 2: Reason for the FIFO method to yield the highest gross profit

FIFO method computes the cost of issued inventory on a historical basis. So, in comparison to other methods, the cost computation under FIFO would always be lower. The reason is that the market prices have a general trend of rising. So the cost today would always be lower than the cost tomorrow. 

In such a case FIFO method would always fetch the highest profit.