Question
The following events occurred during the first month of operations for XYZ Corp, a company specialised in providing software to motorcycle manufacturers.
Jan. 1The shareholders invested £300,000 in cash, a land worth £100,000 and a building worth £250,000 in exchange for common shares.
Jan. 2In order to develop a research facility, XYZ acquired computer equipment for £175,000. The purchase price was paid 20% in cash and the remaining on a note.
Jan. 4XYZ issued an advertisement in the newspaper in order to recruit a research lab specialist. The ad will run throughout the month and will cost £1,500. The invoice was received on the 15th of the month.
Jan. 31The research specialist worked for the last 2 weeks of the month. The salary of £5,500 was paid on the last day of the month.
Jan. 31The company started shipping products during the last week of the month. During that period, sales amounted to £265,000, all received in cash except for £15,000, which was sold on account.
Jan. 31At the end of the month, XYZ received a bill from My Telecomm Ltd. for its telephone, Internet and cell phone charges. The total of the invoice amount to £750 to be paid by the end of the following month. In addition, the company paid the newspaper company for the advertisement services provided.
Jan. 31To ensure the survival of the company in case of an incident, the company prepaid £5,000 for an annual insurance policy with coverage starting at the beginning of the following month.
Jan. 31Given the success of the company, the board of directors declared and paid a dividend of £15,000.
To answer this question:
Prepare the journal entries for the current month. Do not prepare any entries for transactions that relate to the following month.
Question 2
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The table below shows a summary of the transactions during the 2014 fiscal year of ABC Ltd. The company is specialised in one computer hardware product, namely, XYZ. After performing an inventory count at the end of the year, ABC Ltd. has determined that only 24,500 units were left on hand. The market value per unit at year end has also been established to be £5.80/unit.
| Transaction | Quantity | Purchase Price Per Unit |
| Beginning inventory | 8,000 | £5.15 |
| Purchases – February 2 | 6,500 | £5.25 |
| Purchases – April 1 | 21,000 | £5.30 |
| Purchases – July 1 | 42,500 | £5.85 |
| Purchases – October 31 | 6,500 | £6.25 |
To answer this question:
- Calculate ending inventory and cost of goods sold under the weighted average method.
- Calculate ending inventory and cost of goods sold under the FIFO method.
- Which of the two methods is preferred for income tax purposes? Why?
Answer
Journal Entries and Inventory Valuation
Question 1
Jan. 1
| Account | Debit
($) |
Credit
($) |
| Cash | 300,000 | |
| Land | 100,000 | |
| Building | 250,000 | |
| Common Stock | 650,000 |
Jan. 2
| Account | Debit
($) |
Credit
($) |
| Computer Equipment | 175,000 | |
| Cash | 35,000 | |
| Notes Payable | 140,000 |
Jan. 4
| Account | Debit
($) |
Credit
($) |
| Advertising Expenses | 1,500 | |
| Accounts Payable | 1,500 |
Jan. 15
| Account | Debit
($) |
Credit
($) |
| Accounts payable | 1,500 | |
| Cash | 1,500 |
Jan. 31
| Account | Debit
($) |
Credit
($) |
| Salaries Expense | 5,500 | |
| Cash | 5,500 |
Jan. 31
| Account | Debit
($) |
Credit
($) |
| Cash | 250,000 | |
| Accounts receivable | 15,000 | |
| Sales | 265,000 |
Jan. 31
| Account | Debit
($) |
Credit
($) |
| Utility expenses | 750 | |
| Accrued utilities | 750 |
Jan. 31
| Account | Debit
($) |
Credit
($) |
| Prepaid insurance | 5,000 | |
| Cash | 5,000 |
Jan. 31
| Account | Debit
($) |
Credit
($) |
| Dividend | 15,000 | |
| Cash | 15,000 |
Question 2
- Calculate ending inventory and cost of goods sold under the weighted average method
The weighted average method uses the weighted average cost per unit to estimate the cost of goods. The weighted average cost per unit is derived by dividing the total cost of goods by the total number of sales.
The total weighted cost is $475,875 while the total quantity is 84,500 units.
The weighted average cost per unit is
Cost of closing stock (Closing stock in units x weighted average unit cost)
= 24,500 x 5.632 = $137,984.
Cost of goods sold: (cost per unit x number of units sold)
= (84,500 – 24,500) x 5.632 = $337,899
- Calculate ending inventory and cost of goods sold under the FIFO method
Ending inventory
Total units sold = total units of goods – closing stock
= 84,500 – 24,500 = 60,000 units.
Thus, 18,000 units in the month of July were in stock.
| Units | Rate ($) | Amount | |
| Purchases – July 1 | 18,000 | 5.85 | 105,300 |
| Purchases – October 31 | 6,500 | 6.25 | 40,625 |
| Total | 145,925 |
Cost of goods sold
| Units | Rate ($) | Amount | |
| Beginning inventory | 8,000 | 5.15 | 41200 |
| Purchases (February 2) | 6,500 | 5.25 | 34125 |
| Purchases (April 1) | 21,000 | 5.3 | 111300 |
| Purchases (July 1) | 24,500 | 5.85 | 143325 |
| Total | 329950 |
The preferable method
For tax purposes, an organization would opt for the weighted average cost method since it leads to lower inventory cost. This in turn leads to lower profits and thus lower taxes. On the other hand, FIFO method leads to a larger profit and net income (Horngren et al., 2012). This in turn leads to higher taxes, which may be detrimental to the organization.
Reference
Horngren, C. et al. (2012). Accounting. New York, NY: Pearson Higher Education.
