Journal Entries and Inventory Valuation

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

Print Page

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.