Question

Blago Wholesale Company began operations on January 1, 20X1, and uses the average cost method in costing its inventory. Management is contemplating a change to the FIFO method in 20X2 and is interested in determining how such a change will affect net income. Accordingly, the following information has been developed:

20X1 20X2
Final inventory:
Average cost $150,000 $255,000
FIFO 160,000 270,000
Condensed income statements for Blago Wholesale appear below:
20X1 20X2
Sales $1,000,000 $1,200,000
Cost of goods sold 600,000 720,000
Gross profit 400,000 480,000
Selling, general, and
administrative 250,000 275,000
Net income $150,000 $205,000
Required:
Based on this information, what would 20X2 net income be after the change to the FIFO method? Ignore any income tax effects of this change in accounting method.

Answer 1

The net income for Blago Wholesale Company in 20X2 after changing to the FIFO method would be $220,000, which is an increase of $15,000 from the reported net income using the average cost method (before tax effects).

Step-by-step explanation:

To determine how the change to FIFO would affect net income for Blago Wholesale Company in 20X2, we need first to understand the impact of using FIFO (First-In, First-Out) instead of the average cost method on the Cost of Goods Sold (COGS). Under FIFO, the oldest inventory costs are assigned to COGS, while under the average cost method, COGS is based on the weighted average of all units available for sale during the period.

For 20X2, using the average cost method, the final inventory is $255,000, while using FIFO, the final inventory is $270,000. A higher ending inventory on the balance sheet results in a lower COGS on the income statement as Inventory is an asset and COGS is an expense. The difference between the FIFO and average cost inventory values for 20X2 is $270,000 - $255,000 = $15,000.

To calculate the adjusted net income using FIFO, we subtract the difference from the reported COGS to find the FIFO COGS:

720,000 (reported COGS using average cost)
- 15,000 (difference in ending inventory valuation)
= 705,000 (adjusted COGS using FIFO)

Now, we can calculate the adjusted net income:

1,200,000 (sales revenue)
- 705,000 (adjusted COGS using FIFO)
- 275,000 (selling, general, and administrative expenses)
= 220,000 (adjusted net income using FIFO)

Therefore, the net income for 20X2 after the change to the FIFO method would be $220,000, before considering any tax effects.