Speed World Cycles sells high-performance motorcycles and Motocross racers. One

Question

Speed World Cycles sells high-performance motorcycles and Motocross racers.  One of Speed World’s most popular models is the Kazomma 900 dirt bike.  During the current year, Speed World purchased eight of these cycles at the following costs:

Purchase Date                                             Units Purchased      Unit Cost   Total Cost

July 1                                                                        2                    $4,950          $9,900

July 22 3                      5,000           15,000

August 3                                                                  3                        5,100           15,300

                                                                                ------                                  ------------

8                                            $40,200

On July 28, Speed World sold four Kazomma 900 dirt bikes to the Vince Wilson racing team. The remaining four bikes remained in inventory at September 30, the end of Speed World’s fiscal year.

Assume that Speed World uses a perpetual inventory system.

Compute the cost of goods sold relating to the sale on July 28 and the ending inventory of Kazomma 900 dirt bikes at September 30, using the following cost flow assumptions:

Average cost

FIFO

LIFO

Show the number of units and the unit costs of each layer comprising the cost of goods sold and ending inventory.

Using the cost figures computed in part a. answer the following questions:

1. Which of the three cost flow assumptions will result in Speed World Cycles reporting the highest net income for the current year?  Would this always be the case?  Explain.

2. Which of the three cost flow assumptions will minimize the income taxes owed by Speed World Cycles for the year? Would you expect this usually to be the case?  Explain.

3. May Speed World Cycles use the cost flow assumption that results in the highest net income for the current year in its financial statements, but use the cost flow assumption that minimizes taxable income for the current year in its income tax return?  Explain.

Explanation / Answer

Part - 1

Average method

Average cost per unit as on july 28 = (9900+15000)/(2+3) =4980

Goods sold = 4 Units

Cost of goods sold = 4*4980 = 19920

Inventory as on 30 sept = 4 units

Value = 4980+15300=20280

FIFO

COGS = 9900+(2*5000) = 19900 (4 units)

Inventory = (5000*1) + (15300) = 20300 (4 units)

LIFO

COGS = 15000+4950 = 19950 (4UNITS)

Inventory = 4950+15300 = 20250 (4units)

PART 2

1. FIFO system will result in highest income as it has highest inventory and lowrst COGS.

2. In LIFO system, income tax would be minimised as the cost is highest and inventory is lowest resulting in lowest profit and lowest tax liability.

This will not be the usual case as other factors will also be responsible for the same.

3. Yes it can use two seperate cost assumptions for accounting and taxation respectively. However it should not change the assumption on continuous basis as this would lead to breach of fundamental accounting principles.

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