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Most of Tunshill Co’s competitors value their inventory using the average cost (AVCO) basis, whereas Tunshill Co uses the first in first out (FIFO) basis. The value of Tunshill Co’s inventory at 30 September 20X3 on the FIFO basis, is $20 million, however on the AVCO basis it would be valued at $18 million. By adopting the same method (AVCO) as its competitors, the assistant accountant says the company would improve its profit for the year ended 30 September 20X3 by $2 million. Tunshill Co’s inventory at 30 September 20X2 was reported as $15 million, however on the AVCO basis it would have been reported as $13.4 million.
194. What will be the effect of the change in (ii) on profits for the year ended 30 September 20X3?
A Increased by $400,000
B Reduced by $400,000
C Increased by $1,600,000
D Reduced by $1,600,000the answer says B. reduced by 400000
why is it that?if the profit should reduce by 1.6m (15m-13.4m)for op inventory and 2m (20m-18m) for closing inventory, giving a total of 3.6m of reduction
Hi,
You have got the numbers right but have not thought through the impact of opening and closing inventory on profit.
Closing inventory would be $2 million lower under the new method, which would reduce the profit by $2 million.
Opening inventory would be $1.6 million lower under the new method, which would increase the profit by $1.6 million.
Remember that opening entry is a debit (a cost) in the SPL and closing inventory a credit (reduction in expense) in the SPL.
The net of these tow adjustments gives the answer above.
Thanks
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