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Hi Sir,Kindly explain the solution for the below question:
Tunshill (1 2/1 0) MCQ case 19 minsThe directors of Tunshill are disappointed by the draft profit for the year ended 30 September 20X3. The company’s assistant accountant has suggested two areas where she believes the reported profit may be improved:
(i) A major item of plant that cost $20 million to purchase and install on 1 October 20X0 is being depreciated on a straight-line basis over a five-year period (assuming no residual value). The plant is wearing well and at the beginning of the current year (1 October 20X2) the production manager believed that the plant was like’ to last eight years in total ie from the date of its purchase). The assistant accountant has calculated that, based
on an eight-year life (and no residual value) the accumulated depreciation of the plant at 30 September 20X3 would be $7.5 million ($20 million /8 years x 3). In the financial statements for the year ended 30 September
20X2, the accumulated depreciation was $8 million ($20 million/S years x 2). Therefore. by adopting an eight-year life. Tunshill can avoid a depreciation charge in the currentyear and instead credit $0.5 million ($8
million— $7.5 million) to profit or loss in the current year to improve the reported profit.
(ii) Most of Tunshill s competitors value their inventory using the average cost (AVCO) basis, whereas Tunshill
uses the first in first out (FlFO) basis. The value of Tunshills inventory at 30 September 20X3 (on the FlFO
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’s inventory at 30 September 20X2 was reported as
$105 million, however on the AVCO basis it would have been reported as $13.4 million.What will be the effect of change in (ii) on profits for yr ended 30 sep X3?
This presumably cannot be correct!
“Tunshill’s inventory at 30 September 20X2 was reported as $105 million, however on the AVCO basis it would have been reported as $13.4 million”
And can I rely on the rest of the information that you have typed out?
And what are the options available to me?
Sorry for the error in the question Sir,the below is the corrected one:
The directors of Tunshill are disappointed by the draft profit for the year ended 30 September 20X3. The company’s assistant accountant has suggested two areas where she believes the reported profit may be improved:
(i) A major item of plant that cost $20 million to purchase and install on 1 October 20X0 is being depreciated on a straight-line basis over a five-year period (assuming no residual value). The plant is wearing well and at the beginning of the current year (1 October 20X2) the production manager believed that the plant was like’ to last eight years in total ie from the date of its purchase). The assistant accountant has calculated that, based
on an eight-year life (and no residual value) the accumulated depreciation of the plant at 30 September 20X3 would be $7.5 million ($20 million /8 years x 3). In the financial statements for the year ended 30 September 20X2, the accumulated depreciation was $8 million ($20 million/S years x 2). Therefore. by adopting an eight-year life. Tunshill can avoid a depreciation charge in the currentyear and instead credit $0.5 million ($8 million— $7.5 million) to profit or loss in the current year to improve the reported profit.
(ii) Most of Tunshill s competitors value their inventory using the average cost (AVCO) basis, whereas Tunshill uses the first in first out (FlFO) basis. The value of Tunshills inventory at 30 September 20X3 (on the FlFO 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’s inventory at 30 September 20X2 was reported as $15 million, however on the AVCO basis it would have been reported as $13.4 millionWhat will be the effect of change in (ii) on profits for yr ended 30 sep X3?
Increase by $400,000
Decrease by $400,000
Increase by $1,600,000
Decrease by $1,600,000The answer is Decrease by $400,000 but I cant understand why.
Concentrate on cost of sales and the way we arrive at the figure for cost of sales:
Opening inventory plus
Purchases less
Closing inventoryThe purchases will not change whether we use FIFO or AVCO so let’s say that purchases is $200
Under FIFO, the cost of sales calculation looks like this:
15 +
200 –
20 =
195and under AVCO it looks like:
13.4 +
200 –
18 =
195.4If cost of sales increases by $.4, what happens to profits?
OK?
Hint – if you can’t figure out some exercise like this, I always find that it helps to put in make-believe missing figures and that then tends to show clearly the result
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