Question

Pickering Financial Management believes that the biotechnology industry is a good investment and is considering investing in one of two companies. However, one company, BrightWorid, Inc., uses the FIFO method of inventory, and another company, BioTech, Inc., uses LIFO. Because the companies use two different methods and because BioTech is a much larger company, it is difficult to compare their net incomes to see which is a better investment. The following information about the two companies is available from their annual reports:
BrightWorid, Inc.
2018 2017
Inventory $ 96,000 $ 80,000
Cost of goods sold. 1,144,000 913,000
Sales....... 1,760,000 1,660,000
Net income 197,000 190,000
BioTech, Inc. 2018 2017
Inventory (See Note), 344,000 $ 299,000
Cost of goods sold 3,864,000 4,224,000
Sales 7,360,000 7,040,000
Net income 830,000 730,000
Notes to the Financial Statement. If BioTech had used the FIFO method, inventory would have been $21.000 higher at the end of 2017 and $26,000 higher at the end of 2018.
To better compare the two companies, Pickering wants you to prepare the following analysis.
Showthe computation of BioTech's cost of goods sold in 2018 using the LIFO method.
Prepare summary journal entries for 2018 for BioTech's purchases of inventory (assume all purchases are on account), sales (assume all are on account), and cost of goods sold. A T- account has been set up for inventory. Post these transactions into the T-account. The company uses the perpetual inventory method.
Show the computation of BioTech's cost of goods sold for 2018 using the FIFO method.
Compute the gross profit percentage for 2018 for both BrightWorid and BioTech using FIFO figures for both.
Compute the inventory turnover for 2018 for both BrightWorid and BioTech using FIFO figures for both.
Which company appears stronger? Support your answer.

Answer 1

Answer:

Pickering Financial Management

A. Summary journal entries for 2018: BioTech:

Debit Inventory $3,909,000

Credit Accounts Payable $3,909,000

To record the purchase of inventory on account.

Debit Accounts Receivable $7,360,000

Credit Sales revenue $7,360,000

To record the sale of goods on account.

Debit Cost of goods sold $3,864,000

Credit Inventory $3,864,000

To record the cost of goods sold.

B. T-accounts:

Inventory

Account Titles                   Debit           Credit

Beginning balance      $299,000

Accounts Payable      3,909,000

Cost of goods sold                     $3,864,000

Ending balance                                344,000

C. Computation of Cost of Goods Sold using the FIFO method:

Beginning inventory        $320,000

Purchases                       3,909,000

Goods available              4,229,000

less Ending inventory        370,000

Cost of goods sold      $3,859,000

D. The gross profit percentage, using FIFO:

                                      BrightWorld     BioTech

Gross profit percentage     35%               48%

E. Inventory Turnover:       20x                 21x

F. BioTech is doing better and appears stronger than BrightWorld.  Its gross profit margin is higher than BrightWorld's.  It turns its inventory 21 times as against BrightWorld's 20x, though they are maintaining similar level of net income percentages.

Explanation:

a) Data and Calculations:

Inventory methods:

BrightWorld, Inc. = FIFO (First-in, First-out)

BioTech, Inc. = LIFO (Last-in, First-out)

BrightWorid, Inc.

                                    2018             2017       Average

Inventory                  $ 96,000   $ 80,000     $88,000

Sales.......                  1,760,000 1,660,000

Cost of goods sold. 1,144,000     913,000

Gross profit               616,000     747,000

Net income                 197,000   190,000

BioTech, Inc.

                                    2018             2017

Inventory (See Note), 344,000 $ 299,000

Cost of goods sold 3,864,000  4,224,000

Sales                       7,360,000   7,040,000

Net income                830,000     730,000

BioTech, Inc. Inventory using FIFO:

                                    2018             2017        Average

Inventory                  $370,000    $320,000     $345,000

Sales                       7,360,000    7,040,000

Cost of good sold  3,859,000 using FIFO

Gross profit             3,501,000

                                         LIFO

Cost of goods sold   $3,864,000

Ending inventory            344,000

Goods available        $4,208,000

Beginning inventory      299,000    

Purchases                 $3,909,000

Gross profit percentage:

BrightWorld = Gross profit/Sales * 100 = $616,000/1,760,000 * 100 = 35%

BioTech = $3,501,000/$7,360,000 * 100 = 48%

Inventory Turnover = Net Sales/Average Inventory

BrightWorld = $1,760,000/$88,000 = 20x

BioTech = $7,360,000/$345,000 = 21x