Randall Corp. began operations on January 1, 2019, and uses FIFO to cost its inventory. Management is contemplating a change to the average cost method and is interested in determining what effect such a change will have on pre-tax income. Accordingly, the following information has been developed: Based upon the above information, a change to the average cost method in 2020 would result in pre-tax income for 2020 of
A) $ 790,000.
B) $ 860,000.
C) $ 940,000.
D) $ 980,000.

Question

Randall Corp. began operations on January 1, 2019, and uses FIFO to cost its inventory. Management is contemplating a change to the average cost method and is interested in determining what effect such a change will have on pre-tax income. Accordingly, the following information has been developed:  Based upon the above information, a change to the average cost method in 2020 would result in pre-tax income for 2020 of
A) $ 790,000. 
B) $ 860,000. 
C) $ 940,000. 
D) $ 980,000.

Quizplus · Accepted Answer

The change from FIFO to average cost method would result in a lower cost of goods sold and higher ending inventory, which would lead to a higher pre-tax income. Using the average cost method, the cost per unit for the 10,000 units purchased on August 1, 2020, would be $75 [(5,000 x $70) + (5,000 x $80) / 10,000 = $75]. The cost of goods sold for 2020 would therefore be $3,725,000 [(20,000 x $60) + (10,000 x $75)]. The ending inventory would be $2,525,000 [(5,000 x $70) + (15,000 x $75)]. The pre-tax income for 2020 would be $940,000 ($4,880,000 - $3,725,000).