Heinz Company began operations on January 1, 2014, and uses the FIFO method in costing its raw material inventory. Management is contemplating a change to the LIFO method and is interested in determining what effect such a change will have on net income. Accordingly, the following information has been developed: Based on the above information, a change to the LIFO method in 2015 would result in net income for 2015 of
A) $1,170,000.
B) $1,130,000.
C) $1,054,000.
D) $1,050,000.

Question

Heinz Company began operations on January 1, 2014, and uses the FIFO method in costing its raw material inventory. Management is contemplating a change to the LIFO method and is interested in determining what effect such a change will have on net income. Accordingly, the following information has been developed:  Based on the above information, a change to the LIFO method in 2015 would result in net income for 2015 of
A) $1,170,000. 
B) $1,130,000. 
C) $1,054,000. 
D) $1,050,000.

Quizplus · Accepted Answer

Switching to the LIFO method would result in a higher cost of goods sold and therefore a lower gross profit, as LIFO assumes that the most recent inventory purchases are sold first (at higher prices). Using the LIFO method, the cost of goods sold for 2015 would be $2,980,000, calculated as follows: 
Beginning inventory (from 2014) + purchases in 2015 - ending inventory = cost of goods sold 
$680,000 + $2,800,000 - $1,500,000 = $2,980,000

This would result in a gross profit of $520,000 ($3,500,000 - $2,980,000). Deducting operating expenses of $81,000 would result in net income of $439,000. However, since LIFO would have been used in 2014, the beginning inventory for 2015 would also have to be recalculated as if LIFO had been used in the prior year. This would result in a beginning inventory for 2015 of $600,000 ($800,000 - $200,000).

So, the cost of goods sold for 2015 under LIFO would be $2,980,000, gross profit would be $520,000 ($3,500,000 - $2,980,000), and net income would be $474,000 ($520,000 - $81,000 + $35,000). Therefore, net income would decrease by $580,000 ($1,054,000 - $474,000) if Heinz switched to the LIFO method in 2015.

Heinz Company Began Operations on January 1, 2014, and Uses