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BE6-5 In its first month of operation, Hoffman Company purchased 100 units of inventory for $6, then 200 units for $7, and finally 140 units for $8. At the end of the month, 180 units remained. Compute the amount of phantom profit that would result if the company used FIFO rather than LIFO.

Explain why this amount is referred to as phantom profit. The company uses the periodic method. Identify the impact of LIFO versus FIFO.

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Answer:

Compute the amount of phantom profit that would result if the company used FIFO rather than LIFO.

  • If the company used FIFO instead of LIFO, their profits would increase by $1,960 - $1,720 = $240 because their COGS would be lower.

Explain why this amount is referred to as phantom profit.

  • Phantom profit basically refers to the profit that the company could have made using a different accounting method.

Identify the impact of LIFO versus FIFO.

  • LIFO increases COGS by $240, reducing gross profits by the same amount.

Explanation:

                             units           price            total

purchase               100              $6              $600

purchase               200             $7              $1,400

purchase               140              $8              $1,120

total                       440                                $3,120

ending inventory  180                            

        using LIFO                                         $1,160

        using FIFO                                         $1,400

COGS using LIFO = $3,120 - $1,160 = $1,960

COGS using FIFO = $3,120 - $1,400 = $1,720

If the company used FIFO instead of LIFO, their profits would increase by $1,960 - $1,720 = $240 because their COGS would be lower.