Calculate the effect on the financial statements in Tables 1 and 2 if the accounting system were changed to incorporate the cost of barrels ($31.50 each) into the inventory accounts. a.
What would pretax profit be in 1961?
Booker Jones increased production by 20,000 barrels. If the cost of barrels is $31.50, then these 20,000 barrels would cost $630,000. This will be added to inventory account and hence will generate pretax profit of $630,000 – 407,000 = $223,000. b.
If the change were made retroactively as of July 1, 1959 (by adding the cost of barrels to all whiskey in inventory), what would be the effect on i.
The balance sheet at the end of 1960?
Compared to 1959, balance sheet in 1960 will include the cost of barrels in inventory accounts. As of June 30, 1960 the number of gallons of whisky was 4,506,000 / $0.52 = 8,665,484.62 gallons. Add $31.5 / 50 gal/bbl = $0.63 to the $0.52 cost to get bulk whiskey inventory of 8,665,484.62 * $1.15 = $9,965,192.31.
Next, we would have to gross up the value of Bottled and Cased Whiskey by the costs of aging barrels. For this account, there are only 35 gallons / bbl (due to evaporation), so the cost increase would be $31.5 / 35 = $0.90. Applying this increase gives $1,969,000 / $11.20 * (11.20 + 0.90) = $2,127,223.21.
Total change in whiskey inventories would be 9,965,192.31 – 4,506,000.00 = $5,459,192.31 for bulk whiskey and $158,223.21 for a grand total incrase in inventories of $5,617,415.52. Since this asset class would go up with no corresponding increase in liabilities, Shareholder’s Equity would increase by the same amount.
The balance sheet at the end of 1961?
Following the same logic as (i.) above, bulk whiskey would become 5,030,000 / .52 * 1.15 = $11,124,038.46 and finished whiskey would become 1,969,000 / 11.20 * 12.10 = $2,127,223.21. This leads to a grand total increase in inventories of $6,252,261.67, and an identical increase in Shareholder’s Equity. iii.
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