- 21 -
that year, after the wholesale price of the item has increased to
$2.00 a unit, T purchases 100 units more. Unfortunately, T makes
no sales during that year. Applying the accountant’s method,
nevertheless, T computes a cost of goods sold of $100. She reaches
that result by determining the value of her ending inventory (200
units, comprising an opening inventory of 100 units plus an
increment of 100 units), at base-year unit cost ($1.00) to be $200
(200 x $1.00). Since the base-year cost of her opening inventory
of 100 units is $100, and she purchased 100 units during the year
for $200, her cost of goods available for sale is $300, which,
after subtracting the value determined for her yearend inventory
($200), results in a cost of goods sold (and a loss) of $100.
Assume further that, in the next year (year 2), T decides to
liquidate her inventory (200 units) and retire. She sells her
inventory in bulk for $300. Her cost of goods sold is her year 2
opening inventory of $200, which results in T realizing a year 2
gain of $100. Of course, T realizes neither a loss in year 1 nor a
net gain in year 2. T’s failure to index the 100 unit increment
included in her year 1 ending inventory distorts her income for
both years 1 and 2.12 The distortion is only matter of timing,
however, since the understatement of income in year 1 is rectified
by the overstatement of income in year 2. The following table
12 For the 100 units purchased during year 1, the index
would be 200%, reflecting the doubling during the year in the
unit cost of the inventoriable item.
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