Chap 8: Inv-Cost Flow Assumption

7.What are the advantages of LIFO?

* Provides proper matching of recent costs with current revenue. *Provides Tax Benefits *Improves future earnings hedge *Ina period of rising prices the inv. method that produced the lowest End. Inv is LIFO PERIODIC METHOD *Deferral of Income Tax when prices are rising *More closely approximates current cost for COGS

5. What are the advantages of FIFO?

*It approximates the physical flow of goods, especially for perishables. *Less subject to manipulation than specific identification. *Preferable if revenues have been increasing slower than costs. *More closely approximates current cost for ending inventory.

8.What are the disadvantages of LIFO?

*Lower reported earnings than FIFO *Reports outdated costs on balance sheet *Contrary to normal physical flow *Creates involuntary liquidation problems with tax consequences. *Invites poor buying habits *Inventory is understated on the balance sheet. *Profits will be lower in inflationary times. Not Preferable When *Prices lag behind costs *Specific identification is traditional *Unit costs tend to decrease as production increases (nullifies tax benefits

4.What is FIFO?

Assumes goods are used in the order in which they are purchased. First-In, First-Out. Most of the time, this is what happens in the real world. In all cases where FIFO is used, the inventory and cost of goods sold are the SAME at the end of the month, whether a perpetual or periodic system is used. *Approximates the physical flow of goods. *Ending Inventory is close to current cost. *Fails to match current costs against current revenues. *When looking at Cost of Goods Sold, start from the top down. When looking at ending inventory, start from the bottom (most recent purchase and work your way up. Look at last purchase made, keep adding up until you get to total count.

10.What is Moving Average Method?

Changes any time there is a purchase. Compute a new average unit cost after each purchase. Usually justifiable for practical reasons - easy to use, objective, and less subject to manipulation. Used by businesses whose inventory consists of similar items.

1.What is Cost Flow Assumption?

Cost flow assumption is not consistent with physical movement of goods. *Should select method that most clearly reflects periodic income. *Companies may use multiple costing methods at one time.

9.What is Average Cost?

Determine an average cost for each unit and use that cost to determine the ending Inventory and the Cost of Goods Sold. Weighted average cost is common in practice - don't have to keep up with rates.

6.What is LIFO?

Last-In, First-Out. When looking at Cost of Goods Sold, start from the bottom up. The cost of the total quantity sold comes from the most recent purchases. When looking at ending inventory, start from the top (oldest purchase) and work your way down. Look at first purchase made, keep adding until you get to total count.

11.What is Retail Inventory Method? ( Advantages and Disadvantages)

Sometimes used by retailers that resell merchandise, to estimate their ending inventory balances. Based on relationship between merchandise cost and retail price. Not particularly accurate. Should be supplemented with periodic count of physical inventory. Not appropriate for year-end financial statements. Ending inventory calculation: Beginning inventory (at cost) + purchases (at cost) - sales (at cost) Advantage: Quick and easy. Disadvantages: *Only an estimate. *Only works with consistent markups across all products. *Assumes historical cost basis continues into current period. *Doesn't work in acquisitions where aquiree uses different markup percentage

2.What is the Goods Available for Sale Formula?

Total Cost of Beginning Inventory + Purchases during the period

3.What is Specific Identification?( IFRS prefers this method)

Used very rarely and typically for a customized product. *match costs with revenue *Cost flow matches physical flow and ending inventory matches actual cost. Ex. buying a specific car from a dealership