Determining the unit cost of inventory is easy when the unit cost remains constant during the period.For example ,during times of inflation,prices rise .To compute cost of goods sold and the cost of inventory on hand ,we must assign the business’s actual cost to each item sold.The three costing methods
that
Generally
Accepted
Accounting
Principles(GAAP)allow are:
1.First-in,First-out (FIFO)Cost
Under the FIFO Method,the first costs into inventory are the first costs out to cost of goods sold -hence ,the name First -In,First-Out.Ending inventory is therefore based on the costs of the latest purchases.
2.Last-in,First-out(LILO)Cost
The LILO method is the opposite of FIFO .Under LILO,the last costs into inventory are the first costs out to cost of goods sold.LILO therefore leaves the oldest costs-those of beginning inventory plus the earliest purchases of the period in ending inventory.
3.Weighted-Average Cost
The Weighted-averaged cost method,often called the averaged-cost method ,is based on the weighted-average cost of
inventory during the period.Weighted-average cost is determined as follows:divide the cost of goods available for sale （beginning inventory plus purchases)by the number of units available for sale (beginning inventory plus purchases）；compute the ending inventory and cost of goods sold by multiplying the number of units by the weighted-averaged cost per cost.
4.The company financial statement and related analysis The Great Wall company sell a commodity by the dollar .At the Great wall company had 200 units of the commodity on hand with a cost of $4,000.Purchases and sales for the month were as follows:
Time Purchases Sold Week 200 units at a cost of $4,800 200 units Week 400 units at a cost of $10,000 300 units Week 100 units at a cost of $4,800 150 units Required: using FIFO method ,calculate the amount to be charged to cost of goods and the amounts of closing stock . 1.Cost Schedule for the FIFO Method
Week In Out Balance 0 200@20 $4000 1 200@24 200@20 $4000 200@20 $4000
2 400@25 200@24 $4800 200@25 $5000 200@25 $5000
3 100@28 200@25 $5000 100@28 $2800 Cost of goods sold:$18,800 Ending balance:$2800 2.Cost Schedule for the LIFO Method
Week In Out Balance 0 200@20 $4000 1 200@24 200@24 $4800 200@20 $4000 2 400@25 400@25 $10000 200@20 $4000 3 100@28 100@28 $2800 100@20 $2000 100@20 $2000
Cost of goods sold :$19,600 Ending balance:$2000 3.Cost Schedule for Weighted-Average Cost Method Week In Out Balance 0 200@20 $4000 1 200@24 200@22 $4400 200@22 $4400 2 400@25 300@24 $7200 300@24 $7200 3 100@28 200@25 $5000 200@25 $5000 Cost of goods sold：$16,600 Ending balance:$5000
How well do LIFO method and FIFO method affect the cost
of goods sold and sales revenue in income statement LILO method and FIFO method affect the cost of goods sold and sales revenue in income statement as follows:LIFO best matches the current value of cost of goods sold with current revenue by assigning to cost of sales the most recent inventory costs.Therefore,LIFO produces the cost-of-goods-sold figure that is closest to what it would cost the company to replace the goods sold.In contrast ,FIFO matches the oldest inventory costs against the period’s revenue -a poor matching of current expense with current revenue.
What effects do the methods have on income taxes LIFO results in lowest tax payment when prices are rising.Taxes are highest under FIFO .When inventory prices are decreasing ,tax payment are highest under FIFO and lowest under FIFO .The weighted-averaged cost method produces amounts between the extremes of LIFO and FIFO. Higher income or lower taxes
The Great Wall company may want to report the highest income,and FIFO meets this need when prices are rising .But the company must pay the highest income.
Which inventory method is better -LIFO or FIFO? There is no single answer to that question.Different companies have
motives for the inventory method they choose. FIFO produces so-called inventory profit
FIFO is criticized because it overstates income by so-called
inventory
profit
during
periods
of
inflation.Briefly,inventory profit is the difference between gross margin figured on the FIFO basis and gross margin figured on the FIFO and LIFO basis.
LIFO allows managers to manipulate reported income -up or down LIFO is criticized because it allows managers to manipulate net income .Assuming that inventory prices are rising rapidly and that a company wants to show less income for the year（in order to pay taxes).Managers can buy a large amount of inventory near the end of the year .Under LIFO these high inventory costs immediately become expense -at cost of goods sold.As a result,the
income
statement
reports
a
lower
net
income .Conversely,if the business is having a bad year,management may wish to increase reported income.To do so,managers can delay a large purchase of high-cost inventory until the next period .This high-cost inventory is not expended as cost of goods sold in the current year .Thus management avoids decreasing the current year’s reported income.In the process ,the company draws down inventory quantities.
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