Financial Accounting: Assets
Assignment
Question 1 (20 marks)
Computer question
The records of Clayton Company showed the following transactions, in the order given,
relating to the major inventory item:
1.
2.
3.
4.
5.
6.
7.
8.
Inventory
Purchase
Sales (at €15)
Purchase
Sales (at €15)
Purchase
Sales (at €18)
Purchase
Units
Unit cost
3,000
6,000
4,000
5,000
9,000
11,000
9,000
6,000
€ 6.90
7.20
7.50
7.66
7.80
Required
Complete the following schedule for each independent assumption (round unit costs to 2
decimal places; show computations):
Independent assumptions
Units and amounts
Ending
Cost of
Gross
inventory
goods sold margin
a. (6 marks)
FIFO, periodic inventory system
b. (7 marks)
Weighted average, periodic inventory system
c. (7 marks)
Moving average, perpetual inventory system
Question 2 (30 marks)
Multiple choice (1 mark each)
a. When determining the unit cost of an inventory item, which of the following should
normally not be included?
1)
2)
3)
4)
Interest on loans obtained to purchase the item
Commissions paid when item purchased
Labour costs of the item when manufactured
Depreciation of plant equipment used in manufacturing the item
b. Which of the following is true with respect to the perpetual inventory system?
1)
2)
3)
4)
Under this system, it is possible to determine the value of inventory and cost
of goods sold without taking an inventory count.
The cost of this system is usually higher than that of a periodic inventory
system.
Under this system, it is possible to determine the amount of inventory
shortages.
All of the above
c. Which of the following is true with respect to the periodic inventory system?
1)
2)
3)
4)
Inventory is counted periodically to verify inventory.
Inventory is counted periodically to determine inventory.
Inventory is counted periodically to determine the amount of inventory theft.
Only the specific cost identification method of inventory costing can be used
with the periodic inventory system.
d. Which inventory costing system results in the most recent purchases being assigned
to ending inventory?
1)
2)
3)
4)
Moving weighted average
Specific cost identification
FIFO
Weighted-average
e. When prices are rising, which inventory costing method produces the highest
reported profit?
1)
2)
3)
4)
Moving average
Weighted-average
FIFO
Specific identification
f. Which inventory costing method produces the worst match between sales and the
current cost of the items being sold?
1)
2)
3)
4)
FIFO
Specific identification
Weighted-average
Moving average
g. Which inventory costing method is not an allowed treatment for interchangeable
inventory items under IAS 2?
1)
2)
3)
4)
Moving weighted average
FIFO
Specific identification
Weighted-average
h. XYZ Inc. has been using the average cost method of inventory valuation for five
years, since it began operations. Its 20X6 ending inventory was €64,000, but it would
have been €96,000 if FIFO had been used. Thus, if FIFO had been used, what would
XYZ’s profit before income taxes have been?
1)
€32,000 greater over the five-year period
2)
3)
4)
€32,000 less over the five-year period
€32,000 greater in 20X5
€32,000 less in 20X4
i. Delta Inc.’s inventory General ledger account shows inventory at December 31, year 1
of €96,000 for Product #2385. Delta determines that this inventory could be sold for
€98,500 and that selling costs of €5,000 would be incurred to make the sales. At what
amount should this inventory be reported on the December 31 balance sheet?
1)
2)
3)
4)
€96,000
€103,500
€91,000
€93,500
j. Which statement is true about the gross profit method of inventory valuation?
1)
2)
3)
4)
It can be used as a substitute for the annual physical count of inventory.
It assumes past percentages of gross profit are appropriate for the current
period.
It uses markups but not markdowns
It is designed to approximate inventory at the lower of cost and net realizable
value.
k. Which of the following is not a reason for using the retail method of inventory
estimation?
1)
2)
3)
4)
To estimate the final inventory for interim financial statements where a
periodic or perpetual system is not available
To provide a means of converting a physical inventory priced at retail to one
priced at approximate cost
To verify the ending inventory reported under a perpetual inventory system
To provide a basis for planning and controlling inventory, theft, purchases,
markups, and markdowns
l. If ending inventory is overstated by €24,000 at the end of the period, Cost of goods
sold for that period is understated by €24,000? What is the effect of the error on the
Cost of goods sold of the next period?
1)
2)
3)
4)
Understated by €24,000
No effect
Understated by €48,000
Overstated by €24,000
m. Teal Inc. uses a periodic inventory system. Teal incorrectly recorded purchases in
year 3. Purchases were too low by €12,500. What is the effect of that error?
1)
2)
3)
4)
Inventory at end of year 3 will be too low by €12,500.
Profit for year 3 will be too low by €12,500.
Profit for year 3 will be too high by €12,500.
Cost of goods sold for year 4 will be too low by €12,500.
n. If a company using a periodic inventory system misses counting some inventory
during its year end physical count, what is the impact on the gross profit of the
period?
1)
2)
3)
4)
Gross profit for the period will be too low.
Gross profit for the period will be too high.
There will be no impact on gross profit for the period.
Gross profit will be reduced by the amount of the inventory shortage.
(2 marks each)
o. Turnip Inc., a retail store chain, had the following information in its General ledger
for the year 20X6:
Merchandise purchased for resale
Interest on notes payable to vendors
Purchase returns
Freight-in
Freight-out
€408,600
4,350
8,250
10,500
8,550
What is Turnip’s inventoriable cost for 20X6?
1)
2)
3)
4)
€400,350
€410,850
€415,200
€423,750
p. Orange Inc. had an inventory of 3,200 saws valued at €8 each to begin the month.
Orange purchased 4,800 saws on the last day of the month at €9.60 each and sold
1,600 saws on the 15th of the month.
What is the moving-average unit cost at the beginning of the next month, assuming
the company uses a perpetual inventory system?
1)
2)
3)
4)
€9.60
€9.20
€8.96
€8.80
q. The following information was available for Trites Inc. for 20X6:
Sales
Beginning inventory
Freight out
Purchases
Sales commissions
Cost of goods sold
€ 200,000
72,000
18,000
86,000
10,000
120,000
What is the 20X6 ending inventory of Trites Inc.?
1)
2)
3)
4)
€56,000
€38,000
€94,000
€28,000
r. Wasserman Inc. sells its merchandise at a gross margin of 30%. The following
figures pertain to Wasserman’s operations for the six months ended June 30, 20X6:
Sales
Beginning inventory
Purchases
€ 400,000
100,000
260,000
On June 30, 20X6, Wasserman’s inventory was completely destroyed by fire. What is
the estimated cost of the inventory destroyed by the fire?
1)
2)
3)
4)
€240,000
€140,000
€80,000
€40,000
s. Corn Inc.’s inventory of €1,100,000 at December 31, 20X6, was based on a physical
count of goods priced at cost. Goods shipped FOB shipping point on December 24,
20X6, from a vendor at an invoice cost of €90,000 to Corn. Inc. were received on
January 4, 20X7, and recorded as purchases as of that date. Which of the following
statements is true?
1)
2)
3)
4)
Inventory for 20X6 is understated by €90,000, and cost of goods sold for
20X6 is overstated by €90,000.
Inventory for 20X6 is overstated by €90,000, and cost of goods sold for 20X6
is overstated by €90,000.
Inventory for 20X6 is understated by €90,000, and cost of goods sold for
20X6 is correctly stated.
Inventory for 20X6 is overstated by €90,000 and cost of goods sold for 20X6
is correctly stated.
t. A company uses the retail inventory method to estimate inventory at the end of each
month. The following data method was available for the month of January, 20X7:
Beginning inventory, Jan. 1
Purchases in January
Sales in January
At cost
At retail
€ 82,000
115,500
€ 120,000
165,000
240,000
What is the estimated inventory at cost at January 31 using the retail inventory
method?
1)
2)
3)
4)
€31,500
€30,700
€31,184
€64,937
u. Goods on consignment from one of Kaling Inc.’s suppliers were inappropriately
included in Kaling’s physical inventory counts at the end of year 5 and year 6. These
goods were costed at €45,000 and €35,000, respectively. What is the impact of these
errors on Kaling’s year 6 profit?
1)
2)
Overstated by €35,000
Overstated by €10,000
Understated by €35,000
Understated by €10,000
3)
4)
v. BR Inc. uses a perpetual inventory system, and follows GAAP/IAS in preparing its
external financial statements. At the end of year 6, the balance in the inventory
account was €36,000; €3,000 of those goods included in ending inventory were
purchased FOB shipping point and did not arrive until year 7. Purchases in year 7
were €300,000. The perpetual inventory records showed an ending inventory of
€42,000 for year 7. A physical count of the goods on hand at the end of year 7
showed an inventory of €38,000. Inventory shortages are included in the cost of
goods sold. What should the company report on its year 7 income statement for cost
of goods sold?
€294,000
€298,000
€300,000
€301,000
1)
2)
3)
4)
Question 3 (14 marks)
Flashy Computers Inc. began operations in year 5. Selected information for the first two
years is presented below:
Year 5
Sales
Retained earnings, beginning of year
Dividends paid during year
38 units
€0
€ 10,000
Year 6
70 units
€ 25,000
€ 22,000
The inventory records reveal the following purchases of computers in chronological
order:
Year 5
20 units at €1,000 each
22 units at €1,200 each
Year 6
30 units at €1,300 each
46 units at €1,400 each
The above figures reflect the base price charged by the suppliers. In addition, Flashy paid
duty of 10% on each of the units purchased.
The physical inventory count at the company’s warehouse revealed three units on hand at
the end of year 5 and seven units on hand at the end of year 6. In addition, there was one
computer out on consignment at the end of year 5 and two computers out on consignment
at the end of year 6.
Flashy uses the FIFO periodic method of accounting for its inventory.
Required
1. (5 marks)
Determine the cost of inventory on hand at the end of year 5 and year 6. Assume that
inventory levels have increased steadily over time.
2. (4 marks)
What is the cost of inventory shortages for year 6?
3. (5 marks)
Calculate profit for year 5 assuming the company had used the average cost method of
accounting for inventory.
Question 4 (16 marks)
Relam Inc. maintains a perpetual inventory system and uses the moving average cost
flow assumption. At the beginning of 20X6, it had 5,000 units of a certain inventory with
a moving average unit cost of €12. The following purchases and sales of this inventory
item took place during 20X6:
Relam Inc.
Inventory purchase information 20X6
Units
Unit cost
Total cost
Opening inventory, January 1
5,000
€12.00
€ 60,000
Purchases, May 8
1,000
€10.25
10,250
500
€8.50
4,250
1,000
€7.50
7,500
Purchases, October 7
Purchases, December 6
Relam Inc.
Inventory sales information 20X6
Units
Unit selling
price
Total sales
Sales, February 14
2,500
€15
€ 37,500
Sales, June 15
2,500
€12
30,000
Sales, November 10
1,000
€11
11,000
Total sales in units and €
6,000
€ 78,500
At December 31, Relam estimates that it can sell this inventory for a price €9 per unit
plus a selling cost of €1 per unit.
Required
1. (6 marks)
Determine the December 31 ending inventory using the moving average cost flow
assumption.
2. (4 marks)
At what amount should this inventory be reported on the December 31, 20X6, balance
sheet of Relam?
3. (2 marks)
Why is it important to report inventory at the lower of cost or net realizable value?
4. (4 marks)
What would Ending inventory at December 31, 20X6, and 20X6 Cost of goods sold be
for Relam if it used the FIFO cost flow assumption rather than the moving average unit
cost method?
Question 5 (20 marks)
Acme Computer Distributors Inc. has been in the computer sales business for a number
of years. The company accounts for its inventory of computers held for resale using a
perpetual inventory system with the FIFO cost flow assumption. During the past three
years, the cost of the computers purchased by Acme for resale has been declining. Senior
management of the company has noted that Acme is not as profitable as its major
competitors. All of the major competitors account for their inventory of computers using
perpetual inventory systems with the moving average unit cost flow assumption. The
senior management of Acme is compensated through a combination of salary and bonus
based on profit. Acme is considering switching its inventory cost flow assumption from
FIFO to the moving average unit cost method.
Required
1. (4 marks)
Explain why the profitability of Acme would be lower than that of its competitors as a
result of its inventory costing method.
2. (4 marks)
What impact would a switch from FIFO to the moving average unit cost method have on
management bonuses at Acme?
3. (4 marks)
What impact would a switch from FIFO to the moving average unit cost method have on
Acme’s cash flow before management bonuses and income tax?
4. (4 marks)
Does the choice between FIFO and the moving average unit cost method make any
difference to profit in the long run? Explain. Would there be any impact on the lower of
cost or net realizable value inventory valuation from a switch to the moving average unit
cost method?
5. (4 marks)
On what basis should accounting policy choices be made? What should Acme do in this
case?
Suggested solutions
Question 1 (20 marks)
Independent assumptions
a. FIFO, periodic system
b. Weighted average, periodic system
c. Moving average, perpetual system
Units and amounts
Ending
Cost of
Gross
inventory
goods sold margin
€ 69,780
67,500
69,690
€162,680
165,000
162,770
€194,320
192,000
194,230
6 marks for FIFO (2, 3, and 1 marks)
7 marks for weighted average (3, 3, and 1 marks)
7 marks for moving average (3, 3, and 1 marks)
Calculations:
Sales = 13,000  15 + 9,000  18 = 357,000
FIFO:
CGS
4,000 sold = 3,000  6.90 + 1,000  7.20 = 27,900
9,000 sold = 5,000  7.20 + 4,000  7.50 = 66,000
9,000 sold = 1,000  7.50 + 8,000  7.66 = 68,780
Ending inventory = 3,000  7.66 + 6,000  7.80
Weighted Average:
Unit cost = (3,000  6.90 + 6,000  7.20 + 5,000  7.50 + 11,000  7.66 + 6,000  7.80)
all divided by 31,000 = 232,460 / 31,000 = 7.50
CGS = 22,000  7.50
Ending inventory = 9,000  7.50
Moving Weighted Average:
CGS
4,000 sold = 4,000  [(3,000  6.90 + 6,000  7.20) ÷ 9,000] = 4,000  7.10 = 28,400
9,000 sold = 9,000  [(5,000 @ 7.10 + 5,000 @ 7.50) ÷ 10,000] = 9,000  7.30 = 65,700
9,000 sold = 9,000  [1,000 @ 7.30 + 11,000 @ 7.66) ÷ 12,000] = 9,000  7.63 = 68,670
Ending inventory = 3,000  7.63 + 6,000  7.80
Question 2 (30 marks)
Multiple choice (1 mark each)
a. 1)
Interest on loans obtained to purchase inventory is normally treated as a financing
expense. IAS 23 provides for capitalization of interest in very limited circumstances.
b. 4)
All responses are features of the perpetual inventory system.
c. 2)
Under the periodic inventory system, no running total of inventory is kept since the
inventory is not updated as sales are made. Therefore, the only way to determine
inventory at a specific point in time is to do a physical inventory count. Under the
perpetual inventory system, inventory is counted periodically to verify the inventory
number that has been maintained in the accounting records.
d. 3)
FIFO means that the first units purchased have been sold; therefore, the last items
purchased (the most recent purchases) should still be in inventory.
e. 3)
Since FIFO assigns the oldest costs to Cost of goods sold, the lowest costs are being
assigned to Cost of goods sold in a period of rising prices. This will produce the lowest
Cost of goods sold and, therefore, the highest profit.
f. 1)
Since FIFO assigns the oldest costs to Cost of goods sold, there is a poor match between
sales and the current cost of the item being sold.
g. 3)
FIFO and weighted average are benchmark treatments for costing interchangeable
inventory items under IAS 2. Specific identification is not is an allowed treatment for
interchangeable items.
h. 1)
If ending inventory is higher under FIFO by €32,000, then Cost of goods sold under
FIFO would have to be €32,000 lower. If Cost of goods sold is lower by €32,000, profit
over the five years would have been €32,000 higher.
i. 4)
IAS 2 require inventory be reported at the lower of cost or net realizable value. NRV is
€93,500 (€98,500 – €5,000), which is less than cost.
j. 2)
The gross margin method of estimating inventory may be used to estimate inventory for
interim financial statements and other purposes, but all enterprises must have at least an
annual physical inventory count.
k. 3)
Ending inventory under a perpetual inventory system must be verified by a physical
inventory count.
l. 4)
The overstatement of ending inventory means the opening inventory of the next period
will also be overstated. If opening inventory is overstated by €24,000, then Cost of goods
sold will be overstated based on the relationship Opening inventory + Purchases –
Ending inventory = Cost of goods sold.
m. 3)
In year 3, profit will be too high by €12,500 because Cost of goods sold will be too low
based on the relationship Opening inventory + Purchases – Ending inventory = Cost of
goods sold.
n. 1)
If some inventory is not counted, ending inventory will be too low. If ending inventory is
too low, Cost of goods sold for the period will be too high. If Cost of goods sold is too
high, gross profit for the period is too low.
(2 marks each)
o. 2)
€408,600 – €8,250 + €10,500
p. 2)
[(1,600  €8.00) + (4,800  €9.60)] ÷ (1,600 + 4,800)
q. 2)
€72,000 + €86,000 – €120,000
r. 3)
(€100,000 + €260,000) – (€400,000  70%)
s. 3)
The goods belong to Corn Inc. effective December 24, 20X6. Therefore, Corn’s ending
inventory is understated. This would normally mean that 20X6 Cost of goods sold was
overstated. However, since the goods were not recorded as purchases until 20X7, 20X6
purchases are also understated which offsets the understatement of inventory for
purposes of the Cost of goods sold calculation.
t. 3)
Cost ratio = (€82,000 + €115,500) ÷ (€120,000 + €165,000) = 0.69298
Ending inventory at retail = €120,000 + €165,000 – €240,000 = €45,000
Ending inventory at cost = €45,000  0.69298 = €31,184 (rounded)
u. 4)
Year 6 Cost of goods sold is overstated by €10,000 (€45,000 – €35,000). Therefore, year
6 profit is understated by €10,000.
v. 2)
€36,000 + €300,000 – €38,000
Question 3 (14 marks)
Requirement 1 (5 marks)
Total Inventory
Year 5
(€1,200 + 10%)  4
€ 5,2801
Year 6
(€1,400 + 10%)  9
€13,8602
1
At the end of year 5, there are three units on hand and one on consignment for a total
inventory of four units. Under FIFO periodic, these will be the newest units purchased
in the year, which are the ones purchased at €1,200 each plus the duty.
2
At the end of year 6, there are seven units on hand plus two on consignment for a total
inventory of nine units. Under FIFO periodic, these will be the newest units from the
current year (the newest purchases) — which are the ones purchased at €1,400 each
plus the duty.
Requirement 2 (4 marks)
At the end of year 6, there should be 10 units of inventory on hand according to the
inventory records as follows:
Purchases (20 + 22 + 30 + 46)
Less: Sales (38 + 70)
Inventory, end of year 6
118
108
10
The actual inventory on hand is only nine units (7 in warehouse + 2 on consignment).
Therefore, one unit of inventory has gone missing. Under FIFO, the oldest purchases are
the ones assumed to be sold first. Since the missing one has been “consumed,” it should
be costed at the oldest inventory cost. However, the key here is to note that the sales of
108 units over the two years means the first 108 units are “sold.” The 108th unit comes
from the last 46 purchased. Therefore, its cost is €1,540 (€1,400  1.1).
Requirement 3 (5 marks)
Profit under average cost (€25,0001 +
€10,000 (year 5 dividends))
Less: Ending inventory under average cost2
Plus: Ending inventory under FIFO (4  1,200  1.1)
Profit under average cost
1
2
€ 35,000
(4,860)
5,280
€ 35,420
The opening RE for year 5 is nil while the opening RE for year 6 is €25,000.
Therefore, the profit for year 5 has to be €25,000.
The average cost for year 5 would be [(20  €1,000) + (22  €1,200)]  1.10 ALL
divided by 42 — or €1,215.24 (rounded to €1,215)
Question 4 (16 marks)
Requirement 1 (6 marks)
The cost of the Ending inventory under the moving average unit cost method is €12,750
as calculated below:
Date
Units
January 1
February 14
May 8
June 15
October 7
November 10
December 6
1
2
3
1,000
Purchases
Unit
Total
cost
cost
€ 10.25 € 10,250
Units
8.50
4,250
1,000
7.50
7,500
€ 22,000
Total
cost
Units
5,000
2,500
3,500
11.50
28,750 1,000
1,500
10.50
10,500
500
1,500
€ 69,250
2,500 € 12.00 € 30,000
2,500
500
Sales
Unit
cost
1,000
Inventory
Unit
Total
cost
cost
€12.00 € 60,000
12.00
30,000
11.501
40,250
11.50
11,500
2
10.50
15,750
10.50
5,250
8.503 €12,750
(€30,000 + €10,250)  (2,500 + 1,000)
(€11,500 + €4,250)  (1,000 + 500)
(€5,250 + €7,500)  (500 + 1,000)
Requirement 2 (4 marks)
Inventory should always be reported at the lower of cost or net realizable value. Relam
should make a comparison at the end of the year between cost and net realizable value
and report at the lower amount.
Inventory cost (per Requirement 1)
Net realizable value (1,500  (€9.00 – €1.00))
Lower of cost or net realizable value
€12,750
€12,000
€12,000
Therefore, the inventory should be reported at €12,000, since net realizable value is less
than cost.
Requirement 3 (2 marks)
The reason for reporting inventory at the lower of cost or net realizable value is to ensure
that inventory is not reported on the balance sheet at an amount in excess of its of its
realizable value.
Requirement 4 (4 marks)
The simplest way to calculate Ending inventory and Cost of goods sold if Relam used the
FIFO cost flow assumption is to remember that the FIFO cost flow assumption produces
the same allocation of cost of goods available for sale to Ending inventory and Cost of
goods sold under both the periodic and perpetual methods of recording inventory. Since
the calculations under the periodic inventory method are simpler, we will use that
method. Of course, the student may choose to do the calculations using the perpetual
inventory method.
The first step is to calculate the Cost of goods available for sale as follows:
Opening Inventory, January 1
Units
5,000
Unit cost
€ 12.00
Total cost
€ 60,000
Purchases, May 8
Purchases, October 7
Purchases, December 6
Units and Cost of goods available for sale
1,000
500
1,000
7,500
10.25
8.50
7.50
10,250
4,250
7,500
€ 82,000
Since there were sales of 6,000 units in the year, there are 1,500 units left in ending
inventory (assuming no shortages). Under FIFO, these 1,500 units are assumed to be the
most recent ones purchased. Therefore, Ending inventory would be
Opening Inventory, January 1
Purchases, May 8
Purchases, October 7
Units
1,000
500
1,500
Unit cost
€ 7.50
8.50
Total cost
€ 7,500
4,250
€ 11,750
Cost of goods sold is calculated as Cost of goods available for sale minus the Ending
inventory or
€82,000 – €11,750 = €70,250
This can be verified by assigning the oldest purchases to Cost of goods sold for the 6,000
units sold as follows:
From Opening inventory
From May 8 purchase
Cost of goods sold (FIFO)
Units
5,000
1,000
6,000
Unit cost
€ 12.00
10.25
Total cost
€ 60,000
10,250
€ 70,250
Question 5 (20 marks)
Requirement 1 (4 marks)
The FIFO cost flow assumption matches the cost of the oldest purchases with current
revenues. In a period of declining prices, this means that the Cost of goods sold will be
charged with relatively higher costs, since the older costs are the higher ones. The
moving average unit cost method bases the Costs of goods sold on a weighted average of
all of the units available at the time of sale. Therefore, in a period of declining prices, the
moving average unit cost method would give a lower Cost of goods sold than the FIFO
cost flow assumption. Since Acme’s competitors are using the moving average unit cost
method, they would have higher profitability than Acme, all else being equal.
Requirement 2 (4 marks)
Management bonuses at Acme are based on profit. If Acme switched its inventory
costing from FIFO to the moving average unit cost method, costs of goods sold at Acme
would decrease and profit would increase. Because of the increased profit, the
management bonuses would increase. This assumes that the price of the computers
continues to decline. If prices were to rise, then the moving average unit cost method
would give a lower profit than FIFO and the bonuses would be lower.
Requirement 3 (4 marks)
Inventory cost flow assumptions are simply methods of assigning costs of inventory to
Cost of goods sold and Ending inventory. The cost flow assumption selected will have an
impact on the reported profit before management bonuses and income tax for the period
but no effect on cash flow before management bonuses and income tax. The cash flow
before management bonuses and income tax is based solely on how much Acme pays for
the inventory. Since management bonuses and income tax (both of which will have an
impact on cash) are based on profit before management bonuses and income tax, there
will be an impact on cash flow after bonus and income tax. Therefore, the switch from
FIFO to the moving average unit cost method of inventory valuation would have no
impact on cash flow before management bonuses and income taxes.
Requirement 4 (4 marks)
In the long run, profit will be based on the selling price of the inventory less what the
inventory cost. The total cost of the inventory purchased will be assigned to Cost of
goods sold in the long run. In the short run, the choice of inventory costing methods will
have an impact on Cost of goods sold of individual reporting periods. However, since the
total cost of goods purchased is eventually allocated to Cost of goods sold, the choice
between FIFO and the moving average unit cost makes no difference to profit in the
long run.
If Acme switched to the moving average unit cost method, the ending inventory would be
higher than under FIFO, assuming prices are declining. It is possible that this higher cost
of ending inventory could trigger a write down of inventory under the lower of cost or net
realizable value rule. This is because the ending inventory value might now be higher
than net realizable value where it wasn’t when it was recorded at a lower cost under
FIFO.
Requirement 5 (4 marks)
Accounting policy choices are made by referring to IFRSs to see if there is a standard for
the particular issue in question. As we have seen, IAS 2 requires that entities use either
the FIFO or weighted-average cost flow assumption for inventory valuation for items that
are normally interchangeable. Where the standards provide this choice, the entity must
decide which alternative to choose. One thing the entity might look to for guidance is
what alternative seems to predominate in the industry that the entity operates in.
Choosing the industry standard may make the entity’s financial statements more
comparable with those of its competitors. As noted above, the selection of an inventory
costing method has no impact on cash flow before bonuses and income taxes and no
impact on long run profit. A sophisticated reader of financial statements should be able to
make comparisons between companies that choose alternative accounting policies by
making appropriate reconciliations.
It might be reasonable for Acme to switch to the moving average unit cost method since
that is the method used by most of its competitors. This would help investors and other
users more easily make comparisons of the companies in that industry. If management
only switches to the moving average unit cost method to increase profit and bonuses,
they must be reminded that the new method will result in lower management bonuses if
prices paid for computers start to increase. If that happens it will be very difficult to
argue that they should switch back to FIFO. Consistency is a very important feature of
financial reporting. Companies may not continuously change accounting policies just to
achieve short term profit goals.