Inventory Cost Flow Assumptions

During March, Jeremy’s Friendly Market showed the
following results:
 Beginning
inventory of Big Q Beans was 400 cans at $0.75
per can
 Purchased 1,000 cans of Big Q Beans for $0.79 per can.
Later that month, they purchased 2,000 more cans of Big Q
Beans for $0.84 per can
 It sells 2,400 cans of beans during March

What is the cost of the beans sold?

Cost flow assumptions allocate goods available for
sale (GAS) to cost of goods sold and ending inventory
(EI)
 What
is the cost of the beans remaining in merchandise
inventory?
 BI +
 GAS
Purch = GAS
– EI + GoGS (GAS = EI + GoGS)

Alternate inventory cost flow assumptions
 Specific
identification
 tracks the actual cost of each item in merchandise
inventory and the actual cost of items sold
 Weighted
average
 Same
cost is assigned to all GAS for each inventory item
carried by the business.

Average cost per unit in GAS:
Total cost of inventory item _
Total # of units of inventory item
 First-in, first-out (FIFO)
 Assumes that FIRST items purchased are first items sold
 Oldest costs are in CoGS
 Most recent costs are in EI
 Last-in, last-out (LIFO)
 Assumes that LAST items purchased are first items sold
 Most recent costs are in CoGS
 Oldest costs are in EI
Effect of Cost Flow Assumptions on Financial
Statements
FIFO
LIFO
Wt. Avg.
Sales
$ 3,000 $ 3,000 $3,000
Cost of G. S.
1,930
1,996
1,955
Gross Margin
1,070
1,004
1,045
Oper. exp.
250
250
250
Pretax Inc.
820
754
795
Taxes (30%)
246
226
239
Net Income
$574
$528
$556
Assumes sales price $1.25/can & op exp $250
Effect of Cost Flow Assumptions on Financial
Statements
 Effect
of reported inventory and CoGS under
different cost flow assumptions
 GAS
= CoGS + EI
 Income
 Sales
tax effects under LIFO and FIFO
revenue and operating expenses - same
 Choosing
 Similar
an inventory cost flow method
companies
 Maximize tax savings and cash flows
 Maximize net income
 If LIFO is used for tax purposes, it must also be used
for financial statement purposes
 Lower-of-cost-or-market
If
Rule
market value is lower than cost
Reduce
Reduce
 Inventory
Measures
the inventory account
net income
turnover
inventory
how quickly a firm is selling its
Cost of goods sold
Average inventory
Average
 Average
365
inventory = (BI + EI) / 2
days in inventory
(days in year) / Inventory turnover
Business Risk, Control, and Ethics
 Inventory
padding
 Safeguarding assets
Physical
controls
Includes
 RFID
ensuring that products don’t spoil
tags
 Controlling inventory levels and
monitoring product developments to
prevent inventory obsolescence
ASSIGN 11 - pg. 304-305, E6-2A, E6-3A, E6-8A
ASSIGN 12 - pg. 309-312, P6-1A, P6-7A