Lecture 7 0213 - ORIE 350 Inventory Costing Methods First...

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    ORIE 350 February 13, 2007
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    Inventory Costing Methods First, cost flow is not the same as goods flow. We always sell the old beer first, before its expiration date. However, the cost associated with that beer remaining in inventory may be that of the old beer! Cost flow ≠ goods flow With one exception…on the next slide.
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    Inventory Costing Methods – the Big 4 1. Specific Identification (the exception) 2. Average Weighted Cost 3. FIFO (first in, first out) 4. LIFO (last in, first out)
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    FIFO Meaning the oldest inventory item is removed from inventory when a customer buys an item. We just mean the cost associated with that item, of course. Equivalent statement is LISH (last in, still here) In a time of rising inventory purchase costs, how does FIFO usage affect net income?
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    FIFO In the 1970’s, the inflation rate was high, so inventory replacement costs were rising. Chrysler actually switched to FIFO in the late 1970’s to exploit this, so they could show a higher net income (by selling the old, cheap inventory) for a short time. However, you do not need inflation (which is a rather arbitrary construct anyway) to cause rapid changes in inventory replenishment costs. Can you think of an example where inventory replenishment costs drop rapidly today? How does this affect the firms that use those items in their products?
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    LIFO The newest item is removed from inventory when the customer buys something. Again, we just mean the cost of the newest item. An equivalent statement is FISH (first in, still here). In a time of rising inventory replenishment costs, how does LIFO usage affect net income? If you are a small business owner, which will you use, FIFO or LIFO?
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    Recap FIFO – first in, first out. 1. Also LISH (last in, still here) 2. New items are in inventory. Thus, the inventory amount on the B/S is accurate! 3. Old items were sold. The amount shown on the income statement as the cost of goods sold is NOT accurate or up to date! 4. FIFO → balance sheet is accurate. 5. FIFO has been criticized for magnifying the effect of the business cycle on income.
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    Recap LIFO – last in, first out 1. Also FISH (first in, still here) 2. Old items are in inventory. The amount in Inventory on the balance sheet is out of date or inaccurate.
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