# Principles of Accounting I thru Test 3.ppt - The Accounting...

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Chapter 7---InventoriesInventory cost flow assumptionsFIFO: first-in, first-outLIFO: last-in, first-outAverageSpecific identificationWhat is the effect of rising or declining prices under eachassumption?Inventory errorsWhat happens if beginning inventory is understated oroverstated?What happens if ending inventory is understated oroverstated?Inventory is valued at the lower of its cost or market
Example of Cost Flow AssumptionsUnitsPriceTotalBeginning100\$10\$1,000July purchase50\$11\$550October purchase50\$12\$600Available for sale200\$2,150Suppose 125 units are soldWhat is the cost of goods soldand ending inventoryunder each cost flow assumption?
Example of Cost FlowAssumptions----continuedFIFO—cost of goods sold100X\$10=\$1,00025X\$11=\$275Total\$1,275FIFO—ending inventory50X\$12=\$60025X\$11=\$275Total\$875
Example of Cost FlowAssumptions----continuedLIFO—cost of goods sold50X\$12=\$60050X\$11=\$55025X\$10=\$250Total\$1,400LIFO—ending inventory75X\$10=\$750Total\$750
Example of Cost FlowAssumptions----continuedAverage—cost of goods soldTotal Cost\$2,150= \$10.75 average price per unitUnits available for sale200125 (units sold) x \$10.75 = \$1,343 cost of goods sold75 (units remaining) x \$10.75 = \$807 ending inventorySummaryCOGSEnding InventoryFIFO\$1,275\$875Average\$1,343\$807LIFO\$1,400\$750
Period of Rising PricesNote that in our example, the prices of the purchaseswere rising.Thus, in a period of rising prices:Cost of goods sold:FIFO<Average<LIFONet Income:FIFO>Average>LIFOEnding Inventory:FIFO>Average>LIFOTax Liability:FIFO>Average>LIFOThe exact opposite occurs in a period of decliningprices.
Inventory ErrorsErrorCOGSNet IncomeUnderstate BeginningUnderstateOverstateOverstate BeginningOverstateUnderstateUnderstate EndingOverstateUnderstateOverstate EndingUnderstateOverstate
LO 2LO 2Inventory Cost Flow Assumptions
Assume that one unit is sold on May 30for \$20.Depending upon which unitwas sold, the gross profit varies from\$11 to \$6 as shown below:LO 2LO 2Inventory Cost Flow Assumptions
Under the specific identificationinventory cost flow method, the unitsold is identified with a specificpurchase.LO 2LO 2Inventory Cost Flow Assumptions
Inventory Cost Flow AssumptionsUnder the first-in, first out (FIFO) inventorycost flow method, the first units purchasedare assumed to be sold first and the endinginventory is made up of the most recentpurchases.LO 2LO 2
Inventory Cost Flow AssumptionsUnder the last-in, first out (LIFO) inventorycost flow method, the last units purchasedare assumed to be sold first and the endinginventory is made up of the first unitspurchased.LO 2LO 2
Inventory Cost Flow AssumptionsUnder the average inventory cost flowmethod, the cost of the units sold and inending inventory is an average of thepurchase costs.LO 2LO 2
LO 2LO 2Inventory Cost Flow Assumptions(continued)
LO 2LO 2Inventory Cost Flow Assumptions(continued)
LO 2LO 2Inventory Cost Flow Assumptions(concluded)
EE 7-1EE 7-1

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