current-assets-part-ii

10 weighted average cost of goods available for sale

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Unformatted text preview: r sale $ 48,000 232,000 $280,000 64,000 ... = Ending inventory ($64,000) 4,000 X $12 = $48,000 1,000 X $16 = $16,000 $304,000 202,222 $101,778 GONZALES CHEMICAL COMPANY B alance Sheet December 31, 20XX $77,778 $202,222 ASSETS ... 77,778 I nventory 6.11 Comparing Inventory Methods The following table reveals that the amount of gross profit and ending inventory numbers appear quite different, depending on the inventory method selected: FIFO *** LIFO WeightedAverage $304,000 $304,000 $304,000 195,000 216,000 202,222 Gross Profit $109,000 $ 88,000 $101,778 Ending Inventory $ 85,000 $ 64,000 $ 77,778 Sales Cost of Goods Sold Download free ebooks at bookboon.com 31 Inventory Costing Methods Current Assets: Part II The results above are consistent with the general rule that LIFO results in the lowest income (assuming rising prices, as was evident in the Gonzales example), FIFO the highest, and weighted average an amount in between. Because LIFO tends to depress profits, you may wonder why a company would select this option; the answer is sometimes driven by income tax considerations. Lower income produces a lower tax bill, thus companies will tend to prefer the LIFO choice. Usually, financial accounting methods do not have to conform to methods chosen for tax purposes. However, in the USA, LIFO “conformity rules” generally require that LIFO be used for financial reporting if it is used for tax purposes. In many countries LIFO is not permitted for tax or accounting purposes. Accounting theorists may argue that financial statement presentations are enhanced by LIFO because it matches recently incurred costs with the recently generated revenues. Others maintain that FIFO is better because recent costs are reported in inventory on the balance sheet. Whichever side of this debate you find yourself, it is important to note that the inventory method in use must be clearly communicated in the financial statements and related notes. Companies that use LIFO will frequently augment their reports with supplement data about what inventory would be if FIFO were instead used. No matter which method is selected, consistency in method of application should be maintained. This does not mean that changes cannot occur; however, changes should only be made if financial accounting is improved. 6.12 Specific Identification As was noted earlier, another inventory method is specific identification. This method requires a business to identify each unit of merchandise with the unit’s cost and retain that identification until the inventory is sold. Once a specific inventory item is sold, the cost of the unit is assigned to cost of goods sold. Specific identification requires tedious record keeping and is typically only used for inventories of uniquely identifiable goods that have a fairly high per-unit cost (e.g., automobiles, fine jewelry, and so forth). Download free ebooks at bookboon.com 32 Perpetual Inventory Systems Current Assets: Part II 7. Perpetual Inventory Systems All of the preceding illustrations were based...
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