Chapter 5 – Accounting for Inventories
Accounting for Inventories
(a) FIFO: The cost of the first (earliest) items purchased in inventory flow to cost of
goods sold first. (b) LIFO: The cost of the last (most recent) items purchased in
inventory flow to cost of goods sold first.
Merchandise inventory is disclosed on the balance sheet as a current asset.
also sometimes reported in the income statement as part of the calculation of cost
of goods sold.
Incidental costs sometimes are ignored in computing the cost of inventory because
the expense of tracking such costs on a precise basis can outweigh the benefits
gained from the increased accuracy.
The accounting constraint of
permits such practices when the effects on the financial statements are not
significant (that is, when such practices do not impact business decisions).
LIFO will result in the lower cost of goods sold when costs are declining because it
assigns the most recent, lower cost purchases to cost of goods sold.
The full-disclosure principle requires that the nature of the accounting change, the
justification for the change, and the effect of the change on net income be disclosed
in the notes or in the body of a company's financial statements.
No; changing the inventory method each period would violate the accounting
concept of consistency.
No; the consistency concept does not preclude changes in accounting methods
from ever being made.
Instead, a change from one acceptable method to another is
allowed if the company justifies the change as an improvement in financial
Many people make important business decisions based on period-to-period
fluctuations in a company's financial numbers, including gross profit and net
As such, inventory errors—which can substantially impact gross profit, net
income, current assets, and cost of sales—should not be permitted to cause such
fluctuations and impair business decisions.
(Note: Since such errors are “self-
correcting,” they will distort net income in only two consecutive accounting periods
—the period of the error and the next period.)
An inventory error that causes an understatement (or overstatement) for net income
in one accounting period, if not corrected, will cause an overstatement (or
understatement) in the next. Since an understatement (overstatement) of one period
offsets the overstatement (understatement) in the next, such errors are said to