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Lecture_Notes_-_Assign_4

2 find units in ending inventory beginning purchases

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2. Find units in ending inventory: beginning + purchases – sales 3. Use FIFO or LIFO to find the cost of the ending inventory units. Activity: You may want to try this exercise on your own first and compare it to the results below. FIFO 1. First, find total cost. Units Cost per Unit Total Cost Mar 1 st Inventory 25 $90 $2,250 Mar 5 th Purchase 20 $94 1,880 Mar 9 th Sale 18 Mar 13 th Sale 20 Mar 21 st Purchase 15 $95 1,425 Mar 31 st Sale 8 ______ Available for sale $5,555
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2. Next, find ending inventory in units. 25+ (20+15) – (18+20+8) = 14 (note: This is the same as perpetual. Regardless of which method is used, the units are always the same.) 3. Cost the units using FIFO – The first units purchased have been sold. The units in ending inventory are the last units purchased (hint: start at the bottom). Solution: 14 units at $95 = $1,330. This is the same as for perpetual. Whether the perpetual or periodic method is used, the cost under FIFO will be the same. LIFO Steps 1 and 2 are the same as FIFO. 3. Cost the units using LIFO – The last units purchased have been sold. The units in ending inventory are the first units (hint: start at the top). Solution: 14 units at $90 = $1,260. Summary of Inventory Costing In times of inflation, FIFO gives a higher ending inventory, lower Cost of Merchandise Sold, and higher Net Income. LIFO is the opposite with a lower ending inventory, higher Cost of Merchandise Sold, and lower Net Income. Historically, FIFO was the inventory costing method used in the United States until the high inflation of the 1970s. LIFO became popular in the 1970s as accountants successfully argued that businesses were showing too high of income and, thus, paying too much income tax. FIFO gives a higher net income and would attract investors. LIFO gives a lower net income to avoid income tax. The opposite would be true in times of deflation. LIFO is not allowed under IFRS, international accounting standards. Errors Since inventory errors affect the income statement, the error will be carried forward to the next year. Cost of Merchandise Sold (COMS) is difference between the cost assigned to ending inventory and the inventory available for sale. Thus, adjustments to ending inventory impact the COMS which impacts net income and retained earnings over a two year period. Year 1 Beginning inventory correct Available for sale correct Ending inventory overstated COMS understated Net income overstated Ending retained earnings overstated Year 2 Beginning inventory overstated Available for sale overstated Ending inventory correct COMS overstated Net income understated Retained earnings correct
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