assume that Dubbo Electronics sold its 550 units for$11 500, had operating expenses of $2000, and is subject to an income tax rate of 30%.Figure: Comparative effects of cost flow methodsAlthough the cost of goods available for sale ($12 000) is the same under each of the three inventory cost flow methods, both the ending inventories and costs of sales are different. This difference is due tothe unit costs that are allocated to cost of sales and to ending inventory. Each dollar of difference in ending inventory results in a corresponding dollar difference in profit before income tax.In periods of changing prices, the cost flow assumption can have a significant impact on profit and on evaluations based on profit. In a period of inflation, FIFO produces a higher profit because the lower unit costs of the first units purchased are matched against revenues. If prices are falling, the results from the use of FIFO and LIFO are reversed where FIFO will report the lowest profit and LIFO the highest. To management, higher profit is an advantage as it causes external users to view the business more favourably. In addition, if management bonuses are based on profit, FIFO will provide the basis for higher bonuses.STATEMENT OF FINANCIAL POSITION EFFECTSA major advantage of the FIFO method is that, in a period of inflation, the costs allocated to ending inventory will approximate their current cost.Conversely, a major shortcoming of the LIFO method is that, in a period of inflation, the costs allocated to ending inventory may be significantly understated in terms of current cost. The understatement becomes greater over prolonged periods of inflation if the inventory includes goods purchased several years earlier.TAXATION EFFECTS
We have seen that both inventory on the statement of financial position and profit on the statement of profit or loss are higher when FIFO is used in a period of inflation.In the United States, many companies have switched to LIFO. The reason is that LIFO results in the lowest income taxes (because of lower profit) during times of rising prices.USING INVENTORY COST FLOW METHODS CONSISTENTLYWhatever cost flow method a business chooses, it should be used consistently from one accounting period to another. Consistent application enhances the comparability of financial statements over successive periods.Although consistent application is preferred, it does not mean that a business mayneverchange its method of inventory costing. When a business adopts a different method, the change and its effects onprofit should be disclosed in the financial statements.7Explain the lower of cost and net realisable value basis of accounting for inventoriesVALUING INVENTORY AT THE LOWER OF COST AND NET REALISABLE VALUECost is the main basis for recording and reporting most assets, including inventory. When the cost of inventory fluctuates, inventory costing methods can be used to determine inventory cost. However, when there has been a decrease in the selling price of inventory, in certain circumstances it is necessary to report inventory at an amount below its original cost.