1 beginning inventory increase 2 purchases increase 3

This preview shows page 2 - 4 out of 77 pages.

1. Beginning inventory increase 2. Purchases increase 3. Ending inventory decrease 4. Purchase returns decrease 5. Freight-in increase Four methods of assigning cost to ending inventory and cost of goods sold are (1) specificidentification, (2) first-in, first-out (FIFO), (3) last-in, first-out (LIFO), and (4) average cost. The specific identification method requires each unit sold during the period or each unit on hand at the end of the period to be traced through the system and matched with its actual cost. First-in, first-out (FIFO) assumes that units sold are the first units acquired. The last-in, first-out (LIFO) method assumes that the units sold are the most recent units purchased. The average cost method assumes that cost of goods sold and ending inventory consist of a mixture of all the goods available for sale. The average unit cost applied to goods sold or ending inventory is an average unit cost weighted by the number of units acquired at the various unit prices. When costs are declining, LIFO will result in a lowercost of goods sold and higherincomethan FIFO. This is because LIFO will include in cost of goods sold the most recently purchased lower cost merchandise. LIFO also will provide a higherending inventory in the balance sheet.
Chapter 08 - Inventories: Measurement8-3 Answers to Questions (continued)Question 8-10 Question 8-11 Question 8-12 Question 8-13 Question 8-14 Proponents of LIFO argue that it provides a better match of revenues and expenses because cost of goods sold includes the costs of the most recent purchases. These are matched with sales that reflect a current selling price. On the other hand, inventory costs in the balance sheet generally are out of date because they are derived from old purchase transactions. It is conceivable that a company’s LIFO inventory balance could be based on unit costs actually incurred several years earlier. When inventory quantity declinesduring a period, then these out-of-date inventory layerswill be liquidated and cost of goods sold will match noncurrent costs with current selling prices. Many companies choose the LIFO inventory method to reduce income taxes in periods when prices are rising. In periods of rising prices, LIFO results in a higher cost of goods sold and therefore a lower net income than the other methods. The companies’ income tax returns will report lower taxable incomes using LIFO and lower taxes will be paid currently. If a company uses LIFO to measure its taxable income, IRS regulations require that LIFO also be used to measure income reported to investors and creditors. The gross profit, inventory turnover, and average days in inventory ratios are designed to monitor inventories. The gross profit ratio is calculated by dividing gross profit (net sales minus cost of goods sold) by net sales. Inventory turnover is calculated by dividing cost of goods sold by average inventory, and we compute average days in inventory by dividing the number of days in the period by the inventory turnover ratio.

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture