Question

1:Jim’s accountant insisted that he should use a perpetual inventory system instead of a periodic inventory system and the average cost method for valuating the inventory. Do you agree with this advice (justify your answer)? Would the balance of the inventory at the end of the month be the same? And the net income?

2:Jim expects that the prices of the merchandise will dramatically decrease in the next future as a result of the Covid 19 crisis. Which method of valuation of the inventory would you thus recommend to Jim? Explain your answer.

Answer 1

1. Yes perpetual inventory methodhas many advantages of its own , such as daily movement of goods acn be easily tracked. Any discrepancy , theft or loss of items can be located. Stoppage of work need not to be done for counting of inventory. Under stocking or over stocking of inventory can be known on time . So it is advisable to use perpetual inventory system.

The calculation of used to determine unit cost under average cost method is simpler than the alternative methods. Also there is consistency in product cost used . Alternative methods require the accountant to use a variety of costs, depending on the individual costs incurred with each transaction.

Yes the balance of inventory and the income will be the same . Even if there is some difference , that would be of insignificant amount.

2. Since it is the time of recession and the value of goods are likely to decline., Fifo method should be used.

This is because fifo method reflect the latest cost of the inventory which is equivalent to the market variables. To show the true value of inventory in the financial statements, it would be advisable to go with the fifo method.

Else if the prices decline and the inventory is shown at average cost or using LIFO method, the true cost will not be reflected as it would be affected by the past costs when the situation was stable.