Question

Assume you are opening a furniture store. To finance the business, you need a loan, and your banker requires a set of forecasted financial statements. Assume you are preparing the statements and must make some decisions about how to do the accounting for the business. A. 1. Critically analyze the choices of inventory systems and select one for the your furniture store. discuss the reasons for your selection. 2. Inventory costs are rising. Analyze inventory costing methods with the purpose of maximizing net income.

Answer 1

1) In order to take decision about various Inventory sytems we should first understand the systems. There are 4 main system

a) specific cost method

under this inventory and cost of goods sold is valued at the cost at which they are orginally purchased or produced.

They are applied in industries like automobiles , Jewelary , real estate. Basically high value inventory industries since its Furniture store whwre inventory are not so high value this method will not bbe preferable . since inventory cost are rising this will not be used.

b)First -in - First out method (FIFO)

As the name suggest here it is assumed the first units are sold first. Cost of goods sold is based on the earliest units purchased. since its assumed units purchased are sold first closing inventory usually consist of latest purchased  units .

This is basically used in fast moving products with less shelf life . But in period of rising inventory cost this will the best method as it will give lowest cost of goods sold as goods purchased earlier are assumed to be sold first and higest net income

c) Last- in- first out (LIFO)

This method is opposite of fifo here its assumed inventory purchased latest are sold first. As latest inventory is assumed to be sold cost of goods sold closely reflect the recent units.

Closing stock here is consist of oldest units.

Under rising inventory cost this will give highest cost of goods sold and lowest net income so this will not be considered.

d) Weighted average cost

Here inventory is updated with average cost after each purchase or sale of good.This method averages the cost so it not impacted by rising or falling inventory prices .Since we want high net income this will not be suitable method as net income will be less then fifo.

Under period of rising inventory

	Specific	FIFO	LIFO	Weighted
Cost of goods sold	Indiferrent	Lowest	Highest	average
Net income	indifferent	Highest	Lowest	Average
Closing stock	Indifferent	Highest	Lowest	Average

So FIFO method will be selected if inventory prices are rising