Question

In at least 250 words, explain the differences and similarities between the accounting for the buyer and seller using a perpetual inventory system versus using a periodic inventory system. Be specific!

1.What are the three (3) inventory cost-flow assumptions?

2. Which inventory cost-flow assumption usually yields the highest net income? Why?

3. Which inventory cost-flow assumption usually yields the highest ending inventory? Why?

4. Which inventory cost-flow assumption usually yields the lowest tax bill? Why?

5. During a recession, which inventory cost-flow assumption would you choose if you'd like to report the lowest net income? Why?

6. During a recession, which inventory cost-flow assumption would you choose if you'd like the lowest tax bill? Why?

Answer 1

In at least 250 words, explain the differences and similarities between the accounting for the buyer and seller using a perpetual inventory system versus using a periodic inventory system. Be specific!

Under perpetual inventory method, the cost of goods sold, is computed after each transaction, and updated in the stock register. Hence the balance in inventory account is updated after each transaction. The buyer and seller both record each transaction, and update the inventory records, thereby adjusting the stock balance immediately.

Under Periodic inventory system, the cost of goods sold is computed at the end of the period, and updated in the stock register. At the end of period, a physical stock verification is carried out and accordingly cost of goods sold and ending inventory is worked out. The buyer records each purchase in purchase account. The seller makes only sales entry and don’t make any entry for cost of goods sold (inventory), while recording sales transaction.

1.What are the three (3) inventory cost-flow assumptions?

          The three cost-flow assumptions are:

1. First In First out
2. Last in First out
3. Average cost method

2. Which inventory cost-flow assumption usually yields the highest net income? Why?

If the price of inventory is having increasing trend, FIFO method will yield highest net Income. Under FIFO method, latest purchases having lower cost will become part of goods sold, and therefore yield more gross profit.

However, in case inventory is having decreasing trend, LIFO method will yield highest net Income. Under LIFO method, Latest purchases having lower cost will become part of goods sold, and therefore yield more gross profit.

3. Which inventory cost-flow assumption usually yields the highest ending inventory? Why?

If the price of inventory is having increasing trend, FIFO method will yield highest ending inventory. Under FIFO method, latest purchases having higher cost will become part of ending inventory.

However, in case inventory is having decreasing trend, LIFO method will yield highest ending inventory. Under LIFO method, earlier purchases having higher cost will become part ending inventory.

4. Which inventory cost-flow assumption usually yields the lowest tax bill? Why?

An inventory method having higher cost of goods sold, will result in lower net income and therefore lower tax bill.

If the price of inventory is having increasing trend, LIFO method will yield lower net Income. Under LIFO method, latest purchases having higher cost will become part of goods sold, and therefore yield lower gross profit.

However, in case inventory is having decreasing trend, FIFO method will yield lowest net Income. Under FIFO method, earlier purchases having higher cost will become part of goods sold, and therefore yield lower gross profit.

         

                  

5. During a recession, which inventory cost-flow assumption would you choose if you'd like to report the lowest net income? Why?

During recession, the inventory is having decreasing trend, therefore FIFO method will yield lowest net Income. Under FIFO method, earlier purchases having higher cost will become part of goods sold, and therefore yield lower gross profit / net income.

6. During a recession, which inventory cost-flow assumption would you choose if you'd like the lowest tax bill? Why?

During recession, the inventory is having decreasing trend, therefore FIFO method will yield lowest net Income, which in turn will give lowest tax bill. Under FIFO method, earlier purchases having higher cost will become part of goods sold, and therefore yield lower net income / lowest tax bill.