Question

Cost for inventory purposes should be determined by the inventory cost flow method most clearly reflecting periodic income. Students should respond to the three questions presented below:

1. Describe the fundamental cost flow assumptions for the average cost, FIFO and LIFO inventory cost flow methods.

2. Discuss the reasons for using LIFO in an inflationary economy.

3. Where there is evidence that the utility of inventory will be less than cost, what is the proper accounting treatment, and under what concepts is that treatment justified?

Answer 1

1) Avarage Cost Method

Avarage cost flow assumption means All the cost of inventories are added together and then, Divided by the Total number of Inventories that purchased.

Cost of Purchase / Total Unit = Avarage Price.

This method is also called weighted Avarage Cost method,

Finally the number of unit sold can determined by Avarge price of goods sold.

Closing stock unit multiplied by Avarage price

eg; purchase material A in 1st day 10 unit @ $20

2nd day 10 unit @ $25

3rd day 10 unit @ $30

Avarage cost of purchase = (10*20+10*25+10*30) / 30 = $25/unit

if sales was 16 unit, cost of sales ---- 16*25 = $400

then, closing stock will be --- 15*25 = $350

FIFO or first in first out method

in case the purchase price are different from different purchases,

FIFO assumes that the inventories are selling out by the first entered will be the first out.

in the above example; Purchase are same Unit,Price,and Day

sales of 22 unit. cost of sales will be

out of 22 unit, as per FIFO assumption first 10 unit will be which purchased 1st Day

next 10 unit will be which purchased 2nd Day

next 2 unit will be which purchased 3rd Day

Then Cost of sales will be, 10*20 = 200

10*25 = 250

2*30 = 60

_____________

Total    $510

Closing stock 8*30=$240

LIFO or Last in First out Method

this assumption is directly opposite to the FIFO assumption.

Assumes that the inventory which comes last in will be the first out.

By Considering the same example,

cost sales of 22 units will be

1st 10 unit = 10*30 = 300

2nd 10 unit = 10*25 = 250

3rd 10 unit = 2*20 = 40

___________

Total $590

closing stock = 8*20 =$160

2) in inflationary economy price of inventry are increasing day by day. cost of purchase will be high during this time, also selling price of the goods will be high in the all over the market. during this time seller will get the tax benefit by increasing the cost of sales.

3) Where utility of the inventory is less than cost, inventory should not carry more than the net realizable value,

Net realizable value or Cost which ever is lower should carry. it happening due to decrease in selling price or decrease in replacement cost,

Note; i reduced my ans as much as i can,

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