Question

THE INVENTORY VALUATION ISSUE IS SOLVED BY USING DIFFERENT COST FLOW ASSUMPTIONS (METHODS):

Introduction: Pretend you are at the drug store waiting in line. There is a basket filled with one particular brand of candy all in identical wrappers. But suppose the candy was purchased by the drug store on different dates in a rising economy and at different costs, say a lot of 100 units was purchased at .04 cents/per unit, and another lot of 150 units was purchased at .05 cents per unit, and a third lot of 200 units was purchased at .06 cents per unit, then how does the drug store track the different costs of this identical product in the basket for purposes of calculating profit or loss? It has to first identify the cost of the product it sold. But it doesn't really know whether the one candy item was originally purchased at a cost of .04, .05 or .06 cents.

There is a point where it is not economically feasible to track similar items separately. So to resolve, the accounting world devised and relies on certain COST FLOW ASSUMPTIONS or methods to place a value on its inventory.

Note the characteristics used in each calculation as applied in the FIFO and LIFO methods below:

EXAMPLES: Using the following beginning inventory, purchases, and sales data for cell phones for March, note how Ending Inventory is calculated differently using First-In, First-out, Last-in, First-out, and the Lower of Cost or Market methods.

March 1: Beginning inventory: 1,000 units at $40

Purchases during March:

March 5: 500 units at $42

March 20: 450 units at $44

Sales during March:

March 8: 700 units

March14: 600 units

March 31: 300 units

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FIRST-IN, FIRST-OUT (FIFO) METHOD: Assumes the oldest purchase was the first used or sold. Thus your remaining balance would be valued at the more recent remaining costs.

Example #1: Assume that the perpetual inventory system is used, costing by FIFO method, determine the cost of merchandise sold for each sale and the inventory balance after each sale for the above data. For understanding, study and trace the transactions through in the example provided.

LAST-IN, FIRST-OUT (LIFO) METHOD: Assumes the newest purchase was the first used or sold. Thus the remaining balance would be valued at the costs of the older remaining products.

Example #2: Using the same data above, now assume that the perpetual inventory system is used, costing by LIFO method, determine the cost of merchandise sold for each sale and the inventory balance after each sale. For understanding, study and trace the transactions through in the example provided.

LOWER OF COST OR MARKET METHOD (LCM) METHOD: This method might be used for diamonds, or minerals or the like where the market price changes daily or more frequently. Conservative accounting philosophies dictate to value such items at either the lower of the price (cost) when the merchandise was purchased or at its current market value(which is the price the item is currently being sold at). Hence if on the last day of the month, an item purchased earlier in the month by the company, say at $500 per unit was then selling at $600 per unit, the inventory value used in the accounting records at the end of the month would be $500. (i.e. the lower of the cost or the market price).

Using the data below, apply the LCM method to calculate Ending Inventory:

Commodity Quantity Unit Cost Unit Market Price

Aquarius 20 $80 $92

Capricorn 50 70 65

Leo 8 300 280

Scorpio 30 40 30

Taurus 100 90 94

Example #3: Calculate the lower of cost or market for each item above and total those amounts to calculate final inventory value. For understanding, study and trace the amounts through in the example provided.

Answer 1

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