Question

For this discussion, let us return to our favorite local merchants from units 5 and 6. What inventory valuation method would you advise them to use? Why do you think it is the best suited to their business? Describe the valuation method you would use (ex.FIFO or LIFO) and why. Describe how you would adjust the value of inventory by applying the lower of cost or market technique. THIS COULD BE A SPORTING GOODS STORE OR GROCERY.

Answer 1

As we know that both methods (FIFO and LIFO) have its own advantages and disadvantages but overall we can say LIFO method should be adopted by local merchant because LIFO methods will generate following benefits;

1. It will records actual costs of the goods sold because as per LIFO latest purchased goods will be sold first hence there will be real cost of the sold goods in the books.

2. We also know that in case of FIFO methods old costs are recorded in the books for goods sold hence in case of rising prices of the purchased goods it will generated higher amount of net income but actually net profit should be lower hence FIFO method is not perfect in such case thus LIFO method will be much better because it will show real net income of the firm.

3. LIFO method also reduces tax burden because high costs of the sold goods will result into lower amount of net income. And if net income is lower then income tax burden also will be lower. Hence it proves that LIFO method will be good option for the firm.

4. When local merchant use LIFO method then value of unsold goods will be lower because ending inventory will include costs of old purchased goods hence balance sheet of the firm will show real value of ending inventory.

Describe how you would adjust the value of inventory by applying the lower of cost or market technique;

Value of inventory is adjusted with the help of an adjusting journal entry. As we know that in case of lower of cost or market value we have to record inventory at the value which is lower either it may be cost or market price of the inventory.

Suppose market value of the inventory is $58000 and its cost is $60000 then we will adjust it with the help of following adjusting entry;

	Debit	Credit
Cost of Goods Sold	$2000
Inventory		$2000

Now let’s take another case when market price is more than cost of inventory.

Suppose market value of the inventory is $62000 and its cost is $60000 then no adjusting entry will be made because we follow lower of cost or market value hence inventory will be recorded at cost $60000 hence no adjusting entry will be made.