Question

how do you calculate ending inventory or cost of goods sold under LIFO and FIFO    

how do you use the Gross Profit Method to estimate a loss of inventory

how do you use the relative sales value method of allocating cost to items purchased

What are the common disclosures required for inventory?

Answer 1

Part A) Calculation of ending inventory or cost of goods sold under LIFO and FIFO -

We know that-

Cost of goods sold = Beginning inventory + Inventory purchases - Ending inventory

Ending inventory= Beginning inventory + Inventory purchases- Cost of goods sold

LIFO, short for last-in-first-out, means the last items bought are the first ones sold. The cost of sales is determined by the cost of items purchased the most recently. Because this method assumes that the most recently purchased items are sold, the value of the ending inventory is based on the cost of the oldest items.

FIFO, first in-first out, means the items that were bought first are the first items sold. The cost of sales is determined by the cost of the items purchased the earliest. Ending inventory is valued by the cost of items most recently purchased. FIFO is the most commonly used method in the U.S. A primary reason is that this approach appeals to common sense. Good inventory management would dictate that the oldest goods should be sold first, while the most recently purchased items remain in inventory.

Part B) Use the Gross Profit Method to estimate a loss of inventory-

Step 1.Determine the sales and cost of goods sold for the company. Sales and cost of goods sold are on the company's income statement. Say, for example, that a company has $150,000 in sales and $70,000 in cost of goods sold when a fire destroyed all its inventory.

Step 2. Divide the cost of goods sold by sales to determine the cost of goods sold percentage. This percentage also equals 1 minus the gross profit percentage. In the example, $70,000 divided by $150,000 equals about 46 percent.

Step 3. Multiply the cost of goods sold percentage by total sales to determine the cost of goods sold. In the example, $150,000 times 46 percent equals $70,000.

Step 4. Add beginning inventory and purchases to determine the cost of goods available for sale. In the example, if beginning inventory was $150,000 and purchases were $125,000, then the cost of goods available for sale equals $275,000.

Step 5. Subtract the cost of goods sold from the cost of goods available for sale to determine the amount of inventory destroyed. In our example, $275,000 minus $70,000 equals $205,000 of inventory loss.

Part C)  Use the relative sales value method of allocating cost to items purchased-

Relative sales value is an appropriate basis for pricing inventory when a group of varying units is purchased at a single lump-sum price (basket purchase). The purchase price must be allocated in some manner or on some basis among the various units. When the units vary in size, character, and attractiveness, the basis for allocation must reflect both quantitative and qualitative aspects. A suitable basis then is the relative sales value of the units that comprise the inventory.

Part D) The following common disclosures in relation to inventories are required-

1.The accounting policies that were adopted in measuring inventories, including the cost formula used;

2.The total carrying amount of inventories and the carrying amount in classifications that are appropriate to the entity;

3.The carrying amount of inventories that are carried at fair value less the costs to sell;

4.The amount of inventories that are recognized as an expense during the reporting period;

5.The amount of any write-down of inventories that are recognized as an expense in the reporting period;

6.The amount of any reversal of any write-down that is recognized as a reduction in the cost of sales during the reporting period;

7.The circumstances or events which have led to the reversal of a write-down of inventories; and

8.The carrying amount of inventories that are pledged as security for liabilities.

The inventory-related disclosures under US GAAP are quite similar to those under IFRS, except that requirements 6 and 7 are irrelevant due to the fact that US GAAP prohibits the reversal of prior-year inventory write-downs. In addition, US GAAP requires disclosure of significant estimates applicable to inventories and of any material amount of income which results from the liquidation of LIFO inventory.

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