Question

Compare and contrast the different inventory cost flow assumptions. Explain the consequences that result from the use of alternative inventory cost flow assumptions

Answer 1

Different inventory Cost Flow assumptions are as follows:

a)First in First Out(FIFO)

FIFO method assumes that,the first item purchased is also the first one sold.In other words,inventory units are withdrawn from the oldest inventory held by the entity.

b)Last in First Out(LIFO)

This method assumes that the last item purchased is also the first one sold.In other words,inventory units are withdrawn from the latest inventory held by the entity.

c)Weighted Average cost

In this method,the costs are averaged out and for computation of inventory consumed/sold and inventory still in the store is measured on the basis of average cost of figure.

d)Specific Identifiaction

Under this method,you can physiaclly identify which specific items are purchased and then sold,so the cost flow moves with the actual item sold.

Consequences that result from the use of alternative inventory cost flow assumptions;

In periods of rising material prices,the LIFO methods results in higher cost of goods sold,lower profits,and therefore lower income taxes. In periods of declining material prices,the FIFO methods yields the same results.

When a company uses the weighted-average method and prices are rising,its cost of goods sold is less than obtained under LIFO,but more than that obtained under FIFO.Weighted-average costing takes a middle of the road approach.

Companies that use the specific identification method of inventory costing state their cost of goods sold and ending inventory at the actual cost of specific units sold and on hold.However it permits the manipulation of income.