Question

3. Alpha Carpets uses the LIFO cost allocation model for their inventory items. Omega Carpets, their French, IFRS-using competitors, use FIFO cost allocation for their very similar inventory items. Omega estimates that they would have a savings of $150,000 last period and $350,000 this period if they instead used LIFO to cost inventory.

What adjusting entry must be made to be able to directly compare Omega to Alpha Carpets?

Answer 1

The LIFO (Last in first out) method of cost allocation model values the inventory under the assumption that the last bought inventory is sold first. While the FIFO (First in first out) method assumes that the material that was bought first will be sold first and the inventory will be valued accordingly.

In the given case, Alpha valued its stock using LIFO method while Omega used the FIFO method. Hence, it is not prudent to directly compare the value of the inventories of both the companies.

To compare Omega directly to Alpha Carpets, the inventory value needs to be adjusted to reflect the value of the same as per LIFO method. Hence, both, the closing and the opening stock, as well as the cost of goods used for the production of the sold items, need to be revised in order to facilitate direct comparability. Hence, adjusting entries need to be made for all of the above-mentioned items.

Omega's claim that it would have savings of $150,000 for the last period and $350,000 for this period can only be verified when the adjustments for the inventory and the cost of goods sold are done.