Question

The records at the end of January of the current year for Young Company showed the following for a particular kind of merchandise:

Beginning Inventory at FIFO: 17 Units @ $20 = $340

Beginning Inventory at LIFO: 17 Units @ $16 = $272

January Transactions	Units	Unit Cost				Total Cost
Purchase, January 9	30	$	18			$	540
Purchase, January 20	51		23				1,173
Sale, January 21 (at $40 per unit)	37
Sale, January 27 (at $41 per unit)	27

Required:

1. Compute the inventory turnover ratio for the month of January under the FIFO and LIFO inventory costing methods.

2. Which costing method is the more accurate indicator of the efficiency of inventory management?

Answer 1

Ans. 1 The inventory balances, purchases and sales, and cost of goods sold under each method, FIFO and LIFO, are tabulated as below:

FIFO method
Date	Purchases			Sales			Balance
	Units	Unit cost	Total Cost	Units	Unit cost	Total cost	Units	Unit cost	Total cost
Jan. 1							17	$20	$340
Jan. 9	30	$18	$540				17	$20	$340
							30	$18	$540
Jan. 20	51	$23	$1,173				17	$20	$340
							30	$18	$540
							51	$23	$1,173
Jan. 21				17	$20	$340	10	$18	$180
				20	$18	$360	51	$23	$1,173
Jan. 27				10	$18	$180	34	$23	$782
				17	$23	$391
Cost of Goods Sold in January under FIFO						$1,271

Working notes:

As per FIFO method, items purchased first are assumed to be sold first. So, accordingly for sales on Jan. 21, 37 units are sold as 17 units @ $20 first (being the first inventory) and balance 37-17 = 20 units @ $18 from the next lot i.e., 30 units at $18. After this sale, balance inventory will be 30 – 20 = 10 units @ $18 and 51 units @ $23. The first 17 units @ $20 are no more part of inventory since they are utilized first. Similarly, for sale on Jan. 27

Next, Cost of Goods Sold in January = $340 + $360 + $180 + $391 = $1,271

Average inventory = (Beginning inventory + Ending inventory) / 2

                                 = ($340 + $782) / 2

                                 = $1,122 / 2

                                = $561

Inventory turnover ratio = Cost of Goods Sold / Average inventory

So, inventory turnover ratio for January under FIFO method = $1,271 / $561

                                                                                                     = 2.27

Similar table is constructed under LIFO method as follows:

LIFO method
Date	Purchases			Sales			Balance
	Units	Unit cost	Total Cost	Units	Unit cost	Total cost	Units	Unit cost	Total cost
Jan. 1							17	$16	$272
Jan. 9	30	$18	$540				17	$16	$272
							30	$18	$540
Jan. 20	51	$23	$1,173				17	$16	$272
							30	$18	$540
							51	$23	$1,173
Jan. 21				37	$23	$851	17	$16	$272
							30	$18	$540
							14	$23	$322
Jan. 27				14	$23	$322	17	$16	$272
				13	$18	$234	17	$18	$306
Cost of Goods Sold in January under LIFO						$1,407

Working notes:

Under LIFO method, the stock last purchased is assumed to be sold first. So, on Jan. 21 when 37 units are sold, they are taken from the latest inventory which is 51 units @ $23. After the sale, the balance inventory of 17 units @ $16 and 30 units @ $18 remain unaffected (since they were earlier stock) and out of 51 units @ $23, 37 are sold so balance 14 units remain in stock. Similarly, for sale on Jan. 27.

Cost of goods sold under LIFO method = $851 + $322 + $234

                                                                      = $1,407

Average inventory = ($272 + $272 + $306) / 2

                                  = $825 / 2

                                    = $425

Inventory turnover ratio under LIFO method = $1,407 / $425

                                                                                   = 3.31

Ans. 2

From the point of view of being an accurate indicator of the efficiency of inventory management, FIFO is a better method. The reasoning is that prices generally increase with time. So, with increasing prices, under FIFO method, inventory that was purchased earlier is consumed first, leaving behind latest inventory, which is more reflective of current market prices. So, the inventory under FIFO gives a more realistic picture of the inventory balance since the prices are somewhat at par with the market. Also, in most of the trades, specially perishable items, FIFO is the most realistic approach since practically, what we receive first we consume first to avoid risk of obsolescence.