Question

1) What is FOB shipping Point and FOB Destination Point?

2) Where does Office Supply Expense go on the Income Statement?

3) Using the Gross Method, how do Discounts Lost and Discounts Taken effect the Purchases Account?

4) In a period of rising prices, which inventory method results in the highest ending inventory: Weighted Average, Moving Average, LIFO, FIFO?

5) Calculate Gross Profit when you are given Sales and the Cost of Goods Sold?

6) Which inventory system provides a better matching of revenue and expenses - Weighted Average, Moving Average, LIFO, FIFO?

Answer 1

1. FOB Shipping Point : Free On Board (FOB) shipping point means that the buyer takes all the risks and rewards at the Shipper's dock/port. Hence the Sale occurs at the time when the Shipper makes goods available to buyer at Shipper's dock. As the sale occurs at time of shipping of goods, freight charges from shipping dock to the buyer's dock are to be borne by the buyer.

FOB Destination Point : This means that the buyer will take all the risks and rewards of the goods being supplied at the time when they finally reach at buyer's dock. Hence the sale occurs at the time when goods reach at the buyer's dock. And all the freight charges of shiiping the goods are borne by the Shipper.

2. Office Supply means the expenses which are incurred by an organisation to make certain services available to the staff of the organisation to perform their duties and tasks. For example, stationery items required by each and every organisation for its employees. These are expenses which form part of below the line items in the income statement. Below the line items means those part of income statements which do not affect the gross profit but effect the Net profit in the income statement. It can be said they are a part of General & Administration expenses.

3. Unlike Net method under Gross Method, it is assumed that the discount will not be taken and purchases are booked at the original transaction (without taking into consideration of discount). Hence, if the discounting period is over or the discount is lost, it will not affect the Purchases as it has already been booked on no discount availment assumption. However, if the discount has been taken Purchases will be reversed (or credited) with the discount amount.

4. FIFO method is the method which will result in highest ending inventory in the period of rising prices. As in FIFO method, oldest inventory is sold first, high price inventory will remain in stock till its turn comes for sale. Hence, inventory value will be higher in comparison to Weighted Average, Moving Average and LIFO method of inventory Valuation.

5. Gross Profit is the difference between Sales and Cost of goods sold. Thus, when Cost of Goods Sold (COGS) is reduced from Sales, it results in Gross Profit/ Gross Loss.

6. Lets first see how all these 4 methods work:

FIFO Method: Here latest inventory remain in stock as it follows to sale that inventory which is oldest in stock. Hence, in period of high prices, inventory value will be very high for latest inventory purchased and vice versa in period of low prices.

LIFO Method: Here oldest inventory remain in stock as it follows to sale that inventory which is purchased lately. Hence, in period of high prices, inventory value will be lower for oldest inventory in stock and vice versa in period of low prices.

Moving Average Method: In this method cost is calculated after every transaction of sale and purchase. And it averages after every transaction. Thus, if during the month first purchase is occured, inventory is valued by averaging opening cost and purchased cost for total inventory (opening qty plus purchase qty). Then, afterwards if sale occurs inventory is again valued by averaging opening cost plus purchase cost (as earlier done) and cost of goods sold for inventory remaining after sale (opening qty plus purchased qty minus sale qty).

Weighted Average Method: In this method cost is calculated generally on a monthly basis by adding purchases to opening stock. Opening Cost plus purchase cost divided by the number of quantity (opening qty plus purchase qty). Now, if here sale occurs, it does not change the inventory valuation as it happens in Moving average method.

Conclusion: Now if we compare above 4 methods, clearly FIFO and LIFO are simple to use but do not show the correct picture of the Inventory. Between Moving average (Perpetual Method) and Weighted Average (Periodic Method), Weighted Average provides a better matching of revenue and expense as the inventory valuation of ending inventory done in weighted average matches with the cost of goods sold as COGS is calculated at the weighted average cost only. However, in moving average, inventory valuation of the ending inventory may differ from COGS as it is perpetual system of valuation.