Question

how do you prepare calculations comparing the effects on profit of the three inventory cost flow assumptions?

Answer 1

Three Inventory Cost Flow assumption

1) FIFO cost flow Assumption - under this, First item purchase is first item sold. If First item purchase value is lower than cost of goods sold will be lower and profits will be shown higher.

2) LIFO cost flow Assumption - In this, Last item purchased is first item sold. Hence if last item purchased has higher cost then cost of goods sold will be higher and Profits wouod be shown lower.

3) Weighted Average cost flow assumption - In this, cost is average of all purchase cost hence it generates mid level profits and mid level Cost of goods sold

Example - First purchase price - $10

Second Purchase cost - $20

Third Purchase cost - $30

FIFO - cost of Goods sold will relate to $10 which is lowest hence profit will be shoen higher

LIFO - Cost of goods sold relate to $30. It is highest cost hence profits will be shown lower

Weighted Average - This will give average cost of approximately $20 which will give mid level profit and cost