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The document discusses three common inventory valuation methods: weighted average, first-in first-out (FIFO), and last-in first-out (LIFO). It provides an example to illustrate how each method calculates cost of goods sold, ending inventory, and gross margin differently. Under the FIFO method, the ending inventory consists of the most recently purchased goods. The LIFO method assumes the most recently purchased goods are sold first, resulting in lower reported income during inflationary periods but higher tax savings. The document notes LIFO provides the closest measure of replacing inventory costs but FIFO best measures the current value of ending inventory.

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37 views

Comparison Avg

The document discusses three common inventory valuation methods: weighted average, first-in first-out (FIFO), and last-in first-out (LIFO). It provides an example to illustrate how each method calculates cost of goods sold, ending inventory, and gross margin differently. Under the FIFO method, the ending inventory consists of the most recently purchased goods. The LIFO method assumes the most recently purchased goods are sold first, resulting in lower reported income during inflationary periods but higher tax savings. The document notes LIFO provides the closest measure of replacing inventory costs but FIFO best measures the current value of ending inventory.

Uploaded by

abhi_19891
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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INVENTORY VALUATION METHODS

This is based on the standard periodic inventory model: Net Sales Beginning inventory + Net Purchases & Freight = Goods Available for Sale - Ending inventory = ..................................>

- Cost of goods sold =Gross Margin

THE MAJOR OBJECTIVE: Determine the cost that will be associated with ending inventory. Notice that this will directly affect COGS and thus Gross Margin. THREE COMMON VALUATION METHODS: 1. Weighted average 2. First-in, first-out (FIFO) 3. Last-in, first-out (LIFO) Information for examples: #Items Beginning inventory Purchase #1 Purchase #2 Purchase #3 Goods Available for sale Units Sold Units Remaining 200 400 300 350 1,250 870 380 Unit Cost Total Cost $12.00 13.00 13.70 14.20 $2,400 5,200 4,110 4,970 $16,680 $17,400

At $20

A. Weighted average. Determine one average cost by dividing total costs by total units. Use units remaining to determine ending inventory. 16,680/1,250 = $13.344 x 380 = $5,071 ending inventory Goods Available for 16,680 Net sales $17,400

Sale -Ending inventory =Cost of goods sold

5,071 11,609

-Cost of Goods Sold Gross Margin

11,609 $5,791

B. First-in, first-out (FIFO). If you assume that those purchased first were sold first, then those remaining would be the last ones. This makes sense from a physical flow standpoint, but it DOESNT MATTER. You can use any of these methods for the "costs" regardless of whether you sold the first ones first or the last ones first or a combination! However, the FIFO method values the ending inventory as if you sold the first ones first. Remaining units: 350 x 14.20 30 x 13.70 380............. 4,970 411 5,38l

ending inventory

Goods Available for Sale -Ending inventory =Cost of goods sold

16,680 5,381 11,299

Net sales -Cost of Goods Sold Gross Margin

$17,400 11,299 $6,101

C. Last-in, first out (LIFO). If you assume that those purchased last were sold first, then those remaining would be the first ones. Although this doesnt usually make sense from a physical flow standpoint, again IT DOESNT MATTER. The actual flow does not need to match the one chosen for the costs. Remaining units: 200 x 12.00 180 x 13.00 380............. 2,400 2,340 4,740

ending inventory

Goods Available for Sale -Ending inventory =Cost of goods sold

16,680 4,740 11,940

Net sales -Cost of Goods Sold Gross Margin

$17,400 11,940 $5,460

SUMMARY OF THREE METHODS

FIFO Gross Margin Ending Inventory Things to notice: $6,101 $5,381

W.Avg. $5,791 $5,071

LIFO $5,460 $4,740

1. When prices are rising, LIFO gives the lowest profit and FIFO the highest. 2. The LIFO profit is the closest to measuring the cost of goods sold as the cost to replace the inventory. 3. When prices are rising, FIFO gives the best measure of the cost of the ending inventory at current prices

Advantages and Disadvantages of All Four Methods:


Method Weighted average Advantages Hard to manipulate Easy to calculate FIFO Hard to manipulate Makes physical sense Doesnt minimize taxes Good ending inventory valuation LIFO Minimizes taxes in inflation Reflects current costs Bad ending inventory valuation Easy to manipulate Physical flow unrealistic Produces "inventory" profits Disadvantages Averages may not reflect inflation well

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