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Question 1 The Chelsea Video sells of $9000 of merchandise on account FOB destination on May 4. A/R 9000 –Sales 9000

Question 2 $200 of goods is returned on May 8. Sales Returns and Allowances 200 –Accounts Receivable 200

Question 3 Chelsea Video purchases $7000 of merchandise on account from Highpoint Co. on May 9. Purchases 7000 –A/P 7000

Question 4 Some of the merchandise purchased on May 9 is inoperable. Chelsea returns $500 worth of merchandise on May 10th. Accounts Payable 500 –Purchase returns and allowances 500

Question 5 The correct company pays for the freight from the May 4 th transaction of $500 in cash on May 11 th. Delivery Expense500 – Cash 500

The multi-step income statement under the periodic system requires more detail in the cost of goods sold section, as shown above.

ALLOCATION OF INVENTORIABLE COSTS Beginning Inventory Goods Purchased during the year Cost of Goods Available for Sale Ending Inventory (Balance Sheet) Cost of Goods Sold (Income Statement)

Question 6 Prices are rising FIFO is used Question: –Are the highest or lowest priced purchases used to calculate Cost of goods sold? Answer: –LOWEST (first purchases)

Question 7 Prices are rising LIFO is used Question: –Are the highest or lowest priced purchases used to calculate Ending Inventory? Answer: –LOWEST (first purchases)

Question 8 Prices are rising LIFO is used Question: –Are the highest or lowest priced purchases used to calculate Cost of goods sold? Answer: –Highest (most recent purchases)

Question 9 Prices are rising FIFO is used Question: –Are the highest or lowest priced purchases used to calculate Ending Inventory? Answer: –Highest (most recent purchases)

Question 10 Prices are decreasing FIFO is used Question: –Are the highest or lowest priced purchases used to calculate Cost of Goods Sold? Answer: –Highest (first purchases)

Question 11 Prices are decreasing LIFO is used Question: –Are the highest or lowest priced purchases used to calculate Cost of Goods Sold? Answer: –Lowest (most recent purchases)

Question 12 Prices are increasing FIFO is used The lowest costs are used in COGS Question: –Is net income higher or lower than if we used LIFO? Answer: –Higher.

Question 13 Prices are increasing LIFO is used The highest costs are used in COGS Question: –Is ending inventory going to be higher or lower than if we used FIFO? Answer: –Lower.

USING ACTUAL PHYSICAL FLOW COSTING The specific identification method tracks the actual physical flow of the goods. Each item of inventory is marked, tagged, or coded with its specific unit cost. It is most frequently used when the company sells a limited variety of high unit-cost items.

USING ASSUMED COST FLOW METHODS Other cost flow methods are allowed since specific identification is often impractical. These methods assume flows of costs that may be unrelated to the physical flow of goods. Cost flow assumptions: 1. First-in, first-out (FIFO). 2. Average cost. 3.Last-in, first-out (LIFO).

FIFOFIFO The FIFO method assumes that the earliest goods purchased are the first to be sold. Often reflects the actual physical flow of merchandise. Under FIFO, the costs of the earliest goods purchased are the first to be recognized as cost of goods sold. The costs of the most recent goods purchased are recognized as the ending inventory.

FIFO method assumes earliest goods purchased are the first to be sold

LIFO The LIFO method assumes that the latest goods purchased are the first to be sold and that the earliest goods purchased remain in ending inventory. Seldom coincides with the actual physical flow of inventory. Under the periodic method, all goods purchased during the year are assumed to be available for the first sale, regardless of date of purchase. Rarely used in Canada.

LIFO method assumes latest goods purchased are the first to be sold

AVERAGE COST The average cost method assumes that the goods available for sale are homogeneous. The allocation of the cost of goods available for sale is made on the basis of the weighted average unit cost incurred. The weighted average unit cost is then applied to the units sold to determine the cost of goods sold and to the units on hand to determine the ending inventory.

Allocation of the cost of goods available for sale in average cost method is made on the basis of the weighted average unit cost

Average cost method assumes that goods available for sale are homogeneous

INCOME STATEMENT EFFECTS In periods of rising prices, FIFO reports the highest net income, LIFO the lowest and average cost falls in the middle. The reverse is true when prices are falling. When prices are constant, all cost flow methods will yield the same results.

FIFO produces the best balance sheet valuation since the inventory costs are closer to their current, or replacement, costs. BALANCE SHEET EFFECTS

USING INVENTORY COST FLOW METHODS CONSISTENTLY A company needs to use its chosen cost flow method consistently from one accounting period to another. Such consistent application enhances the comparability of financial statements over successive time periods. When a company adopts a different cost flow method, the change and its effects on net income should be disclosed in the financial statements.