1. © 2015 Cengage Learning. All Rights Reserved.
LESSON
5-2
Inventory Costing
Methods
Learning Objectives
LO3 Determine the cost of merchandise inventory.
LO4 Determine the reported cost of merchandise inventory.
© 2015 Cengage Learning. All Rights Reserved.

2. First-In, First-Out Inventory Costing Method
Lesson 5-2
First-In, First-Out Inventory Costing Method
LO3
The standards and rules that accountants follow while recording and reporting financial activities are called generally accepted accounting principles.
These standards and rules are often referred to as GAAP.
GAAP permits the use of one of several methods for costing merchandise inventory.
Using the price of merchandise purchased first to calculate the cost of merchandise sold first is called the first-in, first-out (FIFO) inventory costing method.
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3. First-In, First-Out Inventory Costing Method
Lesson 5-2
First-In, First-Out Inventory Costing Method
LO3
1. Assign ending inventory units from the most
recent purchase. The number of units in the ending
inventory is 36. All 16 units from the December purchase are assigned to ending inventory.
2. If all units of the ending inventory have not been assigned, assign units from the next most recent purchase, August.
3. Multiply the units in the FIFO Units on Hand column by the unit prices.
4. Total the columns.
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4. Last-In, First-Out Inventory Costing Method
Lesson 5-2
Last-In, First-Out Inventory Costing Method
LO3
Using the price of merchandise purchased last to calculate the cost of merchandise sold first is called the last-in, first-out (LIFO) inventory costing method.
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5. Weighted-Average Inventory Costing Method
Lesson 5-2
Weighted-Average Inventory Costing Method
LO3
Using the average cost of the beginning inventory
plus merchandise purchased during a fiscal period to
calculate the cost of merchandise sold is called the
weighted-average inventory costing method.
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6. Costing Inventory During Periods of Increasing Prices
Lesson 5-2
Costing Inventory During Periods of Increasing Prices
LO3
The rate at which the price for goods and services increases over time is called inflation.
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7. Tax Limitations on Using LIFO
Lesson 5-2
Tax Limitations on Using LIFO
LO3
In an inflationary period, a business would choose to use the FIFO method to prepare its financial statements and LIFO to calculate its taxable income.
Early tax rules did not allow LIFO for calculating taxable income, because it reduced the tax revenue for the government.
However, during the late 1930s, Congress changed the tax laws to allow a business to use the LIFO method for calculating income taxes and added an important requirement: the business must use the same method for financial and tax reporting.
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8. Costing Inventory During Periods of Decreasing Prices
Lesson 5-2
Costing Inventory During Periods of Decreasing Prices
LO3
The rate at which the price for goods and services decreases over time is called deflation.
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9. Criticism of the LIFO Method
Lesson 5-2
Criticism of the LIFO Method
LO3
Inflation causes a conflict between the fair reporting of the cost of inventory and the cost of merchandise sold.
In an inflationary period, the LIFO method more accurately presents the cost of merchandise sold but understates the cost of inventory.
Unfortunately, the understatement of the cost of inventory grows over time.
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10. International Accounting Standards
Lesson 5-2
International Accounting Standards
LO3
A set of accounting standards being adopted across the world is called international financial reporting standards, or IFRS.
IFRS do not allow the LIFO method.
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11. Lower of Cost or Market Inventory Costing Method
Lesson 5-2
Lower of Cost or Market Inventory Costing Method
LO4
Using the lower of cost or market price to calculate the cost of the ending merchandise inventory is called the lower of cost or market inventory costing method.
Two amounts are needed to apply the lower of cost or market method:
The cost of the inventory using the FIFO, LIFO, or weighted-average method.
The current market price of the inventory.
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12. Lesson 5-2 Audit Your Understanding
1. Which inventory costing method uses the earliest purchase prices to determine the cost of merchandise inventory?
ANSWER
The last-in, first-out (LIFO) method.
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13. Lesson 5-2 Audit Your Understanding
2. During an inflationary period, what inventory costing method will result in the highest reported net income?
ANSWER
The first-in, first-out (FIFO) method.
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14. Lesson 5-2 Audit Your Understanding
3. What must a business do to qualify for using the LIFO method for tax reporting?
ANSWER
To qualify to use the LIFO method for tax reporting, a business must also use LIFO for its preparation of financial statements using GAAP. Since IFRS do not allow LIFO for preparing financial statements, a business may be unable to use LIFO for its tax reporting.
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15. Lesson 5-2 Audit Your Understanding
4. Which inventory costing method is not allowed by international financial reporting standards?
ANSWER
The LIFO method.
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16. Lesson 5-2 Audit Your Understanding
5. What two amounts are needed to apply the lower of cost or market inventory costing method?
ANSWER
a. The cost of the inventory using the FIFO, LIFO, or weighted-average method.
b. The current market price of the inventory.
© 2015 Cengage Learning. All Rights Reserved.