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Inventory Cost Flow Assumptions During March, Jeremy’s Friendly Market showed the following results: Beginning inventory of Big Q Beans was 400 cans at $0.75 per can Purchased 1,000 cans of Big Q Beans for $0.79 per can. Later that month, they purchased 2,000 more cans of Big Q Beans for $0.84 per can It sells 2,400 cans of beans during March What is the cost of the beans sold? What is the cost of the beans remaining in merchandise inventory? Cost flow assumptions allocate goods available for sale (GAS) to cost of goods sold and ending inventory (EI) BI + Purch = GAS GAS – EI + GoGS (GAS = EI + GoGS)
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Alternate inventory cost flow assumptions Specific identification Specific identification tracks the actual cost of each item in merchandise inventory and the actual cost of items sold Weighted average Weighted average Same cost is assigned to all GAS for each inventory item carried by the business. Average cost per unit in GAS: Total cost of inventory item _ Total # of units of inventory item First-in, first-out (FIFO) First-in, first-out (FIFO) Assumes that FIRST items purchased are first items sold Oldest costs are in CoGS Most recent costs are in EI Last-in, last-out (LIFO) Last-in, last-out (LIFO) Assumes that LAST items purchased are first items sold Most recent costs are in CoGS Oldest costs are in EI
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Effect of Cost Flow Assumptions on Financial Statements FIFO LIFO Wt. Avg. Sales$ 3,000 $ 3,000$3,000 Cost of G. S. 1,930 1,996 1,955 Gross Margin 1,070 1,004 1,045 Oper. exp. 250 250 250 Pretax Inc. 820 754 795 Taxes (30%) 246 226 239 Net Income $574 $528 $556 Assumes sales price $1.25/can & op exp $250
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Effect of Cost Flow Assumptions on Financial Statements Effect of reported inventory and CoGS under different cost flow assumptions Effect of reported inventory and CoGS under different cost flow assumptions GAS = CoGS + EI Income tax effects under LIFO and FIFO Income tax effects under LIFO and FIFO Sales revenue and operating expenses - same Choosing an inventory cost flow method Choosing an inventory cost flow method Similar companies Maximize tax savings and cash flows Maximize net income If LIFO is used for tax purposes, it must also be used for financial statement purposes
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Lower-of-cost-or-market Rule If market value is lower than cost Reduce the inventory account Reduce net income Inventory turnover Measures how quickly a firm is selling its inventory Cost of goods sold Average inventory Average inventory = (BI + EI) / 2 Average days in inventory 365 (days in year) / Inventory turnover
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Business Risk, Control, and Ethics Inventory padding Safeguarding assets Physical controls Includes ensuring that products don’t spoil RFID tags Controlling inventory levels and monitoring product developments to prevent inventory obsolescence
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ASSIGN 11 - pg. 304-305, E6-2A, E6-3A, E6-8A ASSIGN 12 - pg. 309-312, P6-1A, P6-7A
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