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Accounting: The Language of Business - Vol. 2 (Intermediate: Part 165)
- "The plans of the diligent lead to profit as surely as haste leads to poverty". This verse advises that planning for the future is important for avoiding financial stress.
Short-Term Operating Assets: Inventory (Part K)
by
Charles Lamson
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Comparison of the Moving-Average, First-In, First-Out (FIFO), and Last-In, First-Out (LIFO) Methods
Companies typically use either the moving-average cost, FIFO, or LIFO methods for costing inventory. Although the specific identification method is allowed, virtually no firms use it. Exhibit 10.5 presents the percentage of U.S. companies that use the different cost flow assumptions for at least part of their inventory. As shown, FIFO is the most popular method. %20(1)%20(2)%20(2)%20(3)%20(1)%20(1)%20(1)%20(3)%20(1)%20(1).jpg) Examples 10.7 (from Part 162), 10.8 (from Part 163), and 10.9 (from Part 164) demonstrate that the three primary cost flow assumptions produce different results for the cost of goods sold reported on the income statement and the valuation of inventory on the balance sheet. The different results can have a significant impact on reported income and several key financial ratios. The cost-flow assumptions affect only the allocation of the ending inventory and cost of goods sold: The choice of inventory valuation method does not affect cash flows directly. However, the IRS LIFO conformity rule mandates that a company using LIFO for tax purposes must also use it for financial reporting. The effect of inventory valuation methods on cost of goods sold, and thus net income, and the required book-tax conformity for LIFO lead to possible tax and cash-flow consequences. LIFO generally results in a lower income figure in a period of rising inventory cost. Thus, it is advantageous to use LIFO for tax purposes because its use will increase cash flow by decreasing cash paid for income taxes. Investors and other financial statement users understand that even though using LIFO results in lower net income, using LIFO increases the amount of cash that the company repays and can use in operations. Therefore, investors and other financial statement users do not penalize a company for using LIFO and reporting lower net income.  Exhibit 10.6 summarizes the moving-average, FIFO, and LIFO inventory valuation methods illustrated in Examples 10.7, 10.8, and 10.9, providing important insight:
%20(1).jpg) The relationships and ranking between the LIFO and FIFO methods noted in Exhibit 10.6 hold only if costs are rising for inventory acquisition and if units in inventory are constant or increasing. If costs are declining, then the comparison is exactly the opposite with LIFO resulting in higher net income and a higher inventory valuation. Inventory Allocation Methods: International Financial Reporting Standards (IFRS). IFRS does not allow the LIFO approach. International Accounting Standards settings view LIFO as imposing an unrealistic cost-flow assumption that lacks representational faithfulness of inventory flows (IASC, International Accounting Standard 2, “Inventories,” BC 11, 19). The fact that IFRS does not permit the LIFO cost-flow assumption would be a major obstacle for U.S. companies if the United States allowed IFRS. There could be significant cash flow effects for companies currently saving taxes as a result of using LIFO. A company ceasing the use of LIFO is obligated to pay the IRS all the tax savings it received from using LIFO over a four-year period. Consider Chevron Corporation, a petroleum company that uses the LIFO cost-flow assumption. By the end of 2016, it had saved more than $1 billion in taxes by using LIFO.  %20(1)%20(1).jpg) %20(1)%20(1).jpg) *GORDON, RAEDY,SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 524-526* end |
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Accounting: The Language of Business - Vol. 2 (Intermediate: Part 164)
Short-Term Operating Assets: Inventory (Part J)
by
Charles Lamson
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Last-In, First-Out Method The last-in, first-out (LIFO) method assigns the oldest cost to ending inventory and the most recent costs to cost of goods sold as Illustrated in Example 10.9. LIFO is conceptually sound for any company that accumulates inventory, sells units from its most recent acquisitions, and maintains a basic stock (such as a mining company). However, actual Inventory management at most firms does not follow this pattern. %20(1)%20(2)%20(2)%20(3)%20(1)%20(1)%20(1)%20(2).jpg) %20(1)%20(2)%20(2)%20(3)%20(2)%20(2)%20(1)%20(2).jpg) %20(1)%20(2)%20(2)%20(3)%20(2)%20(2)%20(1)%20(3)%20(1)%20(1)%20(1).jpg) %20(1)%20(2)%20(2)%20(3)%20(2)%20(2)%20(1)%20(3)%20(1)%20(1)%20(2)%20(1)%20(1).jpg) *GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 523-524* |
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Accounting: The Language of Business - Vol. 2 (Intermediate: Part 163)
Know well the condition of your flocks, and give attention to your herds,
Short-Term Operating Assets: Inventory (Part I)
by
Charles Lamson
First-In, First-Out Method
The first-in, first-out (FIFO) method assigns the most recent costs to ending inventory and the oldest cost to cost of goods sold. Under a perpetual system (a computerized system that continuously tracks and records inventory levels in real time), the company records the cost of goods sold at the point of each sale. FIFO is conceptually sound for firms selling products that can perish or are subject to style changes, obsolescence, or rapid technological changes. The FIFO cost-flow assumption accurately portrays the actual flow of goods in most companies. For example, it is logical that a computer manufacturer will attempt to sell its oldest models first because they will certainly be replaced by units with more advanced technology. Example 10.8 illustrates the FIFO method. .jpg) %20(1)%20(1).jpg) %20(1)%20(2)%20(1)%20(1).jpg) %20(1)%20(2)%20(2)%20(2).jpg) *GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 521-523* end |
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Accounting: The Language of Business - Vol. 2 (Intermediate: Part 162)
Short-Term Operating Assets: Inventory (Part H)
by
Charles Lamson
Moving-Average Method
The moving-average method determines an average cost for the units on hand and applies that average unit cost to the next sale to determine the cost of goods sold. The term moving-average method, is used in a perpetual inventory system (a computerized system that tracks inventory changes in real time, eliminating the need for physical inventory counts). Under a periodic inventory system (an accounting method that involves physically counting inventory at set intervals, such as quarterly, semi-annually, or annually), this approach is generally referred to as the weighted-average method. The ending inventory is the remaining (unsold) units valued at the average unit cost as shown in Example 10.7. The moving average method is useful for firms selling a high value of a homogeneous product (e.g., oil and gas) and is often used for inventory of raw materials and supplies. .jpg) %20(1).jpg) .jpg) %20(2).jpg) %20(1).jpg) *GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 519-521* end |
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Measurement Methods by Charles Lamson There are two major measurement methods: counting and judging. While counting is preferre...
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Product Life Cycles by Charles Lamson Marketers theorize that just as humans pass through stages in life from infancy to death,...
