Inventory Costing Methods: Financial Impact Analysis

Inventory Costing Methods: Situational Analysis

For each of the following situations, determine whether FIFO, LIFO, or Weighted Average would apply:

• FIFO would produce the highest amount of net income in an inflationary environment.
• FIFO would produce the highest amount of assets in an inflationary environment.
• FIFO would produce the lowest amount of net income in a deflationary environment.
• Weighted Average would produce the same unit cost for assets and cost of goods sold in an inflationary environment.
• LIFO would produce the lowest amount of net income in an inflationary environment.
• Weighted Average would produce an asset value that was the same regardless of whether the environment was inflationary or deflationary.
• LIFO would produce the lowest amount of assets in an inflationary environment.
• LIFO would produce the highest amount of assets in a deflationary environment.

Product Cost Examples

• Freight on goods purchased for resale
• Cost of goods purchased for resale
• Transit insurance on goods purchased for resale
• Cost of merchandise purchased for resale
• Transportation cost of merchandise purchased from suppliers
• Transportation cost on goods received from suppliers
• Commission paid on goods sold last month

Product Cost Matching and Inventory Impact

When are product costs matched against sales revenue?

• When the merchandise is sold.

Impact of Inventory Errors:

• If the balance in ending inventory is understated, retained earnings will be understated.
• If the balance in ending inventory is overstated, selling and administrative expenses will not be affected.
• If the balance in ending inventory is overstated, assets will be overstated.

Financial Statement Classification of Accounts

Consider the following accounts:

1. Cash
2. Merchandise Inventory
3. Cost of Goods Sold
4. Transportation Out
5. Dividends
6. Common Stock
7. Selling Expenses
8. Loss on the Sale of Land
9. Sales

Classifications:

• Balance Sheet: Items 1, 2, 6
• Affect Gross Margin: Items 3, 9
• Income Statement: Items 3, 4, 7, 8, 9
• Affect Operating Income: Items 3, 4, 7, 9

Inventory Valuation in Declining Prices

Question: At a time of declining prices, which cost flow assumption will result in the highest ending inventory?

Answer: FIFO

Application of the Lower-of-Cost-or-Market Rule

The Lower-of-Cost-or-Market (LCM) rule can be applied to:

• Major classes of inventory
• The entire stock of inventory
• Each individual inventory item