...FIFO and LIFO Accounting Implications of Valuing Inventory under FIFO and LIFO Laura Lance Financial Accounting, ACC211 Instructor Suzanne Lozano 8 December 2011 FIFO and LIFO 1 Accounting Implications of Valuing Inventory under FIFO and LIFO LIFO and FIFO Inventory Accounting Methods The two most common methods of inventory accounting are Last-in-first-out (LIFO), and first-in –first out (FIFO), choosing the correct method of inventory accounting could be detrimental to the income statement and the statement of cash flow, and also it would affect the balance sheet of the company. For a company, it is imperative that they track their inventories and cost of goods sold. Both of these methods of accounting are a way they could do this. LIFO and FIFO are methods used for accounting for the inventory. I will discuss these two different methods. FIFO FIFO is a method that companies use whose inventories are like food or an item that could turn bad if not sold quickly. A company using FIFO normally looks better to investors then they are. It is sort of a false advertisement of higher profit then it should be reflecting. The good part of a FIFO method is that it reflects new purchases and with that would show accurate replacement costs. LIFO LIFO is a method that companies would use if their inventories were not perishable or had a wear out date. If and when cost of the items rise, the higher...
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...3217 DECEMBER 9, 2008 WILLIAM E. BRUNS SHARON M. BRUNS SUSAN HARMELING Merrimack Tractors and Mowers, Inc.: LIFO or FIFO? Ricardo “Rick” Martino, president and chief operating officer of Merrimack Tractors and Mowers, Inc., of Nashua, New Hampshire, felt that his job had grown much more complicated during 2007 and 2008. Merrimack was a major regional manufacturer and seller of large commercial grass mowers based on a design developed by his grandfather in the years after World War II. The company’s major competitors were John Deere, The Toro Company, Simplicity, and Husqvarna—much older and larger corporations with extensive lines of lawn care and maintenance equipment. Originally, Merrimack mowers were manufactured and assembled in a workshop and factory in Nashua. However, by 2008 the company was buying all of its tractors and machines, manufactured to its specifications, from a contract manufacturer in China, and it was operating almost exclusively as a machine-and-parts designer and distributor. The company had incorporated in 1980, and an initial public offering was followed by additional offerings of shares over the next decade. By 2008 the company had about 4,000 shareholders, including some mutual funds. About 25% of the outstanding stock was held by members of the Martino family, and shares were traded on NASDAQ. Rick had been elected president after the death of his father late in 1995. Martino’s father had initiated several changes and made decisions that led...
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... FIFO [ FIRST IN FIRST OUT ] | ADVANTAGES | DISADVANTAGES | * If the business trades perishable goods with the use of FIFO it can avoid obsolescence of stock. * Closing stock valuation is done upon the most recent prices paid for stock which takes into account the rate of inflation. * The method is more realistic as the inventory is issued in the order in which they have been received. * FIFO is acceptable method of inventory valuation as per Accounting concepts and conventions. * Inventory is issued to production at the price actually paid purchase them. | * At times of high rate of inflation FIFO values closing stock at the latest price which is high and hence the profit gets overstated as the cost of goods sold gets reduced. * Higher income taxes may have to be paid as FIFO results in profits being inflated. * Manufacturing firms do not issue raw materials at the latest prices and hence it forms a barrier to setting realistic price for the final product. * Identical inventory is issued to production at a different price simply because they are deemed to be made out of different batches of production. This makes the calculation of unit cost difficult as it varies for different batches of production. | 4 LIFO [ LAST IN FIRST OUT ] | ADVANTAGES | DISADVANTAGES | * The inventory is issued to production at the most recent prices paid to acquire them. * The profit is usually understated in LIFO which causes...
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...FIFO, which is stand for “first-in-first-out”, is an inventory costing method which assumes that the first stock bought are the first ones to be sold, and the stock bought later are sold out later. Recently-placed goods that are unsold remain in the inventory at the end of the year. With this inventory valuation approach, the company accounts for the value of inventory received first when sales are made. One of the more common reasons a company chooses FIFO is because it is a more natural straight-line approach since account for the first inventory in as the first items sold. This makes it especially useful when tracking inventory items is simple LIFO, which is stands for “last-in-first-out”, is an inventory valuation method assumes that the last inventories bought are the first one to be sold, and the inventories bought first are sold out last. The goods placed first in the inventory remain in the inventory at the end of the year. Thus, when the accounting in most recently received inventory with first items sold. This actually gives a more realistic look at the market costs of the inventory when sell since it is sold shortly after received. A main reason companies choose LIFO during periods of inflation, though, is that it helps keep current taxable income low since more recent purchases typically have a higher cost basis The weighted average method uses average costs over the reporting period to calculate the inventory balance. It is a new average cost is calculated...
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...INVENTORIES QUESTIONS: 1. Write down the definition of ‘Inventory’ under IAS-2. What physical materials does ‘Inventory’ include? 2. According to IAS-2, what are the components of non-components of Inventory Cost? 3. Distinguish between ‘Perpetual’ and ‘Periodic’ system for recording Inventory? Show proper examples. 4. What are the Cost Flow Formulas/Assumptions allowed in IAS-2 for maintaining Inventory? Show examples. Which one should be used in what situation? 5. Explain LIFO? Why LIFO is not permitted in IAS-2. Do you think repealing LIFO was wise decision of IASB? Discuss with its advantages & disadvantages. 6. What is NRV of an asset? When should company write down its inventories to NRV? Explain write-down processes with illustrations. * Write down the definition of ‘Inventory’ under IAS-2. What physical materials does ‘Inventory’ include? * Paragraph-6 of IAS-2 defines inventories as following- 1. Held for sale in ordinary course of business 2. In the process of production for such sale 3. in the form of materials or supplies to be consumed in the production process or in the rendering of services. This definition implies that 3 types of physical materials are to be included in ‘Inventories’- a) Raw Materials b) Work in process c) Finished Goods * According to IAS-2, what are the components of non-components of Inventory Cost? * Components of Inventory Cost: 1) Cost of Purchase Includes-...
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... LIFO or FIFO Submission Date Sep-9-2015 Class: Accounting Submitted by Objective: Three companies changed their inventory accounting policy. Find the reason behind the change and analyze the impact of the change on the Balance Sheet and Profit & Loss. What accounting lessons we can learn from these two cases? Case 1 Questions 1. Use a table to show general effects of FIFO vs. LIFO Answer: Difference between FIFO and LIFO Market price rise | FIFO | LIFO | VS | Ending inventory | ↑ | ↓ | FIFO > LIFO | Total assets | ↑ | ↓ | FIFO > LIFO | COGS | ↓ | ↑ | FIFO < LIFO | Income tax | ↑ | ↓ | FIFO > LIFO | Net income | ↑ | ↓ | FIFO > LIFO | Current ratio | ↑ | ↓ | FIFO > LIFO | Return on investment | ↑ | ↓ | FIFO > LIFO | 2. (a)What factors should the management of Example Corporation in this case consider when deciding whether to switch from LIFO to FIFO at the beginning of Year 2? (b) Would this change impact the balance sheet or income statement in a material way? Why or why not? Answer: (a) When the company considers whether to switch its inventory method, the impact on the Balance Sheet and P&L for each method needs to be considered. FIFO will allow report of a larger ending inventory and greater net income, but the company will pay more income taxes. Continuing to use LIFO will lead to lower net income but lower taxes. FIFO will also...
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...Chapter 07 Reporting and Interpreting Cost of Goods Sold and Inventory ANSWERS TO QUESTIONS 1. Inventory often is one of the largest amounts listed under assets on the balance sheet which means that it represents a significant amount of the resources available to the business. The inventory may be excessive in amount, which is a needless waste of resources; alternatively it may be too low, which may result in lost sales. Therefore, for internal users inventory control is very important. On the income statement, inventory exerts a direct impact on the amount of income. Therefore, statement users are interested particularly in the amount of this effect and the way in which inventory is measured. Because of its impact on both the balance sheet and the income statement, it is of particular interest to all statement users. 2. Fundamentally, inventory should include those items, and only those items, legally owned by the business. That is, inventory should include all goods that the company owns, regardless of their particular location at the time. 3. The cost principle governs the measurement of the ending inventory amount. The ending inventory is determined in units and the cost of each unit is applied to that number. Under the cost principle, the unit cost is the sum of all costs incurred in obtaining one unit of the inventory item in its present state. 4. Goods available for sale is the sum of the beginning inventory and the amount of goods purchased during...
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...distribution industry. With their company positioned within the industrial sector of the industry, they are susceptible to cyclical pressures when the economy slows. In the current environment, growth has slowed and Summit Distributors is concerned about meeting the covenants in their agreement with Prime Trust Bank as their earnings have fallen and they have had to dig into their retained earnings. The below takes a look at possible opportunities that Summit has to improve their balance sheet, this would ensure that they are within the guidelines of their covenants. 1. If you were Kathy Hutton, what would you do? Due to the fragile nature of Summit Distributors business, we would agree with Dave Flander’s suggestion of going from LIFO to FIFO. There are a few negatives and positives with this decision. First, violating any of the loan covenants would alert the bank, and any future dealing with them would incur a 50 basis point increase on the lending rate (.50%). Also because of the switch older equipment would sit in storage for a longer period of time, thus forcing Summit to eventually sell it at a discount or depreciate it towards the base value only to have it collect dust. The reason for this is that the nature of the industry requires for our firm to have a variety of warehouses located in different locations with the newest equipment, in order to be competitive in the market. Due to the economic decline, fewer of our products will be purchased from us, and we...
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...affected by the increased in cost in Asia. The income of Merrimack of 2008 was below that of 2007 and earlier years and there was a pressure on Rick Martino to keep earning growing. Company's controller had idea to maintain the trend in income growth by changing the method of accounting for inventories of Tractors, mowers and parts. The controller suggested Rick to change the accounting method from LIFO to FIFO which would report to higher income figure in 2008 which subsequently would increase the taxes payable. Inference: After comparing income statements of year 2008 based on LIFO and FIFO methods we can observe a drastic impact it had on NET INCOME. NETINCOME is positive when FIFO method is used and negative when LIFO is used. • As per Colburn’s report,...
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...4. In considering the rules based approach of GAAP and the principles based approach of IFRS we looked at GAAP first. GAAP provides application clarity, low risk, and for companies in the same industry there is easy comparability. These Rules, however, must be accounted for using these rules even if the information is misleading, uneasy to compare across industries and the risk increases when rules are not followed. IFRS allows us to consider best out of multiple ways to account for transactions, comparibility among companies across multiple industries, and it is easier to defend actions and positions by using the principles that were followed. That being said, we believe that the IFRS approach is needed over the US approach. We believe that the rules are put into place by the US approach and companies then take the steps necessary to get around them. We believe that principles should be used and there should be required disclosures to guide investors and shareholders and help them understand the principles that were used and the decisions made that were based on these principles. There is still need for solid framework for larger key issues, but we feel as though principles are the right way to go. To deal with inconsistencies, there would still be a few concrete rules laid out to govern however principles will be still be used. Lessees and Lessors will also be required to show equal and opposite assets and liabilities on their balance sheets for every and all lease without...
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...Differences method between FIFO, LIFO and CWAC FIFO, which is stand for “first-in-first-out”, is an inventory costing method which assumes that the first stock bought are the first ones to be sold, and the stock bought later are sold out later. Recently-placed goods that are unsold remain in the inventory at the end of the year. With this inventory valuation approach, the company accounts for the value of inventory received first when sales are made. One of the more common reasons a company chooses FIFO is because it is a more natural straight-line approach since account for the first inventory in as the first items sold. This makes it especially useful when tracking inventory items is simple LIFO, which is stands for “last-in-first-out”, is an inventory valuation method assumes that the last inventories bought are the first one to be sold, and the inventories bought first are sold out last. The goods placed first in the inventory remain in the inventory at the end of the year. Thus, when the accounting in most recently received inventory with first items sold. This actually gives a more realistic look at the market costs of the inventory when sell since it is sold shortly after received. A main reason companies choose LIFO during periods of inflation, though, is that it helps keep current taxable income low since more recent purchases typically have a higher cost basis The weighted average method uses average costs over the reporting period to calculate the...
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...inventory measured using the LIFO method, which is using last-in, first-out. They also decided on excluding the retail inventory methods. The Board also requires inventory to be measured at net realizable value and at the lower of cost. They believe that the result will cause a reporting entity to not be required to consider replacement costs. There will not be additional disclosures required in the periods after the amendments. The amendments will be applied in the annual reporting periods after December 15th, 2016 with interim reporting periods starting after December 15th, 2017. If LIFO is used for tax purposes, it must also be used for financial reporting of a company. This can cause trouble for certain companies. When prices rise, companies using LIFO minimize their tax liability, but the companies minimize their net income as well, in turn causing failure of the companies to meet the minimum level of profitability under a loan or meet what analysts have forecasted for the company. LIFO is also not used in a good portion of foreign jurisdictions. This limits the ability to expand abroad for companies valuing inventory using LIFO. If a company chose to expand internationally, they would have to keep two sets of inventory records; one for US tax law and domestic financial reporting and one for international reporting. Keeping two separate reports can become expensive for the company to maintain. With the decision of FASB excluding LIFO, CPAs will more than likely...
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... = 1375 units Average cost per unit = 31295/1375 = $22.76 Ending Inventory = 1375 – 1100 = 275 units FIFO Ending Inventory = (110 x 28) + (165 x 24) = 3080 + 3960 = $7040 Cost of goods sold= 31295 – 7040 = $24255 LIFO Ending Inventory = (165 x 18) + (110 x 22) = 2970 + 2420 = $5390 Cost of goods sold= 31295 – 5390 = $25905 Average Cost Ending Inventory = 275 x 22.76 = $6259 Cost of goods sold= 31295 – 6259 = $25036 Highest Inventory amount= FIFO $7040 Highest Cost of goods sold= LIFO $25905 Problem 6-5A Weighted average cost per unit = 11448/212 = $54 Supporting Calculation; Net Purchases June 4: Purchase = 138 x 45 = 6210 June 18: Purchase = 46 x 46 = 2116 June 28: Purchase = 28 x 50 = 1400 ...
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...CHAPTER 6 Reporting and Analyzing Inventory Study Objectives 1. Describe the steps in determining inventory quantities. 2. Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. 3. Explain the financial statement and tax effects of each of the inventory cost flow assumptions. 4. Explain the lower of cost or market basis of accounting for inventories. 5. Compute and interpret the inventory turnover ratio. 6. Describe the LIFO reserve and explain its importance for comparing results of different companies. Summary of Questions by Study Objectives and Bloom’s Taxonomy Item SO BT Item SO BT Item SO BT Item SO BT Item SO BT Questions 1. 1 C 6. 2 AP 11. 2 K 16. 4 AP 21. 6 C 2. 1 K 7. 2 C 12. 3 C 17. 4 K 22. 7 C 3. 1 K 8. 2 C 13. 3 C 18. 2 K 23. 7 C 4. 1 C 9. 2 K 14. 3 C 19. 3 C 24. 8 AN 5. 1 C 10. 2 C 15. 4 C 20. 5 AN Brief Exercises 1. 1 C 3. 2 AP 5. 3 AP 7. 5 AP 9. 7 AP 2. 2 AP 4. 3 C 6. 4 AP 8. 6 C 10. 8 AN Exercises 1. 1 AN 4. 2 AN 7. 2, 3 AP 10. 5, 6 AP 13. 8 AN 2. 1 AN 5. 2 AP 8. 5 ...
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...Chapter 4 Exercise 4-3 a. Describe inventory cost flow assumption of (1) average cost, (2) FIFO, (3) LIF0. Average cost: units sold without regard to the order in which they are purchased and computes COGS and ending inventories as simple weighted average. FIFO: the first units purchased are the first units sold. These units are the units on hand at the beginning of the period. LIFO: the last units purchased are the first to be sold. b. Discuss management’s usual reason for using LIFO as inflationary economy. The use of LIFO can reduce or delay tax payments. Lower cost inventories are matched against sales revenues at current market prices, known as phantom profits. It has two components: economic profit and holding gain. The economic profit is equal to the number of units sold multiplied by the difference between the sales price and the replacement cost of inventories. While the holding gain is the increase in replacement cost since inventories were acquired. By the difference between the current replacement cost and the original acquisition cost. Holding gains are a function in inventory turnover (how long the goods remain on the shelves) and the rate of inflation. LIFO reports ending inventories at prices that can be significant lower than replacement costs. c. When there is evidence the value of inventory, through its disposal in ordinary course of business, is less than cost, what is the accounting treatment? What concept justifies this treatment? Lowe cost of market is the...
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