Question

1(b) Discuss the accounting treatment of inventory and COGS. What are the primary reasons for using LIFO?
(6 marks)

Answer 1

Inventory is one of the current asset which always has debit balance. When inventory increases, it is debited and when it decreases, it is credited. It has three parts -

1) Raw Materials Inventory

2) Work-in Process Inventory

3) Finished Goods Inventory

1) Raw Materials Inventory - When raw materials are purchased, they are debited and Cash or Accounts Payable is credited for cash paid or purchased on account. When raw materials are issued to the production, Raw materials are credited and work in process inventory is debited in case of direct materials and Manufacturing / Factory Overheads is debited in case of indirect materials.

2) Work-in Process Inventory - Work-in process inventory is debited when raw materials are added to the production and work-in process inventory is credited when processed units are completed and issued to Finished Goods Inventory.

3) Finished Goods Inventory - Finished Goods inventory is credited when goods are sold because they decreases due to sale and the cost of goods sold is debited.

Generally, inventory is reported under the current assets section of the balance sheet.

Cost of Goods Sold is the actual cost incurred for the units sold. Cost of goods sold is reported under Trading and Profit and Loss Account. Cost of goods sold is deducted from the total sales to find out the gross profit.

One of the primary reasons for using the LIFO is mostly works during inflation because during inflation, the purchase cost of goods will equal the revenues earned during that period, thus results into decrease of taxable income which results into lesser taxes. Therefore, main reason for using the LIFO is for tax benefit.