Question

• Identify the differences between F.I.F.O., L.I.F.O., and the average-cost method of inventory valuation.
  • Be sure to include the effects of each method on cost of goods sold and net income in your answer.
• Discuss the differences between the physical movement of goods and cost flow assumptions.
  • Your answer should illustrate understanding of the three major inventory valuation methods, and the relationship between physical inventory flow and cost flow assumptions.

Answer 1

FIFO:-it means first in first out,as contained in name itself in this method it is considered that when sale is happen ,the items sold out will go from first came basis,hence the closing stock under this method will contain the latest items.oldest cost of inventory will write off to income statement as cost of goods sold.

LIFO:- it is just opposite to as explained in fifo method.here the assumption is that when sale is happen,the latest came items will go out first.hence cost of latest inventory will write off to income statement as cost of goods sold.

Average cost method:under this method,the cost of whole inventory will consider and total cost of inventory will divide by total quantity to arrive cost per item.

cost flow assumptions:-cost flow assumptions means the methods used to remove cost of inventory from the books of accounts and used to write off as cost off goods sold.the above explained 3 methods are normally using.for example if a company having 3 units of same item which is purchase in defferent prices say $25,$26,$27 and  sold one unit,the accounting treatment under 3 methods will be as follows:-

under FIFO:the cost of sold will be $25,under LIFO the cost of sold will be $27 and under average cost method the cost of goods sold will be $26 as the average of the three costs.

Physical movement of goods-the physical movement of goods means the actual in or out flow of goods .it does not have any affect on cost assumptions.