Question

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2 DUVVU Chap. 6 - Reporting and Analyzing Inventory 1. What are the cost flow assumptions and why are they needed? 2. Describe the methods of costing inventory: FIFO, LIFO, and average cost. 3. What is the lower of cost or market rule? 4. What is the just-in-time inventory method? 5. A company purchased 300 units for $25 each on January 1 and purchased 400 units for S28 each on June 1. Which unit cost is used to calculate cost of goods sold for 100 units under FIFO and LIFO methods?

Answer 1

ANS 1.

Meaning :- The cost flow assumption states that the cost of an inventory item changes from when it is acquired or built and when it is sold. Because of this cost differential, management needs a formal system for assigning costs to inventory as they transition to sellable goods.

why are they Need :- companies tend to select a cost flow assumption that either minimizes profits (in order to minimize income taxes) or maximize profits (in order to increase share value).

Ans 2.

First in First Out (FIFO) Method

This method assumes that inventory that entity bought first will be the first to be issued. In other words inventory units are withdrawn from the oldest inventory held by the entity for the sales or consumption.

This implies that fact that inventory at the end of the period held by the entity is the newest one.

Last in First Out (LIFO) Method

This method assumes that units that entity bought latest will be issued first. In other words inventory units are withdrawn from the latest inventory held by the entity for the sales or consumption.

This also implies that inventory at the end of the period still in the store is the oldest one.

Average Value of Cost (AVCO) Method

In this method the costs are averaged out and for computation of inventory consumed/sold and inventory still in the store is measured on the basis of average cost figure.

Ans 3. The lower of cost or market rule states that a business must record the cost of inventory at whichever cost is lower – the original cost or its current market price.

cost of inventory = Original cost

or    (whichever is lower)   

Current market price of stock

Ans4. The "just-in-time method" is an inventory strategy where materials are only ordered and received as they are needed in the production process. The goal of this method is to reduce costs by saving money on overhead inventory expenses.

Ans5.

As per FIFO Method:-In this method unit bought first will be the first to be issued

$ 25

As per LIFO Method:-This method assumes that units that entity bought latest will be issued first

$28