Question

Explain the different inventory methods that effect the balance sheet and income statement. Identify the differences between the balance sheet and income statement.

Answer 1

Inventory methods-

FIFO - It stands for first-in-first-out and this method assumes that the oldest items of inventory are sold first i.e. in the order in which they are purchased or manufactured.

LIFO - LIFO refers to last-in-first-out and is the opposite of LIFO method of inventory valuation because under this method, it is assumed that inventory items that are most recently bought or manufactured are sold first. This method is mostly used in case of inflation.

Weighted average cost - Under this method, cost of goods sold ( COGS) and inventory are valued on the basis of average cost of all items bought during a particular year.

Specific identification - This method is mostly used by retailers according to which, specific cost is assigned to each and every item available in the stores of retailers.

Differences between balance sheet and income statement-

1) Balance sheet reports assets, liabilities and equity of an entity at a particular point of time whereas an income statement depicts total revenues and expenses for a period of time.

2) Balance sheet shows the financial position with the view to ascertain whether an entity has sufficient resources to pay off its obligations whereas an income statement is used for evaluating the financial performance of an entity.

3) Balance sheet is used by lenders or creditors to see the prospects of extending credit facility to an entity whereas an income statement is used to ascertain whether a business is generating sufficient profits from its operations or not.