Koontz Company uses the perpetual inventory method. On January 1, 2016, the company's first day of operations, Koontz purchased 400 units of inventory that cost $7.50 each. On January 10, 2016, the company purchased an additional 600 units of inventory that cost $9.00 each. If Koontz uses a weighted average cost flow method and sells 550 units of inventory, the amount of inventory appearing on balance sheet following the sale will be
approximately: Show Robert Reas What are the two inventory systems, and why have two of them? What is the difference between the two inventory systems? What are the three methods of valuing ending inventory? What is the difference between the three methods of assigning costs to inventory? Why are there different methods of valuing inventory? Why is it important to have an accurate count of the ending inventory? What are the two inventory systems, and why have two of them? The two systems of inventory are: (1) perpetual inventory and (2) periodic inventory. Each system has certain advantages and disadvantages. The perpetual inventory system provides up-to-date inventory information but requires more time and record keeping to use it. The periodic inventory system is simpler to use but does not provide us with the number of units on hand unless we physically count the inventory. A business has a choice between the two systems. A perpetual inventory system is the best if a business can afford the cost of maintaining it. top What is the difference between the two inventory systems? Under the perpetual inventory system, all merchandise increases and decreases are recorded. When a sale is made, we not only record the sale, we also record the decrease in the inventory account. The merchandise inventory account at any point in time reflects the merchandise on hand at that date. When the periodic inventory system is used, only revenue is recorded each time a sale is made. No entry is made at the time of the sale to decrease the inventory account. A physical count is taken at the end of the accounting period to determine the cost of merchandise sold and the cost of inventory on hand. top What are the three methods of valuing ending inventory? The three most common methods to assign costs to inventory are: (1) first-in, first-out (FIFO), (2) last-in, first-out (LIFO), and (3) average cost. top What is the difference between the three methods of assigning costs to inventory? There are three common cost flow assumptions: (1) the flow of the costs are the same as the flow of the physical goods (first-in, first-out), (2) cost flows are in reverse order to the flow of the physical goods (last-in, first-out), and (3) cost flows are an average of the unit costs (average cost method). The fifo method of costing inventory assumes that costs should be charged against revenue in the order in which they were incurred. The units left in ending inventory are assumed to be the most recently purchased and therefore represent the most recent costs. The fifo method of costing is usually consistent with the physical movement of the merchandise. The lifo method assumes that the most recent costs incurred should be charged against revenue. The units left in ending inventory are assumed to be the first units purchased and therefore the earliest costs. Under lifo, the flow of the costs is not the same as the flow of the physical goods. The average cost method assumes that the average cost of all units sold should be charged against revenue. top Why are there different methods of valuing inventory? Companies have a choice of inventory valuation methods. They can choose the method that provides the results they want to achieve in the financial statements. Each method assumes a different order of cost flows. If the cost of units stays the same during any given accounting period, all three methods yield the same ending inventory values and net income figures. When prices change, however, each method yields different results in the short run (and sometimes long run as well). In periods of rising prices, the fifo method yields the highest amount for ending inventory, the lowest cost of merchandise sold, and the highest net income. In periods of rising prices, the lifo method yields the lowest ending inventory , the highest cost of merchandise sold, and the lowest net income. In periods of declining prices the effects stated in the above two sentences would all be the opposite. The average cost method yields results that are in between those of fifo and lifo. During periods of rising prices, many companies like lifo because it results in paying less income taxes. But if prices later decline, the company would be reporting higher net incomes, thus paying higher taxes. Companies must use a method consistently. Both generally accepted accounting principles and federal tax law prohibit companies from switching back and forth between methods. top Why is it important to have an accurate count of the ending inventory? Accuracy in counting and assigning costs to the units is extremely important to ensure meaningful financial statements. For every dollar that we are off in the ending inventory valuation, our net income will be off the same number of dollars and the same direction.
top Copyright © 2005 South-Western. All Rights Reserved. What method gives the highest ending inventory?Based on the table above, FIFO gives the highest cost for ending inventory. Since the cost of inventory increases the later date the company purchases goods, the inventory with higher costs forms part of the ending inventory.
Which inventory method results in the highest ending inventory value when prices are rising?If prices are increasing throughout the year, a FIFO inventory valuation technique will give you a higher value for closing inventory. If prices are decreasing, a LIFO technique will give you a higher value.
Does FIFO or LIFO have higher ending inventory?FIFO generates a lower-cost goods sold balance than LIFO and a higher ending inventory balance.
What happens to LIFO when prices are rising?This is why in periods of rising prices, LIFO creates higher costs and lowers net income, which also reduces taxable income. Likewise, in periods of falling prices, LIFO creates lower costs and increases net income, which also increases taxable income.
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