FIFO Method in Accounting

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What are inventories?

Asset items that a company holds for sale in the ordinary course of business, or goods that it will use or consume in the production of goods to be sold.

Why do the description and measurement of inventory require careful attention?

To ensure accurate valuation of the investment in inventories, which is often the largest current asset of merchandising and manufacturing businesses.

How do merchandising businesses report their unsold units left on hand?

As merchandise inventory, with the cost assigned to the unsold units.

What are the three inventory accounts that manufacturing businesses normally have?

Raw Materials, Work in Process, and Finished Goods.

What constitutes the work in process inventory for a manufacturing business?

The cost of raw material for unfinished units, direct labor cost, and a share of manufacturing overhead costs.

How do raw materials inventory items differ from finished goods inventory items?

Raw materials can be traced directly to the end product, while finished goods are ready for sale to customers.

What is one advantage of the FIFO method?

The ending inventory is close to current cost.

How does the FIFO method impact the matching of costs and revenues on the income statement?

FIFO method fails to match current costs against current revenues.

Why does the IASB prohibit the use of LIFO for financial statements based on IFRS?

LIFO results in inventories being recognized at amounts that may not reflect recent costs.

What must a company do if it decides to change its inventory pricing method?

Clearly explain the change and disclose its effect in the financial statements.

Why is consistency important in applying an inventory pricing method?

To ensure accurate computation of net income.

What is the main issue with using FIFO in terms of matching costs and revenues?

Charging oldest costs against more current revenues.

What method is not permitted for financial reporting purposes under IFRS standards?


Why do investors want to determine the inventory method used by a retailer?

To have comparable information about inventory when evaluating financial statements.

What can impact an investor’s ability to compare inventory levels and gross profit?

Subjective estimates concerning the measurement and valuation of inventory.

Why might inventory balances not reflect the true state of a company's inventory?

Due to cost flow assumptions like FIFO or weighted-average, as well as significant markdowns and losses.

What are some of the methods discussed in the chapter to develop relevant inventory information?

LCNRV, gross profit method, and retail inventory method.

How does information on inventories help predict financial performance, especially profits?

By providing insights into the company's cost structure and potential gross profit margins.

What costs are included in product cost?

Costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to the point of sale and in salable condition.

What is included in the cost of purchase for inventories?

  1. The purchase price less purchase discount. 2. Import duties and other taxes. 3. Transportation costs. 4. Handling costs directly related to the acquisition of the goods.

What are the conversion costs for a manufacturing company?

Direct materials, direct labor, and manufacturing overhead costs.

What do manufacturing overhead costs include?

Indirect materials, indirect labor, and various costs like depreciation, taxes, insurance, and heat and electricity.

Why are selling expenses, interest costs, and general administrative expenses not included in inventory cost?

These costs are considered indirectly related to the cost of goods sold and are more directly associated with selling or administrative functions rather than production.

Explain the distinction between product costs and period costs.

Product costs are directly related to the acquisition or production of goods, while period costs are indirectly related and include selling expenses, interest costs, and general administrative expenses.

What is the formula used in the retail inventory method to compute the cost-to-retail ratio?

Total goods available for sale at cost divided by total goods available at retail price

In the retail inventory method, how is the ending inventory at cost calculated?

The cost-to-retail ratio is multiplied by the ending inventory valued at retail.

What is the purpose of deducting the sales from the total goods available for sale in the retail inventory method?

To determine an estimated inventory (goods on hand) at retail

How does a retailer convert retail prices to cost using the retail inventory method?

By applying the cost-to-retail ratio to the retail value of goods

What are the key records that a retailer needs to keep for the retail inventory method?

Total cost and retail value of goods purchased, total cost and retail value of goods available for sale, and sales for the period

In the context of the retail inventory method, why is there an observable pattern between cost and price for most retailers?

To facilitate the conversion of retail prices to cost using a formula

Learn about the advantages and disadvantages of using the FIFO (First-In-First-Out) method in accounting, including how it affects income manipulation, expense charging, and inventory valuation.

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