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5.
|
Historical cost
is determined by how inventory costs are assigned to
inventory. This depends on
whether the periodic or perpetual system is used, and
whether FIFO, LIFO, average, or other
method is applied. Finally, the lower of cost or market
requirement also affects historical cost. If
a lower of cost or market valuation results in changing
the inventory to a lower market value,
then historical cost is no longer being used. The value
that results from the selection and
application of these methods is the value that will
appear on the balance sheet.
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6.
|
The
Internal Revenue Service (IRS) requires LIFO to be used
on financial statements if LIFO is
used to on income tax returns to determine income tax. |
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7.
|
When the average method is used with the periodic inventory
system, the average cost is
calculated at the end of a period. The average is calculated
by adding the cost of the beginning
inventory to the cost of all the purchases for the period
and then dividing by the number of
units available. This average is then used to calculate
ending inventory and the cost of goods
sold for the entire period.
|
|
|
|
|
When
the average method is used with the perpetual inventory
system, the average cost is
recalculated each time there is a new purchase of inventory
during the period. The average is
calculated by dividing the total cost of the inventory
available by the total units available. This
average cost is then used to calculate cost of goods sold
for each sale until there is another purchase. |
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8.
|
Understating
ending inventory will overstate cost of goods sold. You
can visualize this by using
the formula BI + net P – EI = C of GS. Overstating
cost of goods sold by $5,000 will understate
net income by $5,000. |
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9.
|
| Cost of
goods available for sale: $185,000 + $745,000 |
= $ 930,000 |
| Estimated
cost of goods sold: $1,500,000
× (1 – .4) |
= 900,000 |
| Estimated
ending inventory: |
$ 30,000 |
|
|
|
|
10.
|
When
assigning cost to inventory, the objective consists of
two parts: (1) determine the cost of
ending inventory and (2) determine the cost of goods sold.
For determining the cost of ending
inventory, the key accounting principle applied is the
historical cost principle. Historical cost is
determined by selecting the inventory system (periodic
or perpetual) and the method applied
(FIFO, LIFO, etc.). However, this principle may be superseded
by a valuation adjustment when
applying the lower of cost or market rule. |
| |
For
determining the cost of goods sold, the key principle
is the matching principle. The cost
matched against revenue is also affected by the selection
of the inventory system (periodic or
perpetual) and the method applied (FIFO, LIFO, etc.). |
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11.
|
LIFO
liquidation occurs when most or all of inventory is sold
and old layers of cost flow into
cost of goods sold and are matched against current period
revenues. If the old costs are much
higher or much lower than current costs, a large distortion
of net income can result—net
income will be very high or very low. |
| |
LIFO can be used
to manipulate income because the cost of the most recent
purchases are the
first costs to flow into cost of goods sold. Therefore,
at the end of a period, purchases can be
either accelerated or deferred for the purpose of manipulating
the amount of cost of goods sold
and net income. |
