Bco114 Accounting - Inventory Valuation

JIM
1 Why in your opinion did Jim’s accountant recommend the average cost method and what difference is there with the
three other methods? Explain the main characteristics of each method of valuation of the inventory and the
consequences they may have on the valuation of the inventory and determination of the net income in case of price
fluctuation. (20 points)
Answer:
(a) Jim's accountant may have recommended the average cost method because it is the inventory valuation method that
assigns a cost to inventory items based on the total cost of goods purchased or produced in a period divided by the
total number of items purchased or produced. The average cost method is also known as the weighted-average
method.
Average cost is the only invetory valauation method that smooths out prce fluctuations. It produces results that fall
somewhere between FIFO and LIFO.
(b) The difference between Average Cost and the other three method is such that Average cost considers all the cost
elements of purchases made within a given period and thus assign that cost at a fixed rate to quantity of goods sold
unlike other methods which picks up a singular cost value which could be cost of oldest purchase, newest purchase,
specific identification as the case applies
When a company uses the weighted-average method and prices are rising, its cost of goods sold is less than that
obtained under LIFO, but more than that obtained under FIFO.
(c) The main characteristics of each method of valuation of the inventory and the consequences they may have on the
valuation of the inventory and determination of the net income in case of price
Characteristics of the specific identification method include:
1 Keeps track of the cost of each, specific good sold
2 Perfect matching of costs of goods to goods sold
3 Often impossible or too costly and allows manipulation by management
4 The assumed flow of costs corresponds with the normal physical flow of goods
5 It states cost of goods sold and ending inventory as the actual cost of specific units sold and on hand
Characteristics of the FIFO method include:

1 Assigns the oldest costs incurred to COGS (cost of goods sold) on the income statement
2 Disallows manipulation by management and cost flow agrees with ideal, physical flow of goods, though the agreement
of cost flow and ideal, physical flow of goods is arguably not important
3 Uses the least relevant cost for the income statement and underestimates or overestimates the cost of goods sold if
prices are rising or falling, respectively
4 The balance sheet amount for inventory is likely to approximate the current market value.
5 The assumed flow of costs corresponds with the normal physical flow of goods
Under FIFO, purchases at the end of the period have no effect on cost of goods sold or net income. FIFO include the
recognition of paper profits and a heavier tax burden if used for tax purposes in periods of inflation.
Characteristics of the LIFO method include:

1 Assigns last costs incurred to COGS on the income statement
2 Disallows manipulation by management and uses the most relevant cost for the income statement
3 Underestimates or overestimates cost of goods sold if prices are falling or rising, respectively and cost flow disagrees
with ideal, physical flow of goods, though the agreement of cost flow and ideal, physical flow of goods is arguably not
important
During periods of inflation, LIFO shows the largest cost of goods sold (COGS) of any of the costing methods because the
newest costs charged to cost of goods sold are also the highest costs.
2 Prepare an Income statement of the company at the end of February using as method of valuation of the inventory
the average cost method, FIFO and LIFO for each one of the products sold by Jim, and calculate the balance of the
inventory at the end of the month. Explain the calculations. (40 points: 30 points for the calculation and 10 for
explanations)
Answer:
JIM
INCOME STATEMENT FOR THE MONTH ENDED FEBRUARY 29, 2020
$ $
a). Using the Average Cost Method
Sales Revenue 236,500.00
Cost of Goods Sold (132,228.21)
Net Profit 104,271.79
Expenses:
Salaries 3,600.00
Electricity 350.00
Renting of equipment 900.00
Rent of warehouse and office 1,600.00
Miscelleneuous 1,300.00
(7,750.00)
Gross Profit 96,521.79
b). Using the FIFO Method

Expenses:
Salaries 3,600.00
Electricity 350.00
(7,750.00)
c). Using the LIFO Method

Expenses:
Salaries 3,600.00
Electricity 350.00
(7,750.00)
WORKINGS
1 Total Sales
Date Description Number of Items Selling Price / unit Total Sales
$ $
04-Feb Sundry Sales:
Pistachios 2,000 21.00 42,000.00
Almond 2,500 12.00 30,000.00
Peanuts 3,000 8.00 24,000.00
05-Feb Fruits Lovers Inc -
Pistachios 500 21.00 10,500.00
Almond 1,000 12.00 12,000.00
Peanuts 1,500 9.00 13,500.00
12-Feb Peanut Lovers: Peanuts 3,500 9.00 31,500.00
18-Feb Sundry Sales: -
Pistachios 1,000 22.00 22,000.00
Almond 1,500 14.00 21,000.00
Peanuts 3,000 10.00 30,000.00
TOTAL 19,500 236,500.00
2 Total Purchases
Date Description Number of Items Cost / unit Total Cost
$ $
01-Feb Pistachios 2500 11 27,500.00
Almond 4000 6 24,000.00
Peanuts 6000 4 24,000.00
02-Feb Pistachios 1500 13 19,500.00
Almond 2000 7 14,000.00
Peanuts 2000 5 10,000.00
11-Feb Pistachios 1500 15 22,500.00
Almond 2000 9 18,000.00
13-Feb Peanuts 6000 5 30,000.00
24-Feb Pistachios 1000 14 14,000.00
Almond 1000 10 10,000.00
Peanuts 1000 5 5,000.00
TOTAL 30,500 218,500.00
3 Cost of Goods Sold (COGS)
i). Using the Average Method:
= total inventory purchased in the month
total inventory count in the month
Pistachios = 83,500
6,500
= $ 12.85
Almond = 66,000
9,000
= $ 7.33
Peanuts = 69,000
15,000
= $ 4.60
Qty sold Cost Price Total cost
$ $
Pistachios 3,500 12.85 44,961.54
Almond 5,000 7.33 36,666.67
Peanuts 11,000 4.60 50,600.00
TOTAL 19,500 132,228.21
ii). Using the FIFO Method:

The oldest cost is assigned to products
Purchase Qty Unit Cost of Unsold Cost of Unsold
Product Sales Date Qty sold COGS
date Purchased Purchase Balance Balance
Pistachios 01-Feb 2,500 11 04-Feb 2,000 22,000
05-Feb 500 5,500 -
02-Feb 1,500 13 18-Feb 1,000 13,000 500 6,500
11-Feb 1,500 15 1,500 22,500
24-Feb 1,000 14 1,000 14,000
Almond 01-Feb 4,000 6 04-Feb 2,500 15,000 - -
05-Feb 1,000 6,000 - -
18-Feb 500 3,000 - -
02-Feb 2,000 7 18-Feb 1,000 7,000 1,000 7,000
11-Feb 2,000 9 2,000 18,000
24-Feb 1,000 10 1,000 10,000
Peanuts 01-Feb 6,000 6 04-Feb 3,000 18,000 - -
05-Feb 1,500 9,000 - -
12-Feb 1,500 9,000 - -
02-Feb 2,000 5 12-Feb 2,000 10,000 - -
13-Feb 6,000 5 18-Feb 3,000 15,000 3,000 15,000
24-Feb 1,000 5 1,000 5,000
TOTAL 30,500 19,500 132,500 11,000 98,000
iii). Using the LIFO Method:

The newest cost is assigned to products
Purchase Qty Unit Cost of Unsold Cost of Unsold
Product Sales Date Qty sold COGS
date Purchased Purchase Balance Balance
Pistachios 24-Feb 1,000 14 04-Feb 1,000 14,000 - -
11-Feb 1,500 15 04-Feb 1,000 15,000 - -
05-Feb 500 7,500 -
02-Feb 1,500 13 18-Feb 1,000 13,000 500 6,500
01-Feb 2,500 11 2,500 27,500
Almond 24-Feb 1,000 10 04-Feb 1,000 10,000 - -
11-Feb 2,000 9 04-Feb 1,500 15,000 - -
05-Feb 500 4,500 -
02-Feb 2,000 7 05-Feb 500 3,500 - -
18-Feb 1,500 10,500 - -
01-Feb 4,000 6 4,000 24,000
Peanuts 24-Feb 1,000 5 04-Feb 1,000 5,000 - -
13-Feb 6,000 5 04-Feb 2,000 10,000 - -
05-Feb 1,500 7,500
12-Feb 2,500 12,500
02-Feb 2,000 5 12-Feb 1,000 5,000 - -
18-Feb 1,000 5,000 - -
01-Feb 6,000 6 18-Feb 2,000 12,000 4,000 24,000
TOTAL 30,500 19,500 150,000 11,000 82,000
d). Closing inventory for the month of February
i). Using the Average Method:
Unsold
Qty Sold
Product Qty Bought Balance Cost/Unit Closing Value
Pistachios 6,500 3,500 3,000 $ 12.85 38,538.46
Almond 9,000 5,000 4,000 $ 7.33 29,333.33
Peanuts 15,000 11,000 4,000 $ 4.60 18,400.00
30,500 19,500 11,000 $ 86,271.79
ii). Using the FIFO Method:

The closing balance of goods purchased is: $98,000
iii). Using the LIFO Method:

The closing balance of goods purchased is: $82,000
Looking at the above closing inventory values, it can be seen that the three methods produced different values. This is
because of the inflationary effect on the cost price of products bought at different time in the month of February.
The FIFO method resulted in the hightest closing stock of $98,000. This method is regarded as a better indicator of
the value for ending inventory because the older items have been used up while the most recently acquired items
reflect current market prices.
Using the LIFO metho, we arrived at $82,000. In this method, the most recent items of inventory are used to value
COGS and are sold first which makes the leftover inventory likely to be extremely old or obsolete. As a result, LIFO
doesn't provide an accurate or up-to-date value of inventory because the valuation is much lower than inventory
items at today's prices.
The average cost method produces results that fall somewhere between FIFO and LIFO. The value of which is
$86,271.79
3
In order to compare with the records made by his accountant, Jim asks you to prepare the different journal entries for
the purchases and sales mentioned above for each one of the 3 different methods used above. (15 points)
Answer:
JOURNAL ENTRIES
Using the
a). Average cost method
DATE DESCRIPTION DEBIT CREDIT
01-Feb Purchases 89,049
Cash / Account Payables 89,049
04-Feb Cash / Account Receivables 96,000
Sales 96,000
Sales 36,000
Sales 31,500

Sales 73,000
b). FIFO method


Sales 96,000
Sales 36,000
Sales 31,500
Sales 73,000
c). LIFO method


Sales 96,000

Sales 36,000


Sales 31,500


Sales 73,000

4 Jim’s accountant insisted that he should use a perpetual inventory system instead of a periodic inventory system and
the average cost method for valuating the inventory. Do you agree with this advice (justify your answer)? Would the
balance of the inventory at the end of the month be the same? And the net income? (15points)
Answer:
The perpetual inventory system is that method of inventory management that involves continuous tracking of
inventory records. It records real-time transactions of purchased or sold stocks through the use of technology. This
system requires accounting records to show the amount of inventory on hand at all times. It maintains a separate
account in the subsidiary ledger for each good in stock, and the account is updated each time a quantity is added or
taken out. On the other hand, periodic inventory system is such that relies on physical inventory count to determine
closing inventory and cost of goods sold(COGS). In this system, accounts are updated at the end of the accounting
period thus sales are recorded as they occur but the inventory is not updated.
In the light of the above, I would agree with Jim's accountants advice to use a perpertual inventory system instead of
a periodic system as perpertual system also has the following advantages above the periodic system:
i). It provides up to date inventory information.
ii). It enables quick valuation of closing inventory.
iii). Due to an enabling platform of allowing regular check on the receipt and issue of stock, it helps to lessen
investment in stock and storage expenses are aslo minimised.
iv). It helps management formulate proper purchasing policies as they can easily determine the flow of stock.
v). With the help of a properly plannned system of perpertual inventory control, wastages, leakages and theft of
stock are at once brought to light.
vi). The system ensure an effective control over storing, issuing and use of stock which leads to avoidance of
unneccessay locking of capital in stock which in turn results in adequate supply of working capital which can be
utilised in other profitable areas.
In the perpetual and periodic inventory system, Weighted Average Coct(WAC) method yields different allocation of
inventory cost. Thus, the proposed coversion from periodic to perpetual inventory system will result in a change in
the value of stock balance at the end and the net income due to resulting change in the cost of goods sold(COGS).
This is due to the fact that, when computing WAC under the periodic inventory system, we would determine the cost
of goods sold and balance over the given period of time irrespective of sales. On the other hand, when computing
under perpetual system, we would determine the average cost before sales of unit.
5 Jim would like to know a forecast of the number of days to sell the inventory based on the results of the month of
February. Explain your calculation and the steps followed. (10 points: 5 for calculation and 5 for explanation)
Answer:
The number of days to sell inventory can be determined by dividing your ending inventory by cost of goods sold
multipled by the number of days in the given period.
This can be represent by:
= Ending inventory x 365days
Cost of Goods Sold
i) Under the Weighted average cost method:

Inventory Turnover = 86,271.79 X 29days
132,228.21
= 18.9 days
ii) Under the FIFO method:

132,500.00
= 21.4 days
iii) Under the LIFO method:
150,000.00
= 15.9 days
Based on the results for the month of February, It can be seen that it took 18.4days, 21.4days and 15.9days to sell the
purchased products under the WAC, FIFO and LIFO method respectively.
Thus, it can be forecasted that the company will sell its inventory within an average of 18.7 days based on an avearge
of the results obatained at the end of February (18.9+21.4+15.9)days divided by 3.
The days of sales in inventory is a key component in a company's inventory management. This is such that
management wants to make sure its inventory moves as fast as possible to minimise the cost (of storing and
maintaining stock as well as preventing it from obsolescence and theft) and to increase cash flow.
The days of inventory sales can also be derived by dividing the number of days in a given period by the inventory
turnover of the same period.
The inventory turnover is that accounting ratio that measures how well a company is turning its inventory into sales.It
is determined by dividing the cost of goods sold(COGS) by the average inventory. This ratio provides management
with insights into inventory purchasing and sales performance. A low ratio is an indication either of overstocked
inventory which increases overhead as a result of high storage cost or an indicator of poor sales as a result of
ineffective advertising, poor quality, inflated price or product obsolescence. On the other hand, high inventory
turnover indicate
It is important thatrobust salesand
sales and thus preferable
inventory to a low
are in line with eachratio.
other.
6 Jim expects that the prices of the merchandises will dramatically decrease in the next future as a result of the Covid
19 crisis. Which method of valuation of the inventory would you thus recommend to Jim? Explain your answer. (5
points) Rubrics
Answer:
Generally, to assess the best method of inventory valuation to adopt, there is need to pay attention to changes in the
inventory costs over a given period of time.
This is such that, if the inventory costs are escalating or are likely to increase, LIFO costing is may be better. As higher
cost items are considered sold, it results in higher costs and lower profits. Where inventory costs are falling, FIFO
costing is advised.
Thus, if Jim expects that COVID -19 will bring about a dramatic decrease in the prices of merchandises in the next
future, then the First in First out(FIFO) method of inventory costing should be adopted.

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JIM

Characteristics of the FIFO method include:

Characteristics of the LIFO method include:

b). Using the FIFO Method

c). Using the LIFO Method

ii). Using the FIFO Method:

iii). Using the LIFO Method:

ii). Using the FIFO Method:

iii). Using the LIFO Method:

13-Feb Purchases 27,600

b). FIFO method

02-Feb Purchases 43,500

02-Feb Purchases 43,500

04-Feb Cash / Account Receivables 96,000

05-Feb Cash / Account Receivables 36,000

11-Feb Purchases 42,000

12-Feb Cash / Account Receivables 31,500

13-Feb Purchases 30,000

18-Feb Cash / Account Receivables 73,000

24-Feb Purchases 29,000

i) Under the Weighted average cost method:

ii) Under the FIFO method:

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