Mid 2 Assignment (Word 1142),

Accounting Principle; Bus 505

PREPARED BY

CHOWDHURY NAFIS NUSRAT ASHA

ID-2135471660

Asha Chowdhury
Dr Samina Rahman
Assistant Professor, NSU
 1. Discuss how you classify (i.e., raw material, work in process, finished goods etc.) and
system to account for (i.e., perpetual or periodic) your inventories.

The business that I have is called ‘Nil Botam’ a crafting business that creates multiple home
décor items and other crafting items.

Classification of Inventories: Based on the business, it is a manufacturing one. For this reason I
have classified my inventories into three stages.

I. Raw materials
II. Work in progress
III. Finished goods

System Account: For my business, I follow the ‘Periodic System’. For this reason I -

• Determine the inventory on hand.

• Determine the cost of goods sold for the period.

2. What inventory cost flow methods (i.e., FIFO, LIFO, Average method) you use in
your business? Why you think this method suits better for your business.

Cost Flow Methods: For the business, I use ‘FIFO method’.

FIFO Method: In this method, costs of earliest goods purchased are first to be recognized in
determining cost of goods sold

I use this method because in this method -

• I determine cost of ending inventory by taking unit cost of most recent purchase and
working backward until all units of inventory have been costed. So, in a period of
inflation, costs allocated to ending inventory will approximate their current cost.

3. Discuss their effects in financial statement (i.e., how your net profit and tax would
be different compare to other inventory methods).

❖ Effects On inventory cost flow method

There are three types of effects

Income stement Effects

Balance sheet Effects
Tax Effects
To discuss the effects in financial statements, we are taking a hypothetical scenario into
account. The effects are explained below;
❖ Income statement Effects
Income statement Of Nil Botam
FIFO(৳) LIFO (৳) Average -Cost (৳)
Sales Revenue 34127 34127 34127
Beginning Inventory 2800 2800 2800
Purchases 19360 19360 19360
Cost of goods available for sale 22160 22160 22160
Ending Inventory 6160 5440 5762
Cost of goods sold 16000 16720 16398
Gross profit 18127 17407 17729
Operating expenses 13264 13264 13264
Income before income taxes 4863 4143 4465
Income tax expense (15%) 730 622 670
Net income 4133 3521 3795

It is observed that the cost of available for sale BDT 22160 is same under the three inventory
cost flow methods but BDT 720 difference is seen between FIFO & LIFO cost of goods sold
owing to the allocation of the unit cost to the cost of goods sold and to the ending inventory.
Some believes that FIFO creates paper/Phantom profits due to the understatement COGS and
overstatement of net income but LIFO creates more realistic net income as it matches the
more recent costs against current revenues .
❖ In case of price fluctuation:-

Particulars FIFO Net Income LIFO Net Income Average-Cost Net

Income
If Price Higher due to Cost of the Lower, due to the Cost of
rises first units purchased is the last units purchased is In between FIFO-LIFO
lower higher
If Prices Lower, due to Cost of the Higher, due to the Cost of
falls first units purchased is the last units purchased is In between FIFO-LIFO
Higher lower

In case Nil Botam net income is highest BDT 4133 in FIFO methods than LIFO as price of unit
cost increased from BDT 40 to BDT 48.
❖ Balance Sheet Effects
Inflation leads to approximate the current cost as cost allocated to the ending inventory (costed
at highest rate 110@48,dated 27/11/2020) and in case of LIFO, inflation contributes to
understate allotted cost of ending inventory remarkably. Understatement becomes greater for
a prolonged period of inflation if inventory counts goods purchased in one or more prior
accounting period.
❖ Tax Effects:
LIFO produces lowest income taxes (BDT 622) as net income lowers (BDT 3521) during the price
rises and incase of FIFO taxes are the highest and net income highest as well.

4. Explain the statement presentation (i.e., lower of cost or market value) and analysis
of inventory (Inventory turnover in times and days)

❖ The lower of cost or market rule

The lower of cost or market rule states that a business must record the cost of inventory at
whichever cost is lower – the original cost or its current market price. This situation
typically arises when inventory has deteriorated, or has become obsolete, or mark et prices
have declined. The rule is more likely to be applicable when a business has held inventory
for a long time, since the passage of time can bring about the preceding conditions. The
rule is set forth under the Generally Accepted Accounting Principles accounting framework.
(Lower of cost or market (LCM) definition, 2021)

The “current market price” is defined as the current replacement cost of the i nventory, as
long as the market price does not exceed net realizable value; also, the market price shall
not be less than the net realizable value, less the normal profit margin. Net realizable value
is defined as the estimated selling price, minus estimated costs of completion and disposal.
(Lower of cost or market (LCM) definition, 2021)

❖ Analysis of inventory:

A hypothetical analysis of inventory is presented below;

FIRST-IN, FIRST-OUT (FIFO)

Ending inventory Cost of Goods Sold(৳) Inventory Turn-Over
Date Units Unit Total Average Inventory=(Beginning
cost(৳) cost(৳) inventory + final inventory/2
27/11 110 48 5280 Cost of goods 22160 Inventory turn-
available for sale over=COGS/Avg.inventory
 24/8 20 44 880 Less: Ending 6160 So inventory turnover 3.571
inventory
Total 130 6160 Cost of goods sold 16000 Days in inventory
=365/3.571=102 days

According to FIFO assumption that first goods bought were the first goods sold and ending
inventory is calculated on the basis of the prices of the most recent units bought. Here, 130
units found as ending inventory resulted from, 110@48,dated 27/11/2020 and 20@44,dated
24/8/2020 respectively.

5. What depreciation you are going to use for your business. Prepare a depreciation
schedule for an imaginary asset (choose an amount of the asset) whose life is five
years with a residual value of tk. 40,000.

❖ Depreciation
It’s a process of allocating to expense of plant assets over its useful life due its revenue
producing ability considering factors like Costs, Useful life and salvage value. As it’s an easy
method to record and expense is same amount for each year. (Keiso)
Nil Botam allocates its delivery truck cost by straight line depreciation.
Nil Botam has bought a delivery truck on January 1,2021 costing BDT 1,40,000 estimated useful
life 5 years and salvage value BDT 40,000.

Cost(৳) - Salvage value (৳) = Depreciable cost(৳)

1,40,000 - 40000 = 1,00,000
Depreciable cost / Useful life Annual Depreciable Expense
1,00,000 / 5 = 20,000

Computation End of Year

Annual
Depreciation Depreciation Accumulated Book
Year X Depreciation
Cost Rate Depreciation Value
Expense
2021 100,000 X 20% 20000 20000 120000
2022 100,000 X 20% 20000 40000 100000
2023 100,000 X 20% 20000 60000 80000
2024 100,000 X 20% 20000 80000 60,000
2025 100,000 X 20% 20000 100000 40,000
Bibliography
1. Keiso, W. K. (n.d.). Accounting Principles.
2. Lower of cost or market (LCM) definition. (2021, August 21). Retrieved from AccountingTools:
https://www.accountingtools.com/articles/2017/5/13/lower-of-cost-or-market-lcm