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MGT101 - Financial Accounting GDB No. 01 Solution and Discussion Spring 2013 Due Date 02-07-2013

opic to be tested:

  • Valuation of stock/inventory

Learning Objectives:

  • To develop an understanding about inventory valuation methods and their impact on financial performance & financial position of a business.

Discussion Question:

Mr. Arslan is a newly employed accountant of Good Company Limited (GCL). He records cost of goods sold at most recently purchase price and inventory at cost of earliest purchases to minimize the amount of tax burden in the period of inflation. Due to this, profitability of the firm is reduced as intended but current replacement cost of inventory is not showing a true and fair result in balance sheet and lower profit is also posing a poor impact on its share’s market price.

  1. Which costing method for inventory valuation is currently applied by Mr. Arslan?
  2. Which costing method for inventory valuation do you suggest to overcome the above mentioned problem? Support your answer with logical reasons.


Note: To avoid negative marking complete your comment within 100 words.

Important Instructions:

 

1.     Your discussion must be based on logical facts.

2.     The GDB will remain open for 3 working days/ 72 hours.

3.     Do not copy or exchange your answer with other students. Two identical / copied comments will be marked Zero (0) and may damage your grade in the course.

4.     Obnoxious or ignoble answer should be strictly avoided.

5.     Questions / queries related to the content of the GDB, which may be posted by the students on MDB or via e-mail, will not be replied till the due date of GDB is over.

Views: 3702

Replies to This Discussion

hani yar kabi first ko FIFO khati ho kabi LIFO kia final ha?

The inventory method chosen will affect the amount of current assets and gross profit income statement, especially when prices are changing.

An effective inventory method can improve a company's bottom line.

  • There are five types of inventory  methods -- FIFO, LIFO, Dollar Value LIFO, Retail Inventory, and Average Cost.

  • The choice of inventory method should reflect a company's economic circumstances in order to create accurate financial statements.

  • When prices are falling, FIFO will result in lower current assests and lower gross profit. LIFO will result in higher current assets and higher gross profit.

  • When prices are rising, FIFO will result in higher current assets and higher gross profit. LIFO will result in lower current assets and lower gross profit.

  • Income Statement 

    Displays the revenues recognized for a specific periods and the cost and expenses charged against these revenues, including write-offs (e.g., depreciation and amortization of various assets) and taxes. The purpose of the income statements is to show managers and investors whether the company made or lost money during the reporting period.

  • Balance Sheet 

    A balance sheet  is often described as a "snapshot of a company's financial condition." A standard company balance sheet has three parts: assets, liabilities, and ownership equity.

  1. 1.      Which costing method for inventory valuation is currently applied by Mr. Arslan?

Answer:

 

LIFO Method of inventory is the goods purchased most recently are sold or used first. In this method, value of the inventory at the end of an accounting period is based on the value of items purchased earliest. During periods of high inflation rates, the LIFO method yields lower value of the ending inventory, higher cost of goods sold, and a lower gross profit than that yielded by the application of the FIFO method.

 

 2.      Which costing method for inventory valuation do you suggest to overcome the above mentioned problem? Support your answer with logical reasons.

 

 Answer:

FIFO Method of inventory is the goods are sold or used in the same sequential order in which they are bought. The cost of goods purchased first is the cost of goods sold first during periods of high inflation-rates, the FIFO method yields higher value of the ending inventory, lower cost of goods sold, and a higher gross profit than that yielded by the LIFO method.

............................................................................

Part A Which costing method for inventory valuation is currently applied by Mr. Arslan?

Under FIFO, the cost of goods sold is based upon the cost of material bought earliest in the period, while the cost of inventory is based upon the cost of material bought later in the year. This results in inventory being valued close to current replacement cost. During periods of inflation, the use of FIFO will result in the lowest estimate of cost of goods sold among the three approaches, and the highest net income.

Part B 

Which costing method for inventory valuation do you suggest to overcome the above mentioned problem? Support your answer with logical reasons.


Under LIFO, the cost of goods sold is based upon the cost of material bought towards the end of the period, resulting in costs that closely approximate current costs. The inventory, however, is valued on the basis of the cost of materials bought earlier in the year. During periods of inflation, the use of LIFO will result in the highest estimate of cost of goods sold among the three approaches, and the lowest net income

(a) First-in, First-out (FIFO): Under FIFO, the cost of goods sold is based upon the cost of material bought earliest in the period, while the cost of inventory is based upon the cost of material bought later in the year. This results in inventory being valued close to current replacement cost. During periods of inflation, the use of FIFO will result in the lowest estimate of cost of goods sold among the three approaches, and the highest net income.
(b) Last-in, First-out (LIFO): Under LIFO, the cost of goods sold is based upon the cost of material bought towards the end of the period, resulting in costs that closely approximate current costs. The inventory, however, is valued on the basis of the cost of materials bought earlier in the year. During periods of inflation, the use of LIFO will result in the highest estimate of cost of goods sold among the three approaches, and the lowest net income

Effect of Inflation:

FIFO

If costs are increasing, the items acquired first were cheaper. This decreases the cost of goods sold (COGS) under FIFO and increases profit. The income tax is larger. Value of unsold inventory is also higher.

LIFO

If costs are increasing, then recently acquired items are more expensive. This increases the cost of goods sold (COGS) under LIFO and decreases the net profit. The income tax is smaller. Value of unsold inventory is lower.

Idea For GDB MGT101

Inventory Valuation Methods Introduction

Inventory valuation methods are used to calculate the cost of goods sold and cost of ending inventory. Following are the most widely used inventory valuation methods:

  1. First-In, First-Out Method
  2. Last-In, First-Out Method
  3. Average Cost Method

First-in-First-Out Method (FIFO)

According to FIFO, it is assumed that items from the inventory are sold in the order in which they are purchased or produced. This means that cost of older inventory is charged to cost of goods sold first and the ending inventory consists of those goods which are purchased or produced later. This is the most widely used method for inventory valuation. FIFO method is closer to actual physical flow of goods because companies normally sell goods in order in which they are purchased or produced.

Last-in-First-Out Method (LIFO)

This method of inventory valuation is exactly opposite to first-in-first-out method. Here it is assumed that newer inventory is sold first and older remains in inventory. When prices of goods increase, cost of goods sold in LIFO method is relatively higher and ending inventory balance is relatively lower. This is because the cost goods sold mostly consists of newer higher priced goods and ending inventory cost consists of older low priced items.

Average Cost Method (AVCO)

Under average cost method, weighted average cost per unit is calculated for the entire inventory on hand which is used to record cost of goods sold. Weighted average cost per unit is calculated as follows:

Weighted Average Cost Per Unit=  Total Cost of Goods in Inventory
Total Units in Inventory

The weighted average cost as calculated above is multiplied by number of units sold to get cost of goods sold and with number of units in ending inventory to obtain cost of ending inventory.

  1. Which costing method for inventory valuation is currently applied by Mr. Arslan?

Answer:

 

LIFO Method of inventory is the goods purchased most recently are sold or used first. In this method, value of the inventory at the end of an accounting period is based on the value of items purchased earliest. During periods of high inflation rates, the LIFO method yields lower value of the ending inventory, higher cost of goods sold, and a lower gross profit than that yielded by the application of the FIFO method.

 

 2.      Which costing method for inventory valuation do you suggest to overcome the above mentioned problem? Support your answer with logical reasons.

 

 Answer:

FIFO Method of inventory is the goods are sold or used in the same sequential order in which they are bought. The cost of goods purchased first is the cost of goods sold first during periods of high inflation-rates, the FIFO method yields higher value of the ending inventory, lower cost of goods sold, and a higher gross profit than that yielded by the LIFO method. 

Part A Which costing method for inventory valuation is currently applied by Mr. Arslan?

Under FIFO, the cost of goods sold is based upon the cost of material bought earliest in the period, while the cost of inventory is based upon the cost of material bought later in the year. This results in inventory being valued close to current replacement cost. During periods of inflation, the use of FIFO will result in the lowest estimate of cost of goods sold among the three approaches, and the highest net income.



Part B 

Which costing method for inventory valuation do you suggest to overcome the above mentioned problem? Support your answer with logical reasons.


Under LIFO, the cost of goods sold is based upon the cost of material bought towards the end of the period, resulting in costs that closely approximate current costs. The inventory, however, is valued on the basis of the cost of materials bought earlier in the year. During periods of inflation, the use of LIFO will result in the highest estimate of cost of goods sold among the three approaches, and the lowest net income
.

Mujay samj nai aa rhe

tariq bhai pehlay question ko FIFO keh rhay hain

jbkey HANI MIT

pehlay question ko LIFO keh rhay hain .

bro pehly ka Mr Arslan ny LIFO method use kia hy r hm FIFO method use kren gy, FIFO main profit increase ho ga r ye bettor hy...

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