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March 11th, 21st and 23rd

by: Callisa Ruschmeyer

March 11th, 21st and 23rd ACCT 2110 - 002

Marketplace > Auburn University > Accounting > ACCT 2110 - 002 > March 11th 21st and 23rd
Callisa Ruschmeyer
GPA 4.0

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About this Document

End of Chapter 6 Periodic vs Perpetual System FIFO, LIFO, and Average Cost
Principles of Financial Accounting
Elizabeth G Miller
Class Notes
Financial Accounting; Miller; Chapter 6
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This 11 page Class Notes was uploaded by Callisa Ruschmeyer on Wednesday March 23, 2016. The Class Notes belongs to ACCT 2110 - 002 at Auburn University taught by Elizabeth G Miller in Fall 2015. Since its upload, it has received 31 views. For similar materials see Principles of Financial Accounting in Accounting at Auburn University.


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Date Created: 03/23/16
March 11and 21-25 Effects of Alternative Inventory Costing Methods  FIFO o Produces the highest cost for ending inventory o Lowest cost of goods sold o Highest gross margin (and net incomes)- least conservative (overestimate) o When purchase prices rise  Highest ending inventory  Lowest cost of goods sold  Highest income o When purchase prices fall  Lowest ending inventory  Highest cost of goods sold  Lowest income o Shows the most realistic amount for inventory because it reports the most current costs on the balance sheet  LIFO o Produces the lowest cost of ending inventory o Highest cost of goods sold o Lowest gross margin (and net income)- most conservative (underestimate) o When purchase prices rise  Lowest ending inventory  Highest cost of goods sold  Lowest income o When purchase prices fall  Highest ending inventory  Lowest cost of goods sold  Highest income o Shows the most realistic amount for income because it matches the most current costs against revenue  Average Cost o All values fall between the FIFO and LIFO extremes Income Tax Effects of Alternative Costing Methods  Rising prices- companies may choose LIFO- it produces the lowest current taxable income and lowest current income tax payment o But in the long run, all inventory costs find their way to cost of goods sold and the income statement o Choosing LIFO to minimize current taxes DOES NOT avoid the payment of taxes- it just postpones them Lower of Cost or Market Rule (LCM)  Under LCM, if the market value of a company's inventory is lower than its historical cost, the company reduces the amount recorded inventory to its market value o This rule is an exception to the cost principle  Replacement cost = market value  To use LCM, a company must first determine the cost of its inventory using one of the inventory costing methods (FIFO, LIFO, or average cost) --> then the company while establish the market value of the inventory o LCM market value is defined as current replacement cost, the current purchase price for identical goods Analyzing Inventory  Basically just various ratios  Inventory Turnover Ratio = Cost of Goods Sold/Average Inventory o Average Inventory = (beginning inventory + ending inventory)/amount o Want to get a high ratio  Average Days to Sell Inventory = 365 days/Inventory Turnover Ratio o Want to get a low ratio LIFO Reserves  LIFO ending inventory- they have to show what it would have been with FIFO o This is reserved to the LIFO reserve o LIFO gives you lower ending inventory o FIFO may violate conservatism because it gives you a higher ending inventory  LIFO Inventory Value = Reported FIFO Inventory = LIFO Reserve Effects of Inventory Errors  Incorrect counts, mistakes in costing, or errors in identifying items are common  Remember, the ending inventory of one period is the beginning inventory of the next  Errors in the measurement of ending inventory affect two accounting periods  If Ending Inventory is If Ending Inventory is Understated Overstated  Current Period Next Period Current Period Next Period Ending Inventory Understated Correct Overstated Correct Cost of Goods Overstated Understated Understated Overstated Sold Net Income Understated Overstated Overstated Understated Total Assets Understated Correct Overstated Correct Periodic Inventory System  Updating inventory all at the same time o Different than the perpetual system, where it continuously updates the accounts  Accounts o Purchases- accumulates the cost of inventory o Purchase discounts- accumulates the amount of discounts o Purchase returns and allowances- accumulates the cost of returns or reductions of merchandise o Transportation-in- accumulates the costs paid by the purchaser for inventory Perpetual vs. Periodic Inventory Systems  Shipping o Perpetual- debit inventory o Periodic- debit freight-in  Sending goods back o Perpetual- affects inventory o Periodic- affects purchase goods and allowances  Paying early with discount o Perpetual- credit inventory o Periodic- credit purchase discounts  Making a sale o Perpetual- two entries- one for the sale and the other for cost of goods sold o Periodic- one entry for cost of goods sold and inventory (only at the very end of the period) Methods and the Periodic Inventory System  Step 1: calculate the cost of goods available for sale in the period  Apply the costing methods for inventory to determine ending inventory and cost of goods sold  Remember these formulas o Cost of goods available for sale = beginning inventory + net purchases o Net purchases = purchases + transportation in - purchase discounts - purchase returns and allowances


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