ACC 230 Week 7 DQ1 - 7391

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Understanding the concepts of inventory valuation is very important to the calculation and understanding of the profit figure as the profit figure can be manipulated by the use of different inventory valuation techniques. The three most common techniques used by the business are:
FIFO
LIFO
AVCO (average costing method)
The FIFO method charges the first inventory to the sales pool thereby including the last inventory in the closing inventory figure. This results in a lower cost of sale figure and thus results in higher profits. On the other hand, the LIFO method charges the last goods to the sales pool, thereby including the first inventory in the closing inventory figure. This practice record the closing inventory at previous prices, therefore resulting in a higher cost of sale and in turn, low profits than FIFO. AVCO on the other hand, averages the first and last inventories and issues them to the sales pool at an average cost, thereby maintaining closing inventory at an average cost. This results in an averaged out cost of goods sold figure that gives profits between that of FIFO and LIFO. The conclusion drawn from this is that:
FIFO reports the highest profits
LIFO reports the lowest profits, and
AVCO reports profits between FIFO and LIFO
Comparing the profits of two companies that use the same valuation method is easy. But comparing the profits of two companies that use different valuation methods is just like comparing chalk with cheese. Suppose if one company uses the FIFO method and the other the LIFO method. You can as well see that the FIFO company may look attractive as its profit figure will be high, although it may not be performing so well. The management may have used FIFO as a manipulation tool. On the other hand, the LIFO company may seem unattractive because its profits will seem low, although on ground, the business may be performing very well. Its management may have used LIFO to evade tax. Inter company profit comparison can only be meaningful if the company profits are compared after the restatement of their income statements after applying the same inventory valuation techniques.

Solution Description

Understanding the concepts of inventory valuation is very important to the calculation and understanding of the profit figure as the profit figure can be manipulated by the use of different inventory valuation techniques. The three most common techniques used by the business are: