Page 256 - DMGT405_FINANCIAL%20MANAGEMENT

Financial Management

Notes 11.6 Comparison of Inventory Valuation Methods

The six inventory values obtained in the illustration are shown below. Assuming total sales of
500, gross margin varies from 164 to 193 depending on the inventory system and cost flow
assumptions applied in valuing the ending inventory.
Perpetual Inventory System of B Comapny Ltd.

FIFO Moving /Weighted Average LIFO
( ) ( ) ( )
Sales 500.00 500.00 500.00
Beginning inventory 180.00 180.00 180.00
Purchases 357.00 357.00 357.00
Goods available for sales 537.00 537.00 537.00
Less: ending inventory 230.00 225.83 220.00
Cost of goods sold 307.00 311.17 317.00
Gross margin 193.00 188.83 183.00

Perpetual Inventory System
FIFO Moving Average LIFO
( ) ( ) ( )
Sales 500.00 500.00 500.00
Beginning inventory 180.00 180.00 180.00
Purchases 357.00 357.00 357.00
Goods available for sales 537.00 537.00 537.00
Less: ending inventory 230.00 214.80 201.00
Cost of goods sold 307.00 322.20 336.00
Gross margin 193.00 177.80 164.00

Clearly the selection of an inventory valuation method has significant effect on inventory
values, product costs and determination of net income. If managers could select an inventory
valuation method at will and change methods whenever they wished, they could easily
manipulate reported income, but the consistency principle, which requires the consistent
application of accounting principles and methods over time, prevents such manipulation. But
one should be aware of the strengths and weaknesses of each of the inventory valuation methods.

11.6.1 Specific Identification
The advantage of specific identification is that it provides good matching of products costs and
revenues. Managers, in some situations, can adjust gross profit by selecting which units of an
inventory are delivered to customer. Anyway, the method cannot be used where there are many
types of inventory and inventory is received at frequent intervals.

First In First Out
Advantages
1. It is simple to understand and easy to operate.
2. It tends to conform to the physical movement of inventory and results in reporting
inventories on the balance sheet at a cost that is close to the current purchase price.
3. In case of falling prices, the use of this method gives better results.

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