Page 257 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 11: Inventory Management

Disadvantages Notes

1. When prices are rising, the higher net income results in a higher income tax expense.
2. In case of rising prices, the real inputs of the concern being low, they may be inadequate
to meet the concern’s demand to purchase raw materials at the ruling price.

Last In First Out

Advantages

1. Lower tax expense during period of rising prices, since net income tends to be stated more
nearly in current terms, because revenues are matched with current rather than old product
costs. The lower tax expense results in improved cash flows.
Disadvantages
1. If used for a number of years, balance sheet inventory values tend to become grossly
understated, because inventories are reported at costs that existed several years ago.
2. If the company has to reduce its inventory below the amount normally at hand, product
costs calculated with old values appear abnormally low.
3. This method of valuation is not acceptable to income tax authorities.

Average Cost Methods

Inventory valuations at average cost are among the least popular methods. They seem to have
all the disadvantages of LIFO and FIFO and few advantages. Neither net income nor ending
inventories are shown at current values.

Notes Selection of Pricing Method
No hard and fast rules of procedure have been laid down to select a method of pricing
issues of materials. However, the ultimate choice of a method may be based on the
following considerations:
1. The method of costing used and the policy of management.

2. The frequency of purchases and issues.
3. The extent of price fluctuations.
4. The extent of work involved in recording, issuing and pricing materials.
5. Whether cost of materials used should reflect current or historical conditions.

Self Assessment

Fill in the blanks:
13. The selection of an inventory valuation method has significant effect on inventory values,
…………… costs and determination of net income.

14. The advantage of …………………..is that it provides good matching of products costs and
revenues.
15. ……………..method of valuation is not acceptable to income tax authorities.

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