AFM101 Chapter Notes - Chapter 8: Financial Statement
7 Jun 2018
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Financial Statement Effects of Inventory Costing Methods
Note: Remember that regardless of the physical flow of goods, a company can use either
the weighted-average or the FIFO inventory costing method.
Companies are expected to use the most representationally faithful method.
Thus, a company is NOT required to use the same method for all inventory items.
Enhance comparability accounting rules require companies to apply their accounting
methods on a consistent basis.
o Company is NOT permitted to use FIFO one period, weighted-average the next
and then FIFO the next.
o A change in method is allowed only if the change will improve the measurement
of financial results and better report the financial position.
LO4 Decide when the use of different inventory costing methods is beneficial to a company.
MANAGER’S CHOICE OF INVENTORY COSTING METHODS
Ch. 6 Management should choose the method that best reflects their economic
circumstances for financial reporting purposes.
Most managers choose generally accepted accounting methods based on 2 factors:
1. Effect on NET EARNINGS (report higher earnings).
2. Effect on INCOME TAXES (pay the least amount of taxes least-latest rule).
Management must ALSO make a 2nd choice of inventory costing method to use on the
company’s tax return generally, use the same inventory costing method for both
financial reporting & tax reporting purposes.
Method that computes lower pre-tax earnings should be used if company’s objective is to
report lower pre-tax earnings and lower taxes.
Method that computer higher pre-tax earnings should be used if the company’s objective
is to report higher net earnings.
LO5 Report inventory at the lower cost and net realizable value (LCNRV).
VALUATION AT LOWER OF COST AND NET REALIZABLE VALUE
Cost of inventories may not be recoverable if their selling prices have declined, they are
damaged or they have become obsolete.
Lower amount should be used as the inventory valuation in compliance with
representational faithfulness, which requires the reporting of inventory values that do not
exceed the amount that can be obtained from selling the inventory.
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Document Summary
Note: remember that regardless of the physical flow of goods, a company can use either the weighted-average or the fifo inventory costing method. Companies are expected to use the most representationally faithful method. Thus, a company is not required to use the same method for all inventory items. Lo4 decide when the use of different inventory costing methods is beneficial to a company. 6 management should choose the method that best reflects their economic circumstances for financial reporting purposes. Most managers choose generally accepted accounting methods based on 2 factors: effect on net earnings (report higher earnings), effect on income taxes (pay the least amount of taxes least-latest rule). Management must also make a 2nd choice of inventory costing method to use on the company"s tax return generally, use the same inventory costing method for both financial reporting & tax reporting purposes.
