ACCOUNTING, ANALYSIS, AND PRINCIPLES Accounting (a) FIFO Residential pumps: Ending inventory cost = (300 X $500) + (200 X $475) = Beginning inventory cost = (200 X $400) = Purchases = $225,000 + $190,000 + $150,000 = Cost of goods sold = $80,000 + $565,000 – $245,000 = $ 245,000 $ 80,000 $ 565,000 $ 400,000 Commercial pumps: Ending inventory at cost = (500 X $1,000) = Beginning inventory at cost = (600 X $800) = Purchases = $540,000 + $285,000 + $500,000 = Cost of goods sold = $480,000 + $1,325,000 – $500,000 = $ 500,000 $ 480,000 $1,325,000 $1,305,000 Total ending inventory at cost = $245,000 + $500,000 = $ 745,000 Total cost of goods sold = $1,305,000 + $400,000 = $1,705,000 (b) Dollar-value LIFO (one pool) Ending inventory at current cost = Ending inventory at base-year cost = (500 X $800) + (500 X $400) = Price index = $745,000 / $600,000 = 1.242 Current Inventory at base cost Ending inventory Base inventory ($80,000 + $480,000) Layer ($600,000 – $560,000) Total $560,000 40,000 $600,000 $ 745,000 $ 600,000 Conversion price index 1.000 1.242 Cost of goods sold = $560,000 + ($565,000 + $1,325,000) – $609,680 = 8-76 Inventory at LIFO cost $560,000 49,680 $609,680 $1,840,320 ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) Analysis (a) The purpose of a current ratio is to provide some indication of the resources the company has available to meet short term obligations, if those obligations come due. FIFO, which generally approximates the current cost of inventory, usually better suits this objective. LIFO inventory numbers on a balance sheet can sometimes be stated at lower values. (b) The U.S. Securities and Exchange Commission requires companies using LIFO to disclose the current cost of their inventories. Many companies disclose the FIFO cost of their inventories since that generally approximates current cost. This difference between LIFO cost and current cost is called the “LIFO reserve.” A financial statement reader can use the LIFO reserve to convert a LIFO company’s inventory and cost of goods sold to what they would have been if the company had used FIFO. This makes it possible to directly compare LIFO and FIFO companies, although the comparison must be done on a FIFO basis, not LIFO. Principles Companies can change from one inventory accounting method to another, but not back and forth. Changes in accounting method (when not mandated by a regulatory body such as the FASB) should be to improve the financial statement reader’s ability to understand the companies’ financial results and position. The tradeoff is usually comparability for consistency. That is, if a company changes to a method that is used by most of its competitors, the change increases comparability. But, because the company now uses different methods across different years, consistency is sacrificed. Companies sometimes change accounting methods because they believe it improves the matching of expenses to revenues. Again, consistency across reporting periods is sacrificed, however. LO: 3, 4, Bloom: SYN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, Communication, AICPA BB: None Reporting, AICPA PC: Communication 8-77