Accounting Demystified phần 5 pdf

64 Accounting Demystified

the amount it cost to acquire the particular item sold (the

amount put into Inventory) with the cost transferred to Cost

of goods sold.

In many (even most) cases it is not possible to directly track

when an item from a particular shipment is sold. We therefore

need to select a cost flow assumption. There are three choices

of cost flow assumption: FIFO, LIFO, and weighted average.

FIFO and LIFO assume that the goods sold were either the first

ones purchased (FIFO) or the last ones purchased (LIFO). With

the weighted average method, a new weighted average cost is

calculated every time a purchase is made, and this weighted

average cost is used to transfer the cost from Inventory to Cost

of goods sold.

Why would a company choose one method over another?

In a period in which prices are either rising or falling, we can

make certain statements about how each inventory cost flow

assumption would affect the financial statements. FIFO trans￾fers the cost of the earliest inventory items to Cost of goods

sold. In periods of rising prices, these will be the lowest-cost

items. Therefore, the amount transferred to Cost of goods sold

is less. Cost of goods sold is a reduction of income, and since

it is lower, the use of FIFO produces a greater net income. It

also leads to a higher value of ending inventory, since the

goods that remain are the ones that were purchased last, at the

higher prices.

Using LIFO in a period of rising prices has the opposite

effect. LIFO transfers to Cost of goods sold the cost of the items

that were purchased last, which are the higher-priced ones.

Higher Cost of goods sold translates to lower net income. It

also means that the Inventory account is lower. Why would a

company choose to have a lower net income? To reduce taxes.

Taxes are a real cash outlay and a real expense. Sometimes

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