Accounting Standards
Case 3-6 Accounting Standards
A. Given the income statement effects of LIFO versus FIFO, how will the balance sheet inventory amounts differ between General Motors and Ford versus Honda and Daimler-Benz? In other words, will inventory be reported amounts representing recent costs or older historical costs? In your opinion, which balance sheet amounts would be more useful to financial statement users in making decisions to buy or sell shares of a company’s stock?
Inventory is an asset that is intended for sale or goods that are produced for sale. To determine the value of inventory to be reflected in the balance sheet, purchases are added to the beginning inventory and then cost of goods sold are subtracted.
The FIFO and LIFO Methods are accounting methods used to value inventory. FIFO stands for “first-in, first-out”, meaning that the oldest inventory items are recorded as sold first. LIFO stands for “last-in, first-out” which means that the most recent inventory are recorded as sold first.
In theory, the cost of items purchased for sale or the materials purchased to manufacture finished goods increases periodically in time.
Using the FIFO method, the balance sheet would show inventory at current costs since the ending inventory is represented by the most current purchases as older inventory would have been sold. The company’s income statement would show costs of goods sold as costs associated with the costs of older inventory. A company’s balance sheet therefore would show a higher amount of assets under the FIFO method. Likewise, a company’s income statement would also reflect a higher gross margin because the cost of goods would be smaller.
Opting for the LIFO method would create a reverse picture. A company’s balance sheet would reflect a lower balance of inventory and assets because the ending inventory value would be based on older costs since the most recent inventory is sold first. Its income statement would show a smaller gross
A. Given the income statement effects of LIFO versus FIFO, how will the balance sheet inventory amounts differ between General Motors and Ford versus Honda and Daimler-Benz? In other words, will inventory be reported amounts representing recent costs or older historical costs? In your opinion, which balance sheet amounts would be more useful to financial statement users in making decisions to buy or sell shares of a company’s stock?
Inventory is an asset that is intended for sale or goods that are produced for sale. To determine the value of inventory to be reflected in the balance sheet, purchases are added to the beginning inventory and then cost of goods sold are subtracted.
The FIFO and LIFO Methods are accounting methods used to value inventory. FIFO stands for “first-in, first-out”, meaning that the oldest inventory items are recorded as sold first. LIFO stands for “last-in, first-out” which means that the most recent inventory are recorded as sold first.
In theory, the cost of items purchased for sale or the materials purchased to manufacture finished goods increases periodically in time.
Using the FIFO method, the balance sheet would show inventory at current costs since the ending inventory is represented by the most current purchases as older inventory would have been sold. The company’s income statement would show costs of goods sold as costs associated with the costs of older inventory. A company’s balance sheet therefore would show a higher amount of assets under the FIFO method. Likewise, a company’s income statement would also reflect a higher gross margin because the cost of goods would be smaller.
Opting for the LIFO method would create a reverse picture. A company’s balance sheet would reflect a lower balance of inventory and assets because the ending inventory value would be based on older costs since the most recent inventory is sold first. Its income statement would show a smaller gross
References: Schroeder, R. G., Clark, M. W., & Cathey, J.M. (2011). Financial Accounting Theory and Analysis 10 ed. Hoboken, NJ: John Wiley & Sons, Inc. Accounting for Inventories retrieved from http://www.wiley.com/college/sc/kiesofund/samp/chapter8.pdf SFAC No. 2 as issued retrieved from http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820900499&blobheader=application%2Fpdf Loren A. Nikolai, John D. Bazley, Jefferson P. Jones (2009). Intermediate Accounting retrieved from http://books.google.com/books?id=_ouCLUeCvKwC&pg=PA56&dq=accounting+conservatism+principle&hl=en&sa=X&ei=AG4fT4LjGMXh0wG9sMEG&ved=0CDQQ6AEwAA#v=onepage&q=accounting%20conservatism%20principle&f=false