25.1: Cost Flow Methods Flashcards
How is COGS relationship measured with EI, BI, and purchases?
EI = BI + purchases - COGS
What are product costs? How is it treated on financial statements? How is expense recognition affected under product cost?
Product costs are costs included in inventory. Under IFRS and GAAP, product costs are capitalized in the inventories account on the B/S, which include:
- Purchase cost less trade discounts and rebates
- Conversion costs (manufacturing, including labour and overhead)
- Other costs necessary to bring the inventory to its present location and condition
By capitalizing inventory cost as an asset, expense recognition is delayed until the inventory is sold and revenue is recognized.
What are period costs? How is it treated on financial statements?
Period costs include:
- Selling costs
- Administrative overhead
- Storage costs
- Abnormal waste of materials, labour, or overhead
Period costs are expensed in the period incurred.
What is the specific identification method and when is this method of valuation appropriate? Provide examples.
Under specific identification method, each unit sold is matched with the unit’s actual cost.
This method of inventory valuation is appropriate when inventory items are not interchangeable and is commonly used by firms with a small number of costly and easily distinguishable items.
Example: jewelry
What is FIFO? What is an advantage of FIFO?
FIFO is when the first item purchased is assumed to be the first item sold.
Advantage: ending inventory is valued based on the most recent purchases, arguably the best approximation of current cost.
What happens to FIFO and LIFO under inflationary environments? What about weighted average cost?
FIFO: COGS will be understated compared to current cost and earnings will be overstated.
LIFO: LIFO COGS > FIFO COGS where LIFO COGS will be overstated and earnings will be lower; ending inventory < current costs
Weighted average COGS will be a value between FIFO and COGS.
