6.3 How cost formulas effect financial statements Flashcards
3 types of cost formulas
specific identification,fifo,avg cost
if a company sells goods that are uneique and distinct form each other
specific identification
if a company sells goods that are not unique and specifically identifiable
fifo and avg cost
can a company use more than one type of cost formula for its inventory?
yes!! car companies might use speicific dientification for each car but avg cost for inventory parts
how does a company pick between fifo or acg cost?
consider 3 things:
1) which cost formula corresponds to the physical flow of goods
2) report inventory cost on SOFP that is close to inventory’s recent cost
3) use same const formula for all inventories of a similar nature/use
should companies keep the same cost formula period over period!
yes so the information is comparable
how does inventory affect sofp
ending inventory=current asset
how does inventory impact soi
cost of goods sold is an expense
how does invnetory affect soce
cogs affects gross profit and net income-> affects RE on soce
How does fifo impact soi (WHEN INVENTORY IS INCREASING)
-> assume oldest is sold first, lower cost units are assigned to cogs, higher cost units attached to ending inventory
-> LOWER COGS
-> lower COGS= higher income before tax; ner income is higher!!
How does avg cost impact soi (WHEN INVENTORY IS INCREASING)
-> cogs under avg cost formula include avg cost of ALL units held prior to sale= HIGHER avg cost per unit sold
->higher cogs= lower income before income tax= lower net income
How does FIFO impact sofp (when inventory is increasing)
ending inventory balance that is higher, because includes most recently purchased units (which have higher costs)
-> when inventory costs are rising, FIFO provides highest possible cost for ending inventory, and higher RE becuase balance,
How does a rising inventory impact the sofp under avg cost?
ending inventory is lower than it would be under FIFO, because avg cost per unit is lower than te cost of the most recently purchased goods
pros of using specific identification
1) actual cogs associated w related revenues is reported on soi
2) tracks actual flow of physical goods
3) ending inventory reported at actual cost
pros of using FIFO
1) ending inventory on sofp is based on mosot current costs MORE RELEVANT
2) approximates the physical flow of goods for morst retailers
pros of AVG cost formulas
1) cogs on the SOI includes more current costs than FIFO; Relevant to gross profit
2) can approximate the physical flow of goods for some companies
3) smooths the effects of price changes by using weighted moving average
if there are rising costs of inventory, how does FIFO impact
1) COGS on SOI
2) gross profit and net income on soi
3) cash on sofp
4) inventory on sofp
5) RE on sofp
lower
higher
same
higher
higher
if there are rising costs of inventory, how does avg cost impact
1) COGS on SOI
2) gross profit and net income on soi
3) cash on sofp
4) inventory on sofp
5) RE on sofp
higher
lower
same
lower
lower
if there are falling costs of inventory, how does FIFO impact
1) COGS on SOI
2) gross profit and net income on soi
3) cash on sofp
4) inventory on sofp
5) RE on sofp
higher
lower
same
lower
lower
if there are lower costs of inventory, how does avg cost impact
1) COGS on SOI
2) gross profit and net income on soi
3) cash on sofp
4) inventory on sofp
5) RE on sofp
lower
higher
same
higher
higher
if there are no changes in costs of inventory, how does FIFO impact
1) COGS on SOI
2) gross profit and net income on soi
3) cash on sofp
4) inventory on sofp
5) RE on sofp
same
same
same
same
smae
if there are no change in costs of inventory, how does avg cost impact
1) COGS on SOI
2) gross profit and net income on soi
3) cash on sofp
4) inventory on sofp
5) RE on sofp
same
same
same
same
same
Note that the same financial statement effects for FIFO and average cost shown above for net income and retained earnings would also flow through to the statement of changes in equity, even though it is not included in the table above. It is also worth remembering that all formulas for determining inventory costs will give exactly the same result over the life cycle of the business or its product. That is, the allocation between the cost of goods sold and ending inventory may vary in any one period, but it will produce the same cumulative results over time.
Note that the same financial statement effects for FIFO and average cost shown above for net income and retained earnings would also flow through to the statement of changes in equity, even though it is not included in the table above. It is also worth remembering that all formulas for determining inventory costs will give exactly the same result over the life cycle of the business or its product. That is, the allocation between the cost of goods sold and ending inventory may vary in any one period, but it will produce the same cumulative results over time.
is, the allocation between the cost of goods sold and ending inventory may vary in any one period, but it will produce the same cumulative results over time.
yes
