P4720- RETAIL OPERATION 2 FIFO vs. LIFO INVENTORY CONTROL

Notes from RETAILING 6th Edition by DUNNE & LUSCH

FIFO
Stands for First In, First Out and values inventory based on the assumption that the oldest merchandise is sold before the more recently purchased merchandise.

• merchandise on the shelf will reflect the most current replacement price

• During inflationary periods this method allows “inventory profits” (caused by selling the less expensive earlier inventory rather than the more expensive newer inventory) to be included as income.


LIFO
Stands for Last In First Out and values inventory based on the most recently purchased merchandise is sold first and the oldest merchandise is sold last.

• designed to cushion the impact of inflationary pressures by matching current costs against current revenues

• costs of goods sold are based on the cost of the most recently purchased inventory; older inventory is regarded as unsold inventory

• during inflationary period, LIFO method results in the application of a higher unit cost to the merchandise sold and lower unit cost to the inventory unsold

• In rapid inflation most retailers use the LIFO method, resulting in lower profits in income statement, thus lower income taxes

• most retailers prefer LIFO for planning purposes since it accurately reflects replacement cost


Sample Situation
You begin the year by a total inventory of 15 home theaters which you purchased on the last day of the preceding year for RM500 each. If these home theater packages were the only merchandise in stock, your beginning inventory was RM7,500 (15xRM500).
Suppose also that during the year you sold 12 packages for RM900 each, for total sales of RM10,800; that in June you purchased 8 new home theater packages (same make and model as the old ones) at RM525; and in November you bought 4 more at RM550.
Thus, your purchase were RM4,200 in June and RM2,200 in November for total of RM6,400 and you will still have 15 home theater packages in stock at the year end.

LIFO ACCOUNTING METHOD
• Ending inventory = beginning inventory = RM7,500
• We assume the 12 packages sold were the 12 purchased during the year

Calculation:
Net sales
RM10,800 (12xRM900)

Beginning inventory
RM7,500(RM15xR500)

Purchases
RM6,400 (RM4,200 in June+RM2,200 in November = RM6,400)

Goods available
RM13,900 (beginning inventory +purchases)

Ending inventory (end of the year)
RM7,500 (beginning inventory=ending inventory)

Cost of goods sold
RM6,400 [(Goods available - ending Inventory) OR
(RM4,200 in June+RM2,200 in November = RM6,400)]

Gross margin
RM 4,400 (Gross margin= Net sales- Cost of goods sold)


FIFO ACCOUNTING METHOD
• We assume we sold 12 of the original RM500 packages and had 3 left.
• These 3 home theater packages + June + November purchases result in ending inventory of RM7,900 [(3xRM500)+(8xRM525)+(4xRM550)]

Calculation:

Net sales

RM10,800 (12xRM900)

Beginning inventory

RM7,500 (15xRM500)

Purchases

6,400 (RM4,200 in June+RM2,200 in November = RM6,400)

Goods available

RM13,900 (beginning inventory +purchases)

Ending inventory (end of the year)

7,900 [(3xRM500)+(8xRM525)+(4xRM550)]

Cost of goods sold

6,000 (Goods available - ending Inventory)

Gross margin
RM 4,800 (Gross margin= Net sales- Cost of goods sold)

Note:
Retailers are permitted to change its method of accounting only once.




Exercise
Instruction: Fill in the blanks with the correct answers.
1. Read the problem question carefully!
2. Calculate and solve this problem using LIFO and FIFO accounting method. Show your work.
3. Send your work here by using the comment box.
4. Send your work before 12.00a.m tonight (27 August 2010).

You begin the year by a total inventory of 20 home theaters which you purchased on the last day of the preceding year for RM600 each. If these home theater packages were the only merchandise in stock, your beginning inventory was RM12,000 (20xRM600).
Suppose also that during the year you sold 13 packages for RM900 each, for total sales of RM11,700; that in June you purchased 8 new home theater packages (same make and model as the old ones) at RM500; and in November you bought 5 more at RM550.
Thus, your purchase were RM4,000 in June and RM2,200 in November for total of RM6,400 and you will still have 20 home theater packages in stock at the year end.

Retailers are permitted to change its method of accounting only ____________.

All the best ;)
Enjoy the long weekend!!!(After you finish this exercise o.k :P)