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Chapter 8: Question 12Q (page 421)

FIFO, average-cost, and LIFO methods are often used instead of specific identification for inventory valuation purposes. Compare these methods with the specific identification method, discussing the theoretical propriety of each method in the determination of income and asset valuation.

Short Answer

Expert verified

There are different alternatives for determining the cost flow assumption. They are LIFO, FIFO, and Average cost method.

Step by step solution

01

FIFO vs. special identification method

FIFO method values inventory based on the chronological order of acquiring them. Under this method, each item is valued at the earliest historical cost irrespective of its date of acquisition.

Special identification values each inventory at their specific cost. This method is ideal but has several difficulties.

FIFO may be closer to special identification in the sense that it values inventory approximately with their actual cost.

02

LIFO vs. against special identification method

LIFO is a method of valuing inventory in the opposite direction of acquiring them. Under this method, the latest introduced inventory is issued first.

This method is not compatible with special identification as the value of COGS is computed at a much higher rate than the actual cost of the inventory.

Unlike special identification, LIFO has the drawback of matching the actual cost with actual revenues.

03

Weighted Average vs. against special identification method

The average method is the valuation of inventories at their mean cost. Like special identification, this method may not be ideal but is the most appropriate method as the unit cost of the inventory includes the cost of acquired inventors.

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Most popular questions from this chapter

Ann M. Martin Company makes the following errors during the current year.

(Evaluate each case independently and assume ending inventory in the following year is correctly stated.)

1. Ending inventory is overstated, but purchases and related accounts payable are recorded correctly.

2. Both ending inventory and purchases and related accounts payable are understated. (Assume this purchase was recordedand paid for in the following year.)

3. Ending inventory is correct, but a purchase on account was not recorded. (Assume this purchase was recorded and paidfor in the following year.)

Instructions

Indicate the effect of each of these errors on working capital, current ratio (assume that the current ratio is greater than 1), retained earnings, and net income for the current year and the subsequent year.

Case 2: Noven Pharmaceuticals, Inc.

Noven Pharmaceuticals, Inc., headquartered in Miami, Florida, describes itself in a recent annual report as follows.

Noven Pharmaceuticals, Inc.

Noven is a place of ideas鈥攁 company where scientific excellence and state-of-the-art manufacturing combine to create new answers to human needs. Our transdermal delivery systems speed drugs painlessly and effortlessly into the bloodstream by means of a simple skin patch. This technology has proven application sinestrogen replacement, but at Noven we are developing a variety of systems incorporating best selling drugs that fight everything from asthma, anxiety and dental pain to cancer, heart disease and neurological illness. Our research portfolio also includes new technologies, such as iontophoresis, in which drugs are delivered through the skin by means of electrical currents, as well as products that could satisfy broad consumer needs, such as our anti-microbial mouth rinse.

Noven also reported in its annual report that its activities to date have consisted of product development efforts, some of which have been independent and some of which have been completed in conjunction with Rhone-Poulenc Rorer (RPR) and Ciba-Geigy. The revenues so far have consisted of money received from licensing fees, 鈥渕ilestone鈥� payments (payments made under licensing agreements when certain stages of the development of a certain product have been completed), and interest on its investments. The company expects that it will have significant revenue in the upcoming fiscal year from the launch of its first product, a transdermal estrogen delivery system.

The current assets portion of Noven鈥檚 balance sheet follows.

Cash and cash equivalents \(12,070,272

Securities held to maturity 23,445,070

Inventory of supplies 1,264,553

Prepaid and other current assets 825,159

Total current assets \)37,605,054

Inventory of supplies is recorded at the lower-of-cost (first-in, first-out)-or-net realizable value and consists mainly of supplies for research and development.

Instructions

(a) What would you expect the physical flow of goods for a pharmaceutical manufacturer to be most like: FIFO, LIFO, or random (flow of goods does not follow a set pattern)? Explain.

(b) What are some of the factors that Noven should consider as it selects an inventory measurement method?

(c) Suppose that Noven had $49,000 in an inventory of transdermal estrogen delivery patches. These patches are from an initial production run and will be sold during the coming year. Why do you think that this amount is not shown in a separate inventory account? In which of the accounts shown is the inventory likely to be? At what point will the inventory be transferred to a separate inventory account?

At December 31, 2016, Stacy McGill Corporation reported current assets of \(370,000 and current liabilities of \)200,000. The following items may have been recorded incorrectly.

1. Goods purchased costing \(22,000 were shipped f.o.b. shipping point by a supplier on December 28. McGill received andrecorded the invoice on December 29, 2016, but the goods were not included in McGill鈥檚 physical count of inventorybecause they were not received until January 4, 2017.

2. Goods purchased costing \)15,000 were shipped f.o.b. destination by a supplier on December 26. McGill received andrecorded the invoice on December 31, but the goods were not included in McGill鈥檚 2016 physical count of inventorybecause they were not received until January 2, 2017.

3. Goods held on consignment from Claudia Kishi Company were included in McGill鈥檚 December 31, 2016, physical countof inventory at \(13,000.

4. Freight-in of \)3,000 was debited to advertising expense on December 28, 2016.

Instructions

(a) Compute the current ratio based on McGill鈥檚 balance sheet.

(b) Recompute the current ratio after corrections are made.

(c) By what amount will income (before taxes) be adjusted up or down as a result of the corrections?

What is a repurchase agreement (product financing) arrangement? How should a product repurchase agreement be reported in the financial statements?

At the balance sheet date, Clarkson Company held title to goods in transit amounting to $214,000. This amount was omitted from the purchases figure for the year and also from the ending inventory. What is the effect of this omission on the net income for the year as calculated when the books are closed? What is the effect on the company鈥檚 financial position as shown in its balance sheet? Is materiality a factor in determining whether an adjustment for this item should be made?
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