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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

LIFO and inventory flows

The following is an excerpt from a conversation between Paula Mario, the warehouse manager for Musick Foods Wholesale Co., and its accountant, Mike Hayes Musick Foods operates a large regional warehouse that supplies produce and other grocery products to grocery stores in smaller communities.

Paula: Mike, can you explain what’s going on here with these monthly statements?

Mike: Sure, Paula. How can I help you?

Paula: I don’t understand this last-in, first-out inventory procedure. It just doesn’t make sense.

Mike: Well, what it means is that we assume that the last goods we receive are the first ones sold. So the inventory consists of the items we purchased first.

Paula: Yes, but that’s my problem, it doesn’t work that way! We always distribute the oldest produce first. Some of that produce is perishable! We can’t keep any of it very long or it’ll spoil.

Mike: Paula, you don’t understand. We only assume that the products we distribute are the last ones received. We don’t actually have to distribute the goods in this way.

Paula: I always thought that accounting was supposed to show what really happened. It all sounds like “make believe” to me! Why not report what really happens?

Respond to Paula’s concerns.

To determine

Perpetual Inventory System:

Perpetual Inventory System refers to the inventory system that maintains the detailed records of every inventory transactions related to purchases, and sales on a continuous basis. It shows the exact on-hand-inventory at any point of time.

Last-in-Last-Out:

In Last-in-First-Out method, the costs of last purchased items are considered as the cost of goods sold, for the items which are sold first. The value of the closing stock consists of the initial purchased items.

To discuss: the response to Mr. P’s concern regarding LIFO inventory method.

Explanation

In this case, the practical need for an assumption concerning the cost of merchandise purchased and sold must be clearly highlighted. In normal scenario, it is practically impossible to specifically identify each item of the inventory when identical goods are frequently purchased. Moreover, when identical goods are purchased as same or similar prices, it does not make any significant difference for financial reporting purposes. But generally in many cases, merchandise inventories are purchased over time and at different prices and therefore there arises a situation to determine which of the inventories must be sold so that cost (price) of the goods could be matched against the sales revenue in determination of operating income of the company.

The accounting principle also emphasizes the information that physical flow of goods may differ from flow of cost. The accounting principle allows for three cost flow assumptions (i...

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