Different methods of inventory costing give different cost of inventory (cost of sales) used to calculate gross profit as well as closing inventory.
Regardless of the method used the ending inventory remains constant (900 units). However, the value of the inventory is varying with the inventory costing method adopted. To start with, the value for perpetual FIFO (first in first out) is $ 52425.00 meaning the value of one unit is $ 58.45. Secondly, the value for perpetual LIFO (last in first out) is $ 47887.50 meaning the value of one unit is $ 53.2. Thirdly, the value of the periodic average cost is $ 48648.75.00 meaning that the value of one unit is $ 54.05. Lastly, the value of periodic FIFO $ 52425.00 meaning the value of one unit is $ 58.45.
This implies that a different method of inventory costing gives different values of ending inventory. However, the value of perpetual FIFO and periodic FIFO are the same. To determine the most suitable method it is advisable to consider changes in the purchase price. The company’s purchasing price for the inventory is $ 50.00 in the first months, but it increases in April to $57.00 decreases in May to $56.80 and increases once again in June to 58.25. According to the observation it is reasonable for the company to adopt the periodic average costing method. This is because it is not only giving a reasonable value of ending inventory but has also the following advantages. Firstly, inventory in the store need not to be individually identified before it is issued for sale. Secondly, it seems that there is no identifiable trend on cost of inventory over time. Third, the method ensures that prices of all inventory purchased during the trading period influences the cost of inventory. Considering the above variation in price of commodities average of the purchased inventory cost should be considered to determine the cost of inventory. The use of periodic average ensure that net income is calculated while considering all purchase prices of inventory acquired during the period.
The company should not use the LIFO method because when the prices change this will distort current income. Current profit will be distorted by previously unrecognized price losses and gains as applicable in inventory reduction. On the other hand, FIFO method is not appropriate because it does not reflect current changes in price. FIFO will therefore maximize the negative effect of price fluctuation witnessed in April, May and June. In addition, profit reported prior to price fluctuation will be deceptive because a proportion of it will be used to replace inventory (Gary & Curtis 2010).
References
Gary A. & Curtis N. (2010). Using financial accounting information: the alternatives to debits
and credits. USA: cangage learning
