TFA

Chapter 26 – Inventory Cost Flow

Lovely Rose R. Atienza

QUESTION 26-1

What are the acceptable cost flow assumptions in measuring inventory?

ANSWER 26-1

The cost flow assumptions acceptable under IFRS are:

a. FIFO or first in, first out

b. Weighted average
c. Specific identification
IFRS prohibits LIFO or last in, first out.
QUESTION 26-2

Explain FIFO method of inventory valuation.

ANSWER 26-2

The FIFO method assumes that “the goods first purchased are first sold” and consequently the
goods remaining in the inventory at the end of the period are those most recently purchased or
produced.

In other words, the FIFO is in accordance with the ordinary merchandising procedure that the
goods are sold in the order they are purchased. The rule is “first come, first sold”.

The inventory is thus expressed in terms of recent or new prices while the cost of goods sold is
representative of earlier or old prices.

This method favors the statement of financial position in that the inventory is stated at current
replacement cost.

The objection to the method is that there is improper matching of cost against revenue because
the goods sold are stated at earlier or older prices resulting in understatement of cost of sales.
QUESTION 26-3

Explain the periodic weighted average method of inventory valuation

ANSWER 26-3

The periodic weighted average method means that cost of the beginning inventory plus the total
cost of purchases during the period is divided by the total units purchased plus those in the
beginning inventory to get a weighted average unit cost.

Such weighted average unit cost is then multiplied by the units on hand to derive the inventory
value.

The average unit cost is computed by dividing the total cost of goods available for sale by the
total number of units available for sale.
QUESTION 26-4

Explain the perpetual weighted average method.

ANSWER 26-4

When used in conjunction with the perpetual system, the weighted average method is popularly
known as the moving average method.

PAS 2, paragraph 27, provides that the weighted average may be calculated on a periodic basis
or as each additional shipment is received depending upon the circumstances of the entity.

Under moving average method, a new weighted average unit cost must be computed after every
purchase and purchase return.

Thus, the total cost of goods available after every purchase and purchase return is divided by the
total units available for sale at this time to get a new weighted average unit cost.

Such new weighted average unit cost is then multiplied by the units on hand to get the inventory
cost.

This method requires the keeping of inventory stock cards in order to monitor the “moving” unit
cost after every purchase.
Rizz Anne G. Balog

QUESTION 26-5

Explain the specific identification method of inventory valuation?

ANSWER 26-5
Specific identification means that specific costs are attributed to identified items of inventory.

The cost of the inventory is determined by simply multiplying the units on hand by their actual
unit cost.

This requires records which will clearly determine the actual costs of goods on hand.

PAS 2, paragraph 23, provides that this method is appropriate for inventories that are segregated
for specific project and inventories that are not ordinarily interchangeable.

The specific identification method may be used in either periodic or perpetual inventory system.

The major argument for this method is that the flow of the inventory cost corresponds with the
actual physical flow of goods.

With specific identification, there is an actual determination of cost of units sold and on hand.

The major argument against this method is that it is very costly to implement even with high-
speed electronic computers.
QUESTION 26-6

What is the meaning of relative sales price method of inventory measurement?

ANSWER 26-6

When different commodities are purchased at a lump sum, the single cost is apportioned among
the commodities based on their respective sales price.

The relative sales price method is based on the philosophy that cost is proportionate to selling
price.
QUESTION 26-7

Explain the measurement of inventory at standard costs.

ANSWER 26-7

Standard costs are predetermined product costs established on the basis of normal levels of
materials and supplies, labor, efficiency and capacity utilization.

A standard cost is predetermined and, once determined, is applied to all inventory movements –
inventory, goods available for sale, purchases and goods sold or placed in production.

PAS 2, paragraph 21, states that the standard cost method may be used for convenience if the
results approximate cost.

However, the standards set should be realistically attainable and are reviewed and revised
regularly in the light of current conditions.
QUESTION 26-8 Multiple choice (AICPA Adapted)

1. Which of the following inventory method reports most closely the current cost of
inventory?
a. FIFO
b. Specific identification
c. Weighted average
d. LIFO

2. Which inventory cost flow assumption would consistently result in the highest income in
a period of sustained inflation?
a. FIFO
b. LIFO
c. Weighted average
d. Specific identification

3. In a period of falling prices, the use of which inventory cost flow method would
typically result in the highest cost of goods sold?
a. FIFO
b. LIFO
c. Weighted average
d. Specific identification

4. In a period of rising prices, the inventory cost allocation method that tends to result in
the highest reported net income is
a. LIFO
b. FIFO
c. Moving average
d. Weighted average

5. During periods of rising prices, when the FIFO method is used, a perpetual inventory
system would
a. Not be permitted.
b. Result in a higher ending inventory than a periodic inventory system.
c. Result in the same ending inventory as a periodic inventory system.
d. Result in a lower ending inventory than a periodic inventory system.
Patricia Ann G. Buen

6. Which method of inventory pricing best approximates specific identification of the actual
flow of costs and units?
a. LIFO
b. FIFO
c. Moving average
d. Weighted average

7. Cost of goods sold is the same under a periodic system and a perpetual system when an
entity uses
a. FIFO
b. LIFO
c. Weighted Average
d. Specific identification

8. Which inventory cost flow assumption provides the best measure of earnings, where
“best” means most appropriate for predicting future earnings, when prices have been
declining?
a. FIFO
b. Specific identification
c. LIFO
d. Average cost

9. Assuming no beginning inventory, what can be said about the trend of inventory prices if
cost of goods sold computed using the FIFO method exceeds cost of goods sold using the
average cost method?
a. Prices decreased
b. Prices remained unchanged
c. Prices increased
d. Price trend cannot be determined from the information

10. The cost of ending inventory was lower using FIFO than LIFO. If there is no beginning
inventory what direction did the cost of purchases move during the period?
a. Up
b. Down
c. Steady
d. Cannot be determined
QUESTION 26-9 Multiple choice (IAA)

1. IFRS prohibits which of the following cost flow assumptions?

a. LIFO
b. Specific identification
c. Weighted average
d. Any of these cost flow assumptions is allowed

2. What is the inventory pricing procedure in which the oldest costs rarely have an effect on
the ending inventory?
a. FIFO
b. LIFO
c. Specific identification
d. Weighted average

3. In a period of falling prices which inventory method generally provides the lowest
amount of ending inventory?
a. Weighted average
b. FIFO
c. Moving average
d. Specific identification

4. In a period of falling prices which inventory method generally provides the lowest
amount of net income?
a. Weighted average
b. Moving average
c. FIFO
d. Specific identification

5. The costing of inventory must be deferred until the end of reporting period under which
of the following method of inventory valuation?
a. Moving average
b. Weighted average
c. LIFO perpetual
d. FIFO perpetual

6. The cost of inventories that are not ordinarily interchangeable and goods or services
produced and segregated for specific projects shall be measured using
a. FIFO
b. Average method
 c. LIFO
d. Specific identification

7. Which is the reason why the specific identification method may be considered ideal for
assigning cost to inventory and cost of goods sold?
a. The potential for manipulation of net income is reduced.
b. There is no arbitrary allocation of cost.
c. The cost flow matches the physical flow.
d. It is applicable to all types of inventory.

8. IFRS requires the specific identification method in certain circumstances. Which of the
following is likely to be a circumstance where the specific identification method can be
used?
a. Unit price is low.
b. Inventory turnover is low.
c. Inventory quantities are large.
d. All of the choices are likely circumstances.

9. Which of the following cost flow assumptions is used for inventory when an entity builds
townhouses?
a. FIFO
b. Specific identification
c. Weighted average
d. Any of these cost flow assumptions