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Inventory Cost

The document discusses inventory costing methods including FIFO, LIFO, and average cost. It analyzes the advantages and disadvantages of each for a pen manufacturing company, and determines that FIFO is the best method due to perishable materials and the need for accurate tracking of inventory purchased and sold.

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arman.anwar
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45 views

Inventory Cost

The document discusses inventory costing methods including FIFO, LIFO, and average cost. It analyzes the advantages and disadvantages of each for a pen manufacturing company, and determines that FIFO is the best method due to perishable materials and the need for accurate tracking of inventory purchased and sold.

Uploaded by

arman.anwar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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The costs of ordering and keeping inventory, as well as the associated documentation, are

included in inventory costs. This expense is considered by management when deciding how
much inventory to hold on hand. This can lead to improvements in the order fulfillment rate
for consumers, as well as changes in the flow of the manufacturing process. The following
are the different types of inventory costs: FIFO (First-In-First-Out), LIFO (Last-In-First-
Out), Average Method.
FIFO: First-In-First-Out is a method where OLDEST items are used first. It’s a method of
pricing the issue of materials in the order in which they are purchased. Basically, the
materials are issued in the order in which they are arrive in the store. When the material cost
is low, this approach is considered ideal in times of falling prices because charged to
production will be high while the replacement cost of materials will be low.
LIFO: Last-In-First-Out is a method where the prices of last received batch (lot) are used for
pricing the issues, until it is exhausted and so on. During the inflationary period or period of
rising prices, the use of LIFO would help to ensure that the cost of production calculated on
the above basis is close to the current one.
Average Method: When prices fluctuate from purchase to purchase and you want
consistency, this method is ideal. The weighted average method helps to balance out price
changes, way that results in a consistent stream of costs instead of just sharp increases and
decreases. After each purchase, you will calculate a new Average Cost (Sales will not
change the average cost).
Ideally, we cannot say that this one is better FIFO over LIFO or LIFO over FIFO. Because it
depends on some factor like business type, purpose, products. Both FIFO and LIFO have
some advantages and disadvantages also. FIFO measures assets better (the most useful
inventory data) during periods of rising prices and stable or growing inventories, but LIFO
measures income better. LIFO The cost of ending inventory is determined by the earliest
purchase prices, and the remaining inventory may be extremely old or obsolete. As a result,
LIFO doesn't include an accurate or latest inventory value because the valuation is much lower
than inventory items at today's prices. FIFO provides us a better indication of the value of
ending inventory because the older items have been used up while the most recently acquired
items reflect current market prices. FIFO is the most logical choice for most of the companies
because it’s used their oldest inventory first in the production of their goods. Our company is a
‘Pen Manufacturing’ company and we use Polystyrene(plastic), Polypropylene(plastic), Color
black, Ink black, Nib, Ballpoint as a raw material. There are some materials which are
perishable. So, we cannot sit the material idle since the material could spoil and leading to losses.
It’s important for us to track the inventory that is purchased as well as the inventory that is
sold accurately. Without an advance inventory tracking system, company has no way of
telling when the sold items were actually purchased. So, we choose FIFO because it
simplifies things. it also increases net income, because the cost of goods sold is measured using
inventory that may be many years old. When net income is increasing the amount of tax is
increasing also and company needs to pay the tax also. Until the higher tax risk is considered,
this becomes an acceptable form of valuation for companies who need to impress investors.
FIFO reports a higher amount of pretax earnings because it results in a lower reported cost per
unit. Companies will also face higher taxes as their revenues rise.
Considering all of these we choose FIFO as an inventory costing method for our company. We
think that FIFO is best suitable over LIFO & Average Method.

References:
1. Businessnewsdaily.com. n.d. [online] Available at:
<https://www.businessnewsdaily.com/5514-fifo-lifo-differences.html> [Accessed 10
April 2021].
2. Investopedia. 2020. Inventory Valuation — LIFO vs. FIFO. [online] Available at:
<https://www.investopedia.com/articles/02/060502.asp> [Accessed 10 April 2021].
3. Team, T., 2016. CFA Level I Exam: Learning Outcome Statements. [online]
Analystnotes.com. Available at: <https://analystnotes.com/cfa-study-notes-calculate-and-
explain-how-inflation-and-deflation-of-inventory-costs-affect-the-financial-statements-
and-ratios-of-companies-that-use-different-inventory-valuation-methods.html> [Accessed
8 April 2021].

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