Cambrige AS and A Level Accounting Notes (9706)/ ZIMSEC  Advanced Accounting Level Notes: Inventory valuation: Inventory valuation methods: Effects of different valuation methods on profit

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  • As has already been demonstrated when we looked at an example question using (the question is the same for all these methods the only different part is the required part):
  • FIFO
  • AVCO and
  • LIFO
  • different inventory valuation methods result in different closing inventory value
  • Since closing inventory is used in the calculation of gross profit and ultimately net profit
  • It means using different inventory valuation methods results in different profit amounts
  • This can be demonstrated by looking at the question talked of above and calculating Gross Profit
  • Please go to the example question to see the question we are using

Gross Profit using the FIFO method

$$
Revenue31 000
Opening Inventory1 500
Purchases

18 290

19 790
Closing Inventory

640

(19 150)

11 850

Gross Profit using the AVCO method

$$
Revenue31 000
Opening Inventory1 500
Purchases

18 290

19 790
Closing Inventory(31x20)

620

(19 170)

11 830

  • We used the period end method here by simply rounding off to the nearest dollar resulting in a cost per unit of $31
  • The materiality concept allows us to do the rounding off as a few cents are not material

Gross Profit using the LIFO method

$$
Revenue31 000
Opening Inventory1 500
Purchases

18 290

19 790
Closing Inventory

610

(19 180)

11 820

  • We used the continuous method for closing inventory here
  • Had we used the period end method the result would be $11 820
  • That is $10 less that of the continuous method

General effect of valuation method on profit amount

  • In times of rising prices:
    • FIFO gives the highest profit
    • LIFO gives the least profit
    • AVCO profit is in between these two
  • The opposite is true in times of falling prices
  • If prices remain the same there will be no difference between closing inventory and thus profit figures from each method

NB

  • IAS 8 -(Accounting Policies, Changes in Accounting Estimates and Errors) requires consistency
  • This means that once a business (entity) have chosen a valuation method they will have to stick to it
  • It’s not acceptable to switch methods from one year to another

To access more topics go the ZIMSEC Advanced Level Accounting page

To access more topics go to the Cambridge AS/A level page


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