Inventory valuation methods: Effects of different methods on profit

• 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

Gross Profit using the AVCO method

• 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

• 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

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