Table I: How Inventory Methods Impact the Balance Sheet and Income Statement RISING COSTS
FALLING COSTS
UNITS
PURCHASE PRICE
TOTAL
UNITS
PURCHASE PRICE
TOTAL
1ST INVENTORY BATCH
100
$10
$1,000
100
$10
$1,000
2ND INVENTORY BATCH
100
$11
$1,100
100
$9
$900 $900
3RD INVENTORY BATCH
100
$11
$1,100
100
$9
4TH INVENTORY BATCH
100
$12
$1,200
100
$8
TOTAL INVENTORY
400
$4,400
400
AVERAGE COST PER 100 UNITS
$800 $3,600
$1,100
$900
AVERAGE COST
LIFO
FIFO
AVERAGE COST
LIFO
FIFO
SALES (200 UNITS AT $15)
$3,000
$3,000
$3,000
$3,000
$3,000
$3,000
COST OF GOODS SOLD
$2,200
$2,300
$2,100
$1,800
$1,700
$1,900
GROSS PROFIT
$800
$700
$900
$1,200
$1,300
$1,100
STARTING INVENTORY VALUE
$4,400
$4,400
$4,400
$3,600
$3,600
$3,600
COST OF GOODS SOLD
$2,200
$2,300
$2,100
$1,800
$1,700
$1,900
ENDING INVENTORY VALUE
$2,200
$2,100
$2,300
$1,800
$1,900
$1,700
However, if inventory is damaged, used or obsolete it should be reported at its net realizable value (selling price less estimated selling costs). When inventory can be purchased new at an amount that is less than its original cost, inventory should be written down to the lower of cost or market. The ceiling, or maximum, market amount at which inventory can
be carried on the books is equal to the net realizable value. The floor is the net realizable value minus a normal profit. Any reductions in inventory value are expensed in the current period. Inventory costing and valuation have a direct impact on the assets and net income of the company. It is important to
evaluate the different options and select the methods which accurately reflect the company’s operations and leverage any potential income tax benefits. William Ryan, CPA, is a manager at Smolin, Lupin & Co., P.A. He is a member of the New Jersey Society of CPAs. Contact him at wryan@smolin.com or 973-439-7200.
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NEW JERSEY CPA • JANUARY • FEBRUARY 2012
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