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Identify the different inventory costing methods—specifically the periodic method—and discuss their application based on given data for Merit Company and Chen Sales Corporation. Compute the cost of goods sold and ending inventory using FIFO, LIFO, and weighted average methods under periodic and perpetual systems. Additionally, analyze which inventory method best reflects actual product flow, minimizes taxes, and reports the largest net income for perishable goods.

Paper For Above instruction

Inventory costing is a fundamental aspect of financial accounting, influencing the reported gross profit, net income, and ending inventory figures on a company's financial statements. The selection of an inventory costing method and system—whether periodic or perpetual—can significantly impact these financial metrics and reflect different perspectives on inventory management and tax obligations. This paper explores the application of various inventory costing methods, focusing on periodic and perpetual systems, using detailed examples and calculations pertinent to Merit Company and Chen Sales Corporation. It critically examines how these methods operate, their inherent advantages and limitations, and their appropriateness for firms dealing with perishable goods.

Introduction

Inventory management is vital for companies to accurately track and value their stock. The two primary systems—periodic and perpetual—differ in how they record inventory transactions. The periodic system updates inventory and cost of goods sold (COGS) at specific intervals, typically at period-end, whereas the perpetual system updates these continuously with each transaction. Within these systems, various methods—FIFO, LIFO, and weighted average—serve to allocate costs to inventory and COGS, each reflecting different assumptions about product flow and cost matching.

Periodic Inventory System and Costing Methods

The periodic inventory system evaluates inventory and COGS at the end of an accounting period. It relies on physical inventory counts to determine ending inventory, with COGS calculated as: Beginning inventory + Purchases – Ending inventory. The choice of costing method affects the valuation of inventory and COGS, with FIFO assuming the oldest stock is sold first, LIFO assuming the newest stock is sold first, and weighted average averaging the costs over all units available for sale.

Application to Merit Company

Merit Company's data include beginning inventory, purchases, and sales during May. Using this data, calculations under the periodic system for May involve first determining the total units available for sale, then applying each method to compute COGS and ending inventory.

First-In, First-Out (FIFO)

FIFO assumes units purchased first are sold first, so ending inventory comprises the most recent purchases. The calculation involves valuing the units remaining at the latest costs. For May, merit’s ending inventory includes units purchased at $36 and $35, while COGS includes units sold at the older costs.

Last-In, First-Out (LIFO)

LIFO assumes the newest units are sold first; thus, the ending inventory consists of the earliest purchases. In the May example, COGS reflects the cost of the most recent purchases, while ending inventory is made up of older costs.

Weighted Average Cost

The weighted average method takes the total cost of units available for sale divided by the total units, producing an average cost per unit. COGS and ending inventory are valued based on this average, smoothing out price fluctuations.

Perpetual Inventory System and Costing Methods

Under perpetual systems, each transaction immediately updates inventory balances and COGS, providing real-time insights. For the May 16 sale, calculations using FIFO, LIFO, and weighted average require tracking inventory layers as purchases are made and sales occur.

FIFO in Perpetual System

The sale on May 16 uses the earliest inventory costs, with remaining inventory being the most recent purchases. This method reflects a natural flow of goods where older stock is sold first, which is typical for perishable items.

LIFO in Perpetual System

Here, the sale on May 16 consumes the latest purchase costs, which can be advantageous for tax purposes during inflationary periods.

Weighted Average in Perpetual System

Calculations dynamically update the average cost after each purchase, making it sensitive to fluctuating inventory costs throughout the period.

Chen Sales Corporation: Inventory Methods Analysis

Chen’s scenario involves more complex purchase and sales data across the year. Calculations for COGS and ending inventory under different methods provide insight into how inventory flows influence profitability and taxation.

FIFO for Chen

Assuming FIFO, the earliest purchased units are sold first, likely leading to lower COGS and higher ending inventory in periods of rising prices, thus possibly reporting higher net income.

LIFO for Chen

Adopting LIFO typically results in higher COGS and lower taxable income, which can be advantageous for tax minimization but may not reflect actual inventory flow for perishable goods.

Weighted Average for Chen

This method smooths out cost fluctuations and can provide a middle ground in financial reporting and taxation strategies.

Strategic Considerations for Perishable Goods

In managing perishable inventory, the method that best aligns with actual product flow and minimization of waste is crucial. FIFO mirrors the natural first-use flow, reducing spoilage risks. However, tax strategies might favor LIFO during inflation, despite potential mismatches with physical movement.

Conclusion

The choice of inventory costing method under periodic and perpetual systems hinges on the company's operational realities, strategic priorities, and tax considerations. FIFO generally provides a realistic reflection of inventory flow for perishables while LIFO can optimize tax benefits during inflationary periods. The weighted average method offers simplicity and stability, particularly useful for firms with fluctuating costs. Ultimately, the selected method should align with the company's management practices and financial reporting goals.

References

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