BUS FPX 2061 Assessment 5 Inventory Management

BUS FPX 2061 Assessment 5 Inventory Management

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Capella university

BUS-FPX2061 Accounting Fundamentals

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Date

Assessment 5: Inventory Management

Respond to the following five questions using grammatically correct language.

1. To place the proper valuation on inventory, a business must determine which costs should be included in inventory cost. Getting goods ready to sell should include what items?

Getting goods ready for sale involves determining both the quantity and price of inventory. To establish quantity, a company must conduct an inventory count, which may be done through a physical inventory (manual counting of each item) or through perpetual inventory records (continuous tracking in an accounting system).

The price represents the amount paid for the goods purchased. To calculate the cost of ending inventory, the total quantity of goods is multiplied by the unit cost. This ensures that the inventory valuation reflects all necessary costs associated with preparing goods for sale.

2. If inventory is being valued at cost and the price level is steadily rising, which of the three methods of costing—FIFO, LIFO, or weighted average cost—will yield the lowest annual after-tax net income? Which method will yield the highest after-tax net income in a scenario where the price level is steadily declining?

During periods of rising prices (inflation), the LIFO (Last In, First Out) method yields the lowest net income. This occurs because LIFO accounts for the most recently purchased, higher-cost items first, leading to a higher cost of goods sold (COGS) and lower taxable income.

In contrast, during periods of declining prices (deflation), the FIFO (First In, First Out) method produces the highest net income. FIFO records older inventory purchased at higher prices as the cost of goods sold, leaving lower-cost inventory on hand, which increases reported profit margins.

3. Some circumstances justify departures from the historical cost approaches of FIFO, LIFO, and weighted average cost. Identify each of these alternative methods. Describe each alternative method. Include an example of when each method may be applied.

When conditions warrant, businesses may use alternative methods to value inventory. These include the Lower-of-Cost-or-Market (LCM) method, the Gross Margin method, and the Retail Inventory method.

1. Lower-of-Cost-or-Market (LCM) Method:
   This method values inventory at the lower of its historical cost or current market value. It is typically used when the market value of goods declines below cost, ensuring that inventory is not overstated.
   Example: A clothing retailer uses LCM when seasonal items lose value after the end of a fashion season.
2. Gross Margin Method:
   This approach estimates ending inventory by subtracting the estimated cost of goods sold from the cost of goods available for sale. It assumes a consistent relationship between gross margin and sales.
   Example: A small convenience store may use this method to prepare interim financial statements between physical counts.
3. Retail Inventory Method:
   This method estimates ending inventory by applying a cost-to-retail ratio to goods available for sale at retail prices. It allows businesses to estimate inventory without performing a physical count.
   Example: Large department stores often use this method to estimate inventory at the end of each month.

4. Given the following information, calculate the inventory turnover for a company. Evaluate the trend results.

The inventory turnover ratio measures how efficiently inventory is sold and replaced during a period. A higher ratio suggests strong inventory management and effective sales performance.

In 2020, the turnover ratio of 4.83 indicates efficient inventory utilization. However, in 2021, the ratio declined to 2.24, suggesting slower movement of inventory. This drop could be due to overstocking, slower sales, or obsolete inventory. Despite a decrease in ending inventory in 2021, sales performance did not improve enough to offset the lower cost of goods sold.

5. Identify which methods could be used to determine whether there has been shrinkage or shortage in the physical inventory.

The Retail Inventory Method can effectively identify inventory shrinkage or shortages. For instance, if a physical inventory count shows goods valued at $62,000, but the retail method estimates inventory at $66,000, a shortage of $4,000 is identified. This difference represents lost, stolen, or damaged inventory and must be recorded as a loss in the accounting records.

References

Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2021). Financial Accounting: Tools for Business Decision Making (10th ed.). Wiley.

Wild, J. J., Shaw, K. W., & Chiappetta, B. (2020). Fundamental Accounting Principles (25th ed.). McGraw-Hill Education.

BUS FPX 2061 Assessment 5 Inventory Management

Horngren, C. T., Sundem, G. L., & Elliott, J. A. (2020). Introduction to Financial Accounting (12th ed.). Pearson Education.

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