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Financial Statement Effects of Inventory Costing Methods:Rising Prices

Brian Krogol
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Alright. So now we've seen how to use FIFA life, oh and average cost. Let's see the effect of choosing one over the other, what effect that has on the financial statements. So when we choose one over the other, we're gonna see just like we saw when we were doing our practice problems, we're gonna see that there is going to be differences in how we calculate cogs, right? We got different answers for cost of goods sold in every depending on the method and since it's gonna give us differences in cogs, that means it's gonna change our gross profit based on the method we choose. Right? Think about it. Cogs is an essential part of the gross profit equation. So if gross profit or if cause is gonna be a different number, well we're going to get a different gross profit and if we get a different gross profit, we're gonna get a different net income to write net income. Well, gross profit is a part of our net income equation. So gross profits, different net income is going to be different. And finally ending inventory is also gonna be different, depending on which case which uh cost flow assumption we pick FIFA life. Oh or average cost. Okay, so those are all gonna be affected based on what we pick. So let's see how they get affected. So here we go. We have excerpts this came from the periodic uh inventory example that we did previously, But um either way it doesn't matter where the numbers came from, it's just the idea of, I just want to show you that it can be different notice that the sales amount, the amount we sold is still the same regardless of which method we chose. But the cost of goods sold is different based on the methods. So let's go ahead and calculate gross profit in each of these situations just to get a little practice. And that's just gonna be our our sales minus our cost of goods sold 26-720. So in this first one we get 12,280 right? That's just that minus that. 39,000 minus 26 7 20. And we'll do that for each of them, 39,000 minus 29 1 80. And notice we're getting different answers for all of them. Right? Our gross profit is different in each case -27968. And we get 11 032. Right? So one more thing I want to note is that the Fife oh and the life oh are always gonna be extremes. They're always going to be on one end of the spectrum. And then the average cost is gonna be in the middle. That makes sense, right? Because it's the average. So the FIFA and Life oh are extremes here. And that's what I want to focus on what happens. What's the difference with Fife Oh and Life Oh and remember the whole reason we have to use these costing methods is because we don't always get the products at the same price, right? We might pay more for one shipment than we did for another shipment. And that's gonna cause discrepancies here. Okay. So the way we think about how Fife oh and life oh are going to be affected is whether prices are generally rising or declining over the period. Right. So did prices go up throughout the period or did prices fall throughout the period? Okay. So let's think about how this is going to affect all of these accounts based on these environments. Let's start with the rising price environment. And I want to go down here to this little uh simplified little schedule I have down here. So let's start in the left most red boxes where we're in a rising environment and we're in a Fife o situation, right? We're gonna use Fife Oh, so that means we're selling the oldest units. Okay. And notice I've got a rising price environment with my metaphor here of these growing dollar signs. Right? So you would imagine that that last shipment cost us a lot more because of the rising price. Okay, so let's say for this example so that we can be consistent, let's say that we sell three of the shipments and we have one of the shipments left in ending inventory from a Fife oh perspective, if we're gonna sell three shipments, we're gonna sell the three cheaper shipments, right? Because Phife o sells the oldest ones first and those will be all going to our cost of goods sold. Right? And then this down here, this would be left in ending inventory, Right? So what does that mean? In this case we see that the large largest value is still in ending inventory where the small values went to cost of goods sold, compare that to a Life. Oh Method. If we're doing life, Oh well we're gonna sell the latest units first. Right. So you can probably see what's gonna happen here. If we sell three shipments now, we're gonna have the expensive shipments in cost of goods sold and we're gonna have the cheap shipment that's left over. That's the one that goes to ending inventory. All right. So let's make that comparison now notice that our cost of goods sold is going to be a lot bigger in a life. Oh Method than in a FIFA Method. When we're dealing with rising prices right? In this situation, the prices were rising. So those expensive shipments made their way in to cost of goods sold in life. Oh, alright. So let's go ahead and see. Let's fill in this little chart based on what we just learned. So in Fife oh, if we're in a rising price environment, the cost of goods sold in Fife O is gonna be less, right? We're gonna have a less lower, a lower value and cost of goods sold and this is gonna be higher. Right? These are gonna be higher, just like we saw down here. right? We circled the big ones. So the big ones went to cost of goods sold in in life. Oh okay. So how is that gonna affect our gross profit? So remember gross profit. Cogs is a negative number, right? We have a negative number for cogs uh to get us to our gross profit. So if cogs is smaller, that means that the expense part of gross profit is smaller, right? That makes gross profit higher. Does that make sense? Because the expense, the cost of goods sold is less. So we're gonna have a higher gross profit. Okay. And that's gonna extend to a higher net income as well because we have that lower expense. But what happens to ending inventory? Uh So I guess we can make the same assumption here. This is what's happening here. This is gonna be lower for our gross profit, right? Because in a life oh situation the more expensive shipments made it into cost of Good Soul. How about ending inventory? Let's look what's left over in our ending inventory in Fife. Oh we have the expensive stuff, right? So the ending inventory is gonna be higher in Fife. Oh and it's going to be lower in life. Oh. So notice this all has to do with a situation where we have rising prices, right? So the prices are going up through the period? So you have to think of, well at the end of the period the prices were higher, Right? So those in life? Oh, method. Those higher prices go to cost a good soul. Alright, so let's go ahead. Let's let's take a quick break and we'll do the same thing with the falling price environment. Okay, So we'll see how this affects and falling prices. Cool. Let's pause now.