c. Why do companies use cost flow assumptions to determine inventory cost? What
ID: 2549716 • Letter: C
Question
c. Why do companies use cost flow assumptions to determine inventory cost? What cost flow assumption(s) does Deere & Company use to determine inventory cost?
d. Assume that prices that Deere and CNH Global pay for inventory typically increase over time. CNH uses the first-in, first-out (FIFO) cost flow assumption to measure its inventories. In general terms, how do the balance sheet values for inventories of the two companies differ due to their cost flow assumptions? What numbers on the two companies’ income statements would differ? What if prices typically decrease over time?
Explanation / Answer
Solution:-
Cost flow assumptions are necessary because of inflation and the changing costs experienced by companies. If costs were completely stable, it would not matter how costs were flowed.
Example:- Let assume that a company product had a cost of $100 at the start of the year, at mid-year the cost was $105, and at the end of the year the cost was $110. Which cost would you match with the sale of one item at the end of the year? Would you match the $100 cost with the selling price of the unit sold? (If so, you are assuming a FIFO cost flow.) Would you match the $110 cost with the sale? (That's the LIFO cost flow assumption.) If you would matched the average of $105, you would be using the weighted-average cost flow assumption.
(b)
Method Cost of goods sold Net income Invetory FIFO Under estimate Overestimate Overestimate LIFO Overestimate Under estimate Under estimateRelated Questions
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