BUS FPX 2061 Assessment 5 Inventory Management

BUS FPX 2061 Assessment 5 Inventory Management

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Capella University

BUS-FPX2061 Accounting Fundamentals

Prof. Name:

Date

Assessment 5: Inventory Management

Question 1: Determining Costs Included in Inventory Valuation

To accurately value inventory, a business must determine which costs are included in the total inventory cost. The process of preparing goods for sale requires calculations related to both quantity and price.

To determine quantity, a company may conduct a physical inventory, which involves manually counting each item, or use a perpetual inventory system, where transactions are continuously recorded in real time. The price component reflects the amount the company paid to acquire the product.

The total cost of ending inventory is computed by multiplying the quantity of inventory by the unit cost. This ensures that the valuation accurately reflects the resources invested in obtaining and preparing goods for sale.

Question 2: Costing Methods and Their Impact on Income

When inventory is valued at cost and prices are steadily rising, the LIFO (Last In, First Out) method results in the lowest annual after-tax net income. This occurs because LIFO records the cost of goods sold using the most recent (and typically higher) purchase prices during inflationary periods, leading to higher expenses and lower net income.

Conversely, during periods of declining prices, the FIFO (First In, First Out) method results in the highest after-tax net income. FIFO uses the cost of older, higher-priced inventory to calculate the cost of goods sold, thereby increasing the profit margin as newer inventory is acquired at lower prices.

The weighted average cost method typically yields results between those of FIFO and LIFO, depending on market conditions.

Question 3: Alternative Inventory Valuation Methods

Under specific circumstances, businesses may deviate from the traditional historical cost methods—FIFO, LIFO, and weighted average cost—and adopt alternative inventory valuation approaches. These methods include lower-of-cost-or-market (LCM), gross margin, and retail inventory methods.

These alternative methods are often applied when precise inventory counts are impractical or when there is a need to adjust for changes in market value.

Question 4: Calculating and Evaluating Inventory Turnover

The inventory turnover ratio measures how efficiently a company manages its inventory. It is calculated using the formula:

[
\text{Inventory Turnover} = \frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}
]

Table 1 below presents the calculation for each year:

A higher inventory turnover ratio generally indicates effective inventory management and stronger profitability. In 2020, the company’s turnover ratio was 4.83, showing efficient inventory utilization. However, in 2021, the ratio dropped to 2.24, suggesting slower inventory movement. This decline may imply overstocking or decreased sales performance, reducing operational efficiency.

Question 5: Identifying Inventory Shrinkage or Shortages

Inventory shrinkage or shortage occurs when the physical count of inventory is less than the expected amount based on accounting records. The retail inventory method can be used to identify such discrepancies.

For example, if a physical inventory count reports $62,000 worth of goods on hand, but the retail inventory method estimates $66,000, a shortage of $4,000 is identified. This shortage must be recorded as a loss in the company’s financial records, helping management detect theft, damage, or record-keeping errors.

References

Financial Accounting Standards Board (FASB). (2023). Accounting standards codification: Inventory valuation and cost flow assumptions. Retrieved from https://asc.fasb.org/

Horngren, C. T., Datar, S. M., & Rajan, M. V. (2021). Cost accounting: A managerial emphasis (17th ed.). Pearson Education.

BUS FPX 2061 Assessment 5 Inventory Management

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