Question: Since company officials are allowed to select a cost flow assumption, which of these methods is most typically found in the reporting of companies in the United States?Īnswer: To help interested parties gauge the usage of various accounting principles, a survey is carried out annually of the financial statements of six hundred large companies in this country.
Thus, for this men’s clothing store, all the following figures are presented fairly but only in conformity with the cost flow assumption used by the reporting company.įigure 9.4 Results of Possible Cost Flows Assumptions Used by Clothing Store Instead, the auditor states that the statements are “presented fairly…in conformity with accounting principles generally accepted in the United States of America.” That is a substantially more objective standard. The report of the independent auditor never assures decision makers that financial statements are “presented fairly.” That is a hopelessly abstract concept like truth and beauty. In Chapter 6 “Why Should Decision Makers Trust Financial Statements?”, an important distinction was made. Ultimately, the numbers in financial statements must be presented fairly based on the cost flow assumption that is applied. Arguments over both their merits and problems have raged for decades. Unfortunately, specific identification is nearly impossible to apply unless easily distinguishable differences exist between similar inventory items. Which of the cost flow assumptions is viewed as most appropriate in producing fairly presented financial statements?Īnswer: Because specific identification reclassifies the cost of the actual unit that was sold, finding theoretical fault with that approach is difficult. Is the gross profit for this men’s clothing store really $60 (FIFO), $40 (LIFO), or $50 (averaging) in connection with the sale of one blue shirt? Analyzing the numbers presented by most companies can be difficult if not impossible without understanding the implications of the assumption applied. Question: FIFO, LIFO, and averaging can present radically different portraits of identical events. GAAP and their income tax returns based on the Internal Revenue Code so that significant differences often exist. companies prepare financial statements according to U.S. largely stems from the presence of this tax rule. Understand the meaning of the LIFO conformity rule and realize that use of LIFO in the U.S.Recognize that three cost flow assumptions (FIFO, LIFO, and averaging) are particularly popular in the United States.GAAP, which includes several different allowable cost flow assumptions. Appreciate that reported inventory and cost of goods sold numbers are not intended to be right or wrong but rather must conform to U.S.At the end of this section, students should be able to meet the following objectives: