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Dear Mr Mike,
I have been thinking about the FIFO method applied in a company which has multi stores (in different cities, say). Normally, the FIFO method will apply for whole company or each of its store?
An example:
+ Company has 2 stores A & B selling gas. A,B also can deliver gas internally to each other in some cases, say, if store A does not have enough gas in tank, the company can order a delivery from store B.
+ Now in the period, store B buys 2 tank of gas, 1st tank is 10$/gallon; 2nd tank is 11$/gallon. Store A requires internal transfer, B delivers to A a tank of gas.If FIFO is applied for each store then the delivery from B > A can be counted as an “OUT” @ the price 10$. Then any sale from B will have cost of goods sold @ 11$. I think this treatment will be appropriate with “matching” principles.
If FIFO is applied for whole company then the cost of goods sold is still @ 10$.I am thinking company may manipulate the profit by using FIFO for each store. Return to this example, if company wants increase the cost to reduce tax in the period, it may arrange a delivery from B > A without any actual demand.
Sorry for the long text! I don’t know how to say my thought in more effective way 🙁
“Normally, the FIFO method will apply for whole company ” – the whole company! It’s a company policy so you cannot cherry pick what method to apply to each different store
If you remember anything about consolidations, profits made on intra-group sales, where the items are still in inventory at the year end, are eliminated on consolidation
The same principle applies with branches of a business. You said it yourself – a “company may manipulate the profit by using FIFO for each store”
No, FIFO is a company-wide policy
Yeah, thank you Mr Mike.
Just to clarify, in the case above, FIFO is applied for all stores, no “cherry pick” method for each store such as FIFO for store A, LIFO for store B. So, the FIFO is still for “company-wide” range? Which means that no matter how goods are transferred internally between stores inside company, the ending balance inventory is still the latest purchased goods from outside (3rd parties)?
Dear Mr Mike,
Return to above case, now there is one more problem arising. If the internal transfers cause transport expenses, then how the transport expenses are accounted?
If transport expenses is accounted in the value of inventory then we must find a way to allocate the expenses to the ending inventory and to the cost of goods sold. The common solution of course may be based on the quantity of goods sold.
But, as we do not apply FIFO for “store-range”, we cannot assume which goods has been sold for each store (only assume which goods in “company range”). For example, 2 batches of 1000 gallon gas (each) has been delivered internally to store B with respective transport cost 100$ and 120$. 1000 gallon from store B has been sold. Now, how do we choose which transport cost has been allocated to cost of goods? 100$ or 120$.
As the result, the only appropriate method maybe average cost, applying specifically to transport cost only. But by doing so, it may mean that we use two different methods for inventory: FIFO for the material (purchase) cost and Average cost for transport cost.
Applying FIFO, the 1,000 gallons sold was the delivery that cost $100 to deliver
Therefore the 1,000 gallons still in inventory must have been the consignment that cost $120 to deliver.
What’s the problem?
Dear Mr Mike,
Please let me make an example, I still cannot sort out my thought:
Company has store A & B.
Jan: Buy 1000 @ price 10$/unit, placed at store A, transport cost: $100
Feb: Buy 1000 @ price 11$/unit, placed at store B, transport cost: $110
Jan: Deliver 1000 from A to B, transport cost: $50
Feb: Deliver 1000 from A to B, transport cost: $60
Mar: Sell 1000 from B
May: Buy 1000 @ price 12$/unit, placed at store A, transport cost: $120.
June: Sell 1000 from A.Then, according to FIFO, ending inventory (material value) = 1000 @ 12$, cost of goods sold = 1000 @ $10 + 1000 @ $11. If we follow the above way to allocate transport cost, then: the transport cost goes to cost of goods sold = $150 (= 100 + 50; sold from B in Mar) + $120$ (sold from A in June). Then: the material cost of goods sold is the value of 1st and 2nd purchase. But the transport cost allocated to cost of goods sold is of 1st and 3rd purchase. There is a mismatch between value of material and transport cost.
Those goods acquired in January cost A $10,100
Those goods acquired in February cost A $11,110
Those goods acquired in May cost A $12,120 and were then sold by A
The January goods were delivered to B with the additional expense of $50 and then sold by B
The February goods were delivered to B with the additional expense of $60 and are still in B inventory
Do you accept that inventory should be “valued at the lower of …………. where cost includes all that incurred in bringing the inventory to its present location and condition”
So what’s the value of the February purchase?
The only inventory is in B at a value of $11,110
Cost of goods sold for the company is the cost of the January goods and the May Goods = $10,100 + $12,120
OK?
Now, we have aggregate costs of $33,330 and we have inventory of $11,110 of which less than 1% is related to carriage inwards ($110)
This $110, you suggest, should in fact be $120 as being the last carriage inwards cost of the most recent delivery
You may be right!
But the difference in the final figures is $10 and that represents less than one tenth of one percent. I’m beginning to think to myself that this is immaterial. What about you?
Incidentally, I believe that the inventory is the February delivery and not the May delivery as you suggest. We can identify specifically the goods that are in inventory and we can categorically and accurately state the cost of those specific goods
Thank you for your time and very detailed explanation!!!
With current technology we may identify exactly the goods we sold. But just as you suggest in previous posts, when we apply FIFO we apply for “whole company”. That is why even we know exactly that the goods in inventory is of Feb purchase but the FIFO requires us to value the ending inventory @ the price of May – the latest purchase.
If it’s available to identify exactly which goods are still in inventory, then FIFO doesn’t apply
Imagine a car dealer that sells used cars and buys them individually. That dealer knows exactly the 10 cars still in inventory and knows the individual cost of those cars.It’s not just 10 cars out of the 187 cars that the dealer has bought through the year. It’s specifically those 10
So the concept of FIFO is not applicable. If the store B that you introduced had more than 1,000 units in inventory then we would have applied FIFO to the excess over 1,000
Say there was 1,200 in inventory and the previous delivery had been 500. So out of the 500, 200 remain. We can identify the cost of that 200 as being 2/5 of the purchase price paid by A maybe back in November when A bought those goods
OK?
Thank you! I just would like to ask more. You must be very angry with me for asking again and again a simple matter!
First, you suggested: when we can identify which goods are still in inventory then FIFO does not apply.
So, back to example of company with 2 stores (A&B). Imagine that company buys 1000 gallon of liquid @ 10$/gallon to A. Now, they know that in the future the price would decrease and they want to manipulate “better” profit. Then, they would transfer 1000 gallon of liquid immediately to B. After that, as they predicted, the price goes down to 9$, they buy another 1000 gallon to A and sell that 1000 gallon from A.
Because we know exactly that the goods in B have 10$ price and the goods we sold from A purchased @ 9$ price, the cost of goods sold must be the later 1000 gallon @ 9$. As the result, by just simply transferring goods from A to B, company can choose which goods is sold, which goods is hold in inventory.
If we apply FIFO to the whole company, even we know exactly the goods we sold, the cost of goods sold is still the first purchase @ 10$ price.
Have you forgotten that inventory is valued at the lower of cost and net realisable value?
That 1,000 gallons transferred from A to B needs to be valued at nrv ie at $9 per gallon
Why are you punishing yourself with hypothetical ways of manipulating results?
Sorry sir, but why the nrv is 9$? In the above example I did not mention the selling price! The liquid company sold can be at any price, 15$, 16$ etc… May you suggest that the price company sells is also the same as the market price that company may buy? No, the case is: company buy the goods from other market that the company’s customer cannot buy (for example, they import goods and resell to local market, therefore the cost of purchase is always lower than the selling price).
The problem I asked is actually a real life accounting problem, that’s why I really need your help! I would like to make a last example! Please be patience, I promise that after this post I would not ask again 🙂
Example: company has 2 store A&B, their business is to import liquid and resell domestic. Before any selling, they has purchased 2 tanks of liquid from overseas, 1st 1000 gallons @ 10$/gallon, 2nd 1000 gallons @ 9$/gallon. 2 tanks of total 2000 gallons has been stored in store A. Now, they finish a deal to sell 1000 gallons. If applying FIFO as usual, the 1000 gallon they sell will be valued @ 10$/gallon (as of the 1st purchase). But the company do not want that. Immediately before delivering the liquid to customer, they transfer 1000 gallon from A to B.
Now, that is where my problem arises: the 1000 gallon from A to B will be valued @ what price? If we apply FIFO to store A as a separate unit, of course the 1000 gallon from A to B would be valued @ 10$/gallon, 1000 gallon remains at A would be @ 9$/gallon. Therefore, the delivery from A to customer will be valued @ 9$/gallon. In effect, the company has “rightfully” used the LIFO.
Hi Binh
Thank you for coming back to me. Before we go any further, however, let me ask you for the name of your company / firm and the address to which I should send the invoice for my professional fees.
I charge substantially less than any of the Big 4 but I think you will agree that some fee is appropriate in the circumstances
This site is primarily aimed at helping students to pass their professional exams …. and it’s a free service
Your question however is a practical one (I wish you had told me at the start and I would have kept more accurate records of my time spent) but I can make a conservative guess at around 2 hours.
At the rate of $250 per hour you’re already up to $500
Is that ok?
I look forward to receiving the details for invoice purposes
Failing that I suggest that you approach any one of the Big 4 and get their professional opinion
(And by the way, I’m not happy!)
Sorry Mr Mike,
I did not have intention to use this forum to serve my private work! I am indeed an ACCA student. The way of accounting I mentioned previously is actual way of practice in a company I know. I just feels what they do is contrast with what I learned. I and my friends had a debate about the correctness of this method. That’s why I came here to reach an “official” solution to this endless debate 🙂
I am going to prepare the P2 (thank you for F7 lectures), that is the reason I would like to apply my knowledge in more practical situation. No more no less! Finally, sorry if I makes you angry 🙂
I’m calmed down a little in the last 11 days
Your problem sounds to me like a crude attempt to manipulate results
I suggest that you might contact the ACCA technical department and seek their advice
Or simply make a note for the partner in charge and let them sort out the issue
(My guess is that it will be dismissed as “immaterial”)
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