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I would like to know WHY and HOW it comes that change in inventories affects profit.So the example.
Toshil wishes to change its method of inventory valuation from FIFO to AVCO.The value of firm’s inventory at 30 sep.2009 (on the FIFO) is $20 mln.However, on the AVCO basis it would be valued at $18 mln. Toushil’s inventory at 30 Sept 08 was $15mln.but on AVCO basis it would have been reported as $13.4 mln.
For the question what is correct treatment for the change in valuation method from FIFO to AVCO, correct answer is : Profit would be reduced by $400 000, but I don’t understand why. Can you please answer and point why?
Accept that Cost of Sales is calculated as:
Opening inventory +
Purchases –
Closing inventoryPut figures into this calculation
Say Opening inventory was $300, Purchases $2,000 and Closing inventory was $500
So Cost of Sales is $300 + $2,000 – $500 = $1,800
Now change the basis of inventory valuation so that Closing Inventory is now worth $600
So Cost of Sales is now $300 + $2,000 – $600 = $1,700
And, if the cost of sales has decreased by $100, what has happened to the profit for the year? It has increased by $100
Does that explain it?
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