FIFO and Average-Cost Are the Two Most Common Cost Flow

question 194

Essay

FIFO and average-cost are the two most common cost flow assumptions made in costing inventories. The amounts assigned to the same inventory items on hand may be different under each cost flow assumption. If a company has no beginning inventory, explain the difference in ending inventory values under the FIFO and average-cost cost bases when the price of inventory items purchased during the period have been (1) increasing, (2) decreasing, and (3) remained constant.

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Definitions:

Call Option

An agreement that grants the purchaser the option, not the compulsion, to acquire an asset at a predetermined price during a defined timeframe.

Exercise Price

The specified price at which the holder of an option can buy (call option) or sell (put option) the underlying security or commodity.

Risk-Free Rate

The theoretical return on an investment with no risk of financial loss, typically represented by government bonds.

Market Value

The current price at which an asset or service can be bought or sold in a market.