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Management Accounting: Costing and Budgeting
Finance & Accounting
Pages 10 (2510 words)
1. Many of MPL’s raw materials are expected to rapidly increase in cost next year. (a) Identify which method of stock valuation would give the lowest reported profit next year in these circumstances, and explain why. Ans. LIFO method of stock valuation will give the lowest reported profit next year in case of increasing costs.
Ans: If LIFO method is used over the lifetime of the business where the costs of raw materials are expected to rapidly increase, it will have minimal effect on the reported profits of the business. In the first year of operations, there will be a differ rence in the cost of opening stock and closing stock. However, in future reporting periods, the cost of receipts and issues will be the same or close to each other as the stock received first will be issued first. Thus, there will be no big difference exist between opening and closing stock. Consequently, there will be no difference that will be caused by opening or closing stock. Thus, the LIFO method in the long-term will not effect the reported profits much. (c) One possible stock valuation method is FIFO. Explain the potential problems with using FIFO when raw materials are rapidly increasing in cost. Ans: FIFO (First In First Out) is a method of valuation of stock in which the item are issued in the same manner in which they are received. In the period of rapidly increasing raw materials cost, the use of FIFO method may cause some potential problems in stock valuation. In case of rising prices, this method may give an inadequate picture of the company’s profits. Where the real profits of the company are low, the use of FIFO method may report higher profits. ...
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