Question 3.A.15: Suppose that the 9,000 tonnes of inventories in Example 3.8 ...
Suppose that the 9,000 tonnes of inventories in Example 3.8 were sold for £15 a tonne.
(a) Calculate the gross profit for the period under each of the three costing assumptions.
(b) What do you note about the different profit and closing inventories valuations when using each method, when prices are rising?
Your answer should be along the following lines:
(a) Gross profit calculation:
| FIFO | LIFO | AVCO | |
| £000 | £000 | £000 | |
| Sales revenue (9,000 @ £15) | 135 | 135 | 135 |
| Cost of sales | \underline{(90)} | \underline{(117)} | \underline{(108)} |
| Gross profit | \underline{45} | \underline{18} | \underline{27} |
| Closing inventories figure | \underline{270} | \underline{243} | \underline{252} |
(b) These figures show that FIFO will give the highest gross profit during a period of rising prices. This is because sales revenue is matched with the earlier (and cheaper) purchases. LIFO will give the lowest gross profit because sales revenue is matched against the more recent (and dearer) purchases. The AVCO assumption will normally give a figure that is between these two extremes.
The closing inventories figure in the statement of financial position will be highest with the FIFO assumption. This is because the cost of oil still held will be based on the more recent (and dearer) purchases. LIFO will give the lowest closing inventories figure, as the oil held will be based on the earlier (and cheaper) purchases. Once again, the AVCO assumption will normally give a figure that is between these two extremes. During a period of falling prices, the position of FIFO and LIFO is reversed.