Assume that you are the president of your company and paid a year-end bonus according to the amount of net income earned during the year. When prices are rising, would you choose a FIFO or weighted average cost flow assumption? Explain, using an example to support your answer. Would your choice be the same if prices were falling?

Question

Allisson Shields

Business

1 August, 17:41

Assume that you are the president of your company and paid a year-end bonus according to the amount of net income earned during the year. When prices are rising, would you choose a FIFO or weighted average cost flow assumption? Explain, using an example to support your answer. Would your choice be the same if prices were falling?

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Answers (1)

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Rafael Simon · Answer 1

When prices are rising, as a President I would choose weighted average cost method.

Explanation:

If one is the President of the company, he would try to have lower Bonus bill so that the company profits. Year-end bonus is based on the amount of net income earned during the year, is the net income is low, it will lead to lower Bonus bill. This low net income target would be achieved if the cost of closing inventory is low.

Thus, under the rising prices, one should go for the 'Weighted average cost method' for calculating the Closing Stock instead of FIFO method because Closing inventory will be calculated at lower average price of initial lower price and later year's higher price.

In the case the prices are falling, one should go for the FIFO method of inventory valuation, to have lowest Bonus bill. It will provide us lower ending inventory cost in this case.