Scheweser Notes - During peiods of stable prices, all three cost flow methods will yield the same results for inventory, COGS and gross profit. During periods of trending prices different cost flow methods may result in significant differences in these items.
I don’t have much problem in understanding this. But there is a scheweser style ‘Professor Note’ which says
: The presumption in this section is that inventory quantitites are stable or increasing.
What does this statement signify? I am wondering if I am missing something important here.
It means that if somewhere they haven’t specifically mentioned whether the inventory prices are stable, declining or increasing, then you should automatically consider them to be stable or increasing.
I wouldn’t worry about it. The idea is that different methods are going to yield different results with predictable biases under certain simple assumptions (such as relatively stable inventory level). The CFAI will not get too tricky with assumptions.
an-analyst - no, the notes specifically says quantities are stable or rising - an assumption. Why should quantities be a factor - as in the quantum of those inventory quantities. I vaguely remember it has a subtle implication.
waiguy, be creative and try to come up with a scenario where you will see no difference. For example, after a period of stable prices, they start going up. The company doesn’t purchase any more inventory and just sells old inventory. No impact on inventory, COGS, gross profits despite increasing trend in prices. In order to avoid such counter-examples, the assumption of stable or increasing inventory is used.
Gross profits will be higher but they will be equal regardless of the accounting approach used. The fundamental idea is that you want to compare apples and apples. When you compare statements that use different accounting approaches, you need to normalize them.
an-analyst - you don’t want to make that assumption in inventory valuation about rising selling prices (SP). That pass-through or higher market prices is irrelevant here. As maratikus said, even under rising SP, LIFO or FIFO will yield same gross profits, if inventory is depleted. If inventory is assumed to be stable, LIFO and FIFO will yield different gross profits (COGS will different). This will happen despite higher SP. But the point is - it doesn’t matter if SP rises or not.