Inventories (2)
Inventories are reported on the statement of net assets either at cost or at market value, whichever is lower. One important matter in accounting for inventories is referred to as the flow assumption. The flow assumption determines which items from inventory are considered to be sold or used first. The first-in, first-out (FIFO) flow assumption sounds complicated, but simply means that the oldest items from inventory (that is, the first items “in”) are the first items to be sold or used. This is the most common flow assumption used by governments. Assuming that there is consistent inflation at some level, these older inventory items will have a lower cost assigned to them, because they were theoretically purchased at a lower cost. This means that when these items are sold, the profit realized by the government will be higher than when the last items brought into inventory are sold. If the items are used by a government, there is no profit earned per se, but a lower cost will be charged to expense when the older item is assumed to be used first. The alternative flow assumption, last-in, first-out (LIFO), assumes that the last items brought into inventory (that is, assuming inflation, the ones with a higher cost) are the first ones sold or used. This means that when these items are sold, the net profit to the government is lower than it would be using the FIFO flow assumption (or if used, the expense will be higher). While the LIFO method has clear tax advantages to commercial organizations because reported profits are lower, its use by governments is less
popular, because tax considerations are generally not of importance.
The second important consideration for inventory valuation in the statement of net assets is that the amount reported as the cost of inventories on the statement should not be more than the amount that the inventory can be sold for. The commonly used phrase that inventory is reported at the “lower of cost or market” means just that, with the term market referring to how much the item could be sold for, rather than what it would cost the government to replace the inventory item.
Tip There are many other inventory methods with intimidating names that are variations on these two basic concepts, such as the dollar value retail LIFO method. Particularly when inventory amounts are not significant, governments sometimes use the average cost of items in inventory to represent the cost of items sold. This results in a sort of hybrid method, combining the features of the FIFO and LIFO methods. While the calculations may grow in complexity, the basic concepts remain as described above.
Taken From : Governmental Accounting Made Easy