Question

Inventory item 101 purchased in October costs $100. Inventory item 102 purchased in November costs $110. The two inventory items are identical in all respects, except the price paid to acquire them. If item 102 is sold to a customer for $150, which of the following cost flow methods would produce the LOWEST GROSS margin?

Answer 1

Last In, First Out, would produce the lowest gross margin in this question.

The gross margin is calculated as the selling price minus the cost of goods sold.

The cost of goods sold depends on the cost flow method used.

Considering two common cost flow methods:

1. First In, First Out: Assumes that the first items added to inventory are the first to be sold.

Given item 102 is sold for $150,

Cost of goods sold for item 102 = Cost of item 102 = $110

Gross Margin = Selling Price - Cost of goods sold

Gross Margin = $150 - $110 = $40

2. Last In, First Out: Assumes that the last items added to inventory are the first to be sold.

Cost of goods sold for item 102 = Cost of item 101 = $100

Gross Margin = Selling Price - Cost of goods sold

Gross Margin = $150 - $100 = $50

Therefore, using Last In, First Out, would produce the lowest gross margin.