Effects of income, cash flow and working capital of gasoline Essay

Gasoline product is one of the most in demand product among consumers. Many businessmen are persuaded to engage in merchandising the said product due to its favorable return on Investments, As the population rate Increases, different types of machineries are being developed. This results to a rapid growth of necessity for petroleum products. Owning a gasoline station is one of the profitable businesses. This might be the reason why many businessmen are in this same kind of business. But alongside of this are the challenges every business company has to deal with.

One of those things Is the right choice of Inventory accounting method to be employed. Effective inventory accounting method is needed in order to provide the best service to customers, produce at maximum efficiency and manage inventories at predetermined level to control Investments In Inventories. A company’s Inventory typically Includes raw materials that will be used to make products, along with goods in the process of becoming finished products and the finished products themselves. Inventory usually comprises a significant portion of total assets.

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There are three main ethos for calculating inventory: Last-in, First-out (LIFO); First-in, First-out (FIFO); and Average Cost Method (AVOCADO). Because the cost of raw materials can change over time, even during the same accounting period, companies typically need to determine what costs are associated with the revenue they earn; this can help them choose the best inventory method. Having all these in mind, the researchers conducted a study that focuses on these three main accounting methods, their differences and effects to the businesses’ profit.

The Information gathered Is useful to the business owners in profitability. Also, consumer can benefit by making them aware of the costing method practiced by different gasoline stations. Since this study is conducted to determine the effects of inventory accounting methods to the Income, cash flow, and working capital, It Is Important to emphasize that this research work Is mainly concerned with the maximizing and improving the gasoline industry. Working capital, the researchers feel the need of additional related study matters to fully understand the advantage of this research.

The study would help not only the researchers themselves but also the entire industry in Battings City. Conceptual Framework This section provides the readers with a clear statement and information of how the study was undertaken by the researchers. This study took the concept of Arcadian Model of Value-Minimization Theory, also known as the Arcadian Model of Inventory Accounting Choice. Geneses said that the difference in inventory accounting methods can affect the net present value of a firm. All firms with an identical production-investment opportunity set should choose the same inventory accounting method.

For firms with heterogeneous production-investment opportunity set the alee-maximizing manager would adopt an inventory accounting method according to Arcadian principle of comparative advantage. The main objective of establishing the business is to gain profit. Producers, manufacturers, owners, and managers should know how much their product costs. The establishment of sales price requires careful consideration of costs though supply and demands are the usual basis of pricing. Moreover, the recovery of all costs should not be the only basis of pricing but also the security of income under adverse condition.

The effect of inventory accounting methods to the income, cash flow, and working capital were even consideration by the researchers in this study. In order to provide the researchers a better understanding on the subject of the study, the study begins with the determination of the profile of gasoline stations in terms of forms of business organization, years of operation, suppliers and source of financing. It is important to be aware of the methods in costing products. Thus, the researchers also discussed the three inventory accounting methods commonly used in pricing products.

These methods are FIFO, LIFO, and AVOCADO. A research paradigm is presented to further understand the study. Operational Framework of Effects of Inventory Accounting Methods to the Income, Cash Flow and Working Capital to the Gasoline Station in Battings City This paradigm serves as a guide to finish the research study and be easily understood by the readers and the researchers themselves. The study is about “The Effect of Inventory Accounting Methods to the Income, Cash Flow and Working Capital of Gasoline Stations in Battings City’.

The first box presents the profile background of the gasoline stations which includes the form of business organization, years of operation, supplier of gasoline and its source of financing. The second box presents the three Inventory Accounting Methods which are the FIFO, LIFO, and AVOCADO and the third box presents the effects of the methods to the income, cash flow and working capital. The arrows indicate possible relationship between inventory accounting method and to the income, cash flow and working capital. This has been carefully studied and evaluated by the researchers as a basis in arriving to conclusions.

This has been given full attention by the researchers to know the respondent’s opinion through the use of questionnaire. Statement of the Problem This study aimed to determine the effects of the three main inventory accounting methods to the income, cash flow, and working capital to the gasoline stations in Battings City. Specifically, this study attempted to answer the following questions: 1. What is the profile of the gasoline stations in Battings City in terms of the following: 1 . 1. Form of business organization 1. 2. Years of operation 1. 3. Supplier 1. 4. Source of Financing 2.

Is there any significant difference in the following Inventory Accounting Methods: 2. 1. FIFO 2. 2. LIFO 2. 3. AVOCADO 2. 3. 1 under Periodic Inventory Method 2. 3. 2. Ender Perpetual Inventory Method 3. What are the possible effects of inventory accounting methods in the operation of gasoline stations in terms of: 3. 1 . Income 3. 2. Cash Flow 3. 3. Working Capital 3. 3. 1 . Amounts of Current Asset 3. 3. 2. Amounts of Current Liabilities 4. What are the implications of the findings of the study in the effects of income, cash flow and working capital of gasoline stations in Battings City?

Hypothesis There is no significant difference in the effects of inventory accounting methods to the income, cash flow and working capital of the gasoline station in Battings City. Assumptions The researchers are directed by the basic assumptions enumerated below: 1 . The participants will be sincere and cooperative in answering the questionnaire. 2. The information gathered by the researchers would be valid, reliable, and relevant to the study. 3. The gasoline stations have a well-established accounting system. 4. The study conducted will be a reliable source of information for both students and professionals. 5.

All the gasoline stations will allow and welcome the researchers to conduct the study. Scope, Delimitation, and Limitation of the Study In this study, the researchers focused only on the effects of inventory accounting methods to the income, cash flow and working capital. As to the cash flow – the operating activities, and as to the working capital -reporting a higher inventory. This study discussed the profile of the gasoline stations, the implications of the findings of the study to the operations of the gasoline stations and the methods affecting the gasoline stations in terms of income, cash flow and working capital.

This study would exclude other aspects of operations. Non-financial areas will not be given consideration in any part of this study. This will not also include the external forces like government regulation and technological changes that affect the inventory accounting method. Since the only focus is to determine the effects of inventory accounting methods in the income, cash flow and working capital of the gasoline stations in Battings City, the subject was limited to 20 gasoline station participants. In addition, the subject of this study will not include those participants who did not answer the questionnaire distributed.

Therefore, this research work does not assure one hundred percent accuracy and reliability. More so, the data collected and evaluated here are derived from samples randomly chosen from those gasoline stations which are the subject of this study. The data were limited to the responses of the managers and owners of the gasoline stations that were obtained from the result of the interviews and questionnaires prepared by the researchers. The researchers’ challenges when it comes to conducting the field survey include distances of the gasoline stations and lack of cooperation of some participants.

The researchers also perceived the time constraints on the retrieval of the questionnaires susceptibilities on their business. Due to these factors, the researchers gathered limited information. Significance of the Study This research paper is significant in acquiring knowledge and information about the determination of the effects of inventory accounting method to the income, cash flow and working capital of gasoline stations in Battings City. This study will be beneficial to the different parties involved.

To the gasoline station management, the result of this study will serve as a standard measure of their affectively in terms of choosing the best inventory counting methods they have employed. This will also serve as basis of whether management should improve or change the inventory accounting method used. This study will provide gasoline managers awareness of the constraints and limitations of the activity – Inventory Accounting Method. To the government, for they will know the effects of inventory accounting method to income, cash flow and working capital of gasoline station that will benefit the ordinary people and the gasoline management.

To different schools and other institutions, this will be included in their collection f research studies for the benefit of their students and other interested readers. To the accountancy students, they will gain knowledge on the effects of inventory accounting methods to the income, cash flow and working capital. Also, if they have research on the same subject, this study will serve as a guide in finishing a better research. To the future researchers, this will guide in them in doing similar study by knowing the effects of inventory accounting methods to the income, cash flow and working capital of gasoline stations.

This study will serve as a basis for determining he concepts, which will be included and evaluated in their study. And finally, to the researchers themselves, this study will raise awareness of the importance of gaining knowledge about the effects of inventory accounting method to the income, cash flow and working capital of gasoline stations in Battings City. This would serve as a guide when they engage into similar kind of business in their future endeavors. Definition of Terms For the readers to gain a clear understanding of this study, unfamiliar words are defined contextually and operationally by the researchers.

AVOCADO. Stands for Average Costing Method that calculates the cost of ending inventory and cost of goods sold for a period on the basis of weighted average cost per unit of inventory. AVOCADO – Periodic. The cost of beginning inventory plus the total cost of purchases during the period is divided by the total units purchased plus those in the beginning inventory to get a weighted average unit cost. (Avail & Avail, 2012) AVOCADO – Perpetual. Under this method, a new weighed average unit cost must be computed after every purchase and purchase return.

The total cost of goods available after his time to get a new weighted average unit cost. (Avail & Avail, 2012) Cash Flow. It refers to the amount of cash the company generates within a specific period of time. Cash flow is almost never equal to the net profit as companies tend to sell on credit and borrow money. FIFO. Stands for “First In, First Out”. This method assumes that the goods first purchased are first sold and consequently the goods remaining in the inventory at the end of the period are those most recently purchases or produced. (Avail & Avail, 2012) Gasoline.

It is a petroleum – hydrocarbon fuel used principally to rower internal – combustion engines (Growler, 1983). Gasoline Station. It is a service station wherein gasoline had stored in underground tanks. The pumps from this station draw the gasoline from the tanks and deliver it to the fuel tanks of cars and trucks (Ms. Clean, 1996). Income. The increase in economic benefit during the accounting period in the form of an inflow or enhancement of assets or decrease of liabilities that result in increase in equity, other than those relating to contributions from equity participants. This definition encompasses both revenue and gains.

Income is recognized in the income statement when increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably, such as the net increase in assets arising in the sale of goods or services or the decrease in liabilities arising from a waiver of a debt payable. (Patella, 2006). Inventory. Assets which are held for sale in the ordinary course of business, in the process of production for such sale or in the form of materials or supplies to be consumed in the production process or in the rendering of services. Avail, 2012). LIFO.

Stand for Last In, First Out, which assumes that the goods last purchased are first sold and consequently the goods remaining in the inventory at the end of the period are those first purchased or produced. (Avail & Avail, 2012) Petroleum Product. This is a product made at the refinery which gasoline stations acquired to sell. Working Capital. It is the difference between current assets and current liabilities. In accounting, the term “current” refers to the assets that can be turned into cash unless otherwise restricted or liabilities and are due in less than 2 months or in the normal operating cycle whichever is longer. Avail & Avail, 2012) Chapter 2 REVIEW OF RELATED LITERATURE AND STUDIES This chapter presents review of related literature and studies, which were undertaken to provide the researchers knowledge and background of the subject under this study. Inventory includes the raw materials, work-in-process, and finished goods that a company has on hand for its own production processes or for sale to customers. Inventory is considered an asset, so the accountant must consistently use a valid method for assigning costs to inventory in order to record it as an asset.

Inventory accounting methods are used to calculate the cost of goods sold and cost of ending inventory. Inventory counting systems can be periodic or perpetual. According to Carter (2007), when actual cost is recorded in a perpetual inventory system, each issuance of materials is assigned a cost as it moves from storeroom to work in process as direct materials, to factory overhead as indirect materials, or to marketing and administrative accounts as suppliers. The more common methods of costing are “first in, first out” (FIFO); average; and “last in, first out” (LIFO).

Materials traded in modify exchanges, such as cotton, wheat, copper, and crude oil, are sometimes charged at a predetermined or estimated cost, and the only data needed on materials record card are the physical quantities; this greatly simplifies the work of posting receipts and issues. The most common methods which are FIFO, Average, and LIFO represent different assumptions about the flow of cost, but the cost flow assumption need not coincide with the actual physical flow of units.

Although the following discussion refers to materials inventory, the same costing methods are applicable to finished goods. Any cost flow assumption other than FIFO can result in unit costs that are affected by whether a perpetual or periodic inventory system is used. In a periodic inventory system, revenues from sale of merchandise are recorded when sales are made, in the same way as in perpetual system. But, no attempt is made on the date of sale to record the cost of the merchandise sold.

Instead, a physical inventory count is taken at the end of the period. This count determines (1) the cost of merchandise on hand and (2) the cost of goods sold during the period. There is another key difference. Under a periodic system, purchases of researched are recorded in a Purchases account rather than a Merchandise Inventory account. Also, under a periodic system, it is customary to record the following in separate accounts: Purchase Returns and Allowances, Purchase Discounts, and Freight-in on purchases. That way, accumulated amounts for each are known. Carter, 2007) All expenditures needed to acquire goods and to make them ready for sale are included as inventories costs. Inventories costs may be regarded as a pool of costs that consists of the cost of the beginning inventory and the cost of goods purchased during the year. The sum of these two equals the cost of goods available for sale. Conceptually, the costs of the purchasing, receiving, and warehousing departments (whose efforts make the goods available for sale) should also be included in inventories costs.

But there are practical difficulties in allocating these costs to inventory. So these costs are generally accounted for as operating expense in the period in which they are incurred. Inventories costs are allocated either to ending inventory or to cost of goods sold. Under a periodic inventory system, the allocation is made at the end of the accounting period. First, the costs for the ending inventory are determined. Next, the cost of the ending inventory is subtracted from the cost of goods sold available for sale, to determine the cost of goods sold. Weakened, 2005) Patella (2006), determined the advantages According to him, the advantages of periodic inventory system are (1) useful if inventory consists of numerous items; (2) less clerical effort and bookkeeping costs; (3) easy to apply. The disadvantages of periodic inventory system are (1) no available written record of goods on hand; (2) may lead to spoilage, wastage, poor planning; (3) encourages and makes difficult detection of fraud. He also determined the advantages and disadvantages of perpetual inventory system.

The advantages of perpetual inventory system are (1) permits continuous check and control of inventories; (2) facilitates planning and proper scheduling of future purchases. The disadvantages of perpetual inventory system are (1) more expensive; (2) not easy to apply. Inventory accounting methods are used to calculate the cost of goods sold and cost of ending inventory. The accounting method used to create a valuation has a direct bearing on the amount of expense charged to the cost of goods sold in an counting period, and therefore on the amount of income earned.

Thus, the cost of goods sold is largely based on the cost assigned to ending inventory, which brings us back to the accounting method used to do so. When you buy inventory from suppliers, the price tends to change over time so you end up with a group of the same item in stock with some units costing more than others. As you sell items from stock, you have to decide on a policy of whether to charge items to the cost of goods sold that were presumably bought first, or bought last, or based on an average of the costs of all items in stock.

Your choice off policy will result in using either the “first in, first out” method (FIFO), the “last in, first out” method (LIFO), or the average costing method (AVOCADO). According to Weakened, et. Al. (2005), the FIFO method assumes that the earliest goods purchased are the first to be sold. FIFO often parallels the actual physical flow of merchandise because it generally is good business practice to sell the earliest units first. Under the FIFO method, the cost of the earliest goods purchased are the first to be recognized as cost of goods sold.

He further state that this does not serially mean that the earliest units are bold first but the cost of the earliest units are recognized first. Wastage et. Al. (20TH) also noted that the ending inventory is based on the latest units purchased. That is, under FIFO, the cost of the ending inventory is found by taking the unit cost of the most recent purchase and working backward until all units of inventory are cosseted. We can verify the accuracy of the cost of goods sold by recognizing that the first units acquired are the first units sold.

When materials are issued, the FIFO method assigns them the cost of the oldest supply of stock. The FIFO method is convenient whenever only a few different receipts of the materials are on a materials record card at one time; it is very complicated if frequent purchases are made at different prices and if units from several purchases are on hand at the same time. (Carter, 2007) The FIFO method assumes that “the goods purchased are first sold” and consequently the goods remaining in the inventory at the end of the period are those most recently purchased or produced.

In other words, the FIFO is in accordance with the ordinary merchandising procedure that the goods are sold in the order they are purchased. The rule is “first come, first sold”. The inventory is thus expressed in terms of recent or new prices while the cost of goods sold is representative of earlier stated at current replacement cost. The objection to the method is that there is improper matching of cost against revenue because the goods sold are stated at earlier or older prices resulting in understatement of cost of sales. Avail & Avail, 2013) Based on the procession assumption, goods are assumed to be sold in the order in which they are acquired or produced. Patella (2006) however states the advantages and disadvantages of using FIFO. According to him, the advantages of using FIFO are (1) inventory stated at most recent or current costs; (2) conforms with physical movement of goods; (3) simple to apply under periodic system. On the other hand, the disadvantages of FIFO are (1) results in improper matching, I. E. When prices are rising, cost of sales is stated below current costs and if falling, above current costs; and (2) results in “book or paper” profits when prices are rising. The LIFO method assumes that the latest goods purchased are the first to be sold. LIFO seldom coincides with the actual physical flow of inventory. Only for goods in piles, such as ay, coal, or products at the grocery store would LIFO match the physical flow of inventory. Under the LIFO method, the costs of the latest goods purchased are the first to be assigned to cost of goods sold.

Under the LIFO method, the cost of inventory is found by taking the unit cost of the oldest goods and working forward until all units of inventory are cosseted. As a result, the first costs assigned to ending inventory are the costs of the beginning inventory. Under a periodic system, all goods purchased during the period are assumed to be available for the first sale, regardless of the date of purchase. Weakened, 2005) The LIFO method assigns the cost of the most recent purchase in stock to each batch of materials issued to production.

The logic of this method is that the most recent cost approximates the cost of replacing the consumed units and is therefore the most meaningful cost amount to be matched with revenue in calculating income. Under LIFO, the objective is to charge out the cost of current purchase and to leave the oldest cost in the inventory accounts. There are several ways to apply the LIFO method. Because each variation yields different figures for the cost of materials issued, the cost of ending inventory, ND profit, it is important to follow the chosen procedure consistently.

Periodic inventory systems also work well in companies that charge materials to work in process from month-end consumption sheets, which provide the cost department with information about quantities used. (Carter, 2007) The LIFO method assumes that “the goods last purchased are first sold” and consequently the goods remaining in the inventory at the end of the period are those first purchased or produced. The inventory is thus expressed in terms of earlier or old prices and the cost of goods sold is representative of recent or new prices.

The LIFO favors the income statement because there is proper matching of current cost against revenue, the cost of goods sold being expressed in terms of current or recent cost. The objection to the LIFO is that the inventory is stated at earlier or older prices and therefore there may be a significant lag between inventory valuation and current replacement cost. Moreover, the use of LIFO permits income manipulation, such as by making year-end purchases designed to preserve existing inventory layers. At times, these purchases may not even be in the best economic interest of the entity. Avail & Avail, 2013) The inventory costing.

Specifically, AS No. 2, paragraph 25 states that “The cost of inventories… Shall be assigned by using the first-in, first-out (FIFO) method or weighted average cost formula. An entity shall use the same cost formula for all inventories having a similar nature and use to the entity. For inventories with a different nature or use, different cost formulas may be Justified”. The International Accounting Standards Board (SAAB) argued that the LIFO method treats the newest items of inventory as being sold first, and consequently the items remaining in inventory are recognized as if they were the oldest.

This is generally not a reliable representation of actual inventory flows. The use of LIFO in financial reporting is often tax-driven, because it resulted in costs of goods calculated using the most recent prices. The Board concluded that the LIFO method “reduces (increases) profits in a manner that tends to reflect that increased (decreased) prices would have on the cost of replacing inventories sold. However, this effect depends on the relationship between the prices of the most recent inventory acquisitions and the replacement cost at the end of the period.