After reading Greenberg and Wilners article, Teaching Inventory Accounting: A Simple Learning Strategy to Achieve Student Understanding (2011), found at: Greenberg, R. K. & Wilner, N.A. (2011). Teaching inventory accounting: A simple learning strategy to achieve student understanding . Issues in Accounting Education, 26(4): 835-844

Discuss why you think the authors statement below causes confusion among students in regard to understanding the differences among FIFO, LIFO, and average cost:

Students have a difficult time understanding the difference between the physical flow of inventory and the cost flow assumption. Specifically, they do not understand that the actual physical flow of goods relates to a process undertaken by a manufacturer or merchandiser, while the cost flow assumption relates to accounting reporting conventions. The physical flow does not have to be the same as the cost flow assumption (p.836).

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Teaching Inventory Accounting: A Simple Learning Strategy to Achieve Student Understanding Rochelle K. Greenberg and Neil A. Wilner ABSTRACT: This learning strategy offers an efficient and effective technique for teaching inventory in the introductory financial accounting course. It is motivated by the belief that many students memorize how to calculate the cost of goods sold and ending inventory under different cost flow assumptions, but that few understand the subject. This fundamental lack of understanding prohibits them from fully appreciating other issues, such as the difference between the physical flow and the cost flow assumption, the relevance of the cost flow assumption when computing cost of goods sold and income, and the irrelevance of the cost flow assumption when computing cash flow unless taxes are considered. Our learning strategy involves a convenience store selling three bottles of water. Inventory flow, cash flow, and the calculations of cost of goods sold, income, and ending inventory are illustrated under the first-in, first-out method; the last-in, first-out method; the weighted-average method; and specific identification. Keywords: understanding inventory accounting using prompts. INTRODUCTION I mproving the way we deliver our courses does not always have to rely on technology. Publishers keep improving the ancillaries that accompany accounting texts, and they pay particular attention to the introductory courses that have the highest enrollments. A movement to more internet resources and CDs seems to be a fact of life and will continue. We accept and use technology when applicable. We also feel that simple common sense approaches to teaching introductory accounting topics have an equal or more important place in the pedagogy we employ. This learning strategy offers a simple approach to teaching inventory accounting. This topic is very important because the choice of cost flow assumption has effects on the Income Statement (cost of goods sold), the Balance Sheet (inventory), and if considering income taxes, the Statement of Cash Flows due to the LIFO conformity rule. The use of this learning strategy allows us to get more students to the level of understanding the topic rather than mere memorization. Our students do qualitatively better in both short-term assessments and long-term retention because understanding constitutes a higher level of learning (Blooms Taxonomy 1956). Rochelle K. Greenberg is an Associate in Accounting at Florida State University, and Neil A. Wilner is an Associate Professor at the University of North Texas . Published Online: November 2011 835 When teaching the accounting for inventory in the introductory financial course, we have found that although students can perform the computations, they lack a conceptual understanding of the subject. Students have a difficult time understanding the difference between the physical flow of inventory and the cost flow assumption. Specifically, they do not understand that the actual physical flow of goods relates to a process undertaken by a manufacturer or a merchandiser, while the cost flow assumption relates to accounting reporting conventions. The physical flow does not have to be the same as the cost flow assumption. This fundamental lack of understanding prohibits them from fully appreciating other issues. These issues include how the cost of goods sold differs under alternative cost flow assumptions, while inventory purchases and net cash flow (assuming no income taxes) are unaffected by the cost flow assumption . This learning strategy offers an effective method to handle inventory accounting in the introductory course. THE PROBLEM Even the weakest students are able to easily compute cost of goods sold (COGS) and ending inventory (EI). This is true whether using the first-in, first-out (FIFO) method; the last-in, first-out (LIFO) method; or the weighted-average method. When asked to perform these computations on a midterm or final examination, over 80 percent of our students get the correct answers. When asked two different questions that probed their understanding of inventory accounting a little deeper, we witness a stunning disparity in performance. Only 20 to 25 percent of the students get the correct answers on our two probing questions. The first probing question was as follows: Green Sales Company began business on January 1, 2008, and uses the LIFO cost flow assumption for inventory accounting. Green purchased two identical units of inventory during the year: Purchase #1: 1 unit @ $58 Purchase #2: 1 unit @ $52 On December 31, 2008, Green sold one unit for $70, and determined that it was the unit bought in Purchase #2. Green reported cost of goods sold relating to this sale as $52. If the company had sold the unit bought in Purchase #1 instead of the unit bought in Purchase #2, cost of goods sold would have been: a. $52 b. $55 c. $58 d. $70 e. none of the above An overwhelming percentage of the students incorrectly said the answer was c. Knowledge of the physical flow interfered with their ability to do the costing correctly even though the physical flow is irrelevant. We interpret this result to mean that the students think the cost flow assumption is the physical flow. The second probing question was as follows: Mihir Company began the accounting period with no beginning inventory. During the period, Mihir paid cash to purchase two identical inventory items; the first purchase cost $7.00 and the second purchase cost $8.00. On the last day of the accounting period, Mihir sold one inventory item for $9.00 cash. From this information, which of the following conclusions can be drawn assuming Mihir pays no taxes? a. There is a $1.00 net increase in cash if the LIFO cost flow assumption is used. 836 Greenberg and Wilner Issues in Accounting Education Volume 26, No. 4, 2011 We then illustrate that there is no difference in net cash flow under any of the cost flow assumptions. This is shown in Table 3. (Supporting calculations for Table 3 are provided in Appendix B.) Table 3 is used to emphasize the fact that the cost flow assumption determines COGS, but has no effect on the cash paid for inventory purchases. The three columns that concern cash (columns 1, 4, and 5) contain the exact same amounts under each cost flow assumption. This means that a company reporting the highest gross margin in column 3 has the exact same cash flow as a company reporting the lowest gross margin. We focus our attention on the cash in front of the room. We show the class that there is now $3.44 in cash on the table, and they see the change of $.44 ($3.00 1.56 2.00 = $3.44). The visual prompts of the bottled water and the cash help the students to understand this point. They literally see that the only transactions causing changes to cash were those involving the purchases and the sale. The recording of COGS under any inventory method had no effect on cash. Cash Flow with Taxes Instructors considering the effect of income taxes can continue with the aid of the visual prompts. When taxes are considered, there will be a difference in net cash flow between the various costing alternatives. This difference is due to the LIFO conformity rule, which states that the cost flow assumption used for income taxes must be the same method that was used for financial reporting purposes. We assume no operating expense, making gross margin equal to taxable income. Table 4 presents the differences in net cash flow, assuming a 30 percent income tax rate. (Supporting calculations for Table 4 are provided in Appendix B.) We present Table 4 to show that there is a difference in cash flow only when income taxes are considered. We emphasize that while four columns reflect cash flow under the various cost flow assumptions (columns 1, 4, 6, and 7) only taxes are different for each cost flow assumption. The student sees that this difference in taxes in column 4 is the only item causing a difference in net cash flow in column 7. We point out and discuss the paradox that the company reporting the lowest taxable income in column 3 reports the highest net cash flow in column 7 because they pay less in taxes. The cost flow assumption chosen does affect the amount of income taxes owed. To the extent that a cost flow assumption affects taxes, it also affects both profitability and net cash flow. TABLE 3 Cash Flow Assuming No Taxes (1) Sales Revenue (2) COGS (3) Gross Margin (1) (2) (4) Purchases (5) Net Cash Flow (1) (4) FIFO cost flow assumption $2.00 $0.96 $1.04 $1.56 $0.44 LIFO cost flow assumption $2.00 $1.10 $0.90 $1.56 $0.44 Weighted-average cost flow assumption $2.00 $1.04 $0.96 $1.56 $0.44 Specific Identification $2.00 $1.06 $0.94 $1.56 $0.44 Teaching Inventory Accounting: A Simple Learning Strategy to Achieve Student Understanding 839 Issues in Accounting Education Volume 26, No. 4, 2011 EVIDENCE OF PEDAGOGICAL EFFECTIVENESS We collected data from four sections of Financial Accounting Principles for the Fall 2010 semester. 1 Two sections of students were taught inventory accounting using the bottles, and two sections were taught without the bottles. Accounting for inventory was tested on the second midterm examination. The results, reported in Table 5, for questions one through four support our earlier contentions that students have a fairly easy time calculating COGS and EI. The results on questions five and six, the two probing questions requiring a better understanding of inventory accounting, also came out as we predicted. Table 6 provides data from the final examination relating to longer-term retention. We administered the final examination in the same four sections of Financial Accounting Principles where we collected the midterm examination results reported in Table 5. All of the questions used on the final examination were variations of those used on the midterm. Questions one through three asked the students to calculate COGS and EI. The performance was very good on these computational questions. Questions four and five were variations of our two probing questions. Again, the students taught with the bottles did better than the students who were not taught using the bottles. The drop-off in performance for the students taught using the bottles was also less severe than for the students who were taught without the bottles. We interpret this to mean that the bottles helped the students retain their understanding between the second midterm, given in the middle of October, and the final examination, administered in the middle of December. 2 TABLE 4 Cash Flow With Taxes (1) Sales Revenue (2) COGS (3) Gross Margin/ Taxable Income (1) (2) (4) Taxes 30% 3 (3) (5) Net Income (3) (4) (6) Purchases (7) Net Cash Flow [1] [(4 6)] FIFO cost flow assumption $2.00 $0.96 $1.04 $0.31 0.73 $1.56 $0.13 LIFO cost flow assumption $2.00 $1.10 $0.90 $0.27 0.63 $1.56 $0.17 Weighted-average cost flow assumption $2.00 $1.04 $0.96 $0.29 0.67 $1.56 $0.15 Specific Identification $2.00 $1.06 $0.94 $0.28 0.66 $1.56 $0.16 1 We are only able to provide summary statistics for the Fal l 2010 semester as evidence that the method we illustrate in this learning strategy leads to better understandi ng of both inventory flow and inventory accounting. The percentages we reported in the section of the paper entitled The Problem were our collective recollection of the performance of our students when teaching this course in past semesters. Before collecting the Fall 2010 data, we only had this recollection and anecdotal evidence that the learning strategy is a more effective way to teach inventory. The anecdotal evidence came from comments made by students after we switched from a traditional lecture approach to this new approach. We taught the class more than a year ago and do not have the data to re- calculate the percentages. For that reason, we gathered data from the Fall 2010 semester from colleagues in hopes of replicating our findings. Those data, reported in Tables 5 and 6, support our recollection. 2 The differences were in the expected direction. We did n ot do any means tests because we did not run a controlled experiment. The difference in perform ance, nevertheless, provides eviden ce that using the bottles in the lecture does help. 840 Greenberg and Wilner Issues in Accounting Education Volume 26, No. 4, 2011 SUMMARY Our goal in this learning strategy was to present an effective and efficient approach to enhance understanding of a difficult and important topic in introductory financial accounting. We have just demonstrated a simple approach to teaching inventory accounting using three water bottles and $3.00 in cash and have provided anecdotal evidence of its effectiveness. We believe that this pedagogical approach to teaching inventory has short-term and long-term benefits to the students. The pedagogy is quite simple but very effective. REFERENCES Bloom, Benjamin S., ed. 1956. Taxonomy of Educational Objectives: The Classification of Educational Goals; Handbook I: Cognitive Domain . New York, NY: David McKay. TABLE 6 Final Examination Results Question Class Taught with Bottles (n = 106) Percentage Correct Class Taught without Bottles (n = 102) Percentage Correct 1. Compute EI/COGS assuming LIFO 82% 74% 2. Compute EI/COGS assuming FIFO 81% 73% 3. Compute EI/COGS assuming weighted-average 82% 72% 4. First Probing Question: A variation of the Green Sales Co. question 58% 18% 5. Second Probing Question: A variation of the Mihir Co. question 53% 14% Average grade on final exam 72% 68% TABLE 5 Midterm Examination Results Question Class Taught with Bottles (n = 126) Percentage Correct Class Taught without Bottles (n = 122) Percentage Correct 1. Compute EI/COGS assuming LIFO 87% 83% 2. Compute EI/COGS assuming FIFO 86% 80% 3. Compute EI/COGS assuming weighted-average 83% 79% 4. Compute EI/COGS assuming specific identification 83% 80% 5. First Probing Question: Referred to in the paper as Green Sales Co. 65% 30% 6. Second Probing Question: Referred to in the paper as Mihir Co. 62% 26% Average grade on midterm exam 74% 71% Teaching Inventory Accounting: A Simple Learning Strategy to Achieve Student Understanding 841 Issues in Accounting Education Volume 26, No. 4, 2011 APPENDIX A Insights and Tips The instructor should bring the three bottled waters to class with the labels listing the purchase dates and costs already written on them and legible to the entire class. When the purchases information is introduced and written on the board, the instructor should show the class each bottle and have them stored in a clearly visible manner. After the sales are made, we make a big point of physically showing the class each bottle that the purchasing student is taking with them and then showing the remaining bottle in inventory. We try to work into the exercise, as often as possible, the fact that Bottles #1 and #3 were taken and that Bottle #2 remains in inventory. You also need to have chosen the student who buys the two bottles before class so you can give him/her $2.00 in bills before the exercise begins. The instructor also needs to come into the room with the $3.00 in cash, broken down in such a manner as to have $1.56 for the purchases (i.e., two one-dollar bills, three quarters, four nickels, and five pennies). It is a good idea to have a student count up the currency to show the initial position is $3.00 and to have another student count out the $1.56 for the purchases. We also make a big point of demonstrating the cash balance initially, after the purchases, and after the sale. We typically do both the non-tax case and the tax case every time. If an instructor is pressed for time or has other reasons not to introduce taxes, then they should proceed up through Table 3 in the paper. It helps to provide the students with a handout listing the purchases and sale data and copies of Tables 1 through 4 with the dollar values left blank. The students can then fill in the dollar values in each table as they are presented. An instructor may even choose to provide the tables already filled in with the values so that the students can concentrate on the presentation. APPENDIX B Calculations Supporting Tables 1 and 2 Sales Revenue: 2 bottles @ $1.00 per bottle = $2.00 Inventory Purchases: Bottle #1: Purchased 7/1 @ $0.46 per bottle Bottle #2: Purchased 7/17 @ $0.50 per bottle Bottle #3: Purchased 7/22 @ $0.60 per bottle Total purchases: $1.56 FIFO Cost Flow Assumption: Total purchases: $1.56 COGS: 1 @ $0.46 1 @ $0.50 = $0.96 EI: $0.60 LIFO Cost Flow Assumption: Total purchases: $1.56 COGS: 1 @ $0.60 1 @ $0.50 = $1.10 EI: $0.46 Weighted-Average Cost Flow Assumption: Total purchases: $1.56 COGS: ($1.56/3 bottles = $0.52 per bottle 3 2 bottles sold) = $1.04 EI: $0.52 842 Greenberg and Wilner Issues in Accounting Education Volume 26, No. 4, 2011 Specific Identification: Total purchases: $1.56 COGS: Bottle #1 @ $0.46 Bottle #3 @ $0.60 = $1.06 EI: $0.50 (Bottle #2) Calculations Supporting Table 3 FIFO Cost Flow Assumption: Cash receipts from sales revenue $2.00 Cash payments for inventory purchases ($1.56 ) Change in cash $0.44 Gross Margin ($2.00 $0.96 ) $1.04 LIFO Cost Flow Assumption: Cash receipts from sales revenue $2.00 Cash payments for inventory purchases ($1.56 ) Change in cash $0.44 Gross Margin ($2.00 $1.10) $0.90 Weighted-Average Cost Flow Assumption: Cash receipts from sales revenue $2.00 Cash payments for inventory purchases ($1.56 ) Change in cash $0.44 Gross Margin ($2.00 $1.04) $0.96 Specific Identification: Cash receipts from sales revenue $2.00 Cash payments for inventory purchases ($1.56 ) Change in cash $0.44 Gross Margin ($2.00 $1.06 ) $0.94 Calculations Supporting Table 4 FIFO Cost Flow Assumption: Cash receipts from sales revenue $2.00 Cash payments for inventory purchases ($1.56 ) Cash payments for income tax ($0.31)* Change in cash $0.13 * $2.00 (sales) $0.96 (COGS) = $1.04 (gross margin/taxable income) 3 0.30 = $0.31 (rounded) LIFO Cost Flow Assumption: Cash receipts from sales revenue $2.00 Cash payments for inventory purchases ($1.56 ) Cash payments for income taxes ($0.27)* Change in cash $0.17 * $2.00 (sales) $1.10 (COGS) = $0.90 (gross margin/taxable income) 3 0.30 = $0.27 Weighted-Average Cost Flow Assumption: Cash receipts from sales revenue $2.00 Cash payments for inventory purchases ($1.56 ) Cash payments for income taxes ($0.29)* Change in cash $0.15 * $2.00 (sales) $1.04 (COGS) = $0.96 (gross margin/taxable income) 3 0.30 = $0.29 (rounded) Teaching Inventory Accounting: A Simple Learning Strategy to Achieve Student Understanding 843 Issues in Accounting Education Volume 26, No. 4, 2011 Specific Identification: Cash receipts from sales revenue $2.00 Cash payments for inventory purchases ($1.56 ) Cash payments for income taxes ($0.28)* Change in cash $0.16 * $2.00 (sales) $1.06 (COGS) = $0.94 (gross margin/taxable income) 3 0.30 = $0.28 (rounded