Inventory Costing Methods

Inventory cost is determined using one of the following generally accepted methods, each based on a different assumption of cost flow

1. Specific identification method

2. Average-cost method

3. First-in, first-out (FIFO) method

4. Last-in, first-out (LIFO) method

LIFO Method:

• Best suited for the income statement because it matches revenues and cost of goods sold

• Not the best measure of the current balance sheet value of inventory, particularly during a prolonged period of price increases and decreases

FIFO Method

• Best suited to the balance sheet because the ending inventory is closest to current values

• Gives a more realistic view of the current financial assets of a business

• Does not provide as good a matching of current costs and revenues for income statement purposes

Perpetual versus Periodic Inventory Systems: Perpetual: continuous record of quantities and costs is maintained as purchases and sales are made. Cost of goods sold is accumulated as sales are made; costs are transferred from the Merchandise Inventory account to the Cost of Goods Sold account. Cost of ending inventory is the balance of the Merchandise Inventory account. Periodic: Only ending inventory is counted and priced. Cost of goods sold is determined by deducting the cost of the ending inventory from the cost of goods available for sale

Gross Profit Method is used in place of the retail method when records of the retail prices of beginning inventory and purchases are not maintained. Acceptable for estimating the cost of inventory for interim reports only. Assumes that the ratio of gross margin for a business remains relatively stable. It is a useful way of estimating the amount of inventory lost or destroyed by theft, fire, or other hazards.

Inv is merchandise purchased by merchandisers (retailers, wholesalers, distributors) for the purpose of being sold to customers. The cost of the merchandise purchased but not yet sold is reported in the account In or Mechandise Inv.

It is reported as a current asset on the company's balance sheet. In is a significant asset that needs to be monitored closely. Too much in can result in cash flow problems, additional expenses (e.g., storage, insurance), & losses if the items become obsolete. Too little in can result in lost sales & lost customers.

Because of the cost principle, In is reported on the balance sheet at the amount paid to obtain(purchase) the merch&ise, not at its selling price.

periodic FIFO

	№ of	Cost per		Total Cost
Inv at Dec. 31, 2010	1	$85	=	$  85
First purchase (Jany 2011)	1	87	=	87
Second purchase (June 2011)	2	89	=	178
Third purchase (Dec 2011)	1	90	=	90
Total goods available for sale	5			$440
Less: Inv at Dec. 31, 2011	4			- 355
Cost of goods sold	1	$85		$  85

If costs continue to increase, FIFO will always result in more profit than other cost flows, because the first cost is always lower.

periodic LIFO

	№ of s	Cost per		Total Cost
Inv at Dec. 31, 2010	1	$85	=	$  85
First purchase (January 2011)	1	87	=	87
Second purchase (June 2011)	2	89	=	178
Third purchase (Dec 2011)	1	90	=	90
Total goods available for sale	5			$440
Less: Inv at Dec. 31, 2011	4			- 350
Cost of goods sold	1	$90		$  90

"LIFO" is an acronym for Last In, First Out. Under the LIFO cost flow assumption, the last (or recent) costs are the first ones to leave Inv & become the cost of goods sold on the income statement. The first (or oldest) costs will be reported as Inv on the balance sheet.

It's important to note that under LIFO periodic (not LIFO perpetual) we wait until the entire year is over before assigning the costs. Then we flow the year's last costs first, even if those goods arrived after the last sale of the year.