Inventory Costing

Methods
Reported By: Joanne Oliva
Inventory Costing Methods

1. Specific Identification

2. Average Cost

3. FIFO (First-in, First-Out)

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

 Inventory Costing Methods
When there is a means of keeping track of
the purchase, such as with a code affixed to
Specific the item, it is possible to ascertain the
Identification actual cost of each item sold.
Method

150 units were sold. If the merchant selected the 100 units with
a unit cost of $8 and 50 units having a unit cost of $9, the cost
of goods sold would be (100 x $8)+(50
o x $9) = $1,250.00.
If the units with the higher cost were selected, the cost of goods
sold would be (80 x $10) + (60 x $9) = $1,420.00
 Inventory Costing Methods
The average cost of goods available for sale
is computed, and the units in both cost of
Average goods sold and ending inventory are costed
Cost at this average cost.
Method

Assuming the periodic inventory method, the 240 units available

for sale have a total cost of $2,140; hence, the average cost is
$2,140/240 = $8.917 o
 Inventory Costing Methods
Assumes that the oldest goods are sold first
and that the most recently purchased goods
First-in, are in the ending inventory.
First-Out
(FIFO)
Method

Refer to Sample 3

o
 Inventory Costing Methods
It is the opposite of FIFO method. Cost of
goods sold is based on the cost of the most
Last-in, recent purchases, and ending inventory is
Last-Out costed at the cost of the oldest units
(LIFO) available.
Method

Refer to Sample 4

o
 Inventory Costing Methods
LIFO Dollar Value Method
Last-in, In this method, items whose prices tend to
move together are grouped into an inventory
Last-Out
pool.
(LIFO)
Compared unit by unit LIFO method, LIFO
Method Dollar Value saves a considerable amount of
record keeping effort

Ex. A pool may consist of all the items in the inventory of the
house wares department in a store. The calculations required to
determine cost of goods sold ando inventory amounts.
 Inventory Costing Methods
LIFO Reserved
Last-in, At the end of the accounting period, the
difference between LIFO valuation and the
Last-Out
FIFO or average cost valuation is determined.
(LIFO)
It is nothing more than the difference
Method between two inventory amount, based on
LIFO and on different method in of valuing
inventory.
LIFO Reserve = FIFO Inventory – LIFO Inventory
Same as;
o
LIFO Reserve = LIFO Cogs – FIFO Cogs
Refer to Sample 5
 Methods of Comparison

All of the methods described are in accordance with generally

accepted accounting principles (GAAP) and all are acceptable by
the Internal Revenue Service (IRS) for calculating taxable
income.
 Methods of Comparison
It matches the costs of the goods that are
Arguments physically sold with the revenues generated
by selling those goods.
for
The other primary argument for FIFO
FIFO
reflects a balance sheet orientation.

The gross margin should reflect the

difference between sales revenues, which
Arguments are necessarily current amounts, and the
for current cost of the goods sold.
LIFO LIFO proponents downplay the impact of
LIFO on the balance sheet valuation.
 Methods of Comparison
•LIFO results in lower income and income
Income taxes than FIFO or average costly.
Tax •“Conformity Rule”, If the company chooses
LIFO method of tax purposes, it must also
Consideration
use LIFO in its published financial statement.

•The prices of the specific items in a

company’s inventory are not necessarily
Why not increasing.
more •The company must report the lower LIFO
LIFO income to its shareholders because of the
LIFO conformity rule.
 Lower Cost Market
the general inventory valuation principle, deriving from
conservatism concept, is that inventory is reported on the
balance sheet at the lower of its cost or its market value.
Inventory reported at its cost, it is reduced below cost only
when there is evidence that the value of the items, when
eventually sold or otherwise disposed of, will less than their
cost.
 Lower Cost Market
Upper and Lower Boundaries on Market
It should be high the selling item than the estimated selling
price of the item less the costs associated with selling it. The
amount is called net realizable value.
It should not be lower than the net realizable value less a
normal profit margin.
 Lower Cost Market
•Use HISTORICAL COST if that cost is lowest
•Otherwise, use the NEXT-TO-LOWEST of the other three
possibilities
 Analysis of Inventory
The ratio most commonly used in analyzing
the size of the inventory item.

Inventory Inventory Costs of goods sold

=
Turnover Turnover Inventory
Some companies calculate this ratio on the
basis of the ending inventory, others on the
basis of the average inventory
Ex. If the cost of goods sold for a year is $1 million and
inventory is $250,000 then the inventory turnover is 4.0 times.
This is equivalent to saying that othe inventory turns over once a
every three months (quarter of a year).
 Analysis of Inventory
Inventory turnover varies greatly with the
nature of the business. It should be high for
a store that sells fresh produce; otherwise,
Inventory spoilage is likely to be a problem.
Turnover Seasonality of sales must also to be
consider.
It also indicates the velocity with which
the merchandise moves through a business.
Turnover may fall either because of
inventory build up in anticipation of
increased sales or because sales volume has
decline, leaving excess merchandise on
hand.
 Analysis of Inventory
Both Inventory Turnover and Day’s
Inventory calculation are affected by the to
inventory costing methods.
Day’s One way this problem is resolved is
Inventory convert the LIFO data to their FIFO
equivalent and use the adjusted date to
compute ratios.

Inventory Costs of goods sold

= o
Turnover Inventory / 365
 Analysis of Inventory
Gross Margin = (Sales – Cost of goods sold)
Sales
Gross
Margin One of several different measures of a
Percentage company’s profitability.
It measures the percentage of each sales
a company earns before considering
period cost.

Ex. Assuming 2,000 in sales, the FIFO-based gross margin is

37.5% ((2,000 – 1,250) / 2,000); the LIFO-based gross margin is
29% ((2,000 – 1,420) / 2,000)