Posted by: Maj Gatungay
Category: Bookkeeping

The total cost of goods sold for May would be $233,800 (59,000 + 174,800). Specific identification will tell you exactly which purchase to use when determining cost. You will now learn how to calculate the Cost of Goods Sold using 4 different methods.

The method allows them to take advantage of lower taxable income and higher cash flow when their expenses are rising. Last in, first out (LIFO) is only used in the United States where any of the three inventory-costing methods can be used under generally accepted accounting principles. The International Financial Reporting Standards (IFRS), which is used in most countries, forbids the use of the LIFO method.

The company’s profit relating to consigned goods is normally limited to a percentage of the sales proceeds at the time of sale. Auditors may require that companies verify the actual amount of inventory they have in stock. Doing a count of physical inventory at the end of an accounting period is also an advantage, as it helps companies determine what is actually on hand compared to what’s recorded by their computer systems.

  1. These estimates could be needed for interim reports, when physical counts are not taken.
  2. The company uses manual, periodic inventory updating, using physical counts at year end, and the FIFO method for inventory costing.
  3. The FIFO costing assumption tracks inventory items based on segments or lots of goods that are tracked, in the order that they were acquired, so that when they are sold, the earliest acquired items are used to offset the revenue from the sale.
  4. In total, the cost of the widgets under the LIFO method is $1,200, or five at $200 and two at $100.

As you’ve learned, the ending inventory balance is reflected as a current asset on the balance sheet and the ending inventory balance is used in the calculation of costs of goods sold. Understanding how companies report inventory under US GAAP versus under IFRS is important when comparing companies reporting under the two methods, particularly because of a significant difference between the two methods. The FIFO costing assumption tracks inventory items based on segments or lots of goods that are tracked, in the order that they were acquired, so that when they are sold, the earliest acquired items are used to offset the revenue from the sale.

Weighted-Average Cost (WAC)

This means that inventory cost would include the invoice price, freight-in, and similar items relating to the general rule. Conversely, “carrying costs” like interest charges (if money was borrowed to buy the inventory), storage costs, and insurance on goods held awaiting sale would not be included in inventory accounts; instead those costs would be expensed as incurred. Likewise, freight-out and sales commissions would be expensed as a selling cost rather than being included with inventory.

Transportation costs are part of the responsibilities of the owner of the product, so determining the owner at the shipping point identifies who should pay for the shipping costs. The seller’s responsibility and ownership of the goods ends at the point that is listed after the FOB designation. Thus, FOB shipping point means that the seller transfers title and responsibility to the buyer at the shipping point, so the buyer would owe the shipping costs. The purchased goods would be recorded on the buyer’s balance sheet at this point.

So, what impact does an inventory method have on my business?

As you’ve learned, the perpetual inventory system is updated continuously to reflect the current status of inventory on an ongoing basis. Modern sales activity commonly uses electronic identifiers—such as bar codes and RFID technology—to account for inventory as it is purchased, monitored, and sold. Specific identification inventory methods also commonly use a manual form of the perpetual system. The weighted-average cost method (sometimes referred to as the average cost method) requires a calculation of the average cost of all units of each particular inventory items. The average is obtained by multiplying the number of units by the cost paid per unit for each lot of goods, then adding the calculated total value of all lots together, and finally dividing the total cost by the total number of units for that product.

Inventory Methods for Ending Inventory and Cost of Goods Sold

The last transaction was an additional purchase of 210 units for $33 per unit. Ending inventory was made up of 10 units at $21 each, 65 units at $27 each, and 210 units at $33 each, for a total specific identification perpetual ending inventory value of $8,895. The last-in, first-out method (LIFO) of cost allocation assumes that the last units purchased are the first units sold.

Ending Inventory: Definition, Calculation, and Valuation Methods

So, when inventory is sold, the newest cost of an item in inventory will be recovered and reported on the income statement as part of the cost of goods sold. When we are using FIFO or LIFO, we have to consider that small products bought in bulk are rarely individually assigned the costs they were originally purchased at. The exception to this would be large items like cars or appliances or very expensive pieces of jewelry. But in general they are all dumped into one bin and pulled out when sold. For example, assume that you sell your office and your current furniture doesn’t match your new building.

Information Relating to All Cost Allocation Methods, but Specific to Periodic Inventory Updating

LIFO is opposite of FIFO and reports the most current prices as being cost of goods sold. Now, let’s look at each inventory method, the pros and cons of each, and discuss how it can impact your business. Under the FIFO method, we will use the oldest inventory at the time of the sale first.

The specific identification method of cost allocation directly tracks each of the units purchased and costs them out as they are sold. In this demonstration, assume that some sales were made by specifically tracked goods that are part of a lot, as previously stated for this method. For The Spy Who Loves You, the first sale of 120 units is assumed to be the units from the beginning inventory, which had cost $21 per unit, bringing the total cost of these units to $2,520. Once those units were sold, there remained 30 more units of the beginning inventory. The second sale of 180 units consisted of 20 units at $21 per unit and 160 units at $27 per unit for a total second-sale cost of $4,740. Thus, after two sales, there remained 10 units of inventory that had cost the company $21, and 65 units that had cost the company $27 each.

The gross margin, resulting from the specific identification periodic cost allocations of $7,260, is shown in Figure 10.6. Petersen and Knapp allegedly participated in channel stuffing, which is the process of recognizing and recording revenue in a current period that actually will be legally earned in one the inventory costing method that reports the earliest costs in ending inventory is or more future fiscal periods. This and other unethical short-term accounting decisions made by Petersen and Knapp led to the bankruptcy of the company they were supposed to oversee and resulted in fraud charges from the SEC. Practicing ethical short-term decision making may have prevented both scenarios.

Here we will demonstrate the mechanics used to calculate the ending inventory values using the four cost allocation methods and the periodic inventory system. Journal entries are not shown, but the following discussion provides the information that would be used in recording the necessary journal entries. Each time a product is sold, a revenue entry would be made to record the sales revenue and the corresponding accounts receivable or cash from the sale. Merchandise inventory, before adjustment, had a balance of $3,150, which was the beginning inventory. The inventory at the end of the period should be $8,895, requiring an entry to increase merchandise inventory by $5,745. Cost of goods sold was calculated to be $7,260, which should be recorded as an expense.

Maj Gatungay

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