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| Inventory: Cost flow assumptions |
| Inventory: Cost flow assumptions 1. If unit costs of inventory items vary over time --> cost of goods sold and inventory amount will depend on --> which specific items are sold 2. Example 1 January 1, 2011 --> Entity A had 100 units of merchandise in inventory at $10 per unit cost January 15, 2011 --> Entity A purchased 300 units of merchandise at $12 per unit cost January 20, 2011 --> Entity A sold 50 units of merchandise $16 per unit price Sales revenue = 50 units x $16 = $800 What is the amount of cost of goods sold? 3. Specific identification method --> if each unit can be identified --> Entity A can specify which 50 units are sold and --> decide the cost of each specific unit 4. If inventory items are identical and pooled together --> Entity A has to decide which 50 units were sold on January 20, 2011 5. If the units in the beginning inventory --> cost per unit is $10 6. If the units purchased on January 15, 2011 --> cost per unit is $12 7. This is the reason why cost flow assumptions are made --> when specific identification method is not used 8. Cost flow assumptions (1) First-in, First-out (FIFO) --> items purchased first are assumed to be sold first (2) Last-in, First-out (LIFO) --> items purchased last are assumed to be sold first (3) Weighted average --> weighted average cost of all previous purchases is used --> to determine the cost of goods sold 9. Example 1, continued January 1, 2011 --> Entity A had 100 units of merchandise in inventory at $10 per unit cost January 15, 2011 --> Entity A purchased 300 units of merchandise at $12 per unit cost January 20, 2011 --> Entity A sold 50 units of merchandise $16 per unit price Sales revenue = 50 units x $16 = $800 What is the amount of cost of goods sold? 10. First-in, First-out (FIFO) --> Beginning inventory at January 1, 2011 is assumed to be sold first --> cost of 50 units sold: $10 per unit --> 50 units x $10 = $500 11. Last-in, First-out (LIFO) --> the most recent purchase on January 15, 2011 is assumed to be sold first --> cost of 50 units sold: $12 per nit --> 50 units x $12 = $600 12. Weighted average --> weighted average cost = (100 x $10 + 300 x $12) / (100 + 300) units = ($1,000 + $3,600) / 400 units = $4,600 / 400 = $11.50 Cost of 50 units sold = 50 units x $11.50 = $575 13. Cost of goods sold summary (1) FIFO --> 50 units x $10 = $500 (2) LIFO --> 50 units x $12 = $600 (3) Weighted average --> 50 units x $11.50 = $575 13. Inventory (1) FIFO --> 50 units x $10 + 300 units x $12 = $500 + $3,600 = $4,100 (2) LIFO --> 100 units x $10 + 250 units x $12 = $1,000 + $3,000 = $4,000 (3) Weighted average --> 350 units x $11.50 = $4,025 14. Quick comparison of FIFO and LIFO --> If the cost of later purchase is higher than those of previous purchases --> Cost of goods sold FIFO < Weighted average < LIFO --> earlier cost (lower cost) is charged for FIFO --> later cost (higher cost) is charged for LIFO --> Inventory LIFO < Weighted average < FIFO --> later cost (higher cost) stays in inventory for FIFO --> earlier cost (lower cost) stays in inventory for LIFO |
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