Inventory Costs
• What costs are in the inventory account?
– all costs incurred to acquire goods and prepare
them for sale.
• How is inventory valued on the Balance Sheet?
Lower of Cost or Market (LCM)
– item-by-item or aggregate
Inventory Equation
Beginning Inventory + inflows - outflows = Ending Inventory
BI + P - CGS = EI
BI + P = CGS + EI
CG Available for Sale = CGS + EI
– Known: the amount of inventory you started
with and the amount of inventory purchased
(goods available for sale).
– Determine: how much was sold and how much
remains.
When do you determine CGS?
• Periodic Method • Perpetual Method
– Count inventory at end – Record CGS when
of the period (EI) to each sale is made.
determine the amount
sold (CGS).
– Since CGS is a plug, – Periodic inventory
there is no control for counts determine any
shrinkage. shrinkage.
Which inventory was sold?
Inventory Flow Assumptions
• FIFO: • LIFO:
First-In, First-Out Last-In, First-Out
– Oldest inventory is sold – Most recent inventory is
first sold first
• Oldest costs are in CGS • Most recent costs are in
CGS
• Most recent costs are in EI • Oldest costs are in EI
Other Inventory Flow
Assumptions
• Weighted Average (Average Cost)
– No assumption made.
– Add all costs and divide by number of items
available for sale to get an average price.
• Specific Identification
Summary of Cost Flow
Assumptions
Conceptual Conceptual
Advantages Disadvantages
Specific specifically costly to
Identifi- identifies cost of implement
cation goods sold
FIFO balance sheet income statement
approximates out of date
current costs
LIFO income statement balance sheet
approximates out of date
current costs
LIFO is Special!
• LIFO Conformity Rule:
– There is a tax effect and thus a real cash effect
from this accounting choice
• LIFO Liquidations: More cash effects
– Higher net income, but more taxes paid
– Purchases made to avoid liquidations
• LIFO Disclosures:
– LIFO Reserve: What would EI be using FIFO?
– LIFO Liquidations: Did they occur?
Converting LIFO to FIFO
Formulas:
• EI(F) = EI(L) + LIFO Reserve
• CGS(F) = CGS(L) - Increase in LIFO Reserve
• NI(F) = NI(L) + (1-t) [COGS(L) -COGS(F)]
• NI(F) = NI(L) + (1-t) [Increase in LIFO Reserve]
Note: F = FIFO, L = LIFO