Inventory Valuation

Standards BCS-PAI-4 d. Identify and explain the advantages and disadvantages of different types of accounting systems. BCS-PAI-4 g. Analyze business transactions and their effect on the accounting equation.

Objectives Students will be able to explain the difference between the three cost assumption methods to value ending inventory. Students will be able to value inventory using the LIFO, FIFO, and Average Cost methods.

What is inventory? Will eventually bring in revenue Merchandise Finished Goods Work in process Raw materials

What determines how we value inventory? What type of business we are in? Retail, manufacturing How much variance there is in the unit cost for purchases

Ways to value inventory Specific Identification Identification by specific item, barcode, etc. Ex. VIN # on car lots Cost Flow assumptions First–in-First-out Last-in-First-out Average Cost Method

First-in-First-Out Assumes that the first items in the door are the first items that will be sold Assumes that ending inventory must consist of only the most recent purchases Ending inventory is valued using the most recent purchases going backward.

FIFO cont’d

FIFO cont’d Ending Inventory Total units *most recent prices Dec 1 Purchase price 30 * 30 = $900 *note use the price until you get the pricing on all of the units Cost of Goods Sold Available for sale Less ending inventory 5575 -900 COGS $ 4625

Last-in-First-Out Assumes that the last items in the door are the first items that will be sold Assumes that ending inventory must consist of oldest purchases Ending inventory is valued using the oldest recent purchases going forward.

LIFO cont’d

LIFO cont’d Ending Inventory Total units *oldest prices Beginning inventory $750 (25 units) Feb 1 purchase 5 units 5 * 25 = 125 750+ 125 = 875 Cost of Goods Sold Available for sale Less ending inventory 5575 -875 COGS $ 4700

Average Cost Method Assumes that the unit cost of inventory will remain basically the same throughout the period Ending inventory is valued using the total value of units available during period divided by total units available. This gives you the average unit cost.

Average cost cont’d

Average Cost Method cont’d Ending Inventory Value of total available Inventory $5575 divided by Available units 200 Cost per unit 27.88 Times units in Ending inventory 30 Ending inventory $836.40 Cost of Goods Sold Available for sale Less ending inventory $ 5575.00 -836.40 COGS $ 4738.60

Why do care how we value it? We have to pay taxes on it It affects cost of goods sold, which affects our profits

Which method assumes that the first items in the door are the first items that will be sold? A. FIFO C. LIFO B. Average Cost D. Specific Identification

Which method assumes that the unit cost of inventory will remain basically the same throughout the period? A. FIFO C. LIFO B. Average Cost D. Specific Identification

Which method assumes that ending inventory is valued using the most recent purchases going backward? A. FIFO C. LIFO B. Average Cost D. Specific Identification

Which is not a cost assumption valuation method? A. FIFO C. Specific Identification B. LIFO D. Average Cost Method

Which type of company would use specific identification to value inventory? A. Retail C. Manufacturing B. Car Dealership D. Small Business

Which is not something to consider when choosing a valuation method? A. The way we have always done it C. How often the unit costs changes during the accounting period D. Which gives a better representation of actual cost of the goods that were sold B. The type of business that we are in

The FIFO method assumes that the first items in the door are the first items that will be sold. True False

The LIFO method assumes that ending inventory must consist of only the most recent purchases. True False

There is only one appropriate way to value inventory? True False

A company may change their valuation methods often so that they can show a profit? True False

The end

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Inventory Valuation