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Valuation & Accounting of Inventory

The document discusses different methods for valuing inventory in a perpetual inventory system, including first-in, first-out (FIFO), last-in, first-out (LIFO), and average costing. It provides examples of applying each method to calculate cost of goods sold and ending inventory balance. FIFO assumes older inventory is sold first while LIFO assumes newer inventory is sold first. Average costing uses a weighted average cost per unit.

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Prasad Bhanage
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0% found this document useful (0 votes)
79 views21 pages

Valuation & Accounting of Inventory

The document discusses different methods for valuing inventory in a perpetual inventory system, including first-in, first-out (FIFO), last-in, first-out (LIFO), and average costing. It provides examples of applying each method to calculate cost of goods sold and ending inventory balance. FIFO assumes older inventory is sold first while LIFO assumes newer inventory is sold first. Average costing uses a weighted average cost per unit.

Uploaded by

Prasad Bhanage
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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FYMMS – Financial Accounting

Valuation and Accounting of Inventory


(University of Mumbai)

Dr. Prasad Bhanage – Director – MSIBM, Khed, Ratnagiri 415709.


Mobile:9850994143
Email: [email protected]
[email protected]
Methods of Valuation of Inventory
1. First-in, first-out (FIFO) method in perpetual inventory system
2. Last-in, first-out (LIFO) method in a perpetual inventory system
3. Average costing method in perpetual inventory system
First-in, first-out (FIFO) method in perpetual
inventory system
• The first-in, first-out (FIFO) method is a widely used inventory valuation method that
assumes that the goods are sold (by merchandising companies) or materials are issued
to production department (by manufacturing companies) in the order in which they
are purchased. In other words, the costs to acquire merchandise or materials are
charged against revenues in the order in which they are incurred.

• Under first-in, first-out method, the ending balance of inventory represents the most
recent costs incurred to purchase merchandise or materials.

• The use of FIFO method is very common to compute cost of goods sold and the ending
balance of inventory under both perpetual and periodic inventory systems. The
example given below explains the use of FIFO method in a perpetual inventory system.
Example 1
• The Fine Electronics company uses perpetual inventory system to account for acquisition and sale of
inventory and first-in, first-out (FIFO) method to compute cost of goods sold and for the valuation of ending
inventory. The company has made the following purchases and sales during the month of January 2016.
• Jan. 01: Inventory at the beginning of the month; 24 units @ $1,000 per unit.
• Jan. 04: Sales: 16 units.
• Jan. 07: Purchases; 12 units @ $1,020 per unit.
• Jan. 10: Purchases; 10 units @ $1,050 per unit.
• Jan. 14: Sales; 16 units.
• Jan. 23: Sales; 12 units.
• Jan. 24: Purchases; 12 units @ $1,060 per unit.
• Jan. 27: Purchases; 4 units @ $1,080 per unit.
• Jan. 29: Sales; 6 units.
• During the month, all sales have been made @ $1600 per unit.
You are Required to -
• Prepare journal entries to record the above transactions under perpetual inventory system.
• Prepare a FIFO perpetual inventory card.
• Compute the cost of goods sold and the cost of inventory in hand at the end of the month of January 2012.
Inventory Valuation
Cost of goods sold (COGS) and ending
inventory
1. Cost of goods sold: $16,000 + $8,000 + $8,160 + $4,080 + $8,400 +
$2,100 + $4,240 = $50,980
2. Ending inventory: $8,480 + $4,320 = $12,800
Last-in, first-out (LIFO) method in a
perpetual inventory system
• In contrast to first-in, first-out (FIFO) method, the last-in, first-out (LIFO)
method of inventory valuation assumes that the last costs incurred to
purchase merchandise or direct materials are first costs charged against
revenues. In other words, it assumes that the cost of merchandise sold
(in a merchandising company) or the cost of materials issued to
production department (in a manufacturing company) is the cost of
most recent purchases.
• Like first-in, first-out (FIFO), last-in, first-out (LIFO) method can be used
in perpetual inventory system. The following example explains the use
of LIFO method for computing cost of goods sold and the cost of ending
inventory in a perpetual inventory system.
Example 2
LIFO perpetual inventory system in a merchandising company
• BZU uses perpetual inventory system to record purchases and sales and LIFO method
to valuate its inventories. The company has provided the following information about
commodity DX-13C and wants your assistance in computing the cost of commodity
DX-13C sold and the cost of ending inventory of commodity DX-13C.
1. Aug. 01: Beginning inventory; 20 units @ $40 per unit.
2. Aug. 07: Sales; 14 units.
3. Aug. 12: Purchases; 16 units @ $42 per unit.
4. Aug. 17: Sales; 8 units.
5. Aug. 23: Sales; 4 units.
6. Aug. 27: Purchases; 8 units @ $44 per unit.
7. Aug. 30: Sales; 10 units.
You are required to:
• Prepare a LIFO perpetual inventory card.
• Compute cost of goods sold and the cost of ending inventory using LIFO method.
1. LIFO perpetual inventory card
2. Cost of goods sold (COGS) and ending inventory
• LIFO perpetual inventory card (prepared above) can help compute
cost of goods sold and ending inventory.
1. Cost of goods sold (COGS): $560 + $336 + $168 + $436 = $1,500
2. Ending inventory: [$240 + $84] = $324

• When LIFO method is used in a perpetual inventory system, it is


typically known as “LIFO perpetual system”.
• The above example explains the use of LIFO perpetual system in a
merchandising company.
• In manufacturing companies, it is used to compute the cost of
materials issued to production and cost of ending inventory of raw
materials (also known as direct materials).
Example 3
LIFO perpetual system in a manufacturing company
• The Three Star company manufactures product X. Material K5 is used to manufacture product X. The
information about the acquisition and issuance of material K5 for the month of June is given below:
• Jun. 01: Beginning inventory; 50 kgs @ $4.80/kg and 100 kg @ $5.00/kg.
• Jun. 05: 10 kgs of material K5 were returned to supplier.
• Jun. 09: 35 kgs of material K5 were issued to factory.
• Jun. 12: 70 kgs of material K5 were purchased @ $5.10/kg.
• Jun. 17: 50 kgs of material K5 were issued to factory.
• Jun. 19: 25 kgs of material K5 were issued to factory.
• Jun. 23: 50 kgs of material K5 were purchased @ $5.20/kg
• Jun. 26: 60 kgs of material K5 were issued to factory.
• Jun. 30: 5 kgs of material K5 were returned from factory to store room.
• A perpetual inventory system is used to account for acquisition and issuance of direct materials.

You are required to compute:


1. the cost of material K5 issued to factory and
2. the cost of material K5 at the end of June using last-in, first-out (LIFO) method.
1. LIFO perpetual material card
• * Materials returned from store room to supplier is usually recorded
in purchases column and materials returned from factory to store
room is usually written in issues column. The returns are normally
written in red ink to differentiate them from normal purchases and
issues.
1. Cost of material issued to factory:
• = $175 + $255 + $102 + $25 + $260 + $50 – $25*
• = $842
• *Material returned from factory to store room

2. Cost of inventory on hand on June 30th:


• = $240 + $225
• = $465
Average costing / weighted average method
• Under average costing /weighted average method, the average cost of
all similar items in the inventory is computed and used to assign cost
to each unit sold. Like FIFO and LIFO methods, this method is used in
perpetual inventory system.
Example 4
Weighted Average Method of Inventory Valuation
• The Meta company is a trading company that purchases and sells a single product – product X.
The company has the following record of sales and purchases of product X for the month of June
2013.
1. June 01: Balance on hand at the beginning of the month; 200 units @ $10.15.
2. June 05: Purchased 800 units @ $10.25.
3. June 07: Sold 400 units.
4. June 12: Purchases: 600 units @ $10.40.
5. June 14: Sales: 500 units
6. June 20: Purchases: 400 units @ $10.50
7. June 25: Purchases: 800 units @ $10.70
8. June 26: Sales: 1,400 units
9. June 28: Sales: 200 units
10. June 30: Purchases: 600 units @ $10.85

You are required to -


• Compute inventory cost at June 30, 2013 using average cost method assuming the Meta company
uses perpetual inventory system.
1. Inventory Card by Weighted Average Method
2. Cost of goods sold: $4,092 + $5,158 + $14722 + $2,103 = $26,075
(Total of sales column)
3. Cost of ending inventory: $9,665 (Balance column)
THANK YOU

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