INVENTORY METHOD

FIFO(First in, First out)

 under this method, there is an assumed flow of manufacturing operations and as such it is considered
that those units which are first placed into process are presumed to be the first ones completed and those
that are first completed are the ones transferred out.
 The FIFO method assumes that “the goods first purchased are first sold” and consequently the goods
remaining in the inventory at the end of the period are those most recently purchased or produced
 The rule is “first come , first sold”

EXAMPLE

Use the following information to calculate the value of inventory on hand on Mar 31 and cost of goods sold
during March in FIFO periodic inventory system and under FIFO perpetual inventory system.

Solution

Mar 1 Beginning Inventory 68 units @ ₱15.00 per unit

5 Purchase 140 units @ ₱15.50 per unit
9 Sale 94 units @ ₱19.00 per unit
11 Purchase 40 units @ ₱16.00 per unit
16 Purchase 78 units @ ₱16.50 per unit
20 Sale 116 units @ ₱19.50 per unit
29 Sale 62 units @ ₱21.00 per unit

FIFO Periodic

Units Available for Sale = 68 + 140 + 40 + 78 = 326

Units Sold = 94 + 116 + 62 = 272
Units in Ending Inventory = 326 − 272 = 54
       
Cost of Goods Sold Units Unit Cost Total
Sales From Mar 1 Inventory 68 ₱15.00 ₱1,020
Sales From Mar 5 Purchase 140 ₱15.50 ₱2,170
Sales From Mar 11 Purchase 40 ₱16.00 ₱640
Sales From Mar 16 Purchase 24 ₱16.50 ₱396
  272   ₱4,226
       
Ending Inventory Units Unit Cost Total
Inventory From Mar 16 Purchase 54 ₱16.50 ₱891
FIFO Perpetual

Purchases Sales Balance

Date Unit Unit Unit
Units Total Units Total Units Total
Cost Cost Cost
Mar 1             68 ₱15.00 ₱1,020
5 140 ₱15.50 ₱2,170       68 ₱15.00 ₱1,020
              140 ₱15.50 ₱2,170
9       68 ₱15.00 ₱1,020 114 ₱15.50 ₱1,767
        26 ₱15.50 ₱403      
11 40 ₱16.00 ₱640       114 ₱15.50 ₱1,767
              40 ₱16.00 ₱640
16 78 ₱16.50 ₱1,287       114 ₱15.50 ₱1,767
              40 ₱16.00 ₱640
              78 ₱16.50 ₱1,287
20       114 ₱15.50 ₱1,767 38 ₱16.00 ₱608
        2 ₱16.00 ₱32 78 ₱16.50 ₱1,287
29       38 ₱16.00 ₱608 54 ₱16.50 ₱891
 
        24 ₱16.50 ₱396

PERIODIC INVENTORY METHOD

 Under periodic inventory system inventory account is not updated for each purchase and each sale. All
purchases are debited to purchases account. At the end of the period, the total in purchases account is added
to the beginning balance of the inventory to compute cost of goods available for sale. The ending inventory
is determined at the end of the period by a physical count and subtracted from the cost of goods available for
sale to compute the cost of goods sold.

The general formula to compute cost of goods sold under periodic inventory system is given below:

Cost of goods sold (COGS) = Beginning inventory + Purchases – Closing inventory

Example

The following information belongs to John company, a retailer of high-end fashion products:

 Inventory balance on January 1, 2016: ₱600,000

 Purchases made during the year 2016: ₱1,200,000
 Inventory balance on December 31, 2016: ₱500,000

Required: Compute cost of goods sold for the year 2016 assuming the company uses a periodic inventory
system.

Solution:

Cost of goods sold (COGS) = Beginning inventory + Purchases – Closing inventory

= ₱600,000 + ₱1,200,000 – ₱500,000
= ₱1,300,000
Example:

The following information belongs to Paradise Hardware Store:

Beginning inventory: 200 units at ₱12 = ₱2,400

Purchases made during the period: 1800 units at ₱12 = ₱21,600
Sales made during the period: 1200 units at ₱24 = ₱28,800
Ending inventory: 800 units at ₱12 = ₱9,600

Required: Make journal entries to record above transactions assuming a periodic inventory system is used
by Paradise Hardware Store.

Solution:

* (21,600 + 2,400) – 9,600

Periodic inventory system is usually used by companies that buy and sell a wide variety of inexpensive
products.

A disadvantage of periodic inventory system is that overages and shortages of inventory are buried in cost of
goods sold because no accounting record is available against which to compare physical count of inventory.
PERPETUAL INVENTORY METHOD
 The perpetual inventory system is used in accounting to keep inventory records. This system assumes
that the inventory account and the cost of goods sold (COGS) account are updated after each
transaction. Common examples of such transactions are purchase and sale of inventory, purchase and
sales returns, and purchase and sales discounts.
In the perpetual inventory system, each sales transaction requires two journal entries. The first one is
recorded by debiting accounts receivable and crediting the sales account by the sale value of inventory. The
second one is recorded by debiting the inventory account and crediting the accounts payable account if the
sale was made on credit.

Calculation example
RetailX LTD has made the following transactions during March

Assume that the retailer is using the FIFO inventory method.

Mar 1
Inventory Account Balance = 2,500 × $80 = $200,000
Mar 6
Sale = 1,800 × $80 = $189,000
COGS = 1,800 × $80 = $144,000
Inventory account balance = $200,000 + $144,000 = $56,000
Mar 9
Purchase = 4,000 × $85 = $340,000
Inventory Account Balance = $56,000 + $340,000 = $396,000
Mar 17
Sale = 2,300 × $120 = $276,000
COGS = 700 × $80 + 1,600 × $85 = $192,000
Inventory Account Balance = $396,000 – $192,000 = $204,000
Mar 23
Sale = 1,500 × $120 = $180,000
COGS = 1,500 × $85 = $127,500
Inventory Account Balance = $204,000 – $127,500 = $76,500
Mar 27
Purchase = 3,000 × $90 = $270,000
Inventory Account Balance = $76,500 + $270,000 = $346,500
During the accounting period, total sales totaled $645,000, total purchases $610,000, and the cost of goods
sold $463,500. In turn, the balance of inventory account amounted to $346,500 as of 31st of March.

Example
Let’s assume that RetailX LTD makes all purchases and sales on credit. In this instance, journal entries
should look as follows:

T-accounts
In accounting, T-accounts are used to show the balance of each account. Debits are always recorded on the
left side, and credits are always recorded on the right side.
Let’s transform general journal entries from the example above to a T-accounts format.
The inventory is a real asset account; thus, debit increases its balance, and credit decreases it.

The cost of goods sold is a temporary account, so its balance at the beginning of the accounting period
always equals zero. At the end of the accounting period, its balance is transferred to another account, which
is called closing the account.

Accounts receivable is a real asset account. Let’s assume its balance equals zero at the beginning of the
accounting period. In such cases, records should look as follows:

Accounts payable is a real liability account; thus, debits increase it, and credits decrease it. Let’s assume that
its balance equals zero on Mar 1.
The sales account is a temporary account, so it should be displayed as follows:

WEIGHTED AVERAGE METHOD

 under this method there is no assumed flow of manufacturing operation. It involves the merging of
departmental costs, by elements, of the initial work in process inventory with the costs incurred in the
current month and securing a representative average unit cost by dividing the total element of costs by
the equivalent production based upon the sum of units in the initial work in process inventory and the
units placed into productions during the period.
LIFO stands for “Last-In, First-Out”.

 It is a method used for cost flow assumption purposes in the cost of goods sold calculation. The LIFO
method assumes that the most recent products added to a company’s inventory have been sold first.
The costs paid for those recent products are the ones used in the calculation.

The LIFO method is used in the COGS (Cost of Goods Sold) calculation when the costs of producing a
product or acquiring inventory has been increasing. This may be due to inflation.

Although the LIFO accounting method may mean a decrease in profits for a business, it can also mean less
corporate tax a company has to pay. Should the cost increases last for some time, then these savings could
be significant for a business.

Brad runs a small bookstore in Makati called Brad’s Books. He has two partners but they do not
oversee the day-to-day operations, they are merely investors. Brad does most of the work and has
been in business for two months.

Brad prides himself on always making sure his store carries the latest hardcover releases,
because traditionally sales of them have been reported as very good. However, the book industry
has been going through a hard time recently with an increase in customers switching to digital
readers, meaning less demand. As such, his inventory costs have been steadily increasing.
Here is what it’s been costing Brad to build up his inventory:

On Dec 31, Brad looks through the store sales and realizes that Brad’s Books has sold 450 books
to-date. Brad would now like to run a report for his partners that shows the cost of goods sold.

Using the LIFO method, Brad would start with his most recent per book cost of $20.00. However,
he cannot apply that unit price to all 600 books, because he did not pay that price for all 600. What
he can do is this:

Cost of Goods Sold Calculation:

COGS Total: $8662.50

The 450 books are now no longer considered inventory, they are considered cost of goods sold.
The value of the remaining books will stay in inventory.

The LIFO method assumes that Brad is selling off his most recent inventory first. Since customers
expect new novels to be circulated onto Brad’s store shelves regularly, then it is likely that Brad
has been doing exactly that. In fact, the oldest books may stay in inventory forever, never
circulated. This is a common problem with the LIFO method once a business starts using it, in that
the older inventory never gets onto shelves and sold. Depending on the business, the older
products may eventually become outdated or obsolete.

Under LIFO, using the most recent (and more expensive) costs first will reduce the company’s
profit but decrease Brad’s Books’ income taxes.