Which of the following methods identifies the cost of each individual item in the ending inventory?
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Whenever prices change, the allocation of total inventory costs between cost of sales on the income statement and inventory on the balance sheet will vary depending on a company’s choice of inventory valuation method. Calculation of Cost of Sales, Gross Profit, and Ending InventoryThe following example can help illustrate how the calculation of the cost of sales, gross profit, and ending inventory will differ under the four inventory valuation methods. Example 1In one year, a company received 3 shipments of 1,000 sewing machines at $110 each, then 2,500 sewing machines at $100 each, and finally 3,200 sewing machines at $95 each. During the year, the company sold 5,600 sewing machines at $200 each. The company is able to readily identify each shipment received. As a result, the company determines that the entire first shipment (1,000 sewing machines), 1,800 sewing machines from the second shipment, and 2,800 sewing machines from the third shipment were sold to customers during the year. The sales, cost of sales, gross profit, and ending inventory amounts under each inventory valuation method is as follows: Under the LIFO MethodSales: 5,600 × $200 = $1,120,000 COGS: (2,400 × $100) + (3,200 × 95) = $544,000 Gross Profit: $1,120,000 – $544,000 = $576,000 Ending Inventory: (1,000 × $110) + (10 0× $100) = $120,000 Under the FIFO MethodSales: 5,600 × $200 = $1,120,000 COGS: (1,000 × $110) + (2,500 × $100) + (2,100 × $95) = $559,500 Gross Profit: $1,120,000 – $559,500 = $560,500 Ending Inventory: (1,100 × $95) = $104,500 Under the Specific Identification MethodSales: 5,600 × $200 = $1,120,000 COGS: (1,000 × $110) + (1,800 × $100) + (2,800 × $95) = $556,000 Gross Profit: $1,120,000 – $556,000 = $564,000 Ending Inventory: (700 × $100) + (400 × $95) = $108,000 Under the Weighted Average Cost MethodSales: 5,600 × $200 = $1,120,000 Weighted Average Cost: [(1,000 × $110) + (2,500 × $100) + (3,200 × $95)] / 6,700 = $99.10 COGS: 5,600 × $99,10 = $554,960 Gross Profit: $1,120,000 – $554,960 = $565,040 Ending Inventory: 1,100 × $99.10 = $109,010 InterpretationThe calculation demonstrates how each valuation method provides similar sales figures but different figures for the cost of sales, gross profit, and ending inventory. This arises from the fact that:
Periodic versus Perpetual Inventory SystemsChanges to inventory are usually recorded using either a periodic inventory system or a perpetual inventory system. Under a periodic inventory system, inventory values and costs of sales are determined at the end of an accounting period, and the number of goods in ending inventory is obtained or verified through a physical count of the units in inventory. The cost of goods available for sale allocated to the cost of sales and ending inventory may be quite different if the FIFO method is used compared to when the weighted average cost method is used. Under a perpetual inventory system, the inventory values and cost of sales are continuously updated to reflect purchases and sales. Under either system, the allocation of goods available for sale to the cost of sales and ending inventory is the same if the inventory valuation method used is either specific identification or FIFO. Both systems will also result in different allocations to the cost of sales and ending inventory if the LIFO method is used in inventory valuation. Example 2Cameron Ltd. is an electronic retailer company that uses a tracking system to identify every single item in its inventory. The following table illustrates the company’s purchases and sales of LCD screens during the month of April 2017. Assume that the company had no inventory of LCD screens at the beginning of the period and that it sells each unit for $700. Using the given information, calculate the cost of goods sold, the gross profit, and the ending inventory. $$ \begin{array}{c|c|c} \text{} & \textbf{LCD Screens} & \text{} \\ \hline \textbf{Date} & { \textbf{Purchases} } & \textbf{Volume of Sales} \\ \hline {} & {\textbf{Amount} \quad \textbf{Price}} & {} \\ \hline {1^\text{th}} & {{1000} \quad {500$}} & \text{NA} \\ \hline {8^\text{th}} & {\text{NA} \quad \text{NA}} & {800} \\ \hline {15^\text{th}} & {{1200} \quad {650$}} & \text{NA} \\ \hline {20^\text{th}} & {\text{NA} \quad \text{NA}} & {1000} \\ \hline {28^\text{th}} & {{1100} \quad {600$}} & \text{NA} \\ \hline {30^\text{th}} & {\text{NA} \quad \text{NA}} & {1200} \\ \hline \textbf{Total} & \bf{ { 3,300} \quad {1,940,000}} & \bf{3000} \\ \end{array} $$ No matter which method we use, the value of sales would always be the same Revenue = Selling price per unit × Number of units sold = $700 × 3,000 = $2,100,000 1. Calculations Using the Perpetual MethodUnder the FIFO MethodCost of goods sold (COGS) = [(800 units × $500) + ((200 units × $500) + (800 units × $650)) + ((400 units × $650) + (800 units × $600)) = $1,760,000 Ending inventory = Beginning inventory + Purchases – COGS = 0 + $1,940,000 – $1,760,000 = 180,000 Gross profit = revenue – COGS = $2,100,000 – $1,760,000 = $340,000 Under the Specific Identification MethodThe cost of each item sold is separately added to the cost of sales. The rest of the steps would be the same as they are in any other method. Since the items in the example (LCD screens) are interchangeable, and it was not clearly disclosed which batch was sold first, we would assume that the company followed a first in, first-out basis. Under this assumption, the ending inventory and gross profit would be the same as they are under FIFO. Under the Weighted Average Cost MethodFirst, we need to find the average cost of each unit. Average cost per unit on April 8th = $500 Average cost per unit on April 20th = [(200 × 500) + (1,200 × 650)] / 1400 = 629 Average cost per unit on April 30th = [(400 × 650) + (1,100 × 600)] / 1500 = 613 Total cost of all units sold within the period = (800 × 500) + (1,000 × 629) + (1,200 × 613) = 1,764,600 Ending inventory = Beginning inventory + Purchases – COGS = $0 + $1,940,000 – $1,764,600= $175,400 Gross profit = Revenue – COGS = 2,100,000– $1,764,600= $336,000 Under the LIFO MethodThe cost of sales would be determined according to the price of the last purchased items. Cost of sales = (800 units × $500) + (1,000 units × $650) + [(1100 units × $600) + (100 units × $650)] = $1,775,000 Ending inventory = Beginning inventory + Purchases – COGS = $0 + $1,940,000 – $1,775,000 = $165,000 Gross profit = Revenue – Cost of sales = $2,100,000– $1,775,000 = $325,000 2. Calculations Using the Periodic MethodUnder the FIFO MethodThe results would be the same as with the perpetual system. Under the Specific Identification MethodThe results would be the same as with the perpetual system. Under the Weighted Average Cost MethodFirst, we need to find the average of the total cost of units. Average cost/Unit = Total amount of purchase cost/Total number of units purchased = $1,940,000/$3,300 = $587.88 COGS = [Average cost/Unit] × Number of units sold = $587.88 × $3,000 = $1,763,636 Ending inventory = Beginning inventory + Purchases – COGS = $0 + $1,940,000 – $1,763,636 = $176,364 Gross profit = Revenue – COGS = $2,100,000 – $1,763,636 = $336,364 As we can see, the difference between the periodic and the perpetual systems under the weighted average cost method is only $364. Under the LIFO MethodCOGS = (800 units × $600) + [(300 units × $600) + (700 units × $650)] + [(500 units × $650) + (700 units × $500)] = $1,790,000 Ending inventory = Beginning inventory + Purchases – COGS = $0 + $1,940,000 – $1,790,000 = 150,000 Gross profit = Revenue – COGS = $2,100,000 – $1,790,000 = $310,000 Comparing the LIFO method under the periodic system with the same method under the perpetual system, we notice that under the periodic system, the value of gross profit and the value of ending inventory is $15,000 higher under the periodic system.
What are the methods of inventory to identify the cost?The four main inventory valuation methods are FIFO or First-In, First-Out; LIFO or Last-In, First-Out; Specific Identification; and Weighted Average Cost.
What is FIFO and LIFO method?Key Takeaways. The Last-In, First-Out (LIFO) method assumes that the last unit to arrive in inventory or more recent is sold first. The First-In, First-Out (FIFO) method assumes that the oldest unit of inventory is the sold first.
How do you find the ending inventory using FIFO?According to the FIFO method, the first units are sold, and the calculation uses the newest units. So, the ending inventory would be 1,500 x 10 = 15,000 since $10 was the cost of the newest units purchased. The ending inventory for Harod's company would be $15,000.
What are the 4 types of cost flow methods?There are four generally accepted methods for assigning costs to ending inventory and cost of goods sold: specific cost; average cost; first‐in, first‐out (FIFO); and last‐in, first‐out (LIFO).
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