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First-In, First-Out (FIFO) Method

First-In, First-Out (FIFO) is one of the


methods commonly used to calculate the
value of inventory on hand at the end of an
accounting period and the cost of goods sold
during the period. This method assumes that
inventory purchased or manufactured first is
sold first and newer inventory remains
unsold. Thus cost of older inventory is
assigned to cost of goods sold and that of
newer inventory is assigned to ending
inventory. The actual flow of inventory may
not exactly match the first-in, first-out
pattern.

First-In, First-Out method can be applied in


both the periodic inventory system and the
perpetual inventory system. The following
example illustrates the calculation of ending
inventory and cost of goods sold under FIFO
method:
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.

Mar 1

Beginning Inventory

68 units @ $15.00 per unit

Purchase

140 units @ $15.50 per unit

Sale

94 units @ $19.00 per unit

11

Purchase

40 units @ $16.00 per unit

16

Purchase

78 units @ $16.50 per unit

20
29

Sale
Sale

116 units @ $19.50 per unit


62 units @ $21.00 per unit

Solution
FIFO Periodic
Units Available for Sale
Units Sold
Units in Ending Inventory
Cost of Goods Sold
Sales From Mar 1
Inventory
Sales From Mar 5
Purchase
Sales From Mar 11
Purchase
Sales From Mar 16
Purchase

= 68 + 140 + 40 + 78

= 326

= 94 + 116 + 62
= 326 272

= 272
= 54

Unit
s

Unit Cost

Total

68

$15.00

$1,020

140

$15.50

$2,170

40

$16.00

$640

24

$16.50

$396

272
Ending Inventory
Inventory From Mar 16
Purchase

$4,226

Unit
s

Unit Cost

Total

54

$16.50

$891

FIFO Perpetual
Purchases
Date
Mar
1
5

Units

140

Unit Cost

$15.50

Total

Unit
s

Sales
Unit
Cost

Total

$2,170

68

$15.00

26

$15.50

$1,02
0
$403

Unit
s

Balance
Unit
Cost

68

$15.00

68

$15.00

140

$15.50

114

$15.50

Total
$1,02
0
$1,02
0
$2,17
0
$1,76
7

11
16

40
78

$16.00
$16.50

$640
$1,287

20

114

$15.50

40

$16.00

114

$15.50

40

$16.00

78

$16.50

114

$15.50

$1,76
7

38

$16.00

$16.00

$32

78

$16.50

38
24

$16.00
$16.50

$608
$396

54

$16.50

29

$1,76
7
$640
$1,76
7
$640
$1,28
7
$608
$1,28
7
$891

Weighted Average Method


The weighted average method is used to
assign the average cost of production to a
product. Weighted average costing is
commonly used in situations where:

Inventory items are so intermingled


that it is impossible to assign a specific cost
to an individual unit.

The accounting system is not


sufficiently sophisticated to track FIFO or
LIFO inventory layers.

Inventory items are so commoditized


(i.e., identical to each other) that there is no
way to assign a cost to an individual unit.
When using the weighted average method,
divide the cost of goods available for sale by
the number of units available for sale, which
yields the weighted-average cost per unit. In

this calculation, the cost of goods available


for sale is the sum of beginning inventory
and net purchases. You then use this
weighted-average figure to assign a cost to
both ending inventory and the cost of goods
sold.
The net result of using weighted average
costing is that the recorded amount of
inventory on hand represents a value
somewhere between the oldest and newest
units purchased into stock. Similarly, the
cost of goods sold will reflect a cost
somewhere between that of the oldest and
newest units that were sold during the
period.
The weighted average method is allowed
under both generally accepted accounting
principles and international financial
reporting standards.

Weighted Average Costing Example


Milagro Corporation elects to use the weighted-average method for the month of May. During that month,
it records the following transactions:

Quantity

Actual

Actual

Change

Unit Cost

Total Cost

Beginning inventory
Sale
Purchase
Sale
Purchase
Ending inventory

The actual total cost of all purchased or


beginning inventory units in the preceding table
is $116,000 ($33,000 + $54,000 + $29,000).
The total of all purchased or beginning inventory
units is 450 (150 beginning inventory + 300
purchased). The weighted average cost per unit
is therefore $257.78 ($116,000 450 units.)
The ending inventory valuation is $45,112 (175
units $257.78 weighted average cost), while
the cost of goods sold valuation is $70,890 (275
units $257.78 weighted average cost). The
sum of these two amounts (less a rounding error)
equals the $116,000 total actual cost of all
purchases and beginning inventory.
In the preceding example, if Milagro used a
perpetual inventory system to record its
inventory transactions, it would have to
recompute the weighted average after every
purchase. The following table uses the same
information in the preceding example to show the
recomputations:

+150

$220

$33,000

-125

--

--

+200

270

54,000

-150

--

--

+100

290

29,000

= 175

Inventory
Inventory

Moving-

Total

Average

Cost

Unit Cost

--

$33,000

$220.00

Units
on Hand
Beginning inventory

150

Sale (125 units @ $220)


Purchase (200 units @ $270)

--

25

--

27,500

5,500

220.00

225

54,000

--

59,500

264.44

75

--

39,666

19,834

264.44

175

29,000

--

48,834

279.05

Sale (150 units @ $264.44)


Purchase (100 units @ $290)

Purchases Cost of Sales

Note that the cost of goods sold of $67,166 and the ending inventory balance of $48,834 equal $116,000,
which matches the total of the costs in the original example. Thus, the totals are the same, but the
moving weighted average calculation results in slight differences in the apportionment of costs between
the cost of goods sold and ending inventory.

The Gross Profit Method


The gross profit method estimates the amount of ending inventory in a reporting period.
This is of use in the following situations:
For interim periods between physical inventory counts.
When inventory was destroyed and you need to back into the ending inventory balance
for the purpose of filing a claim for insurance reimbursement.
Follow these steps to estimate ending inventory using the gross profit method:
Add together the cost of beginning inventory and the cost of purchases during the period
to arrive at the cost of goods available for sale.
Multiply (1 - expected gross profit %) by sales during the period to arrive at the
estimated cost of goods sold.
Subtract the estimated cost of goods sold (step #2) from the cost of goods available for
sale (step #1) to arrive at the ending inventory.
In addition, it is useful to compare the resulting cost of goods sold as a percentage of
sales to the recent trend line for the same percentage, to see if the outcome is
reasonable.
The gross profit method is not an acceptable method for determining the year-end
inventory balance, since it only estimates what the ending inventory balance may be. It
is not sufficiently precise to be reliable for audited financial statements.

Gross Profit Method Example


Amalgamated Scientific Corporation (ASC) is calculating its month-end inventory for
March. Its beginning inventory was $175,000 and its purchases during the month were
$225,000. Thus, its cost of goods available for sale are:
$175,000 beginning inventory + $225,000 purchases = $400,000 cost of goods available
for sale
ASC's gross margin percentage for all of the past 12 months was 35%, which is
considered a reliable long-term margin. Its sales during March were $500,000. Thus, its
estimated cost of goods sold is:
(1 - 35%) x $500,000 = $325,000 cost of goods sold
By subtracting the estimated cost of goods sold from the cost of goods available for sale,
ASC arrives at an estimated ending inventory balance of $75,000.