Lecture 7: Inventory

I. Introduction
Inventories are assets:
• Held for sale in the ordinary course of business

• In the process of production for such sale

• In the form of materials or supplies to be consumed in the production process or in the

rendering of services

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II. Costs Included in Inventory
Cost is defined as being that expenditure which has been incurred in bringing the inventories to their
present location and condition. Cost includes:

Costs of purchase:
• Purchase price including import duties, transport and handling costs, and any other directly
attributable costs, less trade discounts, rebates and subsidies.

Costs of conversion:
• costs directly related to production (e.g., direct labour):

• Manufacturing overhead costs include indirect materials, indirect labour, and various costs, such
as depreciation, insurance, and utilities.

Other costs:
• Other costs are included only to the extent that they are incurred in bringing the inventories to
their present location and condition.

Costs not to be included in inventory:

• abnormal waste
• storage costs
• administrative overheads not related to production (non-production overheads)
• selling costs

Question 1:

Question 2:

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 Question 2:

III. Comparing Perpetual and Periodic Systems

Question 4:

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IV. Techniques for valuing closing inventory cost
Cost methods allowed
1. FIFO (first-in, first-out)
2. Average cost
3. Specific individual cost
4. Retail method

Cost method NOT allowed

LIFO (last-in, first-out)

1. FIFO (first-in, first-out)

The first-in, first-out (FIFO) method assumes that a company uses goods in the order in which it
purchases them.

In other words, the FIFO method assumes that the first goods purchased are the first used (in a
manufacturing concern) or the first sold (in a merchandising concern). The inventory remaining must
therefore represent the most recent purchases.

2. Average cost
As the name implies, the average-cost method prices items in the inventory on the basis of the
average cost of all similar goods available during the period.

• Periodic Average cost (Periodic AVCO)

In this method, the cost of all purchase during the year is divided by the total number of units
purchased.

• Continuous Weighted Average Cost (Continuous AVCO)

In this method, Companies compute a new average unit cost each time it makes a purchase

3. Specific individual cost

Specific identification calls for identifying each item sold and each item in inventory.

This method may be used only in instances where it is practical to separate physically the different
purchases made. As a result, most companies only use this method when handling a relatively small
number of costly, easily distinguishable items.

This includes some types of jewellery, fur coats, automobiles, and some furniture.

4. Retail method
The retail method is often used in the retail industry for measuring inventories of large numbers of
rapidly changing items with similar margins. The cost of the inventory is determined by reducing tis
sales value by the appropriate percentage gross margin.

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Question 5:
On 1 July 2021 a company held 200 units of finished goods inventory. These were valued
at $10 each. During July two batches of finished goods were purchased as follows:

Quantity Unit Cost

Units $
5 July 500 10.50
19 July 450 11.00

Goods were sold out of inventory during July as follows:

Quantity
Units
12 July 600
26 July 500

Note: Average unit cost should be rounded to four decimal places.

1. Determine closing inventory and cost of goods sold using FIFO

FIFO Method
Date Purchases Cost of Goods Sold Balance
1-Jul 200 units @ $10
$7,250
5-Jul 500 units @ $10.50 500 units @ $10.50

12-Jul 200 units @ $10

400 units @ $10.50 100 units @ $10.50 $1,050

19-Jul 450 units @ $11.00 100 units @ $10.50

$6,000
450 units @ $11.00

26-Jul 100 units @ $10.50

400 units @ $11.00 50 units @ $11.00 $550

• Closing inventory = $500

• Cost of goods sold = (200 x 10) + (400 x 10.50) + (100 x 10.50) + (400 x 11.00) = $11,650

2. Determine closing inventory and cost of goods sold using Periodic AVCO

Periodic AVCO Method

Date Purchases Cost of Goods Sold Balance
1-Jul 200 units @ $10
5-Jul 500 units @ $10.50 500 units @ $10.50 $10.6087
19-Jul 450 units @ $11.00 450 units @ $11.00

• Closing inventory = 50 x 10.6087 = $530

• Cost of goods sold = 1,100 x 10.6087 = $11,670

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 3. Determine closing inventory and cost of goods sold using Continuous AVCO

Continuous AVCO Method

Date Purchases Cost of Goods Sold Balance
1-Jul 200 units @ $10
$10.3571
5-Jul 500 units @ $10.50 500 units @ $10.50

12-Jul 600 units @ $10.3571 100 units @ $10.3571

19-Jul 450 units @ $11.00 100 units @ $10.3571

$10.8831
450 units @ $11.00

26-Jul 500 units @ $10.8831 50 units @ $10.8831

• Closing inventory = 50 x 10.8831 = $544

• Cost of goods sold = (600 x 10.3571) + (500 x 10.8831) = $11,656

V. Effect on profit and assets

In times of rising prices, FIFO produces a higher closing inventory figure, a lower cost of
sales figure and therefore a higher profit figure than AVCO.

Question 6:

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Question 7:

FIFO Method
Date Purchases Cost of Goods Sold Balance

Question 8:

Periodic AVCO Method

Date Purchases Cost of Goods Sold Balance

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Question 9:

Continuous AVCO Method

Date Purchases Cost of Goods Sold Balance

Question 10:

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