Subject: Accounting & Cost

Teacher: Eng. Carlos Chanta

Homework: Inventory recording

methodologies

Students:
Carnet Name
66-1453-2021 SANCHEZ LIMA JOCELYN ESMERALDA

San Salvador, 12th november 2022

Table of contents

Objective General...............................................................................................................................3
Objectives Specifics........................................................................................................................3
Introduction.......................................................................................................................................4
Method FIFO..................................................................................................................................5
Example of FIFO.............................................................................................................................5
Method LIFO..................................................................................................................................7
Example of the FIFO.......................................................................................................................7
Method WACC................................................................................................................................9
Example WACC...............................................................................................................................9
Conclusions..................................................................................................................................11
Bibliography.................................................................................................................................12
Objective General
Investigate the different inventory management methods.

Objectives Specifics
 Know and detail the differences between each inventory management method.
 Identify which of the methods is the most convenient regardless of the area of application.
 Detail the applications that each inventory management method has.
Introduction
In this document, the different methods of inventory management that exist are disclosed, which
are their applications, advantages and disadvantages, inventory management over time has taken
relevance since it helps to keep track of the income and output of merchandise. Considering the
monetary value to focus on maintaining the balance of earnings and investments.

The importance of knowing in detail the characteristics of each inventory management method is
detailed, since each one adapts to the different needs that are generated in the different areas of
application.

Different examples of each method are detailed to better understand what its use is and how the
inventory should be calculated based on the income and outputs that are held in a certain period.
Method FIFO
The FIFO method gets its name from First in First Out. In other words, what has first entered our
warehouse must be what is first given out. It is one of the most used logistics management
methods when handling perishable products, as it seeks to prevent products from reaching their
expiration date in our facilities and thus reduce our losses for this reason.

How a warehouse is valued using the FIFO method

A very important part of keeping good inventory control in our warehouse is knowing exactly what
the value of our merchandise is. This assessment is something that we will usually need in order
not only to optimize our logistics processes, but also to comply with accounting legislation. For this
it is necessary to always have a series of parameters correctly registered:

 Date of acquisition or sale of our products

 Number of units sold or purchased
 Purchase price of each unit

Merchandise receipts

Each entry of products in our warehouse will be reflected in a double column that reflects the
quantity purchased and its purchase price. The product of both quantities will give us the value of
that merchandise in our warehouse.

To know the total value of our warehouse, simply add the amounts resulting from each new entry.

Merchandise outputs

Every time a product is removed from our warehouse, we will discount it from the oldest item,
moving to the next one in time in the event that there is not enough product to complete the
shipment.

The value of our warehouse at that time will be the result of adding the amount of the remaining
items to their corresponding price. In this way, the important thing when making a valuation of
our warehouse according to the FIFO method will not be the sale price, but the price at which we
bought the merchandise at the time.

Example of FIFO
Inventory is assigned costs as items are prepared for sale. This may occur through the purchase of
the inventory or production costs, the purchase of materials, and the utilization of labor. These
assigned costs are based on the order in which the product was used, and for FIFO, it is based on
what arrived first.

Imagine if a company purchased 100 items for $10 each, then later purchased 100 more items for
$15 each. Then, the company sold 60 items. Under the FIFO method, the cost of goods sold for
each of the 60 items is $10/unit because the first goods purchased are the first goods sold. Of the
140 remaining items in inventory, the value of 40 items is $10/unit and the value of 100 items is
$15/unit. This is because inventory is assigned the most recent cost under the FIFO method.
With this remaining inventory of 140 units, let's say the company sells an additional 50 items. The
cost of goods sold for 40 of these items is $10, and the entire first order of 100 units has been fully
sold. The other 10 units that are sold have a cost of $15 each, and the remaining 90 units in
inventory are valued at $15 each (the most recent price paid).

In some countries, FIFO is the required accounting method for keeping track of inventory, and it is
also popular in countries where it is not mandatory. Because FIFO is considered the more
transparent accounting method, it is also less likely to be scrutinized by the tax authorities.
Method LIFO
The last in, first out method is used to place an accounting value on inventory. The LIFO method
operates under the assumption that the last item of inventory purchased is the first one sold.
Picture a store shelf where a clerk adds items from the front, and customers also take their
selections from the front; the remaining items of inventory that are located further from the front
of the shelf are rarely picked, and so remain on the shelf that is a LIFO scenario.

The trouble with the LIFO scenario is that it is rarely encountered in practice. If a company were to
use the process flow embodied by LIFO, a significant part of its inventory would be very old, and
likely obsolete. Nonetheless, a company does not actually have to experience the LIFO process
flow in order to use the method to calculate its inventory valuation.

Effects of LIFO Inventory Accounting

The reason why companies use LIFO is the assumption that the cost of inventory increases over
time, which is a reasonable assumption in times of inflating prices. If you were to use LIFO in such
a situation, the cost of the most recently acquired inventory will always be higher than the cost of
earlier purchases, so the ending inventory balance will be valued at earlier costs, while the most
recent costs appear in the cost of goods sold. By shifting high-cost inventory into the cost of goods
sold, a company can reduce its reported level of profitability, and thereby defer its recognition of
income taxes. Since income tax deferral is the only justification for LIFO in most situations, it is
banned under international financial reporting standards (though it is still allowed in the United
States under the approval of the Internal Revenue Service).

Example of the FIFO

Milagro Corporation decides to use the LIFO method for the month of March. The following table
shows the various purchasing transactions for the company’s Elite Roasters product. The quantity
purchased on March 1 actually reflects the inventory beginning balance.

The following bullet points describe the transactions noted in the preceding table:

 March 1. Milagro has a beginning inventory balance of 150 units, and sells 95 of these
units between March 1 and March 7. This leaves one inventory layer of 55 units at a cost
of $210 each.
 March 7. Milagro buys 100 additional units on March 7, and sells 110 units between March
7 and March 11. Under LIFO, we assume that the latest purchase was sold first, so there is
still just one inventory layer, which has now been reduced to 45 units.
 March 11. Milagro buys 200 additional units on March 11, and sells 180 units between
March 11 and March 17, which creates a new inventory layer that is comprised of 20 units
at a cost of $250. This new layer appears in the table in the “Cost of Layer #2” column.
 March 17. Milagro buys 125 additional units on March 17, and sells 125 units between
March 17 and March 25, so there is no change in the inventory layers.
 March 25. Milagro buys 80 additional units on March 25, and sells 120 units between
March 25 and the end of the month. Sales exceed purchases during this period, so the
second inventory layer is eliminated, as well as part of the first layer. The result is an
ending inventory balance of $5,250, which is derived from 25 units of ending inventory,
multiplied by the $210 cost in the first layer that existed at the beginning of the month.

Advantages of the LIFO method.

The benefits that this logistics method can bring us are the following:

 By having a system whereby the last products we buy are the first we sell. At the
moment when prices rise and recent purchases have a higher price than the goods we
have bought older, the LIFO allows us a result that leads to a higher cost of goods sold,
so it counts. With a lower income than the FIFO.
 This method for warehouse management is used only for homogeneous products,
such as coal, bricks, stone or sand, among others. The way it works is that when a
batch enters the warehouse, it will be stacked on top of the previous batch, so the
newest batch is used first.
 LIFO makes a better comparison of current income and current expenses than FIFO.
This means that it has greater precision when calculating the real cost of the products
sold. However, we should note that the FIFO more accurately reflects the value of
inventory and current costs.
Method WACC
The WACC, which stands for Weighted Average Cost of Capital, also called the weighted average
cost of capital (WACC), is the discount rate used to discount future cash flows when valuing an
investment project. It is interesting to assess the calculation of this rate or it may be useful taking
into account three different approaches. As an asset of the company: it is the rate that should be
used to discount the expected cash flow; from liabilities: the economic cost for the company of
attracting capital to the sector; and as investors: the return they expect, when investing in the
company's debt or equity.

WACC formula, how to calculate it:

Example WACC
The main advantage of the WACC is that it determines the cost of the investment regardless of the
financing sources in order to determine a higher rate of return than the WACC and therefore
generate added value for the shareholders.

On the other hand, one of its drawbacks is that the WACC assumes that the capital structure
remains constant, so it does not contemplate the possibility that the company will reduce or
increase its level of indebtedness in the future.

In conclusion, there is no perfect method to evaluate investment projects, but rather a

combination of them (WACC; NPV; IRR) is recommended to obtain the best possible estimate.
Conclusions

It is important to investigate and learn about the different methods that exist for inventory
management since each one is adapted to the needs of different businesses.

An inventory management method must be established since it is also an accounting way of

having control of the entry and exit of merchandise.

The different inventory management methods are quite useful since they facilitate the control of
these, helping to obtain better results.
Bibliography
https://www.ractem.es/blog/metodo-fifo-lifo-almacen

https://www.investopedia.com/terms/f/fifo.asp#:~:text=Example%20of%20FIFO&text=Imagine
%20if%20a%20company%20purchased,are%20the%20first%20goods%20sold.

https://www.accountingtools.com/articles/last-in-first-out-method-lifo-inventory-method

https://www.transeop.com/blog/FIFO%20-LIFO-Logistica-de-almacen/416/#ventajas-lifo

https://www.empresaactual.com/el-wacc/#:~:text=Qu%C3%A9%20es%20el%20WACC%20y
%20para%20qu%C3%A9%20sirve,-21%20octubre%2C%202019&text=El%20WACC%2C%20de
%20las%20siglas,valorar%20un%20proyecto%20de%20inversi%C3%B3n.