Tutorial 5: Week of February 22

Inventory
Tyler Dolan & Megan Raber
Weekly Checklist: Takeaways from Week 6

• Perpetual vs. Periodic Systems

• Inventory Costing Methods
• Specific Identification
• FIFO
• Weighted Average
• Inventory Valuation (LCNRV)
 The Most Important Inventory Formulas

Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold

Cost of Goods Available For Sale

Beginning Inventory = Last Years Ending Inventory

Inventory Systems
Periodic System
• This involves inventory only being tracked
when a company physically counts the
inventory.
• This is a large disadvantage, since business’
will not have up to date information about
their inventory quantity or cost.
• New Accounts
• Purchased inventory goes into an account called
“purchases”, which gets closed at year end
• No COGS entry is made at time of sale
• No special entry for return of goods, just reverse
sale
Perpetual System
• Balances for inventory and COGS are
continuously updated with each sale or
purchase of inventory
• No purchases accounts. Purchases of
inventory only affect the inventory and
payment accounts (Cash or AP)
• For sale of goods (requires two entries):
• Recognize Revenue
• Input changes in COGS and Inventory
• For return of goods (requires two entries):
• Indicate sales return (under allowances, returns, or
credit account)
• Input changes in COGS and Inventory
Costing Methods: Overview
FIFO (First in, First Out) Weighted Average

• The earliest purchases (first-in) are assumed
to be the first sold (first-out)
• The more recent purchases are in ending
inventory
• The cost of the oldest purchases that make up
COGAS are allocated to COGS
• Assigns a cost to inventory based on the
weighted average cost of units available for
sale at that point
• This means that the assigned cost is uniform

Why we need costing methods:

Since the costs of what we are selling will be changing throughout the year, accountants need to find a way to
track the actual costs of inventory.
Costing Methods: Periodic System
FIFO Weighted Average
• In a periodic system, COGS is only done once, at the end of • In a periodic system, weighted average is also done only at the
the period end of the period.
• When doing this, you look at the total number of units that
• In doing this, you take the total cost of units that you have
were sold and apply the cost on the basis that the oldest units
were sold first. available, and divide it by the number of units.

• For example, if we • For example, if we

• Bought 100 units @ $5 on Jan 1 Bought 100 units @ $5 on Jan 1
• Bought 50 units @ $10 on Jan 31 Bought 50 units @ $10 on Jan 31
• Sold 125 of the units
Sold 125 of the units
• This would give a FIFO cost of (100*5+25*10 = $750)
Average weighted cost would be (100*$5 + 50*$10)/(100 +
• To find the COGS under FIFO, it means that we use the costs 50)
assigned to the first 100 ($5 cost), and then only 25 units of
the $10 ones. This follows the idea of selling the oldest This would make the weighted average cost $6.66 for the
inventory first and assigning the costs on the same basis. whole period, meaning you can apply this number to all
sales
Example: AP7-9A

Calculate COGS, EI, and Gross Margin assuming a periodic system using weighted average
Costing Methods: Perpetual System
FIFO
• FIFO is done the same way regardless of a periodic or
perpetual system
• When doing this, you look at the total number of units
that were sold and apply the cost on the basis that the
oldest units were sold first
• Evaluate the amount of inventory you have from each
purchase compared to your sale. When assigning COGS,
use up the oldest inventory first, then if your earliest
purchase is smaller than your sale, use up the more
recent inventory
• Repeat this process for every sale transaction to evaluate
the COGS
Weighted Average
• In a perpetual system, the weighted average is moving,
meaning it needs to be re-evaluated at every sale of
inventory
• Each time, your weighted average is calculated by
dividing the cost of goods available for sale by the units
available per sale. This is the number you will use to
value your inventory
• Your cost of goods sold is calculated by multiplying your
WAC at the time of the sale by the number of units sold
• Your ending inventory is calculated by multiplying your
units on hand by the last calculated WAC
Example: AP7-8A

Calculate COGS, EI, and Gross Margin assuming a perpetual system using FIFO
Example: AP7-8A Continued

Calculate COGS, EI, and Gross Margin assuming a perpetual system using weighted average
Net Realizable Value
• To answer the question what value do we use for inventory on the statement of
financial position (balance sheet), we use the lower of cost and net realizable value
• Net realizable value is the selling price of inventory, less all costs needed to complete
the sale
• In the situation that we have inventory valued at $10, though we are only able to sell it for $5
(assuming no additional costs), we would value the inventory at $5, which is the lower of cost and
NRV
• If the NRV is lower than the cost, the carrying amount of the inventory must be
reduced. This is treated as an expense where we raise (debit) COGS and lower (credit)
inventory by the difference between the value we are using for inventory and the
cost
• This reduced Net Income by the amount of the inventory writedown, even if it has not been sold
Example: LCNRV
Magli Electronics prepared the following analysis of its inventory at December 31:

Product Quantity Historical Cost / Item NRV Per Item

42” LCD HTV 12 $1,000 $1,100
50” Plasma HDTV 7 1,300 1,000
DVD Recorders 20 120 100

Required:
• Determine the lower of cost and net realizable value for each item oof inventory
• Prepare the journal entry needed on December 31 to value the inventory at LCNRV