Inventory

Items included in the inventory
 
1. Merchandise
2. Raw materials
3. Work-in-process
4. Finished goods
 

Goods in transit

Ownership of the goods in transit depends on the shipping contract
  
FOB shipping point: Ownership transfers when goods leave the shipping place
FOB destination: Ownership transfers when goods arrive at destination
 
FOB shipping point: Goods in transit are owned by the buyer
FOB destination: Goods in transit are owned by the seller
 
FOB: Free on Board 
  

Consigned goods

Consigned goods are owned by the consignor, even if they are physically at the location of the consignee
 

Initial measurement of inventory

Inventories are initially measured at cost
 
An example
Entity A purchased 200 units of merchandise at the cost of $3,000
 
Merchandise inventory is recognized at cost, $3,000
   

Cost flow assumptions

If the purchase costs change over time for identical products, the costs of inventory items sold or remaining will vary depending on which items are assumed to be sold first
 
An example
On March 1, 20X1, Entity A purchased 100 units of merchandise B at the cost of $10 per unit
On April 1, 20X1, Entity A purchased 100 units of merchandise B at the cost of $12 per unit
 
On April 15, 20X1, Entity A sold 50 units of merchandise B at the price of $15 per unit
 
What is the cost of goods sold on April 15, 20X1?
 
If the items purchased on March 1, 20X1 were assumed to sold,
   the cost of goods sold = 50 units x $10 = $500
 
If the items purchased on April 1, 20X1 were assumed to be sold,
   the cost of goods sold = 50 units x $12 = $600
 
If the weighted average cost were used,
   the cost of goods sold = 50 units x $11 = $550
   weighted average cost per unit = (100 x $10 + 100 x $12) / 200 units
   = ($1,000 + $1,200) / 200 units = $2,200 / 200 = $11 per unit
  

Cost flow assumptions

Examples of cost flow assumptions
 
1. First-in, First-out (FIFO)
2. Last-in, First-out (LIFO)
3. Weighted average cost method
 
1. First-in, First-out (FIFO)
   Inventory items purchased "first" are assumed to be sold first
 
2. Last-in, First-out (LIFO)
   Inventory items purchased "last" are assumed to be sold first
 
3. Weighted average cost method
   The cost of goods sold is based on the weighted average of all purchase costs
 

First-in, First-out (FIFO)

FIFO assumes that the inventory items purchased "first" were sold first
 
An example
   Purchases
   March 1, 100 units at $10 per unit
   March 10, 100 units at $12 per unit
   March 15, 100 units at $14 per unit
 
   Sales
   March 20, 60 units
   March 27, 110 units
 
   Cost of goods sold
   March 20 sales of 60 units
      60 units x $10 = $600
   March 27 sales of 110 units
      (40 units x $10) + (70 units x $12) = $400 + $840 = $1,240
 
Value of inventories at March 31
   Total units purchased = 300 units
   Total units sold = 170 units
   Units of inventories = 130 units
   Value of inventories = 30 units x $12 + 100 units x $14
      = $360 + $1,400 = $1,760
 

Last-in, First-out (LIFO)

LIFO assumes that the inventory items purchased "last" were sold first
 
An example
   Purchases
   March 1, 100 units at $10 per unit
   March 10, 100 units at $12 per unit
   March 15, 100 units at $14 per unit
 
   Sales
   March 20, 60 units
   March 27, 110 units
 
   Cost of goods sold
   March 20 sales of 60 units
      60 units x $14 = $840
   March 27 sales of 110 units
      (40 units x $14) + (70 units x $12) = $560 + $840 = $1,400
  
  Value of inventories at March 31
   Total units purchased = 300 units
   Total units sold = 170 units
   Units of inventories = 130 units
   Value of inventories = 100 units x $10 + 30 units x $12
      = $1,000 + $360 = $1,360
 

Weighted average cost method

The cost of goods sold is based on the weighted average of all purchase costs
  
An example
   Purchases
   March 1, 100 units at $10 per unit
   March 10, 100 units at $12 per unit
   March 15, 100 units at $14 per unit
 
   Sales
   March 20, 60 units
   March 27, 110 units
 
   Cost of goods sold
   Weighted average cost
      = (100 x $10 + 100 x $12 + 100 x $14) / 300 units
      = ($1,000 + $1,200 + $1,400) / 300 units
      = $3,600 / 300 units = $12
   
   March 20 sales of 60 units
      60 units x $12 = $720
   March 27 sales of 110 units
      110 units x $12 = $1,320
  
  Value of inventories at March 31
   Total units purchased = 300 units
   Total units sold = 170 units
   Units of inventories = 130 units
   Value of inventories = 130 units x $12 = $1,560
  

Comparison, FIFO, LIFO, Average

An example
   Purchases
   March 1, 100 units at $10 per unit
   March 10, 100 units at $12 per unit
   March 15, 100 units at $14 per unit
 
   Sales
   March 20, 60 units
   March 27, 110 units
 
   Cost of goods sold
   FIFO:  $600 + $1,240 = $1,840
   LIFO:  $840 + $1,400 = $2,240
   Average method:  $720 + $1,320 = $2,040
  
   Inventories
   FIFO:  $1,760
   LIFO:  $1,360
   Average method:  $1,560
 

Comparison, FIFO, LIFO, Average

If the costs of "later" purchases were "higher" than the costs of earlier purchases,
 
   FIFO reports lower cost of goods sold than LIFO
   LIFO reports higher cost of goods sold than FIFO
   FIFO reports higher value of inventories than LIFO
   LIFO reports lower value of inventories than FIFO
 
   Cost of goods sold:  FIFO < LIFO
   Inventories:  FIFO > LIFO
 
   Net income = sales - cost of goods sold
   Net income:  FIFO > LIFO