Inventory for a merchandising company is purchased supply that is got to the condition necessary to put it on the store’s shelves for selling purposes. Inventory for a manufacturing organization usually is classified as raw (or direct) materials, work in process, and finish goods. In some cases, different entities might consider different products as whether finish goods or raw materials. For example, a flour producing company will consider the flour as a finish good because that what they sell. In contrast, a baking firm will recognize the flour as a raw material because they will mix it with other ingredients to make bread. Despite the fact that inventory vary greatly among organizations, but it is a current asset account which should be used or sold by the entities within one year or one operating cycle, whichever is longer.
Inventory cost flow methods
There are FIFO, LIFO, Dollar – value LIFO, weighted average, and moving average method. Different methods can be used for different goods depending on an entity’s preferences or needs (from which inventory cost flow method they will benefit the most). To choose the right inventory method is very important consideration to make because the cost of products acquired should be recognized as cost of goods sold on the income statement and it is influence the company’s income.
What is periodic inventory system?
Under the periodic inventory system inventory levels are not tracked throughout the accounting period. The cost of goods sold is computed at the end of the period which makes the process faster and less complex.
What is perpetual inventory system?
Under the perpetual inventory system inventory levels are tracked throughout the accounting period. The cost of goods sold should be computed after each sale (accordingly to updates).
Periodic vs. perpetual inventory systems
Companies may use the inventory cost flow methods under one of two inventory systems to keep track of their inventory levels, such as periodic or perpetual. There is a little bit different way of calculation under periodic and perpetual system. Cost flow methods under the periodic inventory system typically are easier and faster to compute while under the perpetual one the calculation is more complex, but it provides more detailed data. Only FIFO method gives the same results for cost of goods sold and ending inventory under both periodic and perpetual inventory systems. On the other hand, while using the LIFO and Weighted Average methods the amounts of cost of goods sold are different and the amount of ending inventory are not the same as well under periodic and perpetual inventory systems. The cost of goods sold and ending inventory are lower under perpetual inventory system compare to periodic one.
First in first out inventory cost flow method (FIFO)
This accounting method assumes that the first items which were purchased must be resold or used first. This method is especially appropriate for goods with relatively short expiration date. For example, it is better to use FIFO method for such products as food and drinks.
Last in first out inventory cost flow method (LIFO)
This accounting method assumes that the last items which were acquired must be resold or used first. When using LIFO the expiration date must not be an issue. There won’t suppose to be a difference which box from the pile to take the top or the very bottom one. For instance, this method is convenient for some construction materials especially heavy ones.
As the name implies under the dollar-value LIFO method inventory is measured in dollars instead of units as with regular LIFO method. Price index should be used when converting LIFO inventory to Dollar-value LIFO.
Weighted average inventory cost flow method
It is one of the easiest inventory methods to compute. Under this accounting method all purchased items prices are summed and divided on numbers of the items.
Moving average inventory cost flow method
The moving average method calculates the weighted average cost of inventory after each sale. This is more detailed and updated data method.