Chapter 6: INVENTORY COSTING Unit 2 Test (covering chapter 5 and 6) will occur on Oct 24 (Friday)Unit 2 Test (covering chapter 5 and 6) will occur on Oct 24 (Friday) The next slide shows the income statement for periodic inventory system.

ALLOCATION OF INVENTORIABLE COSTS Beginning Inventory Goods Purchased during the year Cost of Goods Available for Sale Ending Inventory (Balance Sheet) Cost of Goods Sold (Income Statement)

Inventory Costing In order to determine the total cost of the ending inventory and the cost of the goods sold, Unit costs are matched to those quantities after the quantities (in units) have been determined for each inventory item. If all inventory items have been purchased at the same unit price, this calculation is simple.

Inventory Costing However, when identical items have been purchased at different costs during the period, it is difficult to decide what the unit costs are of ending inventory. In chapter 5, we assumed that inventory items always had the same unit cost. In this chapter, you are not given the cost of ending inventory or the cost of the goods sold. Instead you have to calculate EI and COGS.

Inventory Costing For example, assume that Bestbuy bought 1000 Ipad for resale. In 2012, they purchased 500 units at $100 per unit, but the 300 units they purchased in April 2013 was $90 per unit. The 200 units they purchased in August were $80. On December 31, there are 250 units left. BI = 500 units and Purchases = 500 units and EI = 250 units What is the value of EI? (Small group discussion)

Specific Identification In order to determine the cost of goods sold, as well as the cost of ending inventory, we need a method of allocating the purchase cost to each item in inventory and each item that has been sold. Specific Identification uses the actual physical flow of goods to determine cost.

USING ACTUAL PHYSICAL FLOW COSTING The specific identification method tracks the actual physical flow of the goods. Each item of inventory is marked, tagged, or coded with its specific unit cost. It is most frequently used when the company sells a limited variety of high unit-cost items. This is the ideal method for determining costs in most businesses.

Specific Identification For example, Bestbuy buys 3 identical LCD TVs at costs of $700, 750 and 800. During the year, two units are sold at a selling price of $1200 each. At December 31, the company can easily find out that the $750 LCD TV is still on hand. The ending inventory is $750 and the COGS is $1500. Many businesses like Bestbuy, Auto dealership would use this specific identification method.

Specific Identification Today, with bar coding, it is theoretically possible to use this method with nearly any type of product. The reality is that this practice is still quite expensive. What about businesses like Dollarama? Should they use this method? In reality, most companies do not (or can not) keep track of the cost of each item sold. In reality, most companies use Cost Flow Assumptions because they can not keep track of each item.

USING ASSUMED COST FLOW METHODS Other cost flow methods are allowed since specific identification is often impractical. These methods assume flows of costs that may not be same as the physical flow of goods. Any of these CFA can be used both in a perpetual system or periodic system. Cost flow assumptions: 1. First-in, first-out (FIFO). 2. Average cost. 3.Last-in, first-out (LIFO).

FIFOFIFO The FIFO method (First in First out) assumes that the earliest goods purchased are the first to be sold. (common practice in food industry) Often reflects the actual physical flow of merchandise. Under FIFO, the costs of the earliest goods purchased are the first to be recognized as cost of goods sold. The costs of the most recent goods purchased are recognized as the ending inventory.

FIFO method assumes earliest goods purchased are the first to be sold

AVERAGE COST The average cost method assumes that it is impossible to measure a specific physical flow of inventory. Therefore, it is better to use average price. The allocation of the cost of goods available for sale is made on the basis of the weighted average unit cost incurred. The weighted average unit cost is then applied to the units sold to determine the cost of goods sold and to the units on hand to determine the ending inventory.

Allocation of the cost of goods available for sale in average cost method is made on the basis of the weighted average unit cost

Average cost method assumes that goods available for sale are homogeneous

Classwork/ Homework P320 E6.3 P320 E6.4 P321 E6.5