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8 - Basic Concepts of Inventory Costing Methods - YouTube
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this is principles of accounting dot-com
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chapter 8 on inventory in this
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particular module we will look at the
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basic concepts of inventory costing FIFO
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LIFO
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weighted average methods this is a very
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important module now let's start with
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the basics however so the aggregation of
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the beginning inventory and purchases
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gives us the goods available for sale
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our challenge is then to take that total
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amount a sign that gets available for
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sale and decide how much is included in
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ending inventory for the balance sheet
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and how much should be reported is cost
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of goods salt on the income statement
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it's really an allocation problem the
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cost of goods available for sale must be
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allocated either a cost of goods sold or
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to ending inventory cost of goods sold
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appearing on the income statement sales
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minus cost of goods sold giving you a
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gross profit or ending inventory
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appearing on the balance sheet before we
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look at the specific methods like FIFO
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and LIFO though consider this if I
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allocate $1 more to cost of goods sold
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through my costing methods and $1 less
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to ending inventory that's that's a
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necessary thing that occurs if what's
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available to allocate if I place $1 more
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here unnecessarily place $1 less there
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and by placing $1 more in cost of goods
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sold that causes gross profit to be less
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sales minus an increased cost of goods
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salt would give me less gross profit and
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$1 less in the inventory would give me
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less on the balance sheet for the asset
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inventory so inventory is pushed down
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profits are pushed down retained
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earnings is pushed down the balance
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sheet equality is maintained because
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inventories going down as our profits if
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I were to shift that one dollar from one
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category to the other now as we think
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about what cost to include an ending
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inventory it's important to remember
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that inventory should include all costs
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that are ordinary and necessary to put
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the goods in place and in condition for
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resale this would include the invoice
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price the freight cost that is fright in
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the cost that's necessary to bring in to
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its intended condition for resale and
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similar items it does not include
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however carrying cost of inventory such
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as interest that's incurred on financing
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inventory storage our insurance cost
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those costs are expenses in
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they are not inventoriable type costs
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also excluded our selling costs Freight
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out cost which is deemed to be a selling
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cost salesman's commissions and so on
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those costs are also expensed as
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incurred now costing methods each unit
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of inventory will not always have the
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same cost as we buy or acquire
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manufactured goods there may be a
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different cost that's incurred per unit
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therefore a company must adopt an
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inventory costing method that is applied
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consistently from year to year to up to
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allocate the cost of all of the units to
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the units that are an ending inventory
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and the units that are actually sold or
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cost of goods sold so this gives rise to
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certain cost low assumptions which are
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assumptions about how costs are assigned
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to inventory if there's no relation to
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physical flow of goods if we're talking
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about milk for example we could we could
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cost that milk inventory by FIFO or LIFO
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or an average cost method even though
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selling that milk we would probably try
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to sell it on a first in first out basis
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to get rid of the older stock and
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constantly keep the newer stock hold it
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back until we clear the older stock out
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of inventory but no matter how our
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physical flow is occurring such as I've
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described for milk we could use any of
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these methods to assign the cost flow
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for accounting purposes looking at first
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in first out our FIFO the oldest cost
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the first end are matched against
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revenue and assigned the cost of goods
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sold first the recent purchases those
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that are left over the most recent cost
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is assigned to ending inventory looking
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at an example we had 0 beginning
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inventory these are nails barrels of
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nails and we have 3 purchases during the
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period we bought a hundred pounds of
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nails at a dollar a hundred pounds at a
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dollar ten and a hundred pounds at a
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dollar twenty the total cost of all of
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our purchases was three hundred and
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thirty dollars our goods available for
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sale was three hundred and thirty
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dollars when we allocated this on a
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first in first out basis we sold 160
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pounds in this particular case what's
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sold first was this red barrel at a
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dollar and sixty pounds out of the green
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barrel at a dollar ten that's our
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hundred and sixty pounds that were sold
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from the first units purchased the red
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in the green and we came up with cost of
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goods sold of 160
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six the other amounts the forty pounds
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that remain from the green barrel and
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the hundred pounds from the blue barrel
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even though the units are all commingle
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those amounts were assigning the ending
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inventory
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conversely last in first out is just the
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opposite
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the recent costs are matched against
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revenue and assigned to cost of goods
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sold
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while the oldest purchases remain in
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inventory so here we have the same
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purchases of barrels of nails three
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barrels at 100 pounds each at a
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different cost per pound when we assign
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our 330 dollars of cost of goods
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available for sale here we're taking the
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blue and the green first that is the
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last in is the first out and we're
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signing that to cost of goods sold its
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186 dollars the ending inventory from
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the earliest purchases during the period
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last in first out last in first out is
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uniquely a United States based
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accounting method many parts of the
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world will not recognize or allow the
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LIFO method finally the weighted average
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method is a blending of these two
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approaches an average unit cost is used
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to calculate the cost of goods sold in
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ending inventory it's very simply
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determined by a dividing total cost of
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goods available for sale by total units
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so in our nail example 330 dollars was
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spent on 300 pounds of nails giving
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giving us an average cost of $1 10 per
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pound and with 160 pounds sold at a
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dollar 10 we had one hundred and
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seventy-six dollars in cost to get sold
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and our ending inventory 140 pounds
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times the same dollar 10 average cost
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gave us one hundred and fifty four
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dollars assigned to ending inventory you
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might find it helpful indeed I would
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encourage you to look at the textbook
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this very illustration is used in the
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textbook and explained to there again
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and it probably would be helpful to
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actually sit down and really think about
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the mathematics of what's happening with
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FIFO a LIFO and weighted average to
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recap first remember that beginning
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inventory and purchases gives us cost of
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goods available for sale and that amount
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of cost must be allocated either to
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ending inventory or cost of goods sold
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second accountants adopt a cost flow
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assumption to track those inventory
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costs within the accounting system
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whether that's FIFO LIFO or average cost
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third the adopted cost flow assumption
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need not bear any relation to the actual
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physical flow of goods the costing
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method is independent of the physical
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flow of goods to recap briefly then
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with first-in first-out we have our
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beginning inventory in gold and our
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purchases in blue here together that
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comprises our goods available for sale
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under first-in first-out our cost of
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goods sold includes those gold units
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from beginning inventory as well as some
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of the purchases what's an ending
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inventory was from the very last
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purchases during the period
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LIFO is just the opposite here we have
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the same beginning inventory and
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purchases rolled together to give us
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goods available for sale the ending
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inventory is all gold it came from the
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beginning inventory in this case and
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indeed a little bit of the beginning
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inventory is deemed to be liquidated
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along with all the purchases in the
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period and the weighted average what I
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try to show here is all of the cost gets
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blended together for an average cost and
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that cost is interspersed in both ending
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inventory as well as our cost of goods
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sold in the next module we will look at
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actual mathematical examples of applying
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FIFO wife Ellen average methods
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