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Inventory Valuation Methods - YouTube
Channel: Learn Accounting with Iana Zemniakova, CPA
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hello everyone and welcome to financial
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accounting
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our topic today is inventories and the
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cost of goods sold we are going to look
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at the flow of inventory costs
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inventory subsidiary ledger and review
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for inventory valuation methods specific
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identification average cost first in
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first out and last in first out
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finally we will talk about taking a
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physical inventory count
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if you are not familiar with accounting
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for merchandising activities i would
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recommend watching the video on this
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topic the link is in the upper right
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corner and i will also post it in the
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description to this video
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[Music]
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inventory includes all goods that the
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company owns and holds for sale
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regardless of where the goods are
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located when inventory is counted
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inventory is reported as a current asset
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on the balance sheet
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companies that sell inventory report the
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value of the inventory they have in
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stock at the end of the period as a
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current asset on the balance sheet
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companies that sell inventory also have
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an additional expense item called cost
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of goods sold on their income statements
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the cost of goods sold account
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represents the cost of the inventory
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sold during the period to help earn
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revenue
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of goods sold is represented as a
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separate expense item on the income
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statement
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net sales minus cost of goods sold
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equals gross profit
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gross profit is the amount left after
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subtracting the cost of inventory sold
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to cover all other expenses and the
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profit
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let's quickly review the rules of debit
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and credit for accounts that we plan to
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use in this video inventory is an asset
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account it is increased by debit and
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decreased by credit
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cost of goods sold is an expense account
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and is also increased by debit and
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decreased by credit
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cost of goods sold decreases owner's
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equity because it is an expense
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accounts payable is a liability account
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and this increased by credit and
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decreased by debit
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remember that in a perpetual inventory
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system inventory purchases are recorded
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by a debit to inventory and the credit
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to accounts payable
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this entry is similar to the entry made
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when any asset is purchased such as a
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truck or land
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the cost entry on the sale date requires
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a debit to cost of goods sold and the
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credit to inventory for the cost of the
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inventory sold
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what is the unit cost of the inventory
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being sold
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if all the inventory has the same unit
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cost then this is not a difficult
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question to answer
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however in most cases companies will
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have identical units of inventory in
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stock that have different unit costs
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let's see how to determine the cost of a
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unit of inventory sold
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in this example 10 laser lights are sold
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there are
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175 laser lights in stock
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of those in stock the company paid 30
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dollars each for 100 units and 50
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dollars each for 75 units
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so how is the exact cost determined for
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the 10 units we are selling on september
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10th
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there are four ways to determine the
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cost of inventory sold
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specific identification
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average cost
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first in first out also known as fifo
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and last in first out
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also known as lifo
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take a minute and review this chart for
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the bike company
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this data will be used throughout the
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perpetual inventory examples to compare
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results
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note that inventory was purchased four
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times every time at a different cost
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there are also two sales at two
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different retail prices
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when using the specific identification
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method the specific cost of each unit
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that is sold is known
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it is most commonly used in businesses
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that have low sales volume of high
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dollar items like car dealerships
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exclusive jewelry stores and custom
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builders
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on august 1st and 3rd tbc purchases
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inventory
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on august 14th they sell nine bikes that
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cost 91 dollars each and 11 bikes that
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cost 106 dollars each
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the cost of goods sold for august 14th
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is
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1985 dollars
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after the sale cbc has five units in
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inventory
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one unit that cost ninety one dollars
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and four units that cost one hundred and
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six dollars each
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remember that in a perpetual inventory
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system two entries are required to
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record a sale
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the first entry is to record the sale at
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retail and involves cash or accounts
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receivable and sales
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in our example we debit cash for twenty
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six hundred dollars
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twenty bikes at one hundred and thirty
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dollars each and credit sales for the
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same amount
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the second entry is to record cost of
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goods sold at cost
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and remove the items sold from inventory
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in our case we debit cost of goods sold
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for
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1985 dollars and credit inventory for
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the same amount
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we determined that cost of goods sold
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amount on the previous screen
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we will make a similar set of entries
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each time we have a sale
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next tbc makes a purchase on august 17th
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and another on august 28th
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on august 31st tbc sells 23 bikes
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one that cost 91 dollars
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three that cost 106 dollars each
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15 that cost
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115 dollars each and four that cost 119
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each
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the cost of goods sold for the august
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31st sale is 2
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610 dollars after the august 31st sale
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tbc has 12 units in inventory
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one unit that costs
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106 dollars
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five units that cost 115 dollars each
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and six units that cost 119
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dollars each
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using the specific identification method
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cbc would report cost of goods sold on
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their august income statement or four
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thousand five hundred ninety five
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dollars
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and they would report ending inventory
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on the balance sheet of one thousand
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three hundred and ninety five
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dollars when using average cost
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assign the average cost of the goods
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available for sale
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2 cost of goods sold
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the average cost is determined by
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dividing the cost of goods available for
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sale by the units on hand
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on august 1st and 3rd tbc purchases
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inventory
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on august 14th they sell 20 bikes
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first tbc needs to compute the average
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cost of the items in inventory
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they do this by dividing the cost of
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goods available for sale
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of 2500
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by the total units in inventory of 25
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the average cost per unit is 100
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then to determine the cost of goods sold
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for august 14th
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multiply the number of units sold by the
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average cost
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this calculation determines that the
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cost of goods sold for august 14th is 2
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000
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after the sale tbc has five units in
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inventory at an average cost of one
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hundred dollars each
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next tbc makes two purchases on august
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17th and august 28th
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on august 31st tbc sells 23 bikes
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to determine the average cost of the
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inventory items tbc will divide the cost
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of goods available for sale of
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nine hundred and ninety dollars by the
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total units in inventory of thirty five
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the average cost per unit is one hundred
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and fourteen dollars
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the units on hand thirty-five is
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determined by taking the total units
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purchased 55
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and subtracting the units sold 20.
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the cost of goods sold for august 31st
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is 2
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62.
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after the sales tbc has 12 units in
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inventory at an average cost of 114
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dollars each
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using the weighted average method tbc
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would report cost of goods sold on their
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august income statement of 4622
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and they would report ending inventory
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on the balance sheet of 1360
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when using the first in first out method
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the older costs are assigned to the
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units sold
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that leaves the more recent costs to be
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used to value ends in inventory
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on august 1st and 3rd tbc purchases
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inventory
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on august 14th they sell 20 bikes
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using fifo first tbc assigns the cost of
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the 10
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older inventory items purchased on
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august 1st at 91 dollars each
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now they need 10 more units so they move
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down to the next purchase on august 3rd
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and include the cost of 10 units from
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this purchase at 106 dollars each
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the cost of goods sold for august 14th
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is
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1970 dollars
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after this sale tbc has five units in
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inventory at the cost of 106 dollars
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each
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tbc makes two purchases on august 17th
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and august 28th
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on august 31st tbc sells 23 bikes
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to determine the cost of goods sold on
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august 31st using fifo cbc takes the
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cost of the five remaining units from
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the august 3rd purchase at 106 dollars
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each
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then they move down to the next purchase
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on august 17th and take the cost of 18
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units at 115
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each
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the cost of goods sold for august 31st
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is 2600
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after the august 31st sale tbc has 12
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units in inventory 2 units at 115.
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each and 10 units at 119
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each
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using the fifo method tbc would report
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cost of goods sold on their august
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income statement of
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five hundred seventy dollars
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they would report ending inventory on
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the balance sheet of one thousand four
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hundred and twenty dollars
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when using the last in first out method
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we assign the most recent cost to the
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units sold
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that leaves the older costs to be used
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to value ending inventory
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on august 1st and 3rd tbc purchased
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inventory
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on august 14th they sell 20 bikes
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using lifo first tbc assigns the cost of
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the 15 most recent inventory items
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purchased on august 3rd at 106 dollars
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each
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now they need five more units so they
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move up to the next more recent purchase
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on august 1st
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and include the cost of five units from
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the purchase
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at ninety one dollars each
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the cost of goods sold for august 14th
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is 2045.
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after this sale tbc has
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five units in inventory at a cost of 91
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each
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tbc makes two purchases on august 17th
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and august 28th
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on august 31st tbc sells 23 bikes
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using lifo tbc takes the cost of the 10
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units from the most recent purchase on
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august 28th at 119
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each
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then they move up to the next most
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recent purchase on august 17th and take
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the cost of certain units at 115 dollars
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each
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the cost of goods sold for august 31st
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is 2685
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after the august 31st sale cbc has 12
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units in inventory
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five units at 91 dollars each and seven
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units at
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115 dollars each
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using lifo tbc would report cost of
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goods sold of 4730
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on their august income statement
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they would report engine inventory on
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the balance sheet of one thousand two
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hundred sixty dollars
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this slide provides a summary of some of
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the key differences among the four
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inventory evaluation methods
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let's take a few minutes to review it
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specific identification method
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cost of goods sold is the actual cost of
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the units
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inventory is valued at the actual cost
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of units remaining in inventory this
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method parallels physical flow
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it is a logical method when units are
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unique
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however it may be misleading for
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identical items
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average cost method cost of goods sold
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is calculated as the number of units
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sold times the average unit cost
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inventory value is calculated as the
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number of units on hand times the
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average unit cost
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under this method we assign all units
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the same average cost
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current costs are averaged in with older
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costs
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first in first out fifo
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cost of goods sold is the cost of
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earliest purchases on hand prior to the
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sale
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inventory is valued at cost of most
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recently purchased units
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under this method the cost of goods sold
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is based on older costs
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inventory is valued at current costs
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by using this method we may overstate
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income during period of rising prices
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which may increase income taxes due
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last in first out lifo
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cost of goods sold is the cost of most
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recently purchased units
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inventory is valued using the cost of
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earliest purchased units assuming they
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are still in inventory
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under this method cost of goods sold
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shown at recent prices
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inventory is shown at old and perhaps
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out of date costs this method is the
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most conservative method during period
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of rising prices
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it often results in lower income taxes
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the principle of consistency limits
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companies ability to switch accounting
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methods from period to period
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the goal of this principle is to provide
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users with financial statements prepared
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using consistent accounting principles
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from one period to the next this allows
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users to more easily make comparison
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from period to period
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however a company doesn't have to use
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the same account in principle forever
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if a company has a good reason to change
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accounting principles they can
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most companies take a physical count of
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inventory at least once a year
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theoretically the physical count should
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match the numbers of items in the
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inventory records
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in reality this is not the case
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the physical count doesn't match the
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records due to spoilage breakage damage
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obsolescence and theft
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the physical count helps get records up
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to date to reflect what is actually on
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hand
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when a physical account identifies
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inventory shrinkage an entry is made to
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debit cost of goods sold and credit
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inventory
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this entry increases cost of goods sold
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an expense account and decreases the
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inventory account
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thank you for watching this video don't
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forget to like and subscribe
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in the next video we will continue
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talking about inventory and discuss
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lower costal market and other inventory
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write downs
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see you next week
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